Opinion

Why Does Nepal Need FDI?

July 20, 2011

We all know that a healthy flow of Foreign Direct Investment (FDI) is essential for Nepalâ€™s economic growth. In present circumstances, it is even more important for us for more than a single reason.

Firstly, our overall saving level is very low: our domestic saving to GDP ratio is less than 10 percent (9.4 per cent in Fiscal Year 2009/10, according to the Economic Survey published by the Ministry of Finance).That means, we as a nation, consume more than 90 percent of what we produce and hence there isnâ€™t much saving left which can be invested.

Secondly, which I believe is linked to the first point, deposits mobilized by the financial institutions aggregate about 700 billion rupees which is about 10 billion dollars. That is the amount mobilized by the formal financial sector. This amount is not adequate to support large scale development and infrastructure projects which have now become critical to jump-start the economy.

Thirdly, our capital market, both equity as well as debt, has not developed to the extent required for us to be able to raise enough capital from the public for large investments.

Also, for an under-developed country like Nepal, FDI serves as an important vehicle for transfer of better technology and other resources.

Recent Trend in FDI

Following liberalization of the economy, FDI flow gained momentum in the early 90s, but tapered down a few years later due to the conflict and political disturbances, and actually recorded a net reduction during 2004 / 2005 â€“ at the height of the insurgency. I believe thatâ€™s around the time Kodak and Colgate left Nepal.

The flow moved back into positive territory 2007 onwards and last 3 years have seen a steady increase in foreign investment in Nepal. The figure for 2008 / 2009 was 25 million dollars. For 2009 / 2010 it was 40 million.

I believe current fiscal year is looking even better with companies like Telia Sonera and Carlsberg already having made additional investments in their respective Nepal ventures.

Clearly however, despite the recent improvement, level of FDI inflow is very small given our requirement for foreign funds.

Consider this: the size of our GDP is 15 billion dollars. Money sent home by migrant workers is estimated at 3.5 billion dollars. And FDI inflow is less than 500 million dollars.

Remittance has supported our economy a great deal over last 10 years or so but donâ€™t you wish the position was just the opposite? Meaning FDI inflow of 3.5 billion dollars and remittance only 500 million!

The reason why remittance contributes almost 25% to our GDP is that our people are going abroad in increasing numbers to find jobs because they canâ€™t find jobs in Nepal. A healthy flow of FDI would certainly create many more jobs right here in our country so they wouldnâ€™t have to leave. It will certainly be a mistake on our part to bask in the glory of workforce remittance supporting our economy. Migrants will either come back one day or settle abroad if they can move up the value chain: either way remittance will eventually dry up.

So, Why hasnâ€™t FDI flow been better? Is Nepal an unattractive investment destination?

Let me quickly run through the broad reasons why I think FDI flow has been so dismal.

Investment climate suffered over the last decade and a half due to insurgency. Itâ€™s been 4 years since the political change has happened but sadly, politics is still the primary agenda around here. Economic stability and growth do not appear to be in the radar of the people who are running the country. When will our politicians understand that economic prosperity is the most effective way of ensuring political stability? Or do they want political stability at all?

Our government procedures are complex and opaque. There are numerous incoherent regulations and practices which create rooms for interpretation and fodder for the bureaucracy to give businesses a run-around. The attitude at the working-level of the bureaucracy is more hostile than accommodating.

There are bureaucratic delays and lack of transparency in procuring investment licenses. For investments exceeding 1 billion rupees, up to six ministries other than the Ministry of Industry, review the business proposal prior to consideration by the Investment Promotion Board.

I know of a company which is an IT enabled service provider to the financial institutions, that hasnâ€™t been able to get a clearance for almost two years for an equity investment International Finance Corporation (IFC) wishes to make in that company, for a simple reason that the bureaucracy hasnâ€™t been able to sort out which department should process the request.

Political patronage of labour unions makes it extremely difficult for the businesses to manage todayâ€™s labour force. Employers are paying more for less productivity. Recent negotiation between industrial enterprises and labour unions is yet another episode in numerous negotiations and pay hikes already effected in the past few years.

Policy instability is another major hurdle. Rules of the game change frequently. Amendment proposals to Bank and Financial Institutions Act (BAFIA) currently being discussed in the parliament, is a very good example here. The lawmakers are now looking to establish a â€œsovereign mixed economyâ€ â€“ whatever that means â€“ by displacing open liberal economy. This will surely be a major deterrent to investment. In todayâ€™s day and age, this can be nothing but political dogma and an attempt to push the country back several years.

Certainly, democracy is an impediment to development if we do not have the maturity to benefit from it.

All these and many more factors have contributed to a poor business environment and apprehension among investors.

In an article published recently in a weekly newspaper, the Indian Ambassador talked about negative perception among Indian companies about Nepal. Indian companies are actively pursuing investment opportunities across the globe and have apparently committed 70 billion dollars abroad in the last five years but sadly no new major investment has come to Nepal since 2003.

What can we do to improve FDI flow into Nepal

Of course, we should address all the issues Iâ€™ve raised earlier.

First and foremost, economic agenda must be given the priority it deserves. Bureaucracy must be overhauled and revamped in order to bring about attitudinal change and efficiency. Political patronage of labour must end. etc. etc.

But considering how badly we are messed up as a country, all these changes will take time and need positive contribution from all quarters including the private sector.

In the meantime, here are a few initiatives Nepal Economic Agriculture and Trade (NEAT) should consider looking into over next few years, in order to improve the business environment. Iâ€™m making these recommendations based on my understanding of the broad objectives of the NEAT program.

1. Capacity building of the bureaucrats: We need to make our bureaucrats more capable so that they are able to fruitfully negotiate bilateral trade arrangements, effectively showcase Nepalâ€™s strengths and potential to the outside world and generally represent Nepal positively in the international arena.

Also, how about creating true FDI Champions within the bureaucracy? We have plenty of Revenue Champions who are always eager to increase government revenue. If you consider the revenue growth our Tax Officers have been able to achieve, they have been very successful. Iâ€™m certain that FDI Champions will be able to replicate the success of revenue growth if it is appropriately structured and if they are given the right incentives.

2. Structures aimed at strengthening the capital market are gradually beginning to take shape. Central Depository Service, Mutual Funds are examples of recent positive initiatives. We should now speed up the work on legislation and processes to facilitate Foreign Institutional Investors (FIIs) investing directly in the Nepali stock market. Participation of FIIs will not only deepen the capital market but will also bring about better transparency and improved liquidity.

3. Nepalâ€™s microfinance industry has evolved over last couple of decades. I understand NEAT is keen on looking at this space given its links to the grassroots and agriculture. I hear setting up a credit bureau catering to MFIs is a potential project being discussed. I think that will be wonderful. NEAT should also look at possibility of marrying microfinance with technology.

There are now 10 million mobile phones in Nepal â€“ which is one third of our population! And we have a youth bulge â€“ there are too many young people and very few jobs, which means we are sitting on a demographic time bomb.

But the good news is: young people are more open to adopting new technology. Iâ€™m talking about killing two birds with one stone here: empowering todayâ€™s youth through small loans and delivering them through mobile phones. If we can widely and effectively deliver financial services, mainly small payments, through mobile phones and gradually replace cash transactions with mobile payments, we shall also be able to reverse the trend of growing informal economy, which in turn will contribute to better business environment. That actually makes it three birds.

There are already a few banks offering mobile payment services, but they operate in silos. We need to bring MFIs on board, create an inter-operable platform and educate people about the benefits of the service. Mobile Money has worked wonderfully in many Asian and African countries with similar challenges like ours. We are convinced that it will work in Nepal. NEAT can help us reach the tipping point.

The private sector and the banking community will be happy to share many more ideas like these with the NEAT team and also work together in realizing the common goal of improved business environment in Nepal.

We have lost out over last two decades in terms of economic development but we have not lost hope and resilience. Our potentials are far too great to be ignored. We can bounce back and we will, with a little help from friends like USAID.

(The article is based on remarks delivered by Suman Joshi, the CEO of Laxmi Bank, at the launch of Nepal Economic Agriculture and Trade (NEAT) program sponsored by USAID.)

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