Forest degradation, manifested through decline in forest cover, and the resulting soil erosion and organic carbon losses, is a serious problem caused by a complex coupling of bio-physical, socioeconomic and technological factors in the Himalayan watersheds. Greater understanding of the linkages between these factors requires a systems approach. We have proposed such an approach using a bio-economic model to explore the system behaviour of forest degradation, soil erosion, and soil C losses in the forest areas of Nepal. The outcome of the model simulation over a 20-year period indicates that soil erosion and C loss rates may increase more than four-fold by the year 2020 under the existing socioeconomic and biophysical regime (the base scenario). Reductions in the population growth rate, introduction of improved agricultural technology and increase in the prices of major agricultural crops can help slow down the rates of forest decline, soil erosion and C loss or even stabilize or reverse them. The results suggest that economic incentives may be highly effective in the reduction of soil loss, as well as C release to the atmosphere.