Does gravity matter? Evidence from Nepal’s trade pattern

In the midst of globalization, trade of goods and services has been increasingly important. As a World Trade Organization member, Nepal is no exception. Using the gravity model, this study examines Nepal’s trade pattern by analysing a panel dataset of the country’s bilateral trade flows with 94 countries for 29 years (1981–2009). The empirical results for the entire dataset followed the general prediction of the gravity model (positive coefficients for economic size and negative coefficients for distance). When the data was examined by dividing it into two based on Nepal’s economic liberalization in 1991, no significant structural breaks were found. However, when the dataset was re-examined by comparing the actual trade flows with the estimated ones, it was found that Nepal’s trade flows with China, Japan and ASEAN members were undermined, whereas its trade with India was excessively concentrated. It is therefore suggested that Nepal diversify its trading activities and reduce its trade dependency on India.