Higher Trade Deficit: Risk for Macro Stability

By Hom Nath Gaire  

Foreign trade is considered as an essential factor for accelerating the path of economic development. Most countries are involved into foreign trade to create employment, raise propensity to save, increase foreign exchange earnings, and raise the productivity of investment moving from less productive use to high productive use.

For developing countries, foreign trade is the primary vehicle for realizing the benefits of globalization. Import brings additional competition and variety of domestic markets benefiting the consumers. Benefiting business, foreign trade gives firms access to improved capital inputs such as machine, tools, boosting productivity as well. Similarly, foreign trade encourages the redistribution of labor and capital to relatively more productive sectors.

Nepal's foreign trade performance has so far been poor as indicated by trade balance and its ratios to national incomes. Several factors seem to be responsible, and of these, its landlocked geographical position is one of the major causes for Nepal's weak production base, which is eventually linked with the growth of exports and imports of technology and raw material. Not only the open border with India but also the limited transit facilities in one or other way have constrained its trade with overseas countries.

Balance of Trade

Although the trade deficit of Nepal on the rise since some years back, the growth of it has tapering down by 4 percent during last one year. Nepal Rastra Bank (NRB), the central bank of Nepal, on its latest report "Current Macroeconomic Situation of Nepal" reveals that the trade deficit during the six months of Fiscal Year 2013/14 increased by 24.4 percent compared to an increase of 28.4 percent during the same period of the previous year.

The tapering in the growth of trade deficit is attributed to lower growths of deficit with India as well as other countries and higher growth in exports of Nepal against same period of previous year. Nepali exports surged by 15.0 percent during the six months of 2013/14 against a growth of 9.3 percent during the same period of the previous year. In the mean time, the growth of trade deficit with India fell to 26.8 percent from 30.8 percent in the same period of the previous year. The growth of trade deficit with other countries also fell to 19.9 from 24.1 percent during the review period.

Fall in growth of total trade deficit is also contributed by higher growth of exports to India for the review period. Exports to India increased by 18.4 percent during the six months of 2013/14 compared to an increase of 3.8 percent in the corresponding period of the previous year. This is possible due to devaluation of Indian Rupees (INR) against major international currencies. With depreciated INR as the India importers had to pay relatively higher bill for their imports from overseas markets they attracted to Nepali product. Thus a higher growth of exports to India is more responsible to reduce the growth of overall trade deficit. As India is the largest trade partner of Nepal which occupies two third of Nepal's foreign trade, it is obvious to influence the overall trade scenario.

However, exports to other countries went up by mere 9.2 percent against a growth of 20.3 percent in the previous year. Devaluation of Nepalese Rupees (NPR) against major international currencies hampered the growth of Nepali exports to the countries other than India. Since most of the export oriented industries are based on the imported inputs, their cost of production went up with devaluation of Nepalese currency that in turn reduced their competitiveness in the global markets.   

Foreign Trade Scenario of Nepal (Rs Ten Million)
Year	2007/08	2008/09	2009/10	2010/11	2011/12	2012/13
Export	5926.65	6769.75	6082.4	6433.85	7426.1	7691.7
Import	22193.77	28446.96	37433.52	39617.55	46166.77	55674.00
Trade Balance	-16267.1	-21677.2	-31351.1	-33183.7	-38740.7	-47982.3

   

Similarly, relatively lower growths of imports have also contributed for lower growth in trade deficit during the review period. Total imports surged by 23.1 percent during six months of current fiscal year compared to a growth of 25.2 percent for the corresponding period of the previous year. Imports from India went up by 25.6 percent, a marginal decline from the previous year's growth of 26.2 percent. Similarly, growth of imports from other countries fell by a relatively higher pace. The imports from other countries rose by 18.3 percent during the review period compared to an increase of 23.6 percent in the previous year.

Irrespective of growth the excessive imports in comparison to exports have distorted the export to import ratio. The ratio of export to import for the six months of 2013/14 declined to 13.5 percent from 14.5 percent a year ago. This indicates that Nepal is importing 13.5 units for every unit of export during the review period.

Depreciation of NPR could not Matter Much

Despite the depreciation of NPR against major international currencies, Nepali exporters have not been able to increase exports to take advantage. Theoretically it is believed that the depreciation of national currency could promote domestic products in the foreign markets and discourage imports from abroad. The logic behind this is that with the cheaper Nepali currency exporters can earn more than what they earned before from selling their products in a foreign market. 

During review period NPR has depreciated by about 25 percent against the major international currencies. But in the same period, total exports went up by 15 percent, while the import bill went up by 23 percent. It justifies the notion that depreciation of national currency does not maters in reducing trade deficit in import based economies. Even if it matters, it would be more instrumental to stimulate imports bill rather than export receipts.

Macroeconomic Concerns  

Although the growth is tapering the volume of trade deficit is mounting every year. Total amount of trade deficit has exceeded even the amount Nepal’s annual budget since last fiscal year. This simply means that even the national budget of Nepal is not enough to pay for trade deficit per year. Nepal imported worth more than Rs 556.74 billion in the fiscal year 2012/13, which resulted into a trade deficit of Rs. 480 billion for the year. The amount of trade deficit was Rs 480 billion, which was Rs. 142 billion more than the total allocated expenditure of the government, as stated in the annual budget for fiscal year 2012/13.

During the six months of current fiscal year 2013/14, the trade deficit of Nepal stood at Rs 288.76 billion, which indicates it is obvious that it will exceed the national budget this year too. According to annual budget of 2013/14, the Government is planning to spend Rs. 517 billion for the year. As the trade deficit of six months stood at 56 percent of estimated annual budget, it can be projected that deficit for the whole year will reach Rs. 577.52 billion.

Despite the widened trade deficit, overall Balance of Payments (BOP) recorded a surplus of Rs 77.19 billion during the six months of 2013/14 compared to a surplus of Rs. 7.77 billion for the same period of the previous year. The surplus in BOP is attributed to an upsurge in service credit as well as high growth of grants and workers' remittances in the review period. The net service income posted a surplus of Rs. 9.49 billion in the review period in contrast to a deficit of Rs. 1.91 billion in the same period of the previous year. Similarly, net transfers registered a growth of 37.9 percent to Rs. 308.47 billion compared to a growth of 18.2 percent in the previous year. Under the transfers, workers’ remittances surged by 34.4 percent to Rs. 265.62 billion compared to an increase of 21.8 percent in the same period of the previous year.

Due to higher growth of remittance the gross foreign exchange reserves of the country increased by 17.1 percent to Rs. 624.60 billion in mid-January 2014 against Rs. 450.80 billion in the same period of the previous year. On the basis of trend of import during the six months of the current fiscal year, the current level of foreign exchange reserves is sufficient for financing merchandise imports of 11.4 months and merchandise and service imports of 10.2 months.

In such a situation, the remittance fueled BOP surplus is considered only the source of import financing. But the remittance could not be a reliable and sustainable source of import financing forever. Since the growth of remittance is highly exposed to external shocks which are out of the control of the government of Nepal, the BOP surplus is also highly vulnerable and unstable. Therefore, if not checked or managed properly, the current trend of trade deficit in Nepal would pose a serious challenge for macroeconomic stability of the country.

In box  

NRB Data Contradicts with TEPC

A report release by Trade and Export Promotion Centre (TEPC) reveals that the growth of trade deficit fell by more than half during the last one year. According to TEPC, trade deficit of Nepal increased by 13.3 percent during the six month of current fiscal year compared to an increase of 29.6 percent during the same period of the previous year.     

During the review period, total exports of Nepal have increased by 17 percent while total imports have increased by 13.8 percent. As a result, total trade deficit widened by a lower rate for the review period.