Ramesh Chitrakar evaluates FDI policy and investment environment in Nepal in a new ADB report (see chapter 7). The report is about intra-regional trade and investment in South Asia. Sadly, most of the chapters include South Asia as India, Pakistan, Sri Lanka, and Bangladesh (where did Nepal, Bhutan, Maldives and Afghanistan go?). It would have been really helpful if Nepal was also included in the chapter on textiles and clothing, which was Nepal's top export before 2005. The chapter dealing with Nepal has nothing new in terms of information but it is a nice aggregation of all the stuff that has been said about investment climate in Nepal in the past three years.
Here are some points from the report:
-Nepal's landlocked location, technological backwardness, and internal political conflicts have prevented it from fully developing its economy.
-To increase FDI, the government has introduced a "one-window" policy but it has not worked as there are too many procedures.
-Reducing savings-investment gap is one of the challenges of the government in terms of maintaining sound fiscal health.
-Nepal's major trading partner is India (around 62% of total trade took place with India)
-Nepal's export to SAARC as a share of its total exports ranged from 53.9% in FY2003 to 72.5% in FY2007, and of this India's share ranged from 97.5% to 98.4%.
-After India, Nepal's largest export partners during FY2003-FY2007 were the US, Germany, UK, France, Italy, Canada, Japan, Bangladesh, and Spain.
-Imports from SAARC ranged from 53.9% to 67% as a share of total imports during FY2003-FY2007.
-Major countries from where Nepal imports are India, PRC, Indonesia, Singapore, US, UAE, Thailand, Japan, Malaysia, and Saudi Arabia.
-Nepal needs to diversify trade inside and outside SAARC, which is clearly its main market.
-It needs to sort out differences in trade agreements with India-- problems in sanitary and phytosanitary requirements; complex quarantine rules on agricultural products; uneven implementation and interpretation of trade treaty's measures by state governments in India; disagreements on customs clearance procedures for cross-border rail operations (Banlabandh Marg is of little use) [some of these issues have been addressed in a recently signed trade treaty between India and Nepal but some issues on CVD remain)
-To integrate fully in the WTO system, Nepal has to address its domestic and border regulatory constraints (red tape, public service delays, labor laws, and industrial relations)
-Textile and carpet sector has been hit hard by the end of MFA.
-Nepal's proximity to the PRC and India offers opportunities for trade.
Lack of competitiveness arises from geography, policy, and institutions; low productivity and poor business climate due to government instability, inefficient government bureaucracy, corruption, and inadequate supply of infrastructure; high transportation and energy costs, rigid and formal labor market, poor work ethic of the labor force, poor industrial relations, domestic conflict...
-limited backward linkages and unable to keep up with technological developments
Infrastructure: by mid-March 2007, total road length reached 17609 kms, of which 5222 kms were metaled, 4738 kms graveled, and 7649 kms fair-weather roads; 47 airports, with four under construction; costly and unreliable infrastructure, high transportation and transaction costs
Resource endowments: water and hydropower high potential; forest covers 42.4% of landmass and provides 79% of total energy consumption and more than 90% rural household energy needs; labor force is about 1.1 million but skilled labor force lacking with serious brain drain problem, low labor costs...
RTAs: SAFTA is expected to be beneficial as it offers a huge market access; it covers more than 4000 items, most of which are nontradable; need to bring services under SAFTA; Nepal has a special agreement with the PRC for reduced tariffs no trade with Tibet; member of BIMSTEC, which is expected to be finalized by 2017; has preferential access to the EU under the Everything But Arms initiative; not much hope from the WTO…
FDI: first concerted effort to attract FDI came in 1987 with the passage of the Industrial Policy and Industrial Enterprise Act; joint ventures but telecommunications, hydropower, and air transportation were not opened up; in 1992 it introduced the Foreign Investment and Technology Transfer Act and established Investment Promotion Board; then came the one-window policy act; double taxation agreements were signed with India, PRC, Austria, Korea, Mauritius, Pakistan, Sri Lanka, Norway and Thailand with more coming; investment protection agreements with France, Germany, and the UK.
-the flow of FDI has been pretty dismal; flowed mainly in tourism sector and manufacturing
-57 countries had made investments in Nepal by mid-November 2007, of which 39.3% of investments in terms of project costs, 36.4% in terms of total fixed costs, and 44.5% in terms of total FDI were made by SAARC countries (mainly from India).
-some firms closed due to hostile labor relations and unstable political environment with poor regulatory structure
-lately the government has opened up all sectors to FDI except for defense, cigarettes, bidi (a small hand-rolled, often flavored, cigarette), and alcohol
-100% repatriation of equity invested, dividends obtained from foreign investments, and amount received as payment are allowed
-No legal impediments in registering mortgages or repossessions... but, some of the incentives offered in 1992 are being rolled back like reinvestment allowance in the form of deductions from taxable income of up to 40% of investment in expansion or modernization (withdrawn in 2002) and corporate tax rebate of 10% for high local content was removed.
-Priority sectors include services, medicinal herbs, vegetable and flowering seeds production, honey production, hydropower, petroleum exploration, and natural gas exploration
-Business unfriendly legislations: the Labor and Trade Union Act enacted recently permits strikes and requires unions to be affiliated with political parties [it was a disaster decision!]; Bonus Act requires that workers get 10% of yearly profits as bonus regardless of improvements in productivity; Electricity Act has limited bonuses of workers to 2% of yearly profits in the hydropower sector; industrial strikes by labor unions are a major constraint; 50% of the manufacturing workforce is composed of casual workers, who earn the same wage as permanent workers, but who have less job security and fewer fringe benefits.
-Customs and transshipment delays can account for as much as 55% of the logistics costs of sending certain types of goods from Kathmandu to Kolkata, instead of 25% on average for other international routes; it also delays travel time by about 3 to 8 days
-SEZs projects were initiated in 2003 to attract FDI and achieve high economic growth; SEZs at various stages-- Bhairahawa EPZ (under construction); Birgunj, Panchkhal, and Nuwakot SEZs (pre-feasibility studies carried out); clothing processing zone to be established in Simara; studies for more SEZs in Nepalgunj, Kailali, and Kanchanpur.
-Bilateral investment treaties agreements with France (1983), Germany (1986), the UK (1993), Mauritius (1999); no such agreements with India, the US, and PRC; investment agreements in the pipeline with India, Belarus, Qatar, Russia, Sri Lanka, and Thailand; SAFTA and BIMSTEC offer opportunities; double taxation agreements and prevention of fiscal evasion with several countries
-In 2007, total employment provided by approved FDI projects exceeded 180,000 with manufacturing other than textile and clothing accounting for around 35% of this total, followed by T&C with around 20%, and tourism with 9%; No domestic firms have been displaced by foreign manufacturing, tourism, or financial firms.
Constraints: small domestic market and infrastructural problems due to geography (landlocked and mountainous); low labor productivity leading to higher production costs; delays at customs and transshipment to India's Kolkota port; high costs of transport and power; a rigid and formal labor market; lack of labor-employer cooperation; weak policy and institutions in the areas of taxation, investment, and trade promotion; conflict; poor work ethic of the labor force, corruption; weak trade facilitation
FDI potential: access to markets in India and China, India has guaranteed duty-free access to most Nepalese manufactures and an agreement is due with China to designate Nepal as a tourist destination; abundance of natural resources (agriculture sector has high potential; has five climate zones); low tariff rates and a liberal foreign exchange regime and accessibility of the bureaucracy; potential sub-sectors: agriculture, and agro-based industries, flowers and flowering plants, Pashmina (third-largest export item with a share of 10.4% of overseas exports in FY2007), tourism, health and health education, IT, freight forwarding, nursing homes, construction; could piggyback on $10 billion software export industry of India.