The Brief: Paras Kharel on Nepal’s 2026 Graduation from the LDC status: Its Implications and Challenges for the Future

[00:00:04] - [Aslesh Shrestha]
Namaste and welcome to Pods by PEI, a policy discussion series brought to you by Policy Entrepreneurs Inc. My name is Aslesh Shrestha. In today's episode, we have with us Paras Kharel, Executive Director of South Asian Watch on Trade, Economics and Environment, SAWTEE, a Kathmandu based think tank. Paras and I discussed SAWTEE's report on Nepal's LDC graduation, implications for international trade and development and also Paras's paper on Nepal's elusive quest for export success meets LDC graduation. Paras has over fifteen years of research experience in trade and development.

[00:00:41] - [Aslesh Shrestha]
He has a PhD in economics from the University of Melbourne with specializations in international trade and applied microeconomics. His publications include two edited volumes on South Asian cooperation and integration and articles in peer reviewed journals such as review of international economics international economics and the East Asian economic review. In the episode we talk about the rationale behind categorizing countries as an LDC and discuss Nepal's graduation from the LDC status and its implication on trade, development assistance and policy space. We then examine the lackings of the export sector and the policy changes required to boost the sector. We conclude with some key takeaways from the post graduation experiences and strategies of a few countries which have graduated and competently sustained the graduation.

[00:01:34] - [Aslesh Shrestha]
We hope you enjoy the conversation.

Welcome to the show, Paras.

[00:01:38] - [Paras Kharel]
Thank you, Aslesh.

[00:01:42] - [Aslesh Shrestha]
So firstly, I'd like to before discussing the report on Nepal's LDC graduation, I'd like to first bring our listeners to frame about what an LDC country means. How does UN decide a country is to be given LDC status and how does it decide when it is ready to graduate? And also, how is this categorization different from the World Bank's income based classification?

[00:02:09] - [Paras Kharel]
So the United Nations in around 1971 created the least developed country LDC category. So these countries are basically countries that are, you know, poor, have relatively low income, and are structurally handicapped. So the criteria have evolved over the years, but the basic criteria are almost the same. So one criterion is low per capita income low per capita gross national income. The other criterion is human asset index.

[00:02:51] - [Paras Kharel]
Think of it as relatively low education status, health conditions, and so on. And the third criterion is environmental and economic vulnerability. It captures things like the share of agriculture in GDP, export instability, the instability of agricultural production, whether you are landlocked or you are remotely located, and the percentage of population living in low lying coastal areas or victims of natural natural disasters and so on. So if a country's performance in these three criteria are below or above a threshold, then a country becomes an LDC. But one can say that I don't want to become an LDC.

[00:03:37] - [Paras Kharel]
Right? That option is there. But in terms of graduation, if any two of these three criteria are satisfied or the threshold is crossed or your income is significantly higher than the threshold, say, twice more than the threshold, then you graduate. So in other words, if you tick, say, the income box or any two boxes, then you have to graduate. And but you should meet these criteria for six years in a row.

[00:04:14] - [Paras Kharel]
And how is it different from the World Bank's income based classification? So income is one of the three criteria, but there is more to it. For example, your education and health conditions and economic and environmental vulnerability. And the World World Bank as such does not recognize the LDC status. So in terms of its lending, which I'll come to later, LDC status does not feature.

[00:04:44] - [Aslesh Shrestha]
Okay. Any specific purpose the categorization fulfills?

[00:04:49] - [Paras Kharel]
So the categorization was done as a mark for countries to denote that they have a lot of developmental problems. They have they are structurally handicapped and to galvanize, you know, world opinion and resources in support of these countries. So recently, we have the Dua program of action for LDCs, and preceding it was the Istanbul program of action. And these program of actions usually have a target of seeing that certain number of countries graduate. So the idea is to bring the attention of the world to, you know, relatively poor countries and help them.

[00:05:32] - [Aslesh Shrestha]
And as I'll discuss later, countries have provided special support measures for these countries also. So in terms of the support measures, in the broader scheme of things, once a country graduates, what are the impacts in the economy in general?

[00:05:52] - [Paras Kharel]
So in general, by virtue of being an LDC, a country is granted certain preferences globally. One set of preferences is trade preferences. So as an LDC, exports from an LDC get duty free and quota free access to certain markets. For example, the European Union market, to some extent in the American market, or the Australian or Japanese market. China also has provided certain preferences for LDCs.

[00:06:22] - [Paras Kharel]
India also has provided certain preferences. So those preferences might be lost. Right? So we'll instead of paying zero duty at the customs and destination countries, you'll have to pay certain amount of taxes. That's one distinct impact possible impact.

[00:06:40] - [Paras Kharel]
And the other possible impact could be on foreign aid or development cooperation. There are certain windows of finance that are, you know, given especially for LDCs, and that window might be closed. And the third impact could be that LDCs, which currently enjoy certain policy space in the global arena. For example, under under the World Trade Organization, you have to respect certain rules, but leniency or exemption from certain rules are provided to LDCs. Or if LDCs, let's say, violate certain rules unwittingly, you know, countries might be turning a blind eye to that because they are, you know, relatively poor or structurally handicapped countries.

[00:07:27] - [Paras Kharel]
But once you graduate, your how whether you respect global trade rules or not might come under increased scrutiny.

[00:07:35] - [Aslesh Shrestha]
So okay. Now bringing the conversation to Nepal. So we know that Nepal is set to graduate in 2026. So could you shed some light on how we've managed to qualify for the graduation? What were the requirements we fulfilled?

[00:07:49] - [Paras Kharel]
So as I said earlier, if we tick two of the three criteria boxes, then for six successive years, then you qualify for graduation. So the United Nations holds what it calls triennial reviews. We use every three years. So if two boxes are ticked in two triennial reviews, that is six years, then you qualify. So Nepal in a way qualified for graduation in the 2018 triennial review.

[00:08:21] - [Paras Kharel]
But at that time, citing the earthquake of twenty fifteen, which had which had devastating impact on the Nepali economy, Nepal was able to postpone graduation. But then 2021 came. So even back in 2018, for two successive triennial reviews, we had ticked two boxes, and in 2021, also, we ticked those two boxes. And what are those two boxes? Human asset index and economic and environmental, vulnerability index.

[00:08:53] - [Paras Kharel]
On these two criteria, we have crossed the threshold, but we have not crossed the income threshold. But then that's life. The rule suggest that if you tick two boxes, you graduate. However, because we have been also hit by COVID, the usual transition period is, say, three years. So we were recommended for graduation in 2021, so we would have graduated in the normal scheme of things in 2024, but we got an additional two years until 2026, you know, to graduate.

[00:09:27] - [Paras Kharel]
But then COVID has affected Bangladesh and Lao PDR too, so they have also been given the extension. And Nepal is the only LDC on track towards graduation without meeting the income criterion. So that shows that we are still structurally weak and that, for technical reasons, we are graduating.

[00:09:51] - [Aslesh Shrestha]
Yes. So following up on that, do you not think that Nepal not meeting the income criteria will pose certain problems in the future if you were to sustain the graduation?

[00:10:03] - [Paras Kharel]
Yes. Sustainability of graduation and irreversibility that we all desire, including policymakers and we in the think tank community. There's a question mark over that because of this low per capita GNI. Because per capita GNI reflects the productive capacity of the economy. Basically, it's the output that we generate within the territorial limits of the country.

[00:10:28] - [Paras Kharel]
And we have made good progress in terms of health and education, yes, which is reflected in the human assets index. But research also shows that, the relatively you know, the improvement in educational performance and health performance is partly attributable to the remittances that we receive. This is not to discount the importance of remittances, but remittances are generated by output created in some other countries. So this reflects our weak productive capacity. And going forward, because we are so dependent on remittances, the economy is highly vulnerable to external shocks.

[00:11:05] - [Paras Kharel]
And even during COVID, fortunately, remittances, I would say, saved the day just as remittances have been saving the day for nearly two decades now with the huge, you know, out migration and the resulting inflow in remittances. But with a surge in imports in over the last one year or two and remittances not being able to, grow proportionately, it, in a way, sent shivers down the nation's collective spine that we are worried about our balance of payments, And balance of payments are so dependent on remittances, and that also reflects, you know, the structural weaknesses of our weak economy.

[00:11:44] - [Aslesh Shrestha]
So I'll come to the structural weaknesses in a bit. But in the beginning, we've discussed certain impacts of LDC graduation on sir on an economy. So in your report, Nepal's graduation from the LDC LDC category, implications for international trade and development, you provide certain insights on the magnitude of these impacts. So could you share the findings with us? What does the future look like for Nepal after 2026?

[00:12:14] - [Paras Kharel]
Okay. So in that study, we looked at the impact in three areas, international trade, development cooperation, and policy space. So in international trade, since two thirds of our exports are bound for the Indian market, and our trade with India is governed by a bilateral trade agreement, which is not dependent upon LDC status as such, our exports to India won't be impacted. So by extension, our overall exports won't be hurt much. So going by some estimates done through some modeling exercises, the projected impact on our goods exports, that is merchandise exports, is about two to 4%.

[00:12:57] - [Paras Kharel]
That is relatively low compared to the projected impact on, say, Bangladesh or LDC on an average. In their case, it would be 10% or above. So it's that's seemingly relatively low. And that one reason is that two thirds of our exports are destined for the Indian market. And another reason is that whatever preferences are available to us, say, the European Union market or even at The US market, Japanese market, Australian market, or even the Chinese market, we have not been able to utilize them fully and effectively.

[00:13:29] - [Paras Kharel]
So what is unfortunate in the normal circumstances is seemingly fortunate now because the projected impact will be relatively low. But it is relatively low because we have not been able to utilize the preferences, which is actually not a good thing at all, though seemingly fortunate in the current, you know, circumstances. So that's one aspect on foreign trade. And even on trade, the bulk of the impact will be felt in the European Union market where we currently enjoy duty free market access for all products except weapons under the so called everything but arms initiative. So about 90% of that trade impact will be felt in the EU market.

[00:14:13] - [Paras Kharel]
And even in the EU market, the bulk of the impact will be felt in the textiles and clothing sector. But, again, this impact in the EU market can be largely blunted or mitigated if we apply for and get qualified for the GSP plus facility under which many of the preferences that we currently enjoy will be extended. So far so good. But the again, the catch is even if you qualify for the GSP plus, the catch is rules of origin will become more stringent. Rules of origin mean that if you want to get duty free access to a certain market, say the EU, you'll have to demonstrate that the product is has originated in Nepal because the EU wouldn't want other countries' exports to take advantage of that.

[00:15:03] - [Paras Kharel]
That's fine. But the rules of origin will tighten under GSP plus, and to put it in simple words, currently, we can import textiles from other countries and stitch it into apparel, garments, and export it to the EU. But under the GSP plus there is a double transformation requirement whereby we'll have to make textiles on our own. That is, we can import yarn, but we have to turn it into textiles and then turn it into apparel. And if you interact with Nepal's garment exporters, they say that currently, under the current policy regime or under the current industrial structure, they are not will not be able to achieve that.

[00:15:46] - [Paras Kharel]
So, yes, under GSP plus, you will be able to retain duty free preferences for apparel, but double transformation requirement is very difficult to meet. So that's one aspect on trade. And rules of origin will also become more stringent in other countries too. Now that's one aspect. So now let's look at developing cooperation.

[00:16:15] - [Paras Kharel]
Now on developing cooperation, our major sources of, you know, developing finance are the World Bank and the ADB. They account for about, you know, 75, 80% of our, you know, funding from multilateral institutions, and funding from World Bank and ADB are not dependent upon LDC status. K? They are dependent upon income status mostly. But we are encountering what I call double graduation.

[00:16:46] - [Paras Kharel]
So we are graduating from LDC status, but in 2020, we also graduated from low income country status to lower middle income country status. And as our income increases, the level of concessionality in the loans that we get from the World Bank and ADB will also go down over the years. That's not directly linked to LDC status, but both are likely to happen simultaneously parallelly, so policymakers should be cognizant of that. But even if the level of concessionarity in the loans that we get from ADB and World Bank declines, overall, it will the loans will still be highly concessional compared to what we would have to, say, pay if you were to borrow from international financial markets. Then the not insignificant portion of our aid comes from bilateral sources also, and the literature shows that, and we also confirmed it in our study, that bilateral sources of aid are not directly dependent on LDC status.

[00:17:50] - [Paras Kharel]
Historical ties, bilateral relationships, and even geopolitics would drive bilateral aid. So LDC graduation per se won't have an impact on it. But there are certain windows of finance. For example, the United Nations climate fund for LDCs which will close that window will close once we graduate. Although if we have received projects from that fund before graduation, those projects can continue for a while.

[00:18:20] - [Paras Kharel]
A similar argument holds with regard to the enhanced integrated framework under the World Trade Organization that provides aid for trade for LDCs. So in short, the impact on aid won't be very big based on available evidence. That's the second point. And the third implication would be in the area of policy space. Now as an LDC, Nepal can provide, for example, subsidies in the industrial sector.

[00:18:52] - [Paras Kharel]
Now even if Nepal graduates from LDC because its income is below a certain threshold, which is a different threshold as per WTO rules, it may be able to continue providing industrial, you know, subsidies for exports. But once its income crosses a certain threshold, then it won't be able to provide. But, I mean, I don't want to go into, you know, the technical aspects of these, but suffice it to say that there are certain subsidies that Nepal is providing or plans to provide, say, under the special economic zones, for example, aimed at promoting exports, that could run counter to the World Trade Organization rules. And once Nepal graduates from LDC status, Nepal's trade policy will come trade policy and industrial policy will come under greater scrutiny. So one must be prepared for that and, hence, structure our subsidy and tax regime in a smart way.

[00:19:51] - [Paras Kharel]
See how other countries are going about the rules. Right? That's one aspect. And then because we are an LDC, we are not under any compulsion to make further commitments in terms of tariff liberalization at the World Trade Organization. Right?

[00:20:07] - [Paras Kharel]
Even under SAFTA, the South Asian Free Trade Area in South Asia, as an LDC, we have received certain exemptions in terms of tariff liberalization. We are planning to, you know, join in future. Negotiations are underway. Join a free trade area under BIMSTIC, BA of Bengal initiative for multi tech multisector and technical economic cooperation. Now once we graduate from LDC status, we may or I I will say we are likely to come under increased pressure to liberalize further.

[00:20:42] - [Paras Kharel]
Now whether we should liberalize or not is another issue, but if you look at our revenue structure, we'll find that about half of the government's revenue comes from taxes collected at the border. That is taxes on imports, customs duties, VAT, and excise on imports. And if you look at government reports, say the report on revenue prepared by the revenue advisory committee and board, you will see that policymakers are concerned about loss of revenue due to the reduction in tariffs we have undertaken so far. But if we are asked to liberalize even more in terms of tariffs, revenue could take a hit. Now, yes, ideally, we should not be as dependent on import based revenue.

[00:21:22] - [Paras Kharel]
We should go for maybe import income tax revenue VAT on domestic production on and so on. For that, domestic production itself must increase. And if domestic production increase, then the other point that I made about our income being less than the threshold even if we are graduating, that will be partly solved also. Right? That will also be solved.

[00:21:42] - [Paras Kharel]
Our vulnerability will also go down, and our revenue will not be as dependent on imports or not, but we can't do overnight. So that aspect in terms of policy space is also there, that policymakers would have to consider.

[00:21:55] - [Aslesh Shrestha]
So, now we can say that largely the issue in hand is loss of the trade preferences for that we are going to that we are getting at the current scenario. So Yes. Discussing the export scenario right now in Nepal, even after receiving these kind of trade preferences, certain duty free market access, tariff concessions, Nepal's exports still is disproportionately lower than its imports. So why do you think at the current moment the balance of trade deficit is so high even after receiving these kind of preferences for over, around two decades, I think.

[00:22:41] - [Paras Kharel]
So the main reason is our weak productive capacity and supply side constraints, and that also interacts with high trade costs. And because of that, we have not been able to utilize, you know, trade preferences on offer. Even if you go by estimates from modeling exercises, we will see that there's a huge gap between what we currently export and our export potential in terms of goods for the world as a whole or with individual countries, be it India or China that are next door or relatively far off countries.

[00:23:15] - [Aslesh Shrestha]
So could could you elaborate a little bit on the supply side constraints?

[00:23:16] - [Paras Kharel]
So consider the EU market where we get duty free preferences, but the exports are not huge. Right? At the end of the day, our total exports, I would say, is basically $1 billion. So it looks like 1 and a half or 2 billion dollars, thanks or no thanks to palm oil and soybean oil, in which you don't have comparative advantage.

[00:23:37] - [Paras Kharel]
They have been artificially inflating them. So overall, our exports to the EU would be very low because our total exports are itself less than, you know, $1 billion in real terms. So we we get duty free access to the EU market, but we may not be we are not able to meet certain non tariff measures in that market. Those measures are related to, let's say, standards and technical regulations related to animal or plant or human life and health. Certain measures are sacrosanct or nonnegotiable for destination countries, and we have to prove that our products meet those standards.

[00:24:19] - [Paras Kharel]
We are not when you are not able to do so, for example, due to lack of laboratories or lack of adequate human resources in those lab or if our standards and technical regulations are not up to the mark compared to destination markets, then you'll not be able to meet those measures or you'll be able to meet those measures only at a high cost. For example, there are, you know, deep producers that are organically certified and export to the EU market, but relatively small producers, may not have, let's say, deep enough pockets or access to finance or know how or even the idea to meet those organic certification related requirements. So that way, for example, you know, inability to meet those non tariff measures can be interpreted as our own supply side or productivity constraints also. Of course, in certain cases, non tariff measures may be applied relatively arbitrarily, and there may be procedural obstacles. Those things are also there.

[00:25:22] - [Paras Kharel]
But non tariff measures can also be, as I said, partly interpreted as our own productive capacity limitations. That's, you know, one reason. And lack of knowledge about the, you know, preferences available could also be one reason. Because when we talk to the private sector in another context, we are surprised to find that some in the private sector were not aware that certain preferences are available even within the SAFTA or Southeastern Free Trade Area framework. Although, normally, one might tend to think that the private sector would surely be aware of certain things.

[00:25:57] - [Paras Kharel]
And then issues like marketing, branding, and having access to networks in destination markets to be able to export are also there.

[00:26:08] - [Aslesh Shrestha]
So given the impact that the LDC's graduation is going to have on policy space, do you think Nepal is also going to be impacted by the intellectual property scheme strips? Yes. It could be potentially impacted.

[00:26:26] - [Paras Kharel]
So under the World Trade Organization, Nepal has made certain commitments with regard to protection of intellectual property rights under the agreement on trade related aspects of intellectual property rights under the World Trade Organization. So I'll just focus on one aspect of those rules, which concern patent protection for pharmaceuticals. As an LDC, Nepal is exempted from providing patent protection for pharmaceutical products, which what this means is that if there is a pharmaceutical product patented by someone in some country without seeking its consent, without going through any process, Nepal or Nepali producers can, if they have the ability, to do reverse engineering and produce generic versions of those products. Right? But once it graduates from LDC status, it won't be able to do that.

[00:27:35] - [Paras Kharel]
It will have to provide patent protection. Now Nepal Nepal's pharmaceutical industry has not been able to utilize that provision effectively so far. Although when we interact with the pharmaceutical industry, we got some evidence that some in the sector are, you know, producing generic versions of patented medicines. Now the hope is always that, you know, some years down the line, our capacity will improve further, and we'll be able to utilize this provision more effectively. But grad LDC graduation will close that window.

[00:28:33] - [Paras Kharel]
And this exemption from for LDCs from patent protection has been there for many years, and it has been extended. So it has currently been extended to around twenty twenty thirty three or '34, and it might even be further extended. But once we graduate from LDC status in 2026, we won't be getting this exemption. Although, along with other LDCs and graduating LDCs, Nepal has put forth a demand at the WTO that even after graduation, Nepal be allowed to enjoy this facility, say, until 2033 or '34 when this exemption will last. But a decision on that is yet to be taken.

[00:29:23] - [Aslesh Shrestha]
So apart from the pharmaceutical companies, any other industry that will be significantly impacted? In terms of intellectual property rights?

[00:29:35] - [Paras Kharel]
So, no, this is the only area where potentially there could be an impact. But, again, as with the case of trade impact, the impact is relatively low because we have not been able to utilize existing existing preferences. A similar story, let's say, story, holds true in the case of the pharmaceutical industry also.

[00:29:56] - [Aslesh Shrestha]
You just pointed out the certain disadvantages for smaller enterprises due to the loss of the LDC preferences, but I would like to bring in a 2021 paper of yours titled Nepal's elusive quest for export success meets LDC graduation. Quoting the paper, the seemingly low projected impact on aggregate merchandise exports masks the likelihood of small and medium enterprises bearing the brunt of the loss of preferences. Can you elaborate on that why the impact is more on the SMEs? Is this just because of the scale of production or they're vulnerable due to some other reasons as well?

[00:30:42] - [Speaker 1]
So the headline number based on estimates is, say, two to 4% of our exports. Two to 4% could be the projected decline. Now we don't know how that loss will be distributed across different sizes of firms. That's why I have used the word likelihood. So the main market that will be hurt for us is the EU market, and the sector will be apparel and textiles, basically apparel.

[00:31:13] - [Paras Kharel]
And there is, you know, anecdotal evidence as well as descriptive statistics from the literature that lead me to believe that SMEs are dependent. There are SMEs that are dependent on exporting, say, textiles and clothing to the EU market. Now the same amount of loss will be more painful to an SME compared to a large enterprise for, you know, obvious reasons. So even if we suppose that the loss will just be rate 4%, which is low relatively low compared to other countries, what if the bulk of that 4% is concentrated on SMEs? As they say, the, you know, the wearer knows where the, you know, shoe pinches.

[00:31:59] - [Paras Kharel]
So in that case, it is worthwhile to further, you know, probe this issue, talk to SMEs. Right? Because in in the study itself, we are not able to look at it in detail because this scope had to cover other things also. And based on a certain dataset, I made this argument as follows. So if you compare the size of the average shipment to the EU with the size of the average shipment to, say, other countries, then the size is relatively small.

[00:32:27] - [Paras Kharel]
And presumably, you know, these shipments are exported by SMEs.

[00:32:31] - [Aslesh Shrestha]
So we can see that the stakes are definitely high for the export oriented SMEs. And given the population they employ, it can have negative impact in our economy. So in that case, what can the government do to support SMEs to be competitive internationally?

[00:32:48] - [Paras Kharel]
So as a short term measure, the government, along with other graduating LEC's, should work on seeking an extension to the trade preferences, right, at the global level. For example, the European Union has already decided and announced to extend trade preferences to LDCs for an an additional three years after graduation, so until 2029. Not many other countries have made that announcement formally. One can seek that they also make similar announcement. And the LDCs as a group are also demanding in international forums, including the World Trade Organization, that an extension to trade preferences be given for at least nine years.

[00:33:34] - [Paras Kharel]
Initially, the position was, you know, twelve years. You know, there's also bargaining there. So that will help the government, you know, bring about introduced programs to help SMEs because because such support programs cannot be introduced and implemented overnight. Right? That's a I would call it a short term measure.

[00:33:57] - [Paras Kharel]
Then, you know, issues or constraints facing SMEs have to be addressed, and one is related to finance, access to finance. But in the access to finance literature, it's basically focused on access to finance for SMEs in general. But exporters require special type of finance. They have special financing needs, and SME exporters have their own constraints in terms of accessing finance. That should be addressed.

[00:34:28] - [Paras Kharel]
And related matter is the government has introduced and implemented cash in incentive program for exporters. Now whether the cash incentive program is right or not is another matter. But if you are to stick to such program, then it, you know, would make sense to allocate a certain amount of money to SMEs in themselves. Otherwise, a few large exporters might hog, you know, most of those funds for cash incentive. And we know, you know, from the literature that SMEs are especially financially constrained.

[00:35:11] - [Paras Kharel]
And, you know, for the capacity building programs for SMEs to address their weaknesses in terms of technical know how, you know, can be a way out. And the government can also do something in terms of logistics. SMEs have a small amount of output to export. They can export a huge amount of output at one go. Right?

[00:35:37] - [Paras Kharel]
So in the literature, we call it, you know, less than full container load. Right? So their small outputs have to be consolidated somehow, and that, you know, takes cost. Putting in place a mechanism that reduces the cost of such consolidation would help SMEs.

[00:35:58] - [Saurav Lama]
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[00:36:54] - [Aslesh Shrestha]
Okay. I'll bring the discussion to something you've said earlier, which talked about the lack of productive capacity in our economy. So given that the World Bank report in 2021, the Nepal development update showed that Nepal's export potential was at $9.2 billion approximately. And you just mentioned that our approximate figure could be around 1 billion. So it's around a gap of 8.2 billion.

[00:37:26] - [Aslesh Shrestha]
So given that gap, what kind of structural changes does Nepal need to bring in so that we can harness our export potential?

[00:37:36] - [Paras Kharel]
Yes. The gap is huge. And to, you know, tap this potential, I mean, there are a number of things that we should do. And what I'm about to, you know, suggest would be part or should be part of the overall graduation strategy too. So now it may look hackneyed, but this is a fact that because of our low productive capacity, we have not been able to utilize those trade preferences that are available.

[00:38:10] - [Paras Kharel]
And one reason we have such high untapped export potential is partly because of the fact that we have trade preferences, right, but we haven't been able to use them. Now if you look at our policy, say trade policy or Nepal trade integration strategy, which was basically introduced to operationalize the trade policy, there have been at least three such Nepal trade integration strategies dating from twenty o three twenty o four then in 2010 another was introduced then in 2016 and now the government is about to introduce another such strategy. Those strategies are full of actions with regard to building the productive capacity, and building productive capacity includes the ability to meet non tariff measures that is standards and technical regulations in destination countries that cannot be changed. Now dedicating adequate resources to such actions, and there are certain good actions in those action matrix also, dedicating adequate resources for the implementation will be key because many of these actions are underfunded or not at all funded and coordination between relevant government agencies is also a problem and this has been admitted by the Nepal Trade Integration Strategy 2016 also when it reviewed its predecessor Nepal Trade Integration Strategy 2080 2010.

[00:39:43] - [Paras Kharel]
It said that the 2010 version was not effectively implemented because of lack of coordination among government agencies. And let's look at it this way. I think this is very important. So trade policy is not demanded just of the Ministry of Industry, Commerce, and Supplies, although the formal document trade policy is introduced by that ministry. Because at the end of the day, trade policy is about, yes, negotiating in destination countries, what to say trade preferences, that will be done mainly by ministry of industry commerce and supplies.

[00:40:19] - [Paras Kharel]
But in order to be able to utilize those preferences, we need educate marketable surplus. Right? For it could be tea or coffee or ginger or cardamom, and the Ministry of Agriculture will be responsible or should be responsible for adequate production and to ensure that the output meets certain standards that have to be met. On the other hand, we have to import certain raw materials for our exports. So even for carpets, we import wool and, silk from abroad and add value here.

[00:40:57] - [Paras Kharel]
Now exporters get duty drawback facility whereby taxes paid on imports of raw materials or intermediate goods that they use in their production, which they ultimately export, are refunded. But the private sector has often complained that, and this is also borne out by research, that this duty drawback mechanism is not efficient. Now the ministry responsible for duty drawback issue and, you know, tax issue is to a large extent the ministry of finance. So that's why coordination between different ministries is of utmost importance because we have a lot of policies and strategies, and lack of inter ministerial coordination is hurting it. And, let me give you an example from Ethiopia.

[00:41:47] - [Paras Kharel]
So Ethiopia witnessed, an exceptional, you know, performance in exports over a period of one decade or so. And one of the reasons behind that was that it had a committee, something called the Export Promotion Committee, that was headed by a prime minister, and it was able to hold its meetings, say monthly meetings on time. Rarely was such meeting skipped, and there was adequate follow-up on the decisions of the meeting. And if certain decisions were not implemented, questions were asked. And there in in short, there was adequate follow-up.

[00:42:29] - [Paras Kharel]
Right? The prime minister himself took the lead, and there was coordination between multiple agencies. For example, during that period particular period, it saw a surge in exports of cut flowers from almost nowhere. And to export cut flowers, you need adequate production, but apart from that, you cannot just, you know, ship it via sea, sea route because that would take a lot of time. You need, to air freight it.

[00:43:00] - [Paras Kharel]
And there that's where, the role of the Ethiopian Airlines, state owned airlines became important. The point that I'm trying to make is that although there will be, you know, there should be there would be other problems in Ethiopia even in the export sector, some of their successes can be attributed to the strong, you know, leadership demonstrated, which I just gave an example of, and coordination between different agencies. I think that's very important.

[00:43:31] - [Aslesh Shrestha]
So if you're looking at Nepal's landlockedness, do you think Nepal also should exploit the air freight scheme regarding exports?

[00:43:40] - [Paras Kharel]
I mean, thank you for that question. It's very close to my heart because let me give a fact that is often not, you know, discussed. Yes. Two thirds of our exports are bound for India, but if you look at just exports to countries other than India, then 75% of those exports are air freighted. Right?

[00:44:00] - [Paras Kharel]
For example, pashmina shawl or small handicrafts, they are air freighted. So air freight is already important, but many of these exporters, including SMEs, use the air route partly because the sea route is cumbersome, time consuming, and the variability of time is high. It's highly unpredictable. Although, in many cases, shipping by air is more expensive. Now it all depends upon the type of product too.

[00:44:29] - [Paras Kharel]
Remember, we should say now once upon a time, we exported tea to Pakistan when direct flights were available, and that was relatively feasible also. So there are many products where it is feasible to use air freight, and the government has, you know, a policy of, you know, subsidizing air freight for exporters. Now that has not been effectively implemented yet. Now whether that's an appropriate policy or not requires more research. Right?

[00:45:02] - [Paras Kharel]
I cannot say it outright right now. But what I feel is really lacking is that a clear policy with regard to air freight to promote exports does not exist. Even in, let's say, different research reports or reports underpinning government policy, this fact is not strongly highlighted in general. OK? And you might have come across a rep news report in the last one year or so whereby the government decided to open up primary agriculture sector to foreign investment, and that that decision did caught some controversy, you know, with certain sections of the private sector.

[00:45:43] - [Paras Kharel]
But the argument of the government was that foreign investment will be allowed in primary agriculture sector, say even cardamom plantation, for example, or fruit plantation or vegetable plantation, if at least about 75, 80% of the output is exported by that firm. And and when policymakers were defending that decision, they explicitly mentioned fresh vegetables and fruits, and the potential market are arguably in, say, West Asia, The Middle East. Now suppose we have the capacity to generate that amount of export, and we can meet their standards also. The question is, what transport are we envisioning of using? Surely not, you know, transporting fresh vegetables and fruits all the way via Kolkata Port.

[00:46:32] - [Paras Kharel]
So at the back of our mind, it's air freight. But if that let's say, the decision is effectively implemented and let's say, FDI comes in, there's no way we can avoid air freight for that. And for that, we must be thinking about, you know, about air freight. And some in the freight forwarding community have argued that the the regulations and law or as they are implemented make it difficult to bring in freighter flight freight freighter flights dedicated to, you know, freight cargo difficult. So easing such regulations and laws, if that's the case, will also help.

[00:47:09] - [Aslesh Shrestha]
Okay. So we've discussed about the private sector quite many times during this discussion. So what do you think the role of private sector would be in terms of maintaining our graduated status?

[00:47:25] - [Paras Kharel]
So the private sector can begin by being aware. Right? And this is not an advertisement of our, you know, studies, but going through such studies. And the point is things are not all bleak. There are many products where we don't even have to worry about loss of trade preferences.

[00:47:43] - [Paras Kharel]
For example, tea. In tea, whether we are an LDC or not, doesn't matter, and we don't even have to worry about GSP plus or not or rules of origin in the EU market, in The UK market, which is out of the EU or the American market, is zero. Right? So for for those working on tea, they can focus on other issues for maybe organic certification, right, traceability, good agricultural practices for which they need the support of the government also. Right?

[00:48:15] - [Paras Kharel]
Because they are such products also, one thing. And the second point is in the case of, say, the apparel sector. Now they can get duty free access under GSP plus in the EU, but but from what they say, it will be almost impossible for them to currently meet the double transformation requirement. In that case, they should start, you know, lobbying with the government of Nepal to, in turn, seek an exemption from that rule of origin with the EU. Right?

[00:48:45] - [Paras Kharel]
That's that's another point. And then thirdly, they should also explore new opportunities. For example, The US in the wake of the twenty fifteen earthquake granted Nepal extra preferences in 77 products. Right? Not extended to other countries.

[00:49:05] - [Paras Kharel]
Now if you look at the data, we have not been able to utilize preferences in those goods. Those goods include trunks, bags, or suitcases, headgear. Now we don't export these products in huge quantities, but we do export these in small quantities. Market duty free market access is present in these goods also. The private sector should also try to diversify into these products,

[00:49:31] - [Aslesh Shrestha]
you know, and should slightly come out of their traditional comfort zone. So given that we will not be receiving these kind of trade preferences or concessions in the longer run, how do you think the government can facilitate an environment that makes it possible for the Nepali industry to compete globally?

[00:49:57] - [Paras Kharel]
I think the government should seek an extension to preferences along with other graduating like minded LDCs and the LDC group to the extent possible because that will give us room to maneuver and plan a breathing space of sorts. But ultimately, yes, we have to keep our own house in order, and it again all boils down to effectively implementing the trade strategies we have developed so far, and I mentioned earlier, lack of coordination among different government agencies, and not allocating enough resources for certain important actions delineated in the strategies and policies, that should change. And the government should take an integrated approach to export promotion whereby our trade policy and industrial policy and, say, agriculture development strategy, long term vision, should work in tandem with each other.

[00:50:54] - [Aslesh Shrestha]
Looking at the issues in hand for Nepal, is it a possibility that we may not be able to sustain the graduation? Is there some possibility, or do you not see that? So, I mean, theoretically,

[00:51:10] - [Paras Kharel]
if our progress of the progress that we have made in, say, human asset index and economic and environmental vulnerability index unravels, right, that might happen. I don't think that will happen just because of the export shock because export are still relatively a small percentage of our GDP, and we are talking about just goods exports. We have services exports in tourism, which won't be impacted by LDC graduation. But, I mean, just hypothetically speaking, and I don't think anyone of us wants that, but let's say there is a shock to remittances that was anticipated even during COVID, but, fortunately, that didn't happen, then that will directly impact households, household level welfare, and that will impact education and health, and that will, in turn, impact the human asset index, and things may unravel. So the possibility is, you know, there.

[00:52:06] - [Paras Kharel]
But I think an even more important issue for Nepal is that although the projected impact is just two to 4% in terms of goods exports, it does not take into account what I've argued in my other paper is the foregone export potential because you mentioned a World Bank estimate that our goods export potential is about nine to 10 times more than our current level of exports. And the the hope or prospect of meeting that potential is partly based on the fact that we currently enjoy duty free preferences. Okay? Now we have not been able to utilize those preferences because of our supply side constraints and, say, low productive capacity. But the hope is always there that we'll be able to improve on that front.

[00:52:53] - [Paras Kharel]
But improving on that front will take time. It won't happen overnight. Right? So these preferences provide us, as I have argued, a breathing space of sorts. This is the traditional infant industry argument applied to the case of exports.

[00:53:10] - [Paras Kharel]
So let's suppose the government introduces a program to improve our productive capacity and alleviate our supply side constraints. The private sector also joins the government. Think tanks also provide inputs. But to see its effects, it will take time, And those preferences will help will give us some breathing space. But with those preferences gone and even as we, you know, attempt to improve our supply side capacity, we'll not be able to increase our exports to the desired extent.

[00:53:42] - [Paras Kharel]
So the for we'll be foregoing our export potential, and this argument is not readily amenable to mathematical modeling, and those estimates do not capture it. Right? And LDC graduation also has an impact potentially on our export diversification goals. So two thirds of our exports are destined to India. Right?

[00:54:03] - [Paras Kharel]
And I would have made this argument even if two thirds of exports are destined to say The US or China. Right? It's unhealthy to have such a huge chunk of our exports to on a single country going to a single country. Now these trade preferences provided by, say, the EU, Japan, Australia, US, although we haven't been able to use them much, always gave us a hope that we'll be able to diversify our our export in terms of product, in terms of destinations, and there are many products that fetch relatively high, you know, price potentially for which these markets that I mentioned, are potentially key markets. Right?

[00:54:39] - [Paras Kharel]
And we'll be foregoing that potential if, we lose preferences. So so the potential impact in that sense could be much higher than the headline figure of, say, just 4%. But, again, that brings us us back to the issue of getting our own house in order, building our productive capacity, and reducing trade costs.

[00:55:02] - [Aslesh Shrestha]
So as we know, until now, two countries have been included in the LDC category, and six of them have successfully graduated, and seven, including Nepal, is in line for graduation. So from the graduated countries, what do you think Nepal can learn in terms of strategization or policy making?

[00:55:24] - [Paras Kharel]
So of the six countries that have graduated, one is a landlord country in Africa, Botswana, but the similarity ends there, because it is is richly endowed in with mineral resources, including diamond. And it's a country which despite being blessed with mineral resources has bucked the so called, you know, resource curse trend seemingly. Now it graduated in the, you know, mid nineties. Then other countries that have graduated like The Maldives, Vanuatu, Samoa, many of these countries are small island developing countries. So the structure of these economies is significantly different from Nepal's, and it's hard, hence, to, you know, draw parallels between Nepal's future prospect in terms of graduation and the experience of these countries.

[00:56:22] - [Paras Kharel]
But we did take a look at the graduation experience and strategy, not in as detail as we looked at the case of Nepal. We looked at Botswana, Vanuatu, and Maldives. And the key takeaway is that they approached graduation not as an end in itself, but as a milestone in their overall development trajectory. Just a milestone. And their approach towards graduation was built into their overall development plan, strategy, and aspirations.

[00:57:04] - [Paras Kharel]
So for me, a a takeaway is that while the government might and is it almost will surely come up with a LDC graduation strategy to ensure that our graduation is sustainable and irreversible, it should be, you know, part and parcel of its overall development framework and plans. That graduation strategy should speak to other existing plans, policies, and strategies. All those plans and policies and strategies should be now, you know, implemented as part of that graduation strategy rather than considering graduation as an end in itself. Finally, where can our listeners get hold of the Nepal's graduation report which you have published? Okay.

[00:57:57] - [Paras Kharel]
We have two reports. One study report is titled Nepal's graduation from the LDC category implications for international trade and development cooperation and trade policy. You you can find it on our website, sawtee.org. And the other study is a working paper also produced by Sauti, and its title is Nepal's elusive quest for export success meets LDC graduation. It is also available on our website as a working paper.

[00:58:35] - [Aslesh Shrestha]
So we've come to the end of this show. Thank you for joining us, Paras, and sharing your insights. I hope our listeners enjoyed the episode as much as I did.

[00:58:46] - [Paras Kharel]
Thank you for giving me this forum. I also enjoyed it.

[00:58:49] - [Aslesh Shrestha]
It was a pleasure hosting you.

[00:58:51] - [Paras Kharel]
Thank you.

[00:58:53] - [Aslesh Shrestha]
Thanks for listening to Pods by PEI. I hope you enjoyed my conversation with Paras about the implications of LDC graduation for Nepal's exports, external assistance and policy space and the policy changes required for a sustainable graduation. Today's episode is part of the brief. It was produced by Saurav Lama with support from Nirjan Rai, Khushi Hang Rai and Chhedon Kansakar. The episode was recorded at PEI Studio and edited by Chhedon Kansakar.

[00:59:21] - [Aslesh Shrestha]
Our theme music is courtesy of Rohit Shakya from Jindabaad. If you liked today's episode, please subscribe to our podcast. Also, please do us a favor by sharing us on social media and leaving a review on Spotify, Apple Podcast, Google Podcast, or wherever you listen to the show. For PEI's video related content, please search for policy entrepreneurs on YouTube. To catch the latest from us on Nepal's policy and politics, please follow us on Twitter tweet2pei that is TWEET followed by the number two and PEI and on Facebook at Policy Entrepreneurs Inc. You can also visit pei.center to learn more about us. Thanks once again from me Aslesh Shrestha. We'll see you soon in our next episode.