Development policy, inequity and civil war in Nepal

Journal of International Development

J. Int. Dev. 18, 553–569 (2006)

Published online 16 March 2006 in Wiley InterScience

(www.interscience.wiley.com). DOI: 10.1002/jid.1252

DEVELOPMENT POLICY, INEQUITYAND CIVIL WAR IN NEPALy

KISHOR SHARMA*

Faculty of Commerce, Charles Sturt University, Wagga Wagga, Australia

Abstract: It is argued that the civil war which erupted in Nepal in the mid 1990s had its seeds

sown five decades ago when the country embarked on the economic development plan which

placed a heavy emphasis on an urban-based import-substitution strategy. This strategy failed

to benefit 86 per cent of the population who live in rural areas and rely on agriculture. This,

together with poor governance, significantly increased unemployment, poverty and rural–

urban inequality by the mid 1990s, leading to the eruption of civil war. Copyright # 2006

John Wiley & Sons, Ltd.

Keywords: Nepal; development policy; productivity; poverty; inequity; civil war

1 INTRODUCTION

Civil war which erupted in Nepal in the mid 1990s had its seeds sown five decades ago

when the country embarked on an import substitution (IS) strategy. While the IS policy

accelerated growth (brought about by urban-based non-agricultural activities), it failed to

benefit 86 per cent of the population living in rural areas. The bias inherited in the IS policy

favoured urban-based activities and attracted resources away from rural areas, leading to a

fall in agricultural productivity. As agricultural productivity fell, exports declined. This,

together with the lack of alternative employment opportunities, significantly increased

unemployment, poverty and rural–urban inequality. By the early 1990s, poverty and

inequality increased, governance deteriorated and political instability increased, which

forced disadvantaged youth particularly from rural and remote areas to join radical left

wing forces (Maoists) to fight against the political system and economic policy. Who are

the Maoists? Maoists are the left wing forces who did not join the United Left Front during

the struggles for democracy in 1990s, but they did contest the 1991 election. Failing to

Copyright # 2006 John Wiley & Sons, Ltd.

*Correspondence to: K. Sharma, Faculty of Commerce, Charles Sturt University, Wagga Wagga, NSW 2650,Australia. E-mail: [email protected] earlier version of this paper was presented at the UNU/WIDER conference on Making Peace Work inHelsinki. This revised version has benefited from comments from Prema-chandra Athukorala, EdwardOczkowski and an anonymous referee. Needless to say all remaining errors are mine.

secure less than 5 per cent of the vote they rejected the 1991 constitution.1 They then

demanded that a constitution assembly be set up for the formation of a republic state (i.e.

replace the present constitutional monarchy with a Marxist republic) and became an

underground group in 1994, they declared a people’s war on 13th February 1996. This

radical group, which consists of poor farmers and disadvantaged youth from rural areas, is

known as Maoists. They have adopted violent means to change the political and economic

settings in the country. In a very short period of time they have developed their own

military forces and have gained control of several hilly and mountain areas.2

Our aim in this paper is twofold: first, to demonstrate how economic policy failure can

provide a fertile ground for civil war,3 using Nepal as a case study; and second, investigate

the economic and social costs of the ongoing conflict. The paper is organized as follows.

Section II presents an analytical framework to place the Nepalese experience in context.

The political economy of the Nepalese conflict is discussed in section III. Section IV

presents the economic and social effects of the ongoing war in Nepal. The paper concludes

with concluding remarks and policy recommendations in section V.

2 THE CONTEXT

Civil wars have become increasingly common in recent years and they erupt for several

reasons including, ethnic and religious tensions, ideological difference and social and

economic inequalities. Whatever the reasons these wars have enormous economic and

social costs and their effects are passed from generation to generation through landmine

related incidence, brain drain (during and after the war) and the loss of institutions and

infrastructure. Civil wars contribute to lower levels of output, per capita income and export

earnings due to the destruction of production facilities and infrastructure, as well as

uncertainty in the business environment.4 During the war not only do foreign exchange

earnings from exports decline, but also earnings from tourism drop as security becomes a

major concern for tourists. As the budget deficit rises due to an increase in defence

expenditure and a fall in revenue collection (partly due to problems with tax collection and

partly due to a fall in real income), development expenditure as percentage of GDP

declines. Often, health, education and infrastructure are the target. A very simple reason

for lower development expenditure during the war (particularly infrastructure sector

investment) is that implementation of any new project(s) or rehabilitation of damaged

project(s) is likely to be destroyed by rebellion. A fall in expenditure in the infrastructure

sector not only results in lower levels of production, but also discourages private sector

investment (by both local and foreign investors). Rising unemployment and falling real

income, together with entitlements failure, contribute to human suffering.

The term entitlements, which was first introduced by Sen (1981) in the context of

famine, refers to access to basic necessities i.e. food, water, health and education services.

1To be a legitimate political party they were required to secure at least 5 per cent of total cast votes.2It is estimated that the Maoists have 5000–6000 armed fighters, with a further 15 000–20 000 militias, equippedwith home-made weapons, such as bombs (The Economist, 2005).3Not all wars erupted in LDCs in the post-war period are the result of economic policy failure. For instance, war inSri Lanka erupted due to ethnic tension, while the war that broke out in Afghanistan was due to an ideologicaldifference between Muslim fundamentalists and more secular groups aggravated by ethnic divisions.4Unless war is physically fought in a certain region and the region is not important for export production, exportproduction is likely to fall. The Sri Lankan experience suggests that its export earnings have not fallen as war isphysically fought in the North , while its export production is mainly generated in the Colombo vicinity.

554 K. Sharma

Copyright # 2006 John Wiley & Sons, Ltd. J. Int. Dev. 18, 553–569 (2006)

(Stewart and FitzGerald, 2001) Sen (1981) argued that human suffering can occur through

entitlements failure arising from a loss in income (from employment, assets rent and sale

and transfer) and a rise in food prices. While these entitlement failures are the major

sources of suffering in famine affected countries, they do occur in war affected countries.

In fact, war affected countries experience entitlements failure in several other areas apart

from those mentioned by Sen (1981) in the context of famine.5 Since wars have far more

reaching effects than famine, Stewart and FitzGerald (2001) extended the coverage of

entitlements initially developed by Sen (1981). They argued that people in a war affected

economy experience entitlements failure in publicly funded health and education services,

law and order and social security provided by community groups. These services are

severely disturbed in a war economy partly due to the damage caused by rebellion and

partly due to a fall in government expenditure, making access to these services extremely

difficult, particularly for vulnerable groups. This can result in a rise in the mortality rate,

water borne disease and high illiteracy among poor households.

Falling entitlements of all kinds, together with a loss in output and real income,

contribute to significant economic and social losses in a war-affected economy. While

most of the wars that have erupted in poor countries appear to be linked with ethnic,

religious and social tensions, these are not the only causes of unrest. According to

FitzGerald (2001) the following economic factors might lead to civil war:

* The widening of disparities between groups in a society which can be vertical (between

classes within a society) or horizontal (between territorial, ethnic or religious groups).

In both cases, civil unrest is seen as a way to social justice.

* Uncertainty about the economic prospects of dominant or subordinate groups (or both)

in terms of employment prospects, owning of property and maintaining minimum real

income for survival. As a result, the legitimacy of existing institutions is questioned and

social unrest is seen as a way out.

* Inability of the State to provide basic public goods (namely, health and education

services) to a large majority. This occurs when government lacks resources to maintain

its expenditure on health and education. The Structural Adjustment Programme (SAP)

introduced under pressure from the IMF, and the World Bank can further reduce

government expenditure as pressure to reduce budget deficit increases. As subsidies are

removed from basic public goods, their prices increase. In the absence of rising real

wages, access to basic public goods falls for vulnerable groups.

3 THE POLITICAL ECONOMY OF THE NEPALESE CONFLICT

3.1 Geographical Setting and the Economy

Sandwiched between two giant neighbours—China in the north and India in the south,

west and east—Nepal has a population of about twenty five million. The country is

divided into three geographical regions: (i) Himalayan range which is covered with snow

throughout the year, (ii) valleys and hills and (iii) the Terai belt which borders with India.

5It is important to distinguish the effects of famine and war. War damages institution, infrastructure and humancapital (through brain drain) while famine does not. Also, famine is short lived (may be 1 or 2 years with a fewexceptions), but civil war lasts longer and has long-term effects on economic growth and prosperity. (Stewart andFitzGerald, 2001)

Development and Civil War in Nepal 555


About 70 per cent of land area is covered by Hills and high mountains, while the remaining

30 per cent land is found in Terai which is suitable for commercial agriculture. Over

56 per cent of the country’s population lives in hills and mountains and relies on

subsistence farming in the absence of other economic activities. Since the Terai belt has

highly fertile land than other regions, most economic activities are located here. In the

absence of an efficient transport network, access to hills and the Himalayan range is very

difficult, particularly in the winter season. The country’s health and education indicators

are very low compared to other South Asian countries and these indicators are even worse

in the hills and mountains.6 There is a significant internal migration as development

prospects and opportunities are very limited in rural areas.

Agriculture is the backbone of the economy in terms of its contribution to national

income and employment generation. By the 1950s, it contributed as high as 80 per cent to

GDP and employed 90 per cent of the work force. However, with a shift in government

policy since the mid 1950s, its importance as a major contributor to GDP gradually

declined and fell to 40 per cent by 2002/2003. Despite this, agriculture still provides

employment for 80 per cent of the workforce, and 66 per cent of the economic active

population are engaged in agricultural production. The share of manufacturing remains

very small (about 10 per cent in the GDP), while service sector contributes about

40 per cent to GDP, which is largely based in urban-areas.

3.2 Development Policy since the Mid 1950s

3.2.1 Urban-based import substitution strategy until the early 1980s

With the advent of democracy in 1951, Nepal formally embarked on the economic

development plan in 1956. The country’s First Five-year Development Plan was intro-

duced that year with a view of creating employment opportunities and improving living

standards. To achieve these objectives, a heavy emphasis was placed on the urban-based

import-substitution (IS) strategy. The IS industries were granted heavy protection in the

form of high tariffs and/ or import restrictions and they had access to imported inputs at

lower tariffs, making the effective rate of protection excessively high; in some cases over

200 per cent. These industries also had access to scarce foreign exchange to import

machinery, equipment and intermediate inputs. The excessive protection and incentives

granted to the IS industries attracted resources away from agriculture.

By the mid 1970s, the country had developed a large number of IS industries behind the

protective tariff wall,7 while there were only a few export-oriented (EO) industries.

Exports were dominated by primary products such as rice, jute, timber and hide and skin

(Appendix 1). Furthermore, exporters of these primary commodities were heavily taxed to

raise revenue. Exporters of rice and oils were required to sell a certain percentage of their

output to the Nepal Food Corporation—a public enterprise owned by the Government—

at below market prices to provide subsidized food to the urban population. While exports

of rice were channelled through the Paddy and Rice Exporting Corporation (PREC), jute

exports were channelled through the Nepal Jute Corporation (NJC). Prices set by both

Corporations were much lower than international market prices, which discouraged

6Nepal is categorized as one of the poorest countries in the world and on the UNDP’s human development index,it comes 140th of 177 countries.7Manufacturing capacity was largely underutilized. For a further discussion on this, see Sharma (1999).

556 K. Sharma


commercial producers to move away from the production of two major export items (i.e.

rice and jute) towards IS industries. While agricultural input supplying corporations were

established in the public sector, they often lack resources to maintain stocks as per the

requirements of the sector.

As the bias against agriculture rose, investment in rural infrastructure declined in per

capita terms, shortages of labour occurred and agricultural productivity fell significantly.

Poor agricultural productivity resulted in a fall in agricultural exports, which earlier

contributed as high as 75 per cent to export earnings (Sharma, 1997). The share of

agriculture in total export earnings declined to 55 per cent by the mid 1980s from about

68 per cent in the late 1970s (see Appendix 1). By the mid 1980s, GDP growth remained

very low (about 3 per cent pa), exports stagnated at about 5 per cent of GDP, imports

surged (from about 11 per cent of GDP in 1974/1975 to over 17 per cent by 1986/1987) and

the country experienced a severe macro-economic crisis (government budget rose from

about 1 per cent of GDP in 1974/1975 to 7 per cent by 1986/1987), while international

reserves fell significantly (Table 1).

As macro-economic crises emerged, under pressure from the IMF and the World Bank,

Government introduced the Structural Adjustment Programme (SAP) in 1986.

3.2.2 Policy shift since the mid 1980s

The SAP and subsequent reform programmes included measures to arrest the deteriorating

fiscal operation of the government as well as a wide range of reforms in trade, investment,

agriculture, banking and the finance sector. These reforms accelerated growth in output

and exports, and increased foreign exchange earnings by the mid 1990s. For example

during 1985/1986–1995/1996, real GDP grew at 5 per cent per annum (pa), while the share

of exports in GDP reached over 8 per cent. As shown in Figure 1, output growth was

mainly brought about by growth in the urban-based non-agriculture sector, which included

commerce, manufacturing and services-related activities. During 1985/1986–1995/1996,

the non-agricultural sector grew at about 7 per cent pa, while the agricultural sector grew at

about 3 per cent pa. Lackluster agriculture performance even after the policy reform

appears to be partly due to inefficient infrastructure to support agriculture development

and partly due to the lack of finance caused by the security driven lending policy of

commercial banks. Despite a need for greater agricultural investment, such investment

stagnated due to pressure to cut the budget deficit under the SAP and subsequent reform

programs (Appendix 6). Since agriculture growth was marginally higher than the growth

Table 1. Nepal: Macro-economic indicators

1974/1975 1976/1977– 1987/1988– 1995/1996–1986/1987 1994/1995 2001/2002

Real GDP growth (%) — 3.0 4.1 3.8

As % of Real GDP

Exports 5.4 5.1 7.0 10.6

Imports 10.9 17.4 22.6 29.8

Trade deficit 5.6 12.3 14.8 19.2

Current account deficit 0.7 3.5 7.2 4.5

Budget deficit 1.3 6.9 7.2 5.5

International reserves

equal to months of imports 7.0 3.8 6.5 6.4

Source: Calculated from HMG/Nepal, various issues and NRB (2003b).



in population (2.2 per cent pa), the real income of 66 per cent of the population engaged in

agriculture did not increase significantly. In fact, removal of fertilizer subsidies to achieve

fiscal balance resulted in higher input prices, making farmers worse off in the absence of

productivity improvement.8 The consumption of fertilizers fell almost 50 per cent during

1992/1993 to 1996/1997 period; from 83 332 ton to 46 160 ton (CBS, 1998, P. 71). As

shown in Appendix 1, by the mid 1990s agricultural products disappeared from the

country’s export list and no new products based on agriculture emerged despite significant

liberalization in foreign investment policy. Disappearance of agricultural products from

the export list appears to be partly due to higher population growth and partly due to poor

agricultural productivity in comparison with the other South Asian countries with whom

Nepal competes in the international market (Panday, 2000, P. 76).

Despite significant liberalization in foreign investment policy, in the absence of an

overall investment climate, the agriculture sector failed to attract such investment,

particularly in the processed food area. The weak investment climate attracted foreign

investment mainly in the garment and carpet industries to take advantage of Nepal’s GSP

and MFA quotas. In fact, an expansion of the garment and carpet sectors failed to create

much employment opportunities for the rural population as most industries were located in

the Kathmandu Valley and a few in the Terai belt.9 About 86 per cent of the jobs created by

foreign investment were located in these regions and made little contribution to employ-

ment creation in the hilly and mountain range where 56 per cent of the population live

(Athukorala and Sharma, 2005).

By the mid 1990s, this unequal growth pattern contributed to high poverty and

inequality in the country. The percentage of the population below the poverty line rose

from 33 per cent in 1976/1977 to 42 per cent by 1995/1996. The incidence of poverty was

more severe in rural than in urban areas. For example, by the mid 1990s only 20 per cent of

the urban population was below the poverty line as against 44 per cent in rural areas.

-10

-5

0

5

10

15

20

1975

/76

1977

/78

1979

/80

1981

/82

1983

/84

1985

/86

1987

/88

1989

/90

1991

/92

1993

/94

1995

/96

1997

/98

1999

/00

2001

/02

Real GDP Agriculture GDP Non-Agriculture GDP

Figure 1. Growth in real GDP, agriculture and non-agriculture GDP in Nepal

Source: Based on HMG/Nepal (2003).

8As privatization proceeded and subsidies were removed as a part of market-oriented reforms, prices of goodspreviously subsidized rose significantly. These included electricity, water, fuel and some basic consumptiongoods (like sugar). This hurt small farmers and those employed in the urban informal sector.9Furthermore, these investments were capital intensive (US$14 000 per employment) due to rigidity in the 1992Labour Act.

558 K. Sharma


When the incidence of poverty is broken down into regions, it is immediately apparent

that mountain and hilly regions have a higher level of poverty than the Terai belt. Over

63 per cent of the people in the mountain range are poor, as against 50 per cent in hills and

only 37 per cent in the Terai belt (Appendix 2). While to address poverty and rural–urban

inequality, the government placed a high priority from the beginning of the Fifth

Development Plan (1975–1980), in the absence of good governance and lack of political

accountability they failed to make any impact.

While Nepal was already categorized as one of the poorest countries before the

introduction of reforms in the mid-1980s, cuts in development expenditure as a part of

austerity measures to achieve fiscal balance further aggravated the problem.10 Develop-

ment expenditure as percentage of GDP fell from about 13 per cent in 1987/1988 to

9 per cent by 1994/1995, despite the growing need for such spending to reduce rising

poverty and inequality (Appendix 3). Rural areas were the victims of this cut as many

planned irrigation, health and education projects were suspended. By the mid-1990s,

unemployment remained very high, particularly in rural areas and there was no alternative

source of employment for young people.

Rising frustration brought about by poverty and inequality, together with poor govern-

ance, forced the poor and disadvantaged youth to joint the Maoists movement to fight

against the political system and economic policy. The governance became so weak,

especially after the multi-party democracy was reinstated in 1990, that the public had to

bribe government officials even to get their own birth certificates or land title documents.

Institutionalization of corruption not only created frustration among the poor and

disadvantaged youth, but also appeared to have increased inequality between elite and

non-elite.

3.3 Political Development and Nature of Governance

Nepal was ruled by the ‘Rana Family’ for 104 years (until 1950) who had seized the power

of the Royal family. After seizing power, they ruled the country as per their wish rather

than the wish of the people. This prompted late King Tribhuvan to bring democracy to the

country with the help of India and his own people in 1951. With the advent of democracy,

at least two major political parties emerged (Nepali Congress Party and the Communist

Party of Nepal—the former being the biggest party). However, democracy did not last

10While the government budget deficit was brought under control by the mid-1990s (5 per cent of GDP in 1994/1995), it was achieved at the cost of declining development expenditure (Appendix 3).

Table 2. Incidence of poverty in Nepal

1976/1977 1995/1996 2000/2001

Rural areas 33.0 44.0 39.0

Urban areas 22.0 20.0 NA

Nepal 33.0 42.0 NA

Note: Based on minimum caloric requirement per person per day (i.e. 2256calories).Sources: The World Bank (1998) and NASPR (2002) quoted in Karmacharya andSharma (2003).



long mainly due to bitter intra- and inter-party squabbles among the leaders during 1951–

1960. This prompted late King Mahendra to dissolve the parliament and dismissed the

cabinet on 15th December 1960, saying that the multiparty system was no panacea for

socio-political and economic maladies of the country, giving birth to a single party system

known as the Panchayat System. With the introduction of the Panchayat System, Nepali

Congress and Communist parties went underground. Under the single party system

(Panchayat System) the King kept all executive powers and people around him enjoyed

privileges. The heavy-handed policies during the Panchayat System, which lasted for

about 30 years, imparted customary concessions to only those who favoured the system.

This encouraged corruption, lack of transparency and political dishonesty. Late King

Birendra who came to the throne after the death of his father King Mahendra in 1972

continued with the single party system (Panchayat System) until the political agitation of

the late 1980s. The political agitation that broke out in the late 1980s gave way to a more or

less non-violence political transformation in 1990, which reinstated a multi-party

democracy in the country. The new constitution introduced in 1991 gave executive power

to the democratically elected government and the King became a constitutional monarch.

One of the unfortunate outcomes of multi-party democracy reinstated in 1990 was that it

provided the setting for the institutionalization of corruption, nepotism and favouritism in

order to gain political support. Politicians saw public resources and high-level positions as

a means of rewarding their supporters, and generating revenue for themselves and their

parties rather than for the development of the country (Panday 2000). This contributed to

poor governance, and inter- and intra-party conflicts reflected by frequent change in

government.11 By the mid 1990s, rising corruption, poverty and inequality, together with

political instability and bitter intra- and inter-party squabbles among the leaders, provided

a fertile ground for civil war. Many of the demands in the Maoists 40-point manifesto read

like the mission statement of an international aid agency which includes an end to

corruption, racial, sexual and caste discrimination, land reform, drinking water, roads and

electricity for all villages and promotion of cottage industries (The Economist, 2005).

Maoists have also demanded curtailing all the privileges of the royal family, drafting a new

constitution through a constitutional assembly and nationalizing the property of capital-

ists. They have significant support in rural and remote areas, and the government has

largely withdrawn from most rural areas. The army and police are confined to the district

headquarters, and heads of local administrations have been forced by Maoists to resign. In

a very short period of time Maoists have developed their own military forces.

King Gyanendra—who came to the throne after the Royal massacre of 1st June 2001 in

which King Birendra and his entire family were killed—has exercised his constitutional

power to solve the ongoing crisis.12 On 4th October 2002, he sacked the elected

government led by Prime Minister Sher Bahadur Deuba for failing to maintain law and

order in the country and then ruled through a succession of appointed Prime Ministers.

This triggered the constitutional crisis and resulted in political impasses for more than

20 months. After months of political agitation led by major political parties, King

Gyanendra reinstated Mr. Deuba as Prime Minister on 2nd June 2004, and instructed

him to conduct parliamentary elections and restore peace as soon as possible. However,

due to the strong hold of Maoists in rural and remote areas—who have rejected the

11During 1991–2003, the country was ruled by ten different Prime Ministers.12In a family gathering held at the Narayan Hiti Royal Palace in Kathmandu on 1st June 2001, Crown PrinceDipendra shot his father King Birendra, his mother Queen Aishwarya and seven other members of the royalfamily before killing himself.

560 K. Sharma


parliamentary system—the Deuba government was unable to conduct elections. While

three rounds of talks have taken place between representatives of the government and

Maoists they have failed over the political demands of the Maoists (which included the

establishment of an interim government, constitutional assembly and republic state)

because they do not serve the interests of both the Royal Palace and the political parties.

By early 2005, law and order significantly deteriorated and frequent strikes called by

Maoists disrupted the normal life style of people throughout the country. Against this

background, the King assumed absolute power by putting several leaders under-house

arrest and declaring a state of emergency in the country on 1st February 2005. The King

accused the government led by Mr. Deuba for not being able to conduct parliamentary

elections and restore peace in the country. Since then the country is ruled by the 78 000

Royal Nepalese Army under the direct control of the King, which is supported by a small

number of ministers. This has further widen the gap between the King and the political

parties and sent a clear signal to Maoists that both the Palace and the political leaders

are interested in protecting their own interests rather than the interest of the poor and the

disadvantaged groups whom they represent. While the King has invited Maoists for peace

talks, they refused to come to the negotiation table. The King, political parties and Maoists

will have to find a common platform to bring to an end the 8-year long conflict.

4 ECONOMIC AND SOCIAL EFFECTS OF CONFLICT

The war has significantly destroyed the economic, social and physical infrastructure in

Nepal. While estimating the full costs of war is a very difficult (if not impossible) task, the

human and social costs of death, disability, dispossession and the psychological trauma

associated with terror and conflict are not really quantifiable (Arunatilake, Jayasuriya and

Kelegamma, 2001). Empirical studies of even the purely economic costs of wars are rare

because in assessing the costs, one would ideally need to calculate the destruction of

production factors to determine the country’s potential output without war and then

compare this information with the actual output (Colletta, Kostner and Wiederhofer,

1996). Since such exercises are time-consuming and data are rarely available, most studies

provide estimates of losses in output (GDP) and foreign exchange earnings as well as

losses arising from declining social services. This is the approach taken in this paper.

The consequences of civil war are felt in every sphere of social and economic life in

Nepal. There is a widespread sense of insecurity. Political, legal and social rights are being

eroded day by day. For example, schools are frequently closed (due to rising threats and

strikes), looting and forced collection by insurgents is common and supplies of essential

goods are frequently interrupted in remote areas.13 Even the incidence of rape and child

abuse is on the rise in what was once a peaceful country. The deteriorating law and security

situation has forced many households to immigrate to regional headquarters, cities and

even to India. Many young people have even left the country as they were forced to join the

Maoists. Feelings of despair and hopelessness are growing, especially among the youth as

education opportunities and employment prospects shrink. The conflict has brought about

a sharp fall in output and per capita income (Table 3).

13Supplies of essential goods are frequently interrupted in the hills and mountain range where insurgents have astrong hold. Forty-five of the 75 districts suffer from food shortages. It is estimated that about 30 districts areaffected by Maoist insurgency and no aid can reach these districts. Rising insurgency has resulted in thepermanent closure of schools in these districts (about 60 schools in rural and hilly areas are closed) (Kwon, 2003).



GDP growth fell from 5.1 per cent pa in the pre-war period (average for 7 years before

war i.e. 1987/1988–1994/1995) to 3.8 per cent pa in the war period (7 year average for

the war period i.e. 1995/1996–2001/2002) (Table 3). Non-agriculture GDP, which grew at

the rate of 6.6 per cent pa before the war, fell to 3.9 per cent pa during the war period, while

agriculture GDP growth stagnated at 3 per cent pa. Non-agriculture GDP fell sharply,

primarily due to a fall in transport, commerce, hotel services and manufacturing. Several

industries with foreign participation closed down as they were the target of Maoists. The

production of carpet and garments, which contributed about 76 per cent to total exports

before the war, fell significantly, particularly after 2000 as unrest grew.

As expected, the uncertain business environment contributed significantly to a fall in

both export and import growth. Exports, which were growing at the rate of 26 per cent pa

before the war, fell to 16 per cent pa during the war period, while the growth in imports fell

by two thirds, from about 24 per cent pa in the pre-war period to 8 per cent pa during the

war year (Appendix 4). This significant decline in imports was not due to foreign exchange

shortages but to the shaky business environment. In fact, foreign exchange reserves were

equivalent to 11 months’ worth of imports (or US$1384 million) by 2001/2002 (NRB,

2003a), thanks to strong growth in remittances, which almost doubled between the 1995/

1996 to 2001/2002 period. As the security situation deteriorated, the implementation of

new and expansion of exiting projects was postponed in both the public and private

sectors, leading to a fall in imports of machinery and equipment as well as intermediate

inputs.14 As discussed below, imports also fell due to the collapse of tourism where import

intensity was as high as 60 per cent.

Despite the slow down in export growth, exports as a percentage of GDP did not fall

until 2000/2001.15 It was only from 2001/2002 onwards that the share of exports in GDP

fell (11 per cent of GDP) as war intensified (Figure 2). Exports of labour intensive carpet

and garments, which together contributed about 75 per cent of the total export earnings by

the mid 1990s, fell to 50 per cent by 1999/2000 and 35 per cent by 2002/2003. Earnings

from these two major export items declined from U$349 million in 1999/2000 to US$222

Table 3. Nepal: Growth in real GDP, agriculture and non-agriculture GDP and per capita incomebefore and during war periods

Pre-war Post-war(1987/1988–1994/1995) (1995/1996–2001/2002)

Growth in Real GDP 5.1 3.8

Growth in Real Agriculture GDP 3.2 3.2

Growth in Real Non-agriculture GDP 6.6 3.9

Real per Capita income (US$) 232a 162b

a1991 figure.b2001 figure.Source: Author’s calculation based on HMG/ Ministry of Finance (2003), CBS (1998 and 2003).

14One such project includes a hydro-electricity project to be funded under the World Bank assistance program inWestern Nepal. Recently, Government has terminated the Melamchi DrinkingWater Supply Project due to delaysin construction caused by growing insurgency. The Rs 37 billion project was aimed at improving water supply inthe Kathmandu Valley.15During 1994/1995 to 1996/1997, exports as a percentage of GDP fell marginally due to the boycott of Nepalesecarpet in Europe and America on the grounds that they were produced by child labour. As the issue of child labourwas addressed exports picked up and the share of exports in GDP rose from 8 per cent of GDP in 1996/1997 toabout 14 per cent by 2000/2001.

562 K. Sharma


million by 2002/2003 (Nepal Rastra Bank (NRB), 2003b). As exports of labour intensive

carpet and garments declined, it further aggravated unemployment in the country.16

As war broke out, tourist arrivals and earnings fell. Tourist arrivals fell from over

5 per cent pa in the pre-war period to just over 1 per cent pa during the war period, leading

to a decline in foreign exchange earnings. Foreign exchange earnings as percentage

of GDP fell from about 4 per cent in 1995/1996 to just under 2 per cent by 2001/2002

(Figure 2)—the lowest since the1970s. Earnings from tourism fell significantly in the

early 2000s as the intensity of civil unrest increased (Appendix 5). As the growth in tourist

arrivals dropped, particularly from Europe and America, hotel occupancy rates fell to as

low as 10 per cent. While a few big hotels and travel agencies have already closed, many

more are on the verge of collapse.

Lower employment prospects together with growing threats from the Maoists forced

many young people to leave the country in search of work in India, Malaysia and Middle

East countries.17 The number of people going overseas and also to India has increased

rapidly in recent years. According to the Nepal Living Standard Survey II, 1 of every 11

Nepali adults is in foreign employment (over 1 million in 2004). This is reflected by the

growth in private remittances. Remittances as percentage of GDP rose from about

2 per cent in the mid 1990s to over 5 per cent by 2001/2002 (Figure 2). It must be

mentioned that the amount of remittances received is actually far greater than the official

figures suggest because often remittances from India are received through informal

channels, which are not captured by the official statistics.

While growth in remittances has helped ease human suffering, declining per capita

income together with falling expenditure on social services, appears to have contributed to

a net loss in welfare. Even without the war, investments in these services were very low

(2.7 per cent of GDP pa in the pre-war period). With the outbreak of war this has further

fallen (1.8 per cent of GDP pa) (Appendix 6). Regular expenditure increased at the cost of

development expenditure as pressure for defence spending was intensified. The develop-

ment expenditure percentage of GDP fell from 12 per cent pa in the pre-war period to

0

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4

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8

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12

14

16

1987

/88

1988

/89

1989

/90

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

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/98

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/99

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/01

2001

/02

Tourism Remittance Exports

Figure 2. Foreign exchange earnings from exports, tourism and remittance % of GDP in Nepal

Source: Based on data obtained from HMG/Ministry of Finance, (2003) and Nepal Rastra Bank(2003b).

16The readymade garment industry employs 100 000 workers and sustains over 350 000 people.17In order to increase their arm force, Maoists increasingly forced households in the remote areas of Western andFar Western Regions to give at least one youth from each household. Maoists have strong holds in these regions.



9 per cent pa during the war-period, while regular expenditure rose from 7 per cent of GDP

pa in the pre-war period to about 10 per cent during the war period (Appendix 3). A fall in

development expenditure, particularly on social services, infrastructure and agriculture,

appears to have further intensified poverty and inequity (Appendix 6). The Sri Lankan

experience suggests that the preservation of public entitlements can significantly reduce

the incidence of poverty even during the war.

The government has increasingly deployed its already very limited resources in

combating insurgency, while foreign aid has been declining. In the presence of low

domestic savings and declining foreign aid, capital formation has been low and falling in

both the public and private sectors. Public sector capital formation has never exceeded

8 per cent of GDP since the 1990s and this has declined since 2001/2002 as the war

intensified. Capital formation in the private sector has also declined since mid-1998/1999

mainly due to the lack of protection of private property and the deteriorating business

environment (Figure 3). Nepal has one of the lowest domestic savings rates in South Asia,

and with the eruption of civil war this has further fallen from 15 per cent of GDP in the late

1990s to 12 per cent by 2002/2003.

In the context of low domestic savings, foreign aid can play a crucial role in meeting the

investment gap. Despite this reality foreign aid has been falling. It fell from 6 per cent of

GDP in the mid-1990s to just over 3 per cent by 2001/2002 (HMG, 2003). According to the

National Planning Commission estimates Nepal needs about US$556 million worth of

foreign aid to carry out development programmes across the country (Kathmandu Post, 5th

March 2004); however, the country has not been able to secure even half of this. In 2001/

2002, Nepal received US$184.5 million in foreign aid. Foreign aid has been declining

partly due to the unrest and partly due to declining trends in development assistance—a

global phenomenon since the end of the cold war.

5 CONCLUDING REMARKS

This paper contributes to the current debate on the relationship between economic

development and civil unrest in developing countries through a case study of Nepal. It

0

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6

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12

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18

1987/881988/891989/901990/911991/921992/931993/941994/951995/961996/971997/981998/991999/002000/012001/022002/03

Foreign Aid Gross Dom Savings Public Capital Formation Private Capital Formation

Figure 3. Foreign aid, domestic savings and capital formation in the public and private sectors % ofGDP in Nepal

Source: Based on data obtained from HMG/Ministry of Finance (2003).

564 K. Sharma


is argued that civil war which erupted in Nepal in the mid 1990s had its seeds sown five

decades ago when the country embarked on the economic development plan which placed

a heavy emphasis on an urban-based import-substitution strategy. This strategy, by

creating a bias against the rural-based agriculture not only produced a severe macro-

economic crisis, but also poverty and inequity by the mid 1980s. In the mid 1980s, the

government embarked on reform programmes to redress this bias, but the reforms were

half-hearted and failed to redress the bias against the rural areas, where 86 per cent of

the population live whose major source of income is agriculture. By the mid 1990s,

unemployment rose, poverty and inequality surged. These, together with political

instability and poor governance, enabled Maoists, which include people from all ethnic

and religious backgrounds, to mobilize youth in their fight against the government, which

has failed to bring about social and economic justice. The intensity of war increased since

the early 2000 when Maoists were labelled as terrorists.

The costs of war have been high and rising day by day. International actors (donor

community) can play an important role in bringing the country out of the current crisis

through the peace process and targeted development assistance. Since poverty and

inequality in both political and economic dimensions are the root cause of conflict, they

should be addressed. This would mean additional investment in remote areas and the

development of a strong integration between rural and urban areas through a well-

developed transport network. A well-developed transport network is crucial to encourage

economic activities, particularly those based on agriculture in rural areas. This helps

generate income and employment for the poor in rural areas. Despite the importance of

investment in rural areas, development expenditure percentage of GDP remains very low.

In fact this has fallen in recent years, partly due to budget constraints and partly to an

increase in regular spending. More development spending in social services and infra-

structure is required to ease human suffering, but government alone cannot do this without

international assistance. Even without the war Nepal had poor quality social services and

infrastructure, and this has further deteriorated with the eruption of war. Destroyed

institutions, infrastructure and social services should be rehabilitated now rather than

waiting until the war finishes which can further aggravate poverty and increase human

suffering. Foreign aid in social services and rural infrastructure can significantly mitigate

the socio-economic costs of war, particularly in remote areas. However, it should be linked

with good governance and commitments by the government to maintain (and gradually

increase) public spending on health, education and other social services.

REFERENCES

Athukorala P, Sharma K. 2005. Foreign investment in a least developed country: the Nepalese

experience. In Economic Growth, Economic Performance and Welfare in South Asia, Jha R (ed.).

Palgrave Macmillan: New York.

Arunatilake N, Jayasuriya S, Kelegamma S. 2001. The Economic Cost of the War in Sri Lanka.

World Development 29(9): 1483–1500.

Central Bureau of Statistics (CBS). 2003. Population Census 2001: National Report, Kathmandu.

Central Bureau of Statistics 1998. Statistical Pocket Book, Kathmandu.

Colleta NT, Kostner M, Wiederhofer I. 1996. The transition from war to peace in sub-Saharan

Africa. Directions in Development, The World Bank: Washington, DC.



FitzGerald V. 2001. The International Political Economy of Conflict in Poor countries (chapter 8).

In War and Underdevelopment, Stewart F, FitzGerald V (eds). Volume I, OUP: Oxford.

HMG/N Ministry of Finance 2003. Economic Survey, Kathmandu.

Karmacharya B, Sharma K. 2003. Trade Policy Regime, growth and Poverty: the Nepalese

experience. In Trade Policy and Poverty in Asian Developing Countries, Sharma K (ed.).

Routledge: London.

Kathmandu Post. 2004. Daily New Paper, May 5 and 7, 2004.

Nepal Rastra Bank (NRB). 2003a. Macroeconomic Indicators of Nepal, Research Department,

Kathmandu.

Nepal Rastra Bank. 2003b. Nepal Rastra Bank, Quarterly Economic Bulletin, Vol. XXXVII.

Panday DR. 2000. Nepal’s Failed Development. Nepal South Asia Centre: Kathmandu.

Kwon R. 2003. Rebel assault: maoist insurgence in Nepal. Harvard International Review 25(2):

12.

Sen AK. 1981. Poverty and Famines: An Essay on Entitlements and Deprivation. Clarendon Press:

Oxford.

Sharma K. 1999. Trade Liberalisation and Manufacturing Performance in Developing Countries:

New Evidence from Nepal. Nova Science Publishers inc: New York.

Sharma K. 1997. Impact of Policy Reforms on Manufacturing Growth in Nepal. Asian Survey,

XXXVII (6): 550–560.

Stewart F, FitzGerald V. 2001. Introduction: assessing economic costs of war (chapter 1). InWar and

Underdevelopment, Vol. I, Stewart F, FitzGerald V (eds). OUP: Oxford.

The Economist. 2005. Special Report Nepal, April 16th.

Trade Promotion Centre (TPC). Nepal’s Overseas Trade Statistics, Kathmandu, Various Issues.

APPENDIX 1: AVERAGE ANNUAL SHARE OF SELECTED COMMODITIES IN

TOTAL EXPORTS

1974/1975–1979/1980 1980/1981–1984/1985 1985/1986–1993/1994

Jute goods 16.3 14.7 4.5

Raw jute 12.7 11.4 1.6

Hide/skin 8.4 11.7 6.7

Carpets 3.0 12.1 40.0

Handicrafts 2.9 2.6 1.2

Garments 1.0 2.6 30.1

Pulses 5.6 4.2 5.2

Rice 26.0 11.0 negligible

Timber 19.4 7.1 nil

Dried ginger negligible 2.3 negligible

Silver jewellery nil nil 0.6

Other 4.7 19.9 10.1

Total 100.0 100.0 100.0

Source: Author’s calculation based on HMG (2003) and TPC, various issues.

566 K. Sharma


APPENDIX 2: INCIDENCE OF POVERTY BY REGION, 1996 (HEAD COUNT

INDEX IN PER CENT)

Development Ecological region

region

Mountains Hills Terai Total

Eastern 57 68 27 43

Central 48 31 34 34

Western 52 46 44 45

Mid-West 72 66 47 59

Far West 80 73 49 65

Rural — — — 47

Urban — — — 18

Total 63 50 37 45

Note: The NLSS was designed to capture aggregative information, particularly at the development region andecological zone levels; sizeable sampling errors are likely at the sub-regional level.Source: NESAC (1998) quoted in Panday (2000).

APPENDIX 3: GOVERNMENT EXPENDITURE PATTERN IN THE PRE- AND

DURING THE WAR PERIODS

Year Budget Regular Development

Deficit % of GDP Expenditure % of GDP Expenditure % of GDP

1987/1988 6.39 6.32 12.88

1988/1989 9.96 6.61 14.36

1989/1990 8.43 6.69 13.03

1990/1991 9.18 6.52 13.76

1991/1992 7.77 6.83 11.39

1992/1993 7.23 6.95 11.74

1993/1994 6.07 6.48 11.058

1994/1995 5.02 9.17 9.427

1995/1996 5.77 9.01 10.43

1996/1997 5.33 8.97 9.85

1997/1998 6.13 9.38 9.98

1998/1999 5.45 9.41 8.64

1999/2000 4.82 9.43 8.67

2000/2001 6.15 10.87 9.42

2001/2002 5.67 12.01 7.78

Pre-War Average 7.67 7.04 12.11

(7 Year Average)

During War 5.62 9.87 9.25

(7 Year Average)

Source: Author’s calculation based on HMG/Ministry of Finance (2003).



APPENDIX 4: PERFORMANCE OF FOREIGN TRADE

Year Export Imports Average Annual AverageAnnual

(US$ Million) (US$ Million) growth in in Imports (%)

Exports (%)

1987/1988 188.7615 636.2385

1988/1989 178.5106 692.0851 1.94 17.26

1989/1990 188.1752 668.7956 22.91 12.67

1990/1991 253.8488 798.1443 43.27 26.74

1991/1992 320.9836 748.0094 85.54 37.52

1992/1993 405.3052 920.3286 25.97 22.75

1993/1994 393.7347 1052.469 11.74 31.54

1994/1995 359.1733 1296.661 �8.57 23.48

1995/1996 394.0733 1475.798 12.71 16.92

1996/1997 402.4178 1663.164 13.86 25.65

1997/1998 406.997 1316.598 21.55 �4.86

1998/1999 523.4923 1284.299 29.67 �1.66

1999/2000 707.7131 1541.264 39.65 23.97

2000/2001 745.5325 1549.725 11.70 6.62

2001/2002 609.4872 1368.346 �14.58 �7.74

Pre-War Average — — 26.12 24.57

(7 Year Average)

During War — — 16.37 8.41

(7 Year Average)


APPENDIX 5: TOURISTS ARRIVAL AND FOREIGN EXCHANGE EARNINGS

FROM TOURISM IN THE PRE- AND DURING THE WAR PERIODS

Year Number of Annual Foreign Foreign ForeignTourists growth rate Exchange Exchange Exchange(in 000) in Tourists Earnings Earnings as % Earnings as %

Arrival (%) (US$ Million) of Merchandise of GDPExports

1987 248 11 76.86697 40.6 2.3

1988 266 7.2 116.3957 65 3.3

1989 240 �9.8 113.9124 59.5 3.2

1990 255 6.2 123.2852 47.1 3.0

1991 293 15 117.4918 35.9 3.6

1992 334 14.1 140.0469 34.5 3.7

1993 293 �12.2 168.402 42.7 4.1

1994 326 11.2 182.7164 50 4.1

1995 363 11.28 188.7255 47.9 3.8

Continues

568 K. Sharma


APPENDIX 6: BREAKDOWN OF DEVELOPMENT EXPENDITURE IN THEPRE- AND DURING THE WAR PERIODS

Year Expenditure on Expenditure on Expenditure on

Social Services % Agriculture Development Physical Infrastructure

of GDP % of GDP % GDP

1987/1988 2.53 2.44 4.29

1988/1989 2.96 3.07 4.50

1989/1990 2.50 2.40 3.69

1990/1991 2.26 2.29 2.88

1991/1992 2.92 2.41 2.62

1992/1993 3.56 2.48 3.07

1993/1994 2.85 2.89 2.96

1994/1995 1.63 2.47 2.27

1995/1996 1.63 2.13 3.83

1996/1997 1.97 1.71 3.62

1997/1998 2.00 1.58 3.56

1998/1999 1.57 1.48 3.01

1999/2000 1.95 1.40 2.79

2000/2001 1.81 1.60 3.09

2001/2002 1.58 1.41 2.20

Pre-War Average

(7 Year Average) 2.67 2.57 3.14

During War

(7 Year Average) 1.79 1.62 3.16

Source: Author’s calculations based on HMG/Ministry of Finance (2003).

APPENDIX 5: CONTINUED

Year Number of Annual Foreign Foreign ForeignTourists growth rate Exchange Exchange Exchange(in 000) in Tourists Earnings Earnings as % Earnings as %

Arrival (%) (US$ Million) of Merchandise of GDPExports

1996 394 8.3 151.52 37.6 3.0

1997 422 7.2 174.1251 35.9 3.3

1998 464 9.9 179.997 34.1 3.6

1999 491 6 177.1665 24.2 3.2

2000 464 �5.7 166.4347 21 2.9

2001 361 �22.1 104.4675 16.4 1.9

2002 271 �25.1 68.50513 22.7 1.2




Development policy, inequity and civil war in Nepal

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