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Final Report

Nepal's Regional and Bi-lateral Trade Agreements: Performance and Prospects

Report Submitted by:

Uma Shankar Prasad

E-mail: us_prasad@hotmail.com

Submitted to:

Ministry of Industry, Commerce and Supplies

Government of Nepal

Enhancing Nepal’s Trade-Related Capacity (ENTReC)

(NEP/05/006)

December 2007

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Contents

Content Page Number

Acknowledgements 1

List of Tables 3

List of Boxes 3

Abbreviations 4 - 5

Executive Summary 6 -10

Chapter I: Introduction 11 - 15

Chapter II: Trade Liberalization Initiatives 16 - 19

Chapter III: Nepal’s Trade Performance 20 - 32

Chapter IV: Review of Bi-lateral and Regional Trade Agreements 33 - 45

Chapter V: New Dimensions and Future Prospects 46 - 53

Annexes 54 – 94

References 95 - 97

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List of Tables

Table

No. Title Page

3.1 Direction of Nepal’s Foreign Trade (Rs. in million) 21

3.2 Major Export Trade Partners of Nepal 24 3.3 Nepal's Export to SAARC/BIMSTEC Member Countries 25 3.4 Exports of Major Commodities to India 26 3.5 Exports of Major Commodities to Other Countries 27 3.6 Major Import Trade Partners of Nepal 28 3.7 Nepal's Import from SAARC/BIMISTEC Member Countries 29 3.8 Imports of Major Commodities from India 30 3.9 Imports of Major Commodities from Other Countries 31 4.1 TRQ on Nepal’s Exports 39 5.1 Country-wise Foreign Employment 49 5.2 Income from Remittance in Nepal, 1985 – 2003 50 5.3 Major Importers of Nepalese Tea 51

Box

Box

No. Title Page

4.1 Trade Liberalization Programme under SAFTA: Major Elements 34

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ABREVIATIONS AND ACRONYMS

ASEAN - Association of South East Asian Nations

BIMSTEC Bay of Bengal Initiative for multi-sectoral Technical and Economic Cooperation

BOP - Balance of Payment

CTH - Changes in Tariff Heading

ESAF - Enhanced Structural Adjustment Facility

EU - European Union

FTA - Free Trade Agreement

FY - Fiscal Year

GATT - General Agreement on Tariffs and Trade

GDP - Gross Domestic Product

GoN - Government of Nepal

GoP - Government of Pakistan

HMG - His Majesty’s Government

ICD - Inland Clearance Depot

ICT - Information and Communication Technology

IMF - International Monetary Fund

ISI - Import Substituting Industrialization

LDC - Least Developed Countries

MFN - Most Favoured Nation

MoF - Ministry of Finance

NEFAS - Nepal Foundation for Advance Studies

NEP - New Economic Policy

NPC - National Planning Commission

NRB - Nepal Rastra Bank

NRs. - Nepalese Rupee

NTBs - Non-Tariff Barriers

OGL - Open General Licensing

QR - Quantitative Restrictions

RoO - Rules of Origin

SAARC - South Asian Association for Regional Cooperation

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SAFTA - South Asian Free Trade Area

SAL - Structural Adjustment Loan

SAP - Structural Adjustment Policy

SAPTA - SAARC Preferential Trading Arrangement

SAWTEE - South Asia Watch on Trade, Economics & Environment

TBs - Tariff Barriers

TPC - Trade Promotion Centre

TRQ - Tariff Rate Quota

UNDP - United Nations Development Programme

VAT - Value Added Tax

WTO - World Trade Organization

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Executive Summary

Trade liberalization means integration of the national economy with the global economy in terms of easier/free flow of goods and services, technology and information. The politics of trade policy reform displays well-known forms of contradiction between the advocates and the sceptics. Although, the impact of trade liberalization on country’s development has been a highly controversial topic and a concern of debate among the economists around the world, particularly in developing countries, most of the countries around the world are moving towards trade liberalization initiatives and Nepal cannot be an exception.

Nepal was characterized by the interventionist approach of economic policies for a prolonged period of time. Government regulation and large-scale public investments were major policies followed in the 1960s, 1970s, and early 1980s. The basic emphasis was on import substitution and export pessimism was widely prevalent. The trade policy was highly protectionist and regulated through quantitative restrictions on imports. The tariff rates were very high. It was believed that restricted imports would save foreign exchange and stimulate domestic output.

Nepal initiated its economic integration process in mid 1980s. After restoration of multi-party democracy in 1990, Nepal accelerated the process of economic globalization. Trade policy was changed with the new trade policy 1992. The Import Substituting Industrialization (ISI) was replaced by an export led economic growth and imports were made free to assist exports. Following the ideology of New Economic Policy (NEP) to integrate Nepalese economy with world economy, Nepal became the member of the World Trade Organization (WTO) in the fifth ministerial conference of WTO held on 10-14 September 2003 at Cancun, Mexico. Along with the wave of liberalization, Nepal has dismantled trade barriers and has opened the economy to international competition at a fast pace in recent years.

Slow progress in the WTO negotiations, developing countries’ aspirations and advantages of Regional Trade Agreements (easy and quick handling, trade creation, less dispute and less diverse interest etc.) pushed countries to adopt a two-pronged strategy (bi-lateral and regional) of economic integration simultaneously.

As of 2007, Nepal has signed bi-lateral trade agreements with 17 countries including India and Bangladesh with whom it has also bi-lateral transit agreements. These countries include: Bangladesh (1976), Bulgaria (1980), China (1981), Czech Republic (1982), Egypt (1975), India, Democratic People's Republic of Korea (1970), Republic of Korea (1971), Mongolia (1992), Pakistan (1982), Poland (1992), Romania (1984), Sri Lanka (1979), UK (1965), USA (1947), Russia (1970), and Yugoslavia (1965). All the treaties, except with India, are static and perpetual in nature based on Most Favoured Nation (MFN) treatment.

The United States of America, which is the second largest trade partner of Nepal in terms of export and among the ten top countries in terms of import in 2006, has bi-lateral

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friendship and commerce agreement dates back to April 1947 (Annex IV) in the Rana regime, at the time even the General Agreement on Tariffs and Trade (GATT) agreement was not signed. The agreement is diplomatic rather than trade and commerce. The treaty was aimed at strengthening the friendly relations existing between the two countries, further mutually advantageous commercial relations between their peoples, and to maintain MFN principle in its unconditional and unlimited form as the basis of their commercial relations. The treaty also provided unconditional navigation facility between the two nations.

The trade treaties between Nepal and India have been renewed, modified and reviewed from time to time. The major elements included in all the treaties between Nepal and India are: exemption from basic custom duties and quantitative restrictions on imports of primary products on reciprocal basis, Nepali manufactured goods (excluding some items on the negative list) are granted duty free access to Indian market without quantitative restrictions on the basis of non-reciprocity, and manufacturing goods imported from India is granted preferential entry to Nepal, without quantitative restrictions.

Apart from bi-lateral trade agreements, Nepal is a member of two regional trade agreements- South Asia Free Trade Area (SAFTA) which came into force on 1 January, 2006 and the Bay of Bengal Initiative for multi-sectoral Technical and Economic Cooperation (BIMSTEC).

SAFTA was signed without agreements on issues like sensitive list, rules of origin, mechanism for compensation on revenue losses for the (Least Developed Countries) LDCs, and technical assistance. The non-tariff barriers in the region are inconsistent with the WTO provisions. Quantitative Restrictions (QRs) were to be replaced by tariff equivalents but countries of this region are still maintaining them. This shows that South Asian region might have compelled to accept the policy against their willingness and therefore it might be difficult to achieve the goal of SAFTA.

In 2004, BIMSTEC member countries agreed to establish the BIMSTEC Free Trade Area Framework Agreement for a free trade in goods, in services and investments. This includes economic cooperation in Mutual Recognition Agreements, Customs Cooperation, Trade Finance, E-Commerce, and Business and Personal Visa Facilitation. The First Summit level meeting held in July 2004 identified and covered six broad sectors for cooperation, i.e., trade and investment, technology, tourism, transport and communication, energy, and fisheries.

The basic objective of this study is to review and analyze Nepal’s existing trade treaties and suggest new countries and dimensions that has to be covered in future trade agreements with a view to make Nepal’s export trade competitive and sustainable. The data on Nepal’s export and import trade has been examined to assess trade effects of existing regional and bi-lateral trade agreements, new dimensions to be covered in existing bi-lateral trade agreements, and to suggest name of new countries and dimensions that has to be covered in future agreements to make them beneficial for Nepal.

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Available data and Nepal’s existing trade agreements show that the leading export partners of Nepal are India, USA, Germany, United Kingdom, Belgium, France, Japan, Bangladesh, Peoples’ Republic of China, Hong Kong, Switzerland, Spain, Italy and Canada over the last few years. As of 2005/06, around 85 per cent of its exports go to India, the United States, and Germany. Nepal imports its commodity requirements from various countries. India, Peoples’ Republic of China, Singapore, Indonesia, Thailand, Malaysia, Saudi Arabia, Japan, Germany, Republic of Korea, Hong Kong, and New Zealand have been the major import trade partners of Nepal. However, like exports, India has been the country from where Nepal imports its major part. Nepal’s exports as well as imports to SAARC/BIMSTEC countries, except India, have accounted for less than one per cent of its total exports/imports.

Nepal’s major export products have been readymade garments, woollen carpets, woollen and pashmina goods, vegetable ghee, toothpaste, jute and jute goods, pulses, polyester yarns, hide skins and handicrafts. Manufactured exports are concentrated in garments, carpets, and pashmina. Woollen carpets used to be the prime export and readymade garments have been another major export.

Nepal’s imports are diversified compared to its export. Nepal’s major import has been manufactured goods, which constitute around 30 per cent of its total import. Machinery and transport equipment stands as the second largest group to import, which constitutes about 15 per cent. Similarly, minerals, fuel and lubricants, food and live animals, chemical and drugs, animals and vegetable oil and fats have been the major products and items being imported by Nepal.

The main conclusions and recommendations drawn from empirical evidences can be summarized as follows:

Nepal has no bi-lateral trade agreement with Canada, Japan, Singapore, Malaysia, Saudi Arabia, Hong Kong, Thailand, and the other many major trade partners. Therefore, it is an urgent need for Nepal to initiate bi-lateral trade agreement with these countries in the present integration-oriented context. The agreement should not be limited to merchandise trade. It should include trade in services, investment, intellectual property and labour mobility.

Several EU Member States are long-standing development partners of Nepal. In the fiscal year 2005/06, Nepal's export to European Union region was about 16 percent of country's total national export. Many countries of EU like Germany, France, Italy have been major trade partner of Nepal. Nepal does not have trade agreement with EU. Therefore, it is an urgent need for Nepal to make a trade agreement arrangement with EU in present context by covering both the merchandize as well as trade in services.

As of 2007, Nepal had signed bi-lateral trade agreements with 17 countries. But almost all the treaties, except with India, were signed quite back, i.e., before 1980. Hence, it is essential for Nepal to review these treaties in the present context.

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Nepal’s exports to Bhutan are increasing over the current years and there is more or less similar situation with Bangladesh as well. Nepal enjoys comparative advantage for uncooked pasta, soaps, and cereal products with Bhutan and for lentils, weaning foods, and vegetable seeds with Bangladesh. It is recommended that Nepal can gain by FTA arrangement with Bhutan and Bangladesh in recent years. Hence, priority should be given to these two countries for FTA arrangement. Nepal should also take initiatives for FTA with Sri Lanka. These initiatives towards FTA would make Nepalese trade diversified instead of India-centred.

Remittances play an important role in improving living standards of households in Nepal. Given its importance to the economy, fresh bi-lateral initiatives between Nepal and the new destination countries regarding liberal labour mobility policy (labour market liberalization) particularly with Middle East countries are crucial and should be included in trade agreements.

Tea, herbs, and leather are major export potential products for Nepal. However, these products face tariff and non-tariff barriers in the international market. Identification and removal of such barriers are essential to realize its export potential. Bi-lateral, regional, and multi-lateral trade negotiations can be utilized to address these barriers. However, this is not possible without a well-coordinated negotiation strategy with a sound capacity team.

The increasing trend of trade deficit, informal trade between the two countries and imposition of Tariff Rate Quotas (TRQs) by India on some Nepalese exports are the major issues in Indo-Nepal Trade Treaty. These issues need to be addressed. Energy and services, i.e., Information and Communication Technology (ICT), tourism, education, healthcare, are most necessary sectors to be included, in future trade negotiations to benefit both the countries. Nepal could exploit its vast amount of untapped hydroelectricity to fulfil the high demand of energy in Indian market.

Several issues need to be addressed to realize the potential benefits of tariff free access under SAFTA. These are: safeguard measures-sensitive lists and Rules of Origin (RoO), para-tariff and non-tariff barriers, trade facilitation, and transit and transport logistics. The fact is that most of the highly-traded and potential items are in sensitive list. However, the 1996 Indo-Nepal bi-lateral agreement has substantially reduced the sensitive list to only few items. Nepal’s bi-lateral agreement with India is more attractive to Nepal than SAFTA because of non-reciprocal and zero tariff access for Nepalese manufactured products to Indian market. Unless the number of goods from the sensitive lists is reduced in SAFTA, Nepal will benefit little from SAFTA. Similarly, if SAFTA does not compensate financially for customs revenue losses, Nepal would prefer to continue trading with India under bi-lateral agreement.

Trade in services is inseparable from trade in goods. Service sector especially tourism is the most important for employment generation and foreign exchange earning for Nepal. Further, foreign investment in hydroelectricity, tourism, education, health etc. is necessary for Nepal’s economic development. Therefore, Nepal should negotiate to include services and investment liberalization in SAFTA as well as other bi-lateral trade negotiations.

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Although, liberalization of services and investment is included in BIMSTEC Agreement, it is essential to make it to work more effective. Nepal's potential feasible hydroelectricity power capacity of around 83,000 MW (currently only around 1 per cent is being exploited) could be a large net power producer and exporter to SAARC/BIMSTEC countries and especially to India where power demand has steadily increased over the years, if liberalization of services and investment within the region is fully materialized.

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Chapter One

Introduction

1.1 Background

Trade liberalization means integration of the national economy with the global economy in terms of easier/free flow of goods and services, technology and information. The WTO, formed in 1994 as a successor of GATT, is an institutional foundation of the multi-lateral trading system to provide the fundamental principle of trade liberalization, i.e., non-discriminatory trade among trading partners.

Trade liberalization has become the cornerstone of economic reform strategies throughout the world. The process of trade liberalization involves the phasing out of barriers to trade by the conversion of non-tariff barriers into tariff equivalents (tariffication), reduction of tariff rates, export promotion and devaluation of the currency. In spite of many international and regional commitments to multilateralism in the international trade regime through the support of the WTO and several regional trading blocks in different parts of the world, the politics of trade policy reform displays two well-known forms of contradiction between the advocates and the sceptics.

Impact of trade liberalization on country’s development has been a highly controversial topic and a concern of debate among the economists around the world, particularly in developing countries. The proponents of trade liberalization claim that openness and free trade enhances the efficiency of resource allocation, international competitiveness and increases the volume of trade. It enhances a country’s income by forcing resources to move from less productive uses to more productive uses, i.e., utilizing comparative advantage. Therefore, trade liberalization is an important component of any strategy seeking to increase growth. Interventions in trade diminish the efficiency of resource allocation, reduce competitiveness and exacerbate macroeconomic imbalances (Krueger, 1995; Rodrik, 1997; Khattry, 2003; and Bhagwati, 2004).

The sceptics, on the other hand, argue that freer trade would adversely affect the poor in both short and long run because of internal contradictions in the NEP packages. They argue that growth in employment will slow down because massive investment will take place in urban areas with higher profit motive. As a result, growth rate will be higher in urban areas compared to rural areas and the regional disparity will widen. The quality of employment would deteriorate by effecting wage rates. Trade liberalization through tariff reduction tends to decline revenues affecting the pace of economic development. (Amin, 1997; Chossudovsky, 2001; Kumar, 2002; and Stiglitz, 2002).

The detractors argue that today’s globalization is not a new concept but it is only a new phase of globalization, i.e., one-way globalization dominated by the developed countries. Its philosophy of economic development is based on marketization of the structures of the economy and pushing it into all aspects of social functioning. Many claim that globalization has neither succeeded in reducing poverty nor has it succeeded in ensuring stability in the developing countries. The supporting institutions are working on the

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behalf of the wealthiest industrial countries of the West. The social impact of devaluation is brutal and immediate. The domestic prices of food staples, essential drugs, fuel and public services increase overnight.

The explicit goal of trade liberalization strategy was to create a major shift in the growth rate of exports. It was argued that export pessimism was a basic cause of lack of economic development in the developing countries. It was expected that export incentives to the domestic producers would reflect economies of scale and substantial improvement in export performance. Another goal of trade liberalization was to lower import prices through tariff reductions and trade competition which would benefit the poor consumers. But this perception misses the basic point that ability to consume depends upon income, which in turn depends upon employment opportunities. If a particular enterprise closes down because of losses due to competition from imports and more open trade strategy, the real income of workers decline and consumers cannot be benefited from even cheaper imported goods (Chandrasehkar and Ghosh, 2000).

The Preferential Trade Agreements (PTAs) and Free Trade Agreements (FTAs), Regional Trade Agreements (RTAs) and multilateralism are the supporting elements of trade liberalization. Although trade liberalization for developing countries is one of the most controversial issues among the economists, most of the countries around the world are moving towards trade liberalization initiatives and Nepal cannot be an exception.

RTAs have become in recent years a very prominent feature of the global trading system. This second trend1 in the global trading system is rapidly gaining momentum and establishing a very different set of rules2. As a result, the number of RTAs has more than quadrupled since 1990s. Some 368 RTAs have been notified to the GATT/WTO up to December 2006. Moreover, if we take into account RTAs which are in force but have not been notified, those signed but not yet in force, those currently being negotiated, and those in the proposal stage, we arrive at a figure of close to 400 RTAs which are scheduled to be implemented by 20103. The scope and coverage of bi-lateral and regional trade agreements is expanding rapidly and now they are covering the issues of services, investment, intellectual property and labour mobility, apart from the merchandise trade.

As a complement to the multi-lateral trading system, the WTO allows RTAs (an exception to its basic principle of MFN stipulating that the RTA must comply with two main requirements outlined in the GATT Article XXIV. First, the agreement must lower trade barriers within the regional groups. Second, the agreement cannot raise trade barriers for non-participating members.

Slow progress in the WTO negotiations, developing countries’ aspirations and advantages of RTAs (easy and quick handling, trade creation, less dispute and less diverse interest etc.) pushed countries to adopt a two-pronged strategy (bi-lateral and

1 Multi-lateralism is the first trend in global trading system, while second (new) trend is the proliferation of regional (including bi-lateral) trade agreements (RTAs). 2 The World Bank, Global Economic Prospects 2005. 3 http://www.wto.org/english/tratop_e/region_e/region_e.htm

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regional) of economic integration simultaneously. Nepal also adopted the same strategy. Nepal initiated its economic integration process in mid 1980s.4 The process was further boosted after the restoration of multiparty democracy in the 1990s.5 In addition to the unilateral reforms, Nepal entered into bi-lateral, regional and multi-lateral trade agreements to further consolidate its reform process and integrate with the world economy. As of 2007, Nepal has signed bi-lateral trade agreements with 17 countries. These countries include: Bangladesh, Bulgaria, China, Czech Republic, Egypt, India, Democratic People’s Republic of Korea, Republic of Korea, Mongolia, Pakistan, Poland, Romania, Sri Lanka, UK, USA, Russia, and Yugoslavia.

Apart from bi-lateral trade agreements, Nepal is a member of two regional trade agreements- SAFTA which came into force on 1 January, 2006 and BIMSTEC. The fact is that while increasing in the last few years, intra-SAFTA/BIMSTEC trade has not expanded significantly faster than total trade in this relatively open set of economies.

However, Nepal's bi-lateral trade agreements are static6 in nature. The trade agreements have never been reviewed and assessed with any of these countries except India7. It is now realized that a system to review/assess and update these trade treaties is necessary, if the trade partners want to reap the benefits of such treaties in the rapidly changing global and national context. The political and economic dimensions vis-à-vis priorities of the countries are changing. Therefore, it is now necessary for Nepal to review and assess trade treaties and explore potential countries and areas to be covered in the future trade treaties.

With the adoption of new economic policy and in the light of WTO and SAFTA, the concept of bi-lateral trade relation has gradually changed to regional and global trade framework. The concept of bi-lateral FTAs along with regional and multi-lateral free trade arrangements is becoming more and more crucial.

India and China are the traditional trading partners of Nepal. Before 1950, Nepal's foreign trade was confined only to India. Nepal's trade with India formed 98 per cent of its total foreign trade in the mid 1960s. Trade diversification policy began in early 1960s. In subsequent years, more comprehensive measures were taken to achieve the objective of diversification policy.

Economists believe that any country should first acquire the much-needed comparative advantage before entering into free trade agreements. FTAs reflect the development divide: it is the more advanced countries which have the capacity to negotiate and

4 A new Commerce Policy aimed at transforming the trade sector to make it open, competitive and market oriented was formulated and implemented during the Eighth Plan of Nepal (1987-1992). 5 The Ninth Plan (1997-2002) sets a long-term goal of integrating the trade sector into the globalization process by making it fully competitive and market oriented. 6 Never reviewed and updated. 7 The treaty of trade and transit between Nepal and India has been renegotiated in 2006.

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implement such agreements. The poor and predominantly agricultural economies face inflexible internal political pressure against liberalization. The fact remains that unless and until a country improves its capacity to export more at competitive prices, there would be little scope for it to benefit from bi-lateral, regional or multi-lateral free trade arrangements. In the post-liberalization era, Nepal's competitiveness in export has eroded considerably. One of the major objectives of current trade policy has been to diversify trade by identifying, developing, and producing new exportable products through identification of new markets and making export trade competitive and sustainable. The government has adopted the strategy of improvements in the existing trade treaties and transit transport network. Special efforts to reduce transit costs are focused in its import policy. Still Nepal's major trading partner for export is India followed by USA, Germany, Japan, UK and so on. In import side too, India is the biggest partner followed by Singapore, UK, Hong Kong, Saudi Arabia, Thailand and others. Unfortunately, Nepal has no bi-lateral trade agreement with Germany, France, Canada, Italy, Japan, Singapore, Malaysia, Saudi Arabia, Hong Kong, Thailand, and the other many major trade partners. On the other hand, almost all the treaties, except with India, were signed quite back, i.e., before 1980.

1.2 Objectives

The basic objective of this study is to review and analyze Nepal’s existing trade treaties and suggest new countries and dimensions that has to be covered in future trade agreements with a view to make Nepal’s export trade competitive and sustainable. The specific objectives of the study are as follows:

Review and analyze all the agreements (bi-lateral and regional) in which Nepal is a contracting party,

Assess trade effects of existing regional and bi-lateral trade agreements on Nepal.

Suggest improvements/measures needed, in existing bi-lateral trade agreements, to make them beneficial for Nepal,

Suggest new dimensions that has to be covered while updating or negotiating on existing trade agreements,

Suggest name of new countries, on the basis of trade potentials, Nepal should sign trade agreements,

Suggest the content/dimensions that has to be covered in new (future) agreements, and

Document benefits and weaknesses of bi-lateral, regional and multi-lateral trade arrangement and suggest the best way to follow.

1.3 Methodology and Data Base

The study is an analytical study based on secondary data. The published as well as unpublished relevant literature has been used to review the regional and bi-lateral trade

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agreements. Data published by various government and non-government organizations has been used to analyze the situation. Economic surveys, budget speeches and plan documents published by Ministry of Finance and statistical year book and other reports published by Central Bureau of Statistics and National Planning Commission are the major sources of statistical information. Quarterly Economic Bulletin published by Nepal Rastra Bank (Central Bank of Nepal) is another source. Apart from this, reports published by international organizations like the World Bank, the IMF, UNDP etc. are also used. To make the study more relevant, discussions have been held with the appropriate representatives of the government (e.g. Ministry of Industry, Commerce and Supplies and Nepal Rastra Bank etc.); private business (e.g. FNCC); and international organizations.

1.4 Organization of the Chapters

The study is divided into five chapters. It begins with a brief picture of trade liberalization and its theoretical debate at various levels multi-lateral, regional, and bi-lateral along with Nepalese experience. Chapter two analyzes the historical background of trade liberalization particularly in the context of developing countries and Nepal. It further includes the various policy instruments introduced under trade liberalization by the government. Nepal’s export and import trade performance by composition, partners, and direction has been analyzed in chapter three. Chapter four reviews the various bi-lateral and regional trade and transit agreements. Finally, chapter five examines the new dimensions and future prospects of Nepal’s bi-lateral and regional trade agreements.

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Chapter Two

Trade Liberalization Initiatives

2.1 Trade Liberalization: Historical Background

Trade liberalization means integration of the national economy with the global economy in terms of free flow of goods and services, technology and information. The ideology of the global spread of market relations, in the real sense, is not something new. Adam Smith had laid the theoretical basis for modern market economy or liberalism in his work The Wealth of Nations in 1776. He provided profound basis for limiting the role of government and promoting private economic activities to maximize national wealth. From then on libertarian economists assiduously put forward the case for elimination of whatever restrictions the governments had placed on free operation of markets. It was only because of the shock of the Great Depression in the early 1930s that the libertarians were dumbfounded. As a consequence Keynesian liberalism with its insistence on public investment found takers even amongst the orthodox economists. Keynesianism had its heyday for a quarter of a century after the end of the Second World War.

The developing countries faced serious economic difficulties on account of mainly external factors related to the two oil price shocks in 1973 and 1979. To cope with crises of macro-economic imbalances: rising fiscal deficits, balance of payment deficits and repressed inflation in developing countries, the IMF and the World Bank prescribed their Stabilization and Structural Adjustment (SAP) program in 1980s to assist member countries. These programmes bolstered up the strength of the ideology of globalization, that is, the long-term market-oriented policy. As a result, deregulation of domestic goods market by withdrawal of price control, liberalizing the trade regime, i.e., deregulation of the economy by lowering all types of tax and tariff rates, reducing the government expenditure by phasing out of all kind of subsidies, privatization of state-owned enterprises, etc., are taken as the mechanism of liberalization and globalization.

Trade liberalization has become the cornerstone of economic reform strategies throughout the world. The process of trade liberalization involves the phasing out of barriers to trade by the conversion of non-tariff barriers into tariff equivalents (tariffication), reduction of tariff rates, export promotion and devaluation of the currency.

2.2 Nepalese Context

Economic globalization of Nepal is synonymous with the advent of the New Economic Policies (NEP) and may be defined as the integration of the national economy with the global economy in terms of free flow of ideas, goods and services, technology and information. Actually, the Nepalese economy has been globalizing for a long time. Nepal virtually had free trade policy even before 1935. There was no intervention in trade and investment activities before an agency called Udyog Parishad was created in 1935 to

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develop the basic industries. Another attempt at opening up the Nepalese economy was initiated in 1950. This was the period of Rana regime when the country was thrown open to tourists and merchandise imports from overseas countries were allowed. International trade relation was established with India and China. Nepal began to accept foreign aid, in terms of grants and loans, for the purpose of development. Nepal started developing and expanding international relations and became a member of a number of multi-lateral institutions.

The Panchayat government after the political referendum of 1980 followed an expansionary fiscal policy to accelerate the pace of economic growth in the country. As a result, Nepal suffered three consecutive years of BOP deficits around early 1980s. The budget deficit reached as high as 12 per cent of GDP. It was largely financed by printing money. This process accelerated the inflation. The foreign exchange reserves started to decline. To improve the situation, the government approached IMF for support in 1985. In December 1985, the IMF suggested the implementation of stabilization programme and subsequently a series of measures were undertaken.

Nepal was characterized by the interventionist approach of economic policies for a prolonged period of time. Government regulation and large scale public investments were major policies followed in the 1960s, 1970s, and early 1980s. The basic emphasis was on import substitution and export pessimism was widely prevalent. The trade policy was highly protectionist and regulated through quantitative restrictions on imports. The tariff rates were very high. It was believed that restricted imports would save foreign exchange and stimulate domestic output.

During that period, Nepal's trade region was more or less free with India and controlled with rest of the world. Imports from overseas countries were restricted through tariff walls and quantitative restrictions but exports were more or less free. In the early 1990s, after the restoration of democracy, trade policy was changed with the new trade policy 1992. After that, the trade policy became freer. The ISI was replaced by an export led economic growth and imports were made free to assist exports. Following the ideology of NEP to integrate Nepalese economy with world economy, Nepal became the member of the WTO in the fifth ministerial conference of WTO held on 10-14 September 2003 at Cancun, Mexico.

First the government started its NEP programme with a three-year loan agreement with the IMF and contracting for a structural adjustment credit, popularly known as Structural Adjustment Loan (SAL I), from the World Bank covering the period from 1986/87 to 1988/89. The purpose of SAL I was to accelerate the growth rate, stabilize the price levels and correct the balance of payment. Following this, the World Bank provided a SAL II of Rs. 4.1 billion (US$ 60 million) for a three year period effective from August 1989. Its main purpose was to improve the allocation of public and financial resources and increase the participation of private sector.

After restoration of multi-party democracy in Nepal in 1990, Nepal accelerated the process of economic globalization. The newly elected government of the Nepali Congress

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implemented NEP with a new arrangement with the IMF and the World Bank under Enhanced Structural Adjustment Facility (ESAF) in 1992 which is generally known as “Second Generation of Economic Reform”. After that the government has been launching a comprehensive programme of NEP in almost all the sectors of the economy as advocated by Washington Consensus.

Effective from July 1993, the government abolished the system of foreign exchange auction for merchandise imports of industrial raw materials and put everything under Open General Licensing (OGL) system except for a few contraband items. Prior to the OGL, Nepal controlled imports to protect domestic industries especially from overseas countries through QR and tariff rates. With adoption of economic stabilization programme of the IMF in 1985, the Nepali currency was devalued by 14.7 per cent against US dollar on November 30, 1985. QRs have been completely abolished.

Nepal used to impose high tariff rates to control imports with the aim to raise government revenue, protect infant industries, and reduce consumption of luxury commodities and to check BOP deficits. Under NEP, Nepal started to reduce the tariff rates. Additional duties were also eliminated. Earlier peak tariffs rates were as high as 300 per cent. The rate was reduced to 80 per cent in the fiscal year1997-98. Now the tariffs rates have been brought down to 5-20 per cent (Ministry of Finance, 2005-06).

Before adoption of NEP, Nepal had taken many measures to boost export such as export subsidy, dual exchange rate system and bonus system. With the implementation of NEP, these measures were withdrawn and new measures were introduced. The new measures are: export duty drawback system and bonded warehouse scheme. Both the measures are believed to benefit carpet and garment industry.

The export duty drawback system was introduced in 1987. Under this system, both import tax and sales tax paid on imported inputs will be refunded to the exporters. The bonded warehouse scheme introduced in 1980 has also the provision to refund the taxes imposed on imported raw materials. Recently Nepal has introduced VAT in which exports are zero-rated. Taxes level on inputs of goods and services used in the production of exportable commodities are refunded.

2.3 Liberalization Outcomes

Along with Sri Lanka, Nepal has the most liberalized trade policy in South Asia. Following trade liberalization in the early 1990s, Nepal’s exports grew at an average annual rate of 15 per cent throughout the decade. Despite significant structural changes in its merchandise exports over the last two decades, Nepal’s narrow export basket and concentration of exports to only a few countries has made it more vulnerable. A further challenge is posed by the phasing out of the Multi-Fibre Arrangement (MFA) in 2005, whose quotas enabled significant growth of ready-made garments exports. Weak demand, quality problems, and concern in importing countries over child labour in certain

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factories adversely affected Nepal’s major carpets export. Exports of ready-made garments, which benefited from preferential treatment under the Multi-fibre Arrangement (MFA), suffered due to international trade regulations changed and the industry’s inability to compete with exporters from other South Asian countries.

Despite a rigorous efforts by Nepal in the 1970s to diversify its foreign trade partners, Nepal’s dependence on India has recently increased sharply due to the preferential trade treaty signed in December 1996, a slowdown in exports to other key markets and limited success in penetrating regional markets.

While the renewed Nepal-India Trade Treaty 2007 continues Nepal’s customs duty-free access to India in principle, it also continues the restrictive provisions imposed in 2002: more stringent RoO, TRQs, clear specification of safeguard clauses etc. This change in policy, from virtual free trade to one with a number of restrictions, has had an immediate negative effect on Nepal’s export performance with India. Nepal’s increased dependence on India has elevated risks arising from Indian policy shifts.

Nepal’ exports have played a positive role since the 1986-90 period. During this period, their contribution to economic growth increased to 10 per cent, from 2 per cent for the previous period (1976-85). Exports were an engine of economic growth during the 1990s, particularly during the period after economic reforms, 1991-95 (MoICS, 2003).

Nepal has comparative advantage in a number of labour-intensive manufacturing and agricultural products. Despite economic liberalization and growth of trade in the 1990s, the competitiveness of Nepal’s economy is very low. Three key factors contribute to low price competitiveness and productivity in Nepal’s economy: inadequate mechanisms and incentives for firms to acquire new technology, weak infrastructure, and an unfavourable business climate. Nepal’s geography is a major constraint to realizing its trade potential. However, there is considerable scope to improve its competitiveness.

20

Chapter Three

Nepal’s Trade Performance

A significant consequence of Nepal’s land-locked position is its special trading relationship with India and lack of convenient access to any third country. The relationship has many advantages for Nepal but has constrained Nepal’s ability to pursue an independent trade policy. It compels Nepal to depend on India for transit route and many essential commodities of day-to-day needs. India is the only country which provides transit facilities to Nepal. The nearest port for Nepal is the Indian port at Calcutta which is 890 Kms. away from Kathmandu.

Nepal is situated between two giant countries, India in the south, east and west and China in the north. Being a land-locked country, anything Nepal wants to import or export must pass either through India or by air. A road connection with the peoples’ Republic of China exists but extensive trade contacts are inhibited by the high costs and seasonal nature of road transport through Himalayas. Like many other land-locked countries, transport cost of Nepal’s overseas exports as well as imports is very high. Therefore, trade and transit facilities offered by India play a significant role in making Nepal’s external trade viable.

3.1 Direction and Composition of Nepal’s Foreign Trade

For a long time, Nepal’s foreign trade has largely been confined to India because of close proximity, similar socio-economic condition and availability of transport facilities. The volume of Nepal’s foreign trade with India in terms of both exports and imports has been increasing enormously. It is because of the increasing demand of various types of industrial raw materials, machinery and petroleum products in order to run various types of developmental works and consumer goods to fulfil the requirements of fast growing population.

21

Table 3.1

Direction of Nepal’s Foreign Trade (Rs. in million)

Fiscal Year

Exports Imports Trade Deficit

Total To India % to India

Total From

India %

from India

Total With India

% with India

1960-61 209.7

209.2

99.8

398.0

375.1

94.2

188.3

165.9

88.1

1965-66 375.1

370.5

98.8

782.0

763.5

97.6

406.9

393.0

96.6

1970-71 400.5

395.2

98.7

699.1

61,6.8

88.2

298.6

221.6

74.2

1975-76 1,185.8

893.7

75.4

1,981.7

1,227.1

61.9

795.9

333.4

41.9

1980-81 1,608.7

992.4

61.7

4,428.2

2,179.0

49.2

2,819.5

1,186.6

42.1

1985-86 3,078.0

1,241.1

40.3

9,341.2

3,970.9

42.5

6,263.2

2,729.8

43.6

1990-91 7,387.5

1,552.2

21.0

23,226.5

7,323.1

31.5

15,839.0

5,770.9

36.4

1995-96 19,881.1

3,682.6

18.5

74,454.5

24,398.6

32.8

54,573.4

20,716.0

38.0

1996-97 22,636.5

5,226.2

23.1

93,553.4

24,853.3

26.6

70,916.9

19,627.1

27.7

1997-98 27,513.5

8,794.4

32.0

89,002.0

27,331.0

30.7

61,488.5

18,536.6

30.1

1998-99 35,676.3

12,530.7

35.1

875,23.3

32,119.7

36.7

51,847.0

19,589.0

37.8

1999-00 49,822.7

21,220.7

42.6

108,504.9

39,660.1

36.5

58,682.2

18,439.4

31.4

2000-01 55,654.1

26,030.2

46.8

115,687.2

45,211.0

39.1

60,033.1

19,180.8

31.9

2001-02 46,944.8

27,956.2

59.5

107,388.9

44,117.1

41.1

60,444.1

16,160.9

26.7

2002-03 49930.6

26430.0

52.9

124352.1

70924.2

57.0

74421.5

44494.2

59.8

2003-04 53910.7

30777.1

57.1

136277.1

78739.5

57.8

82366.4

47962.4

58.2

2004-05 58705.7

38916.9

66.3

149473.6

88675.5

59.3

90767.9

49758.6

54.8

2005-06 60074.8

41012.6

68.3

162840.7

109305.9

67.1

102765.9

68293.3

66.4

Source: Quarterly Economic Bulletin, Nepal Rastra Bank and Trade Promotion Centre

Table 3.1 summarizes the direction of the foreign trade from 1960-61 to 2005-06. The Table reveals that in the end of the first plan (1960-61), Nepal’s export to India was 99 per cent of its total exports and imports from India was 94 per cent of its total imports. Nepal’s trade with India formed 98 per cent of its overall foreign trade in the mid-1960s. Till the 1960s, Nepal was importing almost all of its requirements from India and exports all of its exportable items to India.

22

To remove the over-dependence on India, Nepal introduced various policies and schemes to diversify its trade to overseas countries. Nepal’s exports as well as imports from India started declining significantly from the year 1970-71. By 1975-76, Nepal’s exports to India decreased to 75 per cent of its total exports and its imports from India to 62 per cent. Further, share of Nepal’s exports to India declined to 18 per cent in 1995-96 and share of imports from India declined to 26 per cent by 1996-97.

The direction and structure of Nepalese trade has changed significantly during the last decade. The reversal trend was experienced in the Nepal’s trade with India since 1997-98. India is again emerging as the top destination of Nepalese trade. Nepal’s export to India has recorded over 26 fold jump during the period of one and half decade from 1990-91 to 2005-06. Nepal’s export to India has increased from 21 per cent to 68 per cent during the period. Nepal’s import from India, as well, has recorded 15-fold jump during the same period of one and half decade. It has steadily gone up from 31 per cent in 1990-91 to 67 per cent in 2005-06. This heavy jump in external trade of Nepal with India might be associated with the regional process of trade liberalization and the reforms in the foreign trade regime in the both countries.

Nepal’s trade deficit with India increased almost 412 fold from Rs. 166 million in 1960-61 to Rs. 68 billion in 2005-06 (Table 3.1). The important factors in Nepal’s ever increasing balance of trade deficit with India are: an emerging system of unequal exchange, importing expensive items like cement, steel, petroleum products, cotton textile, machinery and transport equipments and exporting cheaper items like ghee, jute goods, raw agricultural products etc. However, to control its trade deficit, there is vast scope of expanding the exports of Nepalese products like hydroelectricity, horticulture and floriculture products, jute products, forest products, handicrafts etc.

Nepal has been trapped in trade deficit not only with India but also with overseas countries. An increasing trend of trade deficit is a serious issue for Nepal. Without increasing export capabilities and controlling the import of luxury goods, it is difficult to overcome the problem of trade deficit of the country.

Nepal has been exporting and importing variety of goods and services of their requirement to and from many countries for long time. Before nineteenth century, Nepal’s foreign trade was largely confined to India. Nepal’s imports from India consisted of main items like tobacco, spices, metals etc. and some luxury items like Malmal and Dopatta (then high quality textile). Nepalese exports consisted mainly of agricultural and forest products. The composition of Nepalese exports even today has not been diversified except few products while composition of import has changed tremendously.

The growth rate of Nepalese exports and imports has been fluctuating quite significantly. Growth rate of exports has been exceeding growth rate of imports since 1993-94. The

23

year 1995-96 has again reversed that trend. Growth rate of imports has been faster than the growth rate of exports in general. This observable fact shows the fragile export performance and mounting import requirement of Nepalese economy. Low level of development is mainly responsible for this type of situation in the trade matters.

There have been major structural changes in Nepal’s merchandise exports in the past two decades but it still depends on a few goods and a few markets. The export share of primary products has fell down from about 70 per cent in 1980s to around 15 per cent in 2006 and the share of manufactured products has increased from 30 per cent to above 75 per cent during the same period. On the other side, no significant changes have occurred in Nepal’s import structure. Machinery and transport equipments, intermediate goods and food and fuels are the major imports.

3.2 Nepal's Export Trade: Partners and Commodities

The leading export partners of Nepal have been India, USA, Germany, United Kingdom, Belgium, France, Japan, Bangladesh, Peoples’ Republic of China, Hong Kong, Switzerland, Spain, Italy and Canada over the last few years. As of 2005/06, around 85 per cent of its exports go to India, the United States, and Germany. India has been the major country to import from Nepal from the very beginning. The USA stands to be the second country in Nepal’s export followed by Germany and other countries for the last couple of years.

24

Table 3.2 Major Export Trade Partners of Nepal

S.N

Countries Value in Million Rs. % 2001/02 2002/03 2003/04 2004/05 2005/06 01/02 02/03 03/04 04/05 05/06

1 India 27,956 26,430 30,777 38,917 41,013 59.0 52.9 57.0 66.6 68.3 2 U.S.A 9,378 12,686 9,696 7,571 6,993 19.8 25.4 18.0 13.0 11.6 3 Germany 4,043 3,555 3,567 3,122 2,844 8.5 7.1 6.6 5.3 4.7 4 France 473 454 582 618 1,297 1.0 0.9 1.1 1.1 2.2 5 U.K 809 1,071 1,677 1,051 1,184 1.7 2.1 3.1 1.8 2.0 6 Italy 567 531 589 583 712 1.2 1.1 1.1 1.0 1.2 7 Canada 306 384 546 529 645 0.6 0.8 1.0 0.9 1.1 8 Japan 493 474 526 535 572 1.0 0.9 1.0 0.9 1.0 9 Singapore 146 86 57 44 322 0.3 0.2 0.1 0.1 0.5 10 Switzerland 383 263 306 316 318 0.8 0.5 0.6 0.5 0.5 11 Belgium 295 230 261 319 309 0.6 0.5 0.5 0.5 0.5 12 Spain 154 200 206 223 283 0.3 0.4 0.4 0.4 0.5 13 Turkey 12 89 264 233 278 0.0 0.2 0.5 0.4 0.5 14 Bhutan 27 52 78 150 238 0.1 0.1 0.1 0.3 0.4 15 Bangladesh 237 411 421 291 234 0.5 0.8 0.8 0.5 0.4 16 Netherlands 182 240 286 242 229 0.4 0.5 0.5 0.4 0.4 17 Pakistan 62 74 278 229 186 0.1 0.1 0.5 0.4 0.3 18 U.A.E 127 58 81 154 165 0.3 0.1 0.2 0.3 0.3 19 Australia 60 82 97 101 154 0.1 0.2 0.2 0.2 0.3 20 Hongkong 61 87 77 129 112 0.1 0.2 0.1 0.2 0.2 21 China P. R. 19 31 117 53 108 0.0 0.1 0.2 0.1 0.2 22 Austria 122 60 89 102 100 0.3 0.1 0.2 0.2 0.2 23 Sweden 52 53 97 56 98 0.1 0.1 0.2 0.1 0.2 24 Denmark 25 27 128 88 81 0.1 0.1 0.2 0.2 0.1 25 Taiwan 44 46 51 67 70 0.1 0.1 0.1 0.1 0.1 26 Thailand 56 82 102 78 40 0.1 0.2 0.2 0.1 0.1 27 Norway 18 15 17 32 30 0.0 0.0 0.0 0.1 0.0 28 Mexico 16 27 17 35 26 0.0 0.1 0.0 0.1 0.0 29 Korea R. 59 53 62 36 25 0.1 0.1 0.1 0.1 0.0 30 Portugal 32 414 29 438 13 0.1 0.8 0.1 0.7 0.0

Sub Total 46,214 48,265 51,081 56,342 58,679 97.5 96.5 94.7 96.4 97.7

Other Countries* 1,171 1,742 2,804 2,104 1,393 2.5 3.5 5.2 3.6 2.3

Grand Total

47,385 50,007 53,949 58,446 60,072 100.0 100.0 100.0 100.0 100.0

Note: - Trade with India for the F.Y. 2005/06 is provisional. *Including Exports to Tibet, Autonomous Region of People's Republic of China Source: Trade Promotion Centre

In past few years, Nepal’s exports to India have increased significantly (Table 3.2). This rise is due to long open border leading to free movement of people and capital, the preferential trade treaty and special payments regime between the two countries, slowdown in exports to other key markets, and limited success in penetrating other regional markets (Karmacharya, 2005).

25

Table 3.3 Nepal's Export to SAARC/BIMSTEC Countries (Value in Million NRs.)

Country 2001/02 2002/03 2003/04 2004/05 2005/06 Value % Value % Value % Value % Value %

India 27,956 97.7 26,430 96.5 30,777 95.7 38,917 85.9 41,013 93.4 Bangladesh 237 0.8 411 1.5 421 1.3 291 0.6 234 0.5 Bhutan 27 0.1 52 0.2 78 0.2 150 0.3 238 0.5 Maldives 1

(.) (.) (.) (.) (.) (.) (.) (.) (.)

Pakistan 62 0.2 74 0.3 278 0.9 229 0.5 186 0.4 Sri Lanka 261 0.9 325 1.2 505 1.6 5,612 12.4 2,207 5.0 Afghanistan (.) (.) 12 (.) 15 (.) 6 (.) (.) (.) Thailand 56 0.2 82 0.3 102 0.3 78 0.2 40 0.1 Myanmar (.) (.) (.) (.) (.) (.) (.) (.) (.) (.) Total Export to SAARC/BIMSTEC

28,600 100.0 27,386 100.0 32,176 100.0 45,283 100.0 43,918 100.0 Total Export 47,385

50,007

53,949

58,446

60,072

Export to SAARC/BIMSTEC (In %)

59.0 52.9 57.0 66.6 68.3

Note: (.) means negligible Source: Trade Promotion Centre

The share of Nepal’s export to SAARC/BIMSTEC member countries was 59 per cent of the total export trade in 2001-02. The share gradually increased over the last few years and stood at 68 per cent in 2005-06 (Table 3.3). Among the SAARC/BIMSTEC member countries, India has been the major country to import, i.e., importing more than 90 per cent of its total export to SAARC/BIMSTEC countries. Thailand has been the second after India to import from Nepal in this region. Besides, Nepal also imports from Pakistan, Sri Lanka and Bhutan at a very low scale. In recent years, Maldives has also started to import from Nepal. However, Nepal’s export to other SAARC/BIMSTEC countries have accounted for only about 10 per cent of its exports to SAARC/BIMSTEC countries and about 1 per cent of is total exports.

Nepal’s export products include various goods. The major export products have been readymade garments, woollen carpets, woollen and pashmina goods, vegetable ghee, toothpaste, jute and jute goods, pulses, polyester yarns, hide skins and handicrafts (Table 3.4 and 3.5). Manufactured exports are concentrated in garments, carpets, and pashmina. Woollen carpets used to be the prime export and readymade garments have been another major export. The other commodities include: cotton, hide and skins, gold and silver ornaments, pulses, handicrafts, tea, cardamom, herbs, ginger seeds and perfume oil.

26

Table 3.4 Exports of Major Commodities to India

S.N

Major Items

Value in Million Rs. % 2001/02 2002/03 2003/04 2004/05 2005/06 01/02 02/03 03/04 04/05 05/06

1 Aluminim Section 220 255 381 879 894 0.8 1.0 1.2 2.3 2.2

2 Cardamom 360 470 451 607 608 1.3 1.8 1.5 1.6 1.5 3 Chemicals 87 149 610 1,408 1,058 0.3 0.6 2.0 3.6 2.6 4 G.I. Pipe 166 357 556 424 519 0.6 1.4 1.8 1.1 1.3 5 Ghee

(Vegetable) 7,081 3,812 2,959 4,636 3,862 25.3 14.4 9.6 11.9 9.4 6 Juice 453 600 787 1,091 1,140 1.6 2.3 2.6 2.8 2.8 7 Jute

Goods 1,630 1,899 1,883 2,694 2,637 5.8 7.2 6.1 6.9 6.4

8 Plastic Utensils 771 808 1,192 1,362 808 2.8 3.1 3.9 3.5 2.0

9 Polyester Yarn 1,070 657 1,115 1,896 3,475 3.8 2.5 3.6 4.9 8.5

10 Pulses 1,006 880 579 667 637 3.6 3.3 1.9 1.7 1.6 11 Readymade

Garment 214 399 627 366 1,137 0.8 1.5 2.0 0.9 2.8 12 Textiles 563 878 1,781 2,997 2,155 2.0 3.3 5.8 7.7 5.3 13 Thread 847 1,235 1,637 2,214 1,898 3.0 4.7 5.3 5.7 4.6 14 Tooth

Paste 1,607 1,003 1,479 1,283 731 5.7 3.8 4.8 3.3 1.8 15

Wire 252 151 711 1,221 1,504 0.9 0.6 2.3 3.1 3.7

16 Zinc sheet 13 971 2,785 1,663 2,409 0.0 3.7 9.0 4.3 5.9

Sub Total 16,339 14,524 19,532 25,407 25,472 58.4 55.0 63.5 65.3 62.1

Other Items 11,617 11,906 11,245 13,510 15,541 41.6 45.0 36.5 34.7 37.9

Total 27,956 26,430 30,777 38,917 41,013 100.0 100.0 100.0 100.0 100.0 Note: Data for fiscal year 2005/06 is provisional Source: Quarterly Economic Bulletin, Nepal Rastra Bank

Primary products constitute an overwhelming share of Nepalese exports to India. These are limited to pulses, live animals, jute, ginger, ghee and herbs. Although the share of manufactured goods has been increasing, it is still limited. In last few years it is increased significantly.

The traditional Nepal’s exports to India consisted of agricultural and forest products, i.e., rice, ghee, animals, foodstuffs and wood have been declining because of the increasing demand of food items at home for domestic consumption (according to population census 2001, the rate of population growth is 2.25 per cent per annum (CBS, 2001) whereas the rate of growth of food production is below 2 per cent), the rapid deforestation and destruction of forest resources, and Nepal’s inability to compete with products of other countries in Indian market.

27

Table 3.5 Exports of Major Commodities to Other Countries

S.N

Major Items Value in Million Rs. % 2001/

02 2002/03

2003/04

2004/05

2005/06

01/02 02/03 03/04 04/05 05/06

1 Handicraft (Metal and Wooden) 234 352 626 644 333

1.2 1.5 2.7 3.3 1.7

2 Herbs 25 33 48 55 13 0.1 0.1 0.2 0.3 0.1 3 Nepalese Paper & Paper

Products 201 262 280 240 256 1.1 1.1 1.2 1.2 1.3 4 Nigerseed 13 11 9 0 7 0.1 0.0 0.0 0.0 0.0 5 Pashmina 1,245 1,158 1,064 1,050 1,576 6.6 4.9 4.6 5.3 7.8 6 Pulses 216 215 281 107 191 1.1 0.9 1.2 0.5 0.9 7 Readymade Garments 7,833 11,890 9,550 6,125 6,170 41.3 50.6 41.3 30.9 30.6

8 Readymade Leather Goods 56 33 31 30 14 0.3 0.1 0.1 0.2 0.1

9 Silverware and Jewelleries 274 348 369 363 282 1.4 1.5 1.6 1.8 1.4

10 Tanned Skin 465 227 309 236 286 2.4 1.0 1.3 1.2 1.4 11 Tea 26 45 114 107 107 0.1 0.2 0.5 0.5 0.5 12 Woolen Carpet 6,213 5,320 5,678 5,869 5,825 32.7 22.6 24.5 29.7 28.9

Other Items 2,188 3,607 4,776 4,965 5,095 11.5 15.4 20.6 25.1 25.3

Total 18,989 23,501 23,134 19,789 20,155 100.0 100.0 100.0 100.0 100.0 Note: Data for fiscal year 2005/06 is provisional Source: Quarterly Economic Bulletin, Nepal Rastra Bank

3.3 Nepal Import Trade: Partners and Commodities

Nepal imports its commodity requirements from different countries. India, Peoples’ Republic of China, Singapore, Indonesia, Thailand, Malaysia, Saudi Arabia, Japan, Germany, Republic of Korea, Hong Kong, and New Zealand have been the major import trade partners of Nepal. However, like exports, India has been the country from where Nepal imports its major part.

28

Table 3.6 Major Import Trade Partners of Nepal

S.N

Countries Value in Million Rs. % 2001/02 2002/03 2003/04 2004/05 2005/06 01/02 02/03 03/04 04/05 05/06

1 India 56,622

70,924

78,739

88,675

109,306

52.1 55.3 58.0 59.8 67.1

2 China P.R. 4,316

4,760

5,434

8,254

6,635

4.0 3.7 4.0 5.6 4.1

3 Indonesia 2,878

3,977

3,254

5,223

5,648

2.6 3.1 2.4 3.5 3.5

4 Singapore 7,347

9,039

8,699

7,747

3,375

6.8 7.0 6.4 5.2 2.1

5 Germany 1,670

2,278

1,978

1,571

2,762

1.5 1.8 1.5 1.1 1.7 6 Thailand 3,278

2,989

4,320

3,118

2,602

3.0 2.3 3.2 2.1 1.6 7 Malaysia 4,818

4,010

3,676

2,821

2,475

4.4 3.1 2.7 1.9 1.5

8 Saudi Arabia

3,655

2,364

2,548

3,138

2,330

3.4 1.8 1.9 2.1 1.4 9 Japan 2,179

1,891

1,690

2,565

1,935

2.0 1.5 1.2 1.7 1.2 10 Korea R. 2,501

3,380

3,081

2,784

1,789

2.3 2.6 2.3 1.9 1.1 11 U.S.A 2,526

1,708

1,433

1,764

1,677

2.3 1.3 1.1 1.2 1.0 12 Australia 671

721

1,271 1,521

1,415

0.6 0.6 0.9 1.0 0.9 13 Brazil 150

19

293

839

1,166

0.1 0.0 0.2 0.6 0.7 14 U.A.E 381

583

408

772

1,096

0.4 0.5 0.3 0.5 0.7

15 New Zealand

929

1,422

1,284

1,230

1,019

0.9 1.1 0.9 0.8 0.6 16 Argentina 443

919

1,115

950

1,005

0.4 0.7 0.8 0.6 0.6 17 U.K. 837

1,065

1,035

1,452

961

0.8 0.8 0.8 1.0 0.6 18 Hongkong 2,461

2,277

1,641

1,286

931

2.3 1.8 1.2 0.9 0.6 19 France 706

1,590

675

668

910

0.6 1.2 0.5 0.5 0.6 20 Russia 548 240 227

672

900

0.5 0.2 0.2 0.5 0.6 21 Canada 263 407 688

277

715

0.2 0.3 0.5 0.2 0.4 22 Ukraine 64 64

55

696

611

0.1 0.0 0.0 0.5 0.4 23 Taiwan 713

1,267

1,175

826

568

0.7 1.0 0.9 0.6 0.3 24 Switzerland 452

555

242

222

491

0.4 0.4 0.2 0.1 0.3 25 Qatar 84

119

162

234

482

0.1 0.1 0.1 0.2 0.3 26 Denmark 322

342

339

246

306

0.3 0.3 0.2 0.2 0.2 27 Netherlands 192

254

229

377

304

0.2 0.2 0.2 0.3 0.2 28 Guatemala 8

259

310

284

252

0.0 0.2 0.2 0.2 0.2 29 Belgium 398

1,444

1,126

824

240

0.4 1.1 0.8 0.6 0.1 30 Hungary 4

61

212

243

9

0.0 0.0 0.2 0.2 0.0

Sub Total 101,416 120,928 127,339 141,279 153,915 93.4 94.3 93.7 95.3 94.5

Other Countries*

7,219 7,297 8,497 7,015 8,925 6.6 5.7 6.3 4.7 5.5

Grand Total

108,635 128,225 135,836 148,294 162,840 100.0 100.0 100.0 100.0 100.0

Note: - Trade with India for the F.Y. 2005/06 is provisional. *Including Exports to Tibet, Autonomous Region of People's Republic of China Source: Trade Promotion Centre

29

Table 3.7 Nepal's Import from SAARC/BIMISTEC Member Countries

Value in Million NRs. Country 2001/02 2002/03 2003/04 2004/05 2005/06

Value % Value % Value % Value % Value % India 56,622 92.9 70,924 95.1 78,739 93.6 88,675 96.1 109,305 97.2 Bangladesh 643 1.1 335 0.4 671 0.8 206 0.2 105 0.1 Bhutan 85 0.1 36 (.) 22 (.) 32 (.) 127 0.1 Maldives (.) (.) (.) (.) (.) (.) (.) (.) (.) (.) Pakistan 133 0.2 153 0.2 191 0.2 167 0.2 191 0.2 Sri Lanka 161 0.3 105 0.1 140 0.2 34 (.) 52 (.) Afghanistan (.) (.) (.) (.) (.) (.) (.) (.) (.) (.) Thailand

3,278

5.4

2,989

4.0

4,320

5.1

3,118

3.4

2,602

2.3 Myanmar 17 (.) 7 (.) 11 (.) 6 (.) 18 (.) Total Import from SAARC/BIMSTEC 60,939 100.0 74,549 100.0 84,094 100.0 92,238 100.0 112,400 100.0

Total Import 108,635 128,225 135,836 148,294 162,840

Import from SAARC/BIMSTEC (In %) 56.1 58.1 61.9 62.2

69.0 Note: (.) means negligible Source: Trade Promotion Centre

Nepal’s imports from SAARC/BIMSTEC countries have increased over the years. The major country among SAARC/BIMSTEC region to import has been India from where more than 95 per cent of its requirements are fulfilled. Apart from India, commodities are imported from Bangladesh and Pakistan too but the percentage of imports from these countries is very low. Imports from other SAARC/BIMSTEC countries constitute less than 1 per cent of its total imports.

Nepal’s imports are diversified than its exports. Nepal’s major import has been manufactured goods, which constitute around 30 per cent of its total import. Machinery and transport equipment stands as the second largest group to import, which constitutes about 15 per cent. Similarly, minerals, fuel and lubricants, food and live animals, chemical and drugs, animals and vegetable oil and fats have been the major products and items being imported by Nepal.

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Table 3.8 Imports of Major Commodities from India

S.N

Major Items Value in Million Rs. % 2001/

02 2002/

03 2003/

04 2004/

05 2005/

06 01/02 02/03 03/04 04/05 05/06

1 Agri. Equip. & Parts 351 690 498

431

663

0.6 1.0 0.6 0.5 0.6

2 Baby Food & Milk Products 399 509 428 493 567 0.7 0.7 0.5 0.6 0.5

3 Cement 2,750 2,935 2,319 2,457 1,857 4.9 4.1 2.9 2.8 1.7 4 Chemical Fertilizer 92 184 563 778 1,052 0.2 0.3 0.7 0.9 1.0 5 Chemicals 1,042 1,907 2,564 2,395 3,239 1.8 2.7 3.3 2.7 3.0 6 Coal 634 695 783 1,402 1,186 1.1 1.0 1.0 1.6 1.1 7 Coldrolled Sheet in

Coil 1,149 1,393 3,333 4,085 798 2.0 2.0 4.2 4.6 0.7 8 Cosmetics 133 410 423 512 869 0.2 0.6 0.5 0.6 0.8

9 Electrical Equipment 801 998 1,106 1,237 1,561 1.4 1.4 1.4 1.4 1.4

10 Fruits 216 285 337 380 606 0.4 0.4 0.4 0.4 0.6 11 Hotroiled Sheet in

Coil 928 2,639 2,060 569 1,145 1.6 3.7 2.6 0.6 1.0 12 M. S. Billet 3,177 3,573 4,202 3,394 3,883 5.6 5.0 5.3 3.8 3.6 13 M. S. Wire Rod 834 939 1,339 1,537 1,065 1.5 1.3 1.7 1.7 1.0 14 Medicine 2,980 3,226 3,341 3,436 4,388 5.3 4.5 4.2 3.9 4.0

15 Other Machinery and parts 1,723 2,572 3,295 3,956 3,472 3.0 3.6 4.2 4.5 3.2

16 Petroleum products 13,906 13,812 20,170 26,054 33,656 24.6 19.5 25.6 29.4 30.8 17 Readymade

Garments 422 445 490 809 1,027 0.7 0.6 0.6 0.9 0.9 18 Rice 226 745 556 655 2,157 0.4 1.1 0.7 0.7 2.0 19 Textiles 3,233 4,186 3,276 2,095 1,966 5.7 5.9 4.2 2.4 1.8

Thread 757 1,106 1,004 2,821 2,159 1.3 1.6 1.3 3.2 2.0

Vegetables 685 773 738 900 968 1.2 1.1 0.9 1.0 0.9

Vehiles and Spare Parts 4,259 3,858 4,948 5,357 5,204 7.5 5.4 6.3 6.0 4.8

Sub Total 40,697 47,880 57,773 65,753 73,488 71.9 67.5 73.4 74.2 67.2

Other Items 15,925 23,044 20,966 22,922 35,818 28.1 32.5 26.6 25.8 32.8

Total 56,622 70,924 78,739 88,675 109306 100.0 100.0 100.0 100.0 100.0 Note: Data for fiscal year 2005/06 is provisional Source: Quarterly Economic Bulletin, Nepal Rastra Bank

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Table 3.9 Imports of Major Commodities from Other Countries

S.N

Major Items Value in Million Rs. % 2001/

02 2002/

03 2003/04 2004/0

5 2005/

06 01/02 02/03 03/04 04/05 05/06

1 Aircraft Spare Parts 987 996 2,301

1,205

1,071

1.9 1.9 4.0 2.0 1.6

2 Betelnut 755 600 768 551 807 1.5 1.1 1.3 0.9 1.2 3 Computer Parts 1,771 1,420 1,274 1,122 1,320 3.5 2.7 2.2 1.8 2.0 4 Copper Wire Rods,

Scrapes & Sheets 2,095 874 969 1,249 2,089 4.1 1.6 1.7 2.1 3.2 5 Crude Palm Oil 5,821 5,056 5,277 3,582 4,051 11.5 9.5 9.2 5.9 6.2 6 Crude Soyabean Oil 1,229 1,614 2,079 1,925 1,573 2.4 3.0 3.6 3.2 2.4 7 Electrical Goods 1,572 1,444 1,616 1,300 2,580 3.1 2.7 2.8 2.1 3.9

8 M. S. Billet 0 2 68 499 917 0.0 0.0 0.1 0.8 1.4 9 Medicine 681 620 583 702 1,107 1.3 1.2 1.0 1.2 1.7

10 Other Machinery & Parts 2,176 1,936 2,460 2,778 2,799 4.3 3.6 4.3 4.6 4.3

11 Palm Oil 289 236 309 3,035 2,788 0.6 0.4 0.5 5.0 4.2 12 Polythene Granules 2,025 2,800 2,834 2,207 3,697 4.0 5.2 4.9 3.6 5.6 13 Raw Wool 1,011 1,605 2,018 1,841 1,156 2.0 3.0 3.5 3.0 1.8 14 Telecommunication

Equip. Parts 1,066 2,359 2,484 2,510 1,686 2.1 4.4 4.3 4.1 2.6

15 Textile Dyes 11 10 11 1,329 2,096 0.0 0.0 0.0 2.2 3.2 16 Textiles 1,816 2,032 2,752 3,071 2,264 3.6 3.8 4.8 5.1 3.4 17 Threads 1,871 1,456 1,978 3,091 1,275 3.7 2.7 3.4 5.1 1.9 18 Transport Equip. &

Parts 1,814 1,685 1,626 1,908 2,124 3.6 3.2 2.8 3.1 3.2 19 Zink Ingot 596 932 1,264 1,235 2,327 1.2 1.7 2.2 2.0 3.5

Sub Total 27,586 27,677 32,671 35,140 37,727 54.3 51.8 56.8 57.8 57.3

Other Items 23,181 25,751 24,867 25,658 28,075 45.7 48.2 43.2 42.2 42.7

Total 50,767 53,428 57,538 60,798 65,802 100 100 100 100 100 Note: Data for fiscal year 2005/06 is provisional Source: Quarterly Economic Bulletin, Nepal Rastra Bank

Nepal’s imports from India are highly diversified and have achieved a high degree of diversification during the last thirty years. It is because of increase in the production of variety of manufactured goods in Indian economy. Besides certain food items and other consumer products, electrical goods, machineries and transport equipments are added to the import list of Nepal. The import of non-traditional goods like engineering goods, chemical and allied products, iron ore, cement, transport equipment and machineries, petroleum products have been increasing in order to boost the economic development of the country while there has been decline in the share of traditional goods like livestock, cereals, spices etc.

It is significant to mention here that there is little scope for Nepal to cut its imports from India. At present, Nepal is importing developmental and construction goods and basic consumer goods. Cuts in imports of fertilizer and development goods at this stage would be damaging. Cuts in imports of petroleum products would effect the implementation of developmental projects and the usefulness of existing road network. In the long run,

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substitution of petroleum products by hydropower can reduce the import of petroleum products. Therefore, Nepal has to pay more attention for the maximum exploitation of hydropower and the production of basic consumer goods.

3.4 Unauthorized Trade

While discussing export-import aspects of Indo-Nepal trade, it is important to mention that the volume of trade between the two countries is much bigger than the official figure because of the 500 mile long open boarder and unrestricted movement of the people between the two countries.

No authentic data exists in Nepal, except occasional newspaper reports, to demonstrate the volume and extent of unauthorized trade in Nepal-India boarder. It is quite difficult to fix up the value range since the value fluctuates frequently depending on the risks. Studies estimate that the two-way informal trade ranges between US$368 million (Nepalese estimate) and US$408 million (Indian estimate) in 2000-01 (Karmacharya, 2005). This growth has also been facilitated by the complete freedom of currency movement between the two countries.

Many Indian and Nepalese citizens are responsible, either directly or indirectly, for the growth of unauthorized trade. The effect of unauthorized trade has given rise to extensive corruption and black marketing. There exists the administrative inefficiency and weakness which have played instrumental roles by letting the smugglers free. The dual citizenship of most smugglers has created problems for the administration.

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Chapter Four

Review of Bi-lateral and Regional Trade Agreements

Trade liberalization takes place at various levels: unilateral, bi-lateral, regional and multi-lateral. The proponents of trade liberalization claim that WTO-style liberalization is economically the first best solution and the advantages of regional co-operation lie on the basis of negotiation. WTO coordinates the efforts to liberalize the trade on multi-lateral level. On regional level NAFTA, LAFTA, SAFTA aim at trade liberalization within their regions. Presently, the European Union (EU), composed of twenty-five member states, is the most successful and most advanced model of regional integration. It is a single market with a common trade, agricultural, and regional policy. The union currently has a common single market but it took time, i.e., over fifty years to remove trade barriers and create a genuine single market in which goods, services, people, and capital move around the member states freely and adopting a common currency. On regional level NAFTA, LAFTA, SAFTA aim at trade liberalization within their regions. ASEAN is moving towards establishing an ASEAN Community by 2020.

Since the initiation of trade liberalization in the mid 1980s, Nepal has continuously been in the process of integrating the economy with the world economy through various multi-lateral, regional, and bi-lateral trade agreements. In the recent past, the Government of Nepal has made significant efforts to integrate the economy with global and regional trading system. Following the ideology of NEP to integrate Nepalese economy with world economy, Nepal became the 147th member of the WTO in the fifth ministerial conference of WTO held on 10-14 September, 2003 at Cancun, Mexico. After that, the trade policy became freer. Recently, Nepal has signed two regional free trade agreements: SAFTA which came into force on 1 January 2006 and BIMSTEC free trade area framework agreement. However, SAFTA/BIMSTEC has to work towards bridging the development gaps among its member countries for its success as EU has done.

4.1 Regional Trade Agreements

4.1.1 SAFTA

South Asian Association for Regional Cooperation (SAARC) emerged in 1985 with the objective to accelerate the process of economic and social development in their respective countries through the optimal use of their human and material resources so as to promote the welfare and prosperity of their people and to promote their life. Although the acceleration of economic growth was incorporated in SAARC charter, the need for entering exclusively into South Asian Economic Co-operation was recognized by SAARC leaders in 1987 summit in Kathmandu. The Colombo Summit in 1991 declared

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commitment to the gradual liberalization of trade in the region so that all the countries in the region would share the benefits of trade expansion equitably.

The SAARC Preferential Trading Arrangement (SAPTA) was established in April 1993 in the seventh summit held in Dhaka and became operational in December 1995, exactly a decade after establishment of SAARC, with the objective of liberalizing the trade gradually in the region. The twelfth SAARC summit, held in Islamabad in 2004, has decided to establish South Asian Free Trade Area (SAFTA, Annex II) with effect from 1st

January 2006 for a ten year period for full-fledged implementation. The agreement contains many provisions under trade liberalization programme (Box 4.1 and Annex II). SAFTA has to be converted into South Asian Custom Union (SACU) by the year 2015 and finally into South Asian Economic Union (SAEU) by the year 2020.

SAFTA envisages to dismantling of all tariff and non-tariff barriers to intra-regional trade. The member countries are also agreed to harmonize tariff lines along the internationally accepted harmonized system. The ranges of tariff concessions are 5 to 50 per cent in case of the relatively developed economies and 10 to 100 per cent in case of the least developed economies of the region. India has unilaterally withdrawn almost all non-tariff barriers in case of import from the members of SAARC in 1998.

Box 4.1

Trade Liberalization Programme under SAFTA: Major Elements

The tariff reduction by the Non-Least Developed Contracting States from existing tariff rates to 20 per cent shall be done within a time frame of 2 years, from the date of coming into force of the agreement.

The tariff reduction by the Least Developed Contracting States from existing tariff rates will be to 30 per cent within the time frame of 2 years, from the date of coming into force of the agreement.

The subsequent tariff reduction by the Least Developed Contracting States from 30 per cent or below to 0-5 per cent shall be done within a second time frame of 8 years beginning from the third year from the date of coming into force of the agreement.

Contracting parties shall eliminate all quantitative restrictions, except otherwise permitted under GATT 1994, in respect of products included in the trade liberalization programme.

The contracting states shall notify the SAARC Secretariat all non-tariff and Para-tariff measures to their trade on an annual basis.

However, SAFTA was signed without agreements on issues like sensitive list, rules of origin, mechanism for compensation on revenue losses for the LDCs, and technical assistance. The non-tariff barriers in the region are inconsistent with the WTO provisions. QRs were to be replaced by tariff equivalents but countries of this region are still maintaining them. This shows that South Asian region might have compelled to accept

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the policy against their willingness and therefore it might be difficult to achieve the goal of SAFTA.

The SAARC Transport Minister Level meeting recently held on 31 August 2007 in New Delhi has recommended to launch nine various roads, rail, sea, and air projects to link SAARC member countries. The projects are recommended on the basis of the report prepared by the Asian Development Bank (ADB) on SAARC Regional Multimodal Transport Report. Among these nine projects, two road projects are expected to link Nepal with India and Bangladesh. These two road projects are: Birganj-Kathiyar-Shihabad-Rohanpur-Chatgaun and Kathmandu-Kolkata which are 1,362 and 1,323 KM long respectively (Kantipur, 2007).

4.1.2 BIMSTEC

Nepal has become the member of another RTA, the Bay of Bengal Initiative for Multi- Sectoral Technical and Economic Cooperation (BIMSTEC) in February 2004. BIMSTEC is a forum for sub-regional grouping of some geographically adjoining countries in the Bay of Bengal consisting of five SAARC member countries (Bangladesh, Bhutan, India, Nepal, and Sri Lanka) and two member countries of ASEAN (Myanmar and Thailand).

The idea of this regional cooperation was first mooted by Bangladesh, India, Sri Lanka, and Thailand. The purpose and principles were contained in Bangkok Declaration of 6th

June 1997 on the establishment of Bangladesh-India-Sri Lanka-Thailand Economic cooperation (BIST-EC). The same year on December 22, 1997, Myanmar was included to the grouping where it was decided to rename as BIMSTEC (Bangladesh-India-Myanmar-Sri Lanka-Thailand Economic cooperation). Nepal has been participating in various meetings of the BIMSTEC as an observer since 1998. The Sixth Ministerial Meeting of the forum held in February 2004 in Thailand, Bhutan and Nepal were welcomed as new members.

Article 3 of the agreement provides that products, except those included in the Negative List, are subject to tariff reduction or elimination on the basis two tracks, i.e., fast track and normal track. In 2004, BIMSTEC member countries agreed to establish the BIMSTEC Free Trade Area Framework Agreement for a free trade in goods, in services and investments (Annex III). This includes economic cooperation in Mutual Recognition Agreements, Customs Cooperation, Trade Finance, E-Commerce, and Business and Personal Visa Facilitation. The First Summit level meeting held in July 2004 identified and covered six broad sectors for cooperation comprises trade and investment, technology, tourism, transport and communication, energy, and fisheries.

The objectives of the Framework Agreement on the BIMSTEC Free Trade Area are to strengthen and enhance economic, trade and investment and technical cooperation among the member countries with the liberalization and promotion of trade in goods and services creating transparent, liberal and facilitative investment regime. It also aims at exploring new areas, develop appropriate measures for closer cooperation and facilitate more effective economic integration of the least developed countries in the region.

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The potential of intra-regional trade among BIMSTEC countries remain untapped because of tariff and non-tariff barriers, poor communication and transport links, lack of information about the supply capabilities, and so on. Similarly the intra-regional investment is negligible despite tremendous potential both for market as well as efficiency seeking. These hidden potential could be exploited for mutual benefit through regional economic cooperation. The grouping could move towards the formation of Custom Union and eventually to a Bay of Bengal Economic Community (RIS, 2004).

In BIMSTEC, each of the member countries exhibits differential capabilities in many areas. The members have also different natural resource endowments. There is a great scope for learning and sharing from each other in development experiences. For instance, Bangladesh's experiments in micro-credit and in population management, Thailand's experiences in managing globalization, Sri Lanka's experiences in social sector development, India's development in prudent management of banking and capital markets and in rural telecommunications and others could be exchanged for mutual advantage. Similarly, Nepal's potential feasible hydroelectricity power capacity of around 83,000 MW (currently only around 1 per cent is being exploited) could be a large net power producer and exporter to BIMSTEC countries and especially to India where power demand has steadily increased over the years.

Implementation of transport linkages and physical connectivity among the member countries would generate huge benefits. Member countries should also work towards short route sea shipping and highway linkages and exploitation of its massive potential of hydroelectricity. Discussions have already been held to build a trans-Asia Highway linking the member countries and also setting up a BIMSTEC Airline connecting the capitals and important cities of the member countries.

The Ninth BIMSTEC Ministerial Meeting held in New Delhi on 9 August 2006 has concluded to enhance cooperation in trade and investment, tourism, and energy. The delegates agreed to work towards the establishment of BIMSTEC Tourism Information Centre and the BIMSTEC Tourism Fund. The delegates also agreed to establish the BIMSTEC Energy Centre in India for strengthening cooperation in the energy sector among the member countries.

Asia-Pacific Trade Agreement (formerly known as Bangkok Agreement), which was signed in November 2005 by the member countries, has come into force with effect from 1st July 2006. The Bangkok Agreement is one of Asia’s oldest regional preferential trading arrangements designed to liberalize and expand trade in the Economic and Social Commission for Asia and the Pacific (ESCAP) region. In July 1975, seven countries namely, Bangladesh, India, Laos, Republic of Korea, Sri Lanka, the Philippines and Thailand met in Bangkok and agreed to a list of products for mutual tariff reduction. This resulted in the signing of the first agreement on trade negotiations among developing member countries of ESCAP, known as the “Bangkok Agreement” which was ratified by five of the seven countries except the Philippines and Thailand. The People’s Republic of China joined the Bangkok Agreement in 2001. The objectives of the Bangkok Agreement are to promote Economic Development through a continuous process of trade expansion

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among the developing member countries of ESCAP and to further enhance international economic cooperation through the adoption of mutually beneficial trade liberalization measures consistent with their respective present and future development and trade needs. Nepal has been participating as an observer in APTA. Nepal can also get benefit by joining this regional group.

4.2 Bi-lateral Trade Agreements

Nepal has bi-lateral trade agreements with 17 countries including India and Bangladesh with whom it has also bi-lateral transit agreements. As of 2007, Nepal had signed bi-lateral trade agreements with 17 countries. These countries include: Bangladesh (1976), Bulgaria (1980), China (1981), Czech Republic (1982), Egypt (1975), India, Democratic People's Republic of Korea (1970), Republic of Korea (1971), Mongolia (1992), Pakistan (1982), Poland (1992), Romania (1984), Sri Lanka (1979), UK (1965), USA (1947), Russia (1970), and Yugoslavia (1965). All the treaties, except with India, are static and perpetual in nature. However, Nepal's trade and transit agreement with India has been reviewed many times since the first trade agreement of 1950.

4.2.1 Indo-Nepal Trade Agreement

Due to close proximity, quite long back socio-economic and cultural relation, free border between the two countries, India has been the largest trading partner of Nepal from the ancient time. Trade relations between the two countries are governed by bi-lateral trade and transit agreements and other agreements for cooperation to control unauthorized trade. Due to its geo-situational characteristics, bi-lateral trade and treaties with India play a significant role in the trade pattern and economic development process of Nepal.

There was no formal agreement between the two countries till 1923. Since more than 95 per cent of Nepal's trade was confined to India alone, the first trade treaty between Nepal Government and British-India Government was signed in 1923. Although the article VI of the treaty had the provision to use the British-Indian ports for the development of Nepal-British trade freely, Nepal was restricted to import goods from other overseas countries. Therefore, this treaty had an unfavourable impact on Nepalese industries because instead of encouraging exports, Nepal was compelled to purchase goods manufactured in Britain.

After the restoration of democracy in India and immediately after the signing of the Treaty of Peace and Friendship in1950 between the two countries, the Treaty of Trade and Commerce between Nepal and India signed in Kathmandu on July 31, 1950 can be seen as the landmark towards the external trade of Nepal. It was agreed to remain the treaty for a period of ten years and continue in force for a further period of ten years unless terminated by either party by giving notice of not less than one year in writing.

This Treaty was modified and renewed on May 19, 1961 and August 15, 1971 respectively. The treaty incorporated provisions regarding transit facilities extended by India for Nepal’s trade with a third country, as well as on cooperation to control

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unauthorized trade. The treaty provided freedom of transit through the territories of the either country without making any distinction of flag of vessels, the place of origin, entry, exits etc.

In 1971 Treaty of Trade, the Government of India was agreed to provide access to the Indian market free of basic custom duty and quantitative restrictions for all primary products produced in Nepal with a Nepalese/Indian material content requirement of 90 per cent. The provision was a discouraging component for Nepal's export sector. This was gradually reduced when the Trade Treaty was periodically renewed and in 1993, it was brought down to 50 per cent of Nepalese/Indian material content and Nepalese labour content. The Treaty of Trade, 1971 provided the facility of reimbursement of excise duties and other duties levied on goods exported from India to Nepal. India provided Haldia - another port facility for Nepalese cargos.

On March 25, 1978 in New Delhi, a new treaty with a broad objective was signed between the two countries. Instead of a single Treaty, three different agreements were signed: Treaty of Trade, Treaty of Transit and Agreement of Cooperation to Control Unauthorized Trade. The treaty made the provision to exempt from basic custom duty as well as from quantitative restrictions of primary products on a reciprocal basis with 12 primary products for preferential treatment.

In treaty of 1978 Nepal was provided an opportunity to conduct trade with third countries through Bangladesh. Twenty one routes were made available by India to Nepal in order to conduct trade between the two countries. Similarly, the Treaty of Transit provided for Nepal's cargo at the ports of Calcutta and Haldia to remain there free of charge for seven days instead of three days previously arranged. The treaty of 1978 was renewed in New Delhi on March 21, 1983 for another five years with some modifications. The validity of 1978 Treaties of Trade and Transit expired in March 1989 leading to the termination of all trade and transit relations to India for 15 months.

After so-called restoration of democracy and the advent of democratic government in Nepal, these treaties have been renewed, modified and reviewed from time to time particularly on December 6, 1991 (New Delhi), on December 3, 1996 (Kathmandu), on March 6, 2002 (New Delhi, Annex I) and finally on March 4, 2007. The major elements included in all the treaties between Nepal and India are:

Exemption from basic custom duties and quantitative restrictions on imports of primary products on reciprocal basis.

Nepali manufactured goods (excluding some items on the negative list) are granted duty free access to Indian market without quantitative restrictions on the basis of non-reciprocity.

Manufacturing goods imported from India is granted preferential entry to Nepal, without quantitative restrictions.

Preferential access for Nepalese manufactured exports to India is provisioned by the Rules of Origin (RoO) that have changed over time. The 90 per cent value addition

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requirement of the 1960 trade treaty was reduced to 50 per cent in the trade treaty of 1992 and further it was reduced to 40 per cent of ex-factory prices. Furthermore, the treaty of trade, 1996 provided that the following articles are not being allowed under preferential entry from Nepal to India on the basis of Certificate of Origin, i.e., the negative list of product imported to India were shortened from seven to three items:

a. Alcoholic Liquors/Beverages and their concentrates except industrial spirits, b. Perfumes and Cosmetics with non-Nepalese/non-Indian Brand names, c. Cigarettes and Tobacco.

In the treaty of 2002, several restrictions were introduced consisting of more rigid RoO, tariff rate quotas and safeguard clauses. New provisions for RoO cover domestic content value addition requirement of 30 per cent of ex-factory prices and changes in tariff heading (CTH) at the four-digit level of the harmonized system code. The treaty also provided for the imposition of Tariff Rate Quotas (TRQs) for Nepalese exports. The following Nepalese articles were allowed to get entry into India with free of customs duties on fixed quota basis:

Table 4.1 TRQ on Nepal’s Exports

S. No. Nepalese Article Quantity in MT Per Year

1 Vegetable Fats (Vanaspati) 100,000 2 Acrylic Yarn 10,000 3 Copper Products 10,000 4 Zinc Oxide 2,500

The treaty states that imports of the above four commodities into India in excess of the fixed quota will be permitted under normal MFN rates of duty.

The Indo-Nepal treaty was renewed in March 2007 without any revision on the restrictions imposed by the 2002 treaty. The renewal of the treaty did not address some key issues, such as that of non-tariff barriers that Nepal faces. It will be beneficial for Nepal to revise some restrictions of the treaty such as stringent RoOs, quotas, and specification of safeguard clauses. In addition, new areas of cooperation should be explored. Since Nepal has vast amount of untapped hydroelectricity and India's steady and high level of GDP growth is creating demand for huge amount of energy, trade in energy, thus, is most potential to benefit both the countries. Similarly, new opportunities in the field of services like information technology, tourism, education and health care could be explored (SAWTEE, 2007).

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4.2.2 Trade Arrangement with SAARC Countries

Nepal has diplomatic relations with all seven SAARC countries but has trade agreements with only four member countries: India, Bangladesh, Pakistan and Sri Lanka. Trade agreements with these countries were initiated after the adoption of trade diversification policy by Nepal, especially after the establishment of Trade Promotion Centre in 1971, only one trade promotion agency of the government of Nepal. Nepal has no trade agreements with Bhutan and Maldives.

Among the above mentioned four member countries, Nepal has both trade and transit agreements with India and Bangladesh. In addition, Nepal has an agreement of cooperation with India to control unauthorized trade. Among these agreements, Treaties of Trade and Transit with India have to be considered more important since Nepal is bordered by India in west, east and south, and India accounts for the dominant part in total trade of Nepal. The pattern of trade with other countries is also determined largely by the trade relation and understanding with India. With Sri Lanka, Nepal has only trade agreement.

Trade and payments agreement and transit agreement were signed between Nepal and Bangladesh in Kathmandu on April 2, 1976. The objectives of the agreement were both to promote trade between the two countries and to facilitate Nepal's foreign trade with third countries through the ports of Bangladesh. In the protocol related to the article first of the Transit Agreement, the government of Bangladesh has agreed to provide six points8, i.e., two ports and four other territories of entry and exit for movement of traffic-in-transit of Nepalese cargos by all means of transportation (TPC, 1999).

The trade agreements were signed between the governments of Nepal and Pakistan in Islamabad and between Nepal and Sri-Lanka in Kathmandu on April 3, 1979 and on July 28, 1982 respectively. The agreements have granted provisions of MFN treatment in respect of issuance of licenses, custom formalities, customs duties and taxes and other charges for the import and export of goods and commodities and provision of fostering trade delegations and fairs. All payments resulting from the deliveries of goods and services as well as other payments can be done on any convertible currency mutually agreed upon.

4.2.3 Trade Agreement with China

Like India, Nepal maintains trade relationship with China from primeval ages being its northern neighbour. As of 2006, China is the second largest exporter to Nepal. Trade agreements with former Tibetan Kingdom (presently Tibet Autonomous Region of Peoples’ Republic of China) date back to more than thousand years entailed by formal trade agreement (during 1960s) after the establishment of Communist regime in China (Sharma, 2007). The Trade and Payments Agreement between People's Republic of China and His Majesty's Government of Nepal were signed in Kathmandu on November

8 Khulna-Chalna Port, Chitagong port, Biral, Banglabandh, Chilhati and Benapole

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22, 1981. The agreement provides three trading points9 (further Olangchung Gola/Riwo route was opened) to utilize along their border in order to develop the trade between two countries. The provision is subjected to revision from time to time agreed upon between the two governments. With a view to improve the economic life of the border inhabitants, the two countries were also agreed to carry on the traditional trade on barter basis within an area of 30 Kilometres from the border for the border inhabitants of the two countries.

The agreement of Trade and Other Related Matters, especially aimed to support the movement of persons, between Nepal and the Tibet, an autonomous region of China was signed in Beijing on July 10, 2002 with a view to enhance the traditional friendly relations between the two countries, particularly with Tibet. The agreement provides the provision of travel to the border districts for the border inhabitants of either country for the purpose of pilgrimage, small fairs or border trade in small volumes, visiting relatives or friends with exit-entry passes of the border districts through the existing routes and entry points until such routes and entry points are specified.

China, upon the request of Nepal, has taken initiatives to improve the Nepal’s terms of trade in recent years. A preliminary trade negotiation between Nepal and China was concluded in the beginning of 2006. It was realized to provide duty and quota-free access of Nepalese product to China and China has offered only a little more than 200 products (mostly of less important from Nepalese export concerns) for the preferential treatment but there is little progress in this direction so far (Sharma, 2007).

4.2.4 Trade Agreements with Other Countries

The trade treaties of Nepal with all the seventeen countries, except with the Government of India, are based on the MFN treatment in all matters relating to custom duties, fees and charges to be levied on exportation and importation of commodities and with respect to the methods of levying such duties, and charges and to the applicable rules, formalities and charges in connection with customs management, and to the applications of internal taxes or other charges of any kind imposed on or in connection with imported goods.

The United States of America, which is the second largest trade partner of Nepal in terms of export and among the ten top countries in terms of import in 2006, has bi-lateral friendship and commerce agreement dates back to April 1947 (Annex IV) in the Rana regime, at the time even the GATT agreement was not signed. The agreement is diplomatic rather than trade and commerce. The treaty was aimed to strengthen the friendly relations existing between the two countries, further mutually advantageous commercial relations between their peoples, and to maintain MFN principle in its unconditional and unlimited form as the basis of their commercial relations. The treaty also provides unconditional navigation facility between the two countries.

9 Kodari/Nyalam, Rasuwa/Kyerong, Yari (Humla)/Purang

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The European Union (EU) is a political and economic community of 27 independent sovereign countries primarily located in Europe which are collectively known as member states: Austria, Belgium, Bulgaria, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom.

The EU has a single market by a system of laws which apply in all member states, guaranteeing the freedom of movement of people, goods, services and capital. It has also common trade policy. In 1999, the EU introduced a common currency, the euro, which has been adopted by 13 member states.

Several EU Member States are long-standing development partners of Nepal. In the fiscal year 2005/06, Nepal's export to European Union region was about 16 percent of country's total national export. Many countries of EU have been major trade partner of Nepal. Nepal does not have trade agreement with EU. Therefore, it is an urgent need for Nepal to make a trade agreement arrangement with EU in present context by covering both the merchandize as well as trade in services.

4.3 Nepal's Treaty of Transit

The international trade traffic mostly moves through sea transport which is far cheaper than other mode of transport. The lack of seaports in the inland country inflates the prices of imports by increasing the transit costs and makes exports less competitive in the international market. As a result, the overall performance of trade declines and the economy deteriorates considerably.

4.3.1 Indo-Nepal Treaty of Transit

Recognizing the fact that Nepal is a land-locked country and its need to have access to and from the sea to promote its international trade, the Indo-Nepal Treaties of Transit (signed, renewed and reviewed from time to time in 1950, 1956, 1960, 1971, 1978, 1996, and 1998) have made the provision to ‘traffic in transit’ freedom of transit across their respective territories through routes mutually agreed upon. The treaties provisioned that no distinction shall be made which is based on flag of vessels, the places of origin, departure, entry, exit, destination, and ownership of goods or vessels.

As Nepal's trade with overseas was negligible, Article I of the 1950 Treaty provided Nepal with 'full and unrestricted right' to use all Indian territories and ports. After the expiry of the 1950 Treaty, a new bi-lateral Treaty of Trade and Transit was signed in 1960, which spelled out detailed transit procedures and documentation. Despite the growing need for more free access to the sea on account of Nepal's starting of planned development in 1956, the Treaty of 1960 restricted the movement of transit only to the port of Kolkata. This was subsequently replaced with another Treaty of Trade and Transit

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in 1971, which provided Nepal with covered and open space storage facilities at the port, and specified 11 border points for the passage of transit traffic.

The Transit Treaty of 1978 provided the then newly developed port of Haldia, which is located 120 km southwest of Kolkata, under administration of the same Kolkata Port Trust (KPT). More importantly, the 1978 Treaty also allowed Nepal to use the Radhikapur-Birol transit route for the regular movement of trade with and through Bangladesh. The Radhikapur-Birol is a meter gauge rail route connecting Chittagong port with all the meter gauge rail terminals at the India-Nepal border without requiring any trans-shipment between railway gauges. But the distance to the Chittagong port is longer by over 300 km in compared to the Kolkata port from Nepal border.

The 1978 Treaties of Transit and Trade expired in March 1989 leading to the termination of all trade and transit relations to India for 15 months. During the stalemate period, only two border points of Jogbani and Raxaul were in operation. The setback was created by the political misunderstanding between the two countries and Nepal was pushed into economic blockade during the period. The Radhikapur-Birol route was also kept open for the passage of Nepal's bi-lateral traffic with Bangladesh.

The renewal of the Treaty of Trade on December 1996 which had brought notable changes in the bi-lateral trade relations also coincided with an import change in Transit Treaty that introduced a new system of a mere examination by the Indian Customs of one-time-lock of containerized cargo without physical verification of the contents. On September 1, 1997, India also allowed the additional road transit route of Kakarvitta-Phulbari-Banglabandh for Nepal's trade with and through Bangladesh.

This Treaty was signed on January 5, 1999 between the Government of India and His Majesty’s Government of Nepal in which 22 entry/exit points were opened along with India-Nepal border for mutual trade.

Recently, the Government of Nepal has preliminarily negotiated with the Government of India to use the Jawaharlal Nehru port, Mumbai as the second transit route for Nepal’s international trade. It is estimated that the route will save around 40 per cent transit cost of Nepalese exports and imports. The formal negotiation is in process (The Kantipur, 2007).

In consideration to the growing containerization of the world trade, development of multimodal transport to achieve trade efficiency and the need to reduce transaction cost in trade, Nepal implemented 'Nepal Multimodal Transit and Trade Facilitation Project' with an objective to create three 'Inland Clearance Depot' (ICD) or Dry Port at Biratnagar, Birgunj and Bhairahawa in 1996. The Birgunj ICD is rail-based and connected with the Indian broad-gauge railway network.

After the conclusion of the Rail Services Agreement between Nepal and India, the Birgunj ICD formally began to operate in July 2004 by receiving a full rake of containerized cargo from Kolkata port. It was closed for three and half years because of prolonged negotiations on custom procedures and management of the facility. The

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efficient operation of the Birgunj ICD is expected to reduce the transit overhead costs by about 30 per cent to 40 per cent. As the Birgunj ICD is designed to handle all types of cargo, containerized, break bulk and bulk for both the bi-lateral and third country trade, the smooth operation of the ICD is projected to enhance export competitiveness, and reduce import prices. However, it is not operating at full capacity for various reasons: low frequency of cargo train (twice a week), inadequate information in the schedule of cargo etc.

The following problems are significant in the corridor between Nepal and India transit routes:

Long transit from Kolkata to Raxaul

Higher hauling costs

Inefficiency of Kolkata/Haldia port

Administrative decentralization in India and bribes.

4.3.2 Nepal-Bangladesh Treaty of Transit

Nepal and Bangladesh have signed two separate bi-lateral agreements on Trade and Payment and on Transit on 2 April1976. The Transit agreement and its Protocol specify ports and entry points along with the procedural and documentation requirements for the movement of Nepal's trade with third countries via Bangladesh. The following six entry points have been allowed for the movement of traffic-in-transit through the ports and other territory by all means of transportation:

1. Khulna-Chalna port, 2. Chittagong Port, 3. Biral, 4. Banglabandh, 5. Chilhati, and 6. Benapole

Khulna-Chalna and Chittagong are the sea ports and the other four places are the border entry points located at the Bangladesh-India border. Nepal is currently using two border crossings points at Biral and Banglabandh.

Biral, a meter gauge rail point at Bangladesh border was brought under regular use for moving Nepal's trade traffic to and through Bangladesh after Government of India (GoI) owed the rail connection from its border meter gauge station at Radhikapore from 1978. Though it is longer than the Kolkata route, the chief advantage of the route is the through movement of railway wagons between Chittaagong port of Bangladesh and the rail terminals at the India-Nepal border without any trans-shipment on route. The rail distance from Jogbani to Chattagong is 958 Km where as the rail distance to Kolkata is only 771 km via Katihar-Barauni, and 530 km via Katihar-New Farakka.

Nepal's long standing request to India to allow an additional short road route to Bangladesh was realized on September 1, 1997 when GoI agreed to allow the road

45

connection from its border point of Phulbari to the Bangladesh border point of Banglabandh. A bi-lateral agreement was signed between Government of Nepal (GoN) and GoI on the day for the opening of Kakarvita (Nepal border), Panitanki (India border with Nepal), Phulbari (India border with Bangladesh), and Banglabandh (Bangladesh border with India) for the road movement of Nepal's trade with and through Bangladesh. This border point is only 44 km from Nepal border at Kakarvita. The road route of Phulbari-Banglabandh is allowed only for one Nepal-India border crossing point of Kakarvita-Panitanki with the application of a separate set of transit procedures. 4.4 Agreement of Cooperation to Control Unauthorized Trade

An Agreement of Cooperation to Control Unauthorized Trade was signed between the GoI and His Majesty’s Government of Nepal on December 6, 1991 and was further renewed in 1996. Article I of the Agreement recognized that there is a long and open border between the two countries and there is free movement of persons and goods across the border. It further notes that they have the right to pursue independent foreign trade policies. In order to protect the interest of both the countries the Article made the provision of taking all such measures that are necessary to ensure that the economic interests of the other party are not adversely affected through unauthorized trade between the two countries. As per the Article II of the Agreement, both the countries agreed to cooperate effectively with each other to prevent infringement and circumvention of the laws, rules and regulations of either country in regard to matters relating to customs, narcotics and psychotropic substances, foreign exchange and foreign trade.

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Chapter Five

New Dimensions and Future Prospects

The scope and coverage of bi-lateral and regional trade agreements is expanding rapidly in current years. Apart from merchandise trade, now the policymakers and trade negotiators have turned their attention to cover the issues of services, investment, intellectual property and labour mobility in PTAs, FTAs and RTAs. Agreements on these issues are becoming common because it is argued that they have the greatest potential for affecting incomes and trade in developing countries.

The trade policy of Nepal envisaged enhancing the contributions of trade sector to national economy by promoting internal and international trade with the increased participation of private sector through the creation of an open and liberal atmosphere. It further states to diversify trade by identifying, developing and producing new exportable products through the promotion of backward linkages for making export trade competitive and sustainable. In order to materialize these goals, following basic policies have been formulated:

The role of public sector will be minimized and used as a catalyst to expand the role of private sector in trade.

A dynamic and liberal trade policy will be pursued.

Improvement of balance of payments position by promoting exports to increase foreign exchange earnings as well as by fulfilling internal demand of economic and quality products.

Production of quality goods and services for internal consumption as well as for exports through effective and appropriate utilization of economic resources.

Modernizing management and technology, on promoting market and on attracting direct foreign investment in order to identify and develop new products as well as raise the production and quality of the traditional products.

Public sector trading corporations will gradually be privatized taking into considerations the development and efficiency of the private sector.

Institutional development and information network as well as monitoring system and quality improvement for the promotion of foreign trade.

Similarly, the export policy underlines the following fundamental provisions:

Production and quality of exportable products to make them competitive in the international market

Increase and diversify exports of goods and services with objective of increasing foreign exchange earnings.

More emphasis on the export of profitable but processed and finished products. For the export promotion of these products, new markets will be identified.

Increase service-oriented activities to promote foreign exchange earnings.

Export of hydro-electricity on a profitable basis.

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Export promotion will be provided on an institutionalized basis

5.1 Export Potential for Nepal

5.1.1 Carpets

The carpet/rug industry is a major source of foreign exchange and employer of more than 50,000 workers, contributing to rural and urban household incomes and poverty reduction. The ready-made garment sector was a leading source of growth in manufacturing output, exports, and employment. The exports of carpets declined because quotas were eliminated by the European Union and the U.S. at the end of 2004 under the Agreement of Textiles and Clothing and competition from China and India intensified. Nepalese exporters also now face competition from the preferences granted to selected African and Caribbean countries in the U.S. market.

Nepalese garment exporters have advantages, particularly low-labour costs, which may enable them to exploit existing and emerging market opportunities. But current garments quota allocation rules need to be changed to support efficient producers. Nepal also needs the presence of foreign investors to increase its market access.

5.1.2 Agriculture and Forest Products

Nepal’s comparative advantage extends to a variety of Agricultural (e.g., beans, peas, lentils, other legumes, cardamom, and nutmeg) and forest products, including medicinal herbs and aromatics. Comparative advantage extends to a range of other areas as well like honey, horticulture, livestock, fisheries, fibre, and off-season vegetables. However, large-scale subsidization of agriculture in neighbouring Indian states affects border prices of produce adversely.

5.1.3 Tourism

With huge amount of foreign exchange earnings and a high value-added component, tourism is a key service export for Nepal. The Himalayan landscape, a wide diversity of flora and fauna, and a rich heritage of cultural and religious sites give Nepal inherent advantages. In the last two years, the sector has experienced a severe downturn due to internal security concerns.

5.1.4 Tea

The tea processing industry, though currently small, is seen as a potential growth industry for employment generation and poverty reduction to rural people in Nepal. Large areas are suitable for tea plantations. The quality of Nepal’s tea trees is regarded to be high leading tea to be a potentially important export. However, significant obstacles to investment and expansion remain. These relate to weak capacity of the Tea Board resulting from lack of clarity of its role, inadequate funding, staffing, and inadequate

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participation of the private sector, unwieldy investment processes, and land fragmentation. The limited transport infrastructure and underdeveloped marketing channels further constrain tea’s potential (MoICS, 2003). . 5.1.5 Hydropower

The potential market for selling hydropower from Nepal to India is large. India has estimated a shortage of roughly 10,000 MW in the Northern Region at the end of the Tenth Five-Year Plan 2007. At the same time, Nepal has a significant hydro resource base. By 2020, Nepal’s total domestic power demand is estimated at around 1,650 MW, compared to a hydro potential of about 83,000 MW. But the present level of exchange between Nepal and India is limited in capacity to 50 MW per annum.

The power sector suffers from high costs. Despite a doubling of generating capacity, supply and demand remain unbalanced, both regionally and seasonally. The generation, transmission, and distribution of Nepal’s power utility can increase efficiency by private sector participation. Despite much discussion, large-scale power exports to India have yet to occur due to lack of large capital investments and inadequate regulatory framework for private sector participation.

To achieve the above mentioned trade policy goals and export potentialities, Nepal needs to explore new opportunities and to identify new dimensions in future trade negotiations at various levels: multi-lateral, regional, and bi-lateral. Some of the issues which need to be raised at regional and bi-lateral levels are discussed below.

5.2 Regional/Bi-lateral Level

5.2.1 Foreign Employment and Remittances

The trend of foreign employment is increasing in recent years due mainly to the limited employment opportunities and widespread conflict in the country. India has been the most popular destination for Nepalese migrants. However, migration, in recent years, has increased dramatically with the opening up of newer markets for Nepali labour in the Republic of Korea, Malaysia, Qatar, Saudi Arabia and other Middle Eastern countries. Most of the workers have been sent to the Gulf countries where risk is very high and working environment is dangerous because most of those workers are of low quality having no suitable skills and experience. Export of quality manpower with appropriate training is still lacking. On the other side, the access of poor people to foreign employment is very limited as it demands huge investment which is beyond their affordability.

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Table 5.1

Country-wise Foreign Employment

S. N.

Country 2001-02 2002-03 2003-04 2004-05

% Change

2001/02-2004/05

1 Saudi Arabia 83,459

101,449

118,324

131,683

57.8

2 Qatar 55,222

82,072

106,200

148,152

168.3

3 U. A. E. 25,672

38,322

51,082

63,585

147.7

4 Bahrain 3,171

3,989

4,595

4,853

53.0

5 Kuwait 2,973

3,880

7,074

8,760

194.7

6 Oman -

380

453

758

-

7 Hong Kong 1,753

2,317

2,989

3,167

80.7

8 Malaysia 64,643

108,445

154,215

220,505

241.1

9 Korea 3,119

3,831

5,155

5,480

75.7

10 Brunei -

4,22

-

-

-

12 Other Countries 1,993

1,945

3,635

4,457

123.6

Total 242,005

347,062

453,722

591,400

144.4

Source: Economic Survey, Various Issues

The Table 5.1 shows that people going abroad for foreign employment from Nepal has increased sharply. Foreign employment has increased by 144 per cent between the period of 2001-02 and 2004-05. The people going to Malaysia from Nepal for employment has increased by 241 per cent during the same period. It is argued that remittances received from foreign employment have reduced the incidence of poverty in Nepal.

Labour migration and remittances comprise a crucial component of income for many less fortunate and less-endowed Nepalese people who perform their work at a place distant from their house. Most of the workers are sent to the Gulf countries where risk is very high and working environment is dangerous. For example, 12 Nepalese workers were taken hostage and killed in Iraq by a Muslim extremist group in 2004. People going abroad for foreign employment from Nepal have increased sharply.

India has been a most important destination for Nepalese workers due to its physical proximity and labour markets in India are comparatively easily accessible. The number of migrants to India for work are generally estimated about 1 million to 3 million based on different studies (Graner and Seddon, 2005).

The Table 5.2 shows that a remittance received from foreign employment has increased sharply in Nepal. The total amount of remittances received through official channel increased from Rs. 657 million in 1985 to Rs. 54235 million in 2004, i.e., from 1.5 to 12.4 per cent of GDP. There has been massive increase after 2000. The remittance/GDP ratio increased from 2.8 per cent in 1999 to 9.5 per cent in 2000.

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Remittances play an important role in improving living standards of households in Nepal. Given its importance to the economy, fresh bi-lateral initiatives between Nepal and the new destination countries, particularly Middle East countries are crucial which could be included in trade agreements. Formal bi-lateral agreements encourage legal migration and the use of formal remittance channels.

Table 5.2

Income from Remittance in Nepal, 1985-2003

Year Remittance Income (Rs. Million)

% of GDP

1985 657 1.5 1986 709 1.3 1987 1223 2.0 1988 1594 2.2 1989 1372 1.6 1990 1533 1.5 1991 1749 1.5 1992 2122 1.5 1993 2858 1.7 1994 3274 1.7 1995 4545 2.2 1996 3711 1.6 1997 4378 1.6 1998 5220 1.8 1999 9183 2.8 2000 34919 9.5 2001 45783 11.6 2002 45565 11.2 2003 51971 11.9 2004 54235 12.4

Source: IPRAD and CBS, 2005

5.2.2 Barriers to Trade: Issues of Rules of Origins, Negative List, and NTBs

The rules of origin in SAFTA are one-dimensional, i.e., only on the percentage of value addition criterion. Setting rules of origin is problematic in South Asia because all the South Asian countries currently export asymmetrical type of goods like agricultural commodities (tea, coffee, sugar etc.) and textiles and garments.

Another drawback of SAFTA is that it does not set a deadline for phasing out the negative list, but provides only for a review of the list every four years. It is not desirable to put the agriculture, agro-processing sector, textile and garments on the negative list because these items offer great potential for regional trade in South Asia.

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Tea, herbs, and leather are export potential products for Nepal. However, these products face tariff and non-tariff barriers in the international market. Identification and removal of such barriers are essential to realize its export potential. Bi-lateral, regional, and multi-lateral trade negotiations can be utilized to address these barriers. However, this is not possible without a well-coordinated negotiation strategy with a sound capacity team.

Table 5.3 Major Importers of Nepalese Tea

S. N. Country Export (Tons) Unit Value (US$/Tons) Total Export (US$) 1 India 2869 1,290 3,701,010 2 Pakistan 631 1,154 728,174 3 Germany 77 8,777 675,829 4 Holland 13 5,538 71,994 5 Japan 3 15,252 45,756 6 Belgium 2 5,000 10,000 7 United States 1 12,000 12,000

Source: SAWTEE, 2007

The above Table reflects that India and Pakistan are the major importers of Nepalese tea followed by Germany, Holland, Japan, Belgium and the United States. However, per unit value of tea exported to India and Pakistan is much lower compared to other countries. Nepalese tea faces market access barriers, both the TBs and NTBs, in the international markets. It faces high tariffs, except in Canada, the US and Australia, ranging from around 17 per cent in Japan to 200 per cent in Bangladesh (SAWTEE, 2007). It has been estimated that there was a 100 per cent incidence of NTBs in exports of all types of green tea to India, Pakistan, Canada, Australia, and Korea (Adhikari and Adhikari, 2005).

Exports of herbs, particularly medicinal herbs, are another export potential for Nepal and its export has been increasing over the years. It is estimated that every year between ten to fifteen thousand tones of non-timber forest products are harvested and exported to India and overseas countries (SAWTEE, 2007). However, Adhikari and Adhikari (2005) estimated that there was 100 per cent incidence of NTBs in the exports of Liquorices and Ginseng roots to Pakistan, Canada, and Australia and 25 per cent for China. Similarly, for other medicinal plants, the incidence is 100 per cent for Pakistan, Japan, and Australia and 21 and 20 per cent for Canada and the US respectively.

Another export potential, raw or processed leather, also face both the tariff as well as non-tariff barriers in the international markets. It was estimated that a minimum of 10 million square feet of tanned leathers would be exported from Nepal in 2005/06 worth about NRs 600 million. The export has shifted from Europe to Asia, especially to India. The applied tariff rates on major leather products ranges between 0 to 30 per cent in major market destinations and bound tariff rates are higher than applied rates in most cases. Similarly, NTBs comprised of customs and administrative procedures are also faced by Nepalese leather products (SAWTEE, 2007).

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5.3 Bi-lateral Level

The increasing trend of trade deficit, informal trade between the two countries and imposition of TRQs by India on some Nepalese exports are the major issues in Indo-Nepal trade treaty. These issues need to be addressed. Energy and services, i.e., ICT, tourism, education, healthcare, are most necessary sectors to be included in future trade negotiations to benefit both the countries. Nepal could exploit its vast amount of untapped hydroelectricity to fulfil the high demand of energy in Indian market. Therefore, Nepal should propose these new areas of opportunities in the Comprehensive Economic Partnership Agreement which is already proposed by the Indian delegation in India-Nepal Inter-Governmental Committee on Trade, Transit, and Cooperation meeting held in 2006. The proposed FTA with Bangladesh, Bhutan, Sri Lanka, and Pakistan as well as trade agreements with other countries has to be included by broad coverage of economic cooperation extending beyond tariff and non-tariff measures and should cover other areas of cooperation such as investment and trade in services.

5.4 Regional Level

Several issues need to be addressed to realize the potential benefits of tariff free access under SAFTA. These are: safeguard measures-sensitive lists and RoO, Para-tariff and non-tariff barriers, trade facilitation, and transit and transport logistics. Sensitive lists and RoO are not finalized. The fact is, most of the highly traded and potential Nepalese export items are in sensitive list but the 1996 Indo-Nepal bi-lateral agreement has substantially reduced the sensitive list to only few items. Nepal’s bi-lateral agreement with India is more attractive to Nepal than SAFTA because of non-reciprocal and zero tariff access for Nepalese manufactured products to Indian market. Unless the number of goods from the sensitive lists is reduced in SAFTA, Nepal will benefit little from SAFTA. Similarly, if SAFTA does not compensate financially for customs revenue losses, Nepal would prefer to continue trading with India under bi-lateral agreement.

Trade in services is inseparable from trade in goods. Service sector especially tourism is the most important for employment generation and foreign exchange earning for Nepal. Further foreign investment in hydroelectricity, tourism, education, health etc. is necessary for Nepal’s economic development. Therefore, Nepal should negotiate to include services and investment liberalization in SAFTA. Although, liberalization of services and investment is included in BIMSTEC Agreement, it is essential to make it to work more effective.

5.5 Agenda for Free Trade Agreement: Costs and Benefits

The Government of Nepal has been initiating to explore the possibilities of bi-lateral FTAs with South Asian countries in recent years. If there were a bi-lateral agreement between Nepal and South Asian countries, there would be economic costs and benefits for various groups for the both governments. Changes in economic welfare resulting from an FTA are treated as the sum of changes in consumers’ surplus, producer’ surplus and government revenue from custom duties. The economic cost may fall on poorer section

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of the society as fall in government revenue resulted from tariff cuts will negatively affect the government expenditure on social sector including health care and education.

Nepal’s trade with India has increased sharply over recent years particularly after 1997-98. Nepal’s export to India increased from 59 per cent in 2001-02 to 68.3 per cent in 2005-06 and its import from India increased from 52.1 per cent to 67.1 per cent during the same period (Table 3.2 and 3.4). Nepal’s over-dependency on India in terms of both export as well as import may be a political sensitive issue for Nepal in future. Diversification of Nepal’s trade to other countries has become an essential policy implication.

The concept of bi-lateral FTA is increasing around the globe in recent years. Nepal does not have any FTA experience. It will not be beneficial for Nepal to make FTA arrangements with developed countries in initial stage.

Although, Nepal’s trade with SAARC countries except India is only about one per cent of its total trade, Nepal’s exports to Bhutan have been increasing and there is more or less similar situation with Bangladesh and Sri Lanka as well. The major exports of Nepal to Bhutan are uncooked pasta, soaps, and cereal products. Similarly, Bangladesh imports mainly lentils, weaning foods, and vegetable seeds from Nepal. Nepal enjoys comparative advantage for all these goods as these items are not imported by Nepal from Bhutan and Bangladesh. Nepal can increase its competitiveness by investing in these items and can acquire benefit by exporting these items. It is recommended that Nepal can gain by FTA arrangement with Bhutan and Bangladesh in recent years. Hence, priority should be given to these two countries for FTA arrangement. Nepal should also take initiatives for FTA with Sri Lanka. These initiatives towards FTA would make Nepalese trade diversified instead of India-centred. Furthermore, Nepal can also take advantage by investing, producing and exporting its untapped hydropower to SAARC countries.

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ANNEX - I

TREATY OF TRADE BETWEEN HIS MAJESTY’S GOVERNMENT OF NEPAL

AND THE GOVERNMENT OF INDIA

March 6, 2002

His Majesty’s Government of Nepal and the Government of India (hereinafter referred to as the Contracting Parties),

Being conscious of the need to fortify the traditional connection between the markets of the two countries,

Being animated by the desire to strengthen economic cooperation between them,

Impelled by the urge to develop their economies for their several and mutual benefit, and

Convinced of the benefits of mutual sharing of scientific and technical knowledge and experience to promote mutual trade,

Have resolved to conclude a Treaty of Trade in order to expand trade between their respective territories and encourage collaboration in economic development, and

Have for this purpose appointed as their Plenipotentiaries the following persons, namely,

For His Majesty’s Government of Nepal Shri Gopal Man Shrestha, Minister of Commerce

For the government of India Shri P. Chidambaram, Minister of State for Commerce

Who, having exchanged their full powers and found them good and in due form, have agreed as follows:

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ARTICLE I

The Contracting Parties shall explore and undertake all measures, including technical cooperation, to promote, facilitate, expand and diversify trade between their two countries.

ARTICLE II

The Contracting Parties shall endeavour to grant maximum facilities and to undertake all necessary measures for the free and unhampered flow of goods, needed by one country from the other, to and from their respective territories.

ARTICLE III

Both the Contracting Parties shall accord unconditionally to each other treatment no less favourable than that accorded to any third country with respect to (a) customs duties and charges of any kind imposed on or in connection with importation and exportation, and (b) import regulations including quantitative restrictions.

ARTICLE IV

The Contracting Parties agree, on a reciprocal basis, to exempt from basic customs duty as well as from quantitative restrictions the import of such primary products as may be mutually agreed upon, from each other.

ARTICLE V

Notwithstanding the provisions of Article III and subject to such exceptions as may be made after consultation with His Majesty’s Government of Nepal, the Government of India agree to promote the industrial development of Nepal through the grant on the basis of non-reciprocity of specially favourable treatment to imports into India of industrial products manufactured in Nepal in respect of customs duty and quantitative restrictions normally applicable to them.

ARTICLE VI

With a view to facilitating greater interchange of goods between the two countries, His Majesty’s Government shall endeavour to exempt, wholly or partially, imports from India from customs duty and quantitative restrictions to the maximum extent compatible with their development needs and protection of their industries.

ARTICLE VII

Payment for transactions between the two countries will continue to be made in accordance with their respective foreign exchange laws, rules and regulations. The

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Contracting Parties agree to consult each other in the event of either of them experiencing difficulties in their mutual transactions with a view to resolving such difficulties.

ARTICLE VIII

The Contracting Parties agree to co-operate effectively with each other to prevent infringement and circumvention of the laws, rules and regulations of either country in regard to matters relating to foreign exchange and foreign trade.

ARTICLE IX

Notwithstanding the foregoing provisions, either Contracting Party may maintain or introduce such restrictions as are necessary for the purpose of:

(a) protecting public morals,

(b) protecting human, animal and plant life,

(c) safeguarding national treasures,

(d) safeguarding the implementation of laws relating to the import and export of gold and silver bullion, and

(e) safeguarding such other interests as may be mutually agreed upon.

ARTICLE X

Nothing in this treaty shall prevent either Contracting Party from taking any measures which may be necessary for the protection of its essential security interests or in pursuance of general international conventions, whether already in existence or concluded hereafter, to which it is a party relating to transit, export or import of particular kinds of articles such as narcotics and psychotropic substances or in pursuance of general conventions intended to prevent infringement of industrial, literary or artistic property or relating to false marks, false indications of origin or other methods of unfair competition.

ARTICLE XI

In order to facilitate effective and harmonious implementation of this Treaty, the Contracting Parties shall consult each other regularly.

ARTICLE XII

(a)*This Treaty shall remain in force **for a period of five years from 6th March, 2002 to 5th March, 2007 and shall be automatically extended for further periods of five (5) years at a time, unless either of the parties gives to the other a written notice, three months in advance, of its intention to terminate the Treaty.

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(b)*This Treaty may be amended or modified by mutual consent of the parties. Done in duplicate in Hindi, Nepali and English languages, all the texts being equally authentic, at New Delhi on 6th December 1991. In case of doubt, the English text will prevail.

(P. CHIDAMBARAM) (GOPALMAN SHRESTHA) Minster of State for Commerce Minister of Commerce For the Government of India Government of Nepal

*As modified through exchange of letters dated 3rd December, 1996 between the Commerce Secretaries of India and Nepal.

**As modified through exchange of letters dated 2nd March, 2002 between Commerce Secretaries of India and Nepal.

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TREATY OF TRANSIT BETWEEN HIS MAJESTY’S GOVERNMENT OF NEPAL AND THE GOVERNMENT OF INDIA

March 6, 2002

His Majesty’s Government of Nepal and the Government of India (hereinafter also referred to as the Contracting Parties),

Animated by the desire to maintain, develop and strengthen the existing friendly relations and cooperation between the two countries,

Recognizing that Nepal as a land-locked country needs freedom of transit, including permanent access to and from the sea, to promote its international trade, And recognizing the need to facilitate the traffic-in-transit through their territories,

Have resolved to extend the validity of the existing Treaty of Transit, with modifications mutually agreed upon, and

Have for this purpose appointed as their plenipotentiaries the following persons, namely,

For His Majesty’s Government of Nepal Shri Purna Bahadur Khadka Minister of Commerce

For the Government of India Shri Ramakrishna Hegde Minister of Commerce

Who, having exchanged their full powers, and found them good and in due form, have agreed as follows:

ARTICLE I

The Contracting Parties shall accord to “traffic-in-transit” freedom of transit across their respective territories through routes mutually agreed upon. No distinction shall be made which is based on flag of vessels, the places of origin, departure, entry, exit, destination, and ownership of goods or vessels.

ARTICLE II

(a) Each Contracting Party shall have the right to take all indispensable measures to ensure that such freedom, accorded by it on its

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territory, does not in any way infringe its legitimate interests of any kind.

(b) Nothing in this Treaty shall prevent either Contracting Party from taking any measures which may be necessary for the protection of its essential security interests.

ARTICLE III

The term “traffic-in-transit” means the passage of goods, including unaccompanied baggage, across the territory of a Contracting Party when the passage is a portion of a complete journey which begins or terminates within the territory of the other Contracting Party. The trans-shipment, warehousing, breaking bulk and change in the mode of transport of such goods as well as the assembly, dis-assembly or re-assembly of machinery and bulky goods shall not render the passage of goods outside the definition of “traffic-in-transit” provided any such operation is undertaken solely for the convenience of transportation. Nothing in this Article shall be construed as imposing an obligation on either Contracting Party to establish or permit the establishment of permanent facilities on its territory for such assembly, dis-assembly or re-assembly.

ARTICLE IV

Traffic-in-transit shall be exempt from customs duties and from all transit duties or other charges, except reasonable charges for transportation and such other charges, as are commensurate with the costs of services rendered in respect of such transit.

ARTICLE V

For convenience of traffic-in-transit, the Contracting Parties agree to provide at point or points of entry or exit, on such terms as may be mutually agreed upon and subject to relevant laws and regulations prevailing in country, warehouse or sheds, for the storage of traffic-in-transit awaiting customs clearance before onward transmission.

ARTICLE VI

Traffic-in-transit shall be subject to the procedure laid down in the Protocol hereto annexed and as modified by mutual agreement. Except in cases of failure to comply with the procedure prescribed, such traffic-in-transit shall not be subject to avoidable delays or restrictions.

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ARTICLE VII

In order to enjoy the freedom of the high seas, merchant ships sailing under the flag of Nepal shall be accorded, subject to Indian laws and regulations, treatment no less favourable than that accorded to ships of any other foreign country in respect of matters relating to navigation, entry into and departure from the ports, use of ports and harbour facilities, as well as loading and unloading dues, taxes and other levies, except that the provisions of this Article shall not extend to coastal trade.

ARTICLE VIII

Notwithstanding the foregoing provisions, either Contracting Party may maintain or introduce such measures or restrictions as are necessary for the purpose of :

i) Protecting public morals; ii) Protecting human, animal and plant life; iii) Safeguarding of national treasures; iv) Safeguarding the implementation of laws relating to the

import and export of gold and silver bullion; and v) Safeguarding such other interests as may be mutually

agreed upon

ARTICLE IX

Nothing in this Treaty shall prevent either Contracting Party from taking any measures which may be necessary in pursuance of general international conventions, whether already in existence or concluded hereafter, to which it is a party, relating to transit, export or import of particular kinds of articles such as narcotics and psychotropic substances or in pursuance of general conventions intended to prevent infringement of industrial, literary or artistic property or relating to false marks, false indications of origin or other methods of unfair competition.

ARTICLE X

In order to facilitate effective and harmonious implementation of this Treaty the Contracting Parties shall consult each other regularly.

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ARTICLE XI

The revalidated and modified Treaty shall enter into force on the 6th January, 1999. It shall remain in force up to the 5th January, 2006 and shall, thereafter, be automatically extended for a further period of seven (7) years at a time, unless either of the parties gives to the other a written notice, six months in advance, of its intention to terminate the Treaty provided further that the modalities, routes, conditions of transit and customs arrangement, as contained in the Protocol and Memorandum to the Treaty shall be reviewed and modified by the Contracting Parties every seven years, or earlier if warranted, to meet the changing conditions before the automatic renewal and such modifications shall be deemed to be the integral part of the Treaty.

his Treaty may be amended or modified by mutual consent of the Contracting Parties.

Done at Kathmandu on 5th January, 1999.

(RAMAKRISHNA HEGDE) Minister of Commerce For the Government of India

(PURNA BAHADUR KHADKA) Minister of Commerce For His Majesty’s Government of Nepal

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AGREEMENT OF CO-OPERATION BETWEEN GOVERNMENT OF INDIA AND HIS MAJESTY’S GOVERNMENT OF NEPAL TO CONTROL UNAUTHORISED

TRADE

The Government of India and His Majesty’s Government of Nepal (hereinafter also referred to as the Contracting Parties).

KEEN to sustain the good neighbourliness through mutually beneficial measures at their common border which is free for movement of persons and goods.

Have agreed as follows:

Article I

The Contracting Parties, while recognizing that there is a long and open border between the two countries and there is free movement of persons and goods across the border and nothing that they have the right to pursue independent foreign trade policies, agree that either of them would take all such measures as are necessary to ensure that the economic interests of the other party are not adversely affected through unauthorised trade between the two countries.

Article II

The Contracting Parties agree to co-operate effectively with each other, to prevent infringement and circumvention of the laws, rules and regulations of either country in regard to matters relating to Customs, Narcotics and Psychotropic Substances, Foreign Exchange and Foreign Trade and shall for this purpose assist each other in such matters as consultation, enquiries and exchange of information with regard to matters concerning such infringement or circumvention..

Article III

Subject to such exceptions as may be mutually agreed upon each Contracting Party shall prohibit and co-operate with the other to prevent:

(a) re-exports from its territory to third countries of goods imported from the other Contracting Party without manufacturing activity;

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(b) re-exports to the territory of the other Contracting Party of goods imported from third countries without manufacturing activity. Provided that (a) and (b) above shall not be applicable in the case of the export of the Nepalese goods into India under the procedure set out in Protocol V to the Treaty of Trade between His Majesty’s Government of Nepal and the Government of India.

Article IV

Each Contracting Party will:

(a) prohibit and take appropriate measures to prevent import from the territory of the other Contracting Party of goods liable to be re-exported to third countries from its territory and the export of which from the territory of the other Contracting Party to its territory is prohibited;

(b) in order to avoid inducement towards diversion of imported goods to the other Contracting Party, take appropriate steps through necessary provisions relating to Baggage Rules, gifts and foreign exchange authorisation for the import of goods from third countries.

Article V

The Contracting Parties shall compile and exchange with each other statistical and other information relating to unauthorised trade across the common border. They also agree to exchange with each other regularly the lists of goods the import and export of which are prohibited, or restricted or subject to control according to their respective laws and regulations.

Article VI

The respective heads of the Border Customs Offices of each country shall meet regularly with his counterpart of appropriate status at least once in two months alternately across the common border:

(a) to co-operate with each other in the prevention of unauthorised trade:

(b) to maintain the smooth and uninterrupted movement of goods across their territories;

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(c) to render assistance in resolving administrative difficulties as may arise at the field level.

Article VII

In order to facilitate effective and harmonious implementation of this Agreement, the Contracting Parties shall consult each other regularly.

Article VIII

This Agreement shall remain in force up to 5th March, 2007. It may be renewed for further periods of five years, at a time, by mutual consent subject to such modifications as may be agreed upon (As amended on 5th March, 2002).

Done in duplicate in Hindi, Nepali and English languages, all the texts being equally authentic, at New Delhi on the 6th December 1991. In case of doubt, the English text will prevail.

(P. CHIDAMBARAM) (GOPALMAN SHRESTHA) Minster of State for Commerce Minister of Commerce For the Government of India His Majesty’s Government of Nepal

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ANNEX – II

AGREEMENT ON SOUTH ASIAN FREE TRADE AREA (SAFTA)

The Governments of the SAARC (South Asian Association for Regional Cooperation) Member States comprising the People's Republic of Bangladesh, the Kingdom of Bhutan, the Republic of India, the Republic of Maldives, the Kingdom of Nepal, the Islamic Republic of Pakistan and the Democratic Socialist Republic of Sri Lanka hereinafter referred to as "Contracting States"

Motivated by the commitment to strengthen intra-SAARC economic cooperation to maximise the realization of the region's potential for trade and development for the benefit of their people, in a spirit of mutual accommodation, with full respect for the principles of sovereign equality, independence and territorial integrity of all States;

Noting that the Agreement on SAARC Preferential Trading Arrangement (SAPTA) signed in Dhaka on the 11th of April 1993 provides for the adoption of various instruments of trade liberalization on a preferential basis;

Convinced that preferential trading arrangements among SAARC Member States will act as a stimulus to the strengthening of national and SAARC economic resilience, and the development of the national economies of the Contracting States by expanding investment and production opportunities, trade, and foreign exchange earnings as well as the development of economic and technological cooperation;

Aware that a number of regions are entering into such arrangements to enhance trade through the free movement of goods;

Recognizing that Least Developed Countries in the region need to be accorded special and differential treatment commensurate with their development needs; and

Recognizing that it is necessary to progress beyond a Preferential Trading Arrangement to move towards higher levels of trade and economic cooperation in the region by removing barriers to cross-border flow of goods;

Have agreed as follows:

Article I

Definitions

For the purposes of this Agreement:

1. Concessions mean tariff, para-tariff and non-tariff concessions agreed under the Trade Liberalisation Programme;

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2. Direct Trade Measures mean measures conducive to promoting mutual trade of Contracting States such as long and medium -term contracts containing import and supply commitments in respect of specific products, buy-back arrangements, state trading operations, and government

and public procurement;

3. Least Developed Contracting State refers to a Contracting State which is designated as a "Least Developed Country" by the United Nations;

4. Margin of Preference means percentage of tariff by which tariffs are reduced on products imported from one Contracting State to another as a result of preferential treatment.

5. Non-Tariff Measures include any measure, regulation, or practice, other than "tariffs" and "paratariffs".

6. Para-Tariffs mean border charges and fees, other than "tariffs", on foreign trade transactions of a tariff-like effect which are levied solely on imports, but not those indirect taxes and charges, which are levied in the same manner on like domestic products. Import charges corresponding to specific services rendered are not considered as para-tariff measures;

7. Products mean all products including manufactures and commodities in their raw, semi-processed and processed forms;

8. SAPTA means Agreement on SAARC Preferential Trading Arrangement signed in Dhaka on the 11th of April 1993;

9. Serious injury means a significant impairment of the domestic industry of like or directly competitive products due to a surge in preferential imports causing substantial losses in terms of earnings, production or employment unsustainable in the short term;

10. Tariffs mean customs duties included in the national tariff schedules of the Contracting States;

11. Threat of serious injury means a situation in which a substantial increase of preferential imports is of a nature to cause "serious injury" to domestic producers, and that such injury, although not yet existing, is clearly imminent. A determination of threat of serious injury shall be based on facts and not on mere allegation, conjecture, or remote or hypothetical possibility.

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Article II

Establishment

The Contracting States hereby establish the South Asian Free Trade Area (SAFTA) to promote and enhance mutual trade and economic cooperation among the Contracting States, through exchanging concessions in accordance with this Agreement.

Article III

Objectives and Principles

1. The Objectives of this Agreement are to promote and enhance mutual trade and economic cooperation among Contracting States by, inter-alia:

a) eliminating barriers to trade in, and facilitating the cross-border movement of goods between the territories of the Contracting States;

b) promoting conditions of fair competition in the free trade area, and ensuring equiTable benefits to all Contracting States, taking into account their respective levels and pattern of economic development;

c) creating effective mechanism for the implementation and application of this Agreement, for its joint administration and for the resolution of disputes; and

d) establishing a framework for further regional cooperation to expand and enhance the mutual benefits of this Agreement.

2. SAFTA shall be governed in accordance with the following principles:

a) SAFTA will be governed by the provisions of this Agreement and also by the rules, regulations, decisions, understandings and protocols to be agreed upon within its framework by the Contracting States;

b) The Contracting States affirm their existing rights and obligations with respect to each other under Marrakesh Agreement Establishing the World Trade Organization and other Treaties/Agreements to which such Contracting States are signatories;

c) SAFTA shall be based and applied on the principles of overall reciprocity and mutuality of advantages in such a way as to benefit equitably all Contracting States, taking into account their respective levels of economic and industrial development, the pattern of their external trade and tariff policies and systems;

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d) SAFTA shall involve the free movement of goods, between countries through, inter-alia, the elimination of tariffs, para tariffs and non-tariff restrictions on the movement of goods, and any other equivalent measures;

e) SAFTA shall entail adoption of trade facilitation and other measures, and the progressive harmonization of legislations by the Contracting States in the relevant areas; and

f) The special needs of the Least Developed Contracting States shall be clearly recognized by adopting concrete preferential measures in their favour on a non-reciprocal basis.

Article IV

Instruments

The SAFTA Agreement will be implemented through the following instruments:-

1. Trade Liberalisation Programme 2. Rules of Origin 3. Institutional Arrangements 4. Consultations and Dispute Settlement Procedures 5. Safeguard Measures 6. Any other instrument that may be agreed upon.

Article V

National Treatment

Each Contracting State shall accord national treatment to the products of other Contracting States in accordance with the provisions of Article III of GATT 1994.

Article VI Components

SAFTA may, inter-alia, consist of arrangements relating to:

a) tariffs; b) para-tariffs; c) non-tariff measures; d) direct trade measures.

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Article VII

Trade Liberalisation Programme

1. Contracting States agree to the following schedule of tariff reductions:

a) The tariff reduction by the Non-Least Developed Contracting States from existing tariff rates to 20 per cent shall be done within a time frame of 2 years, from the date of coming into force of the Agreement. Contracting States are encouraged to adopt reductions in equal annual instalments. If actual tariff rates after the coming into force of the Agreement are below 20 per cent, there shall be an annual reduction on a Margin of Preference basis of 10 per cent on actual tariff rates for each of the two years.

b) The tariff reduction by the Least Developed Contracting States from existing tariff rates will be to 30 per cent within the time frame of 2 years from the date of coming into force of the Agreement. If actual tariff rates on the date of coming into force of the Agreement are below 30 per cent, there will be an annual reduction on a Margin of Preference basis of 5 per cent on actual tariff rates for each of the two years.

c) The subsequent tariff reduction by Non-Least Developed Contracting States from 20 per cent or below to 0-5 per cent shall be done within a second time frame of 5 years, beginning from the third year from the date of coming into force of the Agreement. However, the period of subsequent tariff reduction by Sri Lanka shall be six years. Contracting States are encouraged to adopt reductions in equal annual instalments, but not less than 15 per cent annually.

d) The subsequent tariff reduction by the Least Developed Contracting States from 30 per cent or below to 0-5 per cent shall be done within a second time frame of 8 years beginning from the third year from the date of coming into force of the Agreement. The Least Developed Contracting States are encouraged to adopt reductions in equal annual instalments, not less than 10 per cent annually.

2. The above schedules of tariff reductions will not prevent Contracting States from immediately reducing their tariffs to 0-5 per cent or from following an accelerated schedule of tariff reduction.

3. a) Contracting States may not apply the Trade Liberalisation Programme as in paragraph 1 above, to the tariff lines included in the Sensitive Lists which shall be negotiated by the Contracting States (for LDCs and Non -LDCs) and incorporated in this Agreement as an integral part. The number of products in the Sensitive Lists shall be subject to maximum ceiling to be mutually agreed among the Contracting States with flexibility to Least Developed Contracting States to seek derogation in respect of the products of their export interest; and

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b) The Sensitive List shall be reviewed after every four years or earlier as may be decided by SAFTA Ministerial Council (SMC), established under Article 10, with a view to reducing the number of items in the Sensitive List.

4. The Contracting States shall notify the SAARC Secretariat all non-tariff and para-tariff measures to their trade on an annual basis. The notified measures shall be reviewed by the Committee of Experts, established under Article 10, in its regular meetings to examine their compatibility with relevant WTO provisions. The Committee of Experts shall recommend the elimination or implementation of the measure in the least trade restrictive manner in order to facilitate intra SAARC trade1.

5. Contracting Parties shall eliminate all quantitative restrictions, except otherwise permitted under GATT 1994, in respect of products included in the Trade Liberalisation Programme.

6. Notwithstanding the provisions contained in paragraph 1 of this Article, the Non-Least Developed Contracting States shall reduce their tariff to 0-5% for the products of Least Developed Contracting States within a timeframe of three years beginning from the date of coming into force of the Agreement.

Article VIII Additional Measures

Contracting States agree to consider, in addition to the measures set out in Article 7, the adoption of trade facilitation and other measures to support and complement SAFTA for mutual benefit.

These may include, among others: -

a) harmonization of standards, reciprocal recognition of tests and accreditation of testing laboratories of Contracting States and certification of products;

b) simplification and harmonization of customs clearance procedure; c) harmonization of national customs classification based on HS coding system; d) Customs cooperation to resolve dispute at customs entry points; e) simplification and harmonization of import licensing and registration procedures; f) simplification of banking procedures for import financing; g) transit facilities for efficient intra-SAARC trade, especially for the land-locked

Contracting States; h) removal of barriers to intra-SAARC investments; i) macroeconomic consultations; j) rules for fair competition and the promotion of venture capital; k) development of communication systems and transport infrastructure; l) making exceptions to their foreign exchange restrictions, if any, relating to payments

for products under the SAFTA scheme, as well as repatriation of such payments without

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prejudice to their rights under Article XVIII of the General Agreement on Tariffs and Trade (GATT) and the relevant provisions of Articles of Treaty of the International Monetary Fund (IMF); and m) Simplification of procedures for business visas.

Article VIV

Extension of Negotiated Concessions

Concessions agreed to, other than those made exclusively to the Least Developed Contracting States, shall be extended unconditionally to all Contracting States.

Article X Institutional Arrangements

1. The Contracting States hereby establish the SAFTA Ministerial Council (hereinafter referred to as SMC).

2. The SMC shall be the highest decision-making body of SAFTA and shall be responsible for the administration and implementation of this Agreement and all decisions and arrangements made within its legal framework.

3. The SMC shall consist of the Ministers of Commerce/Trade of the Contracting States.

4. The SMC shall meet at least once every year or more often as and when considered necessary by the Contracting States. Each Contracting State shall chair the SMC for a period of one year on rotational basis in alphabetical order.

5. The SMC shall be supported by a Committee of Experts (hereinafter referred to as COE), with one nominee from each Contracting State at the level of a Senior Economic Official, with expertise in trade matters.

6. The COE shall monitor, review and facilitate implementation of the provisions of this Agreement and undertake any task assigned to it by the SMC. The COE shall submit its report to SMC every six months.

7. The COE will also act as Dispute Settlement Body under this Agreement.

8. The COE shall meet at least once every six months or more often as and when considered necessary by the Contracting States. Each Contracting State shall chair the COE for a period of one year on rotational basis in alphabetical order.

9. The SAARC Secretariat shall provide secretarial support to the SMC and COE in the discharge of their functions.

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10. The SMC and COE will adopt their own rules of procedure.

Article XI

Special and Differential Treatment for the Least Developed Contracting States

In addition to other provisions of this Agreement, all Contracting States shall provide special and more favourable treatment exclusively to the Least Developed Contracting States as set out in the following sub-paragraphs:

a) The Contracting States shall give special regard to the situation of the Least Developed Contracting States when considering the application of anti-dumping and/or countervailing measures. In this regard, the Contracting States shall provide an opportunity to Least Developed Contracting States for consultations. The Contracting States shall, to the extent practical, favourably consider accepting price undertakings offered by exporters from Least Developed Contracting States. These constructive remedies shall be available until the trade liberalisation programme has been completed by all Contracting States.

b) Greater flexibility in continuation of quantitative or other restrictions provisionally and without discrimination in critical circumstances by the Least Developed Contracting States on imports from other Contracting States.

c) Contracting States shall also consider, where practical, taking direct trade measures with a view to enhancing sustainable exports from Least Developed Contracting States, such as long and medium-term contracts containing import and supply commitments in respect of specific products, buy-back arrangements, state trading operations, and government and public procurement.

d) Special consideration shall be given by Contracting States to requests from Least Developed Contracting States for technical assistance and cooperation arrangements designed to assist them in expanding their trade with other Contracting States and in taking advantage of the potential benefits of SAFTA. A list of possible areas for such technical assistance shall be negotiated by the Contracting States and incorporated in this Agreement as an integral part.

e) The Contracting States recognize that the Least Developed Contracting States may face loss of customs revenue due to the implementation of the Trade Liberalisation Programme under this Agreement. Until alternative domestic arrangements are formulated to address his situation, the Contracting States agree to establish an appropriate mechanism to compensate the Least Developed Contracting States for their loss of customs revenue. This mechanism and its rules and regulations shall be established prior to the commencement of the Trade Liberalisation Programme (TLP).

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Article XII Special Provision for Maldives

Notwithstanding the potential or actual graduation of Maldives from the status of a Least Developed Country, it shall be accorded in this Agreement and in any subsequent contractual undertakings thereof treatment no less favourable than that provided for the Least Developed Contracting States.

Article XIII Non-application

Notwithstanding the measures as set out in this Agreement its provisions shall not apply in relation to preferences already granted or to be granted by any Contracting State to other Contracting States outside the framework of this Agreement, and to third countries through bi-lateral, plurilateral and multi-lateral trade agreements and similar arrangements.

Article XIV General Exceptions

a) Nothing in this Agreement shall be construed to prevent any Contracting State from taking action and adopting measures which it considers necessary for the protection of its national security.

b) Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the similar conditions prevail, or a disguised restriction on intra-regional trade, nothing in this Agreement shall be construed to prevent any Contracting State from taking action and adopting measures which it considers necessary for the protection of:

(i) public morals;

(ii) human, animal or plant life and health; and

(iii) articles of artistic, historic and archaeological value.

Article XV Balance of Payments Measures

1. Notwithstanding the provisions of this Agreement, any Contracting State facing serious balance of payments difficulties may suspend provisionally the concessions extended under this Agreement.

2. Any such measure taken pursuant to paragraph 1 of this Article shall be immediately notified to the Committee of Experts.

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3. The Committee of Experts shall periodically review the measures taken pursuant to paragraph 1 of this Article.

4. Any Contracting State which takes action pursuant to paragraph I of this Article shall afford, upon request from any other Contracting State, adequate opportunities for consultations with a view to preserving the stability of concessions under SAFTA.

5. If no satisfactory adjustment is effected between the Contracting States concerned within 30 days of the beginning of such consultations, to be extended by another 30 days through mutual consent, the matter may be referred to the Committee of Experts.

6. Any such measures taken pursuant to paragraph 1 of this Article shall be phased out soon after the Committee of Experts comes to the conclusion that the balance of payments situation of the Contracting State concerned has improved.

Article XVI

Safeguard Measures

1. If any product, which is the subject of a concession under this Agreement, is imported into the territory of a Contracting State in such a manner or in such quantities as to cause, or threaten to cause, serious injury to producers of like or directly competitive products in the importing Contracting State, the importing Contracting State may, pursuant to an investigation by the competent authorities of that Contracting State conducted in accordance with the provisions set out in this Article, suspend temporarily the concessions granted under the provisions of this Agreement. The examination of the impact on the domestic industry concerned shall include an evaluation of all other relevant economic factors and indices having a bearing on the state of the domestic industry of the product and a causal relationship must be clearly established between "serious injury" and imports from within the SAARC region, to the exclusion of all such other factors.

2. Such suspension shall only be for such time and to the extent as may be necessary to prevent or remedy such injury and in no case, will such suspension be for duration of more than 3 years.

3. No safeguard measure shall be applied again by a Contracting State to the import of a product which has been subject to such a measure during the period of implementation of Trade Liberalization Programme by the Contracting States, for a period of time equal to that during which such measure had been previously applied, provided that the period of non-application is at least two years.

4. All investigation procedures for resorting to safeguard measures under this Article shall be consistent with Article XIX of GATT 1994 and WTO Agreement on Safeguards

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5. Safeguard action under this Article shall be non-discriminatory and applicable to the product imported from all other Contracting States subject to the provisions of paragraph 8 of this Article.

6. When safeguard provisions are used in accordance with this Article, the Contracting State invoking such measures shall immediately notify the exporting Contracting State(s) and the Committee of Experts.

7. In critical circumstances where delay would cause damage which it would be difficult to repair, a Contracting State may take a provisional safeguard measure pursuant to a preliminary determination that there is clear evidence that increased imports have caused or are threatening to cause serious injury. The duration of the provisional measure shall not exceed 200 days, during this period the pertinent requirements of this Article shall be met.

8. Notwithstanding any of the provisions of this Article, safeguard measures under this article shall not be applied against a product originating in a Least Developed Contracting State as long as its share of imports of the product concerned in the importing Contracting State does not exceed 5 per cent, provided Least Developed Contracting States with less than 5 per cent import share collectively account for not more than 15 per cent of total imports of the product concerned.

Article XVII

Maintenance of the Value of Concessions

Any of the concessions agreed upon under this Agreement shall not be diminished or nullified, by the application of any measures restricting trade by the Contracting States, except under the provisions of other articles of this Agreement.

Article XVIII

Rules of Origin

Rules of Origin shall be negotiated by the Contracting States and incorporated in this Agreement as an integral part.

Article XIX Consultations

1. Each Contracting State shall accord sympathetic consideration to and will afford adequate opportunity for consultations regarding representations made by another Contracting State with respect to any matter affecting the operation of this Agreement.

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2. The Committee of Experts may, at the request of a Contracting State, consult with any Contracting State in respect of any matter for which it has not been possible to find a satisfactory solution through consultations under paragraph 1.

Article XX Dispute Settlement Mechanism

1. Any dispute that may arise among the Contracting States regarding the interpretation and application of the provisions of this Agreement or any instrument adopted within its framework concerning the rights and obligations of the Contracting States will be amicably settled among the parties concerned through a process initiated by a request for bi-lateral consultations.

2. Any Contracting State may request consultations in accordance with paragraph 1 of this Article with other Contracting State in writing stating the reasons for the request including identification of the measures at issue. All such requests should be notified to the Committee of Experts, through the SAARC Secretariat with an indication of the legal basis for the complaint.

3. If a request for consultations is made pursuant to this Article, the Contracting State to which the request is made shall, unless otherwise mutually agreed, reply to the request within 15 days after the date of its receipt and shall enter into consultations in good faith within a period of no more than 30 days after the date of receipt of the request, with a view to reaching a mutually satisfactory solution.

4. If the Contracting State does not respond within 15 days after the date of receipt of the request, or does not enter into consultations within a period of no more than 30 days, or a period otherwise mutually agreed, after the date of receipt of the request, then the Contracting State that requested the holding of consultations may proceed to request the Committee of Experts to settle the dispute in accordance with working procedures to be drawn up by the Committee.

5. Consultations shall be confidential, and without prejudice to the rights of any Contracting State in any further proceedings.

6. If the consultations fail to settle a dispute within 30 days after the date of receipt of the request for consultations, to be extended by a further period of 30 days through mutual consent, the complaining Contracting State may request the Committee of Experts to settle the dispute. The complaining Contracting State may request the Committee of Experts to settle the dispute during the 60-day period if the consulting Contracting States jointly consider that consultations have failed to settle the dispute.

7. The Committee of Experts shall promptly investigate the matter referred to it and make recommendations on the matter within a period of 60 days from the date of referral.

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FATHULLA JAMEEL Minister of Foreign Affairs Republic of Maldives

DR. BHEKH B. THAPA Ambassador-at-large for Foreign Affairs His Majesty's Government of Nepal

KHURSHID M. KASURI Minister of Foreign Affairs Islamic Republic of Pakistan

TYRONNE FERNANDO Minister of Foreign Affairs Democratic Socialist Republic of Sri Lanka

1. The initial notification shall be made within three months from the date of coming into force of the Agreement and the COE shall review the notification in its first meeting and take appropriate decisions.

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ANNEX – III

Framework Agreement on the BIMST-EC Free Trade Area February 8, 2004

PREAMBLE

THE GOVERNMENTS of the kingdom of Bhutan, the Peoples’ Republic of Bangladesh, the Republic of India, the Union of Myanmar, the Kingdom of Nepal, the Democratic Socialist Republic of Sri Lanka and the Kingdom of Thailand, the Member States of BIMST-EC (Bangladesh, India, Myanmar, Sri Lanka and Thailand Economic Co-operation), hereinafter referred to collectively as “the Parties” and individually as “a Party”;

TAKING NOTE of the Agreed Conclusions of the BIMST-EC Economic Ministerial Retreat held in Bangkok, Thailand, on 7th August 1998, that BIMST-EC should aim and strive to develop into a Free Trade Arrangements and should focus on activities that facilitate trade, increase investments and promote technical cooperation among member countries:

MOTIVATED by the need for strengthening economic cooperation in the region to fully realize the potential of trade and development for the benefit of their people.

RECOGNIZING the need to harmonize with the changing global economic environment and the catalytic role that regional trading arrangements can play towards accelerating global liberalization as building blocks in the framework of the multi-lateral trading system.

CONVINCED that a BIMST-EC Free Trade Area will act as a stimulus to the strengthening of economic cooperation among the parties, lower costs, increase intra-regional trade and investment, increase economic efficiency, create a lager market with greater opportunities and larger economics of scale for the businesses of the parties, and enhance the attractiveness of the parties to capital and talent.

REAFFIRMING the rights, obligations and undertakings of the respective parties under the World Trade Organization (WTO) and other multi-lateral, regional and bi-lateral agreements and arrangements, and

RECOGNIZING that the least developed countries in the region need to be accorded special and differential treatment commensurate with their development needs;

HAVE AGREED AS FOLLOWS:

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ARTICLE I

Objectives

The objectives of this Agreement are to:

(a) strengthen and enhance economic, trade and investment cooperation among the parties;

(b) progressively liberalize and promote trade in goods and services, create a transparent, liberal and facilitative investment regime;

(c) explore new areas and develop appropriate measures for closer cooperation among the Parties, and

(d) acilitate the more effective economic integration of the least developed countries in the region, and bridge the development gap among the Parties.

ARTICLE II

Measures for Comprehensive Free Trade Area (FTA)

The parties agree to negotiate expeditiously in order to establish a BIMST-EC FTA to strengthen and enhance economic cooperation through the following.

(a) progressive elimination of tariffs and non-tariff barriers in substantially all trade in goods;

(b) progressive liberalization of trade in services with substantial sectoral coverage;

(c) establishing an open and competitive investment regime that facilitates and promotes investments within the BIMST-EC FTA;

(d) provision for special and differential treatment and flexibility to the least developed countries in the region;

(e) flexibility to the parties in the BIMST-EC FTA negotiations to address their sensitive areas in the goods, services and investment sectors based on agreed principles of reciprocity and mutual benefits;

(f) establishing effective trade and investment facilitating measures, including, but not limited to, simplification of customs procedures and development of mutual recognition arrangements;

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(g) expanding economic cooperation in areas as may be mutually agreed among the parties that will complement the deepening of trade and investment links among the parties and formulating action plans and programmes in the agreed sectors/ areas of cooperation and

(h) establishing appropriate mechanisms for implementation of this Agreement.

ARTICLE III

Trade in Goods

1. The parties agree to enter into negotiations for eliminating the tariffs and non-tariff barriers in substantially all trade in goods between the parties, except, where necessary, those permitted under Article XXIV(8) (b) of the General Agreement on Tariffs and Trade (GATT) 1994.

2. The products, except those included in the Negative List, shall be subject to tariff reduction or elimination on the following two tracks.

(a) Fast Track : Products listed in the Fast Track by a party on its own accord shall have their respective applied MFN tariff rates gradually reduced/ eliminated in accordance with specified rates to be mutually agreed by the parties, within the following timeframe:

Countries For Developing Country Parties

For LDC Parties

India, Sri Lanka & Thailand 1 July 2006 to 30 June 2009 1 July 2006 to 30 June 2007

Bangladesh, Bhutan, Nepal & Myanmar

1 July 2006 to 30 June 2011 1 July 2006 to 30 June 2009

(b) Normal Track : Products listed in the Normal Track by a party on its own accord shall have their respective applied MFN tariff rates gradually reduced/ eliminated in accordance with specified rates to be mutually agreed by the parties, within the following timeframe:

Countries For Developing Country

Parties

For LDC Parties

India, Sri Lanka & Thailand 1 July 2007 to 30 June 2012 1 July 2007 to 30 June 2010

Bangladesh, Bhutan, Nepal & Myanmar

1 July 2007 to 30 June 2017 1 July 2007 to 30 June 2015

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(c) The number of products in the Negative List shall be subject to a maximum ceiling to be mutually agreed among the parties, with flexibility to the LDC parties to seek derogation, in one form or the other, in respect of products of their export interest.

3. Negotiations among the parties to establish the BIMST-EC FTA covering trade in goods shall also include, but not be limited to the following:

(a) detailed modalities governing the tariff reduction or elimination programmes as well as any other related matter, including ( a possibility of establishing a mechanism for compensation of possible revenue losses that may occur to LDC parties due to tariff preferences and) principles governing reciprocal commitments not provided for in the preceding paragraphs of this Article :

(b) Rules of Origin:

(c) Treatment of out-of-quota rates:

(d) Modification of a party’s commitments under the agreement on trade in goods based on Article XXVIII of the GATT 1994;

(e) Non-tariff measures/ barriers imposed on any product covered under this Agreement, and

(f) Detailed procedures for safeguards based on GATT principles:

ARTICLE IV

Trade in Services

With the view to expediting the expansion of trade in services, the parties agree to enter into negotiations to progressively liberalise trade in services with substantial sectoral coverage through a positive list approach. Such negotiations shall be directed to:

(a) progressive elimination of substantially all discrimination between or among the parties and/or prohibition of new or more discriminatory measures with respect to trade in services between the parties, except for measures permitted under Article V(1)(b) of the WTO General Agreement on Trade in Services (GATS).

(b) expansion in the depth and scope of liberalization of trade in services beyond those undertaken by the Parties under the GATS;

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(c) enhance cooperation in services among the Parties in order to improve efficiency and competitiveness, as well as to diversify the supply and distribution of services of the respective service suppliers of the Parties.

ARTICLE V

Investment

To promote investments and to create the facilitative, transparent and competitive investment regime, the parties agree to:

(a) provide for the promotion and protection of investments;

(b) strengthen cooperation in investment, facilitate investment and improve transparency of investment rules and regulations; and

(c) enter into negotiations in order to progressively liberalize the investment regime through a positive list approach.

ARTICLE VI

Areas of Economic Cooperation

1. The parties agree to strengthen cooperation in the already identified sectors of technology, transportation and communication, energy, tourism and fisheries.

2. The parties further agree to enhance trade facilitation in areas, including but not limited to, the following:

(a) Mutual Recognition Arrangements (MRAs), conformity assessment, accreditation procedures, and standards & technical regulations.

(b) Customs cooperation;

(c) Trade finance;

(d) E-commerce; and

(e) Business Visa and travel facilitation.

3. The parties agree to implement capacity building programmes and technical assistance, particularly for the least developed countries of the BIMST-EC, in order to adjust their economic structure and expand their trade and investment with other parties.

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4. The parties further agree to provide technical support, to the extent possible, to the LDC parties in their efforts to comply with the SPS and TBT requirements of the BIMST-EC countries. For this purpose, bi-lateral negotiations for fast tracking the process of MRAs, conformity assessment, accreditation procedures or any other necessary arrangements will be carried out in parallel with negotiations for FTA in goods.

ARTICLE VII

Timeframes

1. The negotiations for tariff reduction/ elimination and other matters as set out in Article 3 of this Agreement shall commence in July 2004 and be concluded by December 2005.

2. For trade in services and investments, the negotiations on respective agreements shall commence in 2005 and be concluded by 2007. The identification, liberalization, etc, of the sectors of services and investments shall be finalized for implementation subsequently in accordance with the timeframes to be mutually agreed; (a) taking into account the sensitive sectors of the parties; and (b) with special and differential treatment and flexibility for the LDC parties.

3. The parties shall continue to build upon existing or agreed programmes, develop new economic cooperation programmes and conclude agreements on various areas of economic co-operation. The parties shall do so expeditiously for early implementation in a manner and at a pace acceptable to all the parties concerned.

ARTICLE VIII

General Exceptions

Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between or among the parties where the same conditions prevail, or a disguised restriction on trade within the BIMST-EC, nothing in this Agreement shall prevent any party from taking action and adopting measures for the protection of its national security or the protection of articles of artistic, historic and archaeological value, or such other measures which it deems necessary for the protection of public morals, or for the protection of human, animal or plant life, health and conservation of exhaustible natural resources.

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ARTICLE IX

Dispute Settlement Mechanism

1. The parties shall establish appropriate formal dispute settlement procedures and mechanism for the purpose of this Agreement by December 2005.

2. Pending the establishment of the formal dispute settlement procedures and mechanism under paragraph 1 of this Article, any dispute arising between the parties regarding the interpretation, application or implementation of this Agreement shall be settled amicably through mutual consultations.

ARTICLE X

Institutional Arrangements

1. BIMST-EC Trade Negotiations Committee (BIMST-EC TNC) shall be established to carry out the programme of negotiations as set out in this Agreement.

2. The BIMST-EC TNC may involve other exports or establish any working group as may be necessary to assist in their negotiations, as also to coordinate and implement any economic cooperation activities undertaken pursuant to this Agreement.

3. The BIMST-EC TNC shall regularly report to the BIMST-EC Trade/ Economic Ministers through the Senior Trade and Economic Officials Meeting on the progress and outcome of its negotiations.

ARTICLE XI

Amendments

The provisions of this Agreement may be modified through amendments mutually agreed upon in writing by the parties.

ARTICLE XII

Miscellaneous Provisions

1. Any subsidiary agreement or arrangement, which may be concluded by the parties pursuant to the provisions of this Agreement, shall form an integral part of this Agreement and be binding on the parties.

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2. Except as otherwise provided in this Agreement, any action taken under it shall not affect or nullify the rights and obligations of a party under other agreements or arrangements to which it is a party.

3. The parties shall endeavour to refrain from increasing restrictions or limitations that would affect the application of this Agreement.

ARTICLE XIII

Withdrawal from the Agreement

1. A party may withdraw from the Agreement by giving a six months’ notice in writing to the other parties.

2. Subject to the dispute settlement procedures and mechanisms to be established pursuant to Article 9, the rights and obligations of a party which has withdrawn from this Agreement shall cease to apply six months after the date of such notice.

ARTICLE XIV

Accession

1. This Agreement shall be open for accession to any new member country of BIMST-EC which notifies its intention in writing to the parties.

2. Accession shall be subject to acceptance by that country of all the rights and obligations accrued as on the date of accession, and such other terms and conditions as may be agreed by the parties.

3. The acceding country may become a party to this Agreement by submitting an instrument of accession through diplomatic channels to the parties.

ARTICLE XV

Entry into Force

1. This Agreement shall enter into force on 30th June 2004, by which time the parties undertake to complete their internal procedures required for this purpose.

2. A party shall, upon the completion of its internal procedures for entry into force of this Agreement, notify all other parties in writing through diplomatic channels.

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IN WITNESS WHEREOF, the undersigned, being duly authorized thereto by their respective Governments, have signed this Framework Agreement on BIMST-EC Free Trade Area.

Done at Phuket, Kingdom of Thailand, on 8th February 2004 in Six (6) originals in the English Language.

For the Government of People’s Republic of Bangladesh

(…………………………)

For the Government of the Kingdom of Bhutan

(…………………………)

For the Government of Republic of India

(…………………………)

For the Government of Union of Myanmar

(…………………………)

For the Government of Democratic Socialist Republic of Sri Lanka

(…………………………)

For His Majesty's Government of Nepal

(…………………………)

For the Government of the Kingdom of Thailand

(…………………………)

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ANNEX – IV

FRIENDSHIP AND COMMERCE AGREEMENT BETWEEN THE UNITED STATES OF AMERICA AND THE KINGDOM OF NEPAL

Agreement effected by exchange of notes Signed at Kathmandu

Entered into force April 25, 1947

The Chief of the United States Special Diplomatic Mission To the Prime minister and Supreme Commander-in-Chief of Nepal

United States Special Diplomatic Mission to the Kingdom of Nepal, Kathmandu, April 25, 1947

Your Highness:

I have the honour to make the following statement of my Government's understanding of the agreement reached through recent conversations held at Kathmandu by representatives of the Government of United States of America and the Government of the Kingdom of Nepal with reference to diplomatic and consular representation, juridical protection, commerce and navigation. These two Governments, desiring to strengthen the friendly relations happily existing between the two countries, further mutually advantageous commercial relations between their peoples, and to maintain in most favoured-nation principle in its unconditional and unlimited form as the basis of their commercial relations agree to the following provisions:

1. The United States of America and the Kingdom of Nepal will establish diplomatic and consular relation at a date which shall be fixed by mutual agreement between the two Governments.

2. The diplomatic representatives of each party accredited to the Government of the other party shall enjoy in the territories of such other party the rights, privileges, exemptions and immunities accorded under generally recognized principles of international law. The consular officers each party who are assigned to the Government of the other Party, and are duly provided with exequaturs, shall be permitted to reside in the territories of such other party at the places where consular officers are permitted by the applicable laws to reside; they shall enjoy the honorary privileges and the immunities accorded to officers of their rank by general international usage; and they shall not, in any event, be treated in a manner less favourable than similar officers of any third country.

3. All furniture, equipment and supplies intended for official use in a consular or diplomatic office of the sending state shall be permitted entry into the territory of the receiving state free of all customs duties and internal revenue or other taxes whether imposed upon or by reason of importation.

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4. The baggages and effects and other articles imported exclusively for the personal use of consular and diplomatic officers and employees and the members of their respective families and suites, who are national of the sending state and are not the nationals of the receiving state and are not engaged in any private occupation for gain in territory of the receiving state, shall be exempt from all customs duties and internal revenue or other taxes whether imposed upon or by reason of importation. Such exemption shall be granted with respect to property accompanying any person entitled to claim and exemption under this paragraph on first arrival or on any subsequent arrival and with respect to property consigned to any such person during the period the consular of diplomatic officer or employees for through whom the exemption is claimed, is assigned to or is employed in the receiving state by the sending state.

5. It is understood, however, (a) that the exemptions provided by paragraph 4 of this Agreement shall be accorded in respect of employees in a consular office only when the names of such employees have been duly communicated to the appropriate authorities of the receiving state; (b) that in the case of the consignments to which paragraph of this Agreement refers, either state may, as condition to the granting of exemption provided, require that a notification of any such consignment be given in such manner as it may prescribe; (c) that nothing herein shall be construed to permit the entry into the territory of either state of any article the importation of which is specifically, prohibited by law.

6. Nationals of the Kingdom of Nepal in the United States of America and nationals of the United States of America in the Kingdom of Nepal shall be received and treated in accordance with the requirements and practices of generally recognized international law. In respect of their persons, possessions and rights, such nationals shall enjoy the fullest protection of the laws, and authorities of the country, and shall not be treated in any manner less favourable than the nationals of any third country.

7. In all matters relating to customs duties and charges of any kind imposed on or in connection with importation or exportation or otherwise affecting commerce and navigation, to the method of levying such duties, to all rules and formalities in connection with importation or exportation, and to transit, warehousing and other facilities, each Party shall accord unconditional and unrestricted most favoured nation treatment to article the growth, produce or manufacture of the other Party, from whatever place arriving, or to article destined for exportation to the territories of such other Party, by whatever route. Any advantage, favour, privilege or immunity with respect to any duty charge or regulations affecting commerce or navigation now or hereafter accorded by the United States of America or by the Kingdom of Nepal to any third country shall be accorded immediately and unconditionally to the commerce and navigation of the Kingdom of Nepal and of the United States of America, respectively.

8. There shall be expected from the provisions of paragraph 7 of this Agreement advantages now or hereafter accorded: (a) by virtues of a customs union of which either party may become a member: (b) to adjacent countries in order to facilitate frontier traffic: (c) to third countries which are parties to a multi-lateral economic agreement of general applicability, including a trade areas of substantial size,

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having as its objective the liberalization and promotion of international trade or international economic intercourse and open to adoption by all the United Nations., and (d) by the United States of America or its territories or possessions to one another, to the Republic of Cuba, to the Republic of the Philippines, or to the Panama Canal Zone. Clause (d) shall continue to apply in respect of any advantages now or hereafter accorded by the United States of America or its territories or possessions to one another irrespective of any change in the political status of any such territories or possessions.

9. Nothing in this Agreement shall prevent the adoption or enforcement by either party: (a) of measures relating to fissionable materials, to the importation or exportation of god and silver, to the traffic in arms, ammunition and implements of war, or to such traffic in other goods and materials as is carried on for the propose of supplying a military establishment., (b) of measure necessary in pursuance of obligations for the maintenance of international peace and security necessary for the protection of the essential interests of such Party in time of national emergency; or (c) of status in relation to immigration.

10. Subject to the requirement that, under like circumstances and conditions, there shall be no arbitrary discrimination by either party against the nations, commerce or navigation of the other Party in favour of the nations, commerce or navigation of any third country, the provisions of this Agreement shall not extend to prohibitions or restriction; (a) imposed on moral or humanitarian grounds, (b) designed to protect human, animal, or plant life or health, (c) relating to prison-made goods., or (d) relating to the enforcement of police or revenue laws.

11. The provisions of this Agreement shall apply to all territory under the sovereignty or authority of either of the parties except the Panama Canal Zone.

12. This Agreement shall continue in force until superseded by a more comprehensive commercial agreement or until 30 days from the date of a written notice of termination given by other Party to the other Party, whichever is the earlier. Moreover either Party may terminate paragraphs 7 and 8 on thirty days written notice.

If the above provisions are acceptable to the Government of the Kingdom of Nepal this note and the reply signifying assent there to shall if agreeable to the Government, be regarded as constituting an agreement between the two Governments which shall become effective on the date of such acceptance.

Please accept. You Highness, the renewed assurance of my highest consideration.

Joseph C. Satterthwaite

His Highness The Maharaja Padma Shum Shere Jung Bahadur Rana Prime Minister and Supreme Commander-in-chief Nepal

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The Prime Minister and Supreme Commander-in-chief of Nepal to the Chief of the United States Special Diplomatic Mission.

Your Excellency,

I have the honour to acknowledge the receipt of your not dated 25th April 1947, in which there is set forth the understanding of your Government of the agreement reached through recent conversations held at Katmandu between the representatives of the Government of the United States of America and the representatives of the Government of Kingdom of Nepal, in the following terms.

The Government the United States of America and the Government of the Kingdom of Nepal, desiring to strengthen the friendly relations happily existing between the two countries, to further mutually advantageous commercial relations between their peoples, and to maintain the most-favoured-nation principle in its unconditional and unlimited form as the basis of their commercial relations agree to the following provisions.

1. The United States of America and the Kingdom of Nepal will establish diplomatic and consular relations at a date which shall be fixed by mutual agreement between the two Governments.

2. The diplomatic representatives of each party accredited to the Government of the other party shall enjoy in the territories of such other party the rights. Privileges, exemptions and immunities accorded under generally recognized principles of international law. The consular officer of each Party who are assigned to the Government of the other party, and are duly provided which exequaturs, shall be permitted to reside in the territories of such other party at the places where consular officers are permitted by the applicable laws to reside: they shall enjoy the honorary privileges and the immunities accorded to officers of their rank by general international usage, and they shall not in any event, be treated in a manner less favourable than similar officers of any third country.

3. All furniture, equipment and supplies intended for official use in a consular or diplomatic office of the sending state shall be permitted entry into the territory of the receiving state free of all customs duties and internal revenue or other taxes whether imposed upon or by reason of importation.

4. The baggage and effects and other articles imported exclusively for the personal use of consular and diplomatic officers and employees and the member of their respective families and suits, who are national of the sending state and are not nationals of the receiving state, shall be exempt from all customs duties and internal revenue or other taxes whether imposed upon or by reason of importation. Such exemption shall be granted with respect to property accompanying any persons entitled to claim an exemption under this paragraph on first arrival or on any subsequent arrival and with respect to property consigned to any such person during the period the consular or diplomatic officer or employee, for or through whom the exemption is claimed, is assigned to or is employed in the receiving state by the sending state.

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5. It is understood, however (a) that the exemptions provided by paragraph 4 of this Agreement shall be accorded in respect of employees in a consular office only when the names of such employees in a consular office only when the names of such employees have been duly communicated to the appropriate authorities of the receiving state: (b) that in the case of the consignment to which paragraph 4 of this Agreement refers, either state may, as a condition to the granting of the exemption provided, require that a notification of any such consignment be given in such manners as it may prescribe: and (c) that nothing herein shall be construed to permit the entry into the territory of either state of any article the importation of which his specifically prohibited by law.

6. Nationals of the Kingdom of Nepal in the United States of America and Nationals of the United States of America in the Kingdom of Nepal shall be received and treated in accordance with the requirements and practices of generally recognized international law. In respect of their persons, possessions and rights, such national shall enjoy the fullest protection of the laws and authorities of the country, and shall not be treated in any manner less favourable than the national of any third country.

7. In all matters relating to customs duties and charges of any kind imposed on or in connection with importation or exportation or otherwise effecting commerce and navigation, to the method of levying such duties and charges and to all rules and formalities in connection with importation or exportation, and to transit, warehousing and other facilities each party shall occur unconditional and unrestricted most-favoured-nation-treatment to articles the growth, produce or manufacture of the other party, from whatever place arriving, or to articles destined for exportation to the territories of such other party, by whatever route. Any advantages, favour, privilege or immunity with respect to any duty, charge or regulation, effecting commerce or navigation now or hereafter accorded by the United States of America or by the Kingdom of Nepal to any third country shall be accorded immediately and unconditionally to the commerce and navigation of the Kingdom of Nepal and of the United States of America, respectively.

8. There shall be excepted from the provisions of paragraph 7 of this Agreement advantages now or hereafter accorded., (a) by virtue of customs union of which either party may become a member., (b) to adjacent countries in other new facilitate frontier traffic., (c) to third countries which are parties to a multi-lateral economic agreement of general applicability, including a trade area of substantial size, having as its objective the liberalization and promotion of international trade or other international economic intercourse and open to adoption by all the United Nations and (d) by the United States of America or its territories or possessions to one another to the Republic of Cuba, to the Republic of the Philippines or to the Panama Canal Zone. Clause (e) shall continue to apply in respect of any advantages now or hereafter accorded by the United States of America or its territories or possessions to one another irrespective of any change in the political status of any such territories or possession.

9. Nothing in this Agreement shall prevent the adoption or enforcement by either party; (a) of measure relating to fissionable materials, to the importation or exportation or gold and silver to the traffic in arms, ammunition and implements

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of war, or to such traffics in other goods and materials as is carried on for the purpose of supplying a military establishment; (b) of measure necessary in pursuance of obligations for the maintenance of international peace and security or necessary for the protection of the essential interests of such party in time of national emergency; or (c) of status in relation to immigration.

10. Subject to the requirement that under like circumstances and conditions there shall be no arbitrate discrimination by either party against the nationals, commerce or navigation of the other party in favour of the nationals, commerce or navigation of any third country, the provision of this agreement shall not extent to prohibitions or restrictions (a) imposed on moral or humanitarian grounds., (b) designed to protect human, animal or plant life or health., (c) relating to prison made goods., or (d) relating to the enforcement of police or revenue laws.

11. The provisions of this Agreement shall apply to all territory under the sovereignty or authority of either of the parties, except the Panama Canal Zone.

12. This Agreement shall continue in force until superseded by a more comprehensive commercial agreement, or until thirty days from the date of a written notice of termination given by either party to the other party, whichever is the earlier. Moreover either party may terminate paragraph 7 and 8 on 40 days written notice. The Government of the Kingdom of Nepal approves the above provisions and is prepared to give effected there to beginning with the date of this reply note. Please accept your Excellency the renewed assurance of highest consideration