Determinants of International Trade: Nepalese Perspectives

International trade, the exchange of goods and services across borders, is crucial for economic growth. It fosters competition, increases access to resources, and promotes specialization. Nepal's economy is significantly impacted by international trade, particularly imports, largely driven by remittance inflows boosting household income and demand. However, imports vastly outweigh exports, creating an imbalance influenced by GDP, remittances, international prices, and exchange rates. This study addresses the gap in comprehensive analysis of these determinants' impact on Nepal's trade balance, aiming to understand the underlying factors contributing to the trade imbalance and inform policy strategies to improve trade performance and sustainable economic growth.

Existing literature on Nepal's foreign trade uses gravity models and analyzes factors like GDP, exchange rates, distance, and regional integration. Acharya (2013) found that trade partners' GDP influences both imports and exports, although Nepal's trade deficit persists. Bista and Adhikari (2021) showed that Nepal's and trading partners' GDP, exchange rates, and SAFTA membership positively affect exports, while distance has a negative impact. Sharma (2020) highlighted Nepal's heavy reliance on India and a persistent trade deficit. This study builds upon this existing research by providing a more in-depth analysis of specific economic determinants and their impact on Nepal's trade balance.

This empirical study uses secondary data from institutions like Nepal Rastra Bank, Ministry of Finance, Central Bureau of Statistics, World Bank, IMF, and Reserve Bank of India. Annual time-series data from July 1975 to July 2023 are employed. Two regression models are used: Model A for imports and Model B for exports. Model A includes real GDP, remittances, India's CPI, and Nepal's CPI as independent variables, while Model B includes India's CPI relative to Nepal's CPI, the exchange rate (NPR/USD), and capital stock. Ordinary Least Squares (OLS) regression is used. Initial analyses revealed multicollinearity issues between Nepal's and India's CPIs, leading to model adjustments. The study also incorporates a dummy variable for the COVID-19 pandemic to account for potential impact on trade. Logarithmic transformations are applied to variables to address non-linear relationships and stabilize variance. The study assesses model validity and reliability through data quality, rigorous analysis, and consideration of potential autocorrelation and heteroscedasticity.

Model A (imports) initially showed that real GDP and Nepal's CPI positively and significantly affected imports, while remittances had a marginally significant negative effect. India's CPI was statistically insignificant due to multicollinearity. After addressing multicollinearity by dropping Nepal's CPI and adding a COVID-19 dummy variable (which proved insignificant and was later dropped), the final Model A showed that real GDP and India's CPI positively and significantly affected imports, while remittances showed a significant negative effect. Model B (exports) initially showed only the exchange rate significantly and positively impacting exports. The ratio of India's CPI to Nepal's CPI and capital stock were not significant. To address potential spurious data, differenced log transformations (DLOG) were applied. The revised Model B, using DLOG, revealed that India's CPI (DLOG(CPII)) had a highly significant negative effect on exports, while the exchange rate (DLOG(EXRATE)) showed a significant positive effect. The addition of real GDP (DLOG(RGDP)) yielded a marginally significant positive impact on exports. The final Model B explained a substantial proportion of the variation in exports (47.06%).

The findings demonstrate that Nepal's import and export patterns are significantly shaped by domestic economic activity (GDP), remittance inflows, and India's price levels. The unexpected negative relationship between remittances and imports requires further investigation. The strong negative impact of India's CPI on exports highlights the need for diversifying export markets and enhancing product competitiveness. The positive relationship between exchange rates and exports emphasizes the importance of prudent monetary policy. The positive impact of GDP on both imports and exports underscores the importance of sustainable economic growth for improved trade performance. The study's high R-squared values suggest strong model fits, although issues like autocorrelation need ongoing consideration.

This study provides valuable insights into the determinants of Nepal's international trade. Policy recommendations include sustainable economic growth strategies, efficient remittance utilization, mitigating rising import costs, diversifying export markets, maintaining a favorable exchange rate, improving product competitiveness, and promoting domestic production. Future research could focus on exploring the nuanced relationship between remittances and imports, investigating the impact of specific sectors on trade, and analyzing the role of non-economic factors, such as political and institutional factors influencing Nepal's trade relations.

The study relies on secondary data, limiting the control over data quality and potential biases. The focus on macroeconomic indicators might overlook micro-level factors influencing trade. The model's reliance on linear relationships might not fully capture the complexity of trade dynamics. The time-series analysis may not capture structural breaks or regime shifts fully affecting trade patterns.