Contemporary South Asia (1998), 7(2), 147-165

Challenges to developing
the economy of Nepal
NARAYAN KHADKA

ABSTRACT Nepal initiated a development policy and plans to both modernise and develop its
predominantly agricultural economy only in the early 1950s. In the last four decades, the country
has implemented nine five-year plans and invested billions of rupees to develop its economy. This
article examines the poor performance of past development efforts in the light of a myriad of
challenges, local and global, economic and political, structural and institu-tional. It concludes that
the economic reforms which have been introduced vigorously since the restoration of democracy in
1990 will not yield the desired results unless they effectively and positively contribute to improving
the agricultural sector, lead to higher productivity and growth, generate increased mobilisation of
domestic resources, alleviate poverty, and bring about greater social equity.

Economic development, whichever way it is defined, should have one fundamen-tal

goal: an improvement in the general welfare of the people. Although attaining higher
economic growth is one of the important elements of economic develop-ment, it will
not be sustained if it is not accompanied by a reduction in inequality and an
alleviation of general poverty. Economic development also will not be dynamic and
sustainable if the improvement in the general welfare of the people does not lead to
social change (a change in attitudes and beliefs). Economic development thus
becomes a multidimensional and complex process embracing not only economic, but
also social, political and institutional factors.
With a per capita income of US$200 in 1996, Nepal is one of the less-devel-
oped countries. Nepal also is ranked by the United Nations' Human Develop-
ment Report as one of the countries with the lowest human development index,
and is beset with problems of massive inequality, both between population and
regions. World Bank estimates show that over 40% of the population fall below
poverty income levels. There are both natural and socio-economic factors
responsible for the poor state of the economy: the former include its poor
resource endowments and landlocked and mountainous geography; while the
latter includes a subsistence agricultural base, underdeveloped socio-economic

Correspondence: Narayan Khadka, 103 Glebe Avenue, Ottawa, Ontario, K1S 2C2, Canada.

0958-4935/98/020147-19 © 1998 Carfax Publishing Ltd

NARAYAN KHADKA

infrastructures, limited size of the domestic market, and lack of adequate capital
and technical know-how. Its history is also a factor in the underdevelopment of
Nepal's economy.
Compared with other countries which have a long history of developing their
economy, Nepal is a late starter. Efforts toward economic development were
made with the establishment of democracy in 1951 after a revolution overthrew
the 104-year-old(?) autocratic Rana regime. The Rana system, a family oligarchy
which ruled Nepal absolutely, was the only capital-owning class. It derived
income and wealth from two sources: state revenue (there was no separate state
treasury maintained); and transferring national resources such as land, forests
and other national properties to family members. A large percentage of the Rana's
wealth was used in building palaces for family members and importing British
goods for their consumption. In 1951, the democratic government realized that
the country had to start the task of both modernizing the traditional society and
developing the primitive economy from a very limited base. The country had an
extremely limited infrastructure mainly concentrated in the Kathmandu Valley: a
few schools and a college, and a few industries which were established during
World War II.

Development strategies and outcomes

Nepal's development policies and programmes has been influenced heavily by
the development theories of the day. For a country that has been so dependent on
foreign aid both financial and technical, such an influence is not uncommon. The
neo-classical theory of growth and development recommended for address-ing
the problems of underdeveloped countries was readily applied to foster
economic development in Nepal. Greater emphasis was laid on developing basic
socio-economic infrastructure such as transport and communication, power,
health and education. Since the private sector was heavily concentrated in the
agricultural sector with a surplus labour but with meagre savings, development
planning was conceived as an important way of allocating the available re-
sources effectively and efficiently. The country's decision-makers believed that
appropriate planning for creating basic socio-economic overheads could eventu-
ally spur the structural transformation from an overwhelmingly agricultural to a
modern industrial economy, and could also integrate the two sectors for
interdependence. The country's first five-year plan (1956-1961) was launched
with these noble goals. Like in many other countries and, more particularly,
India where socialist vision also was a key factor in according greater role to the
state, the state in Nepal played a leading role not only in mobilizing and
allocating resources but in directing the private sector to achieve the develop-
ment goals defined by the state in all the subsequent plans.
Development with faster economic growth through the modernization of the
economy and the creation of basic socio-economic infrastructures domi-nated
economic thinking among the planners and decision-makers of Nepal until the
mid-1970s when it became obvious that growth alone would not

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 DEVELOPING THE NEPALESE ECONOMY

solve the fundamental economic problems in developing countries because,

despite the attainment of higher growth, poverty remained unaddressed. Inter-
national institutions such the World Bank, the OECD and the United Nations, as
well as professional development economists, began to emphasize the growth of
GNP with distributional equity. Following this trend, Nepal not only shifted its
priority from the transport and communication sector to agriculture and rural
development, but it also implemented an economic policy with the goal of
attaining higher growth with redistributive justice and the alleviation of poverty.
Table 1 shows that the four five-year plans from the first (1956) to the fourth
(1970-1975) had accorded highest priority to transport and communication sector
as it was believed that without the development of infrastructure, the
modernization and development of the economy would be difficult. But, as
agricultural growth stagnated and the economic conditions of the rural areas
where over 90% of the total population lived did not improve, planners began to
shift the focus of development plans to agriculture and social development. Table
1 shows that although transport and communication still received second highest
priority in the fifth plan (1975-1980) the agricultural sector received the highest
priority (35% of the total resources). The share of the social services sector was
also raised from about 14% in the previous four plans to 18% in the fifth plan.
This policy was followed by the democratic governments formed after the
restoration of democracy in 1990. Although the exploitation of the country's
hydropower potential, one of its very few natural resources, received high
priority due to foreign aid donors' willingness to finance some of the huge
projects, both the eighth (1992-1997) and the ninth (1997-2002) five-year plans
formulated by two governments representing distinctly opposed political ideolo-
gies (the former by the Nepali Congress and the latter by the United Marxist-
Leninist and the National Democratic Party coalition government) followed the
same policy of according higher priorities to the agriculture and the social
services sectors. The ninth plan has accorded even higher priority to the social
services sector as it became a slogan again that the development goals of
alleviation of poverty and creation of employment will be difficult to achieve
without human development.
The theory that market-determined and outward-oriented economic policy
approaches lead to higher productivity and growth began to dominate economic
thinking in the 1970s and 1980s. It was argued that a greater reliance on market
rather than on state directions and regulations would improve the general
economic welfare of the people. The remarkable economic growth rates achieved
by the East Asian countries which had adopted outward-oriented and more open
economic policies as compared with Latin America, Africa and South Asia led
economists and policy makers in many developing countries to embrace market
1
oriented reforms. By the mid-1980s, Nepal also embraced the develop-ment
strategy of market-led growth and structural reforms. Streamlining devel-opment
administration, embarking on privatization measures and introducing reforms to
correct macroeconomic imbalances were some of the policy measures taken by
the government. Of these policies, structural adjustment—which

149
o >
Table 1. Sectoral priority in allocation of resources in various five year plans (in million Nepali Rupees) >
Z
s
Total of >
1st, 2nd o
3rd and
4th plans Fifth plan Sixth plan Seventh plan Eighth plan Ninth plan
Sectoral priority (1956-1970) (1975-80) (1980-1985)* (1985-1990) (1992-1997) (1997-2002)
Agriculture 1975.0 3971.0 7404.0 24350 43137.0 64950.0

(28.3) (34.8) (33.2) (24.5) (26.0) (16.0)

Industry 1284.0 1040.0 5486.0 7296.0 14673.0 48950.0
(18.4) (9.1) (24.6) (7.4) (8.8) (12.0)
Powerf 122.0 — — 16618 27203.0 76270.0
(1.7) (16.7) (16.4) (18.7)
Transport and communication 2450.0 3385.0 4772.0 15304.0 24434.0 49700.0
(35.1) (29.7) (21.4) (15.4) (14.7) (12.2)
Social services 963.0 2007.0 4638.0 6760.0 12690.0 64190.0
(13.8) (17.6) (20.8) (6.8) (7.60) (15.8)
OtherJ 176.0 100.0 — 5839.0 11457.0 33140.0
(2.5) 8.7 (5.9) (6.9) (8.0)
Finance and real estate — — — 23099 32626 69460.0
(23.3) (19.6) (17.0)
Total planned outlay 6970.0 1140.0 22300 47347.0 — —
(100.0) (100.0) (100.0)
Total actual outlay 5974.0 8831.0 21750.0 29000.0 166220.0 406660.0

(100.0) (100.0)0

*These are only the public sector outlays, f In the fourth and the fifth plan the power sector is included in the industry sector. Therefore, the share
of this sector is underweighed. $ This includes expenditures for statistics, general administration, planning and supplies. The figures for the
seventh, eighth and the ninth plans include only construction, and trade and restaurants. Source: National Planning Commission, various five year
plans.
 DEVELOPING THE NEPALESE ECONOMY

included both macro and microeconomic adjustments designed to increase

savings and investment in public and private sectors, liberalize trade, reduce
dependence on administered pricing, and allow greater private sector involve-
ment—was pursued most vigorously.
The wave of economic liberalization that swept through the world in the late
1980s and early 1990s also led all the governments of Nepal that have been
formed since 1990 and that have represented ideologies from communism to
conservatism to liberalize the country's economy. The eighth five-year plan
(1992-1997) introduced by the Nepali Congress (NC), a party which describes its
ideology as democratic socialist, stated that the 'government will start a process
of disengagement and disinvestment from a number of fields where the private
sector can perform more efficiently without jeopardizing social inter-ests'. 2 The
NC government expressed its commitment to make the economy more market-
oriented, competitive and open. Several economic reform measures have been
introduced including the reduction of tariff rates and removal of import
restrictions, a relaxation of licensing requirements for investment by the private
sector, the gradual divestiture of state-owned enterprises, and a relaxation of the
state monopoly on basic industries such as telecommunications, airlines, power.
The prices set by some of the public enterprises were reformed and by removing
subsidies and giving greater autonomy to management. Another significant
reform was in the external sector. In February 1993, the government announced
the full convertibility of the Nepali rupee and let its exchange rate be determined
by market forces. A number of policy measures were executed to reform the
financial and fiscal sectors. The United Marxist-Leninist (UML) party, which
formed a minority government in early December 1994, also emphasized that, in
order to alleviate poverty and build a 'strong national economy', a 'well balanced
3
economic reform programme' would be imple-mented. The ninth five-year plan
(1997-2001) thus states that economic liberalization measures will be continued
and strengthened.
The total amount of development expenditure invested by His Majesty's
4
Government of Nepal during 1956-1990 comes to little more than Rs 84 billion,
little more than half of which was financed by foreign aid. Available statistics
indicate that, in the period between July 1990 to July 1996, the total amount of
development expenditures in current prices totaled Rs.118 billion. Despite the
rate at which development expenditures have increased the economy has
remained stagnant and there has been not much headway in improving the
general living conditions of the average people.
Nepal's economy has stagnated at a very low level of income and there has
been no significant improvement in the living standards of the population for the
last four or so decades. Table 2 shows Nepal's extremely low level of income
even though per capita income has doubled between 1975 and 1996. During the
three decades (1961-1990) of panchayat rule in Nepal, GDP grew annually by
about 3%. However, since the population grew by 2.4% during the same period,
per capita real income grow only marginally; i.e. by less than 1%. During the
1960s and 1970s, GDP grew only by 2.6% annually (and

151
 i
Table 2. Nepal's major economic and social indicators

NARAY
to

Period Z
1970 1980 1990 1995
>
Per capita GDP (in US $) 100 140 170 200
Average GDP 2.2 (1960-1970) 2.5 (1970-1980) 4.6 (1980-1990) 5.1 (1990-1995)
Domestic savings/GDP ratio 2.6 11.1 7.3 10.3
Investment/GDP ratio 5.8 18.3 19.3 20.2
Development expenditures/GDP 5.3 10.8 16.0 10.2
Revenue/GDP 6.3 9.2 11.0 14.0
Exports/GDP 4.9 14.9 5.6 24
Imports/GDP 8.7 18.9 20.1 37.6
Current account balance 8.0 -93 -264 -375
(in million US $)
External debt/GDP 0.34 10.4 53.8 56.7
Ml/GDP (%) 8.7 12.1 15.6 15.0
M2/GDP (%) 11.1 22.5 34.6 36.8
Inflation 7.7 (1960-1970) 8.6 (1970-1980) 9.1 (1980-1990) 11.6(1985-1995)
Population Growth rate(%) 2.1 (1960-1970) 2.5 (1970-80) 2.6 (1980-1990) 2.5 (1990-1995)
Per capita supply of food
(kg per capita) 355 296 323 297
Per Capita energy consumption
(kg coal equiv.) 14 12 20 28
Literacy rate (%) 14 24 29 36
Life expectancy at birth (years) 41 48 50 55
Infant mortality
(per 1000 live births) 169 132 109 91
Population with access to safe 11 35 48
drinking water (%) 7

Sources: These data are compiled from the World Bank, World Development Report (various issues), HM/G/N, Ministry of Finance, Economic Survey
(various issues), Central Bureau of Statistics, Statistical Year Book of Nepal (various years), UNDP, Human Development Report (various years).
 DEVELOPING THE NEPALESE ECONOMY

by 3.4% in the 1980s). The economy registered higher growth only for certain
years in the late 1980s. The agricultural sector weighs heavily in the composition
of Nepal's GDP and, due to a heavy reliance on monsoon rains for cultivation, a
large segment of the population suffers sharp fluctuations in their incomes.
Although per capita income has doubled in the past two decades, the general
price level has gone up three-fold, making the general living conditions of the
average population worse.
There are other stark realities with regard to the worsening conditions of the
average population: disparities in income distribution, a high incidence of
poverty and a low domestic savings rate. In a 1977 study by the National
Planning Commission, it was found that 40% of the population was living below
the poverty line. The central bank of Nepal, the Rastra Bank, estimated that 43%
of the rural and 19% of the urban population, respectively, fell below the poverty
line in 1984-1985. This study also highlighted the fact that in the rural hills
where the largest number of people live, 50% of households had below poverty-
5
level incomes. The eighth and ninth five-year plans put the number of people
living below the poverty line at 40-45%. Various studies have also found a high
degree of inequality in the distribution of income, both between popula-tions and
geographic regions. The survey of the National Planning Commission conducted
in 1976-1977, revealed that 40% of households receive only about 13% of the
total household income. The Multipurpose Household Budget Survey of the
Nepal Rastra Bank showed some improvement in the mid-1980s as the bottom
40% of households received 23% of total household income. World Bank
estimates indicated that if the highest 10% of Nepali homes had an income share
of 29.8%, the lowest 10% had about 3.2%.6 A recent report of the Central Bureau
of Statistics and the World Bank estimated that the difference in income between
the Kathmandu Valley and the rural western region was huge: Rs. 23,495 for the
former compared with Rs.4792 for the latter, much lower than the poverty-line
income estimated to be Rs.6802 for Nepal. 7 Since much of the GDP originating
in the modern sector is contributed primarily by a small percentage of a mainly
urban population, the distribution of income between agriculture and the modern
sector is also grossly unequal. Past development efforts also have not succeeded
in increasing the rate of domestic savings. Nepal has a very low rate of domestic
savings, accounting for about 10% of its GDP in 1995 and was much lower than
that of Pakistan (16%), India (22%) and Vietnam (19%). 8
Nepal's low level of per capita income with considerable inequalities and a
low domestic savings rate explains why the country's social conditions are bad.
For example, although there has been noteworthy progress in the field of
education, Nepal's literacy rate is only about 35%, and it is lower still for
females. Nepal also fares badly in terms of the number of physicians, hospital
beds and nurses per head of population. Its per capita consumption calories,
access to safe drinking water and other health facilities are also poor.
One of the major reasons for Nepal's low level of per capita income is its
failure to improve the performance of the agricultural sector which affects the
social and economic conditions of the majority of the people. Although the

153
NARAYAN KHADKA

relative contribution of the agricultural sector to the country's GDP has declined
in recent years—this sector accounts for about 80% of employment and about
45% of GDP in the 1990s as compared with over 90% of employment and over
60% of GDP from the 1960s to the 1980s—the alleviation of poverty and an
increase in the general living conditions of the average Nepali will be very
difficult without achieving faster growth in this sector. This sector registered
poor growth performance from the 1960s to the 1980s: it grew by 1.8% in the
1960s and had negative growth rates in the 1970s. This is below the population
growth rate of 2.4% during this period. Despite an increase in the area under
cultivation, yields of the major food crops did not increase. As a consequence,
food production did not keep pace with the population. By the late 1970s, Nepal,
traditionally a food exporter, turned into a net food importer. Unfortunately, this
situation has worsened instead of improving. The food security situation in the
hills and mountain regions has become a huge problem, forcing the government
to supply food at a subsidized price in some of the chronic food-deficit districts.
The failure of Nepal's past development efforts to reduce its mounting
population pressure on the agricultural sector and, consequently, on the environ-
ment is yet another serious problem. Faster growth in the agricultural sector
would not mean generating a surplus for investment but merely becoming self-
reliance on food. Mobilizing domestic resources from the agricultural sector for
investment in the industrial sector is a goal pursued by every government— but
almost impossible for Nepal. This statement is based on a variety of reasons.
First, due to land fragmentation and a high population growth rate, the ratio of
families to arable land has declined. More than 60% of farmers are marginal
farmers (they own less than 1 ha) and the average size of land holding per family
in 1992 was about 1.4 bigha; i.e. 0.96 ha which, given adequate irrigation
facilities or monsoon rain, can support a family of five people for up to 75% of
their food needs. Second, the distribution of land shows that the percentage of
farmers who own more than 30 bighas or 20 ha and who can farm for
9
commercial purpose is very small. Available data also shows that '5% of owners
control about 40% of cultivated land, while the bottom 60% control about
l0
20%'. Third, high population growth rate has forced people to search for new
arable land which means slashing and burning limited forest land. Various
12
estimates show that Nepal's forest has been declining at an alarming rate.
Fourth, because of its high man-land ratio and limited farming opportunities,
people are engaged in agriculture work for only four months a year which means
underemployment of a* serious proportion. Finally, the number of people (cur-
rently at about 10%) becoming landless is also increasing, adding another
significant dimension to poverty, unemployment and deforestation. Over the
years, some progress in urbanization and the development of townships have
offered some off-farm employment opportunities, but Kathmandu, the capital
and the main city in Nepal, has to bear the brunt of a lack of employment
opportunities in the rural areas. In fact, the most daunting challenge faced by the
country is how to productively absorb the labour force that grew by 1.6%
annually in the 1960s and by 2.5% in the 1990s.

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 DEVELOPING THE NEPALESE ECONOMY

No significant change has occurred in the industrial sector in terms of creating

employment. While government statistics reveal an ever-increasing number of
industries, these are mostly trading concerns owned and operated by families in
city and town areas. The problems of falling productivity in the agricultural
sector, mounting population pressure, a high growth rate of labour, intra-regional
migration, and rapid deforestation cannot be addressed through the growth and
development of the non-agricultural sector alone. The formal sector, whose
contribution to GDP varies between 20-25%, employs about 10% of the labour
force. The state sector is the main employer: the civil service, the military and
state-owned enterprises are major sources of employment in the country. The
manufacturing sector, which accounts for about 10% of GDP and between 2-5%
of employment, employed about 150,000 people in 1992-1993. The average
growth of employment in this sector is about 6%. In a country where the labour
force is growing by 200,000 per annum, growth in the manufacturing sector
alone is insufficient to meet demand for employment.
Despite the satisfactory progress in the creation of basic economic infrastruc-
tures (e.g. improvements in the roads, communications and power networks) in
the country, Nepal's industrial sector could not expand as planned. Although
government has offered concessional loans, fiscal and other incentives to attract
investment to the industrial sector, 12 the low effective demand, the small size of
the market, the country's landlocked state and its associated transshipment costs,
competition from India due to an open border, and its growing labour unrest have
hindered the promotion and development of this sector. The government also has
been offering a wide range of incentives to attract foreign investment since the
1980s. By the early 1990s, the government enacted appropriate legislation and
additional facilities were offered to lure foreign investment. Yet, by 1995, only
about US$8 million of investment had been made in the economy. There have
been many grievances by foreign investors in Nepal. The registration system
entails cumbersome procedures and the so-called 'one window' system does not
effectively and efficiently address their needs. Growing traffic closures, or
bandhs, and frequent changes of government are additional problems that have
discouraged foreign investors in recent years.
For several decades, the government has also been introducing various measures
to expand and diversify Nepal's foreign trade with the explicit objectives of earning
foreign exchange achieving self-reliance in some basic goods, and developing its
industrial base. Undoubtedly, in terms of both volume of trade and its diversification
there has been considerable progress in the past four decades. In the period between
1980 and 1995, Nepal's exports increased from US$80 million to US$348 million,
growing by 7.8% during 1980-1990 and by 22% during 1990-1995. But imports
grew at a much higher rate: from US$342 million to US$1374 million during the
same period; its average annual growth rates during 1980-1990 and 1990-1995 were
4.9% and 6.8%, respectively. This increase in the volume of trade has become more
of a problem than a remedy as Nepal's trade deficit rose from US$262 million in
1980 to $1026 million in 1995. Despite a growing number of Nepalese working as
migrant

155
NARAVAN KHADKA

workers overseas, their remittances have been insignificant, and the country's
current account deficit has risen from US$93 million to US$375 million between
1980 and 1995.
In recent years, one part of the Nepali economy that has responded well to
reform is the financial sector. The panchayat government allowed in foreign,
private, joint venture banks in the mid-1980s, followed by the complete deregu-
lation of interest rates and greater autonomy from the central bank. These
measures encouraged the growth of financial institutions and there are now over
40 financial institutions in the country compared to about a dozen in the late
1980s. These institutions are commercial banks, financial companies, coopera-
tives, rural development banks and non-governmental organizations. But since
most of the financial institutions operate within a small domestic financial base,
competition is stiff. As most of these institutions operate are also owned and
managed by family members, their contribution to generating employment
opportunities and increasing institutional credit may not be as significant as their
sheer numbers would suggest.
Other sectors where some progress has been achieved are education and
infrastructural development. In the early 1960s, the literacy rate was a mere 4%.
This rose to 39% by the mid-1990s. The number of primary schools also has
increased quite considerably over the last three decades and, naturally, so have
enrollment rates. In terms of infrastructural development, the country had a
limited motorable road facility in the early 1960s (about 1193 km in 1961), about
1120 telephone lines, and approximately 4848 kW of power in 1961. In the early
1990s, Nepal had over 8000 km of roads, about 70,000 telephone lines covering
42 of the 75 districts, and approximately 300 MW of electricity.

The challenges
Nepal has been experimenting with different development strategies every
decade or so since the 1950s. An inflow of aid helped create a minimum of
socio-economic overheads in the country. However, the country is caught in a
poverty trap and, despite 40 years of planning and development efforts, 45% of
the population have an income of less than a US$1.00 a day. The problems Nepal
has been facing with regard to the development of the economy are not only
socio-economic but also geographic and structural. In the following section we
discuss some of the challenges faced by Nepal.

Geographic constraints
Nepal's efforts towards achieving higher growth and development have been
hindered by its landlocked position, the long open border with India and
2
mountainous terrain. Although the total area of the country is 141,000 km , only
about 2.6 million hectares (18% of the total) is under cultivation. An addition

156
 DEVELOPING THE NEPALESE ECONOMY

3-4% of arable land could be obtained by further clearing the fast depleting
forest resources. Nepal's population density is about 600 persons km 2 of arable
land, one of the highest in the world.
Nepal's three ecological and five development regions vary widely in terms of
per capita holdings and productivity. About 53% of the total population live in
the hill and mountain regions, an area of about one million hectares, containing
about 40% of the country's total cultivated land. Forty-seven per cent of Nepalis
live in the Terai, an area of 1.4 million hectares which amounts for 53% of the
country's land holdings. There are also substantial variations between districts in
the three ecological zones. The three Terai districts of Morang, Jhapa and
Kapilvastu have 111,000, 105,000 and 90,000 ha of cultivated land, respectively,
while the three mountain districts of the Manang, Mustang and Humla have
merely 800, 1200 and 3100 ha of cultivated land, respectively. Most of the
mountain and hill regions have a chronic food deficiency, while the Terai region
normally produces a food surplus. But, since the average purchasing power is so
low in the two regions and modern transport facilities are almost non-existent,
the government has had to bear a huge subsidy in order to distribute foodgrains
at a reasonable price.
The mountainous terrain of the country has posed numerous problems.
Creating a socio-economic infrastructure is formidable and expensive. Expand-
ing the economy into the interior parts of the country and integrating their
subsistence economy into the country's market economy is also difficult. About
90% of the population lives in rural areas. Linking rural areas to urban centers
and providing public goods and services to a widely scattered population living
in over 4000 villages would be a daunting challenge for any government. Nepal
has achieved noticeable progress in extending road networks. However, over
60% of the road networks are concentrated in the Kathmandu Valley and Terai
region. Geographically, the mountains and hills are suitable for dairy and fruit
products but, due to a lack of adequate transportation networks, these products do
not get access to urban markets. Similar is the case with industrial develop-ment.
Over the years, a number of industries both in the state and the private sectors
have been established but most of these are concentrated in the Kath-mandu
Valley and Terai region. Of the 4230 'large' industries (those employing more
than ten employees) in 1991, about half were located in the Central Development
Region and that, too, mainly in the Kathmandu Valley. 13
Nepal's long and open border with India is another challenge to its develop-
ment efforts. The latter has created a number of problems. India's superior
infrastructure, better developed skills and technology, and the economy of scale
provided by its large domestic market act as disincentives to developing
industries in Nepal. Except for some advantages in providing unskilled labour,
there are very few areas where Nepal can compete with India. Therefore, only
industries with some sort of government protection (either by way of subsidy or
other concessions) can become viable.
The question of surviving competition from India, particularly in the industrial
sector, has become even more serious with the advent of economic liberalization

157
NARAYAN KHADKA

in both India and Nepal since the early 1990s. After the liberalization of trade
policies, imports from India have increased considerably, resulting in an ever-
increasing trade deficit for Nepal. The challenge before the government is to
strike a balance between trade with India and the protection of domestic
industries.
The problems associated with its long and open border with India are
exacerbated by Nepal's landlocked position. This imposes direct higher costs of
transit. It also inhibits Nepal's ability to develop commercial relations with other
countries and to pursue independent commercial, monetary and pricing policies.
In addition, Nepali 'businessmen complain that they are unable to get high-
quality goods at international prices from India under the present system. They
suggest that Nepal can import high-quality goods at the same international prices
directly from Europe'.14 India's economic reform measures have eased the
problem to a certain extent, but the country faces the challenge of aligning
pricing and supply policies with those of India. The open border also has become
a constant source of misunderstanding between the two countries as it encour-
ages the cross-border smuggling of goods.

Structural and institutional constraints

Over the past several decades, Nepal has been unable to transform itself
effectively from an overwhelming agricultural to an industrial economy, or to
create sufficient conditions in the agricultural sector for increasing opportunities
for employment and income. Although the percentage of people engaged in
agriculture has declined during 1971-1991 (Table 3), this sector still employs
huge numbers. Without increasing productivity and incomes in this sector, the
employment and income situation for the majority of Nepal's population is not
going to be affected. Barring the service sector (including the financial sector),
the growth in other economic activities is marginal. Employment in production
and labour, as well as professional and technical activities, indicates progress, but
since these sectors had a minimal absorption of the labour force in 1971, their
increase in 1991 is not significant if seen in terms of total number of
economically active population. The country has some prospect of developing
tourism which accounts for about 25% of total foreign exchange earnings. But,
due to excessive pollution and environmental problems, growing political unrest,
and the lack of adequate facilities and protection, there might be a decline of the
tourist industry. Finally, the country's high hydro power potential of about 25,000
MW has not yet been sufficiently exploited; only about 300 MW were utilized up
to 1992.
The failure of the agricultural sector to generate higher growth and savings, as
well as to boost the industrial sector, caused the government in the 1980s to
increase public spending. The failure of past development efforts to increase
GDP and to uplift the conditions of the average poor also required substantial
programs of investment and growth. Since the economy responded rather slowly
to the increase in public spending, the pressure on the demand side escalated,

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Table 3. Economically active population by major occupation (population in 000)

Sectors 1971 1981 1991

Agriculture (farm 4579 (94.4) 6260 (91.4) 5952 (81.4)

and fish)
Production/labour 106 (2.2) 214 (3.1) 310 (4.2)
Professional/technical 25 (0.5) 64 (0.9) 130 (1.8)
Sales 60 (1.2) 85 (1.2) 218 (3.0)
Clerical 47 (1.0) 49 (0.7) 77 (1.1)
Service 34 (0.7) 16 (0.2) 454 (6.2)
Administrative 1 (insig.) 6 (insig.) 22 (0.3)
Workers — (2.3) 153
Others 156 (2.1)
Total 4852 (100.0) 6850 (99.8) 7316 (100.1)

Source: Central Bureau of Statistics, Statistical Year Book of Nepal 1993 (Kathmandu, 1993),
and Central Bureau of Statistics, Population Census Reports (various issues) (Kathmandu).

resulting in an increase in prices, budgetary deficit, an increase in imports and,

consequently a deterioration in balance of payments. As the country required
additional foreign aid to manage the macroeconomic imbalances, international
lending institutions such as the International Monetary Fund (IMF) and the
World Bank imposed the condition that increased loans would be contingent on
stabilization policies combined with institutional and structural reforms. The
result was the acceptance by Nepal of the Structural Adjustment Program of the
World Bank and the IMF in the mid-1980s. The democratic governments of the
post-panchayat period also have introduced economic reforms supported by the
IMF under the Enhanced Structural Adjustment Facility.
However, the reforms have not produced as yet satisfactory results in terms of
increasing growth, alleviating poverty and generating employment opportunities
by correcting macroeconomic imbalances because of structural as well as
institutional weaknesses. The government's efforts in raising higher domestic
resource mobilization is constrained by low per capita income, a higher con-
sumption level due to the subsistence level of the economy (a characteristic of
low-income countries), and inefficient tax administration. Financial deregulation
and liberalization is also constrained by ineffective financial institutions and the
absence of intermediaries. Much private income takes the form of urban real
estate property where taxes are either low or can be evaded. The lack of
confidence in the Nepalese rupee and the probability of its frequent depreciation
induce many businessmen either to deposit their funds with Indian banks across
the border or invest in gold and other precious metals. There has been an
impressive growth of private sector banks, but competition has become intense
as most banking operations have to be targeted at the urban population. In
addition, there exists a dualistic financial market of the formal and the informal
sectors. Coordinating the two, let alone controlling the role of rural money
lenders, is a real challenge. As one report put it,

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despite the progress made in reforming the financial sector in Nepal, it remains thin
and fragmented. For example, interest rates on short term government securities have
yet to be aligned with market levels; an adequate secondary market for government
securities is not yet available; and commercial banking activity is highly concentrated
with 90 per cent of the deposits held by the two major public sector banks. Under
these circumstances, market mechanism can hardly operate to foster the efficient
15
allocation of resources through competition.
Institutional constraints are also responsible for the poor state of Nepal's
economy. There has not been much change in the political economy of social
structures. Traditionally, the rural politico-economic structures were controlled
by the upper caste and this is still very much prevalent. National politics also are
still controlled by the upper caste who derive their economic power base from
land ownership, and this is valid across all political parties. This is one major
reason why, despite several efforts in the past and in recent years to introduce
land reform measures, very little success has been achieved. The government also
has set up a number of institutions to supply the necessary inputs of goods and
services to the public; for example, the Agricultural Development Bank,
Agricultural Inputs Corporation and Nepal Food Corporation. But access to these
services by the poor are restricted by their lack of awareness and education,
cumbersome procedures, and the physical remoteness of village communities.
Due to these constraints, government support services do not reach the needy and
are costly and unsustainable.
The government faces a serious dilemma with regard to reforming institutional
bottlenecks. On the one hand, measures that affect the interests of the econom-
ically better-off and the elites are stiffly opposed. On the other hand, those
decisions that intend to serve the interest of the majority poor are hardly
seriously implemented. One glaring example is the current opposition from the
business community to the government's decision to introduce a value added tax
(VAT). The Federation of Chambers of Commerce has been protesting against
the government's decision to implement the tax, notwithstanding the fact that the
incidence of tax burden is shifted to the consumers. Another example is shown
by the opposition of the student body which is highly politicized, to the
Tribhuvan University (a government-controlled institution) to raise tuition fees
(which have been subsidized for many years).
The centralization of government decision-making has posed yet another
problem in reforming Nepal's institutional mechanisms. Numerous measures,
both legal and administrative, have been taken to decentralize authority. How-
ever, no effective decentralization can take place in Nepal due to the financial
dependence of the regional and district administrative units on the centre.
Pressure from the top echelons also means that either civil servants nor elected
representatives can insulated themselves from the undue influence of higher
authorities. Then there is the element of uncertainty in the bureaucracy, particu-
larly under Nepal's multi-party democracy. Governments have been changing
quite frequently, and the political party that comes to power usually makes
certain changes in administrative personnel. Party sympathizers are offered

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better positions and are rewarded, while those sympathizing with other political
parties are either transferred to other, less important ministries or laid off.
Corruption is also rampant and highly institutionalized at the lower echelons of
the civil service.

Political constraints
There are also political constraints to economic development, both prior to the
restoration of multiparty democracy and today. In the period between 1961 and
early 1990, Nepal was under an absolute monarchy. Opposition to the royal
regime was suppressed and every decision was made subservient to the suste-
nance of the royal regime. However, a movement for the restoration of
democracy (that was ended by a royal coup of the first democratically elected
government in December 1960) remained active, even though political parties
were banned and basic human rights were restricted. The population was divided
between supporters of the royal regime and those of the democratic movement,
as a result of which development became devoid of popular participation and
was defined and led by people with a strong vested interest in continuing with
the royal regime.
Since the restoration of democracy in 1990, there have been five different
governments in seven years. The degree of political fluidity maybe gauged by the
fact that in the six-month period between March 1997, when the UML and
National Democratic (ND) party coalition was formed, and September 1997, the
cabinet was reshuffled eight times. Nepal has experimented with both single-
party and coalition government, with all the major parties being represented at
one time or the other. Undoubtedly, political accountability and transparency are
supposed to be the hallmarks of a democratic regime. The past seven years of
experiment with a multiparty democracy has not been as conducive as thought
for economic development. Nepal's democratic exercise is beset with three major
challenges with regard to its economic development. Firstly, is the 'revolution of
rising expectations'. The common people believed that with the establishment of
a democratic system of government their economic conditions would improve in
the immediate future. This belief was also supported by the catchy slogans and
promises made by political parties during the movement and thereafter in all the
general elections. But since not a single political party, having had an
opportunity to be in power, could deliver on their promises, soon the beliefs of
the general public turned into disappointment and frustration. The consequence
was a greater degree of their involvement in street demonstrations and protest
movements, and growing support for radical parties such as the UML and the
Maoist movement. A second challenge is the nature of Nepal's social structures
in a traditional society where socio-political powers derived from caste,
hierarchy and wealth are major elements in social divisions. If examined from
this perspective, political power is crucial for social status and identity. Most of
the political parties are relentless in coming to and then clinging to power. One
consequence is intra-party feuding, and almost all political parties

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are suffering from disunity and incoherence. Finally, Nepal has a long way to go
before a fully democratic society and order is achieved. At present, unrest,
bandhs, and daily demonstrations have become the rule rather than the excep-
tion.
Politics during Nepal's democratic experiment has remained an important
factor in hindering development. The economic reform measures supported and
implemented by various governments in the post-panchayat period have been
compromised by the weak but politicized development administration as well as
implacable opposition in both the parliament and the street by opposition
political parties. Within weeks of the formation of the NC government in the
Spring of 1991, civil servants started an agitation demanding higher salaries and
benefits. They called off the strike without immediate gains but were later
appeased by the government raising their salary scales by an average of 28%.
The wage levels of public and private sector employees were raised also by about
30%. In a policy to cut expenditure, the government laid off 3700 civil servants
in 1992. But when the NC government was replaced by the UML, some of the
laid-off civil servants were reinstated, causing further divisions in the
bureaucracy along political lines. General strikes by public corporate employees,
and frequent bandhs called by almost every political party in opposition have led
also to huge losses for the economy and discouraged foreign investors.

Suggestions and solutions

Developing Nepal's economy remains a formidable challenge. The past four
decades have produced very little tangible results in terms of tackling the major
economic problems facing the country, let alone putting the economy on the track
of higher growth and prosperity. The country's rugged terrain, the dispar-ities in
resources and productivity in the three ecological zones, a poor resource base, the
dominance of subsistence agriculture and its failure to provide a strong economic
base for the growth and development of the economy, and institutional and
political bottlenecks are some of the major challenges facing Nepal. While the
country has practiced virtually every development strategy that has been vogue
since the 1960s, its fundamental problems of poverty alleviation, raising
productivity, creating off-farm employment opportunities, correcting regional
imbalances, and addressing environmental degradation have remained as serious
as in the past.
An open, competitive and market-determined economy offers the best possi-
bility for attaining growth in Nepal. Encouraging greater involvement of the
private sector and ensuring the efficient functioning of the market mechanisms
definitely offers advantages. In areas where private sector participation is
forthcoming and the principle of 'ability to afford' applies, not only is there no
need for the government to intervene but the impediments to these principles
should be removed. By doing so, the government can free up resources for the
four fundamental goals of higher productivity and growth, greater mobilization
of domestic savings, poverty alleviation, and greater social equity.

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Productivity and growth means shifting the economy from 'commerce' to the
production of goods and services. An accelerated rate of investment is key to
economic growth and a large percentage must be generated by the prime sector;
i.e. agriculture. A dynamic industrial sector is essential for bringing about
structural change and creating sustained employment. However, its growth and
development is dependent on the growth and development of the agricultural
sector. Private investment can be crucial here. The government's role is vital in
removing market imperfections and rigidities, integrating the subsistence econ-
omy with the market economy, correcting institutional bottlenecks, combining
investment policy with appropriate monetary and fiscal policies, and minimising
the crowding out of the private sector. If private investment is to be channeled
into productive sectors, investors also must be protected from competition from
India.
An appropriate investment strategy should be framed to coordinate and
complement the public and private sectors, export- and inward-oriented indus-
tries, the exchange rate and monetary policy, and relative prices between traded
and non-traded goods. The reduction of an anti-export bias the is one good aspect
of policy reform, but the merits of certain policies such as currency depreciation,
export subsidies and tariff reduction must be examined in the light of the overall
economy, especially when the export sector is only a small segment. The
government should also try to remove non-price factor impedi-ments (improving
infrastructure, technology, human skills and marketing) on exports rather than
relying entirely on exchange rate adjustments. However, for both export
promotion and foreign investment, domestic price stabilization is a necessary
condition for an appropriate exchange rate policy to work.
Economic reforms also must mobilise domestic savings. Despite negative real
interest rates, financial savings have increased; this clearly shows that investment
opportunities are limited in Nepal. In recent years elected governments have
widened the tax base, encouraged competition in financial markets, deregulated
interest rates, and decontrolled statutory regulations in lending obligations. But
much more needs to be done. Excess dependence on aid should not compress
governmental efforts in raising more revenue domestically, administrative ma-
chinery must be made efficient, honest and committed, informal financial
markets should be integrated into the formal sector, and improvements made in
the functioning of the capital markets. Financial and industrial organizations
should be mandated to introduce modern systems of accounting that would help
implement a broad-based VAT which will be required to make up for the revenue
loss due to custom and tariff reductions. Similarly, laws must be framed to bind
economic organizations at all levels to modernize and standardize their
accounting and finance systems. Selective fiscal interventions are necessary to
discourage the growing tendency towards luxury and semi-luxury goods con-
sumerism, and the massive growth in real estate investment in urban areas.
Above all, economic reforms must hinge on raising real growth rates in order to
increase the rate of domestic savings in Nepal.
Policy reforms should also address the issue of poverty alleviation. In the

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NARAYAN KHADKA

existing socio-economic framework, the market mechanism has a limited role in

poverty alleviation. The government should increase the efficiency of resources
allocated for social development. In terms of employment and other income-dis-
tribution measures such as public works, human resource development projects
should target the poorer and underprivileged sections through local political
institutions.
Economic reforms should not overlook the issue of distributional equity in
Nepal. Growth should not be at the cost of the poor. In view of the country's
pervasive poverty and highly skewed income and asset distribution, appropriate
legal and fiscal measures should be framed. Since the size of the entrepreneurial
class is very limited, actual competition in various economic activities may be
rare and monopoly tendencies may evolve. The government can address the
social equity issues by way of two approaches; increasing real income through
direct employment opportunities, and removing institutional bottlenecks. En-
couraging fair price shops, guaranteeing minimum floor prices for agricultural
products, opening quality educational facilities for the public, and other social
investment should also help address the equity issue.
The economic reform measures introduced by the various Nepali governments
may need a longer time framework for bearing desirable results. Along with the
development of the market forces, there also must emerge a parallel development
in legal and institutional forces. If the miserable economic performance of Africa
16
is any lesson, one can agree that also in Nepal the requirement for development
is the adoption of policies of a much longer time horizon. However, the
government should make periodic evaluation of the impact of these reforms and
address problems as they appear.

Notes and references

1. See David Dollar, 'Outward-oriented developing economies really do grow more rapidly: evidence from 95
LDCs, 1976-1985', Economic Development and Cultural Change, Vol 40, No 3, 1992, pp 523-544.
2. His Majesty's Government National Planning Commission Approach to the Eighth Plan 1992-97
(Kathmandu: National Planning Commission, 1992), p 10.
3. His Majesty's Government Ministry of Finance Budget Speech of the Fiscal Year 1994-95 (Kathmandu:
Ministry of Finance, 1994), p 6.
4. See N. Khadka, 'Nepal's programme for fulfillment of basic needs (1985-2000): a critical prognosis',
McGill University Center for Developing Area Studies, Discussion Paper No 65, April 1991, p 7.
5. Nepal Rastra Bank, Multi-Purpose Household Budget Survey (Kathmandu, 1987).
6. The World Bank, World Development Report 1997 (New York: Oxford University Press, 1997).
7. Central Bureau of Statistics and the World Bank, Nepal Living Standard Survey Report (Kathmandu,
1996).
8. Asian Development Bank, Asian Development Outlook 1996 and 1997 (New York: Oxford University
Press, 1997).
9. The land administration system classifies 'big farm' as over 1 ha in the hill and mountain regions, and over
5 ha in the low-land region called the Terai but these are not big enough for commercial farming.
10. The World Bank, Nepal: Relieving Poverty in a Resource-Scarce Economy (Vol I, Main Report)
(Washington D.C., 1990), p 33.
11. Between 1970 and the mid-1980s, Nepal's forest may have been reduced by 25%, 'contributing to soil
erosion, fuel-wood shortages and the increasing use of animal dung as fuel, the to the growing detriment of
soil erosion'. See the World Bank, Nepal Policies for Improving Growth and Alleviating Poverty
(Washington D . C . , 1988), p 1.

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12. N. Khadka, 'Industrializing the subsistence agricultural economy of Nepal', Industry and Development
(UNIDO), Vienna, No 34, 1993.
13. Central Bureau of Statistics, Census of Manufacturing Establishments, 1991-92 (Kathmandu).
14. The Kathmandu Post (Kathmandu), 28 November.
15. Asian Development Bank, Asian Development Outlook 1992 (New York: Oxford University Press, 1995), p
187.
16. Due to the poor economic performance of Africa, there has been convergence among analysts of African
development that 'the requirement for economic development for sub-Saharan Africa is the adoption by
policy makers of a much longer time horizon than is implicitly in current structural adjustment programs
and many current evaluations'. See G.K. Hellenier, 'The IMF, the World Bank and Africa's adjustment and
external debt problems: an unofficial view', World Development, Vol 20, No 6, 1992, p 779.

165