Nepal needs to overhaul its practices and start thinking more openly
Siddhant Raj Pandey
The recent economic exigencies faced globally in general and in particular in Nepal are an attestation of how important it is for nation states to be on their toes. Sri Lanka, once the economic gem of South Asia, has been relegated to an economic basket case due to mismanagement of its economy and lack of fiscal probity. As Nepal maneuvers choppy economic conditions along with mismanagement, the former is not as bad as the latter, it needs to facilitate a better enabling environment for investments to avert any repercussions that may further exacerbate the economy.
In order to achieve a GDP of USD 100 billion, Nepal will need investments of USD 6 billion to USD 8 billion annually. To secure 8 percent GDP growth, our investment requirement has to be USD 22 billion. To put things in perspective, in 2020-21, the domestic investments in the country were barely USD 1 billion, and the aggregate foreign direct investments for the past four years were a mere USD 570 million.
Therefore, the balance that is required seems a tall order at this point. Nepal’s FDI is the lowest in South Asia (0.4 percent of GDP), 1/3rd of South Asia’s average.
As the world becomes more competitive, Nepal needs to overhaul its practices and start thinking more openly and from the vantage point of the investors rather than from the myopic lens of bureaucracy. Green financing and the introduction of the environmental social and governance (ESG) framework along with climate-smart approaches to investments are attractive areas that can solicit investments. Investments in small and medium enterprises (SMEs) are an area that anchors economies and communities. Investments that also have a focus on diversity and inclusion (an integral part of ESG) have shown to be good for business by increasing profits and enabling growth. Nepal has been too focused on larger investments that have not met expectations and have overlooked the pervasive SME sector.
Disallowing FDI in primary agriculture and raising the threshold limit ten times from Rs 5 million to Rs 50 million (recently lowered to Rs 20 million) does not augur too well for a growing economy especially when the investments locally are not available or willing to offset the prohibited FDIs.
Private Equity is an investment class and has been a recent financial instrument introduced in Nepal. In the past seven years, it has been able to demonstrate multiple benefits for SMEs. Not only has it been able to address the missing middle, the entrepreneurs who were disenfranchised from receiving capital from the banks and financial institutions due to lack of collateral, but it has also introduced ESG measures and climate-smart approaches to the investments – a very important component in these times of global warming and climate change. This patient capital is the best form of FDI solicitation for a nation like Nepal as it does not expect annual payback to the investor as would be in the case of interest payments in debt. Payments are made back to the investor once the investments exit and make a capital gain. This normally happens in an investment cycle of 4-6 years, assisting the much-needed foreign exchange reserve of the nation. Therefore, models such as this need to be replicated and encouraged.
The first international private equity (PE) fund that was set up in Nepal was formed as a private limited as there was no regulatory framework for a PE fund in Nepal. Business Oxygen (Bo2) operates as a PE fund (Limited partners are the Investors; General Partner is the Fund Manager). The International Finance Corporation (IFC), the private sector lending arm of the World Bank Group, along with Climate Investment Funds and the Foreign Commonwealth and Development Office (FCDO), a UK government agency, are the investors of the fund. The fund has made 16 investments in all FDI-allowed sectors of the economy, all compliant with ESG and climate-smart approaches. The fund (Bo2), fund manager, and its Investee companies in five years have contributed as much as USD 2.3 million in taxes to the Nepal government and that figure will grow as the companies start booking profits and exiting.
A very important part of international PE investment is the compliance and governance aspect.
From investments to exits to repatriation the road in the past few years have been a learning experience for all – Investees, the fund, and the authorities. In order to make PE deep-rooted and endemic, Nepal needs to provide a facilitating environment for such players. Although the Specialized Investment Fund (SIF) regulation has started to churn out licenses to local funds, it remains to be seen how it will operate and how it will address the issues for international FDI funds. There are many issues that SIF does not address, mentioned in the following paragraph, notwithstanding the lack of harmonization of regulations and Acts with other existing ones that govern FDI.
In the past few years, the government has ironed out many issues that were causing delays. There still are a few that need addressing, especially in the case of local PE investments. Double taxation, black listing clause, which is very draconian and inimical to investors that make multiple investments in companies. Section 57 of the tax law is also a deterrent as is the lengthy provision of the initial environment examination (IEE) that requires the repeat process when the capital increment is made in the company regardless of whether the capacity remains the same. All these are teething problems that must be addressed slowly and in doing so, Nepal will demonstrate that it is ready for investments not only in the form of capital but also technical expertise that comes with it. Environment, Social, Governance, and Green financing are the ways forward to addressing the FDI gap, PE brings the wherewithal to address these challenges.
Pandey is Chairman and CEO of Business Oxygen (Bo2).
