IMAGE: AP
IN THE late 1990s, goods worth more than a quarter of Nepal’s annual economic output were sold abroad. Today that figure has withered to less than 7%. Merchandise exports have collapsed to a pathetic 3.2% of GDP. The country haemorrhages foreign exchange on imports while its own products struggle to leave. This export collapse is not due to lazy entrepreneurs or inferior products. It is a perverse case of economic success undermining industrial growth. The very force that props up Nepal, ie: the billions sent home by its overseas workers, is systematically dismantling its ability to sell anything to the world.
Economists have a pungent term for this: Dutch Disease. It describes how a surge of foreign currency, say from resources or remittances, can push up a country’s exchange rate and domestic costs, making its exports uncompetitive. Nepal is a textbook case, updated for the age of global labour. Remittances have swelled from 2% of GDP in 2000 to some 25% today, outweighing tourism and aid combined. That cash has lifted households from poverty and financed a consumption boom.
It has also sent the real effective exchange rate, a measure of competitiveness adjusted for inflation, soaring by about 35% since the mid-1990s. For every 10% rise in that rate, Nepali exports to a given market fall by roughly 3%, estimates the World Bank. The mechanism is pretty simple. The remittance flood increases demand for non-tradable services like construction, haircuts and transport, bidding up their prices. Because Nepal pegs its rupee to India’s, it cannot devalue to offset this. Its inflation has consistently outpaced India’s by around two percentage points a year, a drip-feed of eroding competitiveness.
The damage is quantified. Studies suggest this appreciation alone left exports some 10% smaller over the past decade than they might have been. Remittance inflows explain about half of the exchange-rate strengthening. The effect is magnified by Nepal’s low labour-force participation. With fewer than two in five adults working, the cash inflow per active worker is especially high, turbocharging its distortive power. The result is an economy that consumes but does not compete, a nation sustained by the labour of its absent citizens.
Policy has piled on the pain. To yank up revenue, Nepal imposes high tariffs on imported inputs used by its exporters. A one-percentage-point increase in these duties cuts export values by 2-4%, reckons the World Bank. Over ten years, the average tariff rise has clipped exports by 6-12%. Small firms are hit hardest. They struggle to deal with the bureaucratic maze of duty-drawback schemes intended to refund these tariffs. Larger exporters manage but their sensitivity to exchange-rate moves is greater. Meanwhile grandly named cash-incentive schemes for exporters have fizzled, draining the treasury without boosting trade.
Geography is a cruel constant. Landlocked and mountainous, Nepal faces transport costs that would challenge even the most efficient exporter. Its roads and air-transport networks rank near the bottom in global surveys. Local logistics syndicates operate as cartels, keeping prices artificially elevated. The national quality infrastructure—the labs and certification bodies that prove goods meet international standards—is weak. Export consignments are rejected for non-compliance, a reputation for unreliability that spreads faster than any marketing.
These weaknesses are laid bare in the firm-level data. The number of Nepali exporters actually increased between 2011 and 2021. Yet each firm, on average, now sells fewer products to fewer places for less money. The economy is creating more pygmies not giants. Export discovery—the process by which small firms experiment and find new opportunities—is stalling. This matters because small, agile firms tend to reveal a country’s latent comparative advantage. Nepal’s export basket has instead narrowed and diminished. Some 80% of its dwindling merchandise sales go to India, a dangerous dependency.
A reckoning approaches. Nepal is scheduled to graduate from Least Developed Country status this year. This hard-won progress will trigger the phased withdrawal of the preferential tariff access it enjoys in rich-world markets. For a typical product, losing that preference and facing a five-percentage-point tariff increase could cut exports by about 4%, by some estimates. The country has failed to use its years of preferential access to build a diversified and resilient export sector. It now risks being pushed off a cliff without a parachute.
The policy prescriptions are clear, if politically fraught. Macroeconomic stability is the first step. Taming inflation, particularly in the non-tradable sector, would slow the exchange-rate appreciation. Breaking the cartels in transport and logistics would help. Channeling remittances into productive investment, rather than just consumption and real estate, is a generational challenge. Some economists confide, including this publication, about reviewing the sacred rupee peg with India. A managed float or crawling peg might allow some adjustment, but only if accompanied by rigorous inflation control—a tall order.
On trade policy the government must stop taxing its exporters. Rationalising and reducing input tariffs, starting with raw materials, is essential. Duty-drawback systems must be stripped of complexity, more so for small firms. The futile cash-incentive schemes should be scrapped. Diplomats must fight to preserve market access after LDC graduation and pursue new trade agreements beyond South Asia. At home every infrastructure plan should be judged by one metric: does it lower the cost of getting a Nepali product to a foreign customer?
Nepal can stay a remittance-fed consumer economy, forever dependent on the fortunes of its diaspora and the whims of foreign labour markets. Or it can make the painful choices to rebalance, to invest its foreign earnings not in consumption but in capacity, to let its exchange rate reflect its true competitiveness, and to unleash its entrepreneurs. The money from abroad is a lifeline. It need not be a noose. For now the peg holds, an anchor of stability. But anchors, as any sailor knows, are only useful if you intend to go somewhere. ■
