With imports far exceeding exports, and in the lack of domestic savings to meet investment needs, the crucial role of international capital for developing countries is well recognised. In this regard, Nepal has been pursuing policy reforms but without much result. Foreign investment is needed in facilitating economic development as well as cushioning temporary shocks in the economy. Moreover, in the present context, the need for foreign investment to fulfil developmental aspiration is, historically, manifold. However, capital inflow if it cannot be tied to the potential programmes may lead to a wide range of problems.

Capital flows can be broadly classified into: official grants and concessional and non-concessional loans from bi-lateral and multilateral sources; and private flows in the form of foreign direct investment (FDI), portfolio investment and commercial loans. There is no in-built mechanism to measure and compare the impact of different sources of capital flow. By nature, aid or debt are either absorbed into imported consumption expenditure or require regular payments. The FDI can contribute more favourably to the capital importing country as profit payments can be made only when the investment earns a positive return. Also, the FDI includes the transfer of technology, managerial expertise and marketing knowledge.

Obviously, official grants and concessional loans depend on the strategies of donor countries/agencies, whereas private investment is wholly dependent on economic returns. In fact, private sector capital flows tend to go from low-interest to high-interest environment, from high-risk to low-risk, from a capital-rich place to a labour-abundant area and from capital and labour abundant locations to land-abundant locations. Since foreign investors should comply with the rules of the recipient country, there is no need to worry about the prospect of investors’ domination.

Capital outflow is virtually restricted in Nepal, which is unjustifiable from the point of view of domestic investors. Foreign capital inflow in the form of official grants and concessional loans, undoubtedly, depend on the donor countries’/agencies’ strategy for (i) enhancing military power (ii) supporting a friendly government in power (iii) promoting commercial and other interest and (iv) expectation of future goodwill, along with the redefined criteria of humanitarian and terrorist constraints. Nepal should also give due attention to the impacts of official capital inflows, including (i) debt-trap, (ii) debt-sustainability (iii) and the pros and cons of the possibility of enlisting in the highly indebted poor countries (HIPC).

Nevertheless, despite reforms on legal and policy fronts, the private sector investment in the form of FDI is still miniscule. For the private foreign investors, the risk premiums such as overall performance indicators and rate of returns on capital are sensitive indicators. Moreover, private sector investors always evaluate various risks like the selection of a particular country, the extent of political stability, labour laws and trade union activities prior to making investment decisions.

However, with regard to foreign private investment, the issue of interest rate parity as a measure of capital mobility has not been explored in Nepal. It has been proven that foreign investment has been more productive in stable democracies. Similarly, foreign investment depends on overall macroeconomic performance, which, by its nature, operates on cause and effect basis.

With progressive internationalisation of Nepal, the nature and volume of official capital inflow changed dramatically in 1990s. Nevertheless, Nepal has placed more emphasis on the development route for the non-traditional sectors. But the other reality is that the country has also been facing the dearth of internal resources. Also, a large internal borrowing may not be compatible with private sector-led growth.

Therefore, FDI is essential in order to accelerate the pace of economic development. Even reformed rules and regulations could not attract FDI due to internal conflict and instability. The need for such investments has increased tremendously in the present context when internal resources and official capital inflows are hardly sufficient to meet the requirements for rehabilitation, reconstruction and reintegration. There is a need for consensus on major issues to build the confidence of foreign investors. The ultra-left voices calling for nationalisation of all industries will also cause foreign investors to backtrack from the fast-track mission of overall development. Investors of the democratic world are waiting for smooth settlement of the transitional phase. For this, the Maoists need to prove their adherence to democracy and globally accepted economic policies since other major parties have already vowed to do so.

Dr Paudel is a member, RBB Board