FDI flows to Nepal: Benefits and challenges

The unique aspect of FDI is that it brings in a package of resources — capital, technology, skills, management know-how and marketing capabilities — together with production activities, to a host economy. But retaining investors is the key

Foreign Direct Investment (FDI) is an effective instrument for promoting sustainable development. Both the 2002 Monterrey Consensus on Financing for Development and its successor, the 2015 Addis Ababa Action Agenda on Financing for Development, recognised FDI as a mechanism that can facilitate sustainable development and the implementation of the Sustainable Development Goals (SDGs).

According to UNCTAD’s World Investment Report 2018, global flows of FDI plummeted by 23 per cent in 2017. FDI flows to developing economies remained stable at $671 billion, seeing no recovery following the 10 per cent drop in 2016. Flows to developing Asia also remained stable at $476 billion. The region regained its position as the largest FDI recipient in the world.

FDI in structurally weak economies remained fragile as illustrated by the fact that flows to the least developed countries (LDCs) fell by 17 per cent to $26 billion in 2017. This negative trend remains a matter of concern for policymakers in Least Developed Countries (LDCs) where international investment is indispensable for sustainable industrial development.

FDI can serve as a principal complement to domestic investment and capacity building for the growth and development of the LDCs. The unique aspect of FDI is that it brings in a package of resources — capital, technology, skills, management know-how and marketing capabilities — together with production activities, to a host economy. While these resources and capabilities are utilised in the host-country affiliates and help optimise profits for the investing transnational corporations (TNCs), they also have an array of direct and indirect impacts that can, under suitable conditions, be very beneficial to the host economy.  They can produce not only products for domestic consumption or for export, income and employment but also linkages and spillovers that bolster the capabilities of domestic firms and human resources, contributing to capacity-building and accelerated growth in the host economy.

When the firm-specific assets that constitute the basis for international production through FDI are effectively leveraged and integrated with country-specific advantages of host economies, FDI has the potential to augment consumer welfare, create employment opportunities, increase labour and environmental standards, and contribute to improved living standards and poverty alleviation.

According to Global Investment Competitiveness Report 2017-18, the key factors influencing multinational corporations’ investment decisions in developing countries include political stability and a business-friendly regulatory environment. These two factors outweigh other country characteristics, including infrastructure, access to land, and low tax rates.

In Nepal’s case, though FDI commitments surged to Rs 49.87 billion in the first 10 months of 2017-18, the realisation appears to be nominal. As per data of Nepal Rastra Bank, Nepal received FDI worth Rs 15.51 billion during the first 10 months of 2017-18.

If the investment climate in Nepal is assessed against various parameters such as the condition of the infrastructure, policy stability, legal structure, capacity of the banking and financial sector, human resource profile, responsiveness of bureaucracy and internal security, Nepal would not pass this test as a number of reforms are required in many areas.

The country can no longer depend only on low labour costs; it also needs to create high-quality, productive labour and sustain its comparative advantages. For potential investors, the ability to consistently fulfil product standards as well as production costs, skilled labour, ease of cross-border movement, and the availability of critical inputs (power, transportation, industrial land among others) are some of the crucial factors in the decision-making process.

Moreover, investor aftercare services have often been an overlooked component of investment promotion. The objective is to make sure that foreign affiliates stay and continue to expand or upgrade their business activities.

Despite the foregoing constraints, the country has been implementing a number of policy reforms to promote a competitive investment climate and create a range of investment opportunities – critical for the country in attaining its development goals of creating more and better jobs and the diversification of its export base. Some liberal Acts on Industrial Enterprises and Special Economic Zones have been brought into effect. However, foreign investors are still sceptical about the quality of the domestic institutions and the enforceability of the law and would think twice before investing in Nepal.

Nevertheless, with the right de-risking approaches, a commitment to directing FDI flows to productive sectors, and smart public-private partnerships, it is possible to attract more FDI inflows and generate positive linkages with the rest of the economy.

To conclude, while attracting FDI flows is essential for the country, it is only a small part of the story. Retaining investors is the key. The actual benefits emerge later on, as foreign firms bring in capital, employ local staff, share technology and know-how, and create spillovers that move a country up the value chain.

Pant is with Nepal Rastra Bank