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Executive Summary

Trade and Services in Nepal: Opportunities and Challenges

Services are the fastest growing component of international trade. Trade liberalizationwould be incomplete without liberalization of the services sector in the sense that withrapid expansion this sector has proved to make significant contribution in the growth ofGross Domestic Product (GDP). Statistics shows that the share of services in GDP hasincreased from 65 percent to 72 percent in developed countries during 1990-2005, whilesame for developing countries; it has increased from 45 percent to 52 percent. Theremarkable growth rate of service sector has resulted into many structural changes andhas been an important driver for higher economic growth rate. This sector provides anaverage employment of 70 percent in developed nation while 35 percent of totalemployment in developing countries. This sector has thus exhibited a growing importancein overall output, employment, trade and investment. It has helped in compensating thevolatility in other sectors.

Since there still is the lack of internationally comparable statistics on services especially

among the SAARC member countries at the regional level, there has been nocomprehensive analysis on the prospects and challenges in facilitating services trade inthe region. The developing countries lack adequate empirical evidences to link anysignificant increase in FDI flows after the finalization of General Agreement on Trade inServices (GATS). However, although the manufacturing sector has also shown upwardtrend in growth, its performance is less steady than services sector. The revealedcomparative advantage (RCA) index for services has increased and is close to 2 in post-2000 period, compared to 1 in case of goods.

The service sector includes promising sectors like tourism, the financial services,Engineering, labor, health services, education and the telecommunications servicessector and so on. International trade in services is defined by the Four Modes of Supplyof GATS. (Mode 1) Cross border trade, which is defined as delivery of a service from the

territory of one country into the territory of other country; (Mode 2) Consumption abroad -this mode covers supply of a service of one country to the service consumer of any othercountry; (Mode 3) Commercial presence - which covers services provided by a servicesupplier of one country in the territory of any other country; and (Mode 4) Presence ofnatural person – which covers services provided by a service supplier of one countrythrough the presence of natural persons in the territory of any other country.

Countries have right to decide freely on where to liberalize on the basis of sector-by-sector, including which specific mode of supply they want to cover for a given sector.Most of the service trade such as IT-enabled services and tourism (labor-intensive) aresignificant part in the economy of many low-income countries. IT, Health, education andengineering services contribute to a healthy, well trained workforce. These servicesectors are a key part of the investment climate, and can have a much wider impact on

business performance. The services help increasing growth and productivity possible andtherefore can be expected to contribute to overall social development objectives.

Services account for more than 60 percent of global FDI, increasing from $870 billion to$5.9 trillion from 1990 to 2004. As services are the fastest-growing component of the totaleconomic output and the largest component of foreign direct investment (FDI), this sectoris the future of developing countries. It is the major source of employment. A University ofMichigan study estimates that liberalization of services would produce more than two-thirds of the global economic welfare gain from the elimination of trade barriers. In thecontext that service sector is expanding and contributing significantly to country’s GDP,



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this paper briefly reviews the status of selected service sectors. The review include, stateof service sector in Nepal; an assessment of the existing policies in service trade;identifying the opportunities and challenges in service trade; exploring thecomplementarities in trade in services; recommending appropriate policies with specialreference to:

• growth, equity & poverty alleviation• expanding trade opportunities• promote inclusive growth and gender mainstreaming

This study has mainly relied on the secondary sources of information which includes theNRB bulletin, Economic Survey of Nepal, International Trade Union Center (ITU) database, WITTS data of the World Bank and UNCTAD. A desk review of existing policies ontrade in services was comprehensibly done. However, limitations were observed inaccessing disaggregated service sector data. To identify the additional problems, whichare not usually reflected in available literature, a ‘focus group’ discussion with the privatesector, government and think tanks were conducted to seek primary source ofinformation.

Even though service sector is growing and expanding in Nepal, it has been severelyconstrained by the overall growth rate of the economy. While it’s adjoining Neighbors – China and India, have registered a remarkable growth rate in last decades, Nepal’sgrowth rate has been erratic and low. A new World Bank report has painted a gloomyeconomic progress for Nepal projecting country's GDP growth to remain at 3 percent in2010 and 4 percent in 2011. However, different estimates are now available but theaverage variations in the growth projections made by number of agencies stand between0.5 per cent – 1 per cent.

China had a runaway growth of 13.0% in 2007; 9.6% in 2008. During the third quarter of2010, China’s growth expanded to 9.6%. India retained 9.4% and 7.3% respectivelyduring the same period. The Gross Domestic Product (GDP) in India expanded at anannual rate of 8.80 percent during 2010. From 2004 until 2010, India's average quarterly

GDP Growth was 8.37 percent reaching an historical high of 10.10 percent in Septemberof 2006, which shows a sign of steady and sustained growth(http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=INR).

Nevertheless, given the declining share of agriculture sector and a stagnant industrialsector, the service sector in Nepal owes a significant importance. Its’ contribution hasincreased significantly from almost 35% in 1980 to 51% in 2008. The contribution inemployment is 20 percent. Among the service sector, the share of restaurant and hotel;transport and communication; finance and real estate; community and social sectors aresignificant. Statistics reveal that financial intermediation, Real estate, Health and Socialwork and education are the fastest growing services sector in Nepal. Financialintermediation has increased with an average growth rate of 18.46% during the sameperiod recording a growth rate of as high as of 24.35% in FY 2006. Health/Social work

and Education sector registered an average growth rate of 9.38% and 7.78%. Thewholesale and retail trade has poorest growth record registering negative growth rate onaverage (2005-2008).

The trade in service in Nepal is growing over periods. The total services trade amountedto Rs. 58694.1 million in FY 2004/05 while it increased to Rs. 125928.3 million in FY2008/09; a more than double increase in total volume of trade in services during theperiod of 5 years. The Export of the service was 30374.9 million in 2004/05 whichincreased to 62221.1 million in 2008/09, nearly a double increase in export of services.



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The import of services also recorded more than double increase during same period. Forexample, import of trade in services increased from 2819.2 million in 2004/05 to 63707.2million in 2008/ 09. The recent statistics shows that the share of export of services inGDP has increased from 5.15 percent in 2004/05 to 6.28 percent in 2008/09. Share ofImport of Services has also increased from 4.80 percent in 2004/05 to 6.43 percent in2008/09. The total services trade as share of GDP has increased from 9.96 percent in FY2004/05 to 12.70 percent in 2008/09.

Unlike merchandise trade where two third of total trade in concentrated with India, Indiashares around one third of services trade. The share of trade in services with India isfound decreasing over the years from 31.80 percent in 2004/05 to 26.60 percent in2008/09 but the share of countries other than India has been increasing over the years.The share was 68 percent in 2004/05 which increased to 73 percent in 2008. Theaverage share of this category stands as high as of 70 percent during 2004-2009. Liketotal trade, share of India in total export of service trade is small and declining. The sharewas 17.50 percent in FY 2004/05 while it decreases to 10.87 percent in 2008/09recording an average share of 14 percent during the period. The export of services tradeis increasing with third countries. The share was almost 85 percent in 2004/05 whichreaches to nearly 90 percent in 2008/09, showing prospects for trade diversification in

service sector.

The different heads of export of services include transportation, travel, communicationservices, insurance services, government services, and labor services. Travel has been adominant sector in the export arena. Other services following travel are governmentservices, labor services and other service categories. The export of travel services was34.45 million on 2004/05 while it increases to 44.94 million in 2008/09 recording anaverage of 34.47 percent during the same period. Transportation and Communicationservices have actually recorded a decline in export over the years. Likewise, the majorimported services are the transportation, travel and other service categories. The share oftransportation and travel categories only account nearly three-fourth of total importservices. The share of transportation on import was 37.44 in FY 2004/05 which increasesto 42.47 percent in 2007/08. Likewise, share of Travel has increased from 34.22 percent

to 38.08 percent during the same period. The insurance services are also substantialaccounting nearly 3.30 percent of total import of services.

The focus on consumer satisfaction as a function of performance relative to theconsumers’ expectations is new dimension in service trade that has been recommendedin the present study. The reviewed literature has shown consumer satisfaction service isa value-added service in which the service contents exceed the consumer’s expectationsand add more value to the consumer’s benefit.

Government policies, social changes, business trends, development in IT sector, etc.have influenced shaping services markets. This has greater ramifications in consumptionpatterns and competitive strategy. The message is opening up service trade meansincreased competition, which stimulates innovation. It means organizations dealing with

service sector must focus rather sharply on marketing strategy to survive and growamong other experienced competitors.

In recognition of the increasing contribution of service trade in national economy, it isadvisable to distinguish between trade in goods and trade in services from policyperspective. This can be done by placing them on a scale from tangible-dominant tointangible-dominant. There are some potentially ambiguous products to differentiatebetween the goods and services and therefore, Lovelock and Wirtz (2005) suggestedeconomic taste by drawing a line of whether more than half the value comes from theservice elements? The answer for example, is to disaggregate the cost of food in Hotel



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Annapurna or Yak & Yeti, which accounts for roughly 20-30 percent of the price of themeal. The higher value is added by food preparation and cooking, table service,restaurant & environment and facilities such as parking, toilets, gardens etc.

To sum up, in the context of globalization of the trade in services, the impact needs to beassessed linking the market economy with growth, equity and inclusive growth. The policypractitioners should make sure if the increases in social sector productivity benefitcustomers at the expense of workers or increases income of the workers throughemployment by lowering the costs? The uncertainties of smooth implementation of theongoing trade-facilitation measures have continuously been threatened by Nepal’sprolonged political transformation. Major publications identify the unresolved issues inlabor laws, property rights & market access complexities as the binding constraints indoing business in Nepal. Given the early settlement of Nepal’s fluid politicaltransformation process by overcoming the transitory stage as early as possible, there is agreat hope that Nepal would achieve inclusive growth balancing growth and equity.

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