FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Acknowledgments This study was prepared by a World Bank Trade and Competitiveness Global Practice team led by Gonzalo Varela and including Guillermo Arenas, Laura Gomez-Mera, Claire Hollweg, Aldo Pazzini Bortoluzzi, Alberto Portugal, Daniel Reyes, and Emir Zildzovic. Valuable inputs were provided by Ashish Narain, Celia Ortega Sotes, and Persephone Economou. The study was prepared under the general guidance of Takuya Kamata (Country Manager, SACNP), Esperanza Lasagabaster (Practice Manager, GTC06), and Jose Guilherme Reis (Practice Manager, GTCTC). The team appreciates valuable comments from peer reviewers including Roshan Bajracharya, Paul Brenton, and Michele Ruta. Martin Rama, Chief Economist of South Asia provided useful comments at the concept stage. Other contributions were received from: Taneem Ahad, Sunita Chitrakar, Damir Cosic, Sudyumna Dahal, Markus Kitzmuller, Mariem Malouche, Santosh Pandey, Raihana Rabbany, Saurav Rana, Ashish Rauniar, and Deepa Shakya. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Overview Introduction Trade and integration are critical to achieving the Nepal's integration performance over the last two decades Government of Nepal’s ambitious objective of has been lackluster. Many factors affect Nepal’s trade reaching middle-income status by 2030, and reduc- prospects. A major one is the political instability that the ing absolute poverty to single digits (Government of country has experienced for over 20 years, which has stifled Nepal, 2015a). firms’ investment and innovation and has diverted the atten- tion of policy makers away from relevant reforms (Box 2). Still The envisioned economic transformation requires a shift from other factors are structural; for example, Nepal’s geography a remittance-fueled growth model to one fueled by productiv- makes transport costs high and travel times uncertain. Factors ity and investment. Integration into the global marketplace is related to the country’s level of development include a powerful vehicle for increased investment and productivity. infrastructure deficiencies—most notably electricity shortag- As a small economy, located within a six-hour flight distance es—that create output uncertainty and increase production from the fastest-growing markets in the world, Nepal's growth costs. Skills shortages make it difficult for upgrading into more prospects are closely linked to its success in integrating into skill-intensive activities. In terms of trade integration (both for regional and global marketplaces. The government realizes exports and imports), Nepal shows export and import orienta- this and has formulated the National Trade and Integration tion below average; this assessment also takes into account Strategy (NITS) (Government of Nepal 2015b) that recognizes the country's size, its remoteness from main markets, and its the importance of integration and proposes lines of action for landlocked geography (Figure 1 and Figure 20; see World Bank firms to better profit from it (Box 1). The notes included in this [2013b] for a full diagnostic of trade competitiveness in report seek to support the government’s strategy by assessing Nepal). Policy could have a role to play in improving below-av- the extent to which Nepal has been able to leverage integra- erage trade integration. tion into global markets, and by identifying the opportunities and challenges associated with further integration. Figure 1: Export Orientation Index - 1990-2014 Figure 2: Import Orientation Index - 1990-2014 VNM MDV VNM 50 60 MDV 40 PHL IND IDN PHL IDN 20 IND CHN AFG BGD 0 BTN CHN NPL BGD PAK PAK 0 NPL BTN AFG -20 -50 -40 Source: Calculations based on World Bank Source: Calculations based on WDI data. World Development Indicators (WDI) data. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Introduction In the last decades, slow growth and job creation have tances have led to an appreciation of the real exchange rate. encouraged emigration, further dampening domestic sourc- This has adversely affected export competitiveness and has es of growth. Tepid growth over the past decade, the slowest had no positive effects on productivity (unlike foreign direct in the region, has resulted in few jobs being created, leading investment). This report attempts to determine the extent to to more Nepalese workers seeking opportunities abroad. which these obstacles can be alleviated by policy decisions, as Their remittances (at 28 percent of GDP in 2013) have helped well as exactly which policy decisions should be prioritized reduce poverty in the country and finance increasingly large trade deficits. Like other inflows of foreign exchange, remit- Box 1: A summary of the main objectives outlined in the Nepal Trade and Integration Strategy (2015) The Government of Nepal has recognized the importance of integration into the global marketplace as a means of growth and inclusive development. Nepal began actively pursuing regional and global economic integration efforts when it open up its economy in the late 1980s. These efforts resulted in Nepal joining the World Trade Organization (WTO) in 2004 and signing 17 trade and 2 transit agreements. Moreover, the Govern- ment of Nepal has been seeking to identify constraints to export growth and interventions to alleviate them through different trade integration studies. The Nepal Trade Integration Strategy 2015 (NTIS) is the third successive trade integration strategy, with the first one being drafted in 2004 and the second in 2010. Its preparation includes wide consultations among various stakeholders including line agencies, the private sector, development partners (including the World Bank Group), and others. A national steering committee has been constituted and chaired by the Chief Secretary of the Government of Nepal. The steering committee membership includes the following Ministries: Finance, Industry, Law, Justice, Constitutional Assembly and Parliamentary Affairs, Agricultural Development, Foreign Affairs, and Commerce and Supplies. The committee membership also includes the National Planning Commission, Nepal’s Rastra Bank, the Federation of Nepalese Chambers of Commerce and Industries, the Confederation of Nepalese Industries, the Chamber of Commerce, the Planning and International Trade Cooperation Division of the Ministry of Commerce and Supplies, and the Donor Facilitator for Nepal. The NTIS covers four cross-cutting areas and three “priority export potential sector.” The cross-cutting areas are: (i) transport and trade facilitation; (ii) standards and technical regulations; (iii) sanitary and phyto-sanitary measures; and (iv) intellectual property rights. The priority export sectors, identified on the basis of export poten- tial and development impact, are grouped into three broad sectors (i) agro-food goods (cardamom, ginger, tea, medicinal and aromatic plants); (ii) craft and manufacturing goods (fabrics, textiles, yarn and rope, leather, footwear, pashminas, and carpets); and (iii) services (semi-skilled and skilled professional services, information technology (IT), business process outsourcing (BPO) and IT engineering, and tourism). Focusing on the four cross-cutting areas and priority sectors, and based on identified constraints, the NTIS defines key performance indicators and an action plan to achieve the set objectives. The key performance indicators focus on increased foreign direct investment (FDI), implementation of actions pending from previous strategies, improvements in logistics performance, and export performance of the priority sectors. The action plan, in turn, introduces short- and medium-term interventions in the cross-cutting areas identified as relevant. Further interventions are aimed at improving export performance of the priority sectors, including capacity building, development of sector-specific export strategies, public sector institutional strengthening, export and investment policy interventions, intellectual property rights enforcement, market access, quality certifications, and branding among others (for the complete NTIS action plan, see Government of Nepal 2015b). Source: Elaboration based on NTIS 2015 (Government of Nepal 2015b). FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Introduction The policy notes included in this report aim at supporting reforms; (iii) new analysis for Nepal, applying cutting-edge the NTIS through an evidence-based approach. To do so, methods on a wide set of databases; and (iv) field-level these notes combine the following elements: (i) existing interviews with the private sector, and consultations with analysis on Nepal’s competitiveness from different angles donors and the Government of Nepal. (including existing competitiveness assessments on transport, access to finance, the tourism sector, previous trade competi- tiveness reports, and so forth); (ii) international experience from comparator countries on good practices for trade policy Box 2: Political Instability in Nepal For over 20 years, Nepal has been facing substantial political instability affecting its growth prospects. In 2006, a decade-long conflict came to an end when key stakeholders reached the Comprehensive Peace Agreement. The country successfully held the Constituent Assembly in 2008, just after the Parliament approved the abolishment of monarchy in December 2007, and the country became a republic in May 2008. Since then, Nepal has been making efforts to establish inclusive and accountable governance structures. The transition to peace and democracy has been complex and lengthy. Stakeholders took eight years of deliberations on a new government structure. The new federal constitution was only completed and adopted on September 20, 2015, soon after the April/May 2015 earthquakes had caused a huge loss of lives and assets. However, the rapid close of the constitutional process itself brought about violent protests and clashes across the country’s southern belt bordering with India, which further intensified after September 20. Major disruptions in cross-border trade with India resulted in shortages of essential supplies across the country. These disruptions lasted more than four months and have added to the difficulties that the private sector faces in Nepal to remain competitive in global markets. This political instability has affected Nepal’s growth prospects through two channels. First, it has added to uncertainty, which acts as a brake on private sector investment and innovation. Second, it has diverted attention of policy makers away from difficult and important reforms. Political stability is in fact a key element in Nepal’s path to become a middle-income country as envisioned in the country’s long-term development strategy. Source: Elaboration based on World Bank “Nepal’s Development Update” issues for 2010, 2013, 2014 and 2016. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Introduction The five policy notes, prepared as a response to a direct request of the Government of Nepal, carefully examine the following topics: Policy Note 1 examines the sustainability of Policy Note 2 looks into the challenges that Nepal’s trade imbalances, their underlying drivers, Nepalese firms face when integrating in value and the role played by remittances both in financing chains, both regionally and globally. It proposes a the trade deficit and in perpetuating it. It sheds light number of policy recommendations to better on the relative importance of different drivers of the support firms in that process so that gains from trade imbalance from a macroeconomic perspective, internationalization materialize. Using firm and as well as on their relative contributions during the last customs transaction data and incorporating informa- decades. Based on reasonable forecasting assump- tion collected through field-level interviews, the note tions for the main identified determinants of the trade identifies key obstacles faced by firms to better use an balance, the note provides several expected paths for important platform for integration into global the trade balance in the medium term. It also looks markets—global value chains. It suggests a number of into the links between remittances and the real policy recommendations to overcome some of the exchange rate-an indicator of export competitiveness. obstacles. It also provides some international experi- ences on trade reforms, as well as granular informa- tion, for example, on products with high potential for increased trade with the northern states of India. Policy Note 3 looks into the services sector and Policy Note 4 provides an impact assessment of the main factors preventing its growth. The note the cash incentive scheme for exporters. It looks acknowledges the importance of the services sector both into the design of the mechanism and its impact in Nepal, particularly its dual role as a direct source of on the export performance of firms in terms of exports and as a provider of key inputs for other growth and diversification. It addresses two broad sectors of the economy. It identifies sources of poten- questions: (i) Is the incentive reaching the firms it tial for services exports, and key obstacles for aims to support? (ii) Is the incentive scheme inducing improved efficiency in the sector. It also presents an increase and diversification in exports that would some good practices from across the world in terms have not been observed in its absence? To answer of services trade performance and reforms, and these questions, the note combines export transac- suggests some policy recommendations to alleviate tion data from customs with firm-level data on the observed obstacles. incentive receipts, as well as information from field-level interviews to the private sector and Government of Nepal. Policy Note 5 stresses the importance of supporting the internationalization process of Nepal’s firms, as well as setting up the right infrastructure to attract, retain, and connect FDI. This note looks into the functioning of institutions to promote trade and investment in Nepal and propos- es both changes in institutional design and in support activities conducted, by looking at interna- tional good practices and taking into account the political economy of public sector governance. It offers recommendations on how to improve both design and activities of trade and investment institu- tions, with the goal of enhancing the country’s export competitiveness and ability to attract export-oriented FDI. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Key Messages Integration offers Nepal an opportunity to move over the last 20 years, real exchange rate appreciation due to towards a new growth model. this channel is non-negligible. In turn, appreciation of the real exchange rate favors imports, and biases against exports by To benefit, firms in Nepal need to make good use of available making domestic goods uncompetitive. The impact is possibly platforms for integration. These include (1) regional and largest on low-value, low-margin manufactured goods, which global value chains both for goods and services, (2) services account for a large share of Nepal’s export bundle. Further, trade in activities of marked comparative advantage, and (3) from a political economy perspective, rising imports are an e-commerce for high-quality, low-volume segments. Regional attractive taxation base and incentivize increased reliance on and global value chains (R&GVCs) offer opportunities for firms import taxes. This adds to an anti-export bias, as exporters in Nepal to access markets and benefit from productivity-en- rely on imported goods as key inputs for production. Nepal’s hancing technology and skills transfers and know-how. The current model of growth is not delivering required growth and rise of R&GVCs is one of the most important transformations jobs, and is further promoting a bias against domestic produc- in global trade and investment, a result of falling transport and tion that is likely to perpetuate the current vicious cycle trade costs that have permitted the fragmentation of produc- (Figure 3). A move toward a model based on investment and tion processes. This has created opportunities for firms to production is necessary to promote faster growth and job integrate globally by becoming competitive in a specific task, creation in Nepal, and integration offers a possible driver in rather than in the full production process. Furthermore, this regard. services trade, in particular in activities of marked compara- tive advantage such as travel and tourism, is a yet untapped opportunity for Nepalese firms. Finally, e-commerce is becoming a powerful platform for firms producing high-quali- ty products in low volumes—a niche that Nepal could occupy. Yet, Nepal’s current remittance-driven growth model is introducing an anti-export bias, adding barriers to reaping full gains from integration. Remittances are a key source of income of foreign exchange in Nepal. They help alleviate financial constraints of households, lifting many out of poverty. However, from a macroeconomic perspective, remittances are also helping to grow current large trade deficits, and are contributing to an appreciation of the real exchange rate. Results presented in Policy Note 1 suggest that an increase in remittances by 10 percent leads to a 0.5 percent appreciation of the real exchange rate in the long run. Remittances put upward pressure on the prices of nontradable goods, and with a nominal exchange rate regime that is pegged to the Indian rupee, the result is an apprecia- tion of the real exchange rate. As remittances have grown fast 1 See Policy Note 1 for a detailed description of the analysis. With the average quarterly change in remittances over the period 1995Q1 to 2015Q1 being at 5.8 percent, the estimated appreciation of the real exchange rate due to this channel is of 22 percent. The magnitude of the effect is broadly in line with what is observed in the literature. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Key Messages Figure 3: Vicious circle of migration, low competitiveness, and policies biased against exports Increased remittances Decreased export Increased competitiveness migration Increased imports Decreased export Increase competitiveness import based through anti-export taxation bias Source: Authors’ elaboration FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Key Messages Nepal remains poorly integrated and has more to E-commerce opportunities are yet untapped. gain from integration into regional and global value chains. There appears to be an opportunity for Nepalese e-commerce to penetrate distant markets. One reason is that many Nepa- Even though its exports have high import content, Nepal is not lese firms are concentrating in small-scale production of a good supplier to R&GVCs and is largely missing out on the high-quality products. In addition, Nepal has relatively good growing trade in intermediate products (see more in Policy air-transport connectivity and a well-established country Note 2). A comparison to other countries in the region shows brand. E-commerce allows firms to connect through an online that Nepal has the lowest participation in GVCs through platform directly with final consumers and reduces transac- downstream linkages. Less than a fifth of exported domestic tion costs. More countries are allowing greater amounts of value added from Nepal ends up in third countries’ exports, duty-free e-commerce purchases, thus unilaterally providing which is related to Nepal’s relative specialization in finalized increased market access to foreign firms, including Nepalese goods exports in both agricultural and manufacturing sectors. ones. Some progress has been achieved in setting up the To increase its chances of discovering its competitive advan- necessary soft infrastructure through the approval of the tage and integrating more into GVCs, Nepal would need to e-signature. However, the lack of an international payments make it easier and cheaper to import goods and services gateway in Nepal prevents firms from using this platform. going into exportables, facilitate the entry and operations for foreign investors, and improve the investment climate for firms and reduce the cost this imposes on them. Services export performance has been better than that observed in goods, but there are still untapped opportunities. Services exports are an important source of foreign exchange and value added. In gross, services exports reached US$1.2 billion and represented 54 percent of Nepal’s export basket in 2014. In value added, the services sector accounted for 44 percent of all domestic value added exported from Nepal. This figure includes not only direct exports, but also the value added the services sector demands from other sectors for its exports (that is, the backward linkages). Most of these exports are in the travel and telecommunications sectors (80 percent), although there is a nascent, largely informal, but flourishing software and BPO sector. However, in the largest services export sector, travel and tourism, low-value activities predom- inate. For example, daily tourist expenditures per day in 2012 were US$38, at the lower end of the distribution, and the tourism offering is relatively concentrated in trekking (see a more detailed analysis in Policy Note 3). FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Key Messages What is impeding firms from tapping into these opportunities? The report identified two types of obstacles: the challenges the country faces in attracting foreign investment and external to the firm and internal to the firm. may need reconsideration (see Policy Notes 2 and 3). Obstacles that are external to the firm iii. Domestic competition at home helps in the provision of more efficient inputs, particularly crucial backbone services. Good External obstacles are features of the environment in which quality, efficient services inputs are important for firms’ perfor- firms operate that increase their costs, or prevent them from mance. Insufficient availability of services inputs—including electrici- tapping into opportunities. These include, among others, (i) ty, transport, finance, and water supply—is perceived as an obstacle restrictive trade policies that impede firms from accessing to the manufacturing and agriculture sectors’ performance in Nepal. foreign markets for their output or to source inputs (both These backbone services are particularly important for exporters. For goods and services); (ii) restrictive investment policies and example, top export sectors of Nepal use transport services regulatory uncertainty that prevent the attraction and reten- intensively. Almost 40 percent of services inputs provided to tion of FDI and impede FDI’s connection with domestic processed food exports are from the transport sector. In addition, firms—key for spillovers to materialize; (iii) anticompetitive transport comprises 30 percent of services inputs for leather export- practices in domestic markets, with implications for provision ers and 25 percent for beverages and tobacco exporters. In agricul- of quality key backbone services (transport, telecommunica- ture, 45 percent of services inputs are transport related. Thus, tions, finance); and (iv) inadequate national infrastructure transport sector improvements will have a direct and sizable bearing (both hard and soft), particularly quality infrastructure. on the profitability and competitiveness of these export sectors (see a more detailed analysis in Policy Note 3). iv. Weak infrastructure makes it more difficult for Nepal to change i. Restrictive trade policies have been increasing production costs its export mix. This includes both hard infrastructure, mainly associ- of Nepalese firms. In Nepal, as in other countries, imported inputs ated with connectivity, but also soft infrastructure. In particular, (both of goods and services) are key for the vast majority of export- quality infrastructure associated with certification and standards is ers. More than 90 percent of Nepalese exporters import inputs for important as Nepal moves towards higher-quality exports. Refusals production, which is reasonable given the size of the economy. of Nepalese export products at foreign borders is one example Several industries prioritized by the NTIS rely on significant imports indicating that quality infrastructure remains a challenge in Nepal. In of various raw materials and intermediate inputs for production. For agriculture and within products identified as priorities by the NTIS, example, footwear exporters import more than 20 raw materials average quality is low to medium, compared to that displayed by (leather, glue, soles, accessories, and so forth); exporters of pashmi- competitors. For example, in tea and coffee, Nepal’s exports are nas import wool and silk; manufacturers of hand-woven carpets positioned halfway through the quality distribution, with an average source wool, silk, and dyes from abroad; and higher-end tea export- unit price of 40 percent of the top exporting country (see Policy Note ers source their filter bags internationally. (see both Policy Notes 2 2). Part of this is explained by firms’ limited capabilities in upgrading and 3). quality, but inadequate infrastructure for quality and product certifi- cation and compliance with international standards also matters. Sourcing inputs at competitive prices, irrespective of their origin, Quality challenges are also revealed by recurring import rejections of helps firms grow, diversify, and upgrade. Access to a wide variety of Nepalese products at foreign borders, due to poor handling of inputs relaxes firms’ technological constraints, helping firms diversify products before shipping (including aflatoxin and decomposing into new or better quality products. In Nepal, greater use and variety foods, and presence of undeclared gluten in allegedly gluten-free of imported intermediate inputs is associated with greater exports, flours), or lack of standard compliance (for example, mislabe- diversification of destination markets, and higher export quality (see ling/misbranding, or absence of approved drug applications). These Policy Note 2). For example, firms that import more than 30 percent recurring import rejections of specific shipments pose reputational of intermediates from outside the region have 16.8 percent larger risks across the board, and result in lower export prices and higher export values, export to 40 percent more destinations, and secure on costs for exporters. average 10 percent higher prices for their products than other firms. Inadequate hard infrastructure, mainly related to connectivity, affects producers in general, and tourism in particular. ii. Attracting and retaining FDI is crucial for export performance Apart from increasing transportation costs and making travel times and growth and requires less restrictive investment policies. FDI is uncertain, poor connectivity also affects the prospects of upgrading vital for accessing new markets, integrating and upgrading in in tourism, as well as the diversification of its offering. The latter R&GVCs, and ultimately for creating more and better jobs. But requires substantial investment in supporting infrastructure, particu- inflows into Nepal are very low. At less than 1 percent of GDP, Nepal’s larly airports, bus terminals, and rest stops. FDI inflows are the lowest among comparators. While this is partially explained by firms’ perceived risks of operating in the country, the investment regime in Nepal is more restrictive than in other countries at a similar level of development. Restrictive FDI policies compound FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Key Messages What is impeding firms from tapping into these opportunities? Obstacles that are internal to the firm The cash incentive scheme appears to have had no clear effect on export growth or diversification. At the aggregate level, there is no Firms’ internal obstacles may prevent them from tapping conclusive evidence of the incentive program having affected export into the opportunities associated with integration. growth or diversification away from India. Instead, India appears to Internal obstacles may be related to low managerial capabili- be growing as a destination market after the implementation of the ties or difficulties in accessing relevant market information incentive. Once firm-specific characteristics are controlled for, we regarding trade opportunities. Many governments worldwide, find the change in the incentive scheme in 2013 had no effect on including Nepal’s, support firms in the process of internation- firms’ export performance. Nor do we see the effective incentive rate alization, typically through information provision (‘market affecting export growth or diversification patterns (see Policy Note 4 intelligence’) and sometimes subsidizing capabilities upgrad- for more details). ing. What support is the Government of Nepal providing to help firms overcome internal obstacles, and how is that helping firms integrate into R&GVCs? ii. Traditional trade promotion activities are also sponsored by the Government of Nepal, but these could benefit from for improvement in the design, mandates, and coordination among Nepal’s trade and investment promotion agencies. Like all govern- i. As part of well-needed trade promotion interventions, the ments in the world, Nepal devotes substantial resources to promot- Government of Nepal has set up a cash incentive scheme to ing trade, tourism, and FDI. It is important to align these efforts with support exporters. A scheme was introduced in 2010/11 by which international good practices, in terms of both the actual interven- firms were eligible to receive 2, 3, or 4 percent of their export value tions to support firms and the design of these institutions and their as a cash incentive. To be eligible, firms had to be exporting to coordinating mechanisms (see Policy Note 5 for a detailed discus- countries other than India, and had to be adding domestic value by sion). There are several agencies whose mandate is to promote 30, 50, or 80 percent. The scheme was modified in 2013, reducing trade (primarily in goods or in tourism, with no active promotion of the incentive rates to 1 and 2 percent and introducing a fast-track other services exports) or investment (the responsibility of agencies system. This streamlining was introduced as a response to feedback within the Department of Industry and the Investment Board). But received by the public sector. these agencies and efforts have limited coordination. In a context in which trade and investment globally are strongly linked, coordina- However, evidence from an impact evaluation analysis reveals tion between these agencies should be strong. This may imply that the program is not reaching the firms it is meant to support operating under a common umbrella, or keeping fluid channels of (see more in Policy Note 4). High fixed costs of filing due to a lengthy communication. Also, in Nepal, evidence shows that tourism acts as and complex mechanism have been impediments for exporters an export promotion platform for traditional goods. This link needs (particularly for new exporters) to claim the incentive. In 2012, only to be internalized by trade promotion institutions. 3.3 percent of eligible firms received the incentive. This increased to above 6 percent in 2013 and 14 percent in 2014, but remained low. Most firms exporting eligible products do not receive any incentive, and those that are receiving it are substantially larger, and tend to receive it systematically. In fact, the conditional probability of receiv- ing the incentive given that the firm had managed to receive it the year before was 50–70 percent. Changes in the scheme introduced in 2013 do not seem to have been fully implemented. This is observed both in the analysis of data and from conducting field interviews with eligible firms. The fast-track system introduced in 2013, by which firms exporting priority products would not need to certify domestic value addition, reflect the systematic feedback of the private sector on the complexity of proving that value added content. In fact, the indicator of the fixed costs of filing for the incentive shows an increase rather than a decrease after the announcement of the fast-track system. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Policy Recommendations How can Nepal benefit more from integration? will occasionally send samples to laboratories in Kolkata for testing because SPS certificates granted in Nepal are not Across the different policy notes, evidence points to a number recognized internationally. Nepal’s current SPS system has of policy options that will help break the vicious circle major capacity gaps and weaknesses in World Trade Organiza- described above (Figure 3), increase the competitiveness of tion (WTO) compliance, namely: (i) the SPS system is not the export sector, and create better job opportunities for the risk-based; (ii) the food control system is mainly focused on Nepalese people. Some policies are horizontal in nature, and quality requirements, not on food safety requirements; (iii) some are sector specific. The most important options are SPS agencies and laboratories suffer from frequent rotation of summarized below (for the full set refer to the individual staff; (iv) insufficient capacity in plant pest surveillance and Policy Notes). diagnostics; (v) no capacity to control pesticides; (vi) SPS import inspection is hardly in place and ineffective; and (vii) there is at present no testing capacity and accreditation for Gradually move away from import-based taxation, food safety parameters in microbiology, pesticide residues, streamline tariff lines, and reduce tariff rates, especial- veterinary drug residues, heavy metals, other pollutants, and ly on intermediates that are key for the production of mycotoxins (World Bank 2015c). Field-interviews and priority products. In the meantime, streamline the additional analysis show that two interventions could have a duty-drawback system currently in place for exporters. great impact in compliance with international standards: standards harmonization and international accreditation (see a more detailed discussion in Policy Note 2). The government may consider reducing or eliminating customs duties or other trade restrictions on inputs (both goods and services) that are key for the prioritized sectors. Reduce restrictiveness for trade in services and Given the high share of tax revenue from trade-related taxes, promote competition economy-wide. this option requires careful analysis of its fiscal implications and securing alternative sources of public revenues. As a first step, this option implies better understanding of input-output The regulatory environment governing services providers linkages for key products, the elasticity of demand for imports affects both the quality of domestic services provision as well with respect to tariffs, and the exportable potential for as the ability of countries to export services. This includes the products that will benefit from lower input tariffs. In the actual laws, as well as how those laws are implemented in meantime, the duty-drawback system for exporters needs to practice within a country. Openness in the services sector is be streamlined and made more transparent, and it should be part and parcel of a comprehensive growth-enhancing trade accessible by both direct and indirect exporters (sellers to policy. Lack of competition impairs the ability of other sectors tourists). to use services as inputs, because it creates a reliance on domestic services as inputs for manufacturing production. In India and Indonesia, for example, reforms in the services Improve the national quality infrastructure to boost sectors improved services provision, as well as the perfor- competitiveness and facilitate entry into R&GVCs. mance of manufacturers that used those services (see a more detailed discussion in Policy Note 3). In particular, restrictions around trade in transport services are high. Nepal, a Nepal has favorable access to developed markets like the landlocked country, imposes high restrictions in transport United States, European Union, and Japan for agricultural services trade. The domestic sector is syndicated and highly products (in which sector more than 90 percent of tariff lines anticompetitive, imposing large costs on its users, whose do not pay customs duties). However, the inability of export- services input spending is largely for transport. Policies to ers to comply with sanitary and phytosanitary standards (SPS) manage and regulate the authority of trucks and to strength- prevent Nepal from taking full advantage of its preferential en the government’s ability to control these practices should access. Inadequate national quality infrastructure exacerbates be put in place by the Department of Transportation. some of the disadvantages that Nepal faces as a landlocked country. Inadequate SPS measures contribute significantly to trade time and costs along the Kathmandu-Kolkata corridor. Anecdotal evidence suggest that import authorities in India 2 Reis and Varela (2015) show for Nepal, that an increase in tourism inflows from a given country, in a given year by 1 percent, increases exports of traditional goods to that country, one year later, by 0.5 percent. FROM EVIDENCE TO POLICY: SUPPORTING NEPAL’S TRADE INTEGRATION STRATEGY Policy Recommendations Promote e-commerce platforms with necessary soft provide foreign investors the right to repatriate funds related infrastructure, including a gateway for foreign to foreign investment, in practice repatriation is difficult and payments into Nepal, and strengthen competition in obtaining approvals is a lengthy process (World Bank 2015b). the logistics sector. Entry barriers to foreign investment also persist, including foreign ownership limitations, sector caps, a long negative list, and restrictions in nonequity modes of investment. Nepal E-commerce is a powerful tool for exporters of high-quality retains a foreign ownership limit of 51 percent in some select- products at low volumes. In this area Nepal has great poten- ed sectors, such as legal, accounting, and engineering servic- tial. At the same time, developed countries are increasing the es. The country imposed an even lower foreign participation duty-free allowances for products imported through e-com- limit in banking and finance, a sector crucial for the private merce. For example, in March 2016, the United States sector to flourish. Additionally, despite eliminating the increased that allowance from US$200 to US$800. For Nepal minimum investment requirement of US$200,000, the new to take full advantage of the opportunities of e-commerce, Foreign Investment Policy (FIP) significantly expanded the necessary steps regarding the validation of electronic signa- negative list to include poultry, fishery, print, and electronic tures have been taken. However, the necessary licensing of a media. This limits the amount of foreign investment entering payments gateway that would allow for foreign payments into Nepal and constrains the ability of important sectors of the Nepal is still pending. It is important that the Central Bank economy, including manufacturing, to attract FDI. Restrictions accelerate this process through its recently established Settle- in nonequity modes of investment, such as franchising, in ments Department (see more details in Policy Note 3). Moreo- which there is significant technology, training, and skills trans- ver, a competitive logistics services sector is crucial to fully tap fer, face additional delays and costs during entry and opera- into the potential of e-commerce. tions in Nepal. In particular, slow and arbitrary approval processes, dual registration procedures, delays in trademark registration, and difficulties in remitting royalties and techni- Revise the export incentive scheme, and implement cal fees are among several obstacles faced by these type of monitor and evaluation mechanisms for all interven- investments (World Bank 2015b). tions that imply the use of public funds, as well as impact evaluation analyses. Over the medium term, unify efforts for investment promotion under one authority, and ideally coordinate It is commendable that the Government of Nepal has request- these efforts with those related to export promotion of ed an impact evaluation of its export incentive scheme. Moni- both goods and services. toring policy interventions and rigorously evaluating their impact is of foremost importance to ensure that scarce public funds are allocated to their best use. Evidence provided in this In particular, Nepal may benefit from aligning the mandates of report suggests that the current incentive scheme for export- its investment promotion agencies to emphasize the attrac- ers has not been reaching the intended firms. Nor has it had tion of export-oriented FDI (see more in Policy Note 5). After a any clear impact on export growth or diversification (see more careful analysis of production structures of neighboring Indian details in Policy Note 4). Resources that are currently commit- states, investment attraction efforts should also take into ted to this export incentive scheme could be put to better use account opportunities that integration into regional value financing policy interventions that help a wider universe of chains pose for Nepal (see more in Policy Note 2) firms to be more competitive. The items mentioned above, particularly the reduction of tariffs for key intermediates, could be more effective vehicles for the improvement of export performance. Attract, retain, and connect FDI to the economy through reforms to the investment policy regime. Among the most salient restrictions affecting foreign invest- ment in Nepal are the cumbersome processes for the repatri- ation of funds and the lengthy processes needed to hire foreign workers. Regarding the former, while the law does References Government of Nepal (2015a). “Vision 2030 for Nepal: Towards A Just and Lasting Prosperity.” Draft concept note. Kathmandu. Government of Nepal (2015b). “Nepal Trade Integration Strategy 2015.” Unpublished paper. Kathmandu. Reis, J.G., and G. Varela (2015). “Travel Channel Meets Discover Channel: How Tourism Can Encourage Better Export Performance and diversification in Nepal.” South Asian Economic Journal 16: 183–208. World Bank (2010). “Nepal Economic Update.” Unpublished paper. World Bank, Washington, DC. World Bank (2013a). “Nepal Economics Update.” Unpublished paper. World Bank, Washington, DC. World Bank (2013b). “Trade Competitiveness Diagnostic for Nepal.” Unpublished paper. World Bank, Washington, DC. World Bank (2014). “Nepal Economic Update: Dealing with Excess Liquidity.” Unpublished paper. World Bank, Washington, DC. World Bank (2015b). “Nepal: Binding Constraints for FDI.” Unpublished paper. World Bank, Washington, DC. World Bank (2015c). “Exports and Imports of Nepal of Agriculture and Food Products: SPS-Related Issues and Solutions.” Unpublished paper. World Bank, Washington, DC. 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