Economic growth in Nepal has remained low and capricious over the past few years. The country is surfing through a range of macroeconomic challenges such as low growth rate, a ballooning trade deficit, and high and sticky inflation. Low level of productivity across various sectors has severely affected many structural reforms. The manufacturing sector is almost dormant, and with the services sector having limited absorption capacity, many young Nepali’s are being forced to exit the national labor market to seek better employment opportunities abroad.
Although Nepal recently jumped to an all-time high of 94 among 190 economies in World Bank’s Ease of Doing Business rankings, such procedural changes alone cannot drive investment growth. High cost of finance has always been an impeding factor in Nepal’s growth trajectory. Low Foreign Direct Investment (FDI), high interest rate, dominance of informal lending market and low investment in productive sectors are all hindering the growth prospects of the private sector.
Banks and Financial Institutions (BFIs), who are the intermediary agencies between savings and investment have failed in mobilizing income from diverse sources to productive sectors. Hence, inadequate access to finance or high cost of financing is one of the major binding constraints which is restricting the economic growth of the nation. Critical factors under these constraints are:
Inadequate International Finance[i]
According to the recent ‘Doing Business Report 2020’ released by the World Bank Group, the economy has significantly improved the environment for doing business, but it still has a long way to go in facilitating the starting up of any business. With an overall ranking of 94th position out of 190 economies, this upgradation could certainly attract new and potential foreign investors. However, considering the recent trend of cash inflow, the FDI received by Nepal has gradually dipped since the past 2 years. The current stock of FDI in Nepal is approximately USD 13 billion. Previously the amount for the same used to range between USD 60-70 billion. Similarly, the remittance earning and outbound direct investment (ODI) received by the nation stands at USD 8.1 billion and USD 133 billion, respectively. This is quite low as compared to the other South Asian nations.
Stringent government policies such as the ‘Foreign Investment and Technology Transfer Act (FITTA)’ and the ‘Industrial Enterprises Act (IEA)’, were inefficient in creating a pre-approval system which is required in easing the foreign investors in their investment process, here in Nepal. Had the government been successful in rectifying them, these ‘act’s’ could have identified the ‘national priority sectors’. But the failure in pre-approving the investors hampered the growth of such sectors, which otherwise could have boomed.
Similarly, the presence of dominating agencies in the private sector such as- Investment Board of Nepal (IBN), Industrial Promotion Board (IB), Department of Industry (DoI) are further obstructing FDI inflow in Nepal as foreign investors need approval or clearance from all such entities before making their investment. The recent increment in the threshold level from NPR 50 lakhs to NPR 50 crore is also a huge financial risk or burden for foreign investors. Likewise, although the government-to-government FDI- investment by a foreign government in a public project initiated by the government has increased; people-to-people FDI- investment from one foreign entrepreneur into a business run by a Nepali entrepreneur has reduced. This has hindered the prospects of small-scale entrepreneurs from investing in Nepal.
Lastly, the credit rating of businesses in Nepal can only improve if the nation is more FDI friendly. Thus, by investing in infrastructural projects, the economy can attract in more foreign investors. More FDI in domestic projects ensures higher credit ratings for the same in international market.
Inadequate Local Finance
The recent merge of banks in Nepal has greatly hampered the financing of Small and Medium Enterprises (SMEs). Previous to the announcement of the policy, there were 86 development banks and 79 microfinances all across Nepal. Out of this, 71 development banks were located outside the Kathmandu Valley, providing finances to SMEs at a regional level and at an affordable interest rate. After the implementation of the policy, development banks were aligned with other commercial banks, hence reducing the number of the former to a mere 29 in total. In terms of microfinances, they too were reduced to 33 in total. This has hindered the ease in lending of credit in the financial market and ultimately increased the cost of financing for small scale businesses.
The Banking Business Model (BBM) needs to be more efficient for the proper financing of the private sector. Their inefficiency is currently driving SMEs to depend on informal financial market for borrowing money or loans to finance their businesses. SMEs are currently compelled to pay an interest rate (also known as Meter Byaji) which is as high as 3%-4%-5% per month. This roughly translates to 36%-48%-60% per annum. Such high rate of borrowing neither scales up the production capacity of such organizations nor does it make them sustainable.
Lastly, our fiscal policy too is defective. SMEs can also be financed through ‘alternative investment fund’. Our government has allocated funds for the development of ‘specialized banking organizations’ but the establishment of such organizations is yet to kick off. This is further fueling the problem of high cost of finance and hampering the growth of private sector in Nepal.
Low Domestic Savings
Nepal’s economy is primarily sustained by the remittance earnings that it receives from approx. 3.5 million migrant laborers working abroad. In the previous fiscal year (FY 2018/19), remittance earning worth USD 8.1 billion had entered Nepal, but they did not enter the productive sector.
Households are the consumption units (C) who take economic decision regarding their stock of money or wealth (Y) (in this case- remittance earnings). They consume some portion of it (C) and save the rest (S). Here is where their role in the development of the economy ends. This saving (S) needs to be converted into investment (I) for use by the private or the public sector (G) so that they can finance various productive projects- infrastructure, energy, telecommunication etc.
The Nepalese society as a whole does have a moderately high level of household savings but the private and the public sector have failed in investing (S/I) in productive sectors. This is resulting in low level of private investment and entrepreneurship as corporates have failed in optimizing available funds into high-yielding businesses.
Low productive capacity has resulted in low levels of economic development and per capita income in Nepal. Thus, large majority of laborers are still dependent in low productive agricultural activities for their livelihood. Similarly, being a land-locked country in a slow-growth region, our capital stock has always remained modest. Without a solid financial institution, the economy would always have to struggle with low level of investment, be domestic or foreign, in its productive sectors. Moreover, weak public administration, coordination failure at multiple levels and a faulty bureaucracy has held back significant transformation in Nepal[ii]. Hence, more effort from both the civil society and private sector is needed to boost any economic change across the nation.
(Ms Ghimire is associated with Nepal Economic Forum. The views expressed in this article does not represent those of the organization. In case of any queries, you can reach the author at email@example.com)
[i] “High Cost of Finance”, Nara Bahadur, 2019.
[ii] “Structural economic transformation in Nepal: A diagnostic study submitted to DFID Nepal”, SAWTEE and DFID-Nepal, 2014. Retrieved from- https://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/9019.pdf