Foreign direct investment (FDI) has long been touted as an indispensable development resource for low income countries. FDI is essentially an investment made by an individual or entity in foreign businesses. Such investments provide necessary capital along with technology transfer which have been crucial in driving economic development of nations that face massive capital constraints and low factor productivity. Furthermore, FDIs help in maintaining the foreign exchange reserves of countries that struggle to earn through export of their goods and services.
Nevertheless, there are few contentions surrounding FDIs. The adverse effect of repatriated profits on the balance of payment, “lack of positive linkages with local communities”, environmental implication of foreign investments in extractive industries, excessive commercialization and gentrification, and impact on “competition in national markets” are some of the legitimate concerns of FDIs faced by the host countries. Moreover, studies have shown conflicting results regarding the impacts of foreign investments on domestic investments in different regions; Asia and Africa experienced crowding in of domestic investment while Latin America experienced crowding out during the time period of 1970 to 1996. Excessive presence of foreign-owned businesses curtailing political sovereignty of the host country is another area of concern.
Against this backdrop, the recent revision in the FDI mandate of Nepal, which aims to facilitate freer flow of foreign capital in and out of the country, should be proceeded with caution. Nepal first opened itself up to foreign investment in 1992 with the promulgation of Foreign Investment and Technology Transfer Act (FITTA) coinciding with the country’s shift towards accelerated economic liberalization. However, it was only during the post-conflict period that the country saw a marked surge in FDIs. Despite receiving increased FDIs in recent years, primarily due to foreign interests in the country’s hydropower projects, Nepal still lags behind its developing counterparts in attracting a significant amount of foreign investment to meet the domestic capital needs. There are several challenges that have been attributed to the country’s poor performance in attracting FDIs in the likes of lack of transparency, inefficient selection of projects, and failure to critically evaluate the possible ramifications of FDIs on the national economy. To this end, Nepal has been adopting policy measures to create a more conducive investment environment as well as bringing reforms pertinent to foreign investment.
The importance of FDIs in countries like Nepal, whose economic development is largely stifled by existing capital constraints and its inability to effectively mobilize domestic savings towards productive sectors, is often regurgitated in policy discourse. With this being said, haphazardly opening up economic sectors to foreign investment without an exhaustive understanding of FDIs and their socio-economic implications on respective sectors, could be counterproductive in driving the development of the county to say the least. Directing FDIs to strategic sectors is imperative for Nepal to avail itself of the potential benefits of the said investments. One of the fundamental questions that should be answered when opening up new sectors to FDIs is whether such investments will bring in additional foreign currency, either through the export of end products or through the consumption of the products within the host country by foreigners (using foreign currency). Since the profits generated through FDIs are extracted from the host country to investors’ countries in their respective currency, the revenues should also be generated in foreign currency to preclude adverse impact on the balance of payment. Accordingly, the targeted sectors of FDIs could be broadly classified in the following manner.
FDIs should be directed towards sectors that are export-oriented. Manufacturing sector, in this regard, is the most apt economic sector to receive FDIs. FDI is instrumental in enhancing the productivity of the capital-intensive sector as such through the transfer of technology and technical know-how, widely absent in most developing countries. In Nepal, manufacturing, mining and quarrying subsectors (under industrial sector) accounted for 28.6% of the total FDIs in FY 2018/19. Again, caution must be heeded in extractive sectors in the likes of mining and quarrying as excessive investment in these sectors entail large environmental cost. Similarly, the energy sector holds an immense potential to strengthen Nepal’s foreign exchange if the hydropower projects were to materialize and produce surplus electricity that could be readily exported. The tourism and hospitality subsector under the service sector is also FDI compatible as it attracts foreign currency, as well as any sectors engaged in import substitutions.
Allowing foreign investment in sectors that are catered solely towards domestic consumption is reckless and can cause an undesirable strain on the foreign exchange reserve of the country. Telecommunication industry, for instance, serves domestic consumers and its revenues are generated entirely in domestic currency. Furthermore, there is a pre-existing profit of a substantial amount in this sector. Consequently, foreign investors in this sector reap massive profits without actually adding any value to the already profitable sector; rather there is a negative impact on the country’s balance of the payment. The controversy surrounding FDIs in the agriculture sector could be seen in a similar light. While the proponents argue for increased productivity of the sector through foreign investments, agricultural products are primarily consumed domestically, which again raises doubts on the rationale behind accepting FDIs in this sector. There are also justified concerns whether the productivity enhancement in the sector through FDIs would actually contribute to increased welfare of local farmers.
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