FOREIGN DIRECT INVESTMENT IN

NEPAL: A TREND ANALYSIS

Submitted By

Devi Ram Khanal Roll No.: 740093

Reg. No: 2007-2-22-0065

A Research Report Submitted To Prof. Dr. Prem Raj Pant

Apex College Pokhara University

In partial fulfillment of requirements for the course on Research Methodology

For the degree of Master of Business Administration

Kathmandu August, 2009

I

ACKNOWLEDGEMENTS

This Study has been under taken to analysis the “Foreign Direct Investment in

Nepal : A Trend Analysis” under partial fulfillment of the requirement of MBA

degree. The thesis mainly covers the study to analyze the FDI in Nepal,

comparison of flow of direct investment with the world, South Asia, SAARC

countries and least developed countries.

I would like to express my profound gratitude to Professor Dr. Prem Raj Pant,

without whose kind support, timely advice and continuous encouragement, this

report would not have been prepared.

I sincerely acknowledge to my respected supervisor, Mr. Pushpa Raj Joshi and

Mr. Bharat Singh for his continuous guidance and supervision. The report in this

form is the result of their inspiring and invaluable guidance and supervision.

I express sincere thanks to all librarians of Apex College who helped me directly

and indirectly in the course of review of literature.

Finally, my sincere acknowledgement goes to my grand parents, and beloved

brother and sister, who missed their youngest son and brother all time while I

was away from home for this study, and extend their blessings, love and support

to me.

......…….……........ Devi Ram Khanal

II

CERTIFICATE OF AUTHORSHIP

I, hereby declare that this submission is my own work and that to the best of my

knowledge and belief, it contains no materials previously published or written by

another person nor material which to a substantial extent has been accepted for the

award of any other degree of university or other institutions, except where due

acknowledgement is made in the acknowledgements.

Date: …………… ……………………

Devi Ram Khanal

III

TABLE OF CONTENTS Acknowledgements I Certificate of Authorship II Table of Contents III List of Tables V List of Figures VI Abbreviations VII Executive Summary VIII

Chapter I Introduction

1.1 Background 1 1.2 The Problem Statement 5 1.3 Purpose of the Study 6 1.4 Importance of the Study 6 1.6 Limitations of the Study 7 1.7 Organization of the Study 8

Chapter II Review of Literature

2.1 Foreign Direct Investment: An Overview 10 2.2 The OLI Paradigm for Foreign Investment Decision 13 2.3 Why is Transparency Important for FDI? 14 2.4 FDI and Corruptions 17 2.5 Factor affecting Foreign Direct Investment 20 2.6 Review of Nepalese Research in FDI 24 2.7 Concluding Remarks 36

IV

Chapter III Methodology

3.1 Introduction 38 3.2 The Research Design 39 3.3 Data Collection 40 3.6 The Population and Sampling 40 3.7 Data Gathering Procedure 41 3.8 Data Analysis 41

Chapter IV Presentation and Analysis of Data

4.1 Global Foreign Direct Investment 42 4.2 FDI to SAARC and Southeast Asia 44 4.3 Foreign Direct Investment in Nepal 45 4.4 A Pattern Study of FDI in Nepal 47 4.5 Nepal Goes From Bad to Worse 53

4.6 Doing Business in Nepal 54

Chapter V Summary and Conclusions

5.1 Summary of Findings 61 5.2 Conclusions 63 5.3 Recommendations 65 References

V

LIST OF TABLES Table No. 1 Global FDI Inflows 43

Table No. 2 FDI to South Asia and South-East Asia 44 Table No. 3 Number of industries approved for foreign investment 48 Table No. 4 Number of Industries Registered by Categories up to FY

2064/2064 51

Table No. 5 Number of Industries Registered by Scale UP to FY 2064/2065

52

Table No. 6 Failed State Index 53 Table No. 7 Nepal's Ranking in Doing Business 2009 54 Table No. 8 Summary of Indicator 55

VI

LIST OF FIGURES Fig. No. 1 Number of industries approved for foreign investment 49 Fig. No. 2 Number of employment approved for foreign investment by 50 Fig. No. 3 Number of Industries Registered by Categories up to FY

2064/2064 51

Fig. No. 4 Number of Industries Registered by Scale UP to FY 2064/2065

52

VII

ABBREVIATIONS BIMSTEC Bay of Bangle Initiative for Multi-Sectoral Technical and

Economic Cooperation CPI Corruption Index DFI Direct Foreign Investment DoI Department of Industry FDI Foreign Direct Investment FITTA Foreign Investment and Technology Transfer Act FSI Failed State Index GoN Government of Nepal IMF International Monetary Fund masl meters above sea level MNCs Multinational Companies OLI Ownership, Location and Internalization OECD Organization for Economic Cooperation and Development SAARC South Asian Association for Regional Cooperation SAPTA South Asian Preferential Trade Arrangement SEZs Special Economic Zones TNCs Transnational Corporations UNCTAD United Nations Conference on Trade and Development UN United Nations U.S./US United States EU European Union

VIII

EXECUTIVE SUMMARY

Must firms become more multinational to improve their competitiveness and

performance in an increasingly integrated world economy? Foreign direct

investment (FDI) and international networks bring some competitive advantages.

However, performance is also driven by firm specific advantages such as research

and development (R&D) and marketing, and country specific advantages such as

political and legal institutions. The relative contribution of these factors to

competitiveness will vary by industry and country.

The study explores the flow of foreign direct investment in Nepal till date. The

study also attempt to gain some understanding on the awareness of flow direct

investment among least developing countries and neighboring countries, compared

to the inflow in Nepal. It looks after the productive aspects of foreign direct

investment in Nepal. Still Nepal doesn’t receive the minimum FDI compared to

other developing countries. It also scans the obstacle that curtails in receiving it, and

scrutinizes the challenges and benefits of receiving foreign investment in Nepal.

The study is organized into five chapters. Each chapter covers some facts pertaining

to the FDI in Nepal. First chapter covers background information about foreign

investment and its impact on country’s economy; its importance, statement of

problem, and research purpose etc are stated.

Second chapter presents an overview of literature review. This chapter aims to

provide relevant literature in the field of foreign direct investment.

Third chapter presents the research model and research methodology implemented

in the study. It will describe the chosen methods, research design, sources of data,

population and sample, data gathering procedure and analysis of data.

IX

Chapter four has attempted to analyze and draw inferences from the collected facts

in accordance to the outline laid down in the research plan. The collected data has

been systematically presented in the form of tables and diagram.

Finally, chapter five highlights the major findings of the research, conclusions and

recommendations. This chapter basically focuses on the proceedings of the earlier

chapter. In this chapter, the author answers research questions and get conclusions

based on the theory and analyzed data. Major findings are illustrated which is

followed by recommendations based on findings and experiences of the researcher.

1

CHAPTER I

INTRODUCTION

1.1 Background of Study

Most economic theorist and developing practitioners accept that external capital is

necessary for accelerating growth and industrialization. Today, every developing

country irrespective of their size and political systems tries to attract foreign

investment. A large number of developing countries have now established export

processing zones (EPZ) to attract foreign private and public foreign investment.

The developing countries of the world have in genera been recipient of both official

and private financial flows over the last four decades. Understandably so, since in

most of there countries, the level of domestic savings is generally very low, the

financial sector is widely underdeveloped and in most cases repressed, and therefore

the capacity to harness domestic financial resources for development of key sectors

of the economy is quite limited. A wide body of literature has investigated the role

that this flow of external financing could play in development of recipient countries.

The convergence of opinion seems to be that on balance, there is a net positive

relationship between external financial assistance and economic performance of

countries. Particularly if and when such assistance is accompanied by conducive

policy environment (Burnside and Dollar 2000)

In the last decade or so, where as the flow of official development assistant seems to

have decline in relative importance, the flow of the private resources; in particular,

foreign direct investment (FDI) to developing countries has been on the increase. A

number of reasons have been alluded to in terms of this development. One of such is

the end of cold war and relative increase in net official flows to the countries in

transition in Eastern Europe and former Soviet Republic. Other reasons include the

2

growing importance of private flows, particularly in developing countries

themselves, reflecting the new wave of liberalization, and globalization and

therefore the flow of foreign investment to the telecommunications, financial

services and other sectors in many of the countries.

FDI is now recognized as an important driver of growth in the country.

Government, therefore, makes all efforts to attract and facilitate FDI and investment

from foreign investors. Nonresident including overseas corporate bodies (OCBs)

that are predominantly owned by them, to complete and supplement domestic

investment.

In the trend of economic globalization, the role of FDI in promoting economic

development has been widely studied. Studies such as Athukorala and Menon

(1995), Zhang and Song (2001), Zhang and Felingham (2001) and Liu et al (2001)

find that FDI promotes the manufactured exports of recipient countries. Although

there is no consensus regarding the relationship between FDI and GDP growth, to

attract FDI as a strategy of development has become a trend among developing

countries following the development of newly industrialized countries in the 1960s

and 1970s. Athukorala and Chand (2000) and Balasubramanyan et al (1996) provide

some evidence that the growth enhancing effect of FDI would be significant and

strong in countries with open trade policies and better trade regimes with export

promoting FDI. While many developing countries are competing for FDI inflows,

recent studies attempt to identify condition, which would lead to more beneficial

utilization of FDI. For example Narual and Dunning (2000) point out that the

increased competition for FDI is more for the “right” kind of investment and less

developed countries increasingly need to provide unique, non replicable created

assets to maintain a successful FDI-assisted development strategy. De Mello (1999),

finds that the extent to which FDI is growth enhancing depends on the degree of

complementarily or substitutes between and FDI and domestic investment.

Furthermore Zhang (2001) reports that the extend to which FDI is growth enhancing

appears to depend on country specific characteristics.

3

Potential economic benefits of FDI

FDI inflows can lead to a range of economic benefits for transitional and developing

countries, including:

• restructuring their economic activities in line with dynamic comparative

advantage;

• reducing their costs of structural adjustment;

• fostering more demanding purchasing standards by firms and consumers;

• raising the productivity of national resources and capabilities;

• improving quality standards;

• Stimulating economic growth (adapted from Dunning, 1994).

Nepal started planned programs of economic development as early as mid fifties

with the launching of first five-year plan in 1956. The Tenth Plan is now being

implemented since mid July 2002. The Plan seeks to achieve a higher rate of

sustained economic growth of 8.1 percent per annum by enhancing the competitive

capability of industry and commerce sector. To achieve this target, greater emphasis

has been given to the participation of private sector and the involvement of people at

community level. The Plan takes account of the need to attract foreign investment to

meet the five-year capital requirement. The following policies have been spelt out,

among others, for the industrial sector in the Tenth Plan:

• Set up the mechanism to ensure easy availability of financial resources,

through financial institutions, to establish industries.

• Investment will be channelized to undeveloped or underdeveloped regions of

the country, on the basis of national importance, to ensure regional balance.

• Industrial security system will be made effective.

• Foreign investments will be encouraged in those areas where the country has

comparative advantage.

• Local and newly developed technologies will be encouraged for industrial

development.

4

Government of Nepal has adopted an open and liberal policy to pave the way for the

accelerated economic and social development of the country. Especially in the field

of industry and trade, the government policy is aimed at giving the private sector a

dominant role. The private initiatives and enterprises are expected to increase

efficiency and productivity. The government's role will be that of a facilitator

providing infrastructure and conducive environment for investment. Although there

were a few cases of foreign investment and technology transfer prior to 1981, the

industrial policy and the Foreign Investment and Technology Act, 1981 paved the

way for regular inflow of foreign investment and technology transfer into the

country. Solidarity Ministerial meeting was held in 1982 and an Investment

Promotion meeting was held in 1984 for the promotion of foreign investment and

for creating awareness of the investment opportunities in the country. Subsequently,

Nepal Investment Forum was organized in 1992 at Kathmandu, which was a very

successful event in attracting the foreign investors.

In order to make the investment climate more conducive GoN formulated Foreign

Investment and One Window Policy and Industrial Policy based on which Foreign

Investment and Technology Transfer Act, 1992 (FITTA) and Industrial Enterprises

Act, 1992 (IEA) were promulgated. These Acts were subsequently amended in 1996

and 1997, respectively, in order to make these acts more pragmatic based on the

experiences gained.

The Industrial Policy emphasizes on simplification of procedures, transparency in

implementation and improvement of productivity through the up gradation of

technical knowhow and efficiency of the industries in order to compete in the free

and competitive world market by utilizing comparative advantages of the country

with minimum adverse effects on environment. Whereas, the Foreign Investment

and One Window Policy aim:

• To build a strong and dynamic economy by generating additional opportunities

for income and employment through expanding productive activities.

5

• To increase the participation of the private sector in the process of

industrialization.

• To increase productivity by mobilizing internal resources and materials in

productive sectors and by importing foreign capital, modern technology,

management and technical skills.

• To increase the competitiveness of Nepalese industries in international markets.

1.2 The Problem Statement

Nepal is potentially attractive location for foreign investors. Sandwiched between

two emerging countries of the world with India in the south and China in the North,

Nepali manufacturers have free access to the India market, and tariffs on imported

raw materials and components are lower here than South Asian countries. The

varied climate, natural resources and terrain provide a wealth of niche opportunities,

many of which are barely being exploited at all. Nepal has attracted modest FDI in

niche sectors such as tourism, light manufacturing (apparel) and mineral deposits

(lime stone). Investment is mainly in low technology, labor intensive production.

The impact of FDI has also been modest primarily in job creation.

While the FDI laws were liberalized in 1992, there are still obstacles that investors

face. In the short term, Nepal can attract more FDI in its niche sector- such as

tourism and production of herbs with special investment packages. With all these

possibilities, the FDI has been declining and Nepal is not being able to attract

minimum requirement.

There are some of the weaknesses such as weak financial sector and government’s

mandate and restriction for entry of new foreign bank up to 2010, geographical

constraint, unstable policies and insecurity among the bureaucrats, unclear

investment policies, the current political instability, corruption and lack of corporate

governance etc. Beside the Maoist and other parties’ frequent movement and bandhs

6

is the threat to bilateral and multilateral development projects. The challenge for

Nepal is to put in place an investor-friendly business climate that will compliment

its small bureaucracy. This is a serious problem in attracting foreign investment.

Against these backdrops it is a great challenge for Nepalese to accumulate capital

resources domestically as no one can deny the role of foreign investment in

economic growth and development of the country. An assessment of the probable

reasons for the declining FDI is thus recognized as the problem of the present study.

1.3 Purpose of the Study

The basic purpose of the study is to analyze the study in Nepal, comparison of flow

of direct investment with the world, South Asia, SAARC countries and least

developed countries. The specific objectives of the study are as follows:

• To explore the trend of foreign direct investment in Nepal.

• To study facilities provided by the Ministry of Industry & supply and

Government.

• To identify the problems and constraints of FDI in Nepal and its impact in

future.

1.4 Importance of the study

Nepal, a capital poor economy with low domestic saving rate where development

expenditure, to a significant extend, are dependent on the foreign aid, foreign direct

investment are very necessary lubricant to generate economic growth. FDI is

frequently viewed as instrumental in promoting industrial growth and foreign trade

particularly in developing countries. FDI maintains relatively open economies,

stable macro-economic conditions and limited restrictions on foreign exchange

transactions. It frequently stimulates competition, productivity and innovation by

7

local suppliers because local suppliers compete for lucrative contracts with

multinational enterprise.

Further, it generates income and employment opportunities resulting in higher

wages, competitive price, more revenue, skills and technology transfer and

increased foreign exchange earnings. It contributes to the development of a host

country by increasing the countries investment level beyond what would be

permitted by domestic saving alone. Similarly, it enhances entrepreneurial

capability when the foreign firms bring with it some firm specific knowledge in the

form of technology, managerial expertise, and marketing know-how. It also allows

new local entrants to learn about exports markets, provide training for workers and

stimulates competition with local firms.

Thus, Nepal is to achieve faster rate of economic growth at the present context, it is

essential that it create the necessary and amicable condition to attract FDI.

1.5 Limitation of the study

The study has the following limitations:

• Secondary data are use to analyze for result interpretations, so the accuracy

of the findings depends on the reliability of the available information.

• The study mostly focused on previous literature, reports and data on

mapping the mindset of inflow of FDI in Nepal.

• The study covers the collection of data only a period of 5 years from the

fiscal year 2003 to 2008 and conclusion drawn confines only to the above

period.

• Lack of knowledge gap on FDI issues prior to the study.

This study is done for the partial fulfillment of Masters of Business Administration

program of Pokhara University

8

1.6 Organization of the study

The whole research is organized into five main chapters, which are as follows:

Chapter I Introduction

This chapter includes background of the study, statement of the problem, objective

of the study, importance of the study, limitation of the study, and organization of the

study.

Chapter II Review of Literature

The second chapter is review of the literature which includes theoretical framework

of foreign direct investment. Review of related journals, studies, books and

unpublished thesis and other related document in both national and international

level. Since the study is focus on FDI in Nepal: Patterns and Prospects, special

attention has been given to the previous studies on FDI and other studies related to

this topic.

Chapter III Methodology

This chapter deals with the methodology used for the study. It consists of

introduction, research design, and source of data, population and sample, data

gathering procedure and analysis of data.

Chapter IV Presentation and Analysis of Data

This chapter comprises the pattern analysis and presentation of data collected from

the department of Industry. It is the analytical presentation of the study. Nepal has

attracted modest FDI in Niche sector such as tourism, manufacturing (apparel) and

mineral deposits (limestone). The investment is mainly low-technology, labor

9

intensive production. The impact of FDI has also been modest, primarily in job

creation. Foreign affiliates have imparted skills to local employees, and in a few

instances have introduced skills to local employees, and in a few instances have

introduced new exports products and upgraded technology.

Chapter V Summary and Conclusions

This chapter is suggestive framework containing the summary, overall findings,

conclusions and recommendations.

10

CHAPTER II REVIEW OF LITERATURE

The purpose of this chapter is review the available literature related to foreign direct

investment globally and in the context of Nepal. This chapter gives an introduction

of FDI, the OLI Paradigm for Foreign Investment Decision, Why is Transparency

Important for FDI?, financial system and FDI, factor affecting foreign direct

investment, global review of FDI with historical background of FDI in Nepal along

with legal framework.

2.1 Foreign Direct Investment: An Overview Multinational corporations (MNCs) commonly capitalize on foreign business

opportunities by engaging in direct foreign investment (DFI), which is investment in

real assets (such as land, buildings or even existing plants) in foreign firms, acquire

foreign firms, and form new foreign subsidiaries. Any of these types of DFI can

generate high returns when managed properly. However, DFI requires a substantial

investment and can therefore put much capital at risk. Moreover, if the investment

doesn’t perform as well as expected the MNCs may have difficulty selling the

foreign project it created. Given these return and risk characteristic of DFI, MNCs

tend to carefully analyze the potential benefit and costs before Implementing any

type of DFI.

FDI is conventionally defined as a form of international inter-firm cooperation that

involves a significant equity stake in, or effective management control of foreign

firm (de Mello, 1997)

FDI is the international movement of capital for specific investment purposes. Such

investments are made for the purpose of actively controlling property, assets, or

companies located in host countries. Business organizations undertake FDI to

11

expand foreign markets or gain access to supplier of resources or finished products.

FDI occurs when overseas companies set up or purchase operations in another

country.

FDI can be categorized into three components: equity capital, reinvestment

earnings, and intra company loans. Equity capital comprises of the shares of the

companies in countries foreign to that of investor. Reinvested earning includes the

earning not distributed to shareholders but reinvested into the company. Intra-

company loan relate to financial transactions between a parent company and its

affiliates. FDI thus may take many forms, including

• Purchase of existing assets in a foreign company

• New investment in property like land and building.

• Participation in a joint venture with a local partner.

• Merger and acquisition of activities.

Balance of payment accounts define foreign direct investment as any flow lending

to or purchase of ownership in a foreign enterprise that is largely owned by residents

of the investing country. (Kindreberger 1987)

FDI is the act of acquiring assets may be financial, such as bonds, bank deposits,

and equity shares or direct investment and involves the ownership of means of

production such as factories and land. Direct investment is considered to take place

also if the ownership of equity shares provides control over the operation of firm.

(Johnson 1970) has suggested the expansion of the concept of foreign investment so

that it parallels the modern fisherian approach and distinguishes physical human

knowledge capital. Focusing on foreign direct investments undertaken by firms,

industrial organization theorist analyzed the location choices of multinational

enterprises. This approach was pioneered by John Dunning (1977), who suggested

that firms undertake FDI when three factors are present, and the resulting

advantages are sufficient to offset the natural disadvantages of having to operate in

12

foreign country. These are known as the “Ownership, Location and Internalization”

(OLI) advantages. A firm must have some product or technology that enables it to

enjoy some market power in foreign market (ownership advantage), the firm must

see some advantage in producing in foreign location rather than at home (location

advantage), and there must be some reason for it to want to exploit the ownership

advantage internally, rather than use a market based mechanism to gain payments

for it (Such as license or sell its product or technology in the market for a fee.

Hymer (1960) found that American FDI was mainly concentrated in a few industries

and monopolized by several companies. Multinational companies (MNC’s) were the

product of imperfect markets and monopoly advantages where the companies had

the advantage with regards to choosing where to invest. A number of conclusions

can be drawn from Hymer’s analysis that helps frame up this study:

• First, FDI tends to flow into differentiated markets where a MNC believes

they will have an advantage competitively.

• Second, companies that are able to make investments overseas all have

certain advantages, such as economies of scale, differentiated products,

special skills, and low-cost production. These companies will make

investments in regions that do not have these advantages.

• Third, there are many ways in which MNCs can invest overseas in such as

exporting, and licensing, in addition to direct investment. MNCs without

local partners always prefer to choose foreign direct investment.

• Last but not the least Hymer found that about half of the overseas operating

capital of American firms came from host countries; thus FDI tends to flow

into the countries or regions that have developed financial systems and

capital markets.

13

The basic reasons for attracting FDI by developing countries are:

• Capital Transfer: Developing countries lack capital resources. FDI is an

Importance means of capital flows.

• Productivity Improvement: FDI facilitates technology transfer.

Technological up gradation results in productivity improvement.

• Management Development: Local management people get trained in foreign

firm. They acquire new concepts, tools and techniques of management.

• Employment: Foreign Company generates employment. Due to cheap labor

in developing countries, outsourcing is on the increase by global companies.

Worker acquires new skills.

• Better Product: Foreign Company produces qualitative and branded

products. They have high image. They assure quality and supply of product.

2.2 The OLI Paradigm for Foreign Investment Decision The Ownership, Location, and Internalization (OLI) paradigm is generally viewed

as the preeminent theoretical framework for foreign investment decisions (Dunning

1993) The OLI framework postulates that the decision to produce internationally is

based on three conditions. First, a firm should possess ownership-specific

advantages over firms in other countries. Possible examples include unique property

rights or a broad variety of other intangible aspects, such as a product innovation or

an advantage in marketing. Additionally, some location advantage must be gained

by going abroad, such as a savings in transport costs, natural resources specific to

the host country, proximity to a large market, or a need to get around trade barriers.

Finally, a firm must desire to maintain possession of this advantage, rather than

simply selling or licensing it to foreign companies. In other words, the firm must

want to internalize its advantages across different markets.

14

The political environment of a host state can affect the ownership, locational, and

internalization aspects of the OLI paradigm. Through the proper regulatory

environment, a state can enhance ownership advantages by helping a firm preserve

its intangible aspects or monopolistic advantage over local producers. State

credibility decreases political risk and cost of internalizing production as

multinationals gain confidence that the state will not adopt policies after initial

investment that negatively affect their operations (Jensen 2003). Yet the role of the

host state is strongest as a location factor. Obviously, some locational criteria, such

as natural resources and port access, are essentially fixed. There are various other

ways, however, that states can make their location more desirable. They may offer

preferential taxation policies and other financial incentives (Oman 2000). Moreover,

as discussed below, the political environment of a host country and the education

and skill levels of the workforce may also factor as locational criteria.

Dunning (1981) suggests that transnational corporations (TNCs) will invest in a

foreign location only if the latter offers certain location-specific advantages in terms

of resources and facilities that make it possible for the TNCs to explore their firm-

specific ownership advantages. Various authors, such as Root and Ahmed (1979),

Schneider and Frey (1985), Dunning (1993; 1994) and Burrell and Pain (1997),

suggest that location decisions are influenced by a number of factors. Tuselmann,

(1999) divides these factors into two groups:

• Supply factors (such as labor costs, skills level of the labor force, and

corporate taxation); and

• Demand factors (such as market size and growth, and geographical location).

2.3 Why is Transparency Important for FDI? Transparent economic policies are vital for foreign investors, and the reasons are

several. The first reason is that non-transparency imposes additional costs on

15

businesses. These additional costs arise as firms have to tackle the lack of

information that should have been provided by the appropriate government

department in the implementation of its policies and in the activities of government

institutions. For example, firms bidding for a state asset expect to receive full

information from the government about the company to be privatized. Any set of

information that falls short of the expectation of the bidders will have to be

supplemented – at extra costs, and the latter are typically incurred by the bidders.

Additional costs are also incurred because of corruption - another element of non-

transparency identified above. In many countries, bribery is illegal. Bribery raises,

therefore, the risks and the costs of non-compliance, and the companies will only

take the risk if the rewards are sufficiently high. Corruption can indeed be very

costly to firms. By way of example, bribes are estimated to have accounted for 7

percent of revenue of firms in Albania and Latvia in mid-1990's and in Georgia the

corresponding figures was even higher – 15 percent (Kaufmann, Pradhan and

Ryterman 1999) This process would lead to an investment selection that often has

little to do with choices based on bona fide project appraisal but rather to projects

selected on the basis of contacts, pressures, rent-seeking alliances etc. Moreover,

the majority of law-abiding companies will typically avoid doing business in

countries in which bribery is an inseparable part of business. In brief, the existence

of strong legal provisions against bribery and their effective enforcement will go a

long way towards inducing FDI flows.

The second reason why transparent economic policies are important for FDI is

because they facilitate cross- border mergers and acquisitions. When firms decide

to acquire companies abroad, they will often have to have their acquisitions

approved by the Monopoly Commission or its equivalent in the host (i.e. foreign

investment receiving) country. However, the practices of these competition

commissions often vary from country to country and from region to region. For

example, Neven, Papandroupulos and Seabright (1998) argue in their study of the

European competition policy that the Competition Commission of the European

16

Union enjoys high level of discretion with very little transparency. It is perhaps,

therefore, not surprising that we have so far witnessed little of cross-border mergers

and acquisitions within the European Union.

The third reason is closely related to the previous discussion of competition policies.

Foreign investors require transparent protection of property rights. As we have

argued above, investors generally require that their property be protected and that

the protection be transparent. What holds for investors in general holds, of course,

it holds for foreign investors in particular. This conclusion is intuitive but it also has

a strong backing from business attitude surveys and from empirical literature such

as the study of Rapp et al. (1990) who find that effective protection of intellectual

property rights is strongly correlated with inflows of foreign investment.

The fourth argument for transparent economic policies is that they positively

influence business attitudes. Virtually all surveys of business attitudes convincingly

show that companies base their decisions to invest abroad on their perceptions of

what economists like to call “fundamentals" (Hoekman and Saggi 1999). The latter

include macroeconomic conditions such as low and predictable inflation, prospects

of fast economic growth, healthy balance-of-payments position. They will typically

also include factors such plentiful and relatively skilled labor force, access to natural

resources, efficient infrastructure etc. Furthermore, and most importantly in the

context of our paper, investors typically seek clear, open and predictable economic

policies that minimize the risks of unpleasant and costly surprises. Open trade and

investment regimes are particularly powerful instruments to attract investments in

general and foreign investments in particular (Selowsky and Martin 1997). Clearly,

transparency of economic policies and government institutions figures prominently

on the minds of businessmen and in the meetings of corporate boards of

multinational companies.

The absence of comprehensive and symmetrical legal provisions concerning

business practices has a number of effects for companies. One of the most serious

17

effects is arguably their impact on the competitive position of firms which may

differ among countries as a result of these differences. For example, U.S. Federal

law prohibits U.S. firms from using bribery to gain access to foreign markets. By

contrast some European countries allow firms to treat bribes paid as deductions in

calculating their tax liabilities. This asymmetry of rules poses a disadvantage for

U.S. firms. Therefore, the elimination of corruption is an important issue for U.S.

firms as a means to level the playing field.

Finally, there is another, and perhaps the most important reason why economic

policies must be transparent if countries can establish favorable conditions for

capital inflows. The reason is countries' policy performance and transparencies are

monitored by outside agencies which have a crucial impact on decisions of foreign

investors. These agencies include the IMF and various private credit rating agencies.

Their influence is different – the IMF provides a “credit of approval" of sound

economic policies while credit rating agencies evaluate the credit risk of the country

concerned. Their similarity rests on the fact adverse judgment on government

policies in a given country will typically lead adverse perceptions by foreign

investors of that country. As frivolous as it might sound it is a well known fact from

the business community that foreign investors would base their investment decisions

on credit assessments and country rankings established by some credit rating

agencies. The fact that we shall also heavily rely on country rankings in our

empirical part further below is not, therefore, an entirely academic exercise but one

that is strongly derived from the reality.

2.4 FDI and Corruptions

Foreign Direct Investment (FDI) plays a significant role in modern economies.

World FDI flows have increased from $25 billion in 1973 (Drabek 1998) to $1.4

trillion in 2007 (Kekic 2007). For lesser developed countries, FDI flows often

outstrip foreign aid and make-up a sizable part of local and national economies

18

(Drabek 1998). In a highly globalized world, successful competition for FDI is a

vital part of policymaking and a requisite part of developing states.

Various barriers limit FDI flows: lack of private property rights, poor infrastructure,

excessive regulation, high tax rates, and - not surprisingly - corruption. Many

authors focus on the question of whether corruption has a positive or negative effect

on FDI, growth, and productivity. Responding to conventional wisdom and Samuel

Huntington’s comment that "in terms of economic growth, the only thing worse than

a society with a rigid, over-centralized, dishonest bureaucracy is one with a rigid,

over-centralized, honest bureaucracy" (Huntington 1968), Kaufmann and Wei find

that corruption does not "grease the wheels" of business. High levels of corruption

are associated with greater capital costs and lower profits; bribe-paying may not be

an effective strategy for business (Kaufmann and Wei 1999). Corruption is also

associated with lower levels of development (Ades and Tella 1997), and there is

considerable evidence that it limits private investment (Mauro, 1998). Much of the

literature on corruption focuses on the negative impact of corruption and bribery on

FDI, growth, education spending, and related topics.

One reason that corruption can preclude a partner state from receiving a high level

of FDI is that with corruption comes uncertainty (Wei 1997). All else being equal,

states would prefer to pay a higher tax rate in a partner country than contend with a

high level of corruption because, with corruption, the total costs cannot be known

(Wei 1997). Smarzynska and Wei demonstrate that moving from Mexico’s level of

corruption to Singapore’s affects FDI more than a 20% tax rate increase

(Smarzynska and Wei 2000).

Imagine building a large factory overseas, paying a few bribes to acquire land and

infrastructure, and initiating production. A year later, the electricity goes out, and a

government employee explains to the factory owner that he has two options: be

without power for three months or pay an additional "fee." This "fee" could cost him

anywhere from $1 to $100,000 (or more), but he had no reasonable way to prepare

19

for it - all he knew was that corruption would be a business cost. His business is

completely at the mercy of corrupt practitioners; new "fees" can crop up at any time.

It is easy to see why the presence of corruption has a negative impact on FDI flows

and private investment (Wei 1997, Kaufmann and Wei 1999, Mauro 1998). By

contrast, transparency has a strong positive effect on FDI flows (Drabek and Payne

2001).

Corruption may also decrease FDI flows because it can lead to inefficiency

(bottlenecks, high costs) and violations of business norms and best practices,

making international investors more concerned with corruption than local investors

(Habib and Zurawicki 2002). Habib and Zurawicki argue that the level of corruption

in investor states will impact where their corporations choose to invest; businesses

will try to do business in environments where they are comfortable. Corporations

from corrupt states may feel more comfortable investing in corrupt states. To test

their hypothesis, they interact the CPI score in host countries with the CPI score in

investor states in a regression explaining FDI outflows using data from 1996-1998.

The data supports their hypothesis, but the data is limited because the CPI expanded

greatly in the years following the conclusion of their project; between 1996 and

1998, CPI was only available for a small number of states. Also, the effect may have

less to do with norms and more to do with comparative advantage: states from

corrupt states may have fewer restrictions on their ability to pay bribes in host

states, enabling them to out-compete states with strong anti-bribery laws for

contracts abroad. This is better evaluated by using the Bribe Payers Index and

OECD Convention Ratification to see which states frequently pay bribes overseas.

Two papers by Peter Egger and Hannes Winner look specifically at the question of

how corruption and risk affect FDI flows (Egger and Winner 2003, 2006). In their

2006 paper "How Corruption Influences Foreign Direct Investment: a Panel Data

Study," Egger and Winner examine how other factors impact corruption’s effect on

bilateral FDI flows. Their observations are FDI country pairs from 1983-1999, and

20

to assess level of corruption (or perceived level of corruption), Egger and Winner

use the Transparency International Perceptions of Corruption Index (CPI). Their

empirical model follows other corruption studies, regressing bilateral FDI flows on

CPI and other variables. By building in variables to account for country size,

location, factor endowments, and transport costs, they conclude that - while

corruption has a negative impact on FDI flows - the interaction of corruption with

other factors (factor endowments, location, etc.) can amplify or minimize this

impact. Egger and Winner also conclude that corruption is more relevant for FDI

flows between two OECD states and less so for OECD states investing in non-

OECD states.

Taken as a whole, decreasing corruption leads to higher rates of FDI. But

corporations from some states are less willing to pay bribes - Switzerland and

Sweden, for instance - while others are more likely to pay bribes (Bribe Payers

Index 2006). It therefore follows that the significance of corruption is different

depending on a recipient state’s target investors and current investment partners.

Corporations from states with a higher tolerance for bribery have a comparative

advantage at investing in states with high levels of corruption because they are more

willing to suffer the costs of doing business. Bribe-taking states should see a higher

rate of investment from states that have a greater tolerance for bribe-paying. On the

other hand, when an investor state makes it more difficult for its corporations to pay

bribes overseas (through greater transparency, regulation, reporting, etc.), it will

decrease its corporations’ ability to out compete corporations from states with lax

bribe-paying laws for desirable contracts in corrupt states.

2.5 Factor affecting Foreign Direct Investment Capital flow resulting from FDI change whenever conditions in a country change

the desire of firms to conduct business operations there. Some of the more common

factors that could affect a country FDI are identified here.

21

High Transportation Cost High transport costs arising from its unique geography are obviously a significant

constraint faced by Nepal and put it at a disadvantage compared to many other low-

wage countries in attracting export-oriented FDI. Apart from the long distance to

Indian ports (the port of Calcutta is about 1,000 kilometers away by the shortest

route), inefficiencies of the Indian railways and ports add to the cost of transport for

potential exporters from Nepal. It is also alleged that shipments from Nepal are

given low priorities at the highly congested Indian ports.4 However, focusing on

high transport costs per se can lead to misleading inferences for Nepal’s potential in

labor-intensive export industries for two reasons. First, the relative cost advantage

of Nepal arising from low wages (less than $20 per month for the average factory

worker) may, in certain cases, outweigh the relative disadvantage arising from high

costs of transport. Second, landlocked economies, such as Nepal, can choose to

specialize in “low weight per unit value” products, provided, of course, the overall

economic environment is conducive for the production for such products

(Srinivasan, 1986). Moreover, it is important to note that adverse cost implications

arising from landlessness can be minimized through suitable government policy in

the areas of land and air transport, and customs administration (Bagchi, 1998).

Changes in Restrictions During the 1990s, many countries lowered their restrictions on FDI, thereby

opening the way to more FDI in those countries. Many US based MNCs including

Bausch and Lomb, Colgate-Palmolive, and General Electric, have been penetrating

less developed countries such as Argentina, Chile, Mexico, India, China, and

Hungery. New opportunities in these countries have risen from the removal of

government barrier.

22

Privatization Several national governments have recently engaged in privatization, or the selling

of the same of their operations to corporations and other investors. Privatization is

popular in Brazil and Mexico, in Eastern European countries such as Poland and

Hungary, and in such Caribbean territories as the Virgin Island. It allows for greater

international business as foreign firms can acquire operations sold by national

governments.

Privatization was used in Chile to prevent a few investors from controlling all the

shares and in France to prevent a possible reversion to a more nationalized

economy. In the United Kingdom, privatization was promoted to spread stock

ownership across investors, which allowed more people to have a direct stake in the

success of British industry.

The primary reason that the market value of a firm may increase in response to

privatization is the anticipated improvement in managerial efficiency. Manager in a

privatization is the anticipated improvement in managerial efficiency. Manager in a

privately owned firm can focus on the goal of maximizing shareholder wealth,

whereas in a stated –owned firm business, the state must consider the economic and

social ramifications of any business decision. Also, managers of a privately owned

enterprise are more motivated to ensure profitability because their careers may

depend on it. For these reasons, privatized firms will search for local and global

opportunities that could enhance their value. The trend toward privatization will

undoubtedly create a more competitive global market place.

Potential Economic Growth Countries that have greater potential for economic growth are more likely to attract

FDI. When assessing the feasibility of FDI firms estimate the after tax cash flows

that they expect to earn.

23

Tax Rates Countries that impose relatively low tax rate on the corporate earning are more

likely to attract FDI. When assessing the feasibility of FDI, firms estimate the after

tax cash flows that they expect to earn.

Exchange Rates Firms typically prefer to direct FDI to countries where the local currency is

expected to strengthen against their own. Under this condition, they can invest funds

to establish their operations in a country’s currency are relatively cheap (weak).

Then, earnings from the new operations can periodically be converted back to the

firm’s currency at a more favorable exchange rate.

Importance of factors influencing foreign investment decisions (Erdilek 1982)

• Rapid expected growth of the economy and increase of demand for the

foreign firm's product

• High expected rate of return in supplying primarily in the host market

• Increasing import restrictions, which began to endanger exports to host

country

• Host country’s government incentives and other guarantees

• Foreign investment by other foreign firms in host country.

• Other considerations

• Incentives and guarantees provided by the parent firm's government

• Lower unit production costs for export base.

For a typical developing economy, labor-intensive, consumer goods manufacturing

is generally considered to be the natural starting point in the process of export-led

industrialization. While the availability of cheap and trainable labor is a prerequisite

for attracting export-oriented FDI, the availability of a wider array of

complementary inputs, including operator, technical and managerial skills, suppliers

24

of intermediate goods, and high-quality infrastructure, are also essential. Also, given

the large initial fixed costs involved, Transnational Corporations (TNCs) would be

reluctant to establish assembly plants in a country without having confidence in the

policy continuity and political stability of that country. For these reasons, so far,

only a limited number of developing countries, mostly the high performing East

Asian countries and more recently some transition economies in Eastern Europe,

have been able to attract FDI in assembly operations. The so-called “life- cycle”

investors who expand their production networks globally, largely on scale economy

and efficiency considerations, rarely find low-income countries attractive locations

for investment. (Athukorala, P. C. and Sharma, K., 2006)

2.6 Review of Nepalese Research in FDI Nepal is situated in south Asia is bordered by Tibet Autonomous region of china in

the north and India in the east west and south. the country is roughly rectangular ins

shape, with at total land area of 147181 square kilometers (sq km), stretching 885

km from east to west and between 145 Km and 241 Km from north to south, with a

mean width of 193 km.

Topographically, the country can be divided into three distinct regions from north to

south: the mountainous region, hilly region and flat plains, known the Terai. Lying

at an altitude ranging from 4877 to 8848 meters above sea level (masl), the

mountainous region includes the Himalayas, world’s highest mountain chain. Nepal

Himalayas comprises nine of the world’s highest peaks, including the highest,

Mount Everest (in Nepali, Sagarmatha). The hilly region lies in the middle of the

country, altitude varying between 610 and 4877 masl. Kathmandu Valley, where the

country’s capital, Kathmandu is situated, and many other scenic valleys, basins and

pockets are located in the region. The Terai, which is an extension of the Gangetic

25

plains of India, forms a low flatland along the southern border. It comprises most of

the fertile land and forest areas of the country, and rich and big river basins.

Nepal had attracted modest FDI in niche sectors such as tourism, herbal products,

mineral deposits (lime stone), and light manufacturing apparel; hydro power and

that it had positive impacts on exports, particularly garments. FDI has also enabled

the country to export non-traditional manufactured products such as micro-

transformers and personal consumer products (UNCTAD, 2003b). Investment was

mainly in low-technology, labor-intensive production. The impact of FDI had also

been modest, primarily in job creation. According to the study, FDI inflow was

constrained by political instability, outdated foreign investment law, rigid labor

regulations and poor physical infrastructure. This situation remains current due to

political instability and political transition.

FDI is considered beneficial in view of its contribution to technological transfers,

enhancement of managerial capability and new opportunities for market access.

FDI, particularly in the form of equity investment, adds to the capital stock of the

country and thus enables the recipient country to achieve faster economic growth

through momentum in capital formation. Increases in FDI are also seen as leading to

increases in exports by creating international markets through new marketing and

organizational skills.

The inflow of FDI in Nepal began in the early 1980s through the gradual opening up

of the economy. From 1980 to 1989, FDI inflows to Nepal were minimal with an

annual average of US$ 500,000. FDI inflow showed a distinct acceleration during

the 1990s averaging US$ 11 million per annum during 1990-2000, peaking at US$

23 million in 1997 (UNCTAD, 2003b and 2006). This was primarily due to Nepal’s

more liberal trade policies, which comprised tariff rate reductions, the introduction

of a duty drawback scheme, the adoption of a current account convertibility system

and liberalization of the exchange rate regime. A reversal in the rising trend took

place from the beginning of the 2000s. All in all, FDI inflow is the lowest in Nepal

26

even when compared with other landlocked countries (World Bank, 2003). A

comparison of other Asian countries, Nepal indicates a poor performance of FDI

(UNCTAD, 2003b). The fact that Nepal is landlocked, coupled with its

infrastructure and low level of labor productivity has also constrained FDI inflow

into the country.

Many foreign investors in Nepal are individuals rather than corporate entities. Most

of the FDI projects are of small size 72%, medium-sized 16.5% and large-sized

industries 11.5%. Much of the FDI inflow is for joint ventures because of non-

commercial risks by offering shares to local partners.

Most of the FDI in Nepal is Greenfield-type investment rather than acquisition. FDI

is highly concentrated in the manufacturing sector, which accounted for slightly

more than 45 per cent of approved FDI projects. Within the manufacturing sector,

the textile and garment industry accounts for 28 per cent of total foreign investment,

followed by the chemical and plastic industries at 25.3 percent. Tourism is second,

accounting for almost 25 percent of total FDI projects, followed by the service

sector with 20 per cent of FDI projects. Although the electricity, water and gas

sector has just a few FDI projects, it ranks fourth highest in terms of the size of FDI

inflow.

In total, FDI comes from 50 countries. But the scale and number of projects by each

country vary considerably. Of that total, in terms of investment, India alone

accounted for more than 40 per cent, followed by the United States and China.

Those three countries alone account for two-thirds of cumulative FDI in Nepal. In

terms of number of FDI projects, India ranks first, followed by China, Japan and the

United States. Nepalese and Indian nationals do not need passports or visas when

traveling between their countries. Similarly, the Indian currency is freely convertible

in Nepal. A special relationship with India regarding preferential trade arrangements

also provides an additional incentive to Indian investors.

27

Legal and Institutional Framework

Nepal cannot be far from the benefits of Foreign Direct Investment (FDI). So Nepal

has been given priority for the attraction of FDI and its development by different

polices and rules in national and international level to promote foreign investment

and technology transfer for making the economy viable, dynamic and competitive

through the maximum mobilization of the capital, human and other natural

resources.

Global level

Today, Nepal is one of the most liberalized countries in the South Asian region.

However, growth performance has been very poor in recent years. In this context, a

closer examination of the linkages between foreign direct investment and growth is

critically important from a policy point of view. There are highly liberal FDI and

GDP-related policies supplemented by important Acts. In the aftermath of

liberalization that began in the early 1990s, FDI increased substantially. However,

that could not be sustained for long. After becoming a World Trade Organization

(WTO) member in 2004, Nepal has been pursuing further opening up and

liberalization policies on the FDI. Nepal is also a member of the South Asian

Preferential Trade Arrangement (SAPTA) and the Bay of Bengal Initiative for

Multi-Scrotal Technical and Economic Cooperation-Free Trade Area (BIMST-EC

FTA). New initiatives on FDI have been taken with the aim of enhancing sustained

growth and reducing poverty.

Incentive Level

Although the Government of Nepal is open to foreign direct investment,

implementation of its policies is often distorted by bureaucratic delays and

inefficiency. Besides this, Nepal is still facing some problems for FDI because of

28

lack of direct access to seaports, difficult land transport and lack of trained

personnel, scarce raw materials, inadequate power insufficient water supply, non-

transparent capricious tax administration inadequate and obscure commercial

legislation, and unclear rules regarding labor relations.

In the pre-liberalization period, the investment regime was more restrictive.

Investors had to obtain a government license before undertaking any production and

business activities. The FDI was almost nil before 1980. Although some attempts to

liberalize the investment policy were made from the beginning of the 1980s, it was

speeded up only after 1990. To ensure investment, both domestic and foreign, the

Government adopted various liberal policies, which are still in operation. These

policies include the Industrial Policy, 1992, Industrial Enterprises Act, 1992 (first

amendment, 1997), Foreign Investment and One-window Policy, 1992, the Foreign

Investment and Technology Transfer Act, 1992, the Finance Act of 2002 and the

recent Finance Ordinance 2004 (an annual budget act); the Immigration Rules of

1994; the Customs Act of 1997; the Industrial Enterprises Act of 1997; the

Electricity Act of 1992; and the Patent, Design and Trademark Act of 1965. In a

positive development, Nepal passed the Copyright Act in 2002 etc.

Development Level

Nepal is trying to attract FDI with the different rules and policies. Besides this, FDI

has been involved in every five year‘s Government plan and also some institutional

arrangements for FDI promotion have been implanted for its development.

In the recent decade, Nepal is well coming FDI and has been benefited .Some of the

literature suggests that the FDI inflows have a positive impact on economic growth

of host countries and other literature suggests not at all. However, FDI in itself is

not a development but may act as a catalyst for the needed progress and therefore,

warrant further study.

29

2.6.1 Key policies of the Government of Nepal (GoN) for promoting foreign investment

• Foreign investment will be encouraged in sectors such as hydropower,

tourism, agriculture and non-timber based high value products, development

of education and health-related facilities, financial services, information

technology and biotechnology related industries.

• FDI will be encouraged in export oriented industries, natural resources

excavation, construction of tool roads and construction of goods

management and terminal.

• Individual interested in investing in the development of infrastructure for

dissemination of employment technology, compatible with the existing

economic structure, will be encouraged.

• An appropriate policy will be adopted to attract capital, skills, efficiency,

and technology of non-resident Nepalese.

• Nepalese diplomatic missions abroad will be mobilized to promote foreign

investment.

• A high level investment promotion board will be established to facilitate

foreign investment. This board will function as a ‘one-window’ shop for

meeting the requirements of projects

• Opportunities will be provided to international oil companies for the

exploration of petroleum at feasible locations.

• Effort to facilitate the entry of foreign investment and technology in the

areas of comparative advantage and priority sectors will be made by creating

an investment-friendly environment (DoI,2009)

2.6.2 Key policies of the Government of Nepal (GoN) on the industrial

sector

• Necessary amendments will be made in the policies related to industry,

foreign investment and trade.

30

• Procedure will be simplified to attract foreign investment and to establish

new business.

• The government will be extend support for the promotion, identification

and development of products having comparative advantage in areas

such as hydroelectricity, herbal production and processing, organic

farming, information technology and medicines.

• An industrial security force will be constituted incorporating the private

sector for better industrial security.

• Multinational companies will be invited for the exploration and

extraction as well as production of petroleum products.

• A law relating to special economic zones (SEZs) will be enacted.

• SEZs will also be developed in Jhapa ,Dhanusa, Birgung, panchkhal,

Jumla and Dhangadi to accelerate the establishment of infrastructural

industries to enhance Nepal’s export capacity as well as increasing

industrial processing of local resources.

• The government will reform Nepal Industrial Development Corporation

(NIDC) as it is in a state of inaction due to inadequate capital and weak

management.

• The government will take initiative to establish infrastructure banks with

the involvement of the private sector.

• Load-shedding will be ended in industrial corridors.

• The government will make available public and barren land on long –

term lease to the private sector to establish dairy industries, amusement

parks, tourist rest houses and resorts, hotels, universities and technical

institutes with their investments.

• To reduce dependence on petroleum products, industries locally

producing biodiesel and using widely available plant Sajivan (Zatropha)

and mixing ethanol in petrol by up to 10 percent will be encouraged.

(DoI,2009)

31

International Relations

Nepal foreign policy is guided by the principles enshrined in the Charter of the

United Nations (UN) and the Non- Aligned Movement. As such, Nepal enjoys

cordial relations with all countries of the world. This is manifested by her

diplomatic relations with 128 countries, maintained though twenty-six residential

embassies, three consulates and numerous honorary consul generals or consulates

abroad. Similarly, twenty- two embassies, consulates, cooperation offices, country

representatives of various international organizations, including the UN, World

Bank, International Monetary Fund (IMF) and Asian Development Bank (ADB) ,

based in Kathmandu, have made significant contributions to help Nepal achieve its

foreign policy and economic development goals.

Economic diplomacy has been adopted as another significant dimension of Nepal’s

foreign policy priorities in recent years. Its main objectives are to promote Nepal’s

export trade, attract greater number of tourist to Nepal and enhance the flow of

foreign direct investment (FDI) in to the country.

Nepal attaches considerable importance to the promotion of close economic

cooperation in South Asia. Towards this end, it is actively working with other

members of the South Asian Association for Regional Cooperation (SAARC) for

the realization of South Asian Free Trade Area (SAFTA), and is also engaged in

sub-regional cooperation in the form of the South Asian Growth Quadrangle

(SAGQ), comprising, among others, Bangladesh, Bhutan and India. Nepal has also

been a member of the Bay of Bangle Initiative for Multi-Sectoral Technical and

Economic Cooperation (BIMSTEC). Nepal acceded to the World Trade

Organization (WTO) in 2004. Nepal has been member of the UN and its specialized

agencies since 1966 and World Bank and IMF.

32

2.6.1 Investment and Repatriation 2.6.1.1 Investment Foreign investment may invest part of their equity capital in the form of either a

convertible foreign currency acceptable to Nepal Rastra Bank, the central bank of

Nepal, through proper banking channel or plant, machinery and equipment required

for the approved industry. For investment in the form of plant and machinery, prior

approval of the DoI is a must. Indian national may invest in Indian currency through

proper banking channel.

Equity investment in Cash

Foreign investment must be brought inside Nepal only after obtaining the approval

of the DoI. It is also necessary that the investment is brought inside the country only

through proper banking channel and that the foreign investor or industry maintains

the documentary proof of the investment brought-in. This proof must be produced at

the time of repatriation.

Equity investment in Kind

If the foreign investor wants to invest in the form of plant, machinery and

equipment, it must be clearly stated in the joint venture agreement. While opening a

letter of credit to this effect, approval of the DoI must be obtained before the

shipment. This is essential for custom clearance of the goods imported. For such

approval, the company or the industry must submit to the DoI a copy of resolution

of board of directors, along with the original manufacturer’s detailed invoice of

machinery, indicating the quantity and the price of each unit of equipment. In any

case, the supplier must guarantee that the price of the machinery is competitive, and

it must be supported by the manufacturer’s invoice.

33

Loan investment in Cash

If the foreign investment is in the form of a loan to an industrial firm or company,

an agreement must be entered into by the investing foreign party and the Nepalese

industry, stipulating the terms and conditions, including the amortization schedule

and interest. Approval of the agreement must be obtained from the DoI before

transferring the loan. Such loan amount must be brought through proper banking

channel.

Loan investment in Kind

If industry wishes to obtain a foreign loan in the form of machinery and equipment

or in deferred credit, an agreement to that effect must be entered into, stipulated the

price of the plant and machinery, interest rate, mode of payment, along with a

detailed list of the plant and machinery. Approval of the DoI must be duly obtained.

The supplier must guarantee as to the competitiveness of the price of the machinery,

and it must be supported by the manufacturer invoice. If no letter of credit is

opened, approval of the DoI must be obtained before the shipment for the custom

clearance.

In case the machinery to be imported as part of investment is a second-hand one, a

valuation and certificate of guarantee by an independent surveyor must be attached.

2.6.1.2 Repatriation The foreign investment and technology transfer act 1992 allows foreign investor

investing in a foreign currency to repatriate the following amounts out of Nepal:

• Income from the sale of the share of foreign investment as a whole or part

thereof

• Profit or dividend from foreign investment

• Payment of principal and interest on foreign loans

34

• Income from the agreement for transfer of technology in such currency as set

forth in the agreement concerned approved by the DoI.

A foreign national who is working in an industry with prior approval of the

Department of Labor and who is from a country where convertible foreign currency

is in circulation may repatriate his/her salaries, allowances and emoluments in

convertible foreign currency in an amount not exceeding 75 per cent of such

salaries, allowances and emoluments.

To obtain the repatriation facility, the foreign investor or technology supplier or

expatriate or the company concerned must obtain recommendation from the DoI.

Repatriation of sale of shares

For the repatriation of the amount earned from the sale of shares, the foreign

investor or company concern should apply to the DoI, along with the following

documents, for recommendation to Nepal Rastra Bank:

• Proof of investment made and number of shares owned (the proof of

investment could be certificate from the commercial bank through which the

investment was brought into Nepal.

• Letter from the company certifying the completion of the transfer of the

shares in question with the certification of the CRO or such an authorized

body.

• Prior approval of the DoI, if the share was transferred to a foreign national

• Tax clearance certificate

• Custom declaration form and the approval letter if the investment was made

in the form of plant, machinery and equipment

• Copy of board of directors’ resolution

35

Repatriation of Dividend

A foreign investor wishing to repatriate his/her dividend from his/her investment as

per the Foreign Investment and Technology Transfer Act 1992 has to obtain the

recommendation of the DoI. For this, the foreign investor or company has to apply

to the DoI, along with the following documents

• Documentary proof of investment, issued by a commercial bank. This

document is needed only for the first time and again only when further

investment is made by the investor.

• Custom declaration certificate for the import of plant, machinery and

equipment, if the investment is in the form of capital equipment,

• Auditor’s report, including balance sheet and profit and loss account,

• Tax clearance certificate, and

• Proof of dividend declaration

Repatriation of Loans and Interest

The industrial unit with foreign loan has to apply to the DoI for sending out the

principal and interest on foreign loan obtained with the approval of the DoI, along

with the following documents:

• Certificate from the commercial bank regarding the transfer of loan amount

into Nepal.

• Custom declaration certificate and invoice of the plant and machinery, if the

loan was obtained in the form of machinery

• Letter of approval of the loan agreement, and

• Tax clearance certificate.

Income tax on interest on foreign loan should be deducted at source as per the

prevailing law and is to be deposited at the tax office

36

Repatriation of Technology Transfer Fee

The industrial unit with approved technology transfer agreement, trademark license

agreement, management agreement, technical assistance agreement, etc can apply to

the DoI for the transfer of fees as per the agreement. The company has to submit the

calculation of the amount due to the foreign technology supplier, certificate by the

auditor, along with the certificate of payment of income tax on royalty as per the

prevailing tax rate.

Repatriation of Salaries and Allowances of Expatriates

For the repatriation of the salaries, allowances and emolument received by an

expatriate, the industry has to apply to the DoI for the recommendation, along with

the following documents:

• Work permit issued by the Department of Labor

• Document showing the salaries and allowances received during the period

for which repatriation is sought.

2.7 Concluding Remarks

The review of global, regional and Nepal’s FDI and trade reveals clear patterns and

trends. The global environment of FDI and trade suggests a conducive environment

if competitive one. The tremendous growth in the global FDI and trade as revealed

by the data is testimony to this. On the one hand the trend and patterns for Nepal is

erratic, negative and declining, which is contrary to and reverse of the global trends

and patterns. This appears to suggest that the world economy is moving in one

direction and Nepal in other. The reasons are not hard to differentiate. For private

capital flows and FDI, Nepal has yet to create minimum and necessary

preconditions that would attract private capital flows and FDI. To reverse this

37

balance of trade gap, Nepal must create products and explore niches that have

competitive advantage in the regional and global market. Failure to do so will lead

to further marginalization in a competitive global economy of the 21st century.

Instead of share of the pie of the global prosperity, Nepal may find itself bottom of

the marsh of poverty.

Some causes of poor state of affair of FDI in Nepal are as follows:

• The government has announced FITTA in 1992, to attract foreign

investment. The act is not clear on the definition of foreign investments and

technology transfers.

• Recent political disturbances have even threatened bilateral and multilateral

development projects. With growing political instability the government has

failed to control it. The disturbances have instead spread throughout the

country. This is a serious problem in attracting FDI.

• Nepal is suffering from lack of capital and advanced technology. FDI is an

important source of bringing in capital and technology in a country.

38

CHAPTER III METHODOLOGY

3.1 Introduction

When a particular research area has been identified, research problem defined, and

the related literature in the area have been reviewed; the next foremost step towards

the objective is to set research methodology.

Research methodology is the process of arriving at the solution of the problem

through planned and systematic dealing with the collection, analysis and

interpretation of facts and figures.

Research is a systematic and organized effort to investigate a specific problem that

needs a solution (Sekaran, 1992). This process of investigation involves a series of

well-thought-out activities of gathering, recording, analyzing and interpreting the

data with the purpose of finding answers to the problem. Thus, the entire process by

which we attempt to solve problems or search the answers to questions is called

research.

Research is undertaken not only to solve a problem existing in the work setting, but

also to add or contribute to the general body of knowledge in a particular area of

interest to the researcher, research is thus a knowledge building process. It generates

new knowledge, which can be used for different purposes. It is used to build a

theory, develop policies, support decision-making and solve problems. With the

opening of new frontiers of knowledge through research, new concepts and theories

are developed to explain, verify, and analyze the social phenomena.

39

The basic objective of this study “Foreign Direct Investment in Nepal: Patterns and

Prospects” is to focus how foreign direct investment’s patterns is in Nepal and its

future prospects.

3.2 The Research Design

The research approach is regularly either quantitative or qualitative. Selectivity and

distance to the purpose of research characterize a quantitative approach where as a

qualitative approach is characterized by closeness to the object of research. Both

approaches have their strength and weaknesses and neither one of the approaches

can be held better than other one. The best research method to use for a study

depends on that studies research purposes and the accompanying research question

(Yin 1994).

Based in the problem of the statement of this study above, the researcher gives

better understanding of the research area, so it will get detailed information to

describe the understanding of the objective of the research. It will use the frame of

reference and aim to gain a deeper understanding of this phenomenon as well as

analyze the data in the form of numbers statistically. This research is based on both

quantitative and qualitative data. The description of the situation of FDI in Nepal,

the historical background of FDI and account of different opinions of experts on

FDI are all qualitative information. While the numerical data of inflows of FDI in

South Asia, SAARC countries and Nepal as well the graphic representation of facts

and figures are the quantitative information. So both qualitative and quantitative will

be author inclination.

40

3.3 Data Collection

Data may be obtained from several sources. However documentation, archival

records, direct observations, interviews, questionnaires, participant observations etc

are few of methods of data collection. Within the scope of research, author will use

email, formal interviews, and other observation (interaction with website) as source

of data collection. There are two source of data collection.

3.3.1 Source of Secondary Data

Secondary data are those, which have already been collected by someone else and

have padded the statistical process. The secondary data are gathered in the form of

World Bank Reports, UNCTAD reports, data from Department of Industry

,economic reports, various articles and publication dealing in the subject matter of

the study, websites etc. The researcher has mostly depended upon the secondary

source for the collection of data.

3.3.2 Source of Primary Data

Primary data are those, which are collected fresh and for the first time and thus

happen to be original in character. For the collection of primary data, structured

open-ended interview was taken in the various economists of the country based on

the previous literature. The interview carried out where more or less a ‘free-floating

conversation’ where a number of areas were covered. The information received

from the interview are analyzed and presented in different chapter.

3.4 The Population and Sampling

Sampling is done to draw conclusion from the whole population. The population

refers to the industries of same nature, services and product in general. The research

41

is concentrated on the study of trend of inflows of foreign investment from 2001

onward till date. Purposive sampling was conducted due to time constraint with

selective economist.

3.5 Data Gathering Procedure

The researcher has collected the annual trend of FDI inflow from Department of

Industry and other related books. Primary data has been collected through formal

interviews and reviews of literature. On some aspects, data has also been collected

from the World Bank websites and reports.

3.6 Data Analysis

The goal of analyzing the data is to handle the evidence fairly, to produce

convincing logical conclusion and to rule out alternative interpretations. Data

analysis involves turning a series of recorded observation into descriptive statements

(Yin 1994). Therefore, after the data is collected from different sources, the next

step is to process, analyze and interpret them to drive meaningful conclusion.

The various data collected from different sources have been compiled condensed,

analyzed and presented in the form of tables and diagrams, graphs and chart with

the help of Microsoft Excel.

42

CHAPTER IV PRESENTATION AND ANALYSIS OF DATA

In this chapter we analyze the data after converting the unprocessed data into an

understandable form. The chapter covers particularly patterns and prospects of

inflow of FDI in Nepal that has been analyzed into year wise and sector wise from

2001 to 2008. This chapter also presents the available facts and reviews related to

foreign direct investment in South Asia and SAARC countries and analysis in

context of Nepal.

4.1 Global Foreign Direct Investment

Both developed and developing countries have been attracting FDI by offering

several incentive packages and concessions to foreign investors. The developing

countries particular have been making extra efforts to create an environment, which

is conducive for attracting such investment. In order to attract FDI on large scale,

governments have taken several steps to remove the barriers and irritants, which

hinder the flow of investment.

The global FDI flow in 1980 was around US $699 billion. IN 2007 it rose to US $

1.833 trillion. Thus, almost a threefold increase has been recorded over a period of

two and half decades. The high growth of global FDI flow can be attributed to

increase to increase merger and acquit ions activity and higher share prices. The

global macroeconomic situation during 2000-2007 also provides a favorable climate

for expansion of FDI. The details of the global FDI are presented in the following

table.

43

Table No 1 Global FDI Inflows

Groups of Economics

FDI Inflows

2005 2006 2007

World 958697 1411018 1833324

Developed economies 611283 940861 1247635

Europe 505473 599327 848527

North America 131740 299466 341494

Other Developed economies -25930 42069 57615

Developing Economies 316444 412990 499747

Africa 29459 45754 52982

Latin American and Caribbean 76412 92945 126266

Asia and Oceania 210572 274291 320498

South, East and South-East Asia 167404 208902 247840

Least Developed Countries 7142 12816 13375

Source: UNCTAD, 2008

The US and Western European countries have continued to dominate as recipient of

world FDI. Among emerging market, China is by far the main recipient of FDI

flows.

The UNCTAD estimates of 2008 indicate the global FDI are expected to decrease

by 10 percent in 2008 owing to the ongoing financial turmoil and consequent

liquidity crunch. The global financial turmoil would impact the growth in merger

and acquisitions (M&A) deals in the coming years. Hence, the global FDI outlook

in the medium term doesn’t seems impressive as fund flow could be affected by the

continued slowdown in growth and difficult market conditions in developed

countries. However, UNCTAD estimates that the FDI flow to developing countries

would remain largely stable.

44

4.2 FDI to SAARC and Southeast Asia

The share of LDCs in the global FDI is very small. In 1980, the share of these

countries in the global FDI was US $ 3 billion. In 2008, this increased to US$ 50

billion. Among the developing countries, countries like China, Egypt, Mexico,

Malaysia, Argentina, Russia, and so on take the higher share. The share of the South

Asian countries is very negligible. The FDI inflow in South Asian countries is given

in the following table.

Table 2 FDI to South Asia and South-East Asia

Region FDI Inflows

2005 2006 2007 South Asia 12136 25780 30620 Afghanistan 273 242 288 Bangladesh 845 793 666 Bhutan 9 6 78 India 7606 19662 22950 Maldives 9 14 15 Nepal 2 -7 6 Pakistan 2201 4273 5333 Sri Lanka 272 480 529 South-East Asia 39091 51243 60514 Brunei 289 434 184 Cambodia 381 483 867 Indonesia 8337 4914 6928 Laos 28 187 324 Malaysia 3967 6048 8403 Philippines 1854 2921 2928 Singapore 13930 24743 24137 Thailand 8048 9010 9575 Viet Nam 2021 2630 6739 China 74406 72715 83521

Source: UNCTAD 2008

Cross regional comparisons indicate that South Asia’s share of total FDI to

developing countries is relatively very small. The share of South Asian countries in

the global FDI was only US $31 billion in 2008. Of this too, India has taken about

45

75 percent. So far India, Pakistan and Sri lanka are the largest percipient of FDI in

South Asia. The other South Asian countries like Nepal, Maldives, and Bhutan have

not been able to attract enough FDI despite several economic reforms and

incentives.

All of the countries in South Asia tried to encourage FDI more aggressively in the

1990s, by making changes in their macroeconomic policies along with FDI and

trade policies. As discussed in chapter 13, most of these countries have liberalized

equity restrictions on FDI in the service sector. One hundred percent equity is

allowed in many service sectors.

Of the limited FDI coming to South Asia, the manufacturing, energy and service

sectors occupy the lion’s share. A relatively small portion of FDI has gone to

export-oriented sectors. These trends toward the globalization of production.

South Asia relies on external resources for its economic development. With the

decline in foreign aid, there is an emphasis on the role of FDI and foreign portfolio

investment as channels of non debt creating flows of external resources. However, a

number of challenges remain. Structural weaknesses, institutional bottlenecks,

political movements, narrow nationalism and mutual mistrust are some of the

factors that explain the failure of the region to exploit possibilities.

4.3 Foreign Direct Investment in Nepal

FDI in developing counties like Nepal seems to be a new terminology and issues.

However, historical records and literature present its long history stating that FDI

isn’t new phenomenon.

Nepal is the poorest of the poor country in the world with the per capita income of

$300 per annum. In this situation, FDI has become a hope to Nepal for economic

46

development. Today, almost all developing countries are trying to attract foreign

direct investment with objectives of getting access to foreign capital, technology and

market. Similarly, Nepal is no different than other countries. Nepal started its effort

to attract foreign investment since early 1980s during the sixth plan (1980-1985).

The industrial policy of 1981 has made a separate provision relating to foreign

investment. In order to make legal provision relating to foreign investment. In order

to make legal provision for a promotion and for the regulation of the foreign

investment and technology a separate act entitled “foreign Investment and

Technology Act 1981 (2038)” has been introduced in 1992. The act was again

reviewed and a new act entitled “Foreign Investment and Technology Transfer Act

(FITTA), 1992. After the policy reform it has been able to attract FDI from abroad

(USA, EU, India, Japan etc) in different sectors.

The rules and regulations given by FITTA amended in 1996 prohibits foreign

investment in certain areas like cottage industries, real estate business, travel and

trekking business agency, poultry farming, fisheries, beekeeping and consultancy

services such as management, accounting, engineering, and legal services. This act

restricts potential competition from foreign competitor.

Although Government of Nepal (GoN) is open to foreign direct investment,

implementation of its policies is often distorted by bureaucratic delays

inefficiencies. Nepal has attracted modest FDI in niche sector such as tourism,

manufacturing (apparel) and mineral deposits (limestone). The investment is mainly

in low technology, labor intensive production. This impact of FDI has also been

modest, primarily in job creation. Foreign affiliates have imparted skills to local

employees, and in a few instances have introduced new export products and

upgraded technology.

Though the inflow of FDI in Nepal started during 1980s but the flow started gaining

momentum from 90s with start of economic policy reform and formulations of new

Industrial Enterprises Act and FITTA at the same period. Nepal observed a steady

47

growth during the initial years of liberalization; however, it is declining during last

couple of years. The most influential factors are policy and political environment for

the growth of the FDI for a particular nation. These are the necessary condition to

attract the inflow of the FDI within the country. The otherwise cases seem to be

ineffective for the fact that incentive and motivations are the prerequisite for the

investors to invest. Generally the trend of FDI should be increasing to achieve and

sustain economic growth.

However, statistics of FDI inflow in developing countries like Nepal is not

appreciable level, expected level impacts. Therefore, it is most critical issue in

aspect of its size and growth and impacts.

4.4 A Pattern Study of FDI in Nepal

Structural analysis is an important method for analyzing the trend of FDI in depth.

An inflow of FDI from 2000 to 2008 has been explained into two groups. They are

year wise and sector wise accordingly

4.4.1 Year Wise FDI Project in Nepal

The table 3 presents no of industries approved for foreign investment from the year

2046 to fiscal year 2064/2064. These data are taken from the “Industrial Statistics”

which is published by the Department of Industries (DoI) each year.

48

Table No. 3 Number of industries approved for foreign investment

Number of industries approved for foreign investment by Fiscal year (up to fiscal year 2064/65 FNM)

Fiscal Year No. of

Industries Total

Project CostTotal fixed

Cost Foreign

Investment Total

Employmentup to Ashad

2046

59 5425.92 4581.82 466.84 105862046/47 30 2438.19 2139.6 398.51 95152047/48 23 863.56 690.74 406.28 29742048/49 38 3508.17 2902.1 597.84 56152049/50 64 17886.22 16210.81 3083.67 138732050/51 38 3733.23 3175.66 1378.76 47342051/52 19 1627.28 1247.85 477.59 23862052/53 47 10047.47 9398.54 2219.86 80322053/54 77 8559.25 6692.15 2395.54 93472054/55 77 5569.38 5142.32 2000.28 43362055/56 50 5324.42 4380.17 1666.42 21462056/57 71 2669.09 1910.24 1417.61 47032057/58 96 7917.62 6122.49 3102.56 68802058/59 77 3318.53 1559.59 1209.65 37312059/60 74 4921.82 3608.25 1793.77 35722060/61 78 4323.74 3775.86 2764.8 21442061/62 64 1801.1 1150.89 1639.52 55762062/63 116 4121.08 3296.95 2606.31 73582063/64 188 3425.57 2650.56 3226.79 73892063/64 FNM 121 2690.21 2123.54 2453.12 53982064/65 FNM 139 16057.59 13664.93 7968.1 6604Total 1423 113211.1 93989.88 40799.68 121484

Source: DoI, 2008

49

Figure No. 1 Number of industries approved for foreign investment

Figure1 depict the trend of number of industries approved for foreign investment,

we can find that there is not the constant trend some time it goes up and some time it

goes down but in average the number of industries is increasing year by year. Nepal

can attract more industries in coming days if it focuses to improve the determining

factors like private property rights, infrastructure, regulation, tax rates, corruption

transparency etc.

50

Figure 2 Number of employment approved for foreign investment

In average no of industries is increasing year by year but the no of employment

people are decreasing. The reasons behind it may be lack of skilled manpower and

brain drain etc. Most of the companies which are invested by the foreign investors,

are hiring foreign workers. In such scenario Nepal has to focus in technical and

practical education, develop the policies to retain skilled and educated manpower to

reduce the rate of brain drain as well as to focus in establishing the stable business

environment.

4.4.2 Sector Wise FDI Project in Nepal

Table Foreign Investment Projects in Nepal- Sector wise from the beginning to (FY

2064/2065 FNM) (Rs in Million)

Table 4 Number of Industries Registered by Categories up to FY 2064/2064

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Categories No of Industries

Total Project Costs

Total Fixed Cost

Total No of Employment

Agro-Based 24 525.85 446.49 1344Construction 35 3026.54 2286.36 2647Energy Based 26 26660.42 24947.36 5477Manufacturing 572 42434.76 30765.34 69426Mineral 5 2436.02 1980.70 1461Service 393 21179.05 17558.97 22170Tourism 368 16948.45 16004.66 18959Total 1423 113211.10 93989.88 121484

Figure 3 Number of Industries Registered by Categories

As we know that Nepal can attract more FDI in agro-Based, energy based and

tourism industries than other sectors but here more investment is invested in

manufacturing and service industries.

Table 5 Number of Industries Registered by Scale

52

Number of Industries Registered by Scale (FY 2064/2065)

Scale No of Industries

Total Project Costs

Total Fixed Cost

Total No of Employment

Large 141 85621.41 75493.92 36232Medium 196 14052.98 10037.37 25859Small 1086 13536.71 8458.58 59393Total 1423 113211.10 93989.88 121484

Figure 4 Number of Industries Registered by Scale

Though Nepal can attract foreign investment in large and medium scale projects,

from the above chart we can identify that most of the foreign direct investment is

belong small industries. The main reason behind this may be the Government of

Nepal is not being able to establish the amicable and stable business environment to

attract foreign investor as well as the foreign investment and technology transfer act

is not clear and suitable to foreign investment.

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4.5 Nepal Goes From Bad to Worse

The Washington DC- based fund for Peace has fired yet another warning shot:

Nepal has slid several points below its Failed State Index (FSI) this year compared

to the previous year.

In its fifth annual FSI released recently, the Washington DC-based research

organization has listed Nepal among the worst 38 countries, ranking it 25th. The

level of statelessness in the 38 countries send “warning” signal, according to fund

for peace. While countries such as Iraq and Kenya are seems to progressive, Nepal’s

positions in the 2009 index (95.4) is deteriorating compared to the 2008 index (94.2)

the study states.

Nepal stands in the category that includes countries like Somalia, Zimbabwe, Sudan,

Iraq, Afghanistan, Pakistan and North Korea, which make up the list of worst

governed countries reeling under conflict, corruption, poverty, impunity, and

statelessness. Countries like Norway, Finland, Sweden, and Switzerland, which

ranked 177th, 176th, 175th and 174th respectively are seen a best governed.

Table 6 Failed State Index (FSI)

Social

2008 2009 Demographic Pressure B. 1 B. 5 Refugees & Displaced Person 5.5 4.8 Group Grievance 9 9.2 Human Flight 6.1 6

Economic

Uneven Development 9.2 9.2 Economy 8.2 8.5 Legitimacy of the State 8.3 9.2 Public Services 7 6.2

Political and Military

Human Rights 8.8 9.1 Security Apparatus 8.5 9 Functionalized Elite 8.3 9 External Intervention 7.2 6.7

Total 94.20 95.40 Source: FSI, 2009

54

The study has attributed Nepal’s worsening condition to social, economic and

political indicators such as weak and ineffective government, external intervention,

economic decline poverty and widening inequality, impunity, deteriorating rule of

law, violation of human rights and corruption.

Most indicators used to gauge Nepal’s status in the 2009 index show deteriorating

governance. For instance, there is no let up in external intervention, which is as high

as it was in 2008. The gap between poor and rich continues to widen to and the

country’s overall economy shows a downward spiral.

4.6 Doing Business in Nepal

Nepal is ranked 121 out of 181 economies. Singapore is the top ranked economy in

the Ease of Doing Business

Table 7 Nepal's Ranking in Doing Business 2009

Rank Doing Business 2009 Ease of Doing Business 121 Starting a Business 73 Dealing with Construction Permits 129 Employing Workers 150 Registering Property 28 Getting Credit 109 Protecting Investors 70 Paying Taxes 107 Trading Across Borders 157 Enforcing Contracts 121 Closing a Business 103

Source: “Doing Business 2009”, World Bank.

55

4.6.1 Summary of Indicators – Nepal

Table 8 Summary of Indicator of Nepal's Ranking in Doing Business 2009

Summary of Indicator

Starting a Business

Procedures (number) 7Duration (days) 31Cost (% GNI per capita) 60.2Paid in Min. Capital (% of GNI per capita) 0

Dealing with construction Permit

Procedures (number) 15Duration (days) 424Cost (% of income per capita) 248.4

Employing Workers

Difficulty of Hiring Index 56Rigidity of Hours Index 0Difficulty of Firing Index 70Rigidity of Employment Index 42Firing costs (weeks of salary) 90

Register Property

Procedures (number) 3Duration (days) 5Cost (% of property value) 6.3

Getting Credit

Legal Rights Index 5Credit Information Index 2Public registry coverage (% adults) 0Private bureau coverage (% adults) 0.2

Protecting Investor

Disclosure Index 6Director Liability Index 1Shareholder Suits Index 9Investor Protection Index 5.3

Paying Taxes

Payments (number) 34Time (hours) 408Profit tax (%) 20.3Labor tax and contributions (%) 11.3Other taxes (%) 2.5Total tax rate (% profit) 34.1

Trading Across Border

Documents for export (number) 9Time for export (days) 41Cost to export (US$ per container) 1764Documents for import (number) 10Time for import (days) 35Cost to import (US$ per container) 1900

Enforcing Contracts

Procedures (number) 39Duration (days) 735Cost (% of claim) 26.8

56

Closing a Business

Time (years) 5Cost (% of estate) 9Recovery rate (cents on the dollar) 24.5

Source: “Doing Business 2009”, World Bank

Starting a Business

Nepal is ranked 73 overall for Starting a Business. When entrepreneurs draw up a

business plan and try to get under way, the first hurdles they face are the procedures

required to incorporate and register the new firm before they can legally operate.

Economies differ greatly in how they regulate the entry of new businesses. In some

the process is straightforward and affordable. In others the procedures are so

burdensome that entrepreneurs may have to bribe officials to speed the process or

may decide to run their business informally.

Dealing with Construction permit

Nepal is ranked 129 overall for Dealing with Construction Permits.

Once entrepreneurs have registered a business, what regulations do they face in

operating it? To measure such regulation, Doing Business focuses on the

construction sector. Construction companies are under constant pressure; from

government to comply with inspections and with licensing and safety regulations

and from customers to be quick and cost-effective. These conflicting pressures point

to the tradeoff in building regulation; the tradeoff between protecting people

(construction workers, tenants, passersby) and keeping the cost of building

affordable. Striking the right balance is a challenge when it comes to construction

regulations. Good regulations ensure safety standards that protect the public while

making the permitting process efficient, transparent and affordable for both building

authorities and the private professionals who use it. If procedures are overly

complicated or costly, builders build without a permit, leading to hazardous

construction.

57

Employee Working

Nepal is ranked 150 overall for Employing Workers. Economies worldwide have

established a system of laws and institutions intended to protect workers and

guarantee a minimum standard of living for its population. This system generally

encompasses four bodies of law: employment, industrial relations, social security

and occupational health and safety laws. Doing Business examines government

regulation in the area of employment.

Registering Property

Nepal is ranked 28 overall for Registering Property. Formal property titles help

promote the transfer of land, encourage investment and give entrepreneurs access to

formal credit markets. But a large share of property in developing economies is not

formally registered. Informal titles cannot be used as security in obtaining loans,

which limits financing opportunities for businesses. Many governments have

recognized this and started extensive property titling programs. But bringing assets

into the formal sector is only part of the story. The more difficult and costly it is to

formally transfer property, the greater the chances that formalized titles will quickly

become informal again. Eliminating unnecessary obstacles to registering and

transferring property is therefore important for economic development.

Getting Credit

Nepal is ranked 109 overall for Getting Credit. Firms consistently rate access to

credit as among the greatest barriers to their operation and growth. Doing Business

constructs two sets of indicators of how well credit markets function: one on credit

registries and the other on legal rights of borrowers and lenders. Credit registries,

institutions that collect and distribute credit information on borrowers, can greatly

expand access to credit. By sharing credit information, they help lenders assess risk

and allocate credit more efficiently. And they free entrepreneurs from having to rely

58

on personal connections alone when trying to obtain credit. Three indicators are

constructed to measure the sharing of credit information:

Protecting Investor Nepal is ranked 70 overall for Protecting Investors Companies grow by raising

capital, either through a bank loan or by attracting equity investors. Selling shares

allows companies to expand without the need to provide collateral and repay bank

loans. But investors worry about their money, and look for laws that protect them. A

study finds that the presence of legal and regulatory protections for investors

explains up to 73% of the decision to invest. In contrast, company characteristics

explain only between 4% and 22%. Good protections for minority shareholders are

associated with larger and more active stock markets. Thus both governments and

businesses have an interest in reforms strengthening investor protections. To

document some of the protections investors have, Doing Business measures how

economies regulate a standard case of self-dealing, use of corporate assets for

personal gain.

Paying Taxes

Nepal is ranked 107 overall for Paying Taxes. Taxes are essential. Without them

there would be no money to provide public amenities, infrastructure and services

which are crucial for a properly functioning economy. But particularly for small and

medium size companies, they may opt out and choose to operate in the informal

sector. One way to enhance tax compliance is to ease and simplify the process of

paying taxes for such businesses.

Trading Across Border Nepal is ranked 157 overall for trading across borders. The benefits of trade are well

documented; as are the obstacles to trade. Tariffs, quotas and distance from large

59

markets greatly increase the cost of goods or prevent trading altogether. But with

bigger ships and faster planes, the world is shrinking. Global and regional trade

agreements have reduced trade barriers. Yet Africa’s share of global trade is smaller

today than it was 25 years ago. So is the Middle East’s, excluding oil exports. Many

entrepreneurs face numerous hurdles to exporting or importing goods, including

delays at the border. They often give up. Others never try. In fact, the potential gains

from trade facilitation may be greater than those arising from only tariff reductions.

Enforcing Contract

Nepal is ranked 121 overall for Enforcing Contracts. Where contract enforcement is

efficient, businesses are more likely to engage with new borrowers or customers.

Doing Business tracks the efficiency of the judicial system in resolving a

commercial dispute, following the step-by-step evolution of a commercial sale

dispute before local courts. The data is collected through study of the codes of civil

procedure and other court regulations as well as through surveys completed by local

litigation lawyers (and, in a quarter of the countries, by judges as well).

Closing Business

Nepal is ranked 103 overall for closing a Business. The Doing Business indicators

identify weaknesses in the bankruptcy law as well as the main procedural and

administrative bottlenecks in the bankruptcy process. In many developing countries

bankruptcy is so inefficient that the parties hardly ever use it. In countries such as

these, reform would best focus on improving contract enforcement outside

bankruptcy.

The data on closing a business are developed using a standard set of case

assumptions to track a company going through the step-by-step procedures of the

bankruptcy process. It is assumed that the company is a domestically owned, limited

liability corporation operating a hotel in the country’s most populous city. The

company has 201 employees, 1 main secured creditor and 50 unsecured creditors.

60

Assumptions are also made about the debt structure and future cash flows. The case

is designed so that the company has a higher value as a going concern—that is, the

efficient outcome is either reorganization or sale as a going concern, not piecemeal

liquidation. The data are derived from questionnaires answered by attorneys at

private law firms.

To sum up from this chapter, the data on regional and Nepal’s foreign direct

investment trends starkly reveal that Nepal, so far, doesn’t figure on the global map.

Nepal has not even met the necessary preconditions for FDI and has a long way to

go to make the environment investor friendly. It is therefore imperative that Nepal

creates the necessary preconditions for an FDI framework. The most important and

necessary precondition is to create “stability in the business environment”, an

investment climate. With stability in the environment other condition must follow.

They are: political stability, policy stability price level stability, foreign exchange

stability and a dispute settlement regime that is stable and transparent.

Above all, it is still important for the low income developing countries like Nepal to

focus more on policy factors. These will include factors. These will include factors

that could integrate them into the global trading system, fiscal and non-fiscal

incentives, and improvement of infrastructure, human resources development, the

creation and nurturing of local entrepreneurship. All of these will have to be

creating consistent with the entrenchment of suitable political and legal framework

and such other conditions for productive investment and private sector participation

in order to set the stage for the process of growth and development.

Only when these necessary and sufficient preconditions are in place, Nepal would

be in a position to attract private capital flow and foreign direct investment.

61

CHAPTER V SUMMARY AND CONCLUSIONS

The final chapter focuses on the proceeding of the earlier chapter. In this chapter the

researcher is going to answer the research questions and get conclusions based on

the theory and analyzed the data. Major findings are illustrated which followed by

the conclusion and recommendations based on the findings and experiences of the

researcher.

5.1 Summary of Findings

The above chapter i.e. data presentation and analysis indicates that the Nepal has yet

to appear in the global FDI map. It has not been able to meet the necessary

minimum preconditions for FDI. Nepal has a long way to go to make the

environment investor friendly. A developed stock exchange, full convertibility of

foreign exchange or free mobility of capital and easy repatriation of profits and

deregulations are some of the preconditions for FDI. These preconditions are yet to

be fully achieved in Nepal.

At the same time, political instability and social and political disturbances have

affected the joint venture projects already operating in Nepal. Some of such

undertakings have been withdrawing their capital. For instance, the French

shareholders have withdrawn their capital from the Nepal Indosuez Bank. Similarly,

the Kodak Company and Colgate- Palmolive have closed down their factories at

Hetauda. Many of Indian business executives running garments and carpet factories

in Nepal has also closed down their operations. These recent developments

appearing in the Nepalese business scenario have been a big set back to the ongoing

efforts of the government to attract foreign investment.

The major findings of this study are as follows:

62

1. The country at present lacks any long terms vision with internal security

emerging as major issues.

2. The local investors have to be encouraged and foreign participation needs to

be increased with the provision of adequate incentives for income tax

holidays, repatriation of investment, and if possible, constitutional guarantee

for private property rights.

3. Foreign aid has to be replaced by foreign investment, especially in export

promoting high technology industries.

4. Security and Maoist insurgency was not only the reason for the declining

trend for foreign investment in Nepal.

5. Failure of the government mechanisms for improving degree of

effectiveness in FDI utilization.

6. Natural and domestic resources should be utilized at maximum.

7. Following the global trend and trying to implement them in context of Nepal

is not going to work, as Nepal presents a different economic scenario and

investment environment.

8. Foreign investment in Nepal has developed a wrong perspective among the

people that is dependency and long term it is very dangerous for the growth

and sustainability of the country.

9. There should be division of areas so that there arise no bottleneck for being

landlocked country.

10. Furthermore, the results indicate that most of the causal links are found in

developing countries which experience a higher level of corruption in the

form of excessive patronage, nepotism, job reservations, “favor-for-favors”,

secret party funding, and suspiciously close ties between politics and

business

11. The policy makers, academicians, and politician should face the present

reality of Nepal and do in depths study. PEST analysis to attract and restore

Foreign Investment in the country rather than make only superficial study.

63

Therefore, the main reasons for the poor inflow of FDI to Nepal are unstable

government policies, bureaucratic hurdles, political uncertainties, weak financial

sector and unsupportive investment environment.

5.2 Conclusions

The review of global, regional and Nepal’s FDI and trade reveals clear patterns and

trends. The global environment of FDI and trade suggests a conducive environment

if competitive one. The tremendous growth in the global FDI and trade as revealed

by the data is testimony to this. On the one hand the trend and patterns for Nepal is

erratic, negative and declining, which is contrary to and reverse of the global trends

and patterns. This appears to suggest that the world economy is moving in one

direction and Nepal in other. The reasons are not hard to differentiate. For private

capital flows and FDI, Nepal has yet to create minimum and necessary

preconditions that would attract private capital flows and FDI. To reverse this

balance of trade gap, Nepal must create products and explore niches that have

competitive advantage in the regional and global market. Failure to do so will lead

to further marginalization in a competitive global economy of the 21st century.

Instead of share of the pie of the global prosperity, Nepal may find itself bottom of

the marsh of poverty.

When the research was started, the reason behind declining in FDI was assumed

only the political instability. But after the research, I have found so many reasons as

constraints for FDI inflow in Nepal. As we know political instability is becoming

one of the major constraints to attract FDI in Nepal. And in other hand there are

other so many bureaucratic hurdles which are also becoming one of the major

constraints. Another major problem Nepal is facing is geographical constraint by it

many multinational corporations think it as another hurdle. We know that

transparency and corruption less state can attract foreign investment. Because it

reduces the costs for MNCs but in Nepal it is also becoming a constraint to attract

64

FDI. A good financial system can also play a vital role to establish amicable

environment to attract FDI but in case of Nepal the financial system is not favorable

to MNCs. The cost of financing from Nepalese financial system is higher than other

countries. Another major determining factor to inflow of FDI is Labor laws and

policies where the labor laws are liberal and stable there FDI and MNCs want to go.

Nepal is the one where labor laws are not clear and labor unions are influenced by

the political parties.

While talking about the prospects of FDI in Nepal, It is clear that in a such

transitional and volatile period no bilateral and multilateral projects will come to

Nepal. As we know Nepal is ranked in the poorest index according to “Doing

Business 2009”, World Bank. These indexes are based on 180 countries and Nepal

is ranked as that. In such scenario there is the probability of no more FDI in future.

The government has now constituted the board of investment under the

chairmanship of the Prime Minister. The purpose of this body is to create a amicable

environment in the country including policy and legal reforms for domestic as well

as foreign investment. The safety of investment would also be the prime concern of

this body. The government has also announced that a Monitoring Unit would be

created in the office of the Prime Minister to supervise and monitor the investment

climate in the country.

• The government has announced FITTA, 1992 to attract foreign investment.

The act is not clear on the definition of foreign investment and technology

transfers. It has yet to modify foreign exchange regulations and tax policies.

• Recent political disturbances have even threatened bilateral and multilateral

development projects. With growing political instability, the government has

failed to control it. The disturbances have instead spread throughout the

country. This is a serious problem in attracting FDI

• Social tension and unrest are likely to grow due to rising unemployment

among youths. Market flourishes when there is a peace, not in the midst of

65

war and unrest. Nepalese economy has vast potential to grow. It needs

foreign capital, which in the presence of political instability and social unrest

would shy away.

• The recent approval of the Indian government to allow its citizens to invest

up to IC 600 million in Nepal, without prior approval, has opened new

opportunities for foreign investment areas are yet to be explored.

• There is lack of proper monitoring and supervision of the registered foreign

projects. Most of such projects exist only in name. They have not yet started

their project construction and operations.

• As there is no strict rule to register only foreign companies, any individual

can apply and get registration of the projects in Nepal. Such projects are

never started; the purpose of the individuals is simply to get their stay

extended in Nepal.

5.3 Recommendations

With the limitation of time and resources, this research could not explore the in

depth study of FDI in Nepal. It is seen that most of the scholar and policy makers of

the Nepal follow the global trend and try to implement in Nepal, which is not going

to work. It is found that generally superficial study is done so there is room for in

depth study to attract and restore foreign investment.

Nepal is very viable place for FDI in terms of natural resources and environment. If

we want we can attract more FDI in Nepal, first we must take initiation to establish

the stable political environment, we should focus on good governance as we know

that good governance can establish so many stable variable which helps to inward

FDI. Similarly Nepal is also lacking a smooth financial system. A good financial

system can also help to attract FDI. In Nepal the cost of financing is higher than

other similar countries. It should be taken under consideration. Another important

factor is that our bureaucratic system. As the report published by World Bank i.e.

66

“Doing Business 2009” expressed that it is so tough to establish and run the

business in Nepal in such scenario no investors want to invest and run the business

in Nepal. In one hand we have political instability and in other hand our labor

unions are controlled by the political parties. Though labor unions have to work on

behalf of welfare of labors and to establish the amicable environment to operate the

business, are fighting for the muscle and money and due to this so many

corporations have already closed down. Now we should focus on these factors and

try to make these factors better. Then it is sure that we can be in the countable

position in terms and FDI and economic growth rate.

We should bear in mind that not all types of foreign investment contribute to income

and employment generation. The government should selective about FDI; the

government should not discriminate against domestic investors. The industries using

FDI should also be evaluated in terms of their potential to create employment,

promote exports, transfer technology and encourage human development friendly

activities. The industries having market prospects in India and other SAARC

countries have to be promoted. The extended South Asian Market after the

implementation of SAFTA need to be kept in consideration in providing public

support to new industries.

Only when the above mentioned necessary recommendations are improved by the

Nepal Government, Nepal would be in position to attract more private capital fund

and foreign direct investment.

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