Tourism has become an important economic activity in all the countries of the world. It creates various direct, indirect and induced effects in the economy. This paper attempts to confirm empirically about the positive impact of tourism in Nepal. It is based on Nepalese data of foreign exchange earnings from tourism and gross domestic product for the period between FY 1974/75 and 2009/10. Co-integration test has been done for ascertaining long run relationship and error correction method for short run dynamics. Granger Causality test has been applied to determine causal relationship between these variables. The evidence confirms the conventional wisdom that of tourism development, that tourism (represented by foreign exchange earnings) causes economic growth both in short and long run. The result also indicates bi-directional causality between these variables.

Tourism comprises the activities of persons traveling to and staying in places outside, their usual environment for not more than one consecutive year for leisure, business and other purposes (WTO, 1999). Over the past several decades international tourism has gained distinct importance around the globe. World tourism recovered strongly in 2010 even exceeding the expectations. The tourists' arrivals grew by 6.7 percent in 2010 against the 4.0 percent decline in the previous year – the year hardest hit by the global economic crisis (UNWTO, 2011). Similarly, tourism receipt remained at US $ 852 billion in 2009 (UNWTO, 2010). In Nepal, despite the belated start of formal tourism after the restoration of democracy in 1952, it gained remarkable growth over the years. In 1962, 6,179 tourists1 travelled Nepal (MOTCA, 2010). It is estimated to be around one million in 2011 including the arrivals of foreigners by land. Nowadays, Nepal caters more than half million tourists and earns foreign currency equivalent of about NRs. 16,825 million. The sector provides employment for about 20 percent of economically active population and contributes about 3.0 percent on gross domestic product (GDP). Tourism is one of the productive business activities directed for the production of the goods and services. It provides goods and services to the customers (visitors, generally foreigners) and employment and income to the locals. With this tourism business, enterprises and the people (related directly or indirectly) generate earnings from the operation of the tourism business activities. Further, tourism as an economic activity produces various direct, indirect and induced impacts in the economy. It ultimately increases the foreign exchange earnings, generates employment opportunity and increases income. Again, the resultant income flows being circulation in the economy, encourages for other economic activities to take place inducing many rounds of income. It also stimulates for the income and employment in other sectors of the economy (UN ESCAP, 2001). Tourism has various economic, social, cultural and environmental effects on tourism destinations (Vanhove, 2005) and the effect can be both positive and negative. Several studies tried to measure economic impact of tourism and concluded about its significance for the economy. Nowadays the importance of tourism in economic development of many countries is well documented. However, there is a dearth of literature in Nepal about the economic impact of tourism.

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