An assessment of Nepal’s investment climate

Despite  political and policy uncertainty, the Nepal government’s decision to organize the ‘Third Investment  Conference’ (TIC) on April 28-29 to attract foreign investment is a welcome step. Major issues/obstacles to such investment remain unaddressed amid a change of guard at Singhadurbar, including the ascension of a new finance minister. To make TIC successful is indeed a major challenge, but it is heartening to find the new finance minister committed to the cause. This article will analyze major issues related to investment and prescribe practical solutions expected to play a crucial role in making the conference successful.

A paltry FDI 

Investment, which helps to produce and reproduce goods and services, plays a pivotal role in national economic development. Despite different kinds of investment like public/private, domestic/foreign investment, the focus of this article is on private and foreign investment, especially foreign direct investment (FDI). For rapid economic development and growth, Nepal needs at least Rs 500bn in annual additional investment. Domestic investment alone will not be enough to fill this gap, so FDI is necessary.

Due to the lack of a conducive investment climate, ratio of real fixed investment (total fixed capital formation) to GDP has plunged from 34 percent (which should be around 60 percent, ideally) to 25 percent in a five-year period, whereas the share of total fixed investment of the private sector has gone down from 28 percent to 25 percent. Over the last 30 years (up to the fiscal 2023-24), FDI amounted to Rs 265bn with the average annual increment of a paltry Rs 8.5bn, marked by a receding flow in recent years. In terms of global FDI flow, Nepal’s position is pitiable, registering a 66 percent decline last year and standing shakily at the 6th position in South Asia, as the NRB Survey Report on FDI Flows in South Asia, 2021-22 shows. It is quite discouraging to note that FDI outflow is greater than its inflow.

Policy uncertainty and inconsistency is a major hindrance to both domestic as well as FDI. 

For example, the current government under Maoist leader Prime Minister Dahal is venturing into an undesirable sector by allowing the Nepali Army to run the already-privatized Hetauda Textile Factory, undermining the private sector (TPS) that contributes around 80 percent to the national economy. All this comes even as foreign investors remain quite afraid of pro-socialist provisions of the current constitution, including on the labor rights front. 

Capital flight

Worryingly, the private sector is diverting investment to a low-risk, high-profit trading sector at the expense of the industrial sector. This is not an overnight development, though. For several years, this sector had been urging the government to create a conducive environment for industrial investment in Nepal by amending relevant laws and enacting more than two dozen acts/regulations, to little avail. Instances of strikes and donation terror—the practice of seeking donations by flexing muscles—have gone down, but strong labor laws are still spoiling the investment climate. 

Notwithstanding a one-door policy on investment, there practically are three doors—the line ministry, the subordinate department and the Investment Board. Then there are infrastructural problems like load-shedding in the industrial sector, local communities’ grievances/concerns and political problems that create hurdles in the establishment of industries/factories. All these factors are also discouraging Nepali investors and triggering huge capital flight, formally and informally.  In such a situation, how can Nepal attract foreign investment?

A great dilemma

Globally, the control regime has become obsolete, thanks to a liberal economic policy adopted in the late 80s and 90s. Our neighbors—communist China and democratic India—adopted liberal economic policies and entered an era of economic growth and prosperity. In the case of Nepal and several other developing countries, some problems have appeared in the execution of liberal economic policy due to a higher degree of liberalization than their respective regulatory/supervisory capacities.  In our case, major leftwing parties have not so far committed to the liberal policy adopted 30 years ago, the need for FDI and a stronger role of the private sector for economic development. This is a great dilemma.

The author is an economist