Nepal has taken the chair of the group of the least developed countries (LDCs) at the fifth UN Conference on Least Developed Countries held in Doha on March 5–9.

Though Nepal is currently leading the 46 countries enlisted as LDCs, it will no longer be in a position to lead this group as it is set to graduate to a developing country on November 24, 2026.

The 40th plenary of the 76th Session of the United Nations General Assembly (UNGA) in November 2021 had unanimously adopted a resolution, endorsing Nepal’s graduation from the LDC category with the preparatory period of five years. Nepal has been an LDC since its listing in the group in 1971.

Why the graduation?

To graduate from the LDC, a country needs to meet at least two of three criteria set by the United Nations: per capita income, human asset index (HAI) and economic and environmental vulnerability index (EVI).

Nepal has already met two criteria, HAI and EVI, in three successive triennial reviews in 2015, 2018 and 2021.

The country had earlier refused to graduate in 2015 and 2018, citing the impact of 2015 earthquakes and low per capita income. But in 2021 Nepal agreed to its graduation by 2026. When the resolution of Nepal’s graduation from LDC was adopted by the UN General Assembly, Nepal's per capita income was $1,027 against the requirement of $1,222.

Nepal is yet to meet this criteria, as per data of the last fiscal year from the National Statistics Office.

Nepal’s score was 74.9 in HAI, against the requirement of 66 or above. Likewise, its score was 24.7 in EVI, against the requirement of 32 or below, according to the UN Department of Economics and Social Affairs.

The impact of Covid-19

The pandemic hit Nepal’s economy hard, leading to a negative growth of 2.4 percent in fiscal year 2019-20, the year of the pandemic. In the subsequent fiscal years 2020-21 and 2021-22, the economy grew by just 4.3 percent and 5.8 percent respectively, according to the statistics office.

Nepal witnessed a 0.8 percent growth in the first quarter of the current fiscal year, suggesting a sluggish economic performance this year (2022-23) too.

The crisis caused by depletion of foreign exchange reserves and liquidity crunch in the last fiscal year and the revenue shortfall in the current fiscal year also exposed the vulnerability of Nepal’s economy.

But the country didn’t roll back its plan to graduate from the LDC in 2026, unlike in the past. Posh Raj Pandey, executive chairperson of the South Asia Watch on Trade, Economics and Environment (SAWTEE), a Kathmandu-based think tank, said that despite the Covid-19 setback, Nepal is unlikely to lose ground on its achievements in the areas set by the UN.

“So long as Nepal achieves economic growth, even if marginal, its per capita income will continue to grow,” Pandey said. According to him, there will be no reversal in achievements in education and health, which contributed to HAI.

“Today’s literate person will not be illiterate tomorrow and without a big epidemic or pandemic, achievements in health will not be reversed.”

He also said that Nepal won’t be economically and environmentally vulnerable so long as there is no severe drought hampering agriculture or big natural disasters damaging livelihoods. “So Nepal stepping back from the graduation plan will be a national shame,” he said. “The international community will see Nepal as having graduated anyway.”

Advantages of graduation

The report titled “Nepal Human Development Report 2020: Beyond LDC Graduation: Productive Transformation and Prosperity” points out certain advantages of graduating from the LDC category.

The report jointly prepared by the National Planning Commision and the United Nations Development Programme (UNDP) says graduation makes countries more creditworthy in the eyes of international credit rating agencies, thus improving access to commercial finance.

“Graduation from the LDC category would transmit a positive message to the global community about Nepal’s development prospects. It can be branded as a potentially competitive destination for foreign direct investment inflows and other private investments,” the report said.

But Nepal’s creditworthiness is yet to be determined as the country has never had a sovereign rating. Nepal has failed to attract foreign direct investments (FDI) to the tune of even one percent of its gross domestic product (GDP) so far.

Experts say political and policy instability caused by political changes could deprive Nepal from taking advantage of the graduation.

What challenges will Nepal face?

After Nepal’s graduation to a developing country category, there are possibilities of reduced exports to some markets due to high tariffs, and adverse impact to access to funds specifically created for the LDCs, according to the report prepared by the NPC and UNDP.

As per the report, funding from the UN group could go down, although aid from multilateral donors like the World Bank and the Asian Development Bank as well as from most bilateral donors is not expected to be impacted.

Nepal will also lose preferential market access and see increased competition in international markets after the graduation. This would disproportionately impact export-oriented small and medium enterprises and the jobs they create.

In particular, exports to the European Union, which provides duty and quota-free market access under its “everything but arms” policy, could be badly affected. Exports to the EU could decline by as much as 57 percent due to the lack of preference, the report says.

SAWTEE stated in its report titled Nepal’s Graduation from the LDC Category: Implications for International Trade and Development that Nepal’s exports could fall by 2.5 percent to 4 percent as a result of increased tariffs.

While the EU, the United Kingdom, and Turkey provide a transition period of three years after graduation, Nepal will face new tariff regimes in other preference-granting countries, post-graduation.

The report said that tariff increase in the US, the largest market for Nepal’s exports after India, is relatively low at 1.5 percent.

Export-based industries fear possible loss of market for their products. When the multi-fiber agreement (MFA) was abolished in 2005, Nepal’s garment sector that had benefited from the quota system provided by the US as per the MFA, saw a slump in garment exports. The thriving industry witnessed a terminal decline.

“We are worried about a similar fate for carpets,” said Samik Bikram Shah, vice-president of Nepal Carpet Manufacturers and Exporters Association.

“Following graduation, we will not have tariff advantage under the General System of Preference. So our products will be more expensive compared to those of our competitors. Remember that we depend on imported raw materials and have seen rising labour costs.”

What should Nepal do?

The United Nations General Assembly has given a five-year preparatory period so that Nepal and its businesses can bear the negative consequences of the loss of preferential treatment.

The NPC is now preparing a transition strategy whose implementation would help minimise the adverse impact on the economy.

Ram Kumar Phuyal, an NPC member, said the strategy would focus on the impact of LDC graduation on the economy and the compensation mechanism to be adopted.

“We are going to include measures to be taken and determine what the government and private entities responsible for implementing those strategies should do,” said Phuyal.

According to the SAWTEE study report, one factor Nepal’s exports won’t be severely hurt is that India absorbs about two-thirds of its exports. Nepal and India have bilateral trade treaties under which Nepal can export almost all its goods at zero tariff. There is also a scope for exporting goods in South Asian countries under the South Asia Free Trade Area Agreement (SAFTA).

“We can enter the GSP+ mechanism of the EU which provides duty free market access to up to 70 percent of goods,” said Pandey. “If we fail to enter this mechanism, we can negotiate for the most favoured nation’s status as well.”

The GSP+ gives developing countries a special incentive to pursue sustainable development goals and good governance. “There have also been efforts to give more time to the LDCs before the removal of their existing facilities under the World Trade Organisation,” Pandey added.