1 2 3 CONTENTS ACKNOWLEDGMENTS 6 ACRONYMS 6 I. EXECUTIVE SUMMARY 7 II. INTRODUCTION 15 III. FULLY EXPLOITING TRADE POTENTIALS 18 III.1 A Gravity-Founded Snapshot of Trade Potentials 19 III.2 Agreements and Preferences in Place: Is Nepal Taking Advantage of Them? 22 III.2.1 Aggregate Trade Patterns by Bloc of Destination and Origin 22 III.2.2 Trade Complementarities 23 III.2.3 Is Nepal (and the Region) Profiting from SAFTA? 25 III.2.4 Is Nepal Profiting from GSP? 27 III.2.5 Identifying high-potential products in U.S. markets 28 III.3 Deepening Integration: Why is it Necessary and What Would It Take? 31 III.3.1 Deep Integration: Where is Nepal in That Map? 32 III.3.2 Nepal in GVCs 34 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS 40 IV.1 Trade Policy Reforms in the Region: A Snapshot 42 IV.2 Import Tariffs, the Import-to-Export Environment, and Competitiveness 43 IV.3 Imports Tariffs and Taxes, and Revenues: What is the impact in Nepal? 47 IV.3.1 The Fiscal Cost of Reducing the Tariff Code’s Anti-Export Bias: Some Simulations 49 IV.3.2 Alternatives for Recouping Tariff Revenue Losses 52 V. APPENDIX 54 VI. REFERENCES 60 FIGURES Figure 1. Multilateral Exports and Market Access for Nepal: 2005 and 2014 20 Figure 2. Nepal’s Performance in Export Markets Along Extensive and Intensive Margins 20 Figure 3. High-Potential Export Markets for Nepal 22 Figure 4. Nepal’s Exports to SAFTA Member Countries 23 Figure 5. Nepal’s Imports from SAFTA Member Countries 23 Figure 6. Nepal’s Exports to Various Trade Blocs 23 Figure 7. Nepal’s Imports to Various Trade Blocs 23 Figure 8. Nepal’s Exports to GSP Granting Countries 23 Figure 9. Nepal’s Export Complementarity Indices with SAFTA Members 24 Figure 10. Export Complementarity Indices with Main GSP-Granting Countries and China 25 Figure 11. Export Shares to GSP-Granting Countries 27 Figure 12. Deep PTAs and GVC-Related Trade 31 Figure 13. Number of Agreements and Depth – Nepal and Comparators 32 Figure 14. Network of Agreements 32 4 CONTENTS FIGURES Figure 15. Active Agreements by Country for Selected Economies (2015) 33 Figure 16. Active North-South and South-South Agreements for Selected Economies (2015) 33 Figure 17. PTA Coverage, Selected Economies (2015) 34 Figure 18. Nepal GVC Trade Over Time 34 Figure 19. Nepal GVC-Related Trade, by Region (1990-2014) 35 Figure 20. Top 10 GVC-Related Trade Partners 35 Figure 21. FDI Inflows as Percentage of GDP – Nepal and Comparators 36 Figure 22. Top Announced FDI Projects by Sector in Nepal (2003-2012) 36 Figure 23. MFN Tariffs and GDP Per Capita 42 Figure 24. Import Restrictiveness (TTRI) 42 Figure 25. Simple Average Tariff on Intermediate Goods, 2006-15 43 Figure 26. Simple Average Tariff on Raw Materials, 2006-15 43 Figure 27. Simple Average Tariff on Cotton Fabrics, 2006–1 43 Figure 28. Simple Average Tariff on Capital Goods, 2006–15 43 Figure 29. Export Performance Premia for Exporter-Importers in Nepal 45 Figure 30. Tax Revenue as Percentage of GDP, 2007-2016 47 Figure 31. Import Tax Revenue by Product Type, 2016 47 Figure 32. Patterns of Distributional Impact of Tariff Reform Induced Welfare Gains - Nepal 48 Figure 33. Tariff Rates and Misreporting, 2014 53 Figure 34. Bilateral Exports and Market Access in Nepal: 2005 and 2014 56 TABLES Table 1. Summary of Tariff Reform Scenarios and Associated Revenue Impact 11 Table 2. Summary of Main Policy Recommendations 14 Table 3. Impact of SAFTA on Members’ Exports 26 Table 4. Impact of SAFTA on Members’ Exports by Type of Traded Good 27 Table 5. Tariff Lines with GSP, GSP+ Preferences above 10% 29 Table 6. Change in Nepal’s GVC-Related Bilateral Trade with SAFTA Under Different Scenarios 37 Table 7. Potential Effects from Changes to Import Tariff on Intermediate Inputs 46 Table 8. Impact of Tariff Reforms on Revenue 50 Table 9. Impact of Tariff Reforms on Revenue 51 Table 10. List of Top Under-Reported Import Products (Discrepancy Index<0), 2014 53 Table 11. Top 10 Revenue-Generating Products, by Category 55 Table 12. Nepal’s Top Export Products at hs6-level, 2015 56 Table 13. Deep Agreements and GVC-Related Trade, Regression Results 57 Table 14. List of Individual Products with Preference Margin Above 10% 58 Table 15. Nepal’s Exports of Products Included in List of Concessions from U.S. to Nepal, by destination (2010-2015) 59 LIST OF BOXES Box 1. Estimating Nepal’s Trade Potential with Gravity Equations 21 Box 2. Opportunities for Nepal after Expanded List of GSP-Eligible Products from United States 30 Box 3. Methodology for the Estimation of the Impact of Deep Integration on GVC Integration 38 Box 4: Expenditure gains for trade policy reform in Nepal along the income distribution 48 Box 5: Simulating Trade & Revenue Impact of Tariff Reforms Using TRIST 51 Box 6. Misreporting and Discrepancy Gap 52 5 ACKNOWLEDGMENTS This study is the product of the Trade and Competitiveness Global Practice of the World Bank Group. The team was led by Ashish Narain and Gonzalo Varela, and included Guillermo Arenas, Sunita Shakya Chitrakar, Karly Dairabayeva, Alvaro Espitia and Nadia Rocha. Valuable inputs were provided by Paul Brenton, Mona Prasad, Bob Rijkers and Michele Ruta. 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). ACRONYMS ASEAN Association of Southeast Asian Nations BBIN Bhutan-Bangladesh-India-Nepal CACM Central American Common Market CISE Cash Incentive to Exporters EU European Union EBA Everything But Arms FDI Foreign Direct Investment GATS General Agreement on Trade in Services GSP Generalized System of Preferences GVCs Global value chains LAFTA Latin American Free Trade Agreement NAFTA North American Free Trade Agreement PTAs Preferential Trade Agreements SAARC South Asian Association for Regional Cooperation SAFTA South Asian Free Trade Area agreement SATIS South Asia Trade in Services Agreement SPS Sanitary and phytosanitary TBT Technical barriers to trade TRIMS Trade-related investment measures VAT Value-added tax WTO World Trade Organization 6 I EXECUTIVE SUMMARY 7 I. EXECUTIVE SUMMARY Nepal has been the slowest-growing country in South Asia, Further, few of Nepal’s agricultural exports make it to lucrative with growth over the past decade averaging 4 percent. markets. In terms of investment, Nepal has among the lowest Without a significant change in growth drivers, this growth is participation in global value chains (GVCs) compared with other unlikely to exceed the 5 percent rate over the next several countries in the region, with foreign investment averaging just years that is necessary to reach the government’s objective of 0.2 percent of GDP over the last decade. As far as integration achieving lower middle-income status by 2020. Further, Nepal’s is concerned, Nepal seems to be missing the boat. current growth pattern is failing to generate jobs domestically, especially for most of the population with low educational and Not all of this can be blamed on geography or conflict skill levels. Three-quarters of workers remain stuck in the primary alone. Many are policy related, including, among others, sector. Manufacturing employs a small 7 percent of the workforce, (i) trade policies that either are not supportive enough or while services, the fastest-growing segment, has generated few impede firms from accessing foreign markets for their output jobs. Tepid growth and employment generation have led to more or to source inputs (both goods and services); (ii) restrictive than a quarter of the workforce going overseas. The country is investment policies that prevent the attraction and retention increasingly becoming dependent on their remittances for growth of foreign investment, and its connection with domestic firms, and poverty reduction. (iii) barriers to service trade that affect the quality of key backbone services (transport, telecommunications, finance), For a small economy such as Nepal, strategically located and (iv) inadequate national infrastructure (both hard and next to two emerging powerhouses, and with preferential soft), particularly quality infrastructure (World Bank, 2016). access to many high-income and fast-growing economies, Reforming these policies to support and promote a greater trade and investment can be an important driver of outward orientation is critical for Nepal. growth. Through trade integration, firms in Nepal could take advantage of an enlarged market, and could be exposed to This report examines how Nepal could move away better technologies, more varied intermediates, and potentially from a remittance-driven growth model by reforming become more competitive. Foreign direct investment (FDI), in its trade policies to increase competitiveness. In turn, can help domestic firms overcome obstacles to successful Nepal, remittances are a key source of income of foreign internationalization. It often comes with increased access to exchange. They help alleviate financial constraints of sophisticated markets, permits absorbing foreign knowledge households, lifting many out of poverty. However, from a related to technologies and knowhow or managerial practices, and macroeconomic perspective, remittances also contribute alleviates financial constraints local firms currently face. to large trade deficits, and to an appreciation of the real exchange rate (World Bank, 2016). Remittances put upward Yet, Nepal has not fully taken advantage of integration. pressure on the prices of non-tradable goods, and with a In terms of trade, integration indicators -both for exports and nominal exchange rate that is pegged to the Indian rupee, imports, and considering the country’s characteristics- show the result is an appreciation of the real exchange rate. export and import orientation that is below average. Indeed, In turn, the appreciation of the real exchange rate favors the situation has worsened over the last decades. In 2003, imports, and biases against exports by making domestic Nepal accounted for $12 out of every million U.S. dollars goods uncompetitive. The impact is possibly largest on low- of worldwide trade in goods and services. But by 2014, this value, low-margin manufactured goods, which account for a number fell by 25 percent to just $9. Merchandise export large share of Nepal’s export bundle. Further, from a political growth collapsed from an average rate of 19 percent per economy perspective, rising imports are an attractive year in the 1990s to 0.6 percent per year in the decade after. taxation base and incentivize increased reliance on import 8 I. EXECUTIVE SUMMARY taxes. This adds to the anti-export bias, as exporters rely on Evidence suggests that Nepal has only benefitted from imported goods as key inputs for production. Nepal’s current the South Asian Free Trade Area agreement (SAFTA) as model of growth is not delivering the required growth and an importer, but hardly as an exporter. Likely, challenges of jobs, and is promoting a bias against domestic production implementation of SAFTA along with an increase in trade that is likely to perpetuate the current vicious cycle. This frictions imposed by its member countries following the global report proposes several trade policy reforms aimed at crisis. Firms have also struggled to increase the utilization increasing competitiveness to break this vicious cycle. rates of trade preferences (under the Generalized System of Preferences, GSP) provided by high-income countries. On The report examines the extent to which Nepal has the latter, the opportunities are large because the European been tapping into its trade potentials, the underlying Union (EU) allows the diagonal accumulation of origin among obstacles that it faces, and the type of policy reforms South Asian countries under the GSP. This would allow the that could turn trade and investment into a vehicle for formation of regional value chains to produce exportable growth. Five key messages emerge from the analysis. products to the EU. First, Nepalese exporters remain small, and struggle with Third, diversification opportunities lie in fast-growing increasing their shipments once they enter a new market, economies in East Asia and the Pacific. Efforts regarding rather than with the fixed cost associated with entering. This connectivity, trade facilitation and export intelligence could is essentially due to severe supply-side constraints that affect help firms get to those markets. their trade and production costs. Nepal’s trade complementarity indices suggest that This is revealed by (i) a systematic analysis of export potentials, dynamic export growth requires some diversification, where Nepalese exporters perform on average in terms of number particularly into fast-growing economies in East Asia and of products and destinations reached, but substantially below the Pacific. With these economies, it substantially under- average in terms of shipment sizes, given their characteristics, and trades relative to a benchmark, constructed based on (ii) a case study on the use of preferences granted by the United both partners’ sizes and distance. Strengthening the States, where Nepalese firms seem to reach that market with very Bhutan-Bangladesh-India-Nepal (BBIN) transit agreement small shipments. The finding is likely associated both with high will help improve connectivity and reach some of these trade costs and with challenges to increasing production related to high-potential markets. With India, instead, evidence domestic supply chains. These include difficulties to secure energy suggests Nepal overtrades, and in addition, that export at competitive prices, access to finance, and access to trained complementarities have been declining. Thus, the labor. In the short run the challenges could be offset, to some concentration of the export basket in India may be extent, through negotiating better preferences (because they impeding faster export growth. increase firms’ profit margins), and increased FDI flows (because they improve firms’ financial conditions). Fourth, to reduce the anti-export bias of its trade policy infrastructure, Nepal needs to simplify its tariff code, reduce tariffs Second, Nepalese firms underutilize existing trade agreements on crucial intermediates, and embrace deeper integration, starting and granted trade preferences. with more openness to services and investment. Firms face untapped opportunities to reach markets With respect to the simplification of the tariff code, a gradual with which Nepal has agreements or trade preferences. approach could help stimulate export competitiveness 9 I. EXECUTIVE SUMMARY without compromising tariff revenues in the short run, while Underlying these five main messages are several comprehensive tax reforms are put in place. In the medium policy levers that can help alleviate constraints term, extensive tariff liberalization (i.e. eliminating import that are preventing firms from tapping into the tariffs for all raw materials, intermediate goods, and capital opportunities of increased integration in Nepal. While goods) needs to be considered along with the design of challenging supply-side constraints associated with lack of comprehensive tax reforms. This is because the fiscal cost infrastructure are making it difficult for Nepalese exporters to would be substantive, ranging from 2.6 to 9.9 percent of total grow and diversify, it is also evident that an inadequate trade revenues. However, a gradual approach that starts with tariff policy framework is not helping either. This report identifies reforms targeting key intermediate inputs for export sectors policy actions to alleviate the constraints faced by reducing would result in negligible revenue losses that range from 0.2 the anti-export bias of the tariff code; helping firms tap into to 0.5 percent of total revenues, while substantially boosting the existing opportunities; improving the behind- the-border the competitiveness of exporters. Interestingly, results export climate; and supporting firms’ integration into GVCs. show that a reduction in tariffs -particularly in sectors with Clearly, the impact of these reforms is greater when they are significantly high tariff rates- could lead to increasing, rather combined. Still, each of them will contribute to reduce trade than decreasing, revenues due to a reduction in incentives for costs if applied on their own. These recommendations are misreporting of import values. Further, efforts to reduce tariffs summarized in Table 2 and discussed in detail in what follows. need to be coupled with efforts to integrate more deeply with the world. Nepal’s current integration agreements are To improve the import-to-export environment: ‘shallow,’ focusing only on tariff reductions at the border. As a starting point, services trade agreements and the attraction [1] Move away from import-based taxation, and reduce the anti- of FDI would be of utmost importance to help the private export bias by lowering tariff rates. Start with tariff reductions sector alleviate some of the binding constraints for growth. on crucial intermediates, which are key to producing priority products, and provide negligible tariff revenues to the Fifth, trade reforms in Nepal are welfare enhancing on government coffers in the short run. In the medium to long average, and pro-poor. run, consider a comprehensive tax reform to offset potential revenue losses from eliminating import-based taxation. Tariff reductions will not only increase export competitiveness, but are also likely to lead to income gains for households in every decile This report provides detailed evidence of the revenue cost of of the income distribution, and particularly for the poor. Preliminary alternative scenarios for tariff reform. These scenarios vary in work produced by the World Bank’s research department combines product coverage, ranging from ample liberalization -scenarios (1), data on agricultural and manufacturing tariffs with household (2) and (3) in Table 1, which imply a relatively larger impact on forgone surveys to simulate the impact of trade liberalization on household tariff revenues, to targeted reductions on inputs mostly used for welfare. For Nepal, these simulations suggest average net welfare the production of high-potential products- scenarios (4) and (5), gains of 1.7 percent of a complete tariff liberalization. These gains focusing on cotton fabrics and on key intermediates imported by 1 are positive, on average, along different levels of expenditure apparel, pashminas, and carpet producers. of households, and greater for the poor than for the rich. These estimated gains assume a complete rationalization, rather than a This report recommends that reforms be implemented partial one as suggested in this paper, so they likely indicate a ceiling gradually, starting with scenarios (4) and (5). for the static gains. However, they do not account for the dynamic gains from trade integration, through increased productivity gains, [2] Simplify the duty-drawback system currently in place for which, per international evidence, tend to be sizable. exporters, while tariff reforms are in process. 1_In all scenarios, product choice is based on the understanding of input-output linkages for key products, and on alternative estimates for the elasticity of demand for imports with respect to tariffs. 10 I. EXECUTIVE SUMMARY TABLE 1. SUMMARY OF TARIFF REFORM SCENARIOS AND ASSOCIATED REVENUE IMPACT Reduction in Reduction in Scenarios revenues from revenues from all tariffs (%) taxes on imports (%) (1) Elimination of tariffs in raw materials 6.6 2.6 (2) Elimination of tariffs in intermediate goods 27 9.9 (3) Elimination of tariffs in capital goods 20.7 6.2 (4) Elimination of tariffs in cotton fabrics 0.6 0.2 (5) Elimination of tariffs for key intermediate inputs imported 1.2 0.5 by apparel, pashminas, and carpet manufacturers Source: World Bank calculations based on Nepal’s customs and tariff data. Note: the reduction in revenues from tariffs is calculated as the percentage change by which tariff revenue falls following the tariff reductions as per each of the scenarios. The reduction in revenues from all taxes on imports is calculated as the percentage change by which all import- related tax revenues fall following the tariff reductions as per each of the scenarios. To tap into unrealized trade potentials: [2] Improve the design of current export-promotion instruments, specifically, the Cash Incentive to Exporters. [1] Support firms in the process of compliance with GSP-related rules of origin. To tap into the unrealized export potentials, and reach the government objective of market diversification, firms may Results reported here show low utilization rates of GSP- benefit from better-designed export promotion instruments. related export opportunities by Nepalese firms. Firms The government has in place the Cash Incentive to Exporters exporting products that are in principle eligible to receive (CISE) scheme. This incentive scheme was subject to a recent preferential treatment under GSP may not use the impact evaluation by the World Bank (see Defever et al, 2017), preference. This is likely related to challenges complying which revealed that: (i) the subsidy has not been reaching the with rules of origin. There is ample evidence pointing to firms it meant to support due to a lengthy and complex filing complex rules of origin in reducing GSP utilization rates. procedure, coupled with limited resources and a first-come first- While there is little that Nepal can do to make rules of serve allocation mechanism, (ii) it has focused on subsidizing origin more user-friendly, the government can support firms that were already exporting, and (iii) it has not had any exporters in complying with them by building firms’ impact on export values or quantities. The funds allocated to this capabilities around bookkeeping, and management of incentive could help tap into the unrealized export potentials if input certification as requested by border agencies in the incentive scheme was redesigned along the following lines. the United States, EU, and other GSP-granting countries. For these purposes, the government of Nepal, and the First, the export incentive should apply to new export flows Ministry of Commerce and Supplies could work together (either increments of exports by existing firms, or exports of 2 with the different trade representatives of each GSP- new firms). An exporter would be entitled for an incentive of X granting country or blocs. percent on the incremental growth (achieved by the exporter) 11 I. EXECUTIVE SUMMARY on the free-on-board (FOB) value of exports. Incremental The report also identifies high-potential products in specific growth shall be calculated respective to each product- markets, particularly where there are preferences untapped. destination combination for each exporter. New firms would Here again, export promotion efforts could be focused, by naturally be entitled to obtain the X percent incentive. first identifying challenges firms face to enter markets and designing interventions to overcome them. Second, the filing process needs to be simplified and the allocation mechanism needs to be transparent. This To increase GVC participation: will also reduce the cost of administering the scheme for the government. Specifically, Nepal Rastra Bank should [1] Increase integration in services, in investment, to secure “deep implement the fast track agreed with the Department of integration” with existing and potentially attractive trading partners. Industry, by which certain products do not need to prove domestic value-added content. This has been agreed in the If Nepalese firms are to enter regional and global value Budget Speech of 2070, although, to-date, it has not been chains, they need policies that reduce trade costs at the implemented. In addition, the government of Nepal needs border but also go beyond that. Integration initiatives are to move towards electronic filing of the incentive. In terms becoming “deeper” worldwide, including provisions on of the allocation, if potential incentives accruing to eligible services, investment, competition, etc. This is crucial in a firms exceed available funds, the allocation of funds needs world in which production is fragmented internationally. to be done in a transparent manner. An option is to make the Yet, Nepal’s only full-scope free-trade agreement, SAFTA, allocation random through a lottery process. is among the shallowest in the world, and with limited prospects for advancement in the deep integration arena. Third, the government may gain from allocating part of Nepal needs to seek deeper integration initiatives beyond the CISE funds to finance export intelligence and other the region, and including for example, the Association promotion activities. These funds could be managed by of Southeast Asian Nations (ASEAN)-a bloc including business associations, and subject to strict mechanisms of countries with which Nepal faces high unexploited export accountability, monitoring, and evaluation. They could be potentials. allocated towards provision of export intelligence for small and medium enterprises, and support for participation in [2] Strengthen BBIN transit agreement. exhibitions and trade fairs. The transit agreement including Bhutan, Bangladesh, [3] Focus the supply of export intelligence on high-potential India, and Nepal is crucial for improved connectivity and products and markets. reduced transport and therefore trade costs. This is particularly the case for a landlocked country such as This report identifies high-potential markets-that is, those in Nepal, and given that markets with untapped potential which Nepal is substantially under-exporting, with respect are within the route of that corridor (including ASEAN to the benchmark, based on trade costs and relative market members). Recent research shows the importance of sizes. Export promotion efforts would be more effective combining infrastructure with trade policy reforms to if focused on these high-potential markets, by providing maximize gains (Baniya et al, 2017). exporters with information on shipment costs, consumer preferences, and compliance with key standards and rules In addition, two sets of complementary government actions in these destinations. are likely to make trade policy reforms more effective: 2_The underlying market failure that the export incentive is trying to alleviate is one of high discovery costs. Specifically, the incentive aims at helping firms financing the informational costs at the beginning of the process. Therefore, it is important that the incentive targets new firms, or new export flows, rather than existing, well-established ones. 12 I. EXECUTIVE SUMMARY [3] Attract, retain, and connect FDI to the economy through role in explaining Nepal’s trade performance. These reforms to the investment policy regime. obstacles include, but are not restricted to: (i) the inadequate supply of electricity, leading to high energy First, simplify processes for the repatriation of funds and for uncertainty and costs, (ii) challenges to accessing hiring foreign workers. Regarding the former, while the law finance at competitive prices, (iii) access to qualified does provide foreign investors the right to repatriate funds labor, and (iv) lack of competition in key backbone related to foreign investment, in practice repatriation is input markets including transportation (that, for difficult and obtaining approvals is a lengthy process (World example, account for 20 percent of the input bill paid Bank 2015b). Introducing automatic notification systems by agricultural exporters) and logistics services. Results would be helpful. presented here hint to these factors being impediments to increasing exports along the intensive margin-that is, Second, consider removing or lowering entry barriers to increase shipments within existing flows of a given to foreign investment, including foreign ownership product to a given market. limitations, sector caps, a long negative list, and restrictions in nonequity modes of investment. For To improve the overall export climate behind the border: example, Nepal retains a foreign ownership limit of 51 percent in some selected sectors, such as legal, [1] Continue efforts to attract investments in hydropower accounting, and engineering services. The country to ensure long-run supply of electricity at competitive imposed an even lower foreign participation limit in prices. banking and finance, a sector crucial for the private sector to flourish. Access to finance was among the This entails working towards reducing barriers to FDI as top five constraints identified by exporters to grow. mentioned above. Restrictions in nonequity modes of investment, such as franchising, in which there is significant technology, [2] Promote competition in key backbone services markets. training, and skills transfer, cause additional delays and costs during entry and operations in Nepal. Slow Services are key for the efficiency of the productive and arbitrary approval processes, dual registration sector, as they are crucial inputs for production. For procedures, delays in trademark registration, and example, in the agricultural sector, 20 percent of difficulties in remitting royalties and technical fees production costs is accounted for transport. Ensuring are among several obstacles faced by these type of competition in the services is therefore paramount for investments (World Bank 2015b). overall competitiveness. [4] Continue efforts to reduce structural barriers for [3] Reduce rigidities in the labor market, and ensure export competitiveness, focusing on high potential access to qualified labor. value chains. Part of the constraints identified by firms relates to To be sure, there are many other obstacles to export rigidities in the labor market, as well as difficulties faced competitiveness beyond those imposed by trade by firms to access qualified workers. The buildup of policies that are the focus of this report, although skills, and the reduction of rigidities will help boost job results presented here suggest they play an important creation in the tradable sector. 13 I. EXECUTIVE SUMMARY TABLE 2. SUMMARY OF MAIN POLICY RECOMMENDATIONS Purpose Recommendation Eliminate import tariffs for intermediates used for high To reduce the anti-export bias of the tariff code (1) potential export products following suggestions in scenarios 4 & 5 of Table 1. (2) Simplify the duty-drawback system. Make it accessible for direct and indirect exporters (e.g. those that sell to tourists). Support firms in complying with GSP rules of origin, through To tap into unrealized trade potentials (1) the provision of trainings on bookkeeping and management of input certifications. Liaise with main GSP-granting country trade representatives to support these efforts. Redesign the Cash Incentive to Exporters, by allocating the (2) subsidy to new rather than existing flows, by implementing the fast track for certification of domestic value added, and by introducing clear rules of allocation of funds, such as a lottery. Allocate funds to provision of export intelligence services for (3) high-potential markets and products as identified in this report and subject to strict monitoring and evaluation mechanisms. To increase GVC participation (1) Seek increased integration in services and in direct investments, as well as on customs reforms and cooperation. (2) Strengthen BBIN transit agreement to reduce transport costs and improve connectivity with the region and beyond. (3) Seek to partner with regions exhibiting greater trade complementarities, and that offer deeper integration opportunities. Facilitate FDI attraction by: (4) (i) simplifying processes for repatriation of funds of multinationals, introducing automatic notification systems; (ii) re-evaluating the rationale of low equity limits for foreign ownership in selected business and professional services (e.g., legal, accounting and engineering) as well as banking and finance. Consider eliminating these limits; (iii) reconsidering long negative list in the new foreign investment policy; (iv) removing restrictions in nonequity modes of investment for franchising; (v) increasing transparency in firms’ approval, registrations, and trademark registration processes. To improve the overall export climate (1) Continue efforts to attract investments in hydropower to ensure behind the border long-run supply of electricity at competitive costs. Promote competition in key backbone services markets, (2) specifically in transport and logistics, as well as in finance (see below, on equity limits for foreign investment in finance). (3) Reduce rigidities in the labor market, and ensure access to qualified labor. (4) Identify regional value chains with maximum potential and focus efforts on strengthening these. Source: World Bank elaboration. 14 II INTRODUCTION 15 II. INTRODUCTION The past decade saw Nepal as the slowest-growing This report looks at how Nepal could move away country in South Asia. Averaging 4 percent per from a remittance-driven growth model by reforming year, economic growth has not been enough to reach its trade policies to increase competitiveness. the government’s objective of achieving lower-middle While remittances have helped Nepalese households income status by 2020. In addition, Nepal’s current support consumption and have lifted many out of growth pattern is failing to create jobs for most of its poverty, from a macroeconomic perspective, they have population, and has induced a quarter of the workforce contributed to large trade deficits, and to an appreciation to seek employment opportunities elsewhere, making of the real exchange rate, leading to decreased price Nepalese households highly dependent on remittances competitiveness. The report examines where the binding for consumption. Nepal needs to change its growth constraints are, identifies trade policy levers to alleviate drivers if it is to unlock private sector growth and create them, and proposes specific trade policy reforms aimed more and better jobs. at increasing competitiveness through the adoption of a new, outward oriented, investment and productivity-led For a small economy such as Nepal, embracing growth model. trade and investment is crucial for growth and development, and yet, Nepal seems to be missing The report is structured in two sections. the boat. Integrating further to the region and the world through trade will help domestic firms access a larger The first one identifies unexploited trade potentials market, gain exposure to better technologies and more and assesses the extent to which Nepalese firms varied intermediate inputs, and become more competitive. have been profiting from regional integration Integration through investment may help firms secure initiatives, and from granted trade preferences. It finds access to sophisticated markets, absorb knowledge, learn that there are substantial unexploited trade opportunities about better managerial practices, and alleviate financial in the region and beyond. These opportunities have been constraints. Yet, Nepal has not fully taken advantage of largely untapped because of a combination of (i) supply-side integration. Export shares have fallen, participation in constraints that increase trade and production costs and regional and global value chains is low, and attraction of make export flows remain small—availability of electricity, FDI is underwhelming. As far as integration is concerned, access to finance, inadequate infrastructure, (ii) low firms’ Nepal seems to be missing the boat. capabilities that make it difficult for firms to benefit from existing trade preferences, and (iii) policy barriers that Geography and conflict have not helped. Still, there prevent domestic firms from connecting to multinationals is a role for policy reforms. The subpar integration and that negatively affect the import-to-export environment. performance cannot be blamed on geography and conflict It proposes several reforms to reduce trade costs, while the alone. Trade policies have not been supportive enough or longer-term agenda to address supply side constraints is have impeded firms from accessing foreign markets for implemented. Specifically, it argues that Nepal would benefit their output or to source inputs. Restrictive investment from (i) moving to deeper forms of integration that also policies have prevented the attraction of FDI, its retention, focus on attracting investment and encouraging services and its connection to domestic firms. Barriers to services trade, (ii) improving firms’ managerial capabilities to profit trade have had negative implications on the quality and from preferences and link to regional value chains, and (iii) cost of available backbone services, such as transport, redesigning the export incentives framework to promote telecoms, and finance. diversification, following international good practices. 16 II. INTRODUCTION But part of the problem with Nepal’s anti-export bias in its trade policies lies with import taxes being an important source of government revenue. Therefore, the second section examines alternative scenarios for tariff reforms that would substantially improve the import- to-export environment, taking the fiscal restriction very seriously. It analyzes avenues to simplify its tariff code and reduce its anti-export bias and estimates the fiscal revenue cost. It finds that, contrary to expectations, the fiscal cost of a reduction of tariffs on raw materials, intermediates and capital goods is manageable in the medium run, while a more comprehensive tax reform is designed and implemented. In the short run, tariff reductions on key intermediates for the priority export sectors are found to have negligible effects on tariff and other trade related tax revenues. It proposes five alternative tariff policy reforms, as well as a feasible sequencing scheme. The remainder of this report is structured as follows. Section III considers fully exploiting trade potentials. The first part of the section uses a gravity-founded framework to identify potentials, and identifies whether underperformance is explained due to challenges to diversify or challenges to increase shipments in existing destinations. It looks at patterns of trade and trade complementarities by region and trading bloc. Then, it assesses the extent to which Nepal benefits and uses existing trade agreements and trade preferences. Finally, it looks at how Nepal can benefit from moving to deeper integration schemes, particularly by further integrating with respect to investments and services trade. Section IV looks at improving the import-to-export environment. The first part of the section presents international evidence on the importance of trade policy reforms for competitiveness. Then, it carefully estimates the trade and tax impact of five alternative tariff reforms and presents a proposal for medium- and short-term changes, as well as alternatives to recouping potential tariff revenue losses. 17 III FULLY EXPLOITING TRADE POTENTIALS 18 III. FULLY EXPLOITING TRADE POTENTIALS The purpose of this section is to inform Nepalese III.1 A Gravity-Founded policy makers on untapped trade potentials and on Snapshot of Trade Potentials alternative avenues for realizing them. Nepal has been trading under its potential over the last Understanding where the largest untapped potentials decade. Comparing Nepal’s observed export pattern with its for increased trade lie is important for effective policy potential can assess trade performance. To calculate trade making. Identifying dynamic markets with which trade is potentials, the report relies on a gravity model of trade, essentially currently below potential and where trade complementarities considering the capability of a country and its market access (see could lead to mutual gains is helpful to guide public policy Box 1 for details). Exports are expected to be higher when the efforts in two ways: it can help prioritize trade agreements capabilities of the exporter are high and when foreign demand and reduce trading costs, and it can provide targeted trade is also high (market access). Figure 1 shows that Nepal has been intelligence to firms that may be well positioned to serve the underperforming, both from a global and regional perspective, identified markets. since 2005, while other countries in the region—except for conflict- prone Afghanistan, or more recently, Bhutan—have been exporting It is important to identify the trade policy instruments in line with the conditional average (they are on the regression that permit realizing the potentials. This section first line). This low export performance observed in the aggregate is identifies Nepal’s trade potentials. It then assesses how consistent with an inadequate investment climate, as well as with two instruments, regional trade agreements and trade low FDI—a crucial conduit for market access and knowledge and concessions, have helped in realizing Nepal’s trade potentials. technology transfers. The focus is on SAFTA membership and on the use of trade preferences granted by advanced economies. It argues that Underlying the poor performance are challenges to it is crucial for Nepal to go beyond shallow integration, and to increase shipments of active export products to existing seek deeper integration with the rest of the world if Nepalese destinations rather than to export new products. That is, the firms are to take advantage of the powerful platform that challenge seems to be in the intensive rather than in the extensive GVCs constitute for export growth and job creation. In the margin. Indeed, results reveal that the number of exported goods next section, the focus is placed on the opportunities that by destination is on average aligned with potentials, while the an improvement of the import-to-export environment could average shipment size by destination is subpar, when compared pose for Nepalese firms interested in venturing into export to international competitors (Figure 2). This suggests that some markets. In that case, the instrument considered for realizing of the challenges may lie with the variable costs of operations, the potential consisted in unilateral trade policy reforms to associated with the scale of firms and their ability to secure reduce Nepal’s tariff code anti-export bias. working capital, energy, and qualified labor to expand shipments. It is also in line with responses provided by firms to the World Bank’s The remainder of this section is structured as follows: It Enterprise Survey of 2013: among exporting firms 24 percent starts with a snapshot of trade potentials based on a gravity identified electricity costs as their most important obstacle, modeling. It then looks at Nepal’s trade performance within while 17 percent identified access to finance. These two are the specific trading blocs and discusses how Nepalese firms have most important obstacles for exporters after political instability. made use of concessions granted by advanced countries. In addition, Nepalese firms have shown sluggish growth over The final part of the section looks at how Nepal can gain their lifecycle, not only when compared with firms in developed from deepening its integration with the world and how that countries, but also when compared to others in the neighboring 3 deepening can help exporters enter in GVCs. region of East Asia. 3_See “South Asia’s Turn: Policies to Boost Competitiveness and Create the Next Export Powerhouse,” World Bank (2017), pp. 29-30. 19 III. FULLY EXPLOITING TRADE POTENTIALS FIGURE 1. MULTILATERAL EXPORTS AND MARKET ACCESS FOR NEPAL: 2005 AND 2014 Source: World Bank calculations based on UN-Comtrade-BACI database (CEPII). Note: The figure presents a scatter plot of actual exports (in logs, vertical axis) against potential exports (in logs, horizontal). Each point corresponds to a country as an exporter. Countries below the line show lower exports than potentials. FIGURE 2. NEPAL’S PERFORMANCE IN EXPORT MARKETS ALONG EXTENSIVE AND INTENSIVE MARGINS a. Number of Products Exported by Destination b. Average Size of Shipments Source: World Bank calculations based on UN-Comtrade-BACI database (CEPII). Note: Panel a shows a scatter of the log of the number of exported goods (vertical axis) against the potential (horizontal axis). Dots in red correspond to Nepal’s trading partners. Dots above the line indicate trading partners with which Nepal exports more product varieties than expected given potentials. Panel b shows a scatter of the log of the average export value (vertical axis) against the potential (horizontal axis). Dots in red correspond to Nepal’s trading partners. Dots above the line indicate trading partners with which Nepal exports larger shipments than expected. 20 III. FULLY EXPLOITING TRADE POTENTIALS There are only a handful of countries with which Nepal There are 25 large and fast-growing economies with which exports at potential. Results reveal that both for 2005 Nepal could substantially expand exports. The results that and 2014, with most partners, Nepal has been exporting emerge from the simple gravity benchmarking discussed above 4 below potential. A policy-relevant question to address is are combined with information on the size (GDP) and the dynamism hence: which are the relatively unexploited and large export (GDP growth) of Nepal’s export partners to identify high-potential opportunities? export markets. These export markets are those with which Nepal BOX1. ESTIMATING NEPAL’S TRADE POTENTIAL WITH GRAVITY EQUATIONS In its general version (here adapted from Head and Mayer 2014), the gravity equation represents trade flows between two countries i and j by the following relation: where represents the export value from i to j, captures the capability of country i to export to all destinations, and expresses bilateral accessibility between i and j. The variable expresses the characteristics of the destination market j that affect imports from all sources. One can show further that , where is the total expenditure of country j and measures the average accessibility of consumers in j to supplies from rest of the world (also referred to as the degree of competition in country j). Equation 1 can be aggregated to express total exports of a given country, like Nepal, to the world. Summing over all destinations j and rearranging, one obtains the expression for total exports ( ): where is the market access of country i to the world, as it represents the sum of expenditures addressed to i, weighted by the relative bilateral access between country i and j, compared to all other exporters to j (that is, ). It is interesting to see that two elements determine total exports of a country I, its capability ( ) , and its market access to the world. From theory to the data To predict total exports of a country (that is, to estimate its potential exports), the capabilities of that country and its access to world markets are proxies by the multiplication of the GDP of the exporter and the sum of GDPs of importers, respectively weighted by the inverse of their distance to the exporter. In the same manner, one could obtain another simple prediction of bilateral exports by multiplying the GDP of an exporter with that of the importer and dividing by distance between them. By comparing predicted (bilateral) values to actual (bilateral) flows, one could deduce over- or under-performance of a country. Note: a. The gravity model has been extensively used in international trade due to its intuitive empirical and theoretical appeal. Anderson and van Wincoop (2003), Feenstra (2004), and Baldwin and Taglioni (2006), among others, present exhaustive literature reviews on the gravity equation as applied to international trade. Source: Adapted from “Trade as a Vehicle for Growth in Afghanistan: Challenges and Opportunities,” World Bank (2017). 4_Figure 34 in the Appendix shows bilateral exports plotted against potential (again, using a simple gravity benchmark, here defined as capability and market access of each exporting country). The red dots are bilateral export flows for Nepal with every export partner. 21 III. FULLY EXPLOITING TRADE POTENTIALS FIGURE 3. HIGH-POTENTIAL EXPORT MARKETS FOR NEPAL Source: World Bank calculations based on UN-Comtrade BACI database (CEPII). Note: The index is calculated as the residuals from the gravity equation described in Box 1. substantially underperforms and that are in the top half of the agreement includes a quarter of the world’s consumers, distribution of size, and in the top half of the distribution of GDP it only accounts for 3.4 percent of consumers’ 5 growth (Figure 3). Among these high-potential partners are purchasing power. As mentioned, Nepal is a member of Indonesia, Philippines, Thailand, Singapore, and Vietnam—leaders SAFTA (and has a partial scope agreement with India). While in GVC trade, as well as other members of SAFTA such as Pakistan SAFTA member countries account for a large portion of the or Bangladesh, and countries that are linked with Nepal through world’s population, they are also among the poorest. Still, intense migration flows, such as Saudi Arabia, Kuwait, Qatar, and Nepal’s export opportunities are enhanced by the concessions United Arab Emirates. it receives through the GSP system and the Everything 6 but Arms (EBA) initiative. What are the complementarities Finally, India is the only large and dynamic economy with which between Nepal’s trade structure, SAFTA, and other trading Nepal is trading at its potential. Smaller and less dynamic partners blocs? How have the export flows been evolving and what in the region with trade at potential include Maldives, Bhutan, is the evidence of SAFTA’s success in generating export and Afghanistan. A follow-up question, considering these results, opportunities for Nepal? is: has the SAFTA integration initiative paid off? How has Nepal been profiting from these initiatives and other granted market concessions? This is the focus of the section that follows. III.2.1 Aggregate Trade Patterns by Bloc of Destination and Origin III.2 Agreements and Preferences Figure 4 and Figure 5 display the trade patterns between in Place: Is Nepal Taking Nepal and SAFTA member countries. India dominates both Advantage of Them? export and import sides. When looking at trade patterns with various trade blocs, most of Nepal’s exports go to either Although Nepal’s only full-scope international trade SAFTA or GSP granting countries, namely United States and 5_GDP growth is calculated for the period 2005-2014. 22 III. FULLY EXPLOITING TRADE POTENTIALS FIGURE 4. NEPAL’S EXPORTS TO SAFTA MEMBER COUNTRIES FIGURE 5. NEPAL’S IMPORTS FROM SAFTA MEMBER COUNTRIES Source: WITS, World Bank. HS1996 mirror data. FIGURE 6. NEPAL’S EXPORTS TO VARIOUS TRADE BLOCS FIGURE 7. NEPAL’S IMPORTS TO VARIOUS TRADE BLOCS Source: WITS, World Bank. HS1996 mirror data. FIGURE 8. NEPAL’S EXPORTS TO GSP GRANTING COUNTRIES EU (Figure 6). Most of the products imported to Nepal come from SAFTA, namely, India (Figure 7). Exports to GSP granting countries, instead, have been decreasing since the early 2000s, with a minor pick up of exports to Turkey in recent years (Figure 8). III.2.2 Trade Complementarities The extent to which two potential trading partners have complementary production structures provides some information on the potential gains that can be obtained Source: WITS, World Bank. 6_The Generalized System of Preferences (GSP) allows developing countries to pay less or no duties on their exports to granting countries for approximately two-thirds of all product categories. Granting countries in the case of Nepal include Australia, Belarus, Canada, EU, Iceland, Japan, Kazakhstan, New Zealand, Norway, Russian Federation, Switzerland, Turkey, and the United States. The Everything but Arms (EBA) arrangement for least developed countries (including Nepal) grants duty-free, quota-free access to all products except for arms and ammunitions, being thus, more generous than the GSP arrangement. 23 III. FULLY EXPLOITING TRADE POTENTIALS by reducing trade costs through an international trade index increased by approximately 10 percent over the period, agreement. There are several economic-theory grounded and, currently, together with Pakistan, are the two partners rules of thumb that help evaluate the potential gains from in the region with the greatest trade complementarities. preferential trade agreements (PTAs). An important one is Interestingly, India, Nepal’s main trading partner, shows the related to the differences in comparative advantage between lowest (and declining) value. This result emphasizes the partners and the initial share of trade between them. The higher importance of diversifying away from its main trade partner, if these are the more likely an integration initiative will be welfare sustained export growth is to be achieved. 7 improving. Trade complementarity indices can help shed light on this rule of thumb. The greater complementarity between Some international comparisons are useful for the trading partners, the more likely it is that both gain from a benchmarking. Piazolo (1997), for example, assessing trade agreement (and that protectionist vested interest can be welfare implications of integration of Eastern and Western contained (Piazolo, 1997)). Essentially, these indices measure the Europe reports that trade complementarity indices between extent to which the export profile of a given country matches, or candidates for EU enlargement at the time (Bulgaria, Hungary, 8 complements, the import profile of the partner. Poland, Czech Republic and Slovak Republic) and the core EU ranged between 45 and 59. The indices for countries in Nepal’s export complementarity with SAFTA and with the North American Free Trade Agreement (NAFTA), were an India in particular has been decreasing over time. For the average of 56, 64 between the United States and Canada, period 2003-2015, the match between Nepal’s export bundle and for other unsuccessful arrangements such as the Latin and the import bundle of SAFTA member countries has been American Free Trade Agreement (LAFTA) or the Andean declining (Figure 9). While the series have fluctuated during the Pact (Bolivia, Colombia, Ecuador, Peru and Venezuela), 22 period, the complementarity between Nepal and SAFTA reached and 7 respectively. More recently, WTO (2007) calculates a peak of 54 in 2005, and declined by about 10 points to 45 in complementarities between the United States and Chile 2015. Patterns by country reveal that complementarities have above 80, for Chile and Mexico close to 70, and with Canada fallen with all partners except for Bangladesh, with which the just above 60. FIGURE 9. NEPAL’S EXPORT COMPLEMENTARITY INDICES WITH SAFTA MEMBERS Source: World Bank calculations based on UN Comtrade. Note: the figure plots complementarity indices that range from 0 (no complementarity) to 100 (perfect complementarity). 7_The Sussex Framework (Evans, et al, 2007) suggests three rules of thumb in evaluating the welfare gains associated with integration. Apart from the aforementioned, the other two are related to how large the tariff reductions are (the greater they are, the greater the likelihood of both trade diversion and trade creation), and the number of partners in the agreement, and their degree of similarity in their product mix (the greater these are, the more trade creation there will be because of more scope for specialization). 8_The index values range from zero–when goods exported by one country are not imported by the potential partner, to 100, when there is perfect positive correlation. For details on the construction of the index see http://wits.worldbank.org/WITS/docs/TradeOutcomes-UserManual.pdf. 24 III. FULLY EXPLOITING TRADE POTENTIALS Complementarities with more advanced economies SAFTA with a valid ‘counterfactual.’ The right counterfactual have increased slightly. With the EU, for example, is an estimate of what would have happened with trade complementarity is the highest, and increased slightly from 49 with SAFTA member countries had SAFTA not been in to 51 during the period (Figure 10). Increases are also observed place. To do that the report follows a difference-in-difference for Japan and Australia, although in both cases these have approach within the framework of a structural gravity model been mild. With China, instead, Nepal’s complementarity that essentially consists of computing two differences: the index is the lowest and declining to just above 40 percent. difference in trade before and after SAFTA came into place Interestingly, both of Nepal’s neighbors—India and China— and the difference in trade with SAFTA member countries are the ones with lower complementarities. In addition, a and all other partners. The relevant effect to scrutinize is the 10 comparison of Figure 9 and Figure 10 reveals that, considering coefficient on SAFTA*Before/After reported in Table 3. complementarities only, there are some potential gains from deepening integration with large countries outside the region. There is no clear effect of SAFTA on trade among 10 member countries. Results from alternative specifications reveal no positive effect of SAFTA on trade within the region. III.2.3 Is Nepal (and the Region) Different specifications allow for lags both in implementation Profiting from SAFTA? of the agreement, and in the process of adjustment of traders to the new set of rules, by comparing trade flows in 2001 with The trade patterns of Nepal with SAFTA members those in 2014 (column 2); flows in 2001 and 2002 with those in suggest increases mainly in imports, and also in 2013 and 2014 (column 3); and flows in 2001, 2002, and 2003 with exports, following the announcement of the SAFTA those in 2012, 2013 and 2014 (column 4). In all cases estimated 9 agreement in 2005/6. Indeed, patterns shown in Figure effects are not significantly different from zero, suggesting that 4 and Figure 5 reveal systematic increases in imports, and SAFTA had no effect on trade flows within the region. The only while more volatile, also some increases in exports. Can case in which a statistically significant result (although negative) those increases be attributable to SAFTA? To answer this is obtained is by looking at the whole period (column 1), which question rigorously, it is necessary to compare trade under unrealistically assumes full implementation of SAFTA in 2006. FIGURE 10. EXPORT COMPLEMENTARITY INDICES WITH MAIN GSP-GRANTING COUNTRIES AND CHINA Source: World Bank calculations based on UN Comtrade. Note: the figure plots complementarity indices that range from 0 (no complementarity) to 100 (perfect complementarity). 9_SAFTA agreement was reached on January 2004, at the 12th SAARC summit. The agreement came into force in January 2006, with a multi-speed approach. India, Pakistan, and Sri Lanka committed to reduce duties to 20 percent in the first phase (by 2007), with subsequent annual cuts until duties reach zero (that was committed to happen by 2012). Nepal, Bhutan, Bangladesh, Afghanistan, and Maldives had an additional three years to reduce tariffs to zero. Notice that there have been previous integration efforts. Among the first initiatives was the agreement signed in 1985 among all the aforementioned countries except for Afghanistan, and known as the South Asian Association for Regional Cooperation (SAARC). Then, in 1995, SAARC launched the South Asian Preferential Trade Arrangement (SAPTA). 10_The econometric model estimated to gauge the effect of SAFTA on trade flows is a structural gravity model that controls for time-invariant and country pair specific effects, country of origin, and time variant effects, and country of destination time variant effects. SAFTA is modeled as a step-dummy that takes value 1 for the countries that are signatories to the treaty, for the years in which SAFTA has been in place (allowing for different implementation timeframes). The estimation technique is a Pseudo Poisson Maximum Likelihood (PPML). 25 III. FULLY EXPLOITING TRADE POTENTIALS There are two potential explanations for null effect of Effects of SAFTA for Nepal’s formal trade have SAFTA on members’ trade. First, regional trade frictions mostly worked through increased imports—mostly of have increased after the crisis—specifically, in the form of non- intermediates—rather than increased exports. Both the tariff barriers, offsetting to some extent the tariff reductions aggregate trade and the product-specific estimations allow for achieved through the agreement. Second, most important Nepal-specific effects on exports and imports (the interactions impediments to trade within the region may not be associated SAFTA Before/After*Nepal Exporter; SAFTA Before/After*Nepal with market access but with barriers that require deeper forms Importer, respectively). Results hint to some positive effects on of agreements to tackle them, including free movement of the import side, mainly on increased imports of intermediates– investment, harmonization of standards, and elimination of indeed, import data at the transaction level revealed increased non-tariff related barriers to trade. This hypothesis will be usage of imported intermediates. This may be associated with more formally tested in the next section III.3, when, using the increased integration into regional value chains, although the same methodology, the effect of the depth of agreements on effects on the export side are not visible in the data. Of course, .11 trade patterns will be explored these results refer to formal trade. However, one would expect that increased regional integration efforts lead to a decline in The effects of SAFTA have been heterogeneous by formal trade costs, and therefore, that trades that happened type of traded good, although negative when it has informally before, became formalized. For the case of Nepal, a been significant. When the effect of SAFTA is estimated by country with a long porous border with India, and where informal type of product traded, results show no effects for primary, trade plays a big role, this may be a sizable channel. However, processed, and consumer goods, and negative effects for results presented here do not suggest increases in formal 12 capital goods and intermediates (Table 4). exports to be traced to SAFTA. It is yet worth mentioning that TABLE 3. IMPACT OF SAFTA ON MEMBERS’ EXPORTS All Period 2001 v 2014 2001/2 v 2013/14 2001/3-2012/14 (1) (2) (3) (4) SAFTA Before/After -0.200** -0.0829 -0.182 -0.215 -0.0966 -0.189 -0.177 -0.165 SAFTA Before/After*Nepal Exporter -0.0271 0.416 0.385 0.0404 -0.227 -0.378 -0.331 -0.288 SAFTA Before/After*Nepal Importer 0.154 0.586* 0.584** 0.318 -0.185 -0.348 -0.296 -0.262 Observations 304,971 42,380 84,893 127,763 R-squared 0.975 0.976 0.974 0.974 Source: World Bank calculations. Note: (1) PPML estimations. All specifications include bilateral fixed effects and country-time fixed effects. (2) Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1. 11_There is little evidence on the ex-post effects of South Asia integration agreements and regional trade. An exception to this is Regmi, Devkota and Upadhay (2017). Instead of looking at the effects of SAFTA specifically, the authors focus on the effects of all the regional integration efforts in South Asia, comparing before and after 1995 (when the SAPTA was launched), within a gravity framework. They do find evidence of trade creation, and little trade diversion. However, their approach differs from ours. First, the authors do not use a structural gravity, failing to control, for example, for unobservable, time-varying and exporter and importer varying effects, which increases the scope of biases in the estimates due to omitted variables. They also do not allow for adjustments and implementation delays in the agreements, as they compare the before and after 1995, when a (very) shallow agreement was simply signed. 26 III. FULLY EXPLOITING TRADE POTENTIALS TABLE 4. IMPACT OF SAFTA ON MEMBERS’ EXPORTS BY TYPE OF TRADED GOOD 2001/3-2012/14 2001/3-2012/14 2001/3-2012/14 2001/3-2012/14 2001/3-2012/14 Primary Processed Capital Goods Interm. Goods Consumer Goods SAFTA Before/After 0.380 0.721 -1.325** -1.455*** -0.360 (0.530) (0.457) (0.533) (0.455) (0.314) SAFTA Before/After* 0.113 0.0147 -0.425 -0.707*** -0.287 Nepal Exporter (0.294) (0.203) (0.357) (0.136) (0.211) SAFTA Before/After* 0.286 -0.159 0.0947 1.242*** -0.731** Nepal Importer (0.518) (0.354) (0.362) (0.459) (0.346) Observations 117,574 125,298 120,998 117,203 122,817 R-squared 0.982 0.950 0.983 0.977 0.984 Source: World Bank calculations. Note: (1) PPML estimations. All specifications include bilateral fixed effects and country-time fixed effects. (2) Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1. survey results suggest that informal traders in Nepal and India III.2.4 Is Nepal Profiting from GSP? have developed efficient mechanisms for enforcing contracts, exchange information, and sharing and mitigating risks. They The GSP system has been in place for decades, with Nepal tend to avoid formal channels since transaction costs are being one of the beneficiaries. The long-standing nature of substantially lower when these are kept informal. This suggests the scheme implies that, given data availability, it is not possible that if informality is to be reduced, integration initiatives need to estimate its impact on Nepal’s export flows in the same manner to be deepened further, so that transaction costs fall (see, for as it was done for SAFTA in the previous subsection. This is example, Taneja, N. and S. Pohit, 2001). because the before/after comparison is not available. Instead, this FIGURE 11. EXPORT SHARES TO GSP GRANTING COUNTRIES Source: World Bank calculations based on UN Comtrade. 12_Results by sector are reported when looking at the periods 2001, 2002, and 2003 versus 2012, 2013, and 2014. Alternative period choices yield analogous results. 27 III. FULLY EXPLOITING TRADE POTENTIALS subsection examines Nepal’s trade patterns with GSP-granting it needs to be directly imported into the United States, with the countries and the conditions under which products are eligible, importer claiming the benefit; and the exporter needs to be and identifies several products in which Nepalese exporters may able to provide production and accounting records to verify the benefit from utilizing the preferences more actively. GSP claim. This means that, apart from the firms’ capabilities in keeping information to prove local content, the main binding The importance of GSP-granting countries in Nepal’s export constraint for utilization may be related to rules of origin. basket has been falling substantially over the years. The shares of exports to GSP-granting countries (excluding the EU) and Rules of origin matter for using GSP (and EBA). There are to the EU halved, from around 45 percent in the early 2000s to different rules of origin that Nepalese products (and products less than 20 percent in 2016 (Figure 11). This implies relatively stable from other beneficiary countries) need to comply with to access exports to these groups of countries when measured in current GSP-granting markets at preferential tariff rates. In textiles and dollars (at around $100-120 million USD per bloc). garments, for EU preferences, until 2011, the rule was one of double-stage conversion: from yarn to fabrics to apparel. For For the case of exports to the United States, utilization garments only, this rule was changed in 2011, to one of single rates of these preferences are low. For example, exports transformation. An argument put forward in support of the double from Nepal to the United States in 2011 amounted to $78 transformation rule is that it would lead to the establishment of million, with only $5.1 million (7 percent) being under GSP, and backward linkages in beneficiary countries and contribute to the including silver jewelry, cigars, imitation jewelry, and national development of industrialization. While this may be restrictive flags. This is because many of the products in which Nepal has in small and less developed countries such as Nepal, the GSP 13 a comparative advantage are ineligible for GSP (see Box 2). system allows for diagonal accumulation within four regional Even among the list of eligible products, utilization rates are far groupings: ASEAN, Central American Common Market (CACM), the from being 100 percent, as reported by the Office of the U.S. Andean Community, and the South Asian Association for Regional 14 Trade Representative. The utilization rate of the preference Cooperation (SAARC). This means that originating materials from measures the share of imports of a given eligible product that regional partners can be further processed in another country of enters using the preference. In the case of Nepal, the utilization the group (say, yarn from India processed and converted into a rate in 2011 for hand-hooked carpets, for example, was of 49 pashmina in Nepal), and treated as if the materials were originated 15 percent. That means that about a quarter of a million USD of where the processing is undertaken (Nepal). This has facilitated exports of these type of carpets, from Nepal into the United the organization of regional value chains for the production and States failed to enter with a preference, and instead faced a 6 exports of textiles and apparel products in the region, although 16 percent MFN tariff. Utilization rates for silk shawls and scarves Nepal has not fully taken advantage of them. In which products are greater, at 60 percent, although still far below 100 percent. do GSP opportunities lay for Nepal? This is discussed below, with focus on the United States as a destination. Why would importers of Nepalese products that fall under GSP choose not to benefit from the preference? To qualify for duty-free treatment under GSP, the product III.2.5 Identifying High-Potential needs to be eligible; it needs to comply with rules of origin Products in U.S. Markets (for the case of the United States, this implies either being fully produced or grown in Nepal, or containing local content Despite a declining export share, the United States remains accounting for at least 35 percent of the value of the product); an attractive market for Nepalese exports. In which areas is 13_For the case of the United States, this includes most textiles and apparel, watches, footwear, handbags, luggage, and some gloves and leather goods. 14_See https://ustr.gov/sites/default/files/Nepal%20PP%20English%20August%202012.pdf 15_See Brenton (2003) “Integrating the Least Developed Countries into the World Trading System: The Current Impact of EU Preferences under Everything but Arms.” 16_The literature on the effect of trade preferences on LDCs exports is also mixed. For example, Herz and Wagner (2011) find a negative effect of trade preferences on exports of LDCs (of about 4 percent on average). The authors argue that in the short run GSP-granting countries do benefit because GSP-receiving countries import intermediates from them (to comply with rules of origin), but these often complex and strict rules of origin have distortive effects in the LDC in the long run, leading exporters to use MFN tariffs rather than the GSP preference. Instead, Thelle et al (2015) focus on EU preferences only and identify a positive effect on LDCs exports (of about 6 percent on average, and cumulative during the period). 28 III. FULLY EXPLOITING TRADE POTENTIALS TABLE 5. TARIFF LINES WITH GSP, GSP+ PREFERENCES ABOVE 10% GSP, GSP+ Nepal’s exports, FY15-16 countries, Jan-Nov ‘16 HS2 Sector Number Average Import to USA, to world, to USA, to India, of tariff effective US$ mln US$ mln US$ mln US$ mln, lines rate 2015 42 Articles of leather; saddlery 11 16% 1,503 2.2 1.20 16 Preparations of meat, of fish 4 15% 506 0.0 87 Vehicles other than railway or tram 2 10% 502 0.3 70 Glass and glassware 24 15% 462 4.3 3.83 81 Other base metals; cermets 4 13% 428 0.0 85 Electrical machinery and equipment 13 13% 307 1.5 69 Ceramic products 6 19% 158 0.5 0.19 20 Preparations of vegetables, fruit, 7 14% 157 31.1 0.13 4 Dairy produce; birds’ eggs; natural 94 15% 137 2.0 0.37 82 Tools, implements, cutlery, spoons 4 12% 77 0.1 0.02 96 Miscellaneous manufactured articles 5 13% 75 1.5 0.05 0.0735 61 Articles of apparel and clothing 1 12% 58 18.6 3.89 73 Articles of iron or steel 2 11% 48 10.2 0.04 62 Articles of apparel and clothing 1 12% 39 64.0 15.25 94 Furniture; bedding, mattresses, 2 11% 29 0.5 0.02 7 Edible vegetables and certain roots 6 14% 14 15.4 67 Prepared feathers 1 11% 14 0.2 66 Umbrella, sun umbrellas 1 10% 10 0.0 21 Miscellaneous edible preparations 9 16% 9 0.9 0.17 4.1082 91 Clocks and watches and parts 10 12% 7 0.0 8 Edible fruit and nuts; peel of citrus 5 22% 6 1.8 22 Beverages, spirits and vinegar 7 12% 4 0.4 85.3254 19 Preparations of cereals, flour 12 17% 2 6.6 0.76 45 Cork and articles of cork 1 13% 1 0.0 15 Animal or vegetable fats and oils 4 11% 1 1.0 86 Railway or tramway locomotives 3 13% 1 0.0 63 Other made up textile articles 3 10% 1 32.7 3.05 17 Sugars and sugar confectionery 5 12% 1 0.6 52 Cotton 6 16% 0 0.1 12 Oil seeds and oleaginous fruits 3 27% 0 6.8 0.16 27 Mineral fuels, mineral oils 7 11% 0 0.0 64 Footwear, gaiters and the like 1 11% 0 15.4 Total 264 14% 4,555 218.65 29.13 89.51 Source: Authors’ calculations based on USITC, Nepal Customs and WITS data. 29 III. FULLY EXPLOITING TRADE POTENTIALS there space for Nepalese exporters to take advantage of GSP to the United States and to other countries. The fact that preferences? they are already exported to the United States implies that the production capabilities exist in Nepal, and that Nepalese To answer this question, the report identifies products firms are already producing per the standards required by with high preference margins for Nepalese exporters. American consumers. The challenge there lies in growing at It combines the list of GSP eligible products, with the list the intensive margin—that is, increasing the size of shipments of products for which the effective tariff rate is above 10 of these products, thus creating more job opportunities for percent (that is, products for which, if imported from non- the Nepalese, which are associated with production and trade GSP countries would be taxed at the border with a 10 variable costs. percent effective tariff, thus providing a preference margin to Nepalese exporters of 10 percent). Then, it checks whether For new products, entering the United States poses U.S. imports any of these products from the GSP countries different challenges for Nepalese firms, mainly and whether Nepal exports any of these products to the associated with product certifications. Table 14 also world, the United States, and India. shows products that enjoy high preference margins that are exported by Nepalese firms to all countries but the United For products already being exported to the U.S., the States (highlighted in grey). In this case, the challenges that challenge is in Nepal’s supply capacity. There is potential arise relate to the fixed costs of entering a new market that for Nepalese exporters to increase their existing shipments to entail learning about the characteristics of foreign consumers, the United States, further benefiting from GSP preferences. adapting the product to their tastes, and complying with The products with the highest preference margin enjoyed by certifications and standards required in the importing market. GSP-receiving countries are shown in Table 5. The table shows Indeed, the list of products identified in this category are in bold, those lines of high potential. These are products with mainly animal and vegetable products, subject to strict relatively high preference margins that are already exported sanitary and phytosanitary controls in the importing market. BOX 2. OPPORTUNITIES FOR NEPAL AFTER EXPANDED LIST OF GSP-ELIGIBLE PRODUCTS FROM UNITED STATES In February 2016, the U.S. president signed H.R. 2695, Nepal Trade Preference Act (“the Act”), which provides duty-free access for 17 66 Nepali products to the U.S. market through December 31, 2025. Specifically, these products include certain carpets, headgear, shawls, scarves, and travel goods. The legislation also stipulates that the Nepali value added in the products should be, just as with other GSP-eligible products, of at least 35 percent of the appraised value of the article at the time it is entered the United States. Table 15 in the appendix shows Nepal’s current exports to the United States and the rest of the world of product categories 18 included in the list of duty-free products mentioned above. Two conclusions emerge: (1) Most of the products have already been exported from Nepal to the United States with some exceptions (420291, 570231, 570291, 570500). In these cases, Nepal has exported these products to alternative destinations, suggesting that the capabilities to produce and successfully enter export markets do exist in the economy. (2) There is potential for increased supply of many of these products under the new preferences granted by the United States. In some cases, this could happen through reorientation of exports away from other destinations and into U.S. markets (high-potential products are those which Nepal exports to the world but not to the United States). Source: Authors’ elaboration. 17_The list includes descriptions at 8 digits of the harmonized system (HS). 18_The list of 66 products with duty-free access is defined at 8 digits of the HS system, while the table offers export statistics at 6 digits. Variations from 6 to 8 digits are minor, and it is reasonable to assume that if the capabilities to export exist for a product at 6 digits, these also exist for 8 digit products. 30 III. FULLY EXPLOITING TRADE POTENTIALS III.3 Deepening Integration: Why is it The expansion of GVCs is related to the proliferation of Necessary and What Would It Take? deeper forms of integration. Cross-border production creates needs for the harmonization of certain policies and standards With GVCs being increasingly important, international across countries that were not existent when goods were integration needs to go beyond the elimination of trade produced in a single location. This is because now firms need to barriers at the border, starting with more integration in trade across borders, for example, customized inputs in a world in services and investment. Previous sections of this report which contracts are incomplete, and there are costs of searching 19 discuss alternative options of trade policy reforms. They start suitable foreign input suppliers. Thus, the changing nature of with a discussion of the extent to which existing agreements trade, from trade in final goods to trade in intermediate goods, is that focus on elimination of barriers to trade at the border responsible for the growing demand for deeper agreements that (SAFTA) and trade preferences (GSP) have benefited Nepalese can address these new cross-border effects. For example, with exporters. It is followed, in Section IV, by a discussion on GVC trade being intrinsically linked with investment, and with the how unilateral reforms of the tariff code could reduce anti- movement of (often proprietary) ideas, agreements need to go export biases thus increasing competitiveness while not beyond tariff reductions, to incorporate provisions on investment compromising tariff revenues. Yet, with production processes and intellectual property protection. being fragmented internationally, and most global trade being accounted for GVCs, the need for deeper integration, involving GVC-related trade and FDI are higher on average for not only removal of border barriers but also focusing on behind- countries that have signed deeper agreements. Figure 12 the-border impediments to trade has increased. Is it possible shows that GVC-related trade is higher on average for deeper that the null effect of SAFTA on member countries and Nepal’s agreements. Results from cross-country gravity models that include trade identified in section III.2 is related to the shallowness of measures of depth reveal that adding one provision in an agreement 20 that agreement? is associated with a 0.8 percent increase in GVC-related trade. FIGURE 12. DEEP PTAS AND GVC-RELATED TRADE Source: Calculations based on World Bank PTA content dataset (2016). Note: the figure shows the average GVC- related trade for countries with no PTAs, for countries with low-depth PTAs, with medium- and with high-depth PTAs, respectively. Low depth–agreements with less than or equal to 15 provisions; medium-depth agreements with 15 or more provisions but less than or equal to 30; high depth–agreements with more than 30 provisions. 19_Antras and Staiger (2012), Lawrence (1996). 20_In addition, deep trade agreements have been found to be essentially trade creating compared to shallow agreements. This is because several provisions in deep agreements, such as those regulating competition policy, investment, or customs reforms are public goods and increase trade with all patterns. Other trading partners will also benefit from these provisions. This leads to more trade creation and less trade diversion away from efficient suppliers. Thus, it increases the scope for trade-induced welfare gains, and makes deep agreements an attractive instrument for reforms. Instead, a shallow PTA focusing on barriers to trade at the border between Nepal and a given country ‘A’ would imply only tariff reductions between Nepal and ‘A’. While this will potentially create trade, being welfare increasing, it may also divert trade if it induces Nepal to reorient imports away from the most efficient supplier to ‘A’ because of preferences, while forgoing tariff revenues. This trade diversion effect would be welfare worsening. 31 III. FULLY EXPLOITING TRADE POTENTIALS Alternatively, GVC-related trade between countries that the lack of deepness of SAFTA behind its negligible effect signed the deepest agreement is 38 percent higher than on regional trade? These questions are addressed in this before signing the PTAs. The relationship, of course, section of the report. operates in both directions: higher levels of trade in GVC-trade increase the likelihood of signing deeper agreements. 21 III.3.1 Deep Integration: Where is Nepal in That Map? Cross-country empirical evidence suggests that deeper forms of integration are associated with Nepal is not deeply integrated with its region or with increased FDI inflows. Analyses of the relationship the world. A way to assess this is to look at the number between FDI and deep integration based on selected of agreements that Nepal and other countries have, countries also suggest that the depth of PTAs is positively as well as at the provisions that are covered in these associated with vertical FDI flows. An increase in the depth agreements. Across the world, the average number of of an agreement increases vertical FDI flows by 2 percent. agreements in which countries participate is 14. The EU In addition, evidence suggests that the positive link participates in the largest number of agreements (37), between the depth of PTAs and vertical FDI is driven by followed by European Free Trade Association (EFTA) the regulatory disciplines that improve the contractibility members (between 31 and 29), Chile (22), Singapore (21), 22 of inputs provided by foreign suppliers. Turkey (18), Mexico (10), Egypt (5) and other large emerging economies, such as India (8) and China (11) are not too far How can deeper integration help Nepalese exporters behind. In contrast, Nepal has only one full-scope PTA in in leveraging the powerful platform of GVCs to increase force (Figure 13), placing it in a peripheral position in the trade, and through trade, create more and better jobs? Is network of agreements (Figure 14). FIGURE 13. NUMBER OF AGREEMENTS AND FIGURE 14. NETWORK OF AGREEMENTS DEPTH – NEPAL AND COMPARATORS Source: World Bank elaboration based on Osnago et al. (2016). Source: World Bank calculations based on WTO RTA dataset. 21_Orefice and Rocha (2014), Osnago, Rocha and Ruta (2017). 22_Osnago, Rocha and Ruta (2015) and (2017). 32 III. FULLY EXPLOITING TRADE POTENTIALS Compared to countries that are economically similar, Nepal and Bangladesh have not participated in deep Nepal is less integrated in terms of number of agreements agreements with other regions and with developed 23 signed. In comparison to other SAFTA countries such as economies. In comparison to Malaysia, Thailand, and India, which has signed eight agreements, Nepal only has Vietnam, have signed substantially more agreements, SAFTA. In East Asia, where countries have been key players in and almost half of them have been North-South (see GVCs, Malaysia, Thailand, and Vietnam, for example, have each Figure 16). more than five agreements (see Figure 15). FIGURE 15. ACTIVE AGREEMENTS BY COUNTRY FOR SELECTED ECONOMIES (2015) Source: Calculations based on World Bank PTA content dataset (2016). FIGURE 16. ACTIVE NORTH-SOUTH AND SOUTH-SOUTH AGREEMENTS FOR SELECTED ECONOMIES (2015) Source: Calculations based on WTO RTA dataset. 23_For this analysis, the World Bank dataset on the content of PTAs has been used. This dataset excludes partial scope agreements (such as the one Nepal has with India) and agreements that have not been notified to the WTO. 33 III. FULLY EXPLOITING TRADE POTENTIALS How deep is SAFTA? the number of enforceable provisions- and comparing SAFTA covers a total of four provisions, with only two Nepal to those that are economically similar, Nepal has 24 of them being legally enforceable. SAFTA covers four one of the lowest levels of depth. Except for Sri Lanka and WTO+ provisions: FTA agriculture, FTA industrial, Customs Bangladesh, other comparators have agreements that and TBT. Taking the depth of agreements -measured by cover more or far more than 10 disciplines (Figure 17). FIGURE 17. PTA COVERAGE, SELECTED ECONOMIES (2015) Source: Calculations based on World Bank PTA content dataset (2016). III.3.2 Nepal in GVCs Nepal has not fully taken advantage of the GVC FIGURE 18. NEPAL GVC TRADE OVER TIME platform for export growth. The position of Nepalese firms and their challenges in participating in GVCs have been carefully discussed in the World Bank (2016). Here the report will highlight a couple of stylized facts. First, Nepal has been better integrated in GVCs as an importer than as an exporter. One simple indicator of this is the evolution of Nepal’s GVC-related trade balance that not only is in deficit, but also has been increasing exponentially since 2009, with imports being 10 times larger than exports in 2014. The difference in GVC import and export growth rates is revealing. During the 1990s GVC-related exports grew at 20 percent per year, while imports at 9 percent per year. But during the 2000s exports growth was at 6 percent, whereas Source: Calculations based on World Bank PTA content dataset (2016). imports grew at 11 percent (Figure 18). 24_For a definition of enforceable provision see Hoffman, Osnago and Ruta (2017). 34 III. FULLY EXPLOITING TRADE POTENTIALS Second, and reflecting overall trading patterns, Nepal’s main exports go to India, while about two-thirds of imports originate GVC partner is India. More than three-quarters of GVC related in India. (Figure 19 and Figure 20). FIGURE 19. NEPAL GVC-RELATED TRADE, BY REGION (1990-2014) FIGURE 20. TOP 10 GVC-RELATED TRADE PARTNERS Source: WITS, World Bank. FDI inflows into Nepal have been negligible and Most of announced foreign investment projects are in the not directed to GVC-prone sectors. Another metric to hydropower generation sector (renewable energies), or in understand Nepal’s participation in GVCs is its performance communications and transportation. Relatively more GVC in attracting FDI. In this respect, Nepal has done poorly in prone sectors such as textiles and apparel, food products, comparison with other countries in the region, and with or business services have received negligible amounts in other comparator economies outside the region (Figure 21). the recent years. 35 III. FULLY EXPLOITING TRADE POTENTIALS FIGURE 21. FDI INFLOWS AS PERCENTAGE FIGURE 22. TOP ANNOUNCED FDI PROJECTS BY OF GDP – NEPAL AND COMPARATORS SECTOR IN NEPAL (2003-2012) Source: World Bank calculations based on UNCTAD. Source: World Bank calculations based on UNCTAD. In this respect, and in addition to trade policy reforms, Nepal in GVCs: What is there to gain from Deep Integration? Nepal needs to implement substantial investment policy reforms if it is to attract more FDI. There are several International evidence discussed above suggests de facto and de jure barriers that discourage foreign investors that deepening trade agreements is associated from investing in Nepal. The structural hardships that Nepal with increased GVC trade. Is this the case for SAFTA exhibits for attracting FDI include its landlocked boundaries, members, and specifically for Nepal too? To answer and its propensity to natural disasters, which must be more this question, analogously as done to assess the effect than offset with a top-class investment climate. However, of SAFTA on overall regional trade, the report relies on a this does not seem to be the case. For example, World Bank structural gravity model of GVC trade, augmented to allow (2016) reveals cumbersome procedures to repatriate profits, for a measure of depth of agreements as defined above low equity limits for foreigners on crucial GVC-prone sectors (see Box 3 for details on the methodology). such as business and professional services (in accounting, and legal), or in others that are crucial inputs for GVC players Results confirm the findings of the literature: deeper (banking, transport, logistics), as well as a long negative list integration is associated with increased GVC trade, introduced with the new Foreign Investment Policy that and Nepal is no exception. Every additional provision include some agricultural activities, thus making it more costly included in trade agreements is associated with a 1 percent 25 for the agri-business sector to insert itself in global markets. increase in GVC-related trade. When it comes to the Gradual improvements in these areas are imperative (see effect on Nepal’s exports, evidence suggests that Nepal Policy Recommendations in the Executive Summary for some is no different from the average country in the sample. suggestions). For imports, instead, Nepal shows a greater sensitivity to 25_One caveat from this estimation model is that the marginal effect of an additional provision is the same regardless of what type of provision is included. It is well possible that provisions in deep trade agreements have a different impact depending on how relevant they are for trade. Relying on the literature, it is possible to say that typically, it is provisions associated with movement of capital, competition policy and intellectual property protection that tend to have greater effects on GVC trade. 36 III. FULLY EXPLOITING TRADE POTENTIALS increased depth (see Table 13). This suggests that the lack thus facilitating integration into regional value of effect of SAFTA on regional and Nepal’s trade is to some chains. Including provisions related to, for example, capital extent related to the shallow nature of that agreement. movements or competition policy, will further increase Nepal’s exports to and imports from its PTAs partners. Deepening SAFTA is expected to reduce trade costs, Table 6 presents some back-of-the-envelope calculations TABLE 6. CHANGE IN NEPAL’S GVC-RELATED BILATERAL TRADE WITH SAFTA UNDER DIFFERENT SCENARIOS (a) (b) (c) (d) (e) “ASEAN-India” “ASEAN-Australia-New “Mercosur” “Korea - “EU Deepest” Zealand” ASEAN” scenario scenario scenario scenario scenario Depth 8 16 17 19 44 (USD’000) GVC-related Exports (2014) 0.2% 0.3% 0.3% 0.4% 0.9% Bangladesh $0.6 $1.3 $1.4 $1.5 $3.5 Bhutan $1.1 $2.2 $2.3 $2.6 $6.0 India $432.6 $865.8 $920.0 $1,028.4 $2,387.6 Sri Lanka $0.0 $0.0 $0.0 $0.0 $0.0 Maldives $0.0 $0.0 $0.0 $0.1 $0.1 Pakistan $0.7 $1.4 $1.5 $1.7 $4.0 Total Outflows $434 $869 $924 $1,033 $2,397 (USD’000) GVC-related Imports (2014) 9.1% 19.0% 20.3% 22.9% 61.2% Bangladesh $905 $1,892 $2,022 $2,285 $6,108 Bhutan $318 $664 $710 $802 $2,144 India $195,180 $408,071 $436,007 $492,796 $1,317,230 Sri Lanka $43 $89 $95 $108 $288 Maldives $11 $22 $24 $27 $72 Pakistan $115 $241 $258 $291 $778 Total Inflows $196,445 $410,717 $438,834 $495,991 $1,325,770 Source: Authors’ calculations. Note: the counterfactual analysis is done using the coefficient from the estimation of the specification described in Box 3, and the depth measures from each of the counterfactual integration schemes. 37 III. FULLY EXPLOITING TRADE POTENTIALS based on alternative scenarios that vary in their realism. change in institutions as it would include 42 new disciplines, For example, under the scenario in which SAFTA increases and it is unrealistic to materialize. An alternative scenario its depth to the “EU” level, Nepal would export on average is one in which SAFTA matches its content to the “ASEAN- 1 percent more ($2.4 USD million) with SAFTA members. India.” That would lead to increased exports from Nepal to However, this scenario will of course require a strong its partners by, on average, 0.2 percent, while imports would BOX 3. METHODOLOGY FOR THE ESTIMATION OF THE IMPACT OF DEEP INTEGRATION ON GVC INTEGRATION Gravity equations are derived from models that seek to explain or predict the relationship between a (dependent) variable (in this case bilateral trade in parts and components) and a set of other (independent or explanatory) variables whose values can be estimated (in this case elements of deep integration). An augmented gravity equation is estimated for 93 countries, using data from 1990 to 2014, to investigate the effect of deep integration on GVC-related trade. This methodology has been extensively used by economists to test empirically the determinants of trade flows, and to estimate the effect of preferential trade opening on trade flows. Estimating the effects of PTAs on bilateral trade flows using a gravity equation is, however, susceptible to an endogeneity problem. Endogeneity arises when an explanatory variable in an equation is correlated with the error term of the equation, and the error term is the unexplained deviation of sample data from their unobservable “true” value. Studies such as Baier and Bergstrand (2007) show that omitted variables, and to a lesser extent simultaneity, are the two most important sources of endogeneity bias caused by PTAs. The omitted variables problem of PTAs arises since the error term may retain the effect of some unobservable country-specific policy variables, which at the same time affect both trade and the probability of forming a PTA. If, for example, the formation of a PTA also induces reforms in trade-restrictive domestic regulation, the likelihood of an FTA is higher (since the expected gains from the FTA are higher), and the omission of the domestic regulation variable will bias the PTA coefficient downwards. A simultaneity problem can arise, for instance, when governments of two countries that trade more than their “natural” level of trade may be induced to form a PTA, as there is less probability of trade diversion. In this case, the PTA coefficients will be upward biased. 26 To take account of this, the approach used by Baier and Bergstrand (2007) is followed. Specifically we estimate a fixed-effect 27 gravity regression : 〖GVC〗_ijt=β_1 〖Depth〗_ijt+〖β_2 〖Depth〗_ijt*NPL+δ〗_ij+δ_it+δ_jt+ε_ijt Where is a measure of GVC-related trade between country i and j. GVC-related trade is proxied with trade in parts 28 and components. is a measure of the depth PTAs. A statistically significant and positive coefficient 1 implies that signing a deeper agreement is associated with greater GVC-related trade. This variable is calculated as the number of 29 enforceable provisions that are included in a certain agreement (normalized between o and 1). is an interaction term between depth and a dummy variable equal to one if the exporting or importing country is Nepal. This variable captures the heterogeneous effects of deep PTAs for Nepal. A positive (negative) and significant coefficient implies that for the same level of depth Nepal exported or imported relatively more (less) than the average country in the sample. The are a series of fixed effects: i for importer, j for exporter and t is 5 years’ periods from 1980 to 2014. Finally, is the error term. 26_As an additional robustness check for endogeneity the regressions are estimated using an Instrumental Variables approach. The variable of interest, depth between country i and country j is instrumented with the (weighted) average depth of all the agreements signed by i and j with any other country excluding the agreement(s) they have in common. 27_To account for the presence of zeroes in trade flows, the report estimates equation (1) using the Poisson pseudo maximum-likelihood (PPML) estimator proposed by Santos Silva and Tenreyro (2006). 28_Parts and components are defined as: BEC 21,22 42 and 53. 29_Other indices based on principal component analysis are used to calculate the depth of PTAs (see Osnago, Rocha Ruta, 2016). 38 III. FULLY EXPLOITING TRADE POTENTIALS increase by average 9.1 percent. This scenario will require an addition of six new disciplines such as: agreements on customs procedures, export taxes, SPS (streamlining of sanitary and phytosanitary regulations), TBT (streamlining of technical barriers to trade), trade-related investment measures (TRIMS-agreements on cross-border investment) and the General Agreement on Trade in Services (GATS). However, the political economy of SAFTA makes its deepening unrealistic in the short to medium term. The bloc has stumbled in its efforts to liberalize trade in goods, so it appears relatively unfeasible for it to progress into deeper forms of integration. For example, in services, the South Asia Trade in Services Agreement (SATIS) has not gone beyond some initial (and modest) offers. Therefore, to deepen its integration with the world, Nepal needs to look beyond the region and start with encouraging trade in services – crucial for diversification, and for supporting the productivity of other sectors that use services intensively, on investment – to attract, retain and connect FDI, and on trade facilitation, by strengthening, for example, its stance in Bhutan, Bangladesh, India and Nepal’s transit agreement. The different magnitude of effects of trade policy reforms on exports and imports calls for complementary reforms to boost export capacity. The results described above suggest that exports react less to deep integration reforms than imports. This was also the case when–in an even stronger form, the previous section explored the effect that SAFTA had on Nepalese trade. This hints to the need of complementing trade policy reforms with interventions that boost export capacity. These include improved infrastructure, specifically, improved electricity availability at competitive prices–the main obstacle exporters face per private sector surveys; increased competition in input markets to improve transport and communication costs; and access to competitively priced financing. In addition, it is also important to build capacity for firms to better take advantage of existing preference schemes. 39 IV IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS 40 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS The purpose of this section is to inform Nepalese policy There are three main conclusions that emerge from makers on the costs and benefits of alternative trade this section. policy reforms aimed at reducing costs for Nepalese firms that rely on imported intermediates and capital First, Nepal would benefit from a gradual approach to goods to produce exportable goods. reduced tariffs if it is not going to compromise tariff revenues. To improve the import-to-export environment in Specifically, this section focuses on the impact of a fiscally responsive manner, targeted tariff reductions on unilateral tariff reforms conducive to reducing the intermediate inputs for key export sectors are recommended anti-export bias, on export competitiveness. While the since they can be achieved with negligible revenue previous section focused on how Nepal can gain through losses. These reforms are likely to help increase export open, deeper regionalism, and through taking better competitiveness through access to better technologies and advantage of trade concessions granted to it, this section increased competition. focuses on how certain unilateral tariff reform decisions can help firms increased competitiveness. There is substantive Second, high tariffs may be counterproductive to evidence for Nepal and other countries in the world -large increase revenues because they increase incentives and small, advanced and developing- that links tariff to misreport. There is a positive association between reductions with productivity and export competitiveness misreporting and tariff rates. The higher tariff rates are, the outcomes. These reductions stimulate competition in the higher the evidence of importers misreporting import flows, home economy, inducing local firms to increase productivity likely to avoid paying the high tariffs. to survive, while also increasing their choice in terms of the available input mix through cheaper, more varied, and better Third, preliminary analysis conducted by the World Bank’s quality intermediate inputs. This leads to an improved import- Research Department suggests trade liberalization leads to-export environment, which, in a world where most trade to positive welfare effects in Nepal, and in addition, that happens through global value chains, becomes crucial. these gains are higher among the poorer households. Preliminary estimates suggest gains of about 1.7 percent in Yet, in developing countries, and particularly in Nepal, welfare, on average, with this effect being driven by lower any proposal for tariff reforms needs to consider prices for tradables and non-tradables, and greater for poor revenue costs. Given the importance of taxes on imports for households. It is likely that these estimates are a lower bound government revenue, this section assesses potential trade for the true effect of trade liberalization on welfare in Nepal, policy reforms that enhance the import-to-export environment since they do not consider the dynamic gains that take place and minimize revenue losses. Five alternative scenarios are when, after opening to global markets, firms become more analyzed that consider different intermediates on which to productive through increased exposure to a wider set of reduce tariffs. For the choice of products, we follow different technological options, and through increased competition. approaches: (i) a scenario of ample liberalization (scenario 1 on raw materials, 2 on intermediates, and 3 on capital goods), (ii) The reminder of the section is structured as follows. After identification of crucial inputs for high-potential sectors based describing the evolution of tariff liberalization in Nepal and the on international classification of inputs (in turn based on cross- South Asia region, this section introduces international and country input-output links, scenario 4), and (iii) identification country-specific evidence that links reductions in tariffs with of crucial inputs for high-potential sectors based on import increased productivity and enhanced export outcomes. The patterns of Nepalese firms (scenario 5). importance of imports as a source of tax revenues in Nepal is 41 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS then discussed. The impact of five potential tariff reform scenarios double that in other regions like Sub-Saharan Africa (around are assessed with the goal of finding reforms that minimize 5 percent), Western Asia and North Africa (about 4 percent), 30 revenue losses. Finally, we briefly describe two potential policy and Latin America (4 percent). options to recoup revenue losses arising from tariffs liberalization. The pace of tariff liberalization in Nepal has been slow and the country still applies significantly higher IV.1 Trade Policy Reforms tariffs on key product groups such as intermediate in the Region: A Snapshot and capital goods. Nepal’s simple average tariff declined only 2 percentage points (from 14.2 percent to 12.2 percent) Trade liberalization resulted in a significant worldwide between 2000 and 2017. Nepal has consistently applied reduction in tariffs during the last decades but South higher tariffs on the import of intermediate and capital goods Asia still exhibits one of the highest average tariffs than countries that benefit from integration into global in the world. Figure 23 shows that, despite the decline value chains such as Vietnam and Malaysia. For instance, in tariffs over the last decades, tariff restrictiveness is still in 2015, Nepal had a simple average tariff of 10.2 percent substantially higher in developing countries, where it adds on intermediate goods, which was 6.3 percent higher than about 5 percent to the cost of traded goods relative to Vietnam’s and 6.9 percent higher than Malaysia’s simple developed countries. However, tariff liberalization has not average tariff on intermediate goods, which stood at 3.9 been equally achieved across the developing world with percent. Likewise, Nepal’s average tariff on capital goods tariff restrictiveness relatively higher in South Asia than was 7.8 percent in 2015, which is more than double that of in any other region. Figure 24 shows that average tariff Vietnam and Malaysia, which had average tariffs on capital restrictiveness in South Asia (around 9 percent) is almost goods of 3.1 and 2.3 percent, respectively. FIGURE 23. MFN TARIFFS AND GDP PER CAPITA FIGURE 24. IMPORT RESTRICTIVENESS (TTRI) Source: UNCTAD (2014) Source: UNCTAD (2014). 30_Figure 24 portrays the tariff trade restrictiveness index (TTRI), which measures the average level of tariff restrictions imposed on imports and which is calculated based on applied tariffs (ad-valorem and specific), including tariff preferences. 42 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS FIGURE 25. SIMPLE AVERAGE TARIFF ON FIGURE 26. SIMPLE AVERAGE TARIFF ON RAW MATERIALS, 2006-15 INTERMEDIATE GOODS, 2006-15 Source: World Integrated Trade Solutions Database. Source: World Integrated Trade Solutions Database. FIGURE 27. SIMPLE AVERAGE TARIFF ON COTTON FIGURE 28. SIMPLE AVERAGE TARIFF ON CAPITAL FABRICS, 2006–1 GOODS, 2006–15 Source: World Integrated Trade Solutions Database. Note: cotton fabrics includes HS chapters 52.08-52.12 and 60.01-60.06 IV.2 Import Tariffs, the Import-to-Export and embody technology and knowledge that lead Environment, and Competitiveness to higher firm productivity and improved quality of final products. Since imported inputs enhance firm In most developing countries, imported intermediate productivity, they also play a role for firm export inputs are of higher quality than domestic varieties performance. This is important in the context of Nepal 43 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS because more than 90 percent of Nepalese exporters In another example, Nepalese tea producers that directly import some of the products necessary opt to add value through professional packaging and for production of exports. For example, footwear branding are more heavily burdened since they need exporters import more than 20 types of raw materials to pay 36 percent in tariffs plus value-added tax to (leather, glue, soles, accessories, etc.) mainly from buy filter bags from Germany. India, China, and Thailand; pashmina exporters import wool and silk from China and India; and hand-woven In Nepal, greater use and variety of imported carpet manufacturers source most of their wool, silk intermediate inputs is correlated with higher and dyes from New Zealand, China and Switzerland, exports, diversification of destination markets, respectively. and higher quality of exports. Evidence from firm- level analysis indicates that Nepalese firms that Increasing use of imported intermediate inputs import more than 30 percent of intermediates from is necessary for participation in international outside members of the SAARC have 16.8 percent production networks. According to a recent survey larger export values, export to 40 percent more by the Organization for Economic Cooperation and destinations, and have unit values that are 10 percent 32 Development (OECD) and the World Trade Organization higher on average than other firms (see Figure 29). (WTO) of 250 lead firms and suppliers in the agri-food These estimates, which control for firm and year sector, more than 80 percent of businesses in global fixed-effects, provide some evidence that the foreign value chains perceive imports of goods and services technology embodied in imported intermediate inputs 31 as being important or critical for their exports. In and their higher sophistication have a beneficial a world in which 80 percent of world trade happens effect for exporter performance in Nepal. Similar within international production networks, export evidence was found in Pakistan (World Bank 2017) competitiveness is increasingly dependent on efficient where firms that directly import intermediate inputs sourcing of imported intermediate inputs, as well as had 5.3 percent larger export values, export to 7.2 access to final producers and consumers abroad. percent more destinations overall and to 4.3 percent more destinations outside of the region, on average, For Nepalese firms to be competitive in than other firms. international markets, they need to be able to access the widest set of intermediates from a International evidence suggests that much supplier that offers the best value for money of the gains from trade liberalization result ratio. High input tariffs, para-tariffs, or other forms of from increased productivity of domestic firms protection, add to import costs and restrict the choice that have greater access to a wider variety of that firms face when making technological decisions. inputs. Empirically, most studies have found imports Currently, restrictive trade policies are increasing the of intermediates or declines in input tariffs to be production costs of Nepalese firms. This implies that associated with sizable productivity gains. Halpern Nepal’s tariff code needs to be streamlined, and tariffs et el. (2009) find that importing inputs increases on key intermediates need to be reduced. For example, firm productivity by 11 percent, while Kasahara and producers of pashminas, a traditional Nepalese export Rodrigue (2008) predict that a 100 percent decrease product, need to import yarn from China, paying a 5 in the share of domestic intermediates may lead to a percent tariff. This cuts into their competitiveness. 0.5-13 percent increase in firm productivity. Amiti and 31_Organization for Economic Cooperation and Development and World Trade Organization (2013a). Aid for Trade at a Glance 2013: Linking to Value Chains, Paris: OECD. 32_“Nepal’s Integration into Value Chains – Stylized Facts and Policy Options.” World Bank Group (2016). 44 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS FIGURE 29. EXPORT PERFORMANCE PREMIA FOR EXPORTER-IMPORTERS IN NEPAL Source: World Bank (2016). Note: the figure shows the marginal effects on quality, diversification and export values, of increasing the intensity of usage of imported intermediates, the varieties of imported intermediate inputs used and the number of imported intermediates used, respectively. Konings (2007) suggest that a 10-percentage point the probability of exporting for the average firm. fall in input tariffs leads to a 12 percent productivity Likewise, Chevassus-Lozza, Gaigné, and Le Mener gain for importing firms, which is at least twice as high (2013) find that a 10-percent decrease in input tariffs as any gains from reducing output tariffs. Topalova would increase total export values by 1.1 percent and and Khandelwal (2011) find that a 10-percentage point employment by 0.1 percent if no firms exit the export decline in input tariffs increases productivity by 4.8 market. Feng, Li and Swenson (2016) found a 1 percent percent. increase in a firm’s imports of intermediate inputs lead to a 1.7 percent increase in export value in China. Several studies have found that decreases in Table 7 offers a detailed compilation of recent studies input tariffs lead to either a higher probability of that show a positive impact of a tariff reduction in a firm exporting its products and increasing the intermediate inputs on several firm level outcomes value of exports as well. Using Argentinean data, (productivity, probability of export, export value, etc.). Bas (2012) found that a 10-percentage point decrease in input tariffs resulted in a 6 percent increase in 4_Nepal’s Integration into Value Chains – Stylized Facts and Policy Option.” WBG (2016). 45 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS TABLE 7. POTENTIAL EFFECTS FROM CHANGES TO IMPORT TARIFF ON INTERMEDIATE INPUTS Trade policy change Potential effect Source Country 10 percentage point 12 percent productivity Amiti and Konings (2007) Indonesia reduction in input tariff increase for importing firms 10 percentage point 4.8 percent productivity Topalova and Khandelwal India reduction in input tariff increase (2010) 10 percentage point 1.1 percent increase in Chevassus-Lozza, Gaigné, France reduction in input tariff total export sales and 0.1% and Le Mener (2013) increase in employment 10 percentage point 5.1 percent productivity Yu (2015) China reduction in input tariff increase 10 percentage point 6 percent increase in the Bas (2012) Argentina reduction in input tariff probability of exporting for the average firm, and, similarly, 8 percent for the average importing firm 100 percent decrease in 0.5-13 percent increase in Kasahara and Rodrigue Chile the share of domestic firm productivity (2008) intermediates 1 percentage point 1 percent increase in Rahardja and Varela Indonesia reduction in input tariff probability of producing (2014) high-quality products 10 percentage point 1.22 percent increase in Rahardja and Varela Indonesia increase in the share of product variety (2014) imported intermediates in total inputs Increase in the number of 9.6 percent increase in Bas and Strauss-Kahn France imported inputs from productivity (2014) 0 to 100 percent Increase in the share 11 percent increase in Halpern, Koren and Szeidl Hungary of imported inputs from productivity (2011). 0 to 100 percent 1 percent increase in 1.65 percent increase in Feng, Li and Sweson China import value of export value (2016) intermédiate input Source: Authors’ elaboration. 46 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS IV.3 Import Tariffs and GDP increased from 9.9 percent to 20.3 percent in the last Taxes, and Revenues: decade in Nepal. Although taxes on domestic goods and What is the impact in Nepal? income increased significantly over the last decade, a large share of the increased revenue mobilization was supported Import Tariffs in Nepal by revenue arising from tariffs and VAT charged on imports (Figure 30). The fact that the tax reforms over the last decade Revenue generated by taxing imports continues to have not been able to change the tax revenue mix is not be the dominant source of tax revenues in Nepal. surprising in a low-income country with a substantial informal Besides tariffs, Nepali Customs also raises a substantial sector like Nepal. In such settings, whenever short term needs share of additional revenue at ports of entry by levying a for revenue arise, it is easier to collect revenues by taxing range of domestic taxes like the value-added tax (VAT), excise, imports that are channeled through fewer physical points and agricultural reform fee, and road construction fee. Some of better controlled than domestic sources. these taxes and fees raise nontrivial amounts with respect to tariffs. For instance, for every rupee collected in tariff revenue, Most tax revenue from imports comes from consumer Rs. 1.2 was collected in VAT and Rs. 0.4 in excise duty in 2016. goods. When looking at Nepal’s import revenue in detail, Thus, about half of the government’s tax revenue in Nepal has consumer goods account for the bulk of import revenue (43 come from trade-related taxes over the last decade (between percent), while intermediate and capital goods account for 27 46 percent and 52 percent from 2007 to 2016). The difficulties percent and 25 percent of tariff revenue, respectively (Figure 31). in enforcing the tax code domestically and several exemptions to domestic production has also meant that imports account Table 11 in the Annex displays the list of top 10 revenue- for a significant share of VAT (66 percent) and excise duty (45 generating import products in every category (consumer, percent) revenues compared to domestic activities. 33 capital, intermediate goods, raw materials and cotton fabrics). The bulk of intermediate products that generate a larger The impressive increase in tax revenues as percentage portion of fiscal revenue seem to be construction materials of GDP in the last decade relied significantly on while imports of cotton fabrics constitute less than 1 percent revenue from imports. Tax revenues as percentage of of import revenue. FIGURE 30. TAX REVENUE AS PERCENTAGE OF GDP, 2007-2016 FIGURE 31. IMPORT TAX REVENUE BY PRODUCT TYPE, 2016 Source: World Bank (2016) Source: World Bank calculations based on data from the Nepalese Customs Office. 33_Using data from the Ministry of Finance, Wagle (2011) shows that VAT revenue coming from imports exceeded 60 percent in the 10 years before this study. 47 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS Box 4: Expenditure gains for trade policy reform in Nepal along the income distribution By affecting the price of the goods and services that are traded in an economy and the revenues the government collects, tariff reforms are likely to affect household incomes. And these effects are not likely to be distributionally neutral. This report argues that a simplification of the tariff code, implying tariff reductions, particularly for intermediate inputs would help firms become more competitive, by having access to a wider set of technological choices. But what is the evidence on the effects of trade on average welfare gains, in the case of Nepal, and how different are these gains at different points of the income distribution? In a recent contribution, Artuc, Porto and Rijkers (2017), look at income gains and inequality costs of trade reforms using survey data for 54 developing countries including Nepal. They combine tariffs on agricultural and manufacturing goods with household survey data on income and expenditure patterns, and estimate the first order effects of the elimination of tariffs on household welfare. They examine the effects of trade liberalization on real income along different points of the distribution by estimating the impact on consumption of traded and non-traded goods, on wages, on farm and non-farm income and on government transfers. What do the results show for Nepal? Preliminary results for Nepal suggest that in that country, households would gain an average of 1.7 percent welfare from a trade reform that brings all tariffs to zero. This net gain of 1.7 is the result of (i) a gain in purchasing power, leading to increased expenditures by 6.3 percent, and driven by cheaper tradables and non-tradable goods, and (ii) a loss of 4.6 percent in nominal incomes both in the tradables and non-tradable sectors (as both tradable FIGURE 32. PATTERNS OF DISTRIBUTIONAL IMPACT and non-tradable prices fall after the reduction in tariffs) as OF TARIFF REFORM INDUCED WELFARE GAINS - NEPAL well as through reduced transfers from the government (as their tariff related income has fallen). The welfare gain of tariff reforms is on average stronger for the poor than for the rich. Figure 32 shows the average kernel (in red) and the bivariate kernels. First, results reveal that, on average there are positive welfare gains along different levels of expenditure. This is evidenced by the red curve (the average kernel) being above zero. Second, even if there are average gains along different levels of expenditures, there are some households that lose from the reform, while others gain (some, although a relatively small fraction, of the area of the bivariate kernel falls under zero). Losers are likely net producers of tradables, whose price would have fallen with the reform, while winners are likely net consumers of tradables. These preliminary results are likely to underestimate the gains from trade. This is because they only consider the gains from trade that arise through the static price effect on tradables, and endogenous reactions of non-tradables that also lead to wage changes. However, the results do not consider the dynamic gains associated with reduced tariffs, and therefore increased trade integration through a greater scope for technological progress, as discussed in the literature, and summarized in Table 7 of this report. Source: World Bank based on Artuc, Porto and Rijkers (2017). 48 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS IV.3.1 The Fiscal Cost of Reducing (Table 8). In scenario 1, which eliminates tariffs for raw the Tariff Code’s Anti-Export materials, tariff revenues drop by 6.6 percent from Rs. 83.3 Bias: Some Simulations billion to Rs 77.8 billion and total revenues drop by 2.6 percent from Rs. 199.1 billion to Rs. 193.8 billion. In scenario 2, which Any proposed tariff reform would need to consider eliminates tariffs for intermediate goods, tariff revenues drop Nepal’s fiscal restrictions and the importance of by 27 percent from Rs. 83.3 billion to Rs. 60.9 billion and total imports for tax revenues. Short-term revenue losses arising revenues drop by 9.9 percent from Rs. 199.1 billion to Rs. 179.4 from trade liberalization are negligible when considered in billion. In scenario 3, which eliminates tariffs for capital goods, the broader context of welfare gains due to trade creation, tariff revenues drop by 20.7 percent from Rs. 83.3 billion to Rs. productivity enhancement, and economic diversification. In the 66.1 billion and total revenues drop by 6.2 percent from Rs. 35 short term, trade liberalization might lead to a high reduction 199.1 billion to Rs. 186.7 billion. The main message from Table in tax revenues in a country like Nepal, but these concerns 8 is that these reforms result in significant loss of revenue do not need to stymie trade and fiscal reforms. However, if and that such an extensive tariff reduction (all raw materials, the cost of revenue loses is not adequately addressed, trade intermediate goods or capital goods) cannot be accomplished reforms are not only unlikely to be undertaken but they can without adversely affecting total government revenues. be promptly reversed. Buffie (2001) cites at least 12 episodes where revenue shortfalls triggered partial or full policy A more detailed tariff reform that focuses on key reversals in recent decades. intermediate inputs for export sectors would result in negligible revenue losses. The impact of reducing tariffs on This section develops five trade reform scenarios cotton fabrics, intermediate inputs for ready-made garments, in which tariffs can be cut with the least impact on and key intermediate goods imported by apparel, pashminas, 34 revenue and discusses the results. In the first three and carpet manufacturers seems to be almost negligible scenarios, tariffs are eliminated for all products within three in terms of total revenues. In scenario 4, which eliminates groups separately, namely raw materials, intermediate tariffs for cotton fabrics (71 tariff lines), tariff revenues drop by goods, and capital goods. The essence of this reform is to 0.6 percent from Rs. 83.3 billion to Rs. 82.8 billion and total eliminate the tariffs faced by these product groups for all revenues drop by 0.2 percent from Rs. 199.1 billion to Rs. 198.6 importers and assess the feasibility (in terms of revenues) billion. In scenario 5, which eliminates tariffs for intermediate of facilitating access to inputs for the domestic industry and inputs for ready-made garments (295 tariff lines), tariff consumers. In the next four scenarios, tariffs are eliminated revenues drop by 1.4 percent from Rs. 83.3 billion to Rs. 82.2 only for intermediate inputs used by selected export oriented billion and total revenues drop by 0.5 percent from Rs. 199.1 industries (mainly textile and apparel), namely cotton fabrics, billion to Rs. 198.1 billion. intermediate inputs for ready-made garments, and key intermediate goods imported by apparel, pashminas, and In scenario 6, which eliminates tariffs for a wider definition carpet manufacturers. of intermediate inputs for ready-made garments (480 tariff 36 lines) , tariff revenues drop by 2.5 percent from Rs. 83.3 Extensive tariff liberalization would result in revenue billion to Rs. 81.3 billion and total revenues drop by 0.9 percent losses without additional measures aimed at enhancing from Rs. 199.1 billion to Rs. 197.2 billion. In scenario 7, which the tax base and improve tax collection domestically eliminates tariffs for key intermediate goods imported by 34_Simulations, carried out on integrated customs duty data and import values and revenues from FY15/16. The simulations do not consider revenue gains expected due to increases in firm level productivity, decrease in misreporting and other revenue-enhancing channels. As such, the estimates above represent are a lower bound. 35_The lower reduction in total revenues relative to tariff revenues stems from the fact that the tariff elimination would reduce import prices and stimulate demand for those products. Additional VAT and excise taxes are charged on that induced demand. Those additional domestic taxes partially compensate for the tariff revenue losses. 36_This first definition of intermediate inputs for ready-made garments used in the simulations is based on Ferrantino and Schmidt (2017). Because this classification leaves out some products imported in Nepal by the RMG industry, the second classification includes all products in HS chapter 50-6, which traditionally encompass all textile and apparel intermediates. 49 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS apparel, pashminas, and carpet manufacturers (48 tariff lines), in Nepal was 10.2 percent in 2016. Given the elasticities tariff revenues drop by 1.2 percent from Rs. 83.3 billion to Rs. reported in Table 7, eliminating tariffs on intermediate inputs 82.3 billion and total revenues drop by 0.5 percent from Rs. (even if only for some selected industries) could result in a 5 to 199.1 billion to Rs. 198.1 billion. As can be seen from Table 8, 12 percent increase in productivity and 6 percent increase in the reduction in total revenues arising from these narrower the probability of exporting for the average firm using these reforms range from 0.2 percent to 0.9 percent-a significantly intermediates. If the estimated revenue losses for the more lower and more manageable loss than the wider set of reforms targeted tariff reforms result in less than a 1 percent decline, simulated in the previous step. the benefits of such reforms seem to outweigh their costs. In addition, if tariff reforms are undertaken gradually, the The effect of the proposed reforms on firm productivity revenue gains through increased exports (and thus, economic and exports could be substantial given the high level of activity) could rapidly offset the initial revenue loss due to tariffs in Nepal. The average tariff for intermediate products lower tariff rates. TABLE 8. IMPACT OF TARIFF REFORMS ON REVENUE Scenario 1 Scenario 2 Scenario 3 Reform: Elimination of tariffs for: Raw Materials Intermediate Goods Capital Goods In millions of NPR I II I II I II Impact on imports: Imports pre 774,640 774,640 774,640 774,640 774,640 774,640 Imports post 782,165 778,805 816,317 806,609 794,749 807,943 Change in imports 7,524 4,165 41,677 31,968 20,108 33,302 % change in imports 1.0% 0.5% 5.4% 4.1% 2.6% 4.3% Impact on Revenue: Tariff revenue pre 83,338 83,338 83,338 83,338 83,338 83,338 Tariff revenue post 77,835 77,835 60,858 60,858 66,068 66,068 Change in tariff revenue -5,503 -5,503 -22,479 -22,479 -17,270 -17,270 % change in tariff revenue -6.6% -6.6% -27.0% -27.0% -20.7% -20.7% Total Tax Revenues on Imports Total revenue pre 199,092 199,092 199,092 199,092 199,092 199,092 Total revenue post 193,819 193,590 179,404 178,226 186,649 194,233 Change in Total revenue -5,273 -5,502 -19,688 -20,866 -12,443 -4,859 % change in Total revenue -2.6% -2.8% -9.9% -10.5% -6.2% -2.4% Source: World Bank calculations based on data from Nepal’s Customs. Note: e= product-spec. demand elasticity. I = Kee, Nicita, Olarreaga (2008); II= SMART. 50 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS BOX 5. SIMULATING TRADE & REVENUE IMPACT OF TARIFF REFORMS USING TRIST TRIST (Tariff Reform Impact Simulation Tool) has been developed by the International Trade Department of the World Bank Group, which allows estimates of the impact of tariff reform scenarios based on a partial equilibrium model. Import responses to tariff changes are modeled in a partial equilibrium framework considering substitution of imports from different sources, substitution of domestic production with imports and the effect of tariff liberalization on overall demand. TRIST is only relevant for partial equilibrium analysis of short-term impacts of trade reform since it treats demand for each product in isolation from the rest of the economy. Hence, it does not consider inter- and intra-sectoral linkages or the economy- wide impacts of tariff changes. TRIST cannot be used to provide an overall (medium to long term) estimate of the impact of a reform scenario. In practical terms, the trade response to a tariff change is modeled in three consecutive steps. First, the model allows for the substitution of imports from one trading partner for imports from another trading partner following changes in relative prices of different suppliers due to preferential changes in tariffs. Second, the model allows for substitution between imports and domestic production as the relative price of overall imports of the product changes relative to the price of domestic production. Third, the model allows for a demand (real income) effect according to which the overall consumption of a product changes in response to a change in the overall price of the product. Source: World Bank. TABLE 9. IMPACT OF TARIFF REFORMS ON REVENUE Scenario 4 Scenario 5 Scenario 6 Scenario 7 Reform: Elimination of tariffs for: Cotton Fabrics Intermediate Apparel Textile Apparel Inputs for Pashminas, (HS 50-60) Carpets & Apparel In millions of NPR I II I II I II I II Impact on imports: Imports pre 774,640 774,640 774,640 774,640 774,640 774,640 774,640 774,640 Imports post 775,569 775,359 776,804 776,512 777,977 777,745 776,002 776,175 Change in imports 929 719 2,163 1,872 3,337 3,105 1,362 1,535 % change in imports 0.1% 0.1% 0.3% 0.2% 0.4% 0.4% 0.2% 0.2% Impact on Revenue: Tariff revenue pre 83,338 83,338 83,338 83,338 83,338 83,338 83,338 83,338 Tariff revenue post 82,812 82,812 82,145 82,145 81,296 81,296 82,335 82,335 Change in tariff revenue -526 -526 -1,193 -1,193 -2,042 -2,042 -1,003 -1,003 % change in tariff revenue -0.6% -0.6% -1.4% -1.4% -2.5% -2.5% -1.2% -1.2% Total Tax Revenues on Imports Total revenue pre 199,092 199,092 199,092 199,092 199,092 199,092 199,092 199,092 Total revenue post 198,618 198,591 198,023 197,986 197,215 197,187 198,135 198,158 Change in Total revenue -474 -501 -1,069 -1,106 -1,877 -1,905 -957 -934 % change in Total revenue -0.2% -0.3% -0.5% -0.6% -0.9% -1.0% -0.5% -0.5% Source: World Bank calculations based on data from the Nepalese Customs Office. Note: e= product-specific demand elasticity. . I = Kee, Nicita, Olarreaga (2008); II = SMART. 51 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS IV.3.2 Alternatives for Recouping values reported by importers in Nepal and exported values Tariff Revenue Losses reported from the origin country where the merchandise is coming from. A value of the discrepancy index equal to A reduction in tariffs, particularly in sectors with high tariff zero means there is no under-reporting (the import values rates, could lead to increasing revenues due to a reduction reported by both the exporter and the importer coincide). in misreporting of import values. Research shows that Negative values of the index suggest under-reporting importers have an incentive to understate the value of (the imported value reported by the importer are smaller imports to evade tariffs, with the incentives decreasing compared to the ones reported by the exporter). This inverse in intensity of enforcement (see Box 6). In some cases, relationship between under-reporting and tariff rates at lowering of particularly high ad-valorem tariffs decrease the the sectoral level also holds in Nepal (Figure 33). As such, a incentives for misreporting and smuggling and encourages general decrease in tariff rates can be expected to lead to a more goods to flow through normal channels, thus increasing reduction in misreporting leading to an increase in revenues. tariff revenue. The discrepancy index, to assess the level of The list of top import products with under-reported values is misreporting, is calculated as the difference between import listed in Table 10 in the Annex. BOX 6. MISREPORTING AND DISCREPANCY GAP Ferrantino, Liu and Wang (2010) analyzed simultaneous misreporting to authorities in two countries (China and the US) and find statistical evidence of under-reporting exports at the Chinese border to avoid paying value-added tax (VAT). Historically, China’s reported exports to the USA have been smaller than USA reported imports from China and many researchers have attributed it to re-exports of Chinese goods from Hong Kong to the USA. As the role of Hong Kong as an entrepôt for China- US trade has decreased in recent years, discrepancy has become increasingly large to suggest different causes for misreporting. Ferrantino et al. have used a variation across disaggregated trade data at the Harmonized System subheading level (HS-6) between 1995 and 2008 to identify statistically significant and economically important correlations between the observed discrepancies and the incentives for misreporting. The analysis concentrates on discrepancies between China reported direct exports to the USA and USA reported direct imports from China. The explanatory variables capturing the economic incentives for misreporting include the tariff imposed at the USA border, the difference between the Chinese VAT collection rate and rebate rate, the shares of different enterprise types and trade regimes in China in reported direct exports to the USA, and the share of related-party trade in USA reported imports from China. The measure of statistical discrepancies between USA reported direct imports from China and China reported direct exports to the USA is computed as: GAPit = ln(MitUS)-ln(XitCH), where M is USA reported direct imports from China; X is China reported direct exports to the USA; i represents product; and t represents year. They find the average discrepancy for products with high tariff rates to be much lower than the average discrepancy for products with low tariff rates, which implies a negative association between the GAP and USA tariff rates. This is consistent with the tariff evasion hypothesis: higher US import tariffs lead to under- 37 reporting imports at the USA border and, hence, lower GAP. Source: Ferrantino, Michael; Xuepeng, Liu; Wang, Zhi (2012). Evasion behaviors of exporters and importers: Evidence from the U.S.– China trade data discrepancy, Journal of International Economics 86, pp.141-157. 37_In a recent paper, Kee and Nicita (2017) report a similar relationship between relatively highly trade restrictive NTMs (as measured by their ad-valorem equivalent) and misreporting between China and the United States. 52 IV. IMPROVING THE IMPORT-TO-EXPORT ENVIRONMENT THROUGH TRADE POLICY REFORMS FIGURE 33. TARIFF RATES AND MISREPORTING, 2014 A stronger shift to domestic taxation (whether domestic consumption or income taxes) could also help pay for tariff reform in Nepal. In the case of Nepal, Wagle (2011) shows that tariffs can be reduced without adversely affecting total government revenues by implementing domestic taxes like VAT and excise effectively. More specifically, he found that a single rated VAT with no exemptions is a highly effective form of modern taxation and can negate substantial losses in tariff revenues. There is however a powerful assumption behind the advocacy of a switch from tariffs to a broad-based consumption tax, namely, that countries have the capacity to enforce a complicated system like VAT even when it is easier and less costly to collect taxes at fixed border points. Wagle (2011) finds that low income countries have had a mixed record of achievement in offsetting reductions in trade tax revenue, partly because of their weak Source: World Bank calculations based on UN Comtrade Data. enforcement of domestic taxes like VAT. TABLE 10. LIST OF TOP UNDER-REPORTED IMPORT PRODUCTS (DISCREPANCY INDEX<0), 2014 Product Product description Reported Mirror Discrepancy Import Total code ‘000 USD ‘000 USD Index Tariff Applicable Duty SAARC Other SAARC Other 710812 Gold (incl. gold plated with platin 0.165 163294.5 -0.99 5 5 5 5 720825 Flat-rolled products of iron/non-al 0.023 13681.96 -0.99 5 5 18.65 18.65 610323 Men’s/boys’ ensembles, knitted/croc 0.037 19626.62 -0.99 20 20 35.6 35.6 720826 Flat-rolled products of iron/non-al 0.011 3030.558 -0.99 5 5 18.65 18.65 722620 Flat-rolled products of high speed 0.141 30980.76 -0.99 7 10 20.91 24.3 610422 Women’s/girls’ ensembles, knitted/c 1.109 65505.38 -0.99 20 20 35.6 35.6 871110 Motorcycles (incl. mopeds) & cycles 0.006 350.411 -0.99 30 30 105.6 105.6 611241 Women’s/girls’ swimwear, knitted/cr 0.004 195.891 -0.99 20 20 35.6 35.6 520811 Woven fabrics of cotton, unbleached 0.6 13217.88 -0.99 5 15 18.65 29.95 910212 Wrist-watches, electrically operate 0.425 8489.057 -0.99 9 15 23.45 29.95 841122 Turbo-propellers, of a power >1,100 0.078 1114.362 -0.99 7 10 20.91 24.3 611231 Men’s/boys’ swimwear, knitted/croch 0.099 963.601 -0.99 20 20 35.6 35.6 722100 Bars & rods, hot-rolled, in irregul 0.611 5171.083 -0.99 7 10 20.91 24.3 720390 Spongy ferrous products (excl. of 7 1.359 9857.187 -0.99 5 5 18.65 18.65 610322 Men’s/boys’ ensembles, knitted/croc 27.728 191705.9 -0.99 20 20 35.6 35.6 Source: WITS, World Bank; Nepal Customs Data. Note: Discrepancy Index = [Reported-Mirror]/[Reported+Mirror]. 53 IMPORTS TARIFFS AND TAXES, AND REVENUES: WHAT IS THE IMPACT IN NEPAL? V APPENDIX 54 APPENDIX TABLE 11. TOP 10 REVENUE-GENERATING PRODUCTS, BY CATEGORY HS code Description Imports Share of Revenue, revenue, % mln NPR Consumer goods 87032200 Vehicles of a cylinder capacity exceeding _ 000 cc but not 11,653 6.06% 87032300 Vehicles of a cylinder capacity exceeding _ 500 cc but not 8,287 4.31% 27101930 Diesel 6,686 3.47% 27101210 Petrol 5,682 2.95% 87032190 Other vehicles of a capacity upto 1000cc _ 3,143 1.63% 27111900 LP GAS 2,575 1.34% 85171200 Telephones for cellular networks or for ot _ er wireless net 2,365 1.23% 87033200 Vehicles with diesel engine of cylinder ca_ acity 1500-2500 1,817 0.94% 21069040 Concentrate of non-alcohalic soft drinks _ 1,605 0.83% 69089000 Glazed ceramic flags and paving, hearth or _ wall tiles, etc 1,124 0.58% Capital Goods 87112000 Motorcycles with reciprocating engine of c _ pacity 50-250cc 12,779 6.64% 87060080 Chasis of Bus & Trucks _ 6,684 3.47% 87042110 Goods Vehicles, pick-up with capacity of m _ re than two per 2,759 1.43% 87042120 Delivery Van _ 2,289 1.19% 87112090 Motorcycles with reciprocating engine of c _ pacity 50-250cc 1,695 0.88% 87042300 Goods vehicles, with diesel or semi-diesel _ engines, gvw >2 1,409 0.73% 87042290 Others diesel or semi diesel motor vehicle _ gvw 6-20 tonne 1,325 0.69% 85072000 Lead-acid accumulators (excl for starting _ iston engines) 1,078 0.56% 87112010 Motorcycles with reciprocating engine of c _ pacity 50-250cc 812 0.42% 87089900 Other parts & accessories of motor vehicle _ of 8701 to 870 765 0.40% Intermediate Goods 25231000 Cement clinkers _ 5,240 2.72% 72071900 Semi-finished products of iron or non-allo _ steel, <025% c 4,948 2.57% 15071000 Crude soya-bean oil _ 1,991 1.03% 71081300 Gold 1,752 0.91% 72083900 Flat/hot-rolled iron/steel,in colis, width _ >=600mm, not pi 1,482 0.77% 39021000 Polypropylene, in primary forms _ 1,424 0.74% 39012000 Polyethylene having a specific gravity >=0 _ 4, in primary f 1,327 0.69% 72139110 Bar & rods, hot-rolled circular cross-sect _ on measuring <= 1,298 0.67% 72091800 Flat/cold-rolled iron/steel, in coils, wid _ h >=600mm, < 05 1,270 0.66% 25232900 Portland cement (excl white) _ 1,063 0.55% Raw Materials 27011900 Other coal, not agglomerated, nes _ 2,108 1.10% 24012000 Tobacco, partly or wholly stemmed/stripped _ 1,308 0.68% 8029000 Others nuts _ 773 0.40% 26219000 Other slag and ash, including seaweed ash _ Kelp) 754 0.39% 12051000 Low erucic acid rape or colza seeds _ 661 0.34% 25151200 Marble and travertine merely cut into bloc_ ks or slabs of a 617 0.32% 70109000 Carboys, bottles, flasks, jar, pot, phials _ etc of glass, n 596 0.31% 8028000 Areca nuts _ 402 0.21% 74040000 Copper waste and scrap _ 315 0.16% 26180000 Granulated slag (slag sand) from the manuf _ cture of iron o 289 0.15% Cotton Fabrics 52121500 Printed woven fabrics of cotton, =<200g/m2 _ by weight, nes 230 0.12% 52121300 Dyed woven fabrics of cotton, =<200g/m2 by _ weight, nes 146 0.08% 52121400 Coloured woven fabrics of cotton, =<200g/m _ by weight, nes 96 0.05% 52121100 Unbleached woven fabrics of cotton, =<200g _ m2 by weight, n 92 0.05% 52094200 Coloured denim cotton weave, with >=85% co _ ton, >=200g/m2 90 0.05% 52102900 Bleached woven cotton fabrics, nes, with < _ 5% cotton, =<20 70 0.04% 60032000 Knitted or crosheted fabrics of cotton _ 56 0.03% 52121200 Bleached woven fabrics of cotton, =<200g/m _ by weight, nes 46 0.02% 52083900 Dyed woven cotton fabrics, with >=85% cott _ n, <200 g/m2 by 41 0.02% 60062200 Dyed kintted or crocheted fabrics of cotto _ nes 39 0.02% 55 APPENDIX TABLE 12. NEPAL’S TOP EXPORT PRODUCTS AT HS6-LEVEL, 2015 Product Code Trade Value Product Description Share of total, % in ‘000 USD 220290 85325.39 Non-alcoholic beverages other than 10.55% 570110 60963.26 Carpets & other textile floor cover 7.54% 090830 46598.72 Cardamoms 5.76% 392690 40165.28 Articles of plastics & articles of ot 4.97% 550951 27713.97 Yarn other than sewing thread, of p 3.43% 640419 26755.16 Footwear (excl. waterproof) with ou 3.31% 621420 18367.3 Shawls, scarves, mufflers, mantilla 2.27% 630510 18221.27 Sacks & bags, of a kind used for th 2.25% 080290 18119.68 Nuts, n.e.s. in 08.01 & 08.02, fres 2.24% 721720 16647.53 Wire of iron/non-alloy steel, plate 2.06% 550921 13905.13 Yarn other than sewing thread, of s 1.72% 570190 13567.85 Carpets & other textile floor cover 1.68% 380610 12694.09 Rosin & resin acids 1.57% 550932 12623.73 Yarn other than sewing thread, of s 1.56% 531010 12231.54 Woven fabrics of jute/other textile 1.51% 090240 12169.26 Tea, black (fermented) & partly fer 1.51% 730690 11501.49 Tubes, pipes & hollow profiles of i 1.42% Total 808529.5 100.00% Source: WITS, World Bank. Note: mirror data, HS2007. FIGURE 34. BILATERAL EXPORTS AND MARKET ACCESS IN NEPAL: 2005 AND 2014 Source: Authors’ calculations based on UN-Comtrade-BACI database (CEPII) 56 APPENDIX TABLE 13. DEEP AGREEMENTS AND GVC-RELATED TRADE, REGRESSION RESULTS (1) (2) (3) (4) VARIABLES export_pcnew export_pcnew export_pcnew export_pcnew Depth 0.00869*** 0.00869*** 0.00875*** 0.00874*** (0.00276) (0.00276) (0.00276) (0.00276) Depth* Nepal Exporter -0.0945 -0.0937 (0.0961) (0.0961) Depth*Nepal Importer 0.469*** 0.469*** (0.108) (0.108) BIT 0.117*** 0.117*** 0.118*** 0.118*** (0.0348) (0.0348) (0.0348) (0.0348) PTA -0.163** -0.163** -0.165** -0.165** (0.0821) (0.0822) (0.0822) (0.0822) PTA_notinforce 0.0898** 0.0898** 0.0902** 0.0902** (0.0428) (0.0428) (0.0428) (0.0428) Observations 685,991 685,991 685,991 685,991 R-squared 0.988 0.988 0.988 0.988 Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1. Note: Results from a PPML using bilateral fixed effects, year effects, and country of origin*time and country of destination*time fixed effects. 57 APPENDIX TABLE 14. LIST OF INDIVIDUAL PRODUCTS WITH THE PREFERENCE MARGIN ABOVE 10% G SP, GSP+ Nepal’s Exports to: countries Product HS2 Effective Import World, USA, India, Average Average Product code Rate to USA, US$ mln US$ mln US$ mln price price description US$ mln 2015 USITC) NEPAL (across all countries) 420292 42 15% 937.45 2.509 1.41 0.30 With outer surface of plastic sheet 871200 87 10% 502.32 0.003 121.97 1.63 Bicycles and other cycles 160414 16 16% 495.67 0.000 4.35 Tunas, skipjack and bonito (Sarda s 420212 42 17% 405.81 0.079 0.03 0.76 With outer surface of plastics or o 851310 85 12% 297.42 0.011 1.97 Lamps 691110 69 17% 148.44 0.015 17.99 0.43 Tableware and kitchenware 701399 70 18% 134.23 0.038 0.00 2.34 6.53 Glassware 40690 4 16% 113.90 0.428 0.01 5.02 0.82 Other cheese 420232 42 17% 86.52 0.960 0.33 1.17 0.25 With outer surface of plastic sheet 420222 42 16% 65.52 1.659 0.73 0.00 0.23 With outer surface of plastic sheet 611780 61 12% 57.82 1.031 0.23 5.16 3.10 Madeup clothing, other than shawls 961519 96 10% 0.023 55.73 0.00 Combs, hair-slides 821599 82 12% 45.73 0.003 0.11 0.14 Spoons, forks, ladles 621710 62 12% 38.56 0.538 0.28 3.88 16.22 Madeup clothing, exc. knitted 200840 20 12% 33.88 0.000 1.21 Pears 940591 94 11% 29.03 0.002 0.00 Of glass 820320 82 11% 28.90 0.000 29.56 Pliers (including cutting pliers), 811100 81 13% 23.78 0.000 2.11 Manganese and articles thereof, inc 670290 67 11% 13.95 0.136 0.01 0.02 Artif.flowers, foliage, othen than plastic 960719 96 10% 10.23 0.003 0.16 Slide fasteners, other 691200 69 25% 9.69 0.070 0.02 9.28 0.37 Ceramic tableware, kitchenware, oth 961590 96 10% 8.80 0.020 0.07 Combs, hair-slides, other 420239 42 18% 7.94 0.058 0.01 0.65 0.44 Trunks, suitcases, other 80232 8 17% 5.63 0.000 1.37 Shelled nuts 220600 22 11% 3.61 0.004 1.25 Other fermented beverages 200850 20 23% 3.03 0.000 1.25 0.28 Apricots 190110 19 17% 1.72 0.000 7.12 Preparations for infant use, put up 701310 70 24% 1.30 0.000 1.50 0.89 Of glassceramics 701391 70 15% 1.09 0.002 1.30 0.87 Glassware of lead crystal 630499 63 10% 0.79 1.229 0.97 13.51 0.32 Not knitted or crocheted, of other 170490 17 12% 0.63 0.056 0.05 4.36 0.27 Other 960899 96 10% 0.41 0.000 2.92 Other 220290 22 13% 0.39 85.325 85.33 1.15 0.08 Other 520300 52 16% 0.25 0.000 2.02 Cotton, carded or combed. 210690 21 19% 0.25 1.247 0.68 0.79 0.22 Other 210690 21 19% 0.25 1.247 0.68 0.79 0.20 Other 210690 21 19% 0.25 1.247 0.68 0.79 0.41 Other 210690 21 19% 0.25 1.247 0.68 0.79 1.06 Other 210690 21 19% 0.25 1.247 0.68 0.79 0.84 Other 210690 21 19% 0.25 1.247 0.68 0.79 0.35 Other 80410 8 27% 0.21 0.000 0.25 0.08 Dates 71490 7 17% 0.03 0.003 0.95 Other 960310 96 23% 0.01 0.073 0.07 0.88 0.01 Brooms and brushes 640610 64 11% 0.01 0.000 5.17 0.40 Uppers and parts thereof, other tha Source: USITC, Nepal Customs and WITS data. 58 APPENDIX TABLE 15. NEPAL’S EXPORTS OF PRODUCTS INCLUDED IN LIST OF CONCESSIONS FROM U.S. TO NEPAL, BY DESTINATION (2010-2015) S 6-digit H Code Category U.S. Rest of World 420211 Trunks, suit-cases, vanity-cases, executive-cases, brief-cases, school satches and similar 6454,578 18.25% 28917,630 81.75% containers :-- With outer surface of leather, of composition leather or of patent leather. 420221 Handbags, whether or not with shoulder strap, including those without handle 19,677,390 17.70% 91505,760 82.30% :-- With outer surface of leather, of composition leather or of patent leather. 420222 Handbags, whether or not with shoulder strap, including those without handle 3,274,295 51.97% 3,025,479 48.03% :-- With outer surface of plastic sheeting or of textile materials. 420229 Handbags, whether or not with shoulder strap, including those without handle :-- Other. 07,787 40.44% 600,476 59.56% 420231 Article of a kind normally carried in the pocket or in the handbag :-- With outer surface of leather, of composition leather or of patent leather. 9,904 78.06% 11,500 21.94% 420232 Article of a king normally carried in the pocket or in the handbag 71,259 35.54% 129,265 64.46% :-- With outer surface of plastic sheeting or of textile materials. 420291 Other handbags :-- With outer surface of leather, of composition leather or of patent leather. - 0.00% 16,407 100.00% 420292 Other handbags :-- With outer surface of plastic sheeting or of textile materils. 424,077 69.60% 185,246 30.40% 420299 Other handbags of materials wholly or mainly covered with paper. 29,908 49.37% 30,674 50.63% 570110 Carpets and other textile floor covering of wool or fine animal hair. 149,000,000 44.35% 187,000,000 55.65% 570231 Carpets and other textile floor coverings, woven, not tufted or flocked, whether or not made up, including “Kelem”, “Schumacks”, “Karamanie” and similar handwoven rugs other, - 0.00% 20,870 100.00% of pile construction, not made up :-- Of wool or fine animal hair. 570291 Carpets and other textile floor coverings, woven, not tufted or flocked, whether or not made up, including “Kelem”, “Schumacks”, “Karamanie” and similar handwoven rugs - Other, - 0.00% 2,582 100.00% not of pile construction, made up :-- Of wool or fine animal hair. 570310 Carpets and other textile floor coverings, tufted, whether or not made up - of wool or fine animal hair. 7,739 11.57% 59,137 88.43% 570390 Carpets and other textile floor coverings, tufted, whether or not made up - of other textile material. 8,475 21.42% 31,088 78.58% 570500 Other carpets and other textile floor coverings, whether or not made up. - 0.00% 83,138 100.00% 611710 Shawls, scarves, mufflers, mantillas, veils and the like. 132,587 15.46% 724,786 84.54% 611780 Other made up clothing accessories, knitted or crocheted parts of garments or of clothing 188 1.28% 14,451 98.72% accessories - other accessories. 621410 Shawls, scarves, mufflers, mantillas, veils and the like: Of silk or silk waste. 270,895 19.52% 1,116,801 80.48% 621420 Shawls, scarves, mufflers, mantillas, veils and the like: Of wool or fine animal hair. 10,800,000 11.82% 80,600,000 88.18% 621440 Shawls, scarves, mufflers, mantillas, veils and the like: Of artificial fibres. 20,133 29.55% 47,989 70.45% 621490 Shawls, scarves, mufflers, mantillas, veils and the like: Of other textile materials. 546,448 37.36% 916,278 62.64% 621600 Gloves, mittens and mitt. 16,170 16.19% 83,687 83.81% 621710 Other made up clothing accessories and parts of garments - Accessories. 51,867 5.74% 851,365 94.26% 630190 Other blankets and travelling rugs. 2,363,189 42.91% 3,143,663 57.09% 650400 Hats and other headgear, plaited or made by assembling strips of any material, 549,519 16.68% 2,954,022 84.32% whether or not lined or trimmed. 650500 Hats and other headgear, kintted or crocheted or made up from lace, felt or other textile fabric. 13,600,000 21.86% 48,600,000 78.14% 650699 Other headgear, whether or not lined or trimmed. 10,600,000 40.15% 15,800,000 59.85% Total (2010-2015) 192,241,572 346,169,415 59 VI REFERENCES 60 REFERENCES Amiti, M., and J. 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