Nepal's business investment landscape is undergoing a significant transformation with the emergence of alternative investment avenues such as private equity (PE) and venture capital (VC). The PE/VC ecosystem has expanded considerably over the past decade mainly due to the increased presence of development finance institutions (DFIs) in the country. While DFIs have been present in Nepal for decades, the entry of bilateral DFIs in the late 2000s was a major shift in the business landscape as they could invest capital necessary for the growth and development of small and medium enterprises (SMEs) and budding companies with unique and disruptive business ideas. Bilateral DFIs including FMO, BII, SIFEM, DFC, DEG, Swedfund and Finnfund are active in Nepal.
DFIs are becoming increasingly important sources of alternative financing in a developing country like Nepal where there is a considerable need for investment. These specialised development banks, established by developed countries or international development funds to promote private-sector growth in developing countries, are making their presence felt on the foreign direct investment landscape in Nepal.
Over the past decade, DFIs have maintained a consistent presence across various sectors, including SMEs, energy and hydropower, hospitality, manufacturing and technology. They channel their investments through various avenues such as private equity and venture capital funds, banking sector, and direct equity investments. The two impact funds launched by Dolma Fund Management have collectively raised over $100 million, primarily backed by DFIs including BII, FMO, SwedFund, US DFC, JICA and IFC, among others.
The Nepali government has also recognised the important role of DFIs. The signing of a Memorandum of Understanding between the government and six DFIs on October 31, 2023, is a positive development. For the first time, a group of DFIs has collectively signed such an agreement with Nepal's government. This shows their joint effort to foster a conducive environment for investment in Nepal.
As Nepal aims to become a middle-income country by 2030, private investment will be important to achieving this goal. However, since private capital investment is still relatively low in Nepal, with private fixed capital formation-to-GDP standing at mere 23%, foreign investment becomes a crucial source of development funding for Nepal. This is where DFIs can play a vital role. DFIs make direct investments in the market, collaborate with businesses, and partner with financial intermediaries like banks and private equity/venture capital fund managers to provide essential capital for the growth and development of the private sector.
Nepal's untapped investment potential and relatively low inflow of foreign direct investment (FDI) provides an opportunity for DFIs to establish a successful track record in the country. Investing in emerging markets like Nepal also allows DFIs to enhance their credibility and potentially attract conventional investors in the future. So far, debt has been the preferred instrument for most impact investments in Nepal by DFIs as they are still assessing market viability. Equity transactions require approval from Nepal's central bank, which is a lengthy and unclear process, creating uncertainty for investors. To further engage DFIs on a broader scale, Nepal needs to implement a policy to hedge against foreign exchange risks and conduct a sovereign credit rating.
This edition of the New Business Age explores the evolution, impact and prospects of the engagement of DFIs in Nepal. While the environment for DFI funding is becoming more favourable, it is crucial to continue reforming policies and regulations to facilitate this growth. Capital flows to regions where it is welcomed and treated favourably. Nepal needs to ensure a hospitable environment to harness the potential of DFI funding for the country's economic growth.
Madan Lamsal
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