Why India May Loosen Its Purse Strings To Help Nepal

Neville Cardus had famously dismissed the scoreboard as a measure of the performance of the cricketers. The analogy may be applicable in analysing the vulnerability of India’s smaller neighbours through the prism of macroeconomic fundamentals.

With a transshipment port, reasonably diversified export basket and a booming tourism sector, the Sri Lankan economy was considered most stable, till it was busted. A tiny Bhutan, with the highest debt-gross domestic product or GDP (121 per cent) in South Asia, however, remained out of trouble.

Bhutan is safe as long as India-Bhutan ties remain stable. But Nepal’s case is way more complex. It’s way bigger than Bhutan. Kathmandu is highly unstable both in terms of domestic politics and foreign relations. The economy lacks depth.

But that might not mean Nepal is at risk, at least not in the immediate run. The reasons behind this anticipated stability are difficult to substantiate by economic logic.

Critical Weaknesses

Theoretically, Kathmandu has a favourable 37 per cent debt-GDP ratio. However, external debt to exports reached a dangerous 344 per cent in 2020. While repayment obligations have been rising exponentially for the last 10 years, the critical weakness of the country lies in its earning potential.

According to ITC Trade Map, Nepal exported a record $1.64 billion worth of goods in 2021. Half of it ($867 million) came from soya and palm oil exports to India. Overall, 80 per cent of Kathmandu’s total exports were directed to India and edible oil constituted two-thirds of the basket.

Soya oil comes from Argentina and Brazil. Palm is sourced from Indonesia and Malaysia. As the world’s largest importer in both categories, India has access to better sourcing arrangements and a slew of port-based refining facilities to support the trade.

Landlocked and food deficit, Kathmandu doesn’t have such advantages. No economic logic can explain how Kathmandu can make money by importing edible oil through Kolkata port and transferring it to Nepal by road (700 km) for re-export.

The margin is generated from export subsidies and/or duty sacrifices by Nepal. Duty exemption by India on imports from less developed economies (LDC) offers an added cushion. A small duty revision by Delhi on edible oil imports can change the situation dramatically.

Scratch a little and, Nepal barely has a dependable source of foreign exchange except for remittances, amounting to a quarter of its GDP. Nepalese tea neither has a brand nor critical volume. Peak receipts (current US dollar) from international tourism were $800 million in 2019, one-sixth of the $4.6 billion earnings of Sri Lanka.

Traditional knowledge suggests Nepal’s weaknesses will be more apparent in the next four years. The scheduled graduation from LDC to a low-middle-income country in 2026-27 should deprive the Himalayan country the crucial duty benefits.

The country is now in urgent need of reform and attracting investment in productive assets. According to ITC, in 2019 Kathmandu got only $185 million in FDI as against $785 million in Sri Lanka and $2.8 billion in Bangladesh. Dhaka will also graduate from LDC in 2016-27.

It is told that a sizeable part of the FDI in this part of the world is actually the return of the capital that was once siphoned out of the country. The possibilities are high in Bangladesh and Nepal which put severe restrictions on the movement of capital and allow dual citizenship.

In 2019, FDI accounted for 0.95 per cent of Bangladesh's GDP and the per-capita inflow stood at $17.63. The comparative figures for Nepal (2020) are 0.41 per cent and $4.42 respectively. Clearly, Nepal has a lot of catching up to do.

Instability Is Stability

Can Nepal do it? Optimists say it can, provided there is political stability and policymaking remains objective. The Kathmandu-based NRN Nepal Development Funds is targeting non-resident Nepalese for investment.

The problem, however, remains on the political front which is not expected to be stable anytime soon. “Instability is stability in Nepal,” says Dr Nihar R Nayak from Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi.

At a recent discussion organised by the Kolkata-based Iravati Research and Communication Centre, Nayak explained that Nepalese politics was passing through a flux. Coalitions were made to be broken and partners were up in arms against each other for space.

This was evident in the 2017 general election and the sequence of events after that and would be evident in the course of the next election due at end of this year.

From the governance and policymaking perspective, the instability is killing Nepal. The government was dissolved twice during the Covid pandemic. What happened to governance during such crucial hours is anyone’s guess.

Every change in government is potent to bringing change in foreign policy. Such changes are frequent in Nepal. The current Prime Minister Sher Bahadur Deuba is in power since July 2021. Before that, he was prime minister for eight months between June 2017 and February 2018. In between, K P Oli was prime minister for a little more than three years.

One set of leadership will pick up a fight with India (ignoring its dependence) and award projects to China. The next set will reverse such decisions, obviously under pressure from Delhi. Caught in the tug-of-war, the implementation of projects will suffer endlessly.

The blame goes largely to the Nepalese leadership which has been leveraging its strategic geography to extract benefits from either side for seven decades now. As the rivalry between India and China intensified, Nepal now has little option but to live with it.

On the brighter side, they have learnt the art of living dangerously. The ratification of the Millennium Challenge Corporation (MCC) aid by the Nepalese Parliament on 27 February, opened the gates to $500 million in aid for revamping the electricity infrastructure.

The MCC ratification was held up reportedly at the insistence of China and became a source of tension between the US and Nepal. Resolving the issue opened the gates to another $600 million in American aid to help Nepal mitigate the economic impact of graduation from LDC.

Notably enough the development was followed by reports in Chinese media on Nepal’s delay in the implementation of Belt and Road projects.

On 19 April, the Hong Kong-based South China Morning Post (SCMP) published an article titled: “Nepal’s economic woes, following Sri Lanka’s crisis, turn up the heat on China’s belt and road loans.”

India May Step In

Nepal will not fall as long as the money tap will remain open. Now that pressure is building up from the Chinese front, others have to step in. In this context the recent visit of Prime Minister Narendra Modi to the Buddhist pilgrimage site of Lumbini is significant.

Ever since he assumed power in Delhi, Modi expressed his interest to visit Lumbini twice. Both were cancelled at the insistence of the Nepalese side citing “security risks”. This time, the Nepalese Prime Minister Deuba received Modi at Lumbini

Apparently, the visit didn’t result in many big bang announcements except the award of the 490MW Arun-4 hydroelectric project to India. But significantly enough the visit was announced three days ahead of the local body election in Nepal.

If the indications are right, India will open its purse to help Nepal avoid any immediate fiscal risk.