Better opportunities lie with India than China

DR HARI BANSH JHA

Nepal should think of a free trade arrangement with India to reap huge economic benefits like Sri Lanka has done

Despite over half-a-century’s planning efforts in Nepal, the country is still economically least developed. With per capita income of US $ 340, the country ranks at the bottom even among the least developed countries of the world. The question is where did Nepal miss the bus when it has world’s two fastest growing economies in its neighborhood ie India in the south and China in the north.

India is experiencing an economic growth rate of 8.4 percent; whereas China’s rate of economic growth is over 10 percent. Why is it that Nepal (including its Terai region) stands out as an “Island of Poverty” among all the South Asian countries when it has so much of resources for its development?

In South Asia, besides Afghanistan, all other countries have been doing fairly well in terms of economic growth. Sri Lanka’s growth rate stands at 6 percent and so is the growth rate of countries like Bangladesh and Pakistan. Bhutan’s rate of economic growth is even higher than any of the South Asian countries. Amidst all these encouraging environment, Nepal’s rate of economic growth stands at 3.9 percent which is the lowest in the region.

Nepal seems to have missed a great opportunity by failing to integrate its economy with that of India in the spheres of infrastructure development, skill development or in matters related to knowledge economy. Though late, the only way left for Nepal is to follow the approach of economic integration with either or both of these countries and take advantage of economy of scale, dissemination of information, technology and knowledge spillovers and higher foreign direct investments.

Nepal could benefit immensely from the developmental achievements of India and China through the integration of its economy with them via free trade. As per the Factor Price Equalization Theory in economics, the relative prices for two identical factors of production in the same market happen to be equal to each other due to the competition. The factor that receives the lowest price before two countries integrate economically and become one market becomes more expensive; whereas the one with higher price becomes cheaper. This is applicable in all important sectors including in wage structure.

For instance, after the North American Free Trade Agreement (NAFTA) was signed in Dec, 2009 by Canada, Mexico and the US, unskilled labor wages fell in the US; whereas it increased in Mexico. The same trend was also observed after the formation of the European Union. It is likely that Nepal including the Terai, hill and mountain regions will be able to achieve fast rate of economic growth as that of India or China if it enters into free trade with them and reap benefits outlined by the Factor Price Equalization theory.

Even in South Asian region, India and Sri Lanka entered into Free Trade Agreement (FTA) on March 1, 2000 to take advantage offered by the Factor Price Equalization theory. The FTA was based on the modality of Duty Free Import of goods manufactured in Sri Lanka. This encouraged Indian manufacturers to set up industrial units in Sri Lanka. The goods thus produced proved far cheaper in India as there was no excise duty in Sri Lanka or import duty in India on the goods produced in that country.

Following the FTA in 2000, the trade between India and Sri Lanka increased phenomenally. It not only helped the development of national economies of the two countries but also promoted mutually beneficial bilateral trade.

Statistics show that the bilateral trade between India and Sri Lanka touched the level of US $ 1.7 million in 2004, which further increased to US $ 2.025 billion in 2005. Encouragingly, the exports from India to Sri Lanka which amounted to US $ 1350 million in 2004 substantially shot up to US $ 1437 million in 2005; while during the same period exports from Sri Lanka to India shot up from US $ 382 million to US $ 588 million. Just between 2001 and 2004, there was an increase in bilateral trade between the two countries to the extent to 257 percent. The credit for this development solely goes to FTA arrangement between the two countries.

Soon after signing the FTA, India became the largest source of Sri Lankan import. The FDI showed that India had emerged as the fourth largest investor in Sri Lanka. Indian giant companies such as Indian Oil Corporation, Taj Hotels, Apollo Hospitals, L & T, Ambujas, Tatas and Ashok Leyland have been successfully operating in Sri Lanka. Connectivity between the two counties increased many fold as there are over 100 flights per week to and from some ten destinations in India. Learning from the huge economic benefits of FTA arrangement between India and Sri Lanka, Nepal too should think of similar arrangement with India to reap the advantage of free trade for faster rate of economic growth.

Of the two economies of India and China, however, the Indian economy provides huge opportunities for the exports of products from the Terai region in particular and Nepal in general. In 2008-09, India shared nearly 58 percent of Nepal’s total trade. During the same year, of Nepal’s total imports, Indian share was 63 percent; whereas its share in Nepal’s total exports was 60 percent.

Interestingly, of India’s 1.17 billion population (2009), nearly 361 million (2001) people live in Nepal’s bordering states in India. Figures have it that the bordering Indian state of Uttarakhand has a population of 8.48 million; whereas that of Uttar Pradesh was 190 million, Bihar 82 million, Bengal 80 million and Sikkim 0.54 million. This clearly demonstrates that India at large and its states that border Nepal might be a potential market for the Nepali exportable items. The presence of the huge 361 million customers in the bordering states provides immense prospects for exports from Nepal especially the Terai region if the goods could be produced to meet the taste, preferences and purchasing power of the neighboring Indians.

On the other hand, the vast geographical region of Tibet Autonomous Region of China, that borders Nepal in the north, has a total population of 2.62 million only. Tibet or so to say China is not as much suitable for Nepal’s exports as India is mainly because of the lower population compounded with lower level of purchasing power of the people of that region. Because of this asymmetrical relation between Nepal’s southern and northern neighbors, the prospects for free trade agreement with Nepal’s northern neighbor seem very bleak. However, even to take due advantage from FTA with India, what is needed most is to develop competitiveness, free the country from labor disputes and other problems like strikes, power shortage and higher transport costs.

(Writer is Professor of Economics and Executive Director of Center for Economic and Technical Studies, Nepal.)