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January 2018 Cover Story

Published on: 2018-01-21 11:51:46     1491 times read    0  Comments
Analyzing Manufacturing Prospects

After years of sluggish growth, hopes for a turnaround of Nepal’s manufacturing sector is in the horizon. But will the changing political and economic scenario be supportive to the sector’s revival or not is yet to be seen.

--BY SABIN JUNG PANDE

Economies have thrived expanding their manufacturing base by reforming industrial policies, diversifying outputs, scaling-up production processes and systems, attracting global investments and upgrading connectivity and power-supplies. The world’s second largest economy China, for instance, has amassed immense wealth by prioritising manufacturing and eventually transforming itself into the 'factory of the world.’ In South Asia, the lower real-wage level has accelerated Bangladesh’s manufacturing competitiveness. A 2016 World bank study shows Sri Lanka’s exports are 14 times larger compared to Nepal and even the export value of a tiny island nation like Maldives stands at USD 0.21 billion whereas, according to the World Bank, Nepal exports goods worth USD 0.74 billion, only 3.5 times higher than Maldives.

Just as the rest of the other sectors, Nepal’s manufacturing sector provides a gloomy picture of an ailing economy and untapped economic frontier. Notwithstanding the potential, the country’s manufacturing scenario is gloomy because of the nominal contribution of the sector to Nepal’s GDP and higher trade deficits ultimately resulting in fewer achievements. The contribution in the last 15 years has averaged just 6.8 percent. It plummeted to another extreme recently when it touched 6 percent in 2016, far less than other South Asian economies. Similarly, the sector’s growth rate in the last 10 years has averaged a meagre2.08 percent. 

Paradox of Nepal’s Domestic Market and Demographic Profile
While talking about the domestic market potential, it is important to consider domestic market size and consumption patterns. At present, Nepal’s population is around 3 million and its GDP per capita is around USD 860. AnandBagaria, managing director of Nimbus Holdings, believes that with such a population size and increasing dispensable income, Nepal has a fairly substantial market size. “Our per capita GDP may be minimal but our purchasing power parity is almost four times what our absolute GDP per capita is,” he observes. 

Despite the low per capita income level, significantly rising urban and remittance-receiving population have rapidly changed the domestic consumption pattern. The inflow of remittance has been playing a major role in fuelling domestic consumption. It is estimated that about 35 percent of the money Nepal receives as remittance directly goes to consumption. Overall, the increasing import figures can be used as a measure in generalising how consumption in Nepal has changed over the years. Imports grew by 27 percent in FY2016/17 to Rs 984.30 billion compared to Rs 774.71 billion in FY2015/16. In the last five years, the import value has grown by 60.40 percent.

With such high consumption-friendly population size, Nepal’s domestic market has experienced a drastic change but is unable to boost production and become self-reliant. Part of the reason is dependency on imports that has suppressed the self-sustaining spirit of Nepalis. “Presently, the whole market is flooded with imported products,” notes GP Sah, global business head at FMCG Division of Chaudhary Group. 

It is the traders who are minting money through the easy facilitation they receive from Indian producers and access to easy financial services in Nepal. For producers, investors and entrepreneurs, competing with imports that come in big volume and at competitive prices, appears less lucrative and more stressful. Changing consumer mindsets isn’t easy when there is easy access to imports. 

“Obviously, our economic capacity is restrained by our dependence on remittance and imports,” says Shanker Aryal, director general at Department of Industry. Bagaria too agrees. “Somewhere at the government and bureaucracy level, it is understood that import is the way to run the country and revenue generated from the customs dutieshas become the focal point,” he says. 

As a result, Nepal has a huge trade deficit with India followed by China, two of its major trade partners. Economic reliance on India became transparent when India imposed an economic embargo that stifled Nepal’s economy two years ago.  By now, Nepal has seemingly realised the need for newer trade routes with both India and China. This economically unviable relationship is bound to continue as long as Nepal does not become self-reliant. 

Human Assets 
According to the 2011 National Census, Nepal enjoys a youthful demography with 33.09 percent of the population in the 10-24 years age group. At present, the median age in Nepal is just 21 which is expected to be around 25-26 by 2025. Nepal's demography possesses a substantial workforce required for industrial growth with half a million workers entering the labour market annually. But does it mean Nepal can really enjoy the demographic dividend in terms of utilizing this valuable human asset? Do the youths really want to be part of the Nepali workforce?

While labour conflicts have resulted in economically disastrous situation for manufacturing companies in the past, at present, the lack of skills, fascination towards overseas jobs and high turnover among both white-collar workers and manual labourers are dissuading investors. Estimates suggest that 80 percent of the 500,000 people who enter the labour market have chosen foreign jobs while most of the remaining are engaged in informal sectors. “We are a young country but the lack of opportunities at home has compelled the youths to go for foreign employment. Thus, we are losing not only our workforce but also consumers,” says Sah. 

One of the problems for least-developed economies like Nepal is the onset of globalisation and social-media boom that has simplified migration and intensified overseas attraction. Back home, there is unemployment, limited opportunities, lower earnings and income gaps, dismal working conditions, unregulated market and rising prices and largely, an intense frustration rising out of political bickering, instability and poor governance. At the end, all these culminate in a sense of despair about the future wellbeing. 

In a politically and economically volatile country like Nepal that is aspiring to take a leap in its economic future, such issues pose multiple risks. First, it has a compound effect on the mindset of Nepalis that the ‘grass is much greener on the other side’ despite the associated costs and risks and that their country will never improve with such mass attitude.  

A recent study by the UK-based think tank Overseas Development Institute (ODI) reinforces the intensity of the problem. It has shown that Nepal may face a labour crisis of up to 3.6 million workers by 2030 if the labour-based migration persists at the existing rate. However, industrialists like Bagaria believe Nepal is at the tipping point of witnessing a reverse migration outflow. “I am hopeful that the younger generation will return and do well for the country if a satisfactory level of stability is achieved in the coming days,” hopes Bagaria.

Challenges
The problems in connectivity
In Nepal, access to markets and the expanding manufacturing opportunities is difficult due to the deplorable condition of existing roads and other infrastructures and complete lack of roads in some regions. For instance, the Karnali region which accounts for almost 15 percent of the area of Nepal is almost inaccessible via road while the hills of far-western region too have no easy access. The roadways in the hilly region are risky where roads are mostly single-lane with potholes, ditches and vulnerable to bad weather. The Terai region, which is also the manufacturing base of Nepal, boasts a fair road infrastructure but only relatively. Poor road conditions are correlative to high transaction costs and loss in business confidence. As a result, expansion of economic opportunities is strictly confined. 

While the economies in the 21st century are envisioning and enforcing connectivity beyond their borders, seas and even continents, Nepal’s projects are suffering losses in money and time. As a result, connectivity is still poor. On the other hand, in the absence of a meticulous vision for industrialisation, better connections may only serve to facilitate further imports. 

“The lack of or poor connectivity has increased marginal costs and made access to raw materials and supply to markets difficult. Delay in delivery of goods has become an increasing problem,” says Sah. According to him, as a result of the increasing transportation costs, import costs have gone up in the last 2-3 years. “Both importers and exporters are compelled to pay high demurrage charges,” he adds. Shiwaz Neupane, director at Ambe Group sees the establishing of cargo train routes as a solution to the existing problems in transportation. “If the government works on constructing freight train routes, then the transportation costs will come down which will ultimately reflect in the price of products,” he mentions. 

Will the power-supply really improve?
One of the prerequisites to active production and productivity is regular power supply. In the past, acute power shortages have been one of the most brutal battering rams to Nepali manufacturers. After Kulman Ghising was appointed the Managing Director, Nepal Electricity Authority (NEA) finally got hold of reformation and succeeded in ending the decade-long routine power cuts in several cities across Nepal. Last FY’s 6.9 percent GDP growth, a record growth rate in the last 23 years, was partially attributed to the normalising of the power supply. 

It clearly shows that if the power sector reforms are sustained, manufacturing activities are bound to spur on. “The industrial demand for power will boost as a number of industries are lined up for production,” says Neupane. 

Bagariais hopeful about the future improvements in the country’s energy sector with the number of hydropower projects in the pipeline. Nonetheless, cautious voices have been raised in terms of meeting the long-term power demand of manufacturing companies. “Normalisation of the power supply has been a crucial improvement. But we should note that the industrial demand for power will increase in the future,” observes DoI Director General Aryal, adding, “Electricity authorities must brace themselves to meet the future demand.” 

Industrialisation of Agriculture
Development in agriculture will warrant an optimistic outlook for investment in the manufacturing sector. So far, its subsistence farming, lack of modernisation, insufficient supply of seeds and fertilizers and reliance on good monsoon have restricted scaling up agricultural production. From crops to meat processing, immense possibilities exist in Nepal in agro-processing that have been left untapped.

Sah, whose company is in the food production business, sees ample opportunities in agro-processing. “A country like Bangladesh with lower agricultural productivity than Nepal exports food products to Nepal. Despite importing raw materials from other countries, they are competitive enough to export. Today, Bangladesh exports even beverages and snacks,” he expresses. “We should seriously analyse their competitiveness and learn lessons from them.”

Ironically, Nepal supplies a number of agriculture produce as raw materials to Indian agro-processing industries and imports the processed output as final products at higher prices. “We export wheat to India and import back pasta. Noodles, ketchup, pasta and packs of tea, coffee and sugar all come under agro-processing which are imported,” says Bagaria. According to him, importing processed products that don’t require advanced production technology and can be self-produced doesn’t make economic sense. “Farmers should be bridged with both intermediary and final consumers and encouraged to process their output. So should the private sector,” emphasizes Bagaria. 

Bagaria suggests that policy makers must be open minded when analysing agriculture development and align its development strategy with industrialisation needs. “There is a need to integrate relevant agri-sector policies with industrial policies and needs. For example, identifying pocket areas for selective agricultural products and stipulating subsidies accordingly will enable investors to locate production plants correspondingly,” says Bagaria. 

One way Nepal plans to create opportunities for commercializing agriculture is by successfully implementing the 20-year Agriculture Development Strategy (ADS). Throughout the next 10 years, ADS plans to make USD 50 million strategic investments in agriculture production, processing, trade and auxiliary services like storage and transportation, research, finance and marketing plans. 

Bagaria and Aryal both believe that meeting Agriculture Development Strategy (ADS) objectives will help the industrialisation process by fulfilling demand for inputs like raw materials.

Access to Raw Materials 
Aryal says that the concerns of Nepali manufacturers are primarily related to the lack of raw materials. “Producers have to depend on maize imports from India although its annual domestic production is around two million tonnes. It is the same with wheat and paddy. How can we industrialise when raw materials aren’t sufficient?” questions Bagaria. He believes that most industries dependent on India for raw materials are standing on loose ground considering other numerous constraints that Nepalis industries face. GP Sah explains, “Producers have to bring raw materials from Indian ports to Nepal and take back their finished goods to Indian ports and we know how our dry port infrastructures are. It eventually increases costs and reduces our competitiveness.”

Another crucial element associated with the availability of raw material is tariff. Sah, Bagaria and Aryal share similar view on the need to review the existing tariff structure which adds to the difficulties in the domestic production of final products. “There needs to be some level of difference in the import tax structure imposed on finished goods, raw materials and intermediary raw materials,” mentions Bagaria. According to him, there are many items where low tariff is levied on the import of finished goods rather than on their raw materials. “For instance, resins used in the paint industry can be imported at lower import costs compared to the raw materials. It begs the question why would anyone set up a resin manufacturing plant?” asks Bagaria. 

The existing duty structure is one of the major reasons for making fruit juices produced in Nepal less competitive. Currently, 30 percent import duty is levied on both fruit concentrate, the raw material used to produce fruit juice, and the actual fruit juice which is the finished product. This is disadvantageous for local manufacturers of fruit juice as their cost of production increases due to the unreasonably high duty rates on the import of raw materials.

Investment Climate and Opportunities
Changing political landscape 
Both foreign and local investors are becoming hopeful with the signs of stability seen on the political horizon led by the start of the implementation of the new constitution. But they agree that it may not be immediately easier for businesses to adjust in the new context of federalism. Bagaria expresses hope for political stability but still fears that economic agendas may take a backseat in the whole process of managing the country’s federal structure. 

“There is such a possibility because ambiguities will emerge with the need to coordinate large numbers of local and federal representatives and manage infrastructures for provincial parliaments and other federal institutions,” explains Bagaria. At the same time he is optimistic that the current breakthrough in the seemingly perpetual political instability and possibility of stable government will enable growth in the industries. Neupane holds similar views. “Even traders will step into the manufacturing arena if we achieve a satisfactory level of political stability,” he opines. 

Incentivising Manufacturers 
Before the power supply improved, Nepal inaugurated its first Special Economic Zone (SEZ) just two years ago in Bhairahawa. Of the 69 plots in the SEZ, 48 had already been leased out by August 2016. In July 2016, the SEZ Act, 2014 received parliamentary endorsement imposing a complete ban on strikes and protests within SEZs and introducing a number of tax incentives to domestic and foreign investors. Industries within the SEZs will now enjoy exemptions on income tax and custom duties based on different criteria. 

The incentives include income tax exemption for the first five years and 50 percent income tax exemption for another five years for industries using 60 percent domestic raw materials. Similarly, the Act has provisioned another 25 percent income tax exemption for the next five years and full exemption from custom duties for export industries using imported raw-materials. 

Experts view it as a commendable step. Nonetheless, industrialists seem concerned about the infrastructures at the Bhairahawa SEZ. Both Sah and Bagaria observe the need to develop a robust SEZ equipped with modern and sector-specific infrastructures. “I don’t see any specialisation happening. Since the infrastructure requirements for a steel plant and an agri-business plant aren’t the same, the system in-place will not be able to accommodate the diverse needs of diverse industries,” reasons Bagaria. 

The SEZ Act envisages developing 14 additional SEZs throughout the country with the objective of changing the country’s fortune through manufacturing and export-oriented industries. The new SEZs must draw insights from business communities and lessons from similar international practices, stakeholders say. 

Infrastructure-led domestic demand
At present, the ongoing post-quake reconstruction drive has led to an upsurge in demand for construction materials. Adding to it is the increased demand for such materials in the construction of large infrastructure projects that are progressing, albeit slowly. Currently, 21 projects of national pride including international airports, large hydropower plants, irrigation and highways are in the pipeline. These national ambitions have set the right tone to boost infrastructure-led demand and investors should be quick to sense it. 

Citing the example of his own business house, Neupane informs that domestic steel and cement industries are unable to meet the domestic demand which is why Ambe Group is adding new cement and steel plants soon. Earlier, Nepal bagged one of the largest foreign investment-led manufacturing deals. The USD 359 million joint venture between China’s Hongshi Group and Nepal’s Shivam Holdings plans to commence commercial production of cement in early 2018. 

Conclusion
Economic development across the globe has shown how a young population instills vibrancy in an economy by spurring economic and entrepreneurial activities that integrates technological growth and stimulates investment and consumption demand. In Nepal's case, high dependency on remittance, increasing imports, poor human assets and a brain-drain, and issues with connectivity form a complex web of deterrents to its manufacturing potential. Becoming an ideal investment avenue for manufacturing industries depends on how these intricate factors are managed to create a dynamic investment climate. There is hope that the changing political context will provide a breakthrough. 

Experts Views on Manufacturing Sector in Nepal


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