Prakash Kumar Shrestha: FDI Blueprint of Nepal

Prakash Kumar Shrestha, PhD is currently executive director of Economic Research Department, Nepal Rastra Bank. He has the responsibilities of macroeconomic data compilation and publication, monetary policy formulation and economic research as well as the role of economic adviser.

Despite various policies to attract FDI and tremendous potential in Nepal, the inflows of FDI in Nepal has remained comparatively low. Here is everything to understand on FDI—the problems and the solutions.

FDI in legal documents

As per Nepal’s Foreign Investment and Technology Transfer Act, 2019, foreign investment encompasses share investment in the form of foreign currency/reinvestment from the earnings thereof, loans in the form of foreign currency or capitalized assets, machinery, equipment on lease finance, foreign currency raised by Nepali companies issuing bonds and debentures in other countries with the prior approval of Nepal Rastra Bank, and investment by foreign institutions in listed companies in the secondary market.

‘Technology Transfer’ is also considered a foreign investment, which includes foreign technical consultancy, management and marketing services, trademarks of foreign ownership, goodwill, technological rights, specialization, formulas, processes, patents, or technical know-how of foreign origin. Similarly, the use of intellectual property such as patents, designs, specifications, formulas, processes, and technological knowledge, assignment, user’s licenses, and franchising is also considered foreign investment as technology transfer.

Importance and role

Since Nepal lacks enough financial resources for its development from internal sources, FDI can be a vital source of investment in the economy necessary for production and accelerating economic growth. FDI often brings managerial expertise and best practices, which can improve the efficiency and effectiveness of domestic firms. More importantly, FDI can help Nepal access international markets, opening doors for its products and services, which is essential for its economic growth.

Existing situation

As per the NRB survey, FDI stock in Nepal stood at Rs 264.3bn as of FY 2021/22, which is about five percent of GDP of that fiscal year. As per the UNCTAD’s World Investment Report 2023, Nepal received FDI inflows of $65m in 2022, compared to $722m in Maldives, $3.5bn in Bangladesh, $3.6bn and $49.3bn in India in the same time.

Moreover, there is a significant gap between approved FDI and actual net FDI inflows in Nepal. Between 1995/96 and 2021/22, total actual net FDI inflow stood at around 36.2 percent of total FDI approval, though Nepal has been receiving FDI from more than 57 countries. The NRB survey has found that the average return on equity of FDI companies is more than 14 percent.

Potential areas 

Nepal has tremendous potential in hydropower, tourism, herbal products, and mining industries. Nepal’s rich cultural heritage, stunning landscapes, and adventure tourism attract travelers worldwide. Investment in hotels, resorts, and eco-friendly tourism infrastructure can yield substantial returns. Nepal’s hydropower potential is immense. FDI in hydroelectric projects can contribute to energy security and export opportunities.

The IT sector has experienced remarkable growth. FDI in software development, IT services, and outsourcing can thrive. Export-oriented industries can leverage Nepal’s preferential trade agreements. Investment in hospitals, clinics, and educational institutions can address local needs and attract medical tourists and students. Rich biodiversity has endowed Nepal with a wide variety of herbal plants possessing significant medicinal value. Moreover, Nepal is endowed with a variety of mineral resources such as limestone useful for cement industries, iron, copper among others.

Legal provisions 

Nepal started attracting FDI by opening up its economy in the mid-1980s with the adoption of economic liberalization policy. Accordingly, many market and private sector-friendly policies and legal provisions have been enacted for the promotion of FDI.

Currently active legal frameworks for FDI include the Foreign Investment and Technology Transfer Act, 2019, Industrial Enterprises Act, 2020, Foreign Exchange (Regulation) Act 1962, and Public Private Partnership and Investment Act, 2019. There are related bylaws to these acts to govern the FDI inflows. FDI inflows have opened several sectors. FDI of below Rs 6bn is approved by the Department of Industry and the FDI above Rs 6bn is approved by the Investment Board.

Recently, the government has further simplified the process of approving foreign investments of up to Rs 500m through the automatic route. Investors are allowed 100 percent repatriation of profit from foreign investment and tax rebate for a certain period for various industries such as hydro, manufacturing, mine-based, infrastructure, and tourism sectors.

Constraints 

Continuous political instability and frequent changes in government over the years have created uncertainty and deterred potential foreign investors. Political unrest, including protests, strikes, and disruptions, can undermine investor confidence and discourage long-term investment commitments.

Nepal also faces challenges related to regulatory uncertainty, bureaucratic hurdles, and inconsistent enforcement of laws and regulations. Complex and cumbersome administrative procedures, as well as delayed decision-making processes, make it difficult for foreign investors to navigate the business environment and obtain necessary approval. Concerns about security, stability, and the rule of law can dissuade foreign investors from making long-term commitments and deploying capital in Nepal.

Next is a weak implementation of provisions mentioned in legal documents to attract FDI. Despite the government’s efforts to establish a one-point service center for investor convenience, there have been complaints about its effectiveness. Still, there is a lack of integration of approval of FDI with the tax system, the compliance of which is taking much time and has to pass through the complicated procedures. Tax policy changes frequently and supersede other sectoral policies related to FDI.

Basic infrastructure like road connectivity and reliable electricity supply are still weak, making the economy expensive. Poor infrastructure hampers business operations, increases costs, and reduces the attractiveness of Nepal as an investment destination. Nepal’s small domestic market size limits the scale and scope of investment opportunities for large-scale foreign investment. There are also several non-tariff difficulties to reach the neighboring countries’ market.

Lastly, Nepal is prone to natural disasters, including earthquakes, floods, and landslides, which can disrupt business operations, damage infrastructure, and cause economic losses. The risk of natural disasters adds to the perceived risk profile of investing in Nepal.

Necessary strategies 

First, it is necessary to maintain a stable macroeconomic environment with fiscal discipline, low inflation, and exchange rate stability as well as enough foreign currency reserves in the economy, which also demands political stability with strong institutions.

Second, predictable regulatory frameworks and effective legal systems are essential to protect investors’ rights and ensure the rule of law.

Third, adequate infrastructure, including transportation networks, energy facilities, and telecommunications systems, is critical for attracting FDI. Governments should prioritize infrastructure investment to improve connectivity and reduce the costs of doing business for both domestic and foreign firms.

Fourth, access to a skilled and educated workforce is a key determinant of FDI attraction. Nepal needs to invest in education and vocational training programs to enhance the capabilities of their labor force and meet the needs of modern industries.

Attracting FDI

Governments can offer various incentives to attract FDI, such as tax breaks, subsidies, and preferential treatment for strategic industries. Corporate income tax rate should be comparatively lower than the neighboring countries. Also, Nepal must actively promote themselves as attractive investment destinations through targeted marketing campaigns, investment forums, and networking events. Government agencies, investment promotion boards, and industry associations can play a vital role in showcasing the country’s potential and facilitating business matchmaking.

Nepal needs to penetrate into the vast market of neighboring countries—India and China through balance and strategic economic diplomacy with them. Some old laws also need to be amended or replaced by new laws. Nepal needs to be attentive to catch the changing value chain dynamics in the neighboring countries.

Our private sector should also be dynamic and proactive to network and attract foreign investors in joint ventures. The business environment should be amicable so that investors feel secure and safe. The government needs to improve the investment climate, streamline regulations, and strengthen governance and institutions eliminating corrupt practices.  

Players 

Attracting FDI requires the active participation of multiple stakeholders. Primarily, the government must adopt a proactive approach by implementing appropriate policy and legal frameworks, fostering a conducive environment for investors.

Additionally, the central bank and banking institutions need to maintain robust capabilities to manage the inflow of FDI effectively. Government agencies, such as the Investment Promotion Board and overseas embassies, should play an active role in disseminating information and highlighting the potential opportunities to potential foreign investors. Moreover, the private sector should actively seek partnerships with foreign investors, contributing to the overall effort to attract and retain FDI.   

Risks 

Despite several benefits of FDI, if it is not used properly to generate foreign currency through promoting exports, repayment of FDI in the future may become challenging. FDI projects may have environmental and social impacts, including pollution, habitat destruction, displacement of communities, and violation of labor rights. FDI may displace local industries that are unable to compete with FDI firms. Hence, FDI should be promoted strategically by minimizing likely risks.