Business not as usual

India-Nepal trade relations force another round of turbulence.

IT has been open season on Nepal, first with Indian intelligence agencies raising an alarm about the Himalayan kingdom becoming the new base for subversive activities by Pakistan's Inter-Services Intelligence across the open Nepal-India border, and more recently, with Indian business crying foul about a 'surge' in imports caused by the re-export of third country goods to India by Nepal, taking advantage of the loopholes in the Indo-Nepal trade treaty of December 1996 and worse, accusing Nepal of being a conduit for smuggled Chinese goods. The Federation of Nepalese Chambers of Commerce and Industry (FNCCI) denied any 'surge' or 'loopholes' in the treaty or for that matter any smuggling of Chinese goods via the open border. The Nepalese media, though defensive on the issue, allege that India, which was reluctant to confront China on the trade issue, is bullying and making a scapegoat of Nepal, as it did in the case of the hijacking of the Indian Airlines flight in 1999.

At risk is the 1996 treaty, which wrote up a new preferential script for Nepal, foregrounding "non-reciprocity", the hallmark of the Gujral doctrine towards neighbours. (I.K. Gujral was then the Foreign Minister). The treaty saw a seven-fold jump in Nepal's exports to India and a three-fold increase in India's exports to Nepal. As a consequence, Dabur Nepal's fruit juices, Nepal Lever's Close Up, Colgate-Palmolive's Nepal-made toothpaste and soaps and sundry items like vanaspati ghee, acrylic yarn and copper twine entered the Indian market at highly competitive rates.

Indian producers raised a hue and cry that Indian industry was being threatened by the re-export of third country goods by Nepal. They lobbied with the government to intervene against a surge in imports from Nepal, especially of vanaspati ghee, acrylic yarn and copper wire.

The 'politically motivated' zero duty clause in the 1996 treaty for export of Nepalese manufactures to India, was designed to encourage the industrialisation of Nepal. Instead, has it encouraged third country re-export to India via Nepal? A group of Nepalese businessmen who visited India to discuss matters with the Confederation of Indian Industry (CII) and the Federation of Indian Chamber of Commerce and Industry (FICCI) in February were told in no uncertain terms that Nepal must do something about value addition, or else.

"They were very tough," says Prabhakar Rana, co-chair of the Indo-Nepal Joint Eco Committee. The 1996 treaty is producing bad blood between India and Nepal and the uncertainty over the treaty has put a freeze on bilateral and third country investment, which was eyeing an integrated Nepal-Indian market.

The treaty comes up for (automatic) renewal this year, and all indications are that the Vajpayee government is taking a hard line on complaints about allegations of Nepal's conduit economy for authorised re-export and unauthorised smuggling of Chinese goods. Moreover, with Indian industry's complaints getting intertwined with the security allegations of intelligence agencies, India-Nepal trade relations have a rocky ride ahead. In the case of Nepal, security concerns and threats to domestic industry are mutually reinforcing each other in an overlapping threat scenario. Intelligence agency-inspired news reports project it as a nexus between Nepal-based traders and the ISI, funnelling funds for subversion through systematic under-invoicing of "authorised" trade. And in the case of unauthorised trade, the nexus with the underworld makes for smuggling, not only of goods but arms, explosives and subversives. The signal is that the government is getting tough.

In 2000, lobbying by Indian industry saw Commerce Minister Omar Abdullah respond with an outcrop of non-tariff barriers, including the mandatory Bureau of Indian Standards (BIS) and maximum retail price markings. In this year's budget, Finance Minister Yashwant Sinha levied counter-vailing duty (CVD) on the MRP as opposed to the earlier practice of charging it on the transaction price, for personal care items. As the Minister explained, the logic is to have a level playing field as the excise rate for domestic producers is on the basis of MRP. The measure is not specific to Nepal but its impact on Nepal goes against the grain of the preferential boost to the development of industry and employment in Nepal, which the architects of the 1996 treaty had intended. Nepal-based Indian joint ventures (JVs) have made a representation that the government should keep in mind Nepal's special needs.

According to the Indian Embassy's press spokesperson, Manoj Bharti, Indian investment in Nepal has grown to about 35 per cent of Nepal's gross domestic product (GDP) and accounts for 40 per cent of employment. But the new CVD provisions threaten to squeeze drastically their economics of production.

Says Sandip Ghosh of Nepal Lever, a subsidiary of Hindustan Lever: "The CVD provision will wipe out whatever competitive advantage Indian joint ventures like ours have." In Nepal's export basket, toothpaste and soap are the second and third biggest items. For Nepal Lever, which sources most of its raw materials and packaging from India, it will mean a hike in the cost of Nepal-made Pepsodent or Close Up to the tune of two Nepali rupees a tube. "We don't get MODVAT back, and if you add up the back freight costs, our operations will become unviable," says Ghosh. Even harder hit are Dabur Nepal and Colgate with its 90 per cent to 100 per cent export-oriented production. In the wake of the 1996 treaty, these Indian and third country JVs, such as Kodak Nepal, were set up to serve an integrated Nepal-India market, largely to take advantage of the difference in the tariff structure between Nepal and India.

THE rationale was that the treaty, with its zero duty clause for the export of Nepalese manufactured goods, would give a fillip to the industrialisation of Nepal, otherwise it would continue to remain a conduit economy for the smuggling of third country goods to India. But traders were quick to seize upon a loophole in the treaty as no level of material or labour content is specified, only HMG of Nepal and FNCCI are to certify Nepalese manufacture. Said one embassy source: "What we're getting is not the development of a manufacturing base but traders taking advantage of the difference in tariff structure to re-export through Nepal." The Kodak case is cited as an example of the misuse of the treaty provision. The duty on imported bulk film is 30 per cent in India and less than 10 per cent in Nepal. Where is the value addition in cutting the film and converting it into smaller rolls, they ask.

Consequently, India has refused Kodak Nepal access to its market, and the company has gone to the Nepal Supreme Court charging India with violating the treaty. A multinational company, Kodak could wipe out domestic industry in India, whereas the sundry small producers of vanaspati ghee or acrylic yarn in Nepal do not have the capacity to do so. But that has not stopped the Indian industry lobby from clamouring for protection, alleging a 'surge' in Nepalese export of these items. For over six months the Indian government was trying to fix a meeting under the surge clause in the treaty. Finally, in March, Nepal agreed to discuss the 'surge' in imports alleged to be the result of re-export of third country goods via Nepal. The No.1 item is vanaspati ghee, which tops Nepal's exports to India.

FNCCI secretary-general Badri Ojha maintains that vanaspati exports from Nepal account for less than 1 per cent of the Indian market for the product, while Indian producers claim that Nepal has mopped up 10 per cent of the market. The charge is that Nepal is re-exporting edible oil imported from Indonesia taking advantage of deep duty differential. Duty on edible oils in India is above 35 per cent and in Nepal 10 per cent and refunded on export. The flow chart of the hydrogenation process, say Indian embassy sources, reveals very little value added. And like copper twine and acrylic yarn, it is accused of being a mere re-export. India pays in rupees. It is Nepal which expends foreign exchange. In Budget 2001, duty rates on edible oil have been further increased to protect domestic producers but vanaspati ghee exports from Nepal are out of the loop. A 15 kg tin of Nepal-produced vanaspati, which was cheaper by (Indian) Rs.75, will now become even more competitively priced. Indian domestic industry argues that the hydrogenated process used in Nepal is inferior, and that the product is less healthy. When FNCCI representatives visited India in February, both the CII and the FICCI were adamant about value addition. Subsequently, FNCCI has taken up the matter with Nepal-based producers but with the uncertainty over vanaspati exports, there are no takers for the required investment for an improved product.

On top of this are the security linked charges of massive under-invoicing. Take the case of acrylic yarn. The international price of acrylic fibre is ($1.5) Rs.65 a kg. Nepalese companies export it at (Indian) Rs.68. The spinning cost is only Rs.3 when it should be Rs.30. The difference is collected through hawala channels and the money used to fund subversive activities, sources in the intelligence agencies are quoted in the Indian media as having said.

Badri Ojha denies that Nepal is misusing the zero duty clause to re-export third country goods. And FNCCI prides itself in the norms for certification. But its counterparts in India are not impressed. As for routing Chinese goods through Nepal, FNCCI points out that Nepal has introduced compulsory letter of credit with China and it has minimised diversion. Sino-Nepalese trade has actually declined. As for unauthorised trade, that is, smuggling of Chinese goods, Ojha says Nepal is helpless. But the Nepal government has taken some action. Forces of the Royal Nepal Army have been deployed to strengthen customs posts along the border. There are only three negative items on the trade list - alcohol, tobacco and perfumes.

Pressure is mounting, at the minimum to introduce a 30 per cent material and labour content clause and to expand the negative list. However, the clamour by domestic industry and the intelligence agencies could impel a situation which risks, as an embassy source pointed out, throwing the baby with the bath water. India has important political and economic stakes in the industrial development of Nepal, the raison d'etre of the preferential clause in the 1996 treaty. But clearly, a treaty which is seen as a scam on one side is not tenable. But opinion in Nepal is not impressed. Rajat Sharma, writing in The Kathmandu Post (December 2, 2000) summed it up thus: "Isn't this large-scale duty-free re-export marginal? Isn't the noise being made about imports threatening industry and security disproportionate to size?"

TO make matters worse for the future of Indian-Nepal relations is the groundswell of growing anti-Indian feelings which manifested themselves in the violence in December over the alleged remarks made by Indian actor Hrithik Roshan. Earlier in 2000, the factory premises of some Indian JVs were attacked. The growing Maoist insurgency in Nepal has further undermined Indian and third country investment plans. In particular, anti-Indian sentiments are likely to get worse with the temptation being faced by political parties to project negative nationalism as a unifying plank in Nepal. Already, the transition from autocracy to representational politics in Nepal is splintering the 1950 India-Nepal treaty and the psychological and material structure of friendly bilateral relations. Rocking the 1996 treaty will have further consequences for producing a mindset in which on the one side every Indian is seen as an exploiter and on the other, every Nepali as an India-baiter.

Working out a mutually beneficial economic relationship involves being sensitive to Nepal's defensiveness about trying to maintain economic sovereignty and its right to determine its own tariff structure. Nepal has not forgotten the humiliation of India's 1989 squeeze on the transit of goods to Nepal and the persisting difficulties over transit even now. Politics, not economics, should mediate the present crisis in trade relations, argue political commentators in Kathmandu. For, taking the so-called special relationship with Nepal for granted will only threaten India's security.