Nepal’s Graduation Challenges and Way Forward

Nepal, having fulfilled two of the three criteria for graduation in two subsequent triennial reviews, has been endorsed by the United Nations (UN) General Assembly for graduation from the LDC category with a five-year preparatory period taking note of the recommendations made by the UN Committee for Development Policy (CDP) and the UN Economic and Social Council (ECOSOC). Accordingly, Nepal is poised to graduate from the LDC group in 2026. Graduation would indeed be a major milestone in the history of Nepal. This transition would not only boost Nepal’s image on the world stage but also provide a better credit rating for the country. However, the path after graduation is not easy and accompanied by significant challenges in ensuring sustainable and irreversible graduation.

According to the United Nations Conference on Trade and Development (UNCTAD), many LDCs are likely to face two major challenges beyond graduation: a risk of reversion to the LDC status and the middle-income trap. Every graduation is accompanied by the risk of reversion, mainly due to exogenous shocks such as the COVID-19 pandemic, climate-induced disasters, and trade shocks which are the major threats to the economy of Nepal as well. Likewise, Nepal presents a unique case as it is the first country to graduate from the LDC category without meeting the Gross National Income (GNI) criterion. The GNI per capita income of Nepal was USD 745 against the graduation threshold of USD 1,230 in the 2021 triennial review. Meanwhile, Nepal is graduating by meeting the threshold for other two criteria: Human Asset Index (HAI) and Economic Vulnerability Index (EVI). Consequently, it faces an uphill task in having sustained economic growth to progress from a currently lower-middle income country to a high-income country, due to the persistence of structural vulnerabilities, infrastructural gap, and low levels of human capital, among many other problems.

There are several economic implications of graduation. Upon graduation, Nepal will lose certain special benefits that come with the LDC status, such as preferential market access for goods and services, flexibility in the implementation of the rules of the World Trade Organisation (WTO), international development measures, and special finance. Although Nepal would be eligible for the Generalised Scheme of Preferences (GSP) that is available to developing countries, it is much less generous than the duty-free, quota-free (DFQF) market access provided by most advanced economies to LDCs. For example, exports from Nepal to the European Union countries would face around a 5% increase in tariff on average under GSP which would adversely impact mainly the garment, textile, and carpet industry. A study shows that Nepal could lose 4.3% of exports because of tariff changes when it graduates from LDC status in 2026, the major reasons being the loss of preferential market access and stricter rules of origin (RoO) in the EU, Turkey, and the United Kingdom (UK). Further, the government will have some additional restrictions in its policy space as it will be required to do away with export subsidies, especially in agricultural goods, after graduation. Nepal is, thus, likely to face competitive pressure on export products on withdrawal of international support measures after graduation.

Garnering the financial resources required to finance the necessary investment to put the LDCs on a rapid growth path remains a key challenge for implementing the Doha Programme of Action (DPoA), a dedicated ten-year programme of action adopted by the UN to provide differential treatment to the LDCs, which has a close alignment with the Sustainable Development Goals (SDGs). The fiscal constraint of LDCs has been worsened by the COVID-19 pandemic, primarily due to their undiversified export source that was impacted by global supply chain disruption and travel restrictions during the pandemic. Graduation is further likely to exacerbate the financing challenges as graduating LDCs will lose access to certain funding schemes. For example, Nepal, upon graduation, will no longer be able to receive new funding under the Least Developed Countries Fund (LDCF) which is targeted toward addressing the immediate needs concerning adaptation to climate change. Likewise, Nepal will lose access to Aid for Trade (AfT) under the Enhanced Integrated Framework (EIF) and UN Capital Development Fund (UNCDF) after five years following graduation. Also, once a country graduates from the Least Developed Countries (LDC) category, the minimum grant element of Official Development Assistance (ODA) loans decreases unless it remains classified as a low-income country (LIC); however, Nepal has also climbed up to become a ‘lower-middle-income country (LMIC)’ due to which the lending conditions are becoming comparatively more stringent.

Hence, the coming years will be a defining period for Nepal with both opportunities and challenges as it navigates from an LDC into a developing country toward becoming a middle-income country. As a result, a smooth, nonreversible, inclusive, resilient, and sustainable transition is crucial for a graduating LDC. The concept of smooth transition embodies the principle that LDC-specific support should be phased out gradually and predictably following graduation, so as not to disrupt the development process of the graduating country, under General Assembly resolutions 59/209, 66/213, and 67/221. The Government of Nepal needs to take a lead role in making graduation smooth and sustainable by preparing a transition strategy accompanied by a graduation strategy, and also strengthening and activating the LDC Steering Committee recently formed under the National Planning Commission. The country needs to build its productive capacity, expand its export base, diversify its economy, and make serious efforts toward poverty alleviation to sustain its graduation in the long run. It is equally important to take along the private sector, civil society, and international community while it pursues the agenda of sustainable graduation. Furthermore, Nepal needs to learn from the graduation experience of the graduated former LDCs. For example, Botswana, Cape Verde, and the Maldives had a slowdown in their economic growth during the post-graduation period. However, the Maldives could later maintain stability in their exports post-graduation due to the joint promotional activities of their major export product, i.e., fish, by the private sector and the government. Similarly, Cape Verde undertook good planning before graduation and was able to successfully negotiate with the EU for an additional two-year grace period for the ‘Everything But Arms (EBA)’ arrangement and some additional transition period deals with major trade partners like China. Similarly, Nepal can also negotiate to gain access to the Generalised System of Preferences Plus (GSP+), giving it dedicated preferential tariff rates which are much less than the GSP tariff rates. One of the important conditions to have access to GSP+ is the ratification of 27 conventions on human and labour rights, environment, and governance out of which Nepal has already ratified 26.

Furthermore, development and trading partners, including the United Nations system, should continue to support the implementation of the transition strategy and avoid any abrupt reductions in financial and technical assistance, and should consider extending trade preferences to the graduated country, on a bilateral basis. Development partners should also provide more finance and continue to ensure that more finances are in the form of grants rather than loans, and the interest rates for loans should be kept as low as possible. They should provide more finance to help LDCs adapt to climate change and better manage their disaster risk while considering new approaches that would make these funds easier to access. Similarly, the international community must phase out the LDC-specific support measures, keeping in mind that the graduated countries would not have built the productive capacity to have sustained development. In addition, the WTO should extend the existing special and differential treatment and exemptions available to LDCs for a period appropriate to the development situation. Equally important is for Nepal to build its diplomatic capital to negotiate with UN agencies, multilateral and regional trading bodies, and other international community, seeking appropriate support for sustainable graduation.

This article was originally published in ‘Nefport 50: LDC Graduation and Beyond’ in September 2022.