Graduating from LDC to an Emerging Investment Hub: Challenges and Reforms for Nepal
Nearly five decades ago, the United Nations introduced the concept of Least Developed Countries (LDCs), a protective regime designed to support struggling nations in their quest for economic prosperity. Nepal, along with 24 other countries, was initially listed as an LDC. Over the years, this list has grown to encompass 46 countries, while six have managed to graduate from the LDC group by improving their socioeconomic indicators. Nepal is poised to graduate from the LDC status to a middle-income country in 2026, a prospect that has ignited a robust public discourse marked by both optimism and skepticism.
The impending graduation carries significant implications for Nepal, including the potential loss of targeted aids and concessional financing that have been instrumental in funding essential infrastructure projects. Further, Nepal’s exports have benefited from tariff preferences, providing them with a competitive edge in the global market. To navigate this transition successfully and ensure future economic resilience, one of the things Nepal must prioritise is improving the investment climate and attracting foreign capital.
The reform of foreign investment regulations has been a longstanding agenda in the government’s budget speeches. In recent years, Nepal has undertaken several key reforms to align its framework with global practices. These reforms include:
1. The 2017 Labour Act: This act streamlined the process of obtaining work permits for expatriates hired by companies with foreign direct investment (FDI). It introduced flexibility in hiring and firing practices, allowing businesses to employ casual workers, time-bound employees, and work-bound employees, thus adapting to operational requirements.
2. The 2019 Foreign Investment and Technology Transfer Act (FITTA): Replacing the old FITTA of 1992, the new FITTA introduced the automatic route for foreign investment approval. It expanded avenues for local businesses to receive foreign investment, including lease financing and venture funds with FDI. However, the full implementation of these new provisions is yet to be realised.
3. Reduction in Minimum Foreign Investment Amount: In October 2022, the minimum foreign investment threshold was reduced from Rs 50 million to Rs 20 million. This change has been particularly beneficial for attracting investment in less capital-intensive sectors like IT.
4. Streamlined Approval Process: Until June 2021, foreign investors had to navigate a dual approval process to enter the Nepali market. Nepal Rastra Bank (NRB) eliminated the need for its approval if investors had already obtained approval from the Department of Industry or Investment Board Nepal, significantly reducing the time required for regulatory clearance.
5. Flexible Valuation: NRB introduced changes to its bylaws, allowing parties to undertake transactions within a 10% range of the financial valuation determined by experts. Previously, parties had no leeway to commercially agree on valuation deviations.
Despite these reforms, the pace of change remains frustratingly slow. Nepal’s FDI inflow statistics show some improvements since the introduction of FITTA in 2019, but the correlation between these statistics and the implemented reforms is a topic of debate. Nepal lags behind in becoming an attractive investment destination compared to its South Asian counterparts. For example, in fiscal year 2021/22, Nepal received approximately $145 million in FDI. In contrast, Bangladesh, also set to graduate from LDC alongside Nepal, attracted $3.48 billion in FDI in 2022.
Another issue is the reluctance to approve financial instruments that deviate from plain vanilla structures. Recently, NRB refused to approve a convertible debt instrument citing that the regulation only deals with simple debt, compelling commercial parties to simplify their transaction agreement. Such regulatory hurdles add unnecessary complexity and delay.
Foreign investors also face cumbersome regulation when exiting their investments. To sell their shares and repatriate the proceeds, they must obtain two approvals from the Department of Industry (DoI) and one from Nepal Rastra Bank. Due to the documentary requirements of DoI, investors are required to transfer share ownership before they can apply for approval to repatriate their funds. This system exposes investors to financial losses, particularly in larger deals, as they must keep their proceeds in Nepal while awaiting regulatory clearance.
Bureaucratic obstacles further contribute to delays in obtaining regulatory approvals. These challenges include a lack of understanding among officials regarding international transaction structures and documents, short-term deputation and rent-seeking behaviour.
For instance, an officer at the DoI has repeatedly questioned the governing law of a share purchase agreement, despite clarifying that the law granting contracting parties with autonomy. In another case, an existing foreign shareholder was granted approval to inject further capital after 48 days as the officer questioned different valuations for shares of different rights and classes. Companies are required to go through another lengthy process of seeking approval to increase their issued capital before they can even apply for bringing foreign investment. Challenges such as these needlessly position investment seeking companies in difficult financial situations and is counterproductive for an investment seeking country.
Nepal’s journey from an LDC to an emerging investment hub is an ambitious goal that hinges on effective reforms and the creation of an attractive investment climate. Reforms need to be introduced by rationalising the objective of each regulation and addressing the pain points for investors. For instance: Is there any compelling reason for investors to transfer share ownership before applying for repatriation? Why are some FDI applicants expected to submit audit reports while some are waived? Why must an investor exiting via secondary market produce a share sale agreement with numerous buyers for seeking regulatory approval? The focus of the reforms and working procedures of regulators should be to move funds in and out of the country in the least amount of time. Capacity building of officers at various departments is equally imperative, especially as Nepal seeks more complex investments.
These legal reforms, while crucial, can only bear fruit when coupled with improvements in the business climate and political stability. Nepal has the potential to attract foreign investment but it must address these challenges to seize the opportunities that lie ahead.
