Exploring the contract manufacturing landscape in Nepal

Contract manufacturing is a process where a company hires another company to manufacture goods, primarily in industries with high market demand, to support their supply chain. In some cases, a single company may not produce all the components of a product itself or may be unable to meet market demand in terms of quantity. In such situations, industries may need to collaborate with other companies for the production of goods. Contract manufacturers or third-party companies take on this work, exclusively subcontracting with the principal company.

This practice is prevalent in various European and Asian countries to fulfill demand when a company cannot manufacture and supply the required goods. Even in our neighboring countries, contract manufacturing practices are allowed and widely utilized to manufacture goods with third-party involvement.

In Nepal, the regulations governing such manufacturing practices appear to be somewhat unclear. Section 50 of the Industrial Enterprise Act, 2020 restricts both domestic and industries with foreign investment from entering into contract manufacturing arrangements to produce the main product. However, it does permit contract manufacturing for specific parts of the manufacturing process or for ancillary goods and services required by the industry. Similar restrictions can be found under Section 45 of the Foreign Investment and Technology Transfer Act, 2018, as well.

Article 45 of the Foreign Investment and Technology Transfer Act, 2019, states: “Production may be made upon making contract: (1) Any industry with foreign investment may produce any part of its production or such subsidiary goods or services as required for the industry, except its main production, by a contract with another industry”. Similarly, Article 50 of the Industrial Enterprises Act, 2020, outlines that "Production may be made upon making a contract: (1) Any industry with foreign investment may produce any part of its production or such subsidiary goods or services as required for the industry, except its main production, by a contract with another industry”.

Many multinational companies initially enter a new market through contract manufacturing to gain insights into product demand, facilitating future investment and market strategy planning. Later the parent companies or foreign multinational companies themselves come into manufacturing once they feel confident. However, the recent legal provisions in Nepal have imposed restrictions on this practice.

Before the bill was endorsed by the parliament in 2019, contract manufacturing was a common practice in Nepal. Multinational companies operating in Nepal used to manufacture their products by outsourcing to third-party industries, or in other words, through contract manufacturing.

These restrictions in policies not only create uncertainty for companies but also present policy hurdles in attracting new foreign investments in the manufacturing sector, which is a crucial sector for employment generation in any market. The cost of doing business in Nepal is currently high, with various components involved in the manufacturing process. In some cases, the demand and supply may not align. Contract manufacturing could be a more cost-effective way to maintain a company's market share, rather than making substantial investments in plant expansion.

As Nepal expects to attract more Foreign Direct Investments (FDIs), it is crucial to adopt a pragmatic approach to address such issues. The manufacturing industry plays a significant role in Nepal's economy, contributing 13.7% to the national GDP in 2021/22.

Given the government's ambition to graduate Nepal from a least developed country to a developing one by 2030, government policies should align with this goal, fostering an investment-friendly environment based on best practices. Currently, there is a crisis of funds in the market leading to high interest rates on bank loans, affecting the production and supply chain of goods, ultimately impacting the price of goods, customer purchasing power, and industry sustainability. It is essential for the government to recognize that contract manufacturing is a vital component of the manufacturing ecosystem, as a single company or industry often does not produce all the components of a product by itself. Allowing contract manufacturing can make the manufacturing process more efficient and product prices more competitive.

Moreover, as the government plans to revitalize struggling or underutilized industries that have been closed or operating below capacity for several years, contract manufacturing could be a viable solution for these industrial units. These industries can engage in partial production not only for multinational companies but also for Nepali industries thus contributing to their revival and efficient operation.

If we examine the advantages, we can learn the technical knowledge involved in the production of goods that adhere to international standards. MNCs adhere to their standards, and the Nepali workforce can also acquire this knowledge through the processes they follow, learning through day-to-day operations in the contract manufacturing process. In the contract manufacturing process, the company must meet the specifications set by the contracting company, which will undoubtedly enhance the skills of the workers involved in manufacturing. This aspect, often overlooked, plays a crucial role in upskilling our human resources, ultimately fostering employment generation.

Another significant aspect of contract manufacturing is the industry engaged in the production of goods for other companies or MNCs to generate substantial revenue. This revenue stream enables the industry to operate efficiently with limited resources or, in other words, operating costs, safeguarding the investments of the stakeholders. Simultaneously, the government stands to benefit from increased revenue derived from customs duty, excise duty, VAT, and income tax.

Therefore, the primary concern of investors in the current context revolves around the formulation of policies and laws. While other factors play a role, a well-crafted, investment-friendly policy and legal framework can unquestionably attract investors to Nepal. For this vision to become a reality, the onus is on the government to make decisions and for the bureaucracy to effectively implement them.

The author is the Deputy Director of Nepal-India Chamber of Commerce & Industry (NICCI)