Distorting the Private Sector

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Distorting the Private Sector

The heterogeneous mix of interests of dishonest politicians, bureaucracy and businesspersons has led to the growth of crony capitalism in Nepal distorting the real spirit of entrepreneurship and hindering economic development of the country.  

--BY AJAYA BHADRA KHANAL AND DURGA LAMICHHANE

When Nepali Congress leader, late Krishna Prasad Bhattarai, contested elections in 1995, one of his campaign promises was to make Kathmandu awash with water from Melamchi within five years. More than 23 years later, Melamchi Water Supply Project may be nearing completion, but only after becoming a butt of jokes about corruption, inordinate delays and unfulfilled promises. 

One of the primary reasons for the delay of the project which was formally launched in 1998 is the unhealthy relationship between the political leaders and private contractors. A retired secretary who headed the Ministry of Water Supply, says one of the reasons for the delay and the escalation of costs were the series of disputes with private contractors. 

The case of Melamchi drinking water project indicates that the tendency of the political leadership is to weaken the state institutions and provide impunity to corrupt private sector actors. According to the former secretary, who didn't want to be named, political leaders would support and protect the interests of the private contractors rather than the government institutions.

The problem was not in the law, which meets international requirements, but in its implementation. "While I tried to protect the project manager, the political leaders would constantly harass him," the former secretary said. 

"It is as if the government is trying to bypass the private sector. We are also in favour of protection of consumer interests, but at the same time the interests of industries should also be protected.”

Shekhar Golchha, Senior Vice-president, FNCCIShekhar Golchha
Senior Vice-president, FNCCI

Even after the breakthrough of the tunnel, the Melamchi project’s Italian contractor, Cooperativa Muratori é Cementisti (CMC), claimed payment of an additional Rs 1.65 billion. The project, however, was unwilling to fulfill the variation demand and said it would pay only Rs 280 million. As a result of the ongoing disputes, Melamchi's total cost has escalated to Rs 36 billion from an initial estimate of about Rs 17 billion.

Melamchi is one of the many examples that show how the political regime actively colludes with preferred private sector actors to enhance financial gain, frequently by misusing state resources, bending the rule of law and distorting the environment in which the private sector operates.

At a time when investing in the productive sectors is challenging, the country’s private sector is increasingly turning to easier but more financially rewarding ventures like trading and partnering with the public sector on procurements and extraction of resources.

Even as there is growing collusion between the private sector and the public sector, there are also signs of an adversarial relationship between political leaders and the private sector. 

For example, at an interaction organised by the Federation of Nepalese Chambers of Commerce and Industry (FNCCI) on September 13, Minister for Industry, Commerce and Supplies, Matrika Yadav claimed that Nepal does not have entrepreneurs who would invest in the productive sectors. According to him, most Nepali businessmen tend to make easy money by exploiting the consumers and the state. The audience at the programme observed a row between Yadav and FNCCI executive committee members who criticised the government for what they call unjust and unfair treatment of industrialists and businessmen. The last few months have seen minister Yadav himself going from place to place leading a team of government officials to ‘inspect’ the industries and the market.  

So what will allow us to examine the relationship between the state and the private sector?

According to Mohan Das Manandhar, an expert on public policy and governance, the relationship can be assessed by looking at several arena where the private sector and the state come together—e.g., public procurement, the discretionary use of decision-making in the licensing regime, policy level concessions and subsidies, and political representation. 

Public Procurement
"One of the most important arenas of the relationship between the private sector and the state is the procurement process, the key question being whether the state ensures transparency and proper competition or not," says Manandhar.

According to the 2017 annual report prepared by the Office of the Auditor General (OAG), Rs 2.5 billion worth of procurement in 47 public sector entities were non-compliant with the Public Procurement Rule 2007.

Senior politician and economist Prakash Chandra Lohani views that in a country with a corrupt system like Nepal, there is no investigation of irregularities by the private sector. “Even if there are massive failures like Sikta, the contractors are not penalised," he says. 

The rise in the costs of development of projects has become a trend in Nepal. The 72MW Middle Marsyangdi Hydropower Project is an example in this regard. The development of the project began in 2001 at an initial cost estimate of Rs 13.65 billion. However, by the time Middle Marsyangdi was completed its cost per kilowatt had reached USD 5,500, a far cry from the USD1, 800 averaged by independent power producers. Similarly, the cost of Sikta Irrigation project, has increased to Rs 25 billion from an initial estimate of about Rs 13 billion.

The public procurement process is beset with several malpractices, one of which is the practice of approving variation orders. According to the 2017 OAG report, an additional Rs 610 million was expended in 59 instances due to variation orders. The report said many of these orders, were "irrational" and not justified.

A former secretary who served at the Ministry of Physical Infrastructure and Transport says, "The current situation in the public construction sector and procurements is a reflection of the overall governance situation—there is as much impunity."

Kishore Kumar Pradhan, vice-president of FNCCI agrees. He says that the government has not been able to ensure competition and transparency in procurements, especially in contracts for decades. "None of the projects under the Physical Infrastructure Ministry are constructed in time because of the system of allocation of contract through cartels by ‘A’ class and ‘B’ class contractors," he said.

"None of the projects under the Physical Infrastructure Ministry are constructed in time because of the system of allocation of contract through cartels by ‘A’ class and ‘B’ class contractors."​

Kishore Kumar Pradhan, Vice-president, FNCCIKishore Kumar Pradhan
Vice-president, FNCCI

The Licensing Regime and its Discretionary Use of Power
Another important interface of the relationship between the state and the private sector is the operation of the licensing regime and how discretionary power is used by those holding public offices. Pradhan says the government misuses discretionary authority while issuing licenses or regulating the private sector. 

His claims are backed by government reports. According to the 2017 OAG report, Nepal Telecommunications Authority, the telecom sector regulator, provided an unfair advantage to Nepal Telecommunication Company (NTC), the state-owned telecom services provider, by charging it only Rs 18.9 crores for renewal of licenses in 2014, although it was stipulated in the contract that it would be required to pay the same amount as private sector operators. While a private sector operator was required to pay Rs 20 billion, NTC got away without paying the renewal fees that was due in 2009. 

The Electricity Act, 1992 requires the government to issue licenses for surveys within 30 days and licenses for generation within 120 days. However, the OAG found out in 2017 that licenses had been issued to only 10 percent of applicants for generating 2,397 megawatts of power, while the remaining 108 applicants were being kept in limbo, receiving neither cancellation nor approval.

The case was similar with the Department of Mines and Geology, which had issued licenses to 433 parties in 2017-2018 for exploration and mining. Some 32 parties continued to hold licenses despite failing to carry out exploration or mining and many others were found to have quarried more than the permitted amount.

Similarly, the case of foreign employment shows that despite strong regulation and licensing, government policies lead to distortions. For example, when the government introduced the system of free air tickets and visas in July 2015, there was a drastic reduction in the number of Nepali migrant workers seeking final approvals, which was 123,000 less than the previous year. According to OAG, the licensed companies had started taking fewer quotas of workers but charging more. The bodies overseeing the licensed sector often fail to regulate the sector. For example, the Nepal Bureau of Standards and Metrology, while monitoring some 91 industries in 2016-17, failed to take action against 36 industries that were found to have violated the Nepal Standards Act 2037. 

However, Shekhar Golchha, senior vice-president of FNCCI, feels the opposite. He says the government did not take the private sector into confidence while bringing the Consumer Protection Act. "It is as if the government is trying to bypass the private sector. We are also in favour of protection of consumer interests, but at the same time the interests of industries should also be protected. But the way in which the government brought this bill will create imbalance and bring distortions."

“People from the private sector riding the gravy train will benefit, while those who are outside will only look on.”​

Dr Prakash Chandra Lohani, Former Minister for FinanceDr Prakash Chandra Lohani
Former Minister for Finance

Concessions and Subsidies
The state's relations with the private sector are also reflected by the way the government grants concessions and subsidies to the private sector. Sometimes, these concessions go to the extent of criminality and government institutions facilitating tax avoidance schemes. 

In FY 2016/17, the government provided tax exemptions worth Rs 51.3 billion. Suspecting irregularities, the Public Accounts Committee of the parliament in July 2016 instructed the government to control and monitor the practice of granting remission. The OAG report noted that exemptions were provided to luxury goods, and that the government was unable to monitor whether the goods imported under revenue exemptions were being used for the stated purpose or not.

According to Prakash Chandra Lohani, most of the policy level corruptions that distort the private sector take place through the national budget. 

This view is shared by former health minister and finance secretary, Vidyadhar Mallik who says the long list of concessions in the financial bill reflects policy corruption and crony capitalism. "Tax should be as simple as possible, but when the list of concessions gets longer, it indicates possibility of unhealthy relationship between the government and the private sector," he expresses.

While the government may be actively promoting certain private sector actors by using its discretionary power to grant concessions and subsidies, the overall private sector is not happy.

Energy entrepreneur Gyandendra Lal Pradhan says that a foreign investor gets 50 percent tax rebate while importing cement from abroad but a Nepali investor has to pay 13 percent VAT while buying Nepali cement. "This is like encouraging a Nepali investor to import cement from outside," he mentions.

Similarly, Golchha, on being asked whether the government was favouring some businesspersons and alienating others says, "I don't think that the government is favouring any business, I think it is alienating the whole private sector."

"Tax should be as simple as possible, but when the list of concessions gets longer, it indicates possibility of unhealthy relationship between the government and the private sector."​

Vidhyadhar Mallik, Former Minister of Health/Secretary of FinanceVidhyadhar Mallik
Former Minister of Health/Secretary of Finance

Conflict of Interest
The growing penetration of business interests in political finance and political representation is giving rise to clear conflicts of interest in representational politics and governance. 

In the absence of political/election campaign finance laws and regulations, political leaders running for public office depend on opaque donations and funding from business groups. 

An increasing number of contractors and business interests have run for political office at the federal, provincial and local levels.

As a result, the private sector’s influence on legislation and government policy is increasing. The implications of these trends are that the businesses can now influence both regulation and regulatory bodies and the government's budgetary process. For instance, the previous legislature-parliament had as many as four lawmakers serving as chairman of different banks. They threw their weight to resist reforms in the banking sector. Speaking at a meeting with lawmakers in the parliament’s finance committee in May 2016, Dr Chiranjivi Nepal, governor of Nepal Rastra Bank, had said chairmen and directors of BFIs becoming lawmakers would result in conflict of interest.

Some of the clearest indications of conflict of interest between the business community and the legislative process emerged during the 2017 amendment of the Banks and Financial Institutions Act (BAFIA) and the 2016 amendment of the Education Act.

During the eighth amendment of the Education Act, members of the parliament who had the final say on the amendment were renowned businesspersons running education institutions. 

Similarly, while amending the BAFIA, the parliament's finance committee had several BFI representatives. On top of that, the seven-member sub-committee formed by the finance committee had four members with significant stakes in BFIs. 

“The new government hasn’t done anything to encourage the private sector. New laws have been made punitive by copying the older laws and legislations of other countries keeping more discretionary powers for the government.”​

Jagdish Prasad Agrawal, Chairman, Nimbus GroupJagdish Prasad Agrawal
Chairman, Nimbus Group

Politics and Policies
In recent days, the private sector has become wary of the government's focus on revenue generation, unfriendly regulations and policies, monitoring of businesses and industries, and an attempt to constrain the private sector by emphasising the cooperative sector.Even as there is growing collusion between the private sector and the public sector, there are also signs of an adversarial relationship.

The distrust between the government and the private sector was clearly reflected in the programme organised by FNCCI on September 14, where industry, commerce and supplies minister Yadav claimed that, "traders had become more dominant than industrialists in Nepal, and that they had created an environment where foreign investors could not enter Nepal.”

At the event, FNCCI’s senior vice-president Golchha retorted that Nepal's economy had become trade-centric because the government's policies had become "revenue-centric."

Industrialists claim that in recent months, government agencies have begun to enforce old regulatory laws—some formulated during the regime of late King Mahendra—and begun to call industrialists for hearings and explanations. 

There is a tendency in the government to try and rein in industrialists. 

Talking to New Business Age, Golchha says that government policies do not encourage the industry sector. “Industries have been put in a difficult position. Monitoring is not carried out in a respectable manner.  The government may think that it is in the side of the people when portraying the private sector as an opponent. That (approach) is not correct and we want the government to change its behaviour," he says. 

Jagdish Prasad Agrawal, chairman of Nimbus Group shares similar views. “The new government hasn’t done anything to encourage the private sector. New laws have been made punitive by copying the older laws and legislations of other countries keeping more discretionary powers for the government,” he observes. According to Agrawal, it is not the executive body but the judiciary which has the rights to give punishment if misdeeds are proved. 

Babulal Chachan, chairman of Chachan Group, a Birjung-based business house, sees the activities of the government as unsupportive to the private sector. “Business people have been made terrified in the name of monitoring of industries and businesses,” he says, adding, “From the newly introduced civil and criminal codes to Consumer Protection Act, Industrial Enterprises Act, Labour Act and legal provision related to the minimum wage, many of the laws are not private sector friendly. Several laws have been passed by the parliament in a hurry without proper discussions and evaluation of their implications.” According to him, the government largely ignored the 14-points suggestion submitted by FNCCI and similar recommendations of the Nepal Chamber of Commerce (NCC) while the new civil and criminal codes and Consumer Protection Act were being formulated.      

“From the newly introduced civil and criminal codes to Consumer Protection Act, Industrial Enterprises Act, Labour Act and legal provision related to the minimum wage, many of the laws are not private sector friendly. Several laws have been passed by the parliament in a hurry without proper discussions and evaluation of their implications.”​

Babulal Chachan, Chairman, Chachan GroupBabulal Chachan
Chairman, Chachan Group

Politicisation of the Private Sector
The relationship between political parties and business interests has caused differences within the business community. 

The difference between different member associations and the federation also came to light recently when Bhim Ghimire, chairman of the Morang Industry Association organised a meeting with Prime Minister KP Sharma Oli in Baluwatar. In different interviews to the media, Ghimire said the FNCCI had failed to represent their issues and had showed no interest in doing so.

Similarly, industries in Biratnagar, Birgunj, Bhairahawa and Butwal formed a group and started negotiating with the government directly.

FNCCI officials were also miffed when the government, in August, formed a panel to study the problems facing the private sector but bypassed the FNCCI. An FNCCI official, on condition of anonymity, says that it feels like a move by the government to divide and weaken the private sector body.

Even as these developments, linked with politics, were taking place, the Nepal Chambers of Commerce (NCC), a pioneer umbrella organisation of traders and industrialists established in 1952, decided to separate from FNCCI and expand the organisation along the lines of the country's federal structure.

"One reason for the differences that have emerged between the FNCCI and the NCC is politics," one of the businesspersons interviewed said. "The current FNCCI leadership was supported by an alliance of Nepali Congress leaders and the then CPN (Maoist Centre) chairman and former Prime Minister Pushpakamal Dahal, which has led to a distrust of the institution by the current Prime Minister," he says. 

As the private sector's reach and influence grows, it has been able to penetrate into the democratic representation systems. Speaking during a press event in Pokhara, Home Minister Ram Bahadur Thapa said in May 2018 that Nepal's economy is in the hands of "smugglers and tax evading contractors.” 

An increasing number of private sector actors are entering politics and holding public offices. In the last 10 years, many businesspersons belonging to the major business houses of the country have served as members of parliament. 

Influential businesspersons affiliated to political parties are directly contesting elections while others are managing to get into the parliament through the proportional representation quota system. Some of the powerful businesspeople becoming MPs after the 2017 elections are Binod Kumar Chaudhary, Motilal Dugar, Umesh Shrestha, Jip Tsering Lama and Surya Bahadur KC.

Gyanendra Lal Pradhan believes that the relationship between the business sector and political parties is generally smooth. "Nepal's politics is a politics of revenge. If you challenge anybody with a political status, you are going to get hurt. Therefore no businessperson self destructs by harming political relations," he opines. 

"Nepal's politics is a politics of revenge. If you challenge anybody with a political status, you are going to get hurt. Therefore no businessperson self destructs by harming political relations."​

Gyanendra Lal Pradhan, Former Chairman Energy Committee, FNCCI Gyanendra Lal Pradhan
Former Chairman
Energy Committee, FNCCI 

What's at stake?
What kind of impact will this have on our politics and economy?

Golchha says this is the "first powerful government seen by our generation" and people are expecting big changes. However, he thinks the government has not given enough thought to what will bring prosperity. Whether it is creating employment, increasing productivity, or utilising opportunities like tourism, energy and natural resources, the government must work together with the private sector.

According to Shekhar Golchha, if the private sector loses confidence it will start looking at short term benefits rather than investing in productive sectors. "If this happens, the trade deficit will only increase."

Prakash Chandra Lohani, meanwhile, thinks we are regressing to the Rana period. The big business houses in Nepal now wield more and more power, just like the former Rana houses.

While the private sector members are not yet complaining in public, in private they are expressing concerns about those who are close to the state and those who are not.

According to Lohani, people from the private sector riding the gravy train will benefit, while those who are outside will only look on. “It will lead to an axis of politicians, bureaucrats and big businesses. This axis will misuse the resources and will destabilise the institutions of checks and balances, or co-opt them by appointing their own member, disrupt the vertical control mechanisms,” he states.

Another implication of the unhealthy relationship between the government and the private sector is inefficiency.

While the tax burden is increasing, growing kleptocracy and inefficiency in governance is leading to the creation of a mafia state, which in turn is likely to threaten political stability and the economic growth of the country.

At present, Nepal's tax-to-GDP ratio is about 22 percent, which is comparable to that of developed economies. Lohani predicts the ratio to increase to 30-32 percent as the local governments are also raising taxes. However, the incremental capital output ratio (ICOR), a measure of economic efficiency of a country, is about 5.1. Lohani says corruption and crony capitalism is decreasing the potential growth rate of investment.

"The government believes that it can do anything as it has a two-thirds majority. When such an attitude increases within the political parties, it gives rise to crony capitalism.  The state’s resources are misused and the delivery is affected," he says.

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