In development literature, foreign direct investment (FDI) is regarded as being  instrumental for the economic growth of all countries, particularly the developing ones. It serves as a panacea for breaking out of the vicious circle of low savings/low income and assists in the import of capital goods and modern technical knowhow. While FDI impacts the efficiency of domestic producers through technological dispersion and spill-over effects, it also impinges on the labour market, affecting unemployment levels, human capital formation, and poverty.

Current issues

The outlook  towards inward FDI has changed significantly over the last fewdecades, with most countries undertaking liberal policies to attract investments from foreign multinational corporations (MNCs). On the expectation that MNCs will augment employment, exports, or tax revenue, or that some of the knowledge brought by the foreign companies may spill over to the host country’s domestic firms, governments have slashed a host of entry barriers and opened up new sectors to foreign investment.

A number of host governments also provide different types of investment incentives to persuade MNCs to invest in their jurisdiction, including fiscal incentives such as tax holidays and lower taxes for foreign investors, financial incentives such as grants and preferential loans, as  well as measures like market preferences and infrastructure, among others.

FDI is viewed as one of the most development-friendly avenues of private investment because of its stable nature. In comparison  to portfolio investment which can enter and exit a host country quickly and easily, FDI is generally long term and can create  structural improvements in the host country.

Thus, while portfolio investments escalate the vulnerability of a host country if they abruptly leave during periods of economic uncertainty or difficulties, FDI usually remains stable during short-term economic disruptions.  

FDI can have a number of beneficial impacts on the host nation. It can accelerate productivity gains in host countries. By successfully absorbing frontier knowledge brought in by FDI, local firms can enhance their productivity.

Technological advances implemented by MNCs may spill over to the rest of the economy, giving rise to positive externalities and promoting domestic private activity.

FDI can also boost competition among firms in the local market via reallocation of resources away from less productive to more productive enterprises, thus  increasing total productivity in the long run.

Factors affecting FDI decisions

Many factors affect FDI decisions. While macroeconomic factors are always crucial, the size and growth rate of a domestic or regional market for the goods or services produced in FDI-based operations are also important.

The different  costs of doing business in the host country also stand out prominently, including the tax rates, the availability and price of skilled and unskilled labour, and the state of a country’s energy network. The quality and extent of a country’s transportation and telecommunications infrastructure are critical as well.

Further, a range of other factors often termed as a country’s ‘business and investment environment’ are equally important. For instance, countries where it takes relatively little time and cost to open a new business attract more FDI, relative to GDP, than places where forming a new business is more lingering and onerous.

There is also an array of political factors which sharply affects MNCs’ locational decisions. The legal and regulatory requirements for setting up and operating a business can have a major bearing.

A country’s political stability and the degree of corruption involved in government decisions affecting businesses are important issues for MNCs. In that perspective, the reliability and consistency of the rule of law in a developing economy, and how strictly and reliably the government enforces contracts, protects property rights, and expedites the fair settlement of business disputes are threshold issues for MNCs mulling over new FDI commitments.

According to the UNCTAD’s latest Global Investment Trends Monitor, FDI to developing countries was stable at an estimated $653 billion in 2017, 2 percent more than in 2016. Still, promoting FDI for sustainable development remains a challenge despite the fact that both the ‘Monterrey Consensus on Financing for Development’ of 2002 and its successor, the ‘Addis Ababa Action Agenda on Financing for Development’ of 2015, have recognised  FDI as an instrument that can support sustainable development and the implementation of the Sustainable Development Goals (SDGs).

Nepal’s priorities and challenges

Nepal’s development priorities comprise of attaining sustained economic development to lower poverty by bolstering technological capacities and skills as well as creating jobs, among others. Increased flow of FDI is necessary to pursue these strategies.

However, the country has not been ensuring an investment-friendly climate to ensure that foreign capital keeps flowing into the country. According to World Bank’s Doing Business 2018, Nepal has been ranked 105 among 190 economies in the ease of doing business.

Though the country has seen FDI commitments surge in the recent past, realisation has been nominal compared to the committed amount.  It may be recalled that foreign investors pledged a total of $13.5 billion as foreign investment during the Nepal Investment Summit held in Kathmandu in early March 2017. However, the progress in the materialisation of these commitments has been extremely slow.

Until recently, Nepal was also portrayed as a destination with a high degree of political risk for foreign investors. However, due to the successful completion of the recent polls and expectations of political stability, foreign investors have, in recent days, been eyeing to make investments in Nepal.

For investors, the expected relative risk/return ratio is the driving force of investment decisions. They tend to invest in countries and projects where they expect the maximum returns and the minimum risks. Hence, Nepal’s success in attracting foreign investment thus depends on its competitiveness as an investment location relative to other countries.

Again, policies and strategies for the promotion of FDI should clearly delineate areas in which FDI is desired. It should not be attracted indiscriminately but should be targeted with the country’s needs in mind. At the same time, countries from which MNCs are to be attracted, as well as the MNCs themselves, need to be thoroughly screened on their suitability and targeted on the basis of extensive research and proper marketing techniques.

To conclude, FDI is a desirable form of capital inflow to Nepal as it is less susceptible to crises and sudden stops. To garner the maximum benefits, domestic competencies, technologies and infrastructure have to be well developed so that the citizens can take full advantage of the spill overs that foreign-owned enterprises produce.

And there is no better time than now for this to happen as there appears to be stability in the domestic political climate and together with the guarantee of adequate security, this is bound to create a conducive environment for foreign investors.

Pant is with Nepal Rastra Bank