Capping and Tapping FDI in Nepal

Many countries of the world opened up to structural adjustment programmes after the oil crisis, economic depression and stagflation of the 1970s. Young democracies needed loan and injection of foreign direct investment (FDI) to boost their growth. The 

decolonisation of Africa and Asia during the later half of the 20th century, and fall of Soviet Union led many state controlled economies to switch to market economy.

Following Footsteps

India’s abandoning of Nehruvian model in favour of market economy under young Finance Minister, Manmohan Singh, the present Prime Minister, affected Nepal, which followed its southern neighbour. Ushering multi-party democracy in 1990 saw new breed of western educated Economists like Mahesh Acharya and Ram Saran Mahat, whose economic policies transformed Nepal from a predominantly agrarian subsistence economy into market-oriented one.

However, the transformation has been painstakingly slow, disrupted by Nepal’s political and power crisis. According to Department of Industry (DoI), the flow of FDI in Nepal has been limited to USD 95 million in the last two decades. This is largely due to a decade-long armed-conflict, protracted political transition and chronic power shortage. Nepal has huge potential for market seeking and non-market seeking FDI but lacks basic investment climate including infrastructure, policies and commitment from domestic actors.

The government recently came up with a new Foreign Direct Investment and Technology Transfer Act (FDITTA) which has introduced a minimum ceiling of USD 200,000 on FDI in the country. It aims to streamline FDI and channelise it to essential sectors . However, it lacks vision and suffers from policy short-sightedness. 

Criteria Concerns

To begin with, the ceiling is overambitious and impractical as it ignores the fact that international confidence in Nepal’s business environment is at an all-time low. So, to stifle whatever little FDI is flowing in few sectors does not exactly contribute to making things better.

Secondly, a small investment sector like IT business, which is an idea-based industry, does not offer large scale investment options. There is limited scope for big investments in this kind of enterprise because six out of seven ideas fail during experimental phase and the business is better off run as a small cluster enterprise. Interestingly, the draft makes exceptions for such businesses established inside IT Parks like the one in Banepa. This only exposes the government’s policy inconsistency.

Similarly, in hydropower sector, the draft prevents investment in projects that are less than 30 MW in capacity. This leaves a huge investment gap as domestic investors often find it difficult to raise capital to invest in projects that are of more than four MW capacities. Even commercial banks in Nepal find it difficult to invest in big hydropower projects due to huge risks and long project gestation period. FDI is not just about raising capital. Besides capital investment, a foreign investor brings in management and latest technical expertise in terms of best practices.

The new draft also puts a lower cap on investment in tourism business. Foreign investors may only invest in hotels with more than three-star facilities. This will destabilise the entire tourism industry. In major tourist destinations like Thamel, Nagarkot, Pokhara and Namche Bazaar, there are hundreds of small restaurants run by natives of France, Thailand, Italy, and Spain. These are small businessmen who bring in much needed investment in the sector, adding variety to the services to attract visitors from various parts of the world. Even from a business point of view, investors only plan bigger projects once they succeed in small ventures. The introduction of minimum cap will ruin such long-term possibilities.

Promising Potential

Fortunately, there is a consensus among stakeholders on the role of FDI in Nepal’s economy, which still suffers from capital deficiency. 

Besides injection of capital and job creation, foreign businesses provide grants and assistance for local development as a part of their corporate social responsibility (CSR) commitment. Himal Power Limited, a Norwegian company has built schools and a hospital in Dolakha. It has constructed and handed over two mini-hydro plants to the Khimti Rural Electricity Cooperative (KERC) which distributes electricity to around 8,000 households. 

The positive impact of FDI in developing economies is evident from the fact its share in the GDP remains between 10 to 30 per cent. However, in case of Nepal, the figure is as low as 0.5 per cent. Nepal has good possibilities in natural-resource seeking, market-seeking and efficiency-seeking FDI. 

For too long, Nepal’s private sector had been walking on a double edged sword of preventing domestic capital flight as well as attracting the right kind of foreign investment for the country. This month, the government decided to allow Nepali business houses to invest in foreign soil. Now, by opening Nepali market for foreign investment, the government must promote healthy competition domestically.

With the right kind of policy instruments to protect domestic interests, such de-regulation will increase competitiveness of our private sector at international level. But for that to happen, the government must first hold open discussions with stakeholders about effectiveness and shortcomings of its FDITTA.

(This article was published in The Himalayan Times on 16th June, 2013 and can be seen in the following link

http://www.thehimalayantimes.com/perspectives/fullnews.php?newsid=MjIyOQ==)