Nepal’s Textiles and Clothing Exports

Nepal’s textiles and clothing sector sits at a pivotal moment. Its experience is interesting not only for what it reveals about the country’s own development trajectory, but also for what it illustrates about industrial policy in least developed countries (LDCs). Despite long-standing structural constraints and only limited, inconsistent policy support, garments and carpets have managed to remain core export earners through craftsmanship, niche branding, and preferential market access. As Nepal approaches LDC graduation, this article uses the sector’s experience to explore how industries survive and adapt, and what policy interventions—short of subsidies—could be used to support competitiveness in the years ahead. 

Exports have not been the Nepali economy’s strong suit, especially over the last 25 years. As a percentage of GDP, exports of goods and services fell from 26.3% in 1997 to 6.8% in 2022, lower than the average for LDCs, low-income countries, and lower-middle-income countries. The performance of merchandise exports has been especially dismal, falling from 13.1% of GDP in 1999 to 2.9% in 2022. 

After trailing goods exports for 13 years, services exports exceeded merchandise exports in 2013 and maintained the lead until 2020, when the COVID-19 pandemic dealt a severe blow to tourism. Yet service export receipts have not been sufficient to offset the decline in goods exports relative to GDP. Workers’ remittances, at 22.7% of GDP in 2022, have emerged as the biggest source of foreign exchange, dwarfing the combined earnings from exports of goods and services, foreign direct investment, and foreign aid. 

Manufacturing value added as a percentage of GDP has been in decline since the late 1990s; its highest recorded share was 9%. Although a decline in manufacturing’s share of output and employment is a general global phenomenon, and the peak share has been recorded at progressively lower levels of per capita income over time, the value added in manufacturing as a share of GDP in Nepal peaked at an income level much lower than the world average for such peaking, and the peak itself is significantly lower than the world average. Crippling power cuts and a raging armed insurgency took a severe toll on the manufacturing sector. Even after both challenges subsided, manufacturing has yet to register a robust recovery. Large-scale labour outmigration and the real appreciation of the Nepali rupee, fuelled in part by remittance inflows, have not helped competitiveness either—and have become a permanent feature of the economy. 

Textiles and clothing have long served as a launchpad for industrialization across the world, including in what are now developed countries. Despite the general challenges as well as more specific challenges (discussed below), textiles and clothing continue to be a major source of Nepal’s merchandise exports (31.5% in 2022). Two well-established subsectors in this broad category are readymade garments and hand-knotted woollen carpets. 

Constraints to Competitiveness 

A review of literature suggests that the following factors impede Nepal’s competitiveness in the garment sector: weak physical infrastructure, transportation systems that lengthen lead times, human resource issues, limited capacity for technology upgrading, and poor access to finance. Consultations with garment exporters confirm these findings. 

Producers increasingly identify labour-related challenges as their most pressing concern. A shortage of skilled and semi-skilled labour forces firms to operate below their potential—this results in firms often declining orders that they cannot fulfill on time. In addition, high labour turnover and skill mismatches reduce productivity. 

High logistics costs represent another crucial constraint. Reliance on air freight to meet delivery schedules, combined with the high cost of such transport, significantly drives up exporters’ costs. For landlocked Nepal, the lack of direct access to western Indian ports adds to the time and cost of shipping goods to the western hemisphere, including but not limited to textiles and clothing. This further erodes Nepal’s competitiveness in time-sensitive global value chains. 

Nepali garment exporters estimate their unit cost to be at least 25% higher than that of Bangladeshi competitors and identify low worker productivity as a key factor behind it. Nepali hand-knotted woollen carpet exporters similarly report that their products are at least 25% more expensive than those from India, based on the authors’ interactions with exporters during a survey conducted for a forthcoming SAWTEE study on the carpet industry. 

The high cost of living in Kathmandu valley, home to the capital city, where most of the production units are located, and limited margins to increase wages, according to carpet exporters, have led to a shortage of workers. The younger generation of workers is increasingly choosing to migrate abroad rather than working on the loom for 12 hours a day, 6 days a week, to make only enough to meet their subsistence needs. Hence, enterprises are not able to expand production quickly, even in the face of increased orders. 

Drivers of Competitiveness 

And yet, despite the constraints, Nepali garment and carpet exporters are surviving, if not thriving. What’s behind this? 

Unique craftsmanship and predominantly hand-made production allow Nepal to differentiate its garments from mass-produced items in countries such as China or Vietnam. Enhanced market access stemming from Nepal’s LDC status, particularly duty-free access in the European market and under other Generalized System of Preferences (GSP) schemes, is another crucial source of competitiveness. Additionally, exporters believe Nepal’s positive image has created a market segment that ensures a steady demand for Nepali products. Although Nepali garment exports are a shadow of their former self—with their nominal value still below the peak reached some quarter of a century ago (USD 85.8 million in 2022 versus USD 222 million in 2003)—these factors have contributed to the survival of the industry. It no longer specializes in churning out mass-produced items on a cut-trim-make model, as it did during its heyday from the mid-1980s to the phase-out of global quotas by 2005. Post quota phase-out, what remains of the industry is more rooted in more durable sources of competitiveness. 

Nepali carpet has managed to withstand competition from more efficient competitors and commands a 12% share of world exports of hand-knotted woollen carpets. This can partly be traced to Nepali carpet-producing units being smaller and hence able to take custom orders from buyers. This has also resulted in these carpets being able to fetch premium prices. Moreover, the brand value attached to Nepali hand-knotted carpets is a major selling point. Flexibility, strong customization capacity, and consistently high quality have helped create goodwill among buyers and a brand recognition of Nepali carpets, enabling them to take on cheaper and more efficient competitors like India and create a niche for themselves. Nepal’s carpet sector has pulled itself from the rubble of the 1990s, when it was hit by a storm of bad publicity in European markets concerning the use of child labour. In 1994, Nepal exported carpets worth USD 159 million, and even in the next three decades, it was unable to regain that annual value, with export earnings from carpets in 2022 standing at USD 84 million. 

LDC Graduation 

As Nepal prepares to graduate from LDC status, concerns about the potential loss of preferences are growing. These concerns are particularly pronounced in the garment sector, which is estimated to be the hardest hit by tariff increases following the graduation. A SAWTEE study shows that clothing exports would see a 6.7% hike on average trade-weighted tariff (1.4% if Nepal qualifies for next-best schemes such as the EU’s GSP+), and a World Trade Organization study estimates that the clothing sector would see a drop in exports of 13.3% (of current exports) as a result of increased tariffs. 

Furthermore, more stringent rules of origin—for example, double transformation requirement (yarn to fabric to clothing) compared with the current single transformation (fabric to clothing)—are expected to cause further deterioration of export competitiveness. The yarn industry is a major source of exports. Nepal also has fabric manufacturers. While various iterations of Nepal’s industrial policy over several decades have emphasized the need to foster backward and forward linkages, this has not been backed by actions to address coordination failures that may be preventing yarn, fabric, and export-oriented apparel manufacturers from serving each other’s needs. 

However, a more realistic prediction of the impact of LDC graduation on the clothing sector has not yet emerged. For instance, producers are often not fully aware of what LDC graduation entails. This includes the potential changes in tariffs, whether they would be able to meet the new rules of origin, and the probable impact of these changes on their exports. In addition, recent changes in U.S. trade policy, specifically the imposition of reciprocal tariffs, make estimating the impact of LDC graduation more convoluted, as some exporters believe that they can significantly increase their exports to the United States, provided the existing tariff advantages for Nepal remain. 

Policy Support Rethink 

One of the government’s policies for promoting exports is the establishment of several special economic zones (SEZs), including garment processing zones. However, the two operational SEZs suffer from inadequate infrastructure and gaps in implementing legally mandated facilities. Moreover, they have not been able to attract garment industries, as the sector’s heavy reliance on air freight implies that firms cannot relocate to areas far from Kathmandu, and meeting labour needs in locations outside Kathmandu could be even more challenging. 

Garment and carpet exporters acknowledge that government export subsidies have been helpful, although delays and administrative hurdles reduce their effectiveness. However, the export subsidy program faces an uncertain future, given that the government appears to have an inadequate budget to fully fund it. The government recently indicated it was pausing the scheme pending a review: studies indicate its limited effectiveness in promoting exports, and it runs afoul of World Trade Organization rules (which may come under greater scrutiny after graduation). The imperative of crafting a subsidy policy that is efficient and effective, targeting market failures and generating positive spillovers, is sinking in. However, a recent government decision that implied export subsidies would be ended retroactively—that is, subsidy claims from firms that had exported in the previous fiscal year when the export subsidy scheme was still officially in place would not be processed—has further dented the already low level of trust of the private sector in the state. 

There is an urgent need to take a step back and ask a fundamental question as to whether money thrown at ad-valorem export subsidies to firms (or even production subsidies that policy-makers indicate will be central to a new subsidy regime) might be better spent on gathering and disseminating useful market intelligence, expanding participation in trade fairs, helping establish contacts between producers/exporters and foreign buyers, providing business development services, registering and promoting collective trademarks, and establishing sector development institutes. Many of these steps can be taken with state-industry collaboration, including co-financing. Moreover, incentives and support through fiscal and monetary policies for improving workers’ productivity and adopting and adapting improved technologies have not received meaningful policy attention. 

Industrial policy, of which trade policy can be considered a part, is not just about subsidies. It could be as simple (or perhaps complex) as ensuring inter-agency coordination, among and within ministries, which has been in short supply in Nepal. Policy incoherence and instability have been one result. Fostering linkages between, say, niche pashmina wear and the raising of chyangra (mountain goats) for wool to be spun into yarn requires a well-planned and coordinated teamwork by, inter alia, the Ministry of Industry, Commerce and Supplies, the Ministry of Agriculture and Livestock Development, the Ministry of Finance, and the divisions and departments therein. 

For years, the Board of Trade, which sits atop the institutional architecture for trade policy implementation and coordination, struggled to meet regularly, often falling short of the requirement to convene at least once every 2 months. Nepal can draw lessons from Ethiopia, also a landlocked LDC, where a national export coordination council committee, set up in 2003 and chaired by the prime minister, met every month, almost without fail, and not only adopted measures to ease export bottlenecks but, crucially, rigorously monitored implementation. On the council’s watch, Ethiopian merchandise exports grew by 22% per annum on average between 2006 and 2012. 

The rise of environmental measures with trade implications in important Western markets—for example, the carbon border adjustment mechanism and the digital product passport requirement in the European Union—introduces new challenges but also potential competitive openings for Nepali exporters able to comply early. It also increases the salience of inter-agency coordination. The current industrial-trade policy regime (which includes policies, strategies and institutional mechanisms) is not attuned to a rapidly changing international landscape and needs a rethink. 

This article draws on preliminary findings of an ongoing study at SAWTEE. Views are personal. 

Paras Kharel, Executive Director, Kshitiz Dahal, Senior Research Officer, and Dikshya Singh, Program Coordinator, South Asia Watch on Trade, Economics, and Environment (SAWTEE).