Nepal | July 07, 2020

Private sector governance: Room for improvement

Shashwat Satyal
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Good corporate governance, statutory and environmental compliances may demand minimal costs but come with bigger benefits

Illustration: Ratna Sagar Shrestha/THT

The importance of policy level changes needed from the Nepal Government to increase foreign investments into the country is a much discussed topic; however, the role of the private sector in inviting foreign investment has not been emphasised as it should. The private sector is seen as one of the most important sectors that could attract large institutional investors to invest in Nepal, and it holds a crucial role in increasing foreign investment into the country.

Most valuable foreign investors – large institutional investors – bring in ‘responsible’ capital into the host country. This means that this capital would be used to make economically viable, environmentally friendly and socially respectable investments. Such investors place extreme significance on governance. With regard to financial and statutory governance, they seek to invest in organisations that comply fully with the local statutory regulations including tax compliance and other regulatory compliances such as holding proper licenses and approvals from respective government bodies. They are interested in businesses that prepare financial statements based on books of accounts that are legitimate and transparent, that have accurate documentation procedures and that follow professional organisational management. Global investors also place equal importance on the social and environmental aspects of operating an organisation and want to see their capital invested in clean and green businesses.

Most businesses in Nepal’s private sector are, however, indifferent to governance and therefore not attractive to foreign investors. Corporate governance is only a topic studied in management courses and lacks practice in operational businesses, where it is needed the most. Most SMEs are closely held entities, i.e. are run by individuals and families and prepare financial statements disclosing minimal profits, if not losses to save on corporate income tax. Some of these businesses also follow the practice of preparing a separate set of financial statements for the purpose of obtaining credit facilities from banks and financial institutions. Most, if not all, of these businesses are unaware of the requirements to prepare financial statements on the basis of Nepal Accounting Standards and are not prepared to implement Nepal Financial Reporting Standards (NFRS) for SMEs expected to come into effect in the near future.

Businesses are either unaware or ignorant of all the statutory and legal compliances that must be met to run fully compliant organisations. They lack any form of standard policies governing functional areas from human resources to financial and compliance management. Most SMEs are owned by entrepreneurs who take care of all aspects of their business such as finance, operations, human resources, and administration single-handed, with little delegation of authority, if any. There is little transparency in management, often suggested by large amounts of unsupported expenses or undocumented transactions. Most transactions are carried out in cash rather than routed through proper banking channels. There are instances of diversion of transactions of one business to another business of the same entrepreneur, for no consideration. Similarly, expenses of one business are charged to another, to manage tax liabilities.

On the environmental and social governance front, things are much worse. There is little knowledge about the need for environmental and social governance.

Most entrepreneurs are knowledgeable only of the immediate financial burden that implementing proper environmental, social and health and safety standards may have on their businesses and are therefore hesitant in following these practices.

The lack of enforceability of laws from the Government doesn’t help either. Nepal ranks in the 13th percentile – lowest after Afghanistan in the South Asian region – in the 2015 ‘Government effectiveness’ category of the World Bank Governance index. Similarly, it stands at a 25th percentile in the measure of ‘Regulatory Quality’ or the ability of the Government to formulate and implement sound policies and regulations that permit and promote private-sector development. What is lacking from a regulatory aspect is a process of monitoring environmental issues highlighted throughout the construction and operational phase of the project on regular time-periods.

The Nepali private sector must understand that through good governance practices, businesses will always be ahead through a mechanism of ‘prevention, rather than cure’ of any mishaps in the future. Good corporate governance, statutory and environmental compliances may demand minimal costs but come with bigger benefits. Full compliance with statutory and legal regulations reduce the risk of future penalty payments to the government and the exposure to reputational risk, which is uncompromising to customers as well as to foreign investors and could potentially lead to closure of business. Environmentally friendly businesses can create a brand value that could work as a unique selling point to today’s environmentally conscious customers, thus increasing sales. It can lead to more satisfied and proud employees, consequently lower attrition rates.

More importantly, following proper legal, financial, environmental and social governance can attract larger investments and technical expertise from foreign investors. These investments can be vital for businesses to scale up and grow.

A version of this article appears in print on April 27, 2017 of The Himalayan Times.

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