Will Nepal gain from the new India-Nepal trade treaty-II?

Paras Kharel looks beyond simple economic theoretical benefits from the revised trade treaty (2009) between Nepal and India. The devil in the trade deal is getting clear!

What has also been overlooked by Nepal is the non-binding nature of the provision for waiver of additional duties other than that counterbalancing an excise duty. That India “shall consider” waiver at Nepal’s request does not make it mandatory for India to remove it. Our negotiators have been caught napping. And there is more to it. The possible waiver of such additional duties being applicable only to products of “medium- and large-scale” manufacturing units leaves open the room for applying them on products of small-scale units. In addition, the Protocol to Article I says that the two sides “shall undertake measures” to “reduce or eliminate” non-tariff, para-tariff and other barriers that impede promotion of bilateral trade. This weak formulation does not entail a binding commitment to categorically eliminate such barriers.

The list of primary products qualifying for duty-free and quota-free access has been expanded to include floriculture, atta, bran, husk, bristles, herbs, essential oils, stone aggregate, boulder, sand and gravel. But it was unnecessary to list some of the products as they were already eligible for preferential treatment—for example, the existing list of eligible primary products included flour (atta is one type of flour) and forest produce (herbs come under non-timber forest products). There is a need to make the list clear and precise, based on standard international classification, to remove ambiguities and arbitrariness in interpretation. As things stand now, either country can impose customs duty on products not mentioned in the list, whereas the very first point on the list reads “agriculture, horticulture and forest produce and minerals which have not undergone any processing”—which is quite all-encompassing. Besides, Nepal’s strategy should be to add value to products such as herbs and essential oils through processing rather than exporting them in raw form.

It has been agreed to calculate value addition for Nepali manufactured products to get preferential access to India on a free-on-board, rather than ex-factory price, basis. This is of little help as stringent rules of origin—30 percent value addition and change-in-tariff heading at 4-digit level—that are beyond Nepal’s current level of industrialization and supply capacity have not been relaxed. The quantitative restrictions slapped since 2002 on four Nepali products—vegetable ghee, acrylic yarn, zinc oxide and copper wire rod—remain. Indian manufactured goods, meanwhile, will continue to get preferential treatment from Nepal without having to meet any rules of origin.

See this blog post for additional information.

Lessons for developing countries from Finland’s state-led growth success

Finland is one of the examples of successful state-led development, where the state helped in capital accumulation (reflected in an "unusually" high investment rate) in manufacturing industries while at the same time committing itself to upholding the market economy. With this it was able to smoothen coordination failures and informational externalities, thus aiding the process of specialization and production. In a research paper No. 2009/35 (The Finnish Development State and its Growth Regime), authors Markus Jantti and Juhana Vartiainen argue that the state acted as a net saver, and credit was rationed to productive investment outlays. They also argue that incomes policies and welfare reforms were important in sustaining the necessary political compromise that underpinned the Finnish development state.

Note that Finland was still an agrarian economy until 1930s. As late as in the 1950s, more than half the population and 40 per cent of output were still in the primary sector. Per capita GDP was only half of that of Sweden. Yet by the late 1970s, Finland had become a mature industrial economy.

Finland is an example of a late but successful state-led industrialization that was carried out rapidly. The economic policy strategy that achieved this was a judicious mix of heavy governmental intervention and private incentives. Governmental intervention aimed at a fast build-up of industrial capital in order to ensure a solid manufacturing base. At the same time, however, it was made clear that the aim of heavy-handed state intervention was not to establish a planned economy as a permanent solution. Rather, the government and the constitution made it clear that the basic property rights of capitalism would ultimately be respected. [...]From the 1950s onwards, as trade unions became stronger, the labour movement became a more active partner in this more or less implicit social contract. Thus, in a manner similar to that of Austria, Korea and Taiwan, decision-making has been quite corporatist.

Public savings accounted for as much as 30 per cent of aggregate savings during the 1950s and 1960s. This surplus was channelled partly to support private investments in capital equipment throughout the country, and partly to start public companies in some key sectors of the economy. State companies were established in the basic metal and chemical-fertilizer industries as well as the energy sector. As late as in the 1980s, state-owned companies contributed about 18 per cent of the total industry value-added in Finland. [...]Low and rigid interest rates and administrative rationing of credit to some areas of business investment, at the expense of depositors and households.In the period 1960-84, gross fixed capital formation was 26.3 per cent of GDP, a figure exceeded in the OECD area only by Norway. [...]A pragmatic cooperation between organized private agents (bankers and business leaders), on the one hand, and government officials and civil servants, on the other, has played a key role in enhancing economic growth.[...]The programme of rapid capital accumulation also presupposed wage moderation and the acceptance of higher taxes. Upholding industrial competitiveness and profitability thus acquired high priority on the economic-political agenda. The crude instruments to accomplish these were comprehensive income policy settlements as well as repeated devaluations.[...]The implicit social contract was not limited to upholding industrial competitiveness. Social welfare reforms were gradually introduced at the same time, which can also be interpreted as an attempt to buy wage moderation with the promise of welfare services.

The question now is: are these measures applicable to other countries or can they be emulated in other less developed countries? The authors say No but policymakers can derive "indirect" lessons form Finland's success!

The specific policy package described in this paper is hardly applicable today. We know now that the crude accumulation of physical capital is not the key to rapid economic growth. Instead, today’s leading doctrines of economic development and development assistance emphasize property rights, good infrastructure as well as education, particularly that of women. Using public funds to boost expensive physical investment projects is clearly no longer a relevant policy goal. Nor would such a programme be feasible since the regulation tools of the 1950s—credit rationing, soft monetary policy, public ownership of key industries—have become obsolete.

Furthermore, Finland’s success story may have been due to rather favourable but transitory circumstances. The crucial phase of state-led economic growth and the buildup of welfare services coincided with favourable demographics, so that reforms created more winners than losers. Once the demographic structure becomes less advantageous, it is less certain that there will be such a happy congruence between the demands of the market economy and the political aspirations of voters.

Finland’s example offers a general message of hope for many countries affected by conflicts and poverty. Consider Finland’s history up to the Second World War: a small, backward country colonized by more powerful neighbours, torn by a violent civil war just as independence was within reach, and subsequently limited in its political manoeuvring room by the geopolitically challenging Cold War environment. Yet, it was possible for the Finnish decision makers—the government as well as various corporatist organizations—to forge a political compromise that was deemed politically legitimate and exploited the global economy to undertake a rapid economic transformation. This could be the positive message for any aspiring, less developed country in which initial conditions seem uninspiring.

Does aid aid growth?

This Discussion Paper No. 2009/05 from UNU-WIDER says that aid has a positive and statistically significant effect on growth over the long run.

The micro-macro paradox has been revived. Despite broadly positive evaluations at the micro and meso-levels, recent literature has turned decidedly pessimistic with respect to the ability of foreign aid to foster economic growth. Policy implications, such as the complete cessation of aid to Africa, are being drawn on the basis of fragile evidence. This paper first assesses the aid-growth literature with a focus on recent contributions. The aid-growth literature is then framed, for the first time, in terms of the Rubin Causal Model, applied at the macroeconomic level. Our results show that aid has a positive and statistically significant causal effect on growth over the long run with point estimates at levels suggested by growth theory. We conclude that aid remains an important tool for enhancing the development prospects of poor nations.

Will Nepal gain from the new India-Nepal trade treaty?

Commerce ministers of Nepal and India signed a new bilateral trade treaty, which would have a life of seven years, yesterday. This new treaty is particularly promising for Nepal because it scraps many non-tariff barriers and direct tariffs on majority of goods. It also sorts out certification problems related to sanitary and phyto-sanitary measures. These measures are expected to increase price competitiveness of Nepalese export items. Importantly, it might help decrease the towering, unsustainable trade deficit, which was over Rs 108 billion in FY2008/09. This treaty is highly significant for Nepal because over 60 percent of total trade takes place with India.The top five exports to Indian are textiles, zinc sheet, thread, polyester yarn and juice.

Progressive reforms on sanitary and phyto-sanitary measures are probably the most exciting stuff for some exporters (India’s quality requirements were bugging them for a long time).

The treaty also binds India to recognize Nepal’s standard certification. It also puts the responsibility of upgrading Nepal’s laboratory on India’s shoulder, a provision which officials said will ensure enforcement of standard accreditation provision. Once that happens, exporters of Nepali tea, cardamom, ginger and other agricultural produces will not need to produce quality certification from Indian laboratories in Kolkata or Patna for entering their produces to India. This will prevent traders from losses they incurred while waiting for a week for certification to come, and thus will boost the export of primary goods.

The new treaty has for the first time open bilateral trade via air route. For the purpose, Tribhuvan International Airport (TIA) will be used as the official port for exports and airports in Delhi, Mumbai, Kolkata, Bangalore and Chennai will be ports for imports. It has also added four new land routes, namely, Maheshpur/Thutibari (Nawalparasi), Sikta-Bhiswabazar (Parsa) Gulariya-Murtiya (Bardiya) and Laukahi-Thadi (Siraha), for bilateral trade.

However, there is a hook, which will not help lower extra costs incurred by Nepalese garment exporters. It is not surprising that the Indian government declined to clear all hooks in the garment sector. The Indian government does not want to take dampen its garment sector by importing cheap, similar garments from Nepal.

Despite expressing good gestures and promises of all possible support, Indian Commerce Minister on Tuesday indicated that Nepal’s readymade garment could continue to face countervailing duty (CVD) of 4 percent.

The CVD that India imposed a couple of months ago has brought exports of popular brands like John Players, Peter England and DJ & G to a grinding halt. Nepali exporters argue that the imposition of duty on a product, on which India has no excise duty, was against the spirit of ´National Treatment´ provisioned for Nepali exports.

"Worse still, India has been imposing duty on maximum retail price (MRP), self-assessing the export value as 60 percent of MRP tagged on the product. This is unfair and should be eliminated," said Prashant Pokharel, president of Garment Association Nepal.

Though, it is not a happy moment for the Nepalese garment sector, the agriculture sector (only some of them; differences still remain in sorting out full tariff reduction on some agricultural products), mining and related activities, and pharmaceutical sector should benefit from the new trade treaty. I expect increased trade volume, which is already $3 billion, with India and a decrease in existing negative balance of trade.

The full benefits of new trade concessions from the Indian side (don’t get me wrong, the Nepalese government has also reciprocated with similar tariff reduction, which should benefit Indian exporters even more) would depend on how much Nepal facilitates trade related activities (decrease transaction costs, smoothen supply activities by removing transport bottlenecks, disseminating relevant information to traders, extend credit and technology-related subsidies etc). As of now, trade facilitation in Nepal is dismal. The government has to improve on these complementary factors to reap full benefits from the new trade treaty.

Here are the major points:

• No non-tariff barriers and extra-customs duty on Nepali exports
• India to recognize Nepali standard certification
• DRP, channeling agency on vegetable ghee exports to be annulled
• Trade via air to be recognized
• Five new trading routes to be opened up, including TIA
• Treaty will last for seven years

Bishwamber Pyakuryal, a professor of economics at Tribhuvan University, weighs in:

Correcting imbalances should mean exploring cost-competitive products that are highly in demand in the Indian market. We still lack information about each other on import needs, economic opportunities, market and labor workforce, investment opportunities, export potentials and other inherent constraints. Besides the compilation of annual data, the system of maintaining information on updated country-specific trade data has not yet been developed. The government should integrate the country’s economic policy into foreign policy goals and strategies and develop a system to link national data with Nepali missions abroad to make economic diplomacy result-oriented.

The year 2008/09 looks better than FY 2007/08 with regards to exports to India. In 2008/09, exports went up by 13.5 percent in contrast to a nominal decline of 0.2 percent in the previous year. Exports to India rose by 6.2 percent in 2008/09 as against a decline of 7.6 percent in the previous year. Similarly, exports to other countries also expanded by 26.9 percent compared to an increase of 17.3 percent in the previous year. Therefore, as the trend is positive, with the signing of the revised treaty, one should expect Nepal’s trade deficit with India to gradually reduce.

"Brain drain" is a win-win situation for both exporters and importers

Michael Clemens and David McKenzie argue so:

... common idea that skilled emigration amounts to "stealing" requires a cartoonish set of assumptions about developing countries. First, it requires us to assume that developing countries possess a finite stock of skilled workers, a stock depleted by one for every departure. In fact, people respond to the incentives created by migration: Enormous numbers of skilled workers from developing countries have been induced to acquire their skills by the opportunity of high earnings abroad. This is why the Philippines, which sends more nurses abroad than any other developing country, still has more nurses per capita at home than Britain does. Recent research has also shown that a sudden, large increase in skilled emigration from a developing country to a skill-selective destination can cause a corresponding sudden increase in skill acquisition in the source country.

Second, believing that skilled emigration amounts to theft from the poor requires us to assume that skilled workers themselves are not poor. In Zambia, a nurse has to get by on less than $1,500 per year -- measured at U.S. prices, not Zambian ones -- and a doctor must make ends meet with less than $5,500 per year, again at U.S. prices. If these were your annual wages, facing U.S. price levels, you would likely consider yourself destitute. Third, believing that a person's choice to emigrate constitutes "stealing" requires problematic assumptions about that person's rights. The United Nations Universal Declaration of Human Rights states that all people have an unqualified right to leave any country. Skilled migrants are not "owned" by their home countries, and should have the same rights to freedom of movement as professionals in rich countries.

new research reveals this to be simply unfounded. Skilled migrants also tend to earn much more than unskilled migrants, and on balance this means that a university-educated migrant from a developing country sends more money home than an otherwise identical migrant with less education. The survey of African physicians ... found that they typically send home much more money than it cost to train them, especially to the poorest countries. This means that for a typical African country as a whole, even if 100 percent of a physician's training was publicly funded, the emigration of that physician is still a net plus.

Rodrik on trade and protectionism

Rodrik tries to debunk the overly hyped protectionism debate during the economic crisis:

What about the recent tariffs imposed by the United States on Chinese tires? President Barack Obama’s decision to introduce steep duties (set at 35% in the first year) in response to a US International Trade Commission ruling (sought by US labor unions) has been widely criticized as stoking the protectionist fires.

But it is easy to overstate the significance of this case, too. The tariff is fully consistent with a special arrangement negotiated at the time of China’s accession to the WTO, which allows the US to impose temporary protection when its markets are “disrupted” by Chinese exports. The tariffs that Obama imposed were considerably below what the USITC had recommended. And, in any case, the measure affects less than 0.3% of China’s exports to the US.

The reality is that the international trade regime has passed its greatest test since the Great Depression with flying colors. Trade economists who complain about minor instances of protectionism sound like a child whining about a damaged toy in the wake of an earthquake that killed thousands.

The welfare state is the flip side of the open economy. If the world has not fallen off the protectionist precipice during the crisis, as it did during the 1930’s, much of the credit must go the social programs that conservatives and market fundamentalists would like to see scrapped.

NDB fiasco II: Don’t prolong the death of NDB

Few months ago, I wrote an op-ed arguing for a swift liquidation of Nepal Development Bank (NDB). Four months down the road, the whole issues looks as inconclusive as the political process in Nepal. In a new op-ed, I argue that the court should not stop the NRB from fully liquidating NDB. The unhealthy financial posture of NDB should not even be an issues of concern-- it is a moribund bank and should be put to rest without delay so that poor depositors can get their frozen savings back. Plus, this will help cleaning up of the Nepalese financial system.

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Don't Prolong Death Of NDB

Amidst senseless political bickering, it is easy to forget simple events whose fallout have a huge impact on the lives of general public. A sense of urgency felt by the public is not necessarily shared by the politicians, policymakers and judges. One of such events is the drama surrounding liquidation of Nepal Development Bank (NDB), the financially troubled bank whose liabilities are far more than its assets. The indecisive action from the court, though a lately decisive one from the central bank, has deprived many households of their savings.

Let us recall what happened four months ago. Sensing a deteriorating financial health of NDB, depositors started pulling money out of the bank. The loss of depositors’ confidence on the bank was unsurprising. It had bank deposits and cash worth Rs 196.2 million but its cumulative loss amounted to Rs 609.2 million. Nonperforming loans (NPL) comprised over 50 percent of loan portfolio. Its negative capital ratio of 48.31 percent was far less than 11 percent allowed by the central bank.

In a matter of a few days, it seemed that NDB was more contagious than was thought before, i.e. the panic triggered from a single near-dead bank was putting other healthy financial institutions at risk of bank runs. To contain the bubbling panic among anxious depositors, the central bank (NRB) guaranteed to be the savior of last resort. Meanwhile, it made the right decision to liquidate NDB. It froze transactions and took control of the bank. To fully liquidate the distressed bank, the central bank sought permission from Patan Appellate Court. On July 29, the court tasked chartered accountant Tirtha Raj Upadhaya to present a report explaining if it was necessary to liquidate NDB. While depositors are anxiously waiting to get their money back, the process of liquidation is progressing, if any, at a snail’s pace.

Limited and confusing information about the whole process has further worried depositors. The need to urgently take a final decision about the fate of NDB (which I personally think should be put to rest for good) is not shared by the judges of Appellate Court, further increasing confusion and anxiety among depositors. The situation is so confusion and so little information is channeled to the public that one of the worried elderly depositors emailed me asking when he will get back his hard-earned money, which he saved in NDB so that he could use it for his daughter’s marriage. He was so confounded and nervous that he requested me to “write something sympathetically.”

The court’s decision to deliberately prolong the crisis with complete disregard to the fate of poor depositors is the main constraint in putting to rest the moribund bank. It seems that the judges at the court do not trust technical and relatively specialized analysis from the central bank, which probably has the most relevant information about the financial sector than any other institution in the country. The decision to appoint a chartered accountant to reassess the health of an unhealthy bank and deliberately protract the liquidation process shows inefficiency and incompetency of the court in dealing with financial issues.

A consultant who assisted with projects a decade ago to evaluate Nepal’s financial institutions and who has interviewed the then head of NDB argues that the bank’s management was cooking up methods to swindle money away from the financial system to their personal treasure chests. He says: “It seemed to me then that the NDB’s main function was to shovel government rupees into private pockets ... the inability of the NDB staff to answer basic questions about their lending practices indicated that much was amiss at that institution ... I guess well-connected parties were able to delay recognition of the problem and enforcement of the directive so they could continue to misappropriate the people’s resources.” The unhealthy financial posture and practice of NDB was apparent a decade ago but the concerned authorities, mainly the NRB, stayed mute, downplayed the evolving superficial banking practices and basked on the performance of a few healthy commercial banks.

Now, a quick liquidation is in the interest of the whole banking industry, its poor depositors and the nation. The judges have to comprehend this and let NRB, despite its questionable record to prevent NDB-type banking practices in the past, handle the situation as appropriate. Else, it will foster a situation where banks will take excessive risk and willfully play with depositor’s money thinking that in case of failures, the central bank would come to their rescue. The court should help minimize moral hazard in the banking industry by ratifying NRB’s request to liquidate NDB.

Meanwhile, the central bank should not let the banks take excessive risk, channel huge amount of money to few creditless, politically-affiliated borrowers and engage in any activities that could put poor depositors’ money at excessive and irrecoverable risk. The NDB’s big defaulters should also be punished, although I am not convinced this will happen given the progress in indicting big defaulters in the past. Perhaps, what the consultant observed would be true: “I wonder whether any of NDB’s defaulting borrowers need to be concerned about facing punitive action, or at least public humiliation. Based on my experience in Nepal, I would guess not. At that time, the NRB had a “blacklist” of defaulters but it was highly classified and to the best of my knowledge was not available to commercial banks, except perhaps, on a case-by-case basis, through the NRB’s representative on the Board. So the same people could, at least in theory, keep pulling the same scam over and over.”

Two things warrant immediate attention. First, the judges should give a green signal to liquidate NDB as soon as possible so that poor citizen’s frozen money is freed up. The liquidation should be carried out even if few investors show half-hearted interest in reviving the bank. Second, the NRB should annually publish the list of all big willful defaults to promote transparency and accountability in the banking industry. This will stop big defaulters from exploiting depositor’s money. It will also break the exclusive availability of defaulters list to the board of directors of NRB, who, by the way, privately or publicly advise some of the commercial banks. This is the time for the court and NRB to improve upon their unqualified judgment of the past.

(Published in Republica, October 23, 3009)