Nepal | May 25, 2020

Foreign direct investment: Manifold challenges

Bhubanesh Pant
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FDI is now perceived in Nepal as a vital source of capital, advanced technology, and managerial skills. However, the challenges ahead in attracting it are manifold

Foreign direct investment. Illustration: Ratna Sagar Shrestha/THT

Ample evidences exist showing that foreign direct investment (FDI) is a core ingredient to sustainable economic growth. Beyond simple financing, FDI is instrumental in the rapid and efficient cross-border transfer and implementation of best practices—ranging from technological, managerial, to environmental and social standards. However, FDI comes with certain preconditions. Political and macroeconomic stability are a prerequisite for FDI. Many studies have revealed that political and economic stability are the major determinants for FDI.

A sound policy and regulatory framework and efficient supporting institutions to enforce the relevant laws and regulations are essential for FDI to come in and prosper. The disparity between countries in how favorable their investment climate may be, including how many administrative and regulatory hindrances an investor has to overcome, and how commercial disputes are handled through the judiciary system have a vast impact on where the investor will go. An adequate physical and social infrastructure supplements an effective policy and regulatory framework to generate the necessary climate for attracting FDI. These include the quantity and quality of roads and communication systems, skilled labor, as well as the efficiency with which public services are delivered.

According to the latest UNCTAD Global Investment Trends Monitor, global flows of FDI plummeted 13 percent in 2016 to an estimated $1.52 trillion owing to weak world economic growth and world trade volumes. Inflows to developing economies fell 20 percent to an estimated $600 billion arising from slowing economic growth and falling commodity prices. However, in 2017 global flows are estimated to rise by 10 percent due to sound economic fundamentals. Still, in the short run, uncertainties regarding the shape of future economic policy developments could limit FDI.

Despite this gloomy picture in 2016, developing countries have been competing for FDI since quite some time,  primarily induced by the liberalization of investment policies such as by providing investment guarantees and fiscal incentives, guaranteeing national treatment, allowing profit repatriation and simplifying administrative procedures, as well as the lowering or removal of capital controls. The promotion of these policies was triggered by a host of factors, including speedy improvements in technology, the initiation of global and regional production networks, the building up of bilateral investment agreements, and increasing recognition of the benefits of FDI.

Nepal’s development priorities include attaining sustained economic development to reduce poverty by strengthening technological capacities and skills, improving access to world markets, and generating employment opportunities. To undertake these strategies, increased flow of investment capital, especially FDI, is necessary.

A member of WTO and Multilateral Investment Guarantee Agency (MIGA), Nepal has already signed the Bilateral Investment Protection and Promotion Act (BIPPA) with six countries, including India, to encourage FDI in Nepal. The country’s location between two the large economies ensures access to potential markets.

To encourage FDI, Nepal introduced fairly liberal “Industrial Enterprises Act, 2016” which offers tax rebate and exemption to certain industries and “Special Economic Zone Act, 2016” which facilitates export promotion through special economic zones. Similarly, the “Foreign Investment and Technology Transfer Bill” which encompasses a number of provisions such as income tax rebate, credit facility, and foreign exchange facility is at the final stages of being endorsed by Parliament.

In recent months, FDI commitments to Nepal have been taking an upward trend, registering a 22 percent increase in the first nine months of fiscal year 2016/17 in comparison to the same period of the previous year. Likewise, foreign investors pledged a total of US$ 13.5 billion as foreign investment during the Nepal Investment Summit-2017 held in Kathmandu in early March.

It should be realized that globalization is leading to an increase in competition for FDI among developing countries thereby making it tougher for Nepal to attract new investment flows. Similarly, disincentives to foreign investors in Nepal include paucity of skilled labor, administrative instability, lack of a good functioning infrastructure, poor governance, weak institutional capacity for the implementation of economic policies, and lack of coordination between different government agencies. Most importantly, political instability implies that Nepal presents mainstream foreign investors with a high degree of political risk. Prospective investors will defer the identification and implementation of projects until the risk profile becomes acceptable. Overall, a perception exists among foreign investors that the pro-investment policies and incentives for attracting prospective new investors are somehow lost in the reality they confront when they actually begin to set up and operate their business.

FDI is now perceived in Nepal as a vital source of capital, advanced technology, and managerial skills. However, the challenges ahead in attracting it are manifold. The Government has an important task to create the preconditions for beneficial FDI to enter and play its catalyst’s role in the country’s economic development.

Pant is with Nepal Rastra Bank


A version of this article appears in print on June 16, 2017 of The Himalayan Times.

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