Fluctuations in Indian investments

The India-Nepal economic relationship can be analyzed across three key sectors: annual aid and development assistance, bilateral trade, and investment. Historically, Indian State-Owned Enterprises (SOEs) were the predominant drivers of India’s investments in Nepal until the late 1980s, when economic reforms in Nepal attracted a surge in private sector investments.

However, Indian investments have fluctuated since the 2000s due to various factors, including political instability, civil conflict, and Nepal’s changing economic policies. Although there was a resurgence in Indian investments post-2006, following Nepal’s peace process, the growth has been inconsistent. While India remains the largest cumulative investor in Nepal, investment flows have not returned to pre-2000 levels.

In fiscal year (FY) 1998/99, the Nepali government approved 19 Indian projects, a number that increased to 37 by FY 2000/01. However, a decline in investment activity began in FY 2001/02. Notably, Indian investments witnessed a resurgence starting from FY 2005/06, coinciding with the 12-point agreement between the Maoists and seven major political parties of Nepal, followed by the peace process agreement in November 2006. This period marked a significant phase in India’s active role in the peace process and restoration of democracy, which likely contributed to the renewed investor confidence from India.

Despite the upward trajectory in investment during the post-conflict period and the Constitution-making process from 2008 to 2015, a decline in Indian investment was observed following the formation of governments under the new constitution from 2018. This fluctuation indicates that, while political agreements and stability initially stimulated investment, subsequent political or economic uncertainties may have hindered sustained investment flows. Furthermore, the sustained increase in Chinese investment from 2008 onwards, which has eventually exceeded both Indian and American investments, reflects a shifting landscape in Nepal’s foreign investment dynamics. The contrast between the fluctuating Indian investments and the steady rise in Chinese investments necessitates a thorough examination of the underlying factors influencing investor behavior.

A critical question arises regarding the volatility of Indian investments and the sharp decline observed from FY 2019/20, during which only 19 projects were approved compared to 53 in FY 2018/19. It reached a single-digit figure (total of 09) in the fiscal year 2020/21, the slowest pace since 1981(Annexure-1). Although the number of approved projects improved slightly in subsequent financial years, overall performance has remained below expectations. Despite this, India’s FDI stock was the largest in Nepal during the same period, likely due to substantial investments by state-owned companies in the hydro-energy and financial and insurance sectors, in contrast to the relatively lower investment from private sector companies. This trend necessitates a comprehensive analysis of the economic, political, and bilateral factors that may have contributed to this decrease, underscoring the complexities inherent in investment flows within the region.

Indian private investments in Nepal have experienced significant fluctuations since 1998. The investment trend can be categorised into two major phases: 2002–2005 and the post-constitution period. While the period from 1998 to 2002 saw a steady increase in Indian investments, there was a notable decline beginning in 2003, followed by another downturn in the post-constitution period. The volatility of Indian investments, particularly between 2002–2005 and 2019, reflects the broader political and economic dynamics at play in Nepal. Several key factors have contributed to this volatility, including labor strikes, policy reforms, political instability, and the influence of regional geopolitics.

Nepal’s political transition from a partyless Panchayat system to multiparty democracy in 1990 facilitated the formation of unions and associations by various political parties and the registration of civil society organisations. The Trade Union Act, enacted in 1992, enabled the registration of trade unions starting in 1993. Consequently, trade and labour unions emerged in both state-owned enterprises and private organizations/companies. These unions began negotiating with industries over financial and working conditions, leading to strikes and protests, often orchestrated by political parties to raise funds. The frequent strikes, driven by unresolved union demands, adversely impacted industrial operations and output.

Many industries suffered financial losses and were either forced to shut down or relocate. Dev Raj Dahal characterized the period from 1993 to 1999 as a “conducive” phase for union activism, whereas the period from 2000 to 2002 was marked by intensified challenges. For instance, in 2004, a Nepali labour union with affiliations to Maoist rebels demanded that 35 firms across the country shut down their operations. Similarly, in 2008, numerous factories in Nepal ceased operations over a nine-month period due to demands from trade unions linked to political parties. Observers noted that these unions, particularly those affiliated with the Maoists, were engaging in extortion and issuing threats to industrialists. The Young Communist League (YCL), a Maoist youth organization, actively campaigned on industrial estates to intimidate factory owners. Shalik Ram Jamakatel, then president of the Maoist trade union, indicated that his union had been expanding and planned to acquire a building valued at thousands of dollars.

The policy reforms related to industries and import duties had a severe impact on the investment environment in Nepal. During the Panchayat regime, the domestic market was fully protected to ensure smooth business operations for domestic industries. However, in the early 1990s, Nepal initiated a series of market-oriented economic reforms under the Structural Adjustment Programs (SAP). Major reforms included liberalization of trade and industrial policies and rationalization of the foreign exchange regime. Following trade liberalization, tariff rates were reduced, restructured, and rationalized, with quantitative restrictions and import licensing eliminated.

This policy shift transitioned the Nepali domestic market from a protected environment to a suddenly competitive one, where Nepali industries struggled to compete against imported goods due to lowered import duties. Additionally, production costs increased due to higher labor costs driven by union demands. Consequently, 679 enterprises in Nepal collapsed during 2001–2002, negatively impacting investor confidence in the new political system.

The SAP also introduced new taxes, which increased the cost of finished products and rendered Nepali companies less competitive in both global and regional markets. Highlighting the operational difficulties in Nepal in 2002, a spokesperson from Hindustan Lever, in a media interview, noted that “a large part of the raw material inputs used in the manufacture of personal products, soaps and detergents are sourced from India and subjected to local levies. While such inputs used in manufacture of finished products qualify for credits, no such credit was available when manufacture took place in Nepal, increasing the cost of goods produced there.

Indian companies faced additional operational challenges during this period. For instance, countervailing duties on Maximum Retail Price (MRP) goods, introduced in 2001, increased costs for Nepali exports, while export taxes and suspended duty drawbacks created financial bottlenecks. Meanwhile, transport unions imposed exorbitant charges, further inflating costs, and Maoist-led blockades disrupted supply chains, severely affecting production and sales.

Incidents like the 2004 Maoist bombing at Hindustan Lever’s factory in Nepal further deterred Indian private investments. As a result, companies adopted cautious approaches, delaying or scaling back operations in response to the unstable environment.

Indian investments in Nepal reflect the interplay of political, economic, and regional dynamics. While India’s role in Nepal’s peace process temporarily boosted investor confidence, persistent challenges—including labor instability, policy reforms, and geopolitical competition—have hindered sustained growth.

An excerpt of the research paper published by Asian Institute of Diplomacy and International Affairs titled Foreign Direct Investment Flows: India to Nepal since the 1990s