Nepal’s FDI Trajectory and Desire for Economic Growth

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As post-conflict Nepal is approaching its final phases of political transition with peace on the horizon, the narratives of economics and development are gaining steam. Encouraged by the exemplary economic growth of its larger neighbors, China and India, Nepal’s political and economic establishments are actively calling on global investors, promising to create a friendly business climate.  Nepal primarily wants mega international investors to invest in infrastructure, which it believes will lay the foundation for the country’s long overdue development and modernization. Nepalese increasingly argue that the country needs investment, not aid. By some estimates, Nepal is second to Afghanistan by poverty ranking in Asia, with a USD 21 billion annual GDP.

Nepal had its parliamentary system restored in the 1990s, and the new democratic government initiated policy reforms which resulted in some growth in the foreign direct invest (FDI) when compared to the nominal inflows of FDI in the 1980s.  Nepal adopted liberal trade policies – the Washington Consensus – which reduced heavy tariffs and liberalized the exchange regime. For the low cost manpower, manufacturing was one attractive sector, along with Nepal’s untapped sectors of hydropower and tourism. Since then India has been the major FDI source for Nepal for two decades, and has only recently been surpassed by China. In the Fiscal Year 2010-11, the 10 leading investor countries were: India, China, USA, South Korea, Mauritius, Canada, UK, Singapore, Japan and Norway (Source: Department of Industries, Industry Statistics)

The Nepali Congress, the biggest democratic party of the time, embraced policies to roll out the red carpet to the liberal institutions and international investors. The Foreign Investment and Technology Transfer Act was introduced in 1992.  However, such measures failed to attract international investments for several reasons, and Nepal remained the lowest recipient of FDI compared to other South Asian countries.

Nepal continued to be unfavorable for investments due to several factors. Apart from Nepal’s untapped hydro-power potential and tourism, there were very few niche sectors. The reforms adopted were insufficient to facilitate trade and investment. Nepal’s scale of economy could not attract large international investment without the market access to the neighbors India or China. The newly restored multiparty system became extremely partisan and large investments were highly politicized to the extent that investors pulled out, for instance, the World Bank withdrew from the Arun III hydropower project. Most importantly, in the mid-1990s the Maoists rebels waged an armed conflict which led to an unprecedented worsening of security situation. Similarly, other barriers remained in place: red tape, problems regarding labor laws and taxations, ineffective management, corrupt behavior, lack of infrastructure, and a lack of skilled manpower. There has been a push back from protectionist camp. Some leaders have also used trade and investment agreements to get political mileage by portraying them as a breach of sovereignty.

The FDI began to increase in  2008 as Nepal took a major step forward in its peace transition with the promulgation of the interim constitution and the subsequent constituent assembly election. At this point, Indian investment spiked from USD 28 million to USD 70 million; in fact, India’s investment expanded significantly in Nepal after the two countries signed a trade agreement in 1996. Successive Nepalese governments took different initiatives to attract FDI in 2011-14, which included the formation of a Nepal Investment Board with the view to provide an effective one-stop shop for investors to promote investments, commitments to establishing Special Economic Zones, “a Trade and Industrial Policy, Trade Integration Strategy, Bilateral Investment Promotion and Protection Agreement (BIPPA) with India, and Trade and Investment Framework Agreement (TIFA) with the US.” However, given the volatile political transition, the country did not see much increase in FDI inflows.

Mainly due to the growing investment from India and China, FDI rose substantially reaching USD 104.6 in 2009-10 and USD 116.3 in 2010-11, but then slowed down due to domestic political uncertainty, despite the fact that the global FDI flows recovered in 2012. After the 2015 earthquake, the figure dropped and then picked up again in 2016 when Nepal received USD 106 million in FDI, doubling the FDI inflows of 2015 and had USD 653 million FDI stock. In the Fiscal Year 2014-15, the government approved many project proposals from various countries: 125 from China, 55 from South Korea, 40 from US, 23 from India, 18 from Japan, 11 from the UK, and several more from other countries (Source: Department of Industry)

Despite all these efforts and gradual upward FDI inflows, in the last 5 years, there has not been any increase in large investments, although sector-wise there was some investment growth. Nepal is missing out on an opportunity, since globally the LDCs (Least Developed Countries) are the bigger recipients of FDI than developed countries. In fact, companies are pulling out from Nepal due to the country’s unfavorable political climate. For instance, Norwegian company Statkraft withdrew from 650 MW Tamakoshi hydropower project citing regulatory and bureaucratic hurdles.  

In the 2017 Nepal Investment Summit, several countries pledged huge amounts for sectors such as agriculture, roads and railways, tourism, energy. China promised massive USD 8 billion investment in Nepal. Altogether Nepal received over USD 13 billion investment offer in response to Nepal’s “great desire” (in the words of Indian Finance Minister Arun Jaitely) for economic growth. However, despite these pledges, questions remain about such investment materializing.  Nepal ranks 107th in the World Bank’s 2017 Doing Business list. The traditional hurdles remain, and the country continues to suffer from very weak law and order situation, increasing corruption and political brinkmanship which will most likely discourage potential investors. However, leaders across the political spectrum, liberals and “communists” alike, are “on the same page” (in the words of the Communist Party of Nepal - United Marxist Leninist leader K P Oli) regarding the important role of foreign investments and private sectors in economic growth.

But regardless of politicians’ words, Nepal has big internal and external challenges before it puts commitments into action. In 2015, about 20% of the FDI inflows came from “tax havens.” Some non-transparent approval process for investments coming in from British Virgin Islands is already dragging bureaucrats and politicians into controversy. For its part, the Nepalese business community is asking the government to enable FDI outflows from Nepal which they deem necessary to increase FDI inflows. Similarly, Nepalese leadership is far from ensuring Nepal’s integration into the South Asian economy to make the country an attractive FDI destination. Likewise, protectionism still resonates in Nepal. Therefore, whether Nepal will be able to convince international partners to invest remains to be seen Nepal’s case shows that  liberalized policies only are insufficient to attract FDIs without domestic social, political and economic stability, inter alia.