Nepal’s Neighbourhood Dilemma

12 September, 2021

Research Reports

Since independence, India's neighbourhood policy has been to preserve and expand its political prominence in the subcontinent by following the 'big brother' attitude.[i] One of India's neighbours, Nepal, has also been a part of that diplomacy, with the Himalayan nation receiving security and development aid. India has helped Nepal in developing the country's infrastructure, transportation, defence, energy sector, business sectors, human development and investment. India has constantly been interfering in Nepali domestic politics in return for the aid provided to them.[ii] The unilateral trade blockades imposed by the Rajiv Gandhi government in 1989 and the Narendra Modi government in 2015 have massively hit the Nepali economy and soured the relations between the two neighbours.[iii]  With the evolution of time, Nepal has grown to become a very important player in the Indo-Pacific region due to its geo-strategic location. India has ceased to be the major source of foreign investment in the country in the recent years, as seen from the diversification of its foreign assistance where 39 other countries, apart from India, have stakes in Nepal's FDI. Singapore, Ireland, Japan and Australia are some of them. Several multilateral banks, including the World Bank, are now willing to lend money to Nepal.


Growing Chinese Presence in Nepal


 Even though a number of countries are vying to make their presence felt in the Nepali economy, China has emerged as the most successful one, rapidly increasing its dominance in South Asia. After the 2015 earthquake which had completely destroyed Nepal, China swooped in and seized the opportunity of partnership in the vacuum that India had left.[iv]  This led Nepal to be one of the earliest nations to join China's Belt and Road Initiative (BRI). The Chinese President Xi Jinping’s pet project, the BRI is an extensive collection of development and investment initiatives that would extend from East Asia to Europe. This would help the Chinese expand their economic and political influence.[v] Often this project is also referred to as the New Silk Road as it seeks to repeat the success of the original one. The original Silk Road came into existence in the glorious period when the Chinese Han Dynasty was expanding westwards and creating new trade networks across what has come to be known as the Central Asian countries today, like Afghanistan, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan. This project was announced by Xi Jinping when he officially visited Kazakhstan and Indonesia in 2013. According to Xi, the establishment of the BRI network would help in the expansion of the international use of the renminbi(Chinese currency) and " break the bottleneck in Asian connectivity".[vi] China also has plans to build 50 special economic zones. These will be modelled after the Shenzhen Special Economic Zone which was initiated during Deng Xiaoping’s economic reforms of 1980s. China hopes to assert its global dominance by investing in new countries and cultivating export markets that would result in the growth of Chinese economy and boost domestic consumption.


Even though India remains as the largest trading partner of Nepal, China has overtaken it as the largest source of FDI for Nepal. In the Financial Years of 2015-16, 2016-17, 2017-18, China is leading in FDI pledges to Nepal.[vii] They have pledged to invest in hydropower, cement, herbal medicines and tourism.  According to the Kathmandu Post, the FDI going from India to Nepal saw a decline of around 81 percent in the first few months of 2021 compared to the same period in the last fiscal year. On the other hand, Chinese investment has increased by a small margin, and now constitutes 70 percent of the total FDI that Nepal received in that period.[viii]The Himalayan nation is dependent on Indian power export in order to meet its energy necessities as the country's own vast hydropower potential remains untapped. The Nepali households were severely affected by the 2015 embargo as they did not have access to power and energy. India is responsible for supplying 600 MW of power to Nepal.[ix] Owing to domestic necessities, the landlocked Nepal was forced to look towards its northern neighbour, China, with the Chinese making various investments in power stations and transmission line projects under the BRI program.  The Upper Trishuli hydropower project is one such example. New Delhi was shocked when Nepal and China decided to ink the trade and transit agreement. This meant that India was no longer the only player providing Nepal access to the sea.[x] The agreement meant that Nepal would be able to access seven well-equipped Chinese ports for purposes of third-party trade. The agreement with China forced India to hasten up the construction of a railway connection between Raxaul and Kathmandu, fearing that China would increase its footprints in the power corridors of Nepal.[xi]


Concerns over Chinese Investments


China's expansionist move in the Indo-Pacific region has set alarm bells ringing in New Delhi. Beijing has tacitly used its economic and military might to influence the decision-making processes in the neighbouring countries, while New Delhi has engaged in big brother diplomacy.[xii]However, the BRI has been increasingly criticised for being "debt-trap diplomacy".[xiii] The recipients of the investments from the BRI are mostly low-income developing Asian and African countries that do not boast of a good governance or democracy record. The investments are being provided in the form of concessional loans. This has led many nations like Sri Lanka, Maldives and Malaysia to go back on expensive projects that were to be funded under the BRI. The Sri Lankan government was compelled to lease out the Hambantota port to China for 99 years as they were unable to pay back the loan.[xiv] The Maldivian government of Abdullah Solih also reached out to India for financial support as it could not repay the huge loans that the previous Yameen government had taken for development purposes from China.[xv]


A recent report published by the Keil Institute for World Economy revealed that there are 7 countries whose external loan debt to China has surpassed 25 percent of their country's GDP.  The study, which was titled ‘How China lends’, took into account 100 contracts that were signed between the Chinese government-owned entities and government borrowers in 24 developing nations. The study concluded that the contracts involved strange confidentiality clauses that barred revealing the existence of debt and also involved cancellation, acceleration and stabilisation clauses that allowed the creditor to influence the domestic and foreign policies of the debtor nations.[xvi]


Policymakers from various countries have now become alert to the potential risks involved with the BRI as it makes them lose the ability to make sovereign decisions.  Mahathir Mohammad, the current Malaysian Prime Minister, has termed the BRI as being neo-colonialist in nature.[xvii]  The Malaysian government also decided to call off the $20 billion East Coast Rail Link project owing to mistrust. Another problem the BRI faces is a lack of transparency. According to a report in the Financial Times, most of the projects under the BRI are dollar-denominated and financed for which China will require to co-finance with multilateral institutions.[xviii]  This goes against the Chinese claims of using its own currency to fund the projects.


There is also discord between the countries concerning how the projects would be implemented. This can be seen with the case of the Trans-Himalayan railway line project which, if implemented, would have meant that Nepal was no longer dependant on India for third-country trade and transit. However, the Himalayan nation did not have the required funds to conduct a feasibility survey even when China was providing 50 percent funding for the same. China Railway First Survey and Design Institute had conducted a pre-feasibility test where it had found out that 98.55 percent of the railway will pass through tunnels and bridges.[xix] Taking into account the topography and the difficult terrain of the region, it was estimated that 3.55 billion Nepali rupees/Km would be needed to build the railway line- a cost that the tiny $6 billion Nepali economy cannot afford. In case the project is continued, Nepal would have to rely completely on China's benevolence. The Nepali citizens are also a sceptic of the viability of the project. Nepal has long been dependant on the Indian government for infrastructure development, funding roads and ports for third-country transit. Nepal does not have much of an alternative as it would take the country several years and a huge cost to build the infrastructure that they need to reach the Chinese ports, even when the Chinese have allowed them access to the ports.  The Chinese-supervised road and rail projects have not taken off yet. India, on the other hand, has come to its senses and has decided to hasten up the development initiatives they had undertaken in Nepal.  


Exploring India’s Options


India has lost a lot of goodwill it enjoyed after the 2015 unilateral embargo. New Delhi has now realised that Kathmandu is an invaluable player in the region and it would be better to keep them on its side. Even though a lot of outstanding issues like the border disputes and development projects getting stuck remain, the two governments must come together and hold consultations on how to resolve such problems. In January 2021, an Indo-Nepal joint commission meeting was held where such issues were voiced.[xx] India also donated a million vaccine doses to Nepal as grant assistance so that the country could deal with the ravages of the Covid-19 pandemic. In 2019-20, India had granted 1200 Crore rupees to Nepal. New Delhi has also extended Lines of Credit of USD 1.65 billion for developing infrastructure, especially the post-earthquake reconstruction projects.[xxi]


India hopes to restore the historical and traditional ties with Nepal, even as the Chinese dragon breathing down on its neck. Both countries have been severely impacted by the ongoing Covid-19 pandemic and the ensuing lockdown. Nepal had also fallen into a constitutional crisis during this period. The diplomats of both India and Nepal have reiterated the fact that the ties between these two nations go back a long way and as such, it would remain strong. India would be wary of imposing another unilateral embargo like it did in 2015 and would hope that the problems would be solved by having meaningful dialogues between high-level diplomats. While the Nepali parties and public remain sceptical of India's intentions, New Delhi must show that it is only interested in seeing its neighbour flourish and does not plan to control its internal politics. The recently concluded political crisis in Nepal has brought to light how China is blatantly meddling in the domestic politics of the nation.[xxii] India should not repeat the same mistake and should try to regain the trust of Nepal as an ally. 


Challenges for Deuba


On 13 July 2021, Sher Bahadur Deuba was sworn in as the new Prime Minister of Nepal. Apart from navigating the political landmine of balancing relations between China and India, he has the additional responsibility of procuring Covid-19 vaccines for Nepal. “There are no permanent friends and enemies in foreign policy and international relations but there is always a permanent interest,” Deuba remarked as he was taking the vote of confidence.[xxiii] He added that his “first and foremost foreign policy priority” would be to procure vaccines for his nation.


Another major foreign policy challenge that Deuba has to contend with is balancing the US-led Indo-Pacific Strategy and the G7-led Build Back Better World (B3W) initiative against the BRI. The previous KP Sharma Oli government had fallen into a controversy when the Foreign Minister of the erstwhile government, Pradeep Gyawali, claimed that Nepal is not part of the US-led Indo-Pacific Strategy, which was in contrast to the US claims of Nepal being involved in it.[xxiv] Nepal has thus far refrained from making its position on the B3W initiative known. One of the coalition partners of Deuba’s Nepali Congress, the Nepal Communist Party (Maoist Center), has reservations about ratifying the Millennium Challenge Corporation (MCC) compact in the Parliament. Under this initiative, the US will provide $500 million in grants for two infrastructure projects in Nepal.[xxv] The Maoists intend to ratify the compact only after some of the provisions are amended. The other ally in the government, Janata Samajbadi Party, is in agreement with the Nepali Congress on this issue. Thus, Deuba’s principal challenge would be to somehow maintain cordial relations with China, India and the United States without earning the wrath of any one of them.