3-9 March 2017 #848

Making Nepal FDI friendly

We know what needs to be done to attract investment, we just need to do it
Shyamal K Shrestha
Gopen Rai

Nepal’s net foreign direct investment (FDI) inflows are the lowest in the region as well as among least developed countries (LDCs). The country received $52 million net FDI in 2015, 0.1% of the amount that South Asia received and 0.13% of what LDCs received.

Least-developed countries like Afghanistan, Ethiopia and Haiti mobilised FDI worth $169 million, $2.2 billion, and $109 million in 2015 respectively.

The early 1990s saw a dramatic rise in FDI inflows into Nepal, primarily in garments, carpets and food processing industries, stimulating job creation in the industrial sector, and expanding the manufacturing sub-sector to an all time high of 9.6% of GDP in 1996. But the conflict and instability reduced FDI inflows in the late 1990s.

Although FDI has rebounded since 2009, the bulk of it has come mostly in energy, tourism and services, and not in manufacturing. The industrial sector shrank to 15.4% of GDP and manufacturing to 6.3% of GDP in 2015. Slow job creation has resulted in expansion of the informal economy and overseas job migration.


Foreign Direct Investment in Nepal over the past two decades
Create line charts

Source: World Bank open data. Hover over the points for exact amount.

For the past two decades, Nepal failed to be part of global production networks while Bangladesh, Sri Lanka, and Vietnam attracted FDI in textiles and clothing, and moved steadily up the value chain. These countries also experienced rapid income and productivity growth for a mass of their industrial labor force. India and China, which currently dominate world manufacturing (accounting for 25% of global manufacturing) are upgrading to produce high-technology goods, including vehicles, machinery, machinery spare parts and smart phones by opening up these sectors to FDI.

Nepal must take stock of its own experience as well as draw upon that of its neighbors to mobilise greater FDI. The first litmus test is to institute an FDI friendly regime so all state agencies can coordinate effectively and welcome FDI as a general principle. A ‘negative list’ of industries and business in the government’s proposed new FDI law might be valid from the viewpoint of protecting small producers but would prevent those sectors from reaping productivity gains.

The Foreign Investment Related Act 2017 (which will replace Foreign Investment and Technology Transfer Act 1992) needs to be supported by new legislations governing agriculture, the labour market and infrastructure. Various studies have reiterated the urgency of reforms in these three crucial areas as well as in addressing regulatory hassles.

The absence of contract farming legislation limits economies of scale in farm production. Nepal is currently import-dependent on both staple and cash crops, whose domestic production is short of filling domestic demand. Frequent labour disputes and politically-motivated disruptions have relegated Nepal’s formal non-agricultural sector to a low productivity trap, shielded from competition and new investments.

An immediate outcome of opening restricted sectors to FDI and allowing labour flexibility can bring a marked improvement in Nepal’s manufacturing and export performance. Preferences provided to Nepal’s products (both agricultural and manufactured) by both developing and industrialised nations often fall sort of production and safety standards.

The country must deliver on large energy, transport and communication projects to lower transaction costs and boost return on investments. Improvement in the ease of doing business, identified by Doing Business (DB), should also be one of the main priorities. Rwanda, an LDC like Nepal, was ranked 56 among 190 economies in DB 2017. It attracted $323 million in FDI – six times more than what Nepal, ranked at 107, received – in 2015.

Many conflict-torn and transition economies are making a complete turnaround from their poor economic performance by adopting FDI friendly policies. As a small landlocked LDC emerging from conflict and transition, Nepal must make up for two decades of lost growth and foregone opportunities.

The state should ensure a participatory development process, strengthen governance and incentivise economic agents. The private sector must show it is capable of mobilising resources to promote growth. Both must form a partnership in driving the country’s industrial policy forward.

*The Nepal Investment Summit is taking place from 2-3 March in Kathmandu *


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