Nepal, a landlocked country situated between two major economies—India and China—faces numerous developmental challenges. Among them, the growing influence of informal trade stands out as a major obstacle to economic growth and institutional stability. While formal trade is regulated, taxed, and contributes to the state’s capacity, informal trade operates outside the law. It includes activities that are unregistered, untaxed, and often illegal. Over time, this shadow economy has become deeply embedded in Nepal’s economic structure. In many ways, Nepal suffers more from the harmful effects of informal trade than from any shortcomings in formal trade.
Informal trade in Nepal takes many forms. It includes the smuggling of goods such as gold, fuel, medicines, money laundering and electronics across open borders. It also includes unregistered businesses, undocumented labor, and transactions carried out entirely in cash to avoid tax and regulation. Nepal’s long and porous border with India, combined with difficult-to-monitor terrain in the north, makes informal trade easy to conduct and hard to control. On the domestic front, many small and medium-sized enterprises operate without any legal registration. As a result, they fall completely outside the formal economic system.
The scale of informal trade in Nepal is vast. Estimates suggest that the informal economy may account for 35 percent—40 percent of the country’s GDP and more than 80 percent of total employment. This means a large portion of Nepal’s economic activity is hidden from the state. It does not contribute to taxes, cannot be properly measured, and creates unfair competition for businesses that do comply with the law. While formal trade has its own inefficiencies—such as bureaucratic delays, red tape, and occasional corruption—these can be addressed through policy reforms. Informal trade, by contrast, creates deep and lasting damage that is harder to fix. It undermines public revenue, weakens institutions, and limits Nepal’s ability to plan and deliver services.
Addressing the informal economy is not simple, but it is necessary. A multi-pronged approach is needed—one that focuses on simplifying formal procedures, using technology, building trust, and offering real incentives for businesses and workers to shift into the formal system.
One of the first priorities should be to make it easier for small businesses to formalize. Many avoid registration simply because the process is slow, complex, and costly. Nepal should adopt a digital, one-window registration system that reduces paperwork and lowers barriers to entry. If formality becomes easier and less expensive, more businesses will join.
Another key step is improving border management. Nepal cannot control smuggling effectively using traditional methods alone. New technologies such as automated scanners, GPS tracking, and electronic cargo systems should be introduced. Just as important is cooperation with neighboring countries. Shared data and joint monitoring can help prevent illegal trade across borders.
The informal economy also depends heavily on cash, which makes transactions untraceable. Promoting digital payments is a powerful tool to reduce this dependence. However, digital infrastructure alone is not enough. The government must also invest in public awareness, digital literacy, and incentives to encourage both consumers and businesses to use digital platforms.
To support this shift, the state should reward those who comply. Businesses that register and follow regulations should receive benefits—such as tax breaks, better access to finance, and eligibility for government contracts. This changes the perception of regulation from being a burden to being a business opportunity.
Labor reform is another vital area. Most informal workers in Nepal lack legal contracts, benefits, or protections. To bring these workers into the formal economy, Nepal must design labor policies that fit the needs of small enterprises. Portable social security schemes, flexible contracts, and minimum wage protections should be introduced even for small and transitioning firms.
Overall, the informal economy reflects not just illegal behavior, but deeper problems in Nepal’s institutions and systems. It is not enough to use force or punishment. What Nepal needs is transformation—simple, transparent, and fair systems that encourage people to participate legally. Informality is often a result of necessity, not criminal intent. That’s why the government must respond with practical solutions that make formalization more attractive and accessible.
In conclusion, while informal trade may provide income and survival for many, it does long-term harm to Nepal’s economy. It limits tax collection, distorts markets, and weakens the foundations of good governance. Compared to formal trade, whose problems can be corrected through reform, informal trade creates much deeper challenges. If Nepal wants to build a resilient and inclusive economy, it must take bold steps to reduce the size and influence of its informal sector. By simplifying procedures, using technology, and offering clear incentives, the country can bring more of its economy into the formal fold—and unlock its full potential for growth and prosperity.
