Write up on FDI in Nepal

FOREIGN DIRECT INVESTMENT

CONCEPTS: Foreign Direct Investment (FDI) is direct investment by a company in production located in another country either by buying a company in the country or by expanding operations of an existing business in the country. Investors are granted management and voting rights if the level of ownership is greater than or equal to 10% of ordinary shares. Shares ownership amounting to less that the stated amount is termed portfolio investment and is not categorized as FDI. FDI does not include foreign investments in stock markets. Instead, FDI refers more specifically to the investment of foreign assets into domestic goods and services. When a firm controls (or have a strong say in) another firm located abroad, e.g. by owing more than 10% of its equity, the former is said "parent enterprise" (or "investor") and the latter "foreign affiliate". Foreign Direct Investment (FDI) is the financial investment giving rise and sustaining over time the investor's significant degree of influence on the management of the affiliate. The initial investment can be the purchase of an existing firm (by acquisition or by merger, the so-called "M&A") as well as the foundation of a new legal entity who usually - but not necessarily - makes a green-field real investment (e.g. building a factory) in the foreign country. In a broader definition, FDI consists of the acquisition or creation of assets (e.g. firm equity, land, houses, oil-drilling rigs...) undertaken by foreigners. If in these enterprises, they are not alone but act together with local firms and/or governments, one talk of "joint ventures". Since it is through FDI that a firm becomes a multinational, one could say that, it is the FDI process, which generates MNC (multinational companies). The reverse is also true: firms that are already multinational generate the majority of FDI flows. Composition of FDI: The components of FDI are equity capital, reinvested earnings and other capital (mainly intracompany loans) Equity capital, the foreign direct investors purchase of share of an enterprise in a country other than its own. reinvested earnings, the investor's share of earning not distributed as dividends by affiliates, in proportion to its share in the equity (say for instance 50% in a certain joint venture);
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Write up on FDI in Nepal

intra-company loans, when the investor borrows funds to the affiliate, usually without the intention of asking the money back. To better understand their defining characteristics, consider that FDI are flows of capital that share the following features: they are long-term (in contrast to portfolio investment in bonds and in short-term speculation in shares); they give rise to a property right on the asset built or bought (in contrast to foreign aid). Determinants of FDI The determinants of FDI include the following. Size of the Market: Large developing countries provide substantial markets where the consumers demand for certain goods far exceed the available supplies. This demand potential is a big draw for many foreign-owned enterprises. In many cases, the establishment of a low cost marketing operation represents the first step by a multinational into the market of the country. This establishes a presence in the market and provides important insights into the ways of doing business and possible opportunities in the country. Political stability: In many countries, the institutions of government are still evolving and there are unsettled political questions. Companies are unwilling to contribute large amounts of capital into an environment where some of the basics political questions have not yet been resolved. Macro-economic Environment: Instability in the level of prices and exchange rate enhance the level of uncertainty, making business planning difficult. This increases the perceived risk of making investments and therefore adversely affects the inflow of FDI. Legal and Regulatory Framework: The transition to a market economy entails the establishment of a legal and regulatory framework that is compatible with private sector activities and the operation of foreign owned companies. The relevant areas in this field include protection of property rights, ability to repatriate profits, and a free market for currency exchange. It is important that these rules and their administrative procedures are transparent and easily comprehensive.
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Write up on FDI in Nepal

Access to Basic Inputs: Many developing countries have large reserves of skilled and semiskilled workers that available for employment at wages significantly lower than in developed countries. This provides an opportunity for foreign firms to make investments in these countries to cater to the export market. Availability of natural resources such as oil and gas, minerals and forestry products also determine the extent of FDI. The determinants of FDI differ among countries and across economic sectors. These factors include the policy framework, economic determinants and the extent of business facilitation such as macro-economic fundamentals and availability of infrastructure. Advantages of FDI Foreign Direct Investment has the following potential benefits for less developed countries. a. Raising the Level of Investment: Foreign investment can fill the gap between desired investment and locally mobilized savings. Local capital markets are often not well developed. Thus, they cannot meet the capital requirements for large investment projects. Besides, access to the hard currency needed to purchase investment goods not available locally can be difficult. FDI solves both these problems at once as it is a direct source of external capital. It can fill the gap between desired foreign exchange requirements and those derived from net export earnings. b. Up gradation of Technology: Foreign investment brings with it technological knowledge while transferring machinery and equipment to developing countries. Production units in developing countries use out-dated equipment and techniques that can reduce the productivity of workers and lead to the production of goods of a lower standard. c. Improvement in Export Competitiveness: FDI can help the host country improve its export performance. By raising the level of efficiency and the standards of product quality, FDI makes a positive impact on the host countrys export competitiveness. Further, because of the international linkages of MNCs, FDI provides to the host country better access to foreign markets. Enhanced export possibility contributes to the growth of the host economies by relaxing demand side constraints on growth. This is important for those countries which have a small domestic market and must increase exports vigorously to maintain their tempo of economic growth. d. Employment Generation: Foreign investment can create employment in the modern sectors of developing countries. Recipients of FDI gain training of employees in the course of operating new enterprises, which contributes to human capital formation in the host country.

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Write up on FDI in Nepal

e. Benefits to Consumers: Consumers in developing countries stand to gain from FDI through new products, and improved quality of goods at competitive prices. f. Resilience Factor: FDI has proved to be resilient during financial crisis. For instance, in East Asian countries such investment was remarkably stable during the global financial crisis of 1997-98. In sharp contrast, other forms of private capital flows like portfolio equity and debt flows were subject to large reversals during the same crisis. Similar observations have been made in Latin America in the 1980s and in Mexico in 199495. FDI is considered less prone to crises because direct investors typically have a longer-term perspective when engaging in a host country. In addition to risk sharing properties of FDI, it is widely believed that FDI provides a stronger stimulus to economic growth in the host countries than other types of capital inflows. FDI is more than just capital, as it offers access to internationally available technologies and management know-how. g. Revenue to Government: Profits generated by FDI contribute to corporate tax revenues in the host country. Disadvantages of Foreign Direct Investment FDI is not an unmixed blessing. Governments in developing countries have to be very careful while deciding the magnitude, pattern and conditions of private foreign investment. Possible adverse implications of foreign investment are the following: 1. When foreign investment is competitive with home investment, profits in domestic industries fall, leading to fall in domestic savings. 2. Contribution of foreign firms to public revenue through corporate taxes is comparatively less because of liberal tax concessions, investment allowances, disguised public subsidies and tariff protection provided by the host government. 3. Foreign firms reinforce dualistic socio-economic structure and increase income inequalities. They create a small number of highly paid modern sector executives. They divert resources away from priority sectors to the manufacture of sophisticated products for the consumption of the local elite. As they are located in urban areas, they create imbalances between rural and urban opportunities, accelerating flow of rural population to urban areas. 4. Foreign firms stimulate inappropriate consumption patterns through excessive advertising and monopolistic market power. The products made by multinationals for
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Write up on FDI in Nepal

the domestic market are not necessarily low in price and high in quality. Their technology is generally capital-intensive which does not suit the needs of a laboursurplus economy. 5. Foreign firms able to extract sizeable economic and political concessions from competing governments of developing countries. Consequently, private profits of these companies may exceed social benefits. 6. Continual outflow of profits is too large in many cases, putting pressure on foreign exchange reserves. Foreign investors are very particular about profit repatriation facilities. 7. Foreign firms may influence political decisions in developing countries. In view of their large size and power, national sovereignty and control over economic policies may be jeopardized. In extreme cases, foreign firms may bribe public officials at the highest levels to secure undue favours. Similarly, they may contribute to friendly political parties and subvert the political process of the host country. Key question, therefore, is how countries can minimize possible negative effects and maximize positive effects of FDI through appropriate policies.

FDI in Nepal Nepal has opened foreign direct investment as a part of liberalization from the early 90s. It is believed that foreign direct investment is a supplement to the domestic private investment through foreign capital inflow, transfer of technology, enhancement of managerial skills, productivity and to get into the global market. Government of Nepal has begun carrying out policy and regulatory changes in industry, trade, finance and the Stock Exchange beginning in 1992 in order to promote foreign investment and technology transfer in the country. Single door policy has been carried out to simplify the process of granting necessary approval and providing services to the foreign investment through a single place. Although Nepal is the most liberalized country in South Asia, and adopting various policies to attract the FDI, Nepal become one of the least FDI attracting country among developing countries. 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%( as per ministry of industry 2009/2010). Lack of infrastructure for industrialization, international security problem, landlockness and high transportation cost are the main reasons behind it.

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Write up on FDI in Nepal

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% of approved FDI projects. Within the manufacturing sector, the textile and garment industry accounts for 28% of total foreign investment, followed by the chemical and plastic industries at 25.3%. Tourism is second, accounting for almost 25% of total FDI projects, followed by the service sector with 20% 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( as per
ministry of industry).

Table 1 show the trend of FDI in Nepal, FDI inflows to Nepal was NRS. 398.51 million in 1990. It then decreased to almost NRS.477.59 million up until 1995. In 1996, FDI inflows was NRS. 2219.86 million and fluctuated quite a bit until 2000, in 2001 it rose to NRS. 3102.56 million. It decreased until 2007, in 2008 it was about NRS.6245 million. However it was NRS. 9100 million in the year 2009/2010. And FDI inflow for 2010/11 was about NRS. 10050.72 million. TABLE 1: THE FDI INFLOW IN NEPAL 1989-2011, (NRS.IN MILLIONS)
FISCAL YEAR 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01
2395.54

FDI INFLOWS 398.51 406.28 597.84 3083.67 1378.76 477.59

FISCAL YEAR 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11

FDI INFLOW 1209.65 1793.77 2764.8 1639.52 2606.31 2453.12 9811 6245 9100 10050.72

2000.28
1666.42

1417.61 3102.56

SOURCE MINISTRY OF INDUSTRY, NEPAL

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Write up on FDI in Nepal

FDI inflow
12000 10000 NRS IN MILLION 8000 6000 4000 2000 0 FDI inflow, 10050.72

FIGURE:1 TREND OF FDI INFLOW IN NEPAL

Prospects of FDI in Nepal The ongoing peace process in the country is already having great implications for FDI. almost all potential sides of FDI have improved in the year 2006 and afterwards. The number of projects, committed total cost, committed fixed cost, size of foreign investment and employment opportunities all grew. These vividly signal that the prospects for FDI in the country is getting more and more optimistic day-by-day as the peace process is gradually consolidated. By this, one assumption seems to be pretty valid that once the peace process concludes, FDI will bring in multiple positive implications. Thus, the ongoing peace process and prospects for FDI are interlinked. Nepals economy was badly crippled during the last decade; however, a big opportunity is awaiting the country at its doorstep. Despite the limited size of its domestic market, two giant markets of the world, i.e. India and China, are just within the arms reach for its surging volume of trade. To access these markets, because of the proximity, the transaction cost for goods and services is lower for Nepal than for other countries. Besides, Nepal being an LDC, Nepalese goods and services are granted 0 tariff market access in those markets. With the advantage of this General System of Preferences facility, Nepalese goods and services enjoy better cost competitiveness. It is an obvious hypothesis that lower cost means higher trade prospects.

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Write up on FDI in Nepal

One recent phenomenon is that, currently, business and investment are gradually shifting to eastern and southern countries from western and northern countries. The northern countries represent developed and the southern countries represent developing as well as LDC group of countries like Nepal. Part of the reason for this shift is the lower labour cost in the southern countries vis--vis that in the northern countries where it has been on rise due to the hit syndrome appearing in their economies. Besides, the chance of investment from China and India to Nepal seems to be encouraging in the years ahead. By these virtues, Nepal could greatly entice FDI in the forthcoming times. As the classical economist David Ricardo (1772-1823) propounds in his Law of Comparative Advantages, every country has to look at its own prime advantages. Ricardo states 'there is mutual benefit from trade (or exchange) even if one party (e.g. resourcerich country, highly skilled artisan) is more productive in every possible area than its trading counterpart (e.g. resource-poor country, unskilled labour), as long as each concentrates on the activities where it has a relative productivity advantage' (Wikipedia). While applying the law in the Nepalese case, natural endowment is one such example where the country is blessed with many advantages. As Nepal Trade Integration Strategy (NTIS) 2010 has concisely identified, the country enjoys comparative advantage in relation to other countries in nineteen areas. This list includes cardamom, ginger, honey, lentils, tea, noodles, medicinal herbs/essential oils from agro-food category. Similarly, handmade paper, silver jewellery, iron and still, pashmina and wool products are included from craft and industrial goods category. Likewise, tourism, labour services, IT and BPO services, health services, education, engineering, hydro-electricity are selected from services sector. Finally, transit trade services between Tibet and India, sugar, cement, dairy products and transformers are other potential export sectors. In these sectors, Nepal could excel provided the suggested matrix of the NTIS . FDI could thus be easily attracted to invest in these sectors since they are saleable in destination markets. In terms of policy, Nepal has been a liberal economy. Accession to the World Trade Organization (WTO) in 2004, membership of the Bay of Bengal Initiative for Multi- Sectoral Technical and Economic Cooperation (BIMSTEC), becoming a part of South Asian Free Trade Area (SAFTA), new Trade Policy 2009, new Industrial Policy 2010, NTIS 2010 are some instances of the liberalized economy. In recent days, at high level the country has held Bilateral Investment Promotion and Protection Agreement (BIPPA) and Double Taxation Avoidance Agreement (DTAA) agreements with India in 2011 during the visit of Nepals PM to India. One more agreement Nepal signed is the Trade and Investment Framework Agreement (TIFA) with the USA in 2010. Such arrangements are potential in sending around good gesture and instilling confidence in prospective. PREPARED BY SHOVA GHIMIRE ROLL 25, MBA 4TH SEMESTER INTERNATIONAL BUSINESS
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