FOREIGN DIRECT INVESTMENT IN NEPAL: A TREND ANALYSIS

Submitted By Devi Ram Khanal Roll No.: 740093 Reg. No: 2007-2-22-0065

A Research Report Submitted To Prof. Dr. Prem Raj Pant Apex College Pokhara University

In partial fulfillment of requirements for the course on Research Methodology For the degree of Master of Business Administration

Kathmandu August, 2009

ACKNOWLEDGEMENTS

This Study has been under taken to analysis the “Foreign Direct Investment in Nepal : A Trend Analysis” under partial fulfillment of the requirement of MBA degree. The thesis mainly covers the study to analyze the FDI in Nepal, comparison of flow of direct investment with the world, South Asia, SAARC countries and least developed countries. I would like to express my profound gratitude to Professor Dr. Prem Raj Pant, without whose kind support, timely advice and continuous encouragement, this report would not have been prepared. I sincerely acknowledge to my respected supervisor, Mr. Pushpa Raj Joshi and Mr. Bharat Singh for his continuous guidance and supervision. The report in this form is the result of their inspiring and invaluable guidance and supervision. I express sincere thanks to all librarians of Apex College who helped me directly and indirectly in the course of review of literature. Finally, my sincere acknowledgement goes to my grand parents, and beloved brother and sister, who missed their youngest son and brother all time while I was away from home for this study, and extend their blessings, love and support to me.

......…….……........ Devi Ram Khanal

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CERTIFICATE OF AUTHORSHIP

I, hereby declare that this submission is my own work and that to the best of my knowledge and belief, it contains no materials previously published or written by another person nor material which to a substantial extent has been accepted for the award of any other degree of university or other institutions, except where due acknowledgement is made in the acknowledgements.

Date: ……………

…………………… Devi Ram Khanal

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TABLE OF CONTENTS
Acknowledgements Certificate of Authorship Table of Contents List of Tables List of Figures Abbreviations Executive Summary I II III V VI VII VIII

Chapter I Introduction

1.1 1.2 1.3 1.4 1.6 1.7

Background The Problem Statement Purpose of the Study Importance of the Study Limitations of the Study Organization of the Study

1 5 6 6 7 8

Chapter II Review of Literature

2.1 2.2 2.3 2.4 2.5 2.6 2.7

Foreign Direct Investment: An Overview The OLI Paradigm for Foreign Investment Decision Why is Transparency Important for FDI? FDI and Corruptions Factor affecting Foreign Direct Investment Review of Nepalese Research in FDI Concluding Remarks

10 13 14 17 20 24 36

III

Chapter III Methodology
3.1 3.2 3.3 3.6 3.7 3.8 Introduction The Research Design Data Collection The Population and Sampling Data Gathering Procedure Data Analysis 38 39 40 40 41 41

Chapter IV Presentation and Analysis of Data

4.1 4.2 4.3 4.4 4.5 4.6

Global Foreign Direct Investment FDI to SAARC and Southeast Asia Foreign Direct Investment in Nepal A Pattern Study of FDI in Nepal Nepal Goes From Bad to Worse Doing Business in Nepal

42 44 45 47 53 54

Chapter V Summary and Conclusions

5.1 5.2 5.3

Summary of Findings Conclusions Recommendations

61 63 65

References

IV

LIST OF TABLES

Table No. 1 Table No. 2 Table No. 3 Table No. 4 Table No. 5 Table No. 6 Table No. 7 Table No. 8

Global FDI Inflows FDI to South Asia and South-East Asia Number of industries approved for foreign investment Number of Industries Registered by Categories up to FY 2064/2064 Number of Industries Registered by Scale UP to FY 2064/2065 Failed State Index Nepal's Ranking in Doing Business 2009 Summary of Indicator

43 44 48 51 52 53 54 55

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LIST OF FIGURES

Fig. No. 1 Fig. No. 2 Fig. No. 3 Fig. No. 4

Number of industries approved for foreign investment Number of employment approved for foreign investment by Number of Industries Registered by Categories up to FY 2064/2064 Number of Industries Registered by Scale UP to FY 2064/2065

49 50 51 52

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ABBREVIATIONS

BIMSTEC CPI DFI DoI FDI FITTA FSI GoN IMF masl MNCs OLI OECD SAARC SAPTA SEZs TNCs UNCTAD UN U.S./US EU

Bay of Bangle Initiative for Multi-Sectoral Technical and Economic Cooperation Corruption Index Direct Foreign Investment Department of Industry Foreign Direct Investment Foreign Investment and Technology Transfer Act Failed State Index Government of Nepal International Monetary Fund meters above sea level Multinational Companies Ownership, Location and Internalization Organization for Economic Cooperation and Development South Asian Association for Regional Cooperation South Asian Preferential Trade Arrangement Special Economic Zones Transnational Corporations United Nations Conference on Trade and Development United Nations United States European Union

VII

EXECUTIVE SUMMARY

Must firms become more multinational to improve their competitiveness and performance in an increasingly integrated world economy? Foreign direct investment (FDI) and international networks bring some competitive advantages. However, performance is also driven by firm specific advantages such as research and development (R&D) and marketing, and country specific advantages such as political and legal institutions. The relative contribution of these factors to competitiveness will vary by industry and country. The study explores the flow of foreign direct investment in Nepal till date. The study also attempt to gain some understanding on the awareness of flow direct investment among least developing countries and neighboring countries, compared to the inflow in Nepal. It looks after the productive aspects of foreign direct investment in Nepal. Still Nepal doesn’t receive the minimum FDI compared to other developing countries. It also scans the obstacle that curtails in receiving it, and scrutinizes the challenges and benefits of receiving foreign investment in Nepal.

The study is organized into five chapters. Each chapter covers some facts pertaining to the FDI in Nepal. First chapter covers background information about foreign investment and its impact on country’s economy; its importance, statement of problem, and research purpose etc are stated.

Second chapter presents an overview of literature review. This chapter aims to provide relevant literature in the field of foreign direct investment.

Third chapter presents the research model and research methodology implemented in the study. It will describe the chosen methods, research design, sources of data, population and sample, data gathering procedure and analysis of data.

VIII

Chapter four has attempted to analyze and draw inferences from the collected facts in accordance to the outline laid down in the research plan. The collected data has been systematically presented in the form of tables and diagram.

Finally, chapter five highlights the major findings of the research, conclusions and recommendations. This chapter basically focuses on the proceedings of the earlier chapter. In this chapter, the author answers research questions and get conclusions based on the theory and analyzed data. Major findings are illustrated which is followed by recommendations based on findings and experiences of the researcher.

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CHAPTER I INTRODUCTION

1.1 Background of Study
Most economic theorist and developing practitioners accept that external capital is necessary for accelerating growth and industrialization. Today, every developing country irrespective of their size and political systems tries to attract foreign investment. A large number of developing countries have now established export processing zones (EPZ) to attract foreign private and public foreign investment.

The developing countries of the world have in genera been recipient of both official and private financial flows over the last four decades. Understandably so, since in most of there countries, the level of domestic savings is generally very low, the financial sector is widely underdeveloped and in most cases repressed, and therefore the capacity to harness domestic financial resources for development of key sectors of the economy is quite limited. A wide body of literature has investigated the role that this flow of external financing could play in development of recipient countries. The convergence of opinion seems to be that on balance, there is a net positive relationship between external financial assistance and economic performance of countries. Particularly if and when such assistance is accompanied by conducive policy environment (Burnside and Dollar 2000)

In the last decade or so, where as the flow of official development assistant seems to have decline in relative importance, the flow of the private resources; in particular, foreign direct investment (FDI) to developing countries has been on the increase. A number of reasons have been alluded to in terms of this development. One of such is the end of cold war and relative increase in net official flows to the countries in transition in Eastern Europe and former Soviet Republic. Other reasons include the
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growing importance of private flows, particularly in developing countries themselves, reflecting the new wave of liberalization, and globalization and therefore the flow of foreign investment to the telecommunications, financial services and other sectors in many of the countries.

FDI is now recognized as an important driver of growth in the country. Government, therefore, makes all efforts to attract and facilitate FDI and investment from foreign investors. Nonresident including overseas corporate bodies (OCBs) that are predominantly owned by them, to complete and supplement domestic investment.

In the trend of economic globalization, the role of FDI in promoting economic development has been widely studied. Studies such as Athukorala and Menon (1995), Zhang and Song (2001), Zhang and Felingham (2001) and Liu et al (2001) find that FDI promotes the manufactured exports of recipient countries. Although there is no consensus regarding the relationship between FDI and GDP growth, to attract FDI as a strategy of development has become a trend among developing countries following the development of newly industrialized countries in the 1960s and 1970s. Athukorala and Chand (2000) and Balasubramanyan et al (1996) provide some evidence that the growth enhancing effect of FDI would be significant and strong in countries with open trade policies and better trade regimes with export promoting FDI. While many developing countries are competing for FDI inflows, recent studies attempt to identify condition, which would lead to more beneficial utilization of FDI. For example Narual and Dunning (2000) point out that the increased competition for FDI is more for the “right” kind of investment and less developed countries increasingly need to provide unique, non replicable created assets to maintain a successful FDI-assisted development strategy. De Mello (1999), finds that the extent to which FDI is growth enhancing depends on the degree of complementarily or substitutes between and FDI and domestic investment. Furthermore Zhang (2001) reports that the extend to which FDI is growth enhancing appears to depend on country specific characteristics.
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Potential economic benefits of FDI

FDI inflows can lead to a range of economic benefits for transitional and developing countries, including: • • • • • • restructuring their economic activities in line with dynamic comparative advantage; reducing their costs of structural adjustment; fostering more demanding purchasing standards by firms and consumers; raising the productivity of national resources and capabilities; improving quality standards; Stimulating economic growth (adapted from Dunning, 1994).

Nepal started planned programs of economic development as early as mid fifties with the launching of first five-year plan in 1956. The Tenth Plan is now being implemented since mid July 2002. The Plan seeks to achieve a higher rate of sustained economic growth of 8.1 percent per annum by enhancing the competitive capability of industry and commerce sector. To achieve this target, greater emphasis has been given to the participation of private sector and the involvement of people at community level. The Plan takes account of the need to attract foreign investment to meet the five-year capital requirement. The following policies have been spelt out, among others, for the industrial sector in the Tenth Plan: • • • • •

Set up the mechanism to ensure easy availability of financial resources, through financial institutions, to establish industries. Investment will be channelized to undeveloped or underdeveloped regions of the country, on the basis of national importance, to ensure regional balance. Industrial security system will be made effective. Foreign investments will be encouraged in those areas where the country has comparative advantage. Local and newly developed technologies will be encouraged for industrial development.
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Government of Nepal has adopted an open and liberal policy to pave the way for the accelerated economic and social development of the country. Especially in the field of industry and trade, the government policy is aimed at giving the private sector a dominant role. The private initiatives and enterprises are expected to increase efficiency and productivity. The government's role will be that of a facilitator providing infrastructure and conducive environment for investment. Although there were a few cases of foreign investment and technology transfer prior to 1981, the industrial policy and the Foreign Investment and Technology Act, 1981 paved the way for regular inflow of foreign investment and technology transfer into the country. Solidarity Ministerial meeting was held in 1982 and an Investment Promotion meeting was held in 1984 for the promotion of foreign investment and for creating awareness of the investment opportunities in the country. Subsequently, Nepal Investment Forum was organized in 1992 at Kathmandu, which was a very successful event in attracting the foreign investors.

In order to make the investment climate more conducive GoN formulated Foreign Investment and One Window Policy and Industrial Policy based on which Foreign Investment and Technology Transfer Act, 1992 (FITTA) and Industrial Enterprises Act, 1992 (IEA) were promulgated. These Acts were subsequently amended in 1996 and 1997, respectively, in order to make these acts more pragmatic based on the experiences gained.

The Industrial Policy emphasizes on simplification of procedures, transparency in implementation and improvement of productivity through the up gradation of technical knowhow and efficiency of the industries in order to compete in the free and competitive world market by utilizing comparative advantages of the country with minimum adverse effects on environment. Whereas, the Foreign Investment and One Window Policy aim: •

To build a strong and dynamic economy by generating additional opportunities for income and employment through expanding productive activities.
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• •

To increase the participation of the private sector in the process of industrialization. To increase productivity by mobilizing internal resources and materials in productive sectors and by importing foreign capital, modern technology, management and technical skills.

To increase the competitiveness of Nepalese industries in international markets.

1.2 The Problem Statement
Nepal is potentially attractive location for foreign investors. Sandwiched between two emerging countries of the world with India in the south and China in the North, Nepali manufacturers have free access to the India market, and tariffs on imported raw materials and components are lower here than South Asian countries. The varied climate, natural resources and terrain provide a wealth of niche opportunities, many of which are barely being exploited at all. Nepal has attracted modest FDI in niche sectors such as tourism, light manufacturing (apparel) and mineral deposits (lime stone). Investment is mainly in low technology, labor intensive production. The impact of FDI has also been modest primarily in job creation.

While the FDI laws were liberalized in 1992, there are still obstacles that investors face. In the short term, Nepal can attract more FDI in its niche sector- such as tourism and production of herbs with special investment packages. With all these possibilities, the FDI has been declining and Nepal is not being able to attract minimum requirement. There are some of the weaknesses such as weak financial sector and government’s mandate and restriction for entry of new foreign bank up to 2010, geographical constraint, unstable policies and insecurity among the bureaucrats, unclear investment policies, the current political instability, corruption and lack of corporate governance etc. Beside the Maoist and other parties’ frequent movement and bandhs
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is the threat to bilateral and multilateral development projects. The challenge for Nepal is to put in place an investor-friendly business climate that will compliment its small bureaucracy. This is a serious problem in attracting foreign investment.

Against these backdrops it is a great challenge for Nepalese to accumulate capital resources domestically as no one can deny the role of foreign investment in economic growth and development of the country. An assessment of the probable reasons for the declining FDI is thus recognized as the problem of the present study.

1.3 Purpose of the Study
The basic purpose of the study is to analyze the study in Nepal, comparison of flow of direct investment with the world, South Asia, SAARC countries and least developed countries. The specific objectives of the study are as follows:
• •

To explore the trend of foreign direct investment in Nepal. To study facilities provided by the Ministry of Industry & supply and Government.

To identify the problems and constraints of FDI in Nepal and its impact in future.

1.4 Importance of the study
Nepal, a capital poor economy with low domestic saving rate where development expenditure, to a significant extend, are dependent on the foreign aid, foreign direct investment are very necessary lubricant to generate economic growth. FDI is frequently viewed as instrumental in promoting industrial growth and foreign trade particularly in developing countries. FDI maintains relatively open economies, stable macro-economic conditions and limited restrictions on foreign exchange transactions. It frequently stimulates competition, productivity and innovation by
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local suppliers because local suppliers compete for lucrative contracts with multinational enterprise.

Further, it generates income and employment opportunities resulting in higher wages, competitive price, more revenue, skills and technology transfer and increased foreign exchange earnings. It contributes to the development of a host country by increasing the countries investment level beyond what would be permitted by domestic saving alone. Similarly, it enhances entrepreneurial capability when the foreign firms bring with it some firm specific knowledge in the form of technology, managerial expertise, and marketing know-how. It also allows new local entrants to learn about exports markets, provide training for workers and stimulates competition with local firms.

Thus, Nepal is to achieve faster rate of economic growth at the present context, it is essential that it create the necessary and amicable condition to attract FDI.

1.5 Limitation of the study
The study has the following limitations: • • • Secondary data are use to analyze for result interpretations, so the accuracy of the findings depends on the reliability of the available information. The study mostly focused on previous literature, reports and data on mapping the mindset of inflow of FDI in Nepal. The study covers the collection of data only a period of 5 years from the fiscal year 2003 to 2008 and conclusion drawn confines only to the above period. • Lack of knowledge gap on FDI issues prior to the study.

This study is done for the partial fulfillment of Masters of Business Administration program of Pokhara University
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1.6 Organization of the study
The whole research is organized into five main chapters, which are as follows:

Chapter I Introduction

This chapter includes background of the study, statement of the problem, objective of the study, importance of the study, limitation of the study, and organization of the study.

Chapter II Review of Literature

The second chapter is review of the literature which includes theoretical framework of foreign direct investment. Review of related journals, studies, books and unpublished thesis and other related document in both national and international level. Since the study is focus on FDI in Nepal: Patterns and Prospects, special attention has been given to the previous studies on FDI and other studies related to this topic.

Chapter III Methodology

This chapter deals with the methodology used for the study. It consists of introduction, research design, and source of data, population and sample, data gathering procedure and analysis of data.

Chapter IV Presentation and Analysis of Data

This chapter comprises the pattern analysis and presentation of data collected from the department of Industry. It is the analytical presentation of the study. Nepal has attracted modest FDI in Niche sector such as tourism, manufacturing (apparel) and mineral deposits (limestone). The investment is mainly low-technology, labor
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intensive production. The impact of FDI has also been modest, primarily in job creation. Foreign affiliates have imparted skills to local employees, and in a few instances have introduced skills to local employees, and in a few instances have introduced new exports products and upgraded technology.

Chapter V Summary and Conclusions

This chapter is suggestive framework containing the summary, overall findings, conclusions and recommendations.

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CHAPTER II REVIEW OF LITERATURE

The purpose of this chapter is review the available literature related to foreign direct investment globally and in the context of Nepal. This chapter gives an introduction of FDI, the OLI Paradigm for Foreign Investment Decision, Why is Transparency Important for FDI?, financial system and FDI, factor affecting foreign direct investment, global review of FDI with historical background of FDI in Nepal along with legal framework.

2.1 Foreign Direct Investment: An Overview
Multinational corporations (MNCs) commonly capitalize on foreign business opportunities by engaging in direct foreign investment (DFI), which is investment in real assets (such as land, buildings or even existing plants) in foreign firms, acquire foreign firms, and form new foreign subsidiaries. Any of these types of DFI can generate high returns when managed properly. However, DFI requires a substantial investment and can therefore put much capital at risk. Moreover, if the investment doesn’t perform as well as expected the MNCs may have difficulty selling the foreign project it created. Given these return and risk characteristic of DFI, MNCs tend to carefully analyze the potential benefit and costs before Implementing any type of DFI. FDI is conventionally defined as a form of international inter-firm cooperation that involves a significant equity stake in, or effective management control of foreign firm (de Mello, 1997)

FDI is the international movement of capital for specific investment purposes. Such investments are made for the purpose of actively controlling property, assets, or companies located in host countries. Business organizations undertake FDI to
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expand foreign markets or gain access to supplier of resources or finished products. FDI occurs when overseas companies set up or purchase operations in another country.

FDI can be categorized into three components: equity capital, reinvestment earnings, and intra company loans. Equity capital comprises of the shares of the companies in countries foreign to that of investor. Reinvested earning includes the earning not distributed to shareholders but reinvested into the company. Intracompany loan relate to financial transactions between a parent company and its affiliates. FDI thus may take many forms, including • • • •

Purchase of existing assets in a foreign company New investment in property like land and building. Participation in a joint venture with a local partner. Merger and acquisition of activities.

Balance of payment accounts define foreign direct investment as any flow lending to or purchase of ownership in a foreign enterprise that is largely owned by residents of the investing country. (Kindreberger 1987)

FDI is the act of acquiring assets may be financial, such as bonds, bank deposits, and equity shares or direct investment and involves the ownership of means of production such as factories and land. Direct investment is considered to take place also if the ownership of equity shares provides control over the operation of firm. (Johnson 1970) has suggested the expansion of the concept of foreign investment so that it parallels the modern fisherian approach and distinguishes physical human knowledge capital. Focusing on foreign direct investments undertaken by firms, industrial organization theorist analyzed the location choices of multinational enterprises. This approach was pioneered by John Dunning (1977), who suggested that firms undertake FDI when three factors are present, and the resulting advantages are sufficient to offset the natural disadvantages of having to operate in
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foreign country. These are known as the “Ownership, Location and Internalization” (OLI) advantages. A firm must have some product or technology that enables it to enjoy some market power in foreign market (ownership advantage), the firm must see some advantage in producing in foreign location rather than at home (location advantage), and there must be some reason for it to want to exploit the ownership advantage internally, rather than use a market based mechanism to gain payments for it (Such as license or sell its product or technology in the market for a fee.

Hymer (1960) found that American FDI was mainly concentrated in a few industries and monopolized by several companies. Multinational companies (MNC’s) were the product of imperfect markets and monopoly advantages where the companies had the advantage with regards to choosing where to invest. A number of conclusions can be drawn from Hymer’s analysis that helps frame up this study: • First, FDI tends to flow into differentiated markets where a MNC believes they will have an advantage competitively. • Second, companies that are able to make investments overseas all have certain advantages, such as economies of scale, differentiated products, special skills, and low-cost production. These companies will make investments in regions that do not have these advantages. • Third, there are many ways in which MNCs can invest overseas in such as exporting, and licensing, in addition to direct investment. MNCs without local partners always prefer to choose foreign direct investment. • Last but not the least Hymer found that about half of the overseas operating capital of American firms came from host countries; thus FDI tends to flow into the countries or regions that have developed financial systems and capital markets.

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The basic reasons for attracting FDI by developing countries are: • • • • Capital Transfer: Developing countries lack capital resources. FDI is an Importance means of capital flows. Productivity Improvement: FDI facilitates technology transfer.

Technological up gradation results in productivity improvement. Management Development: Local management people get trained in foreign firm. They acquire new concepts, tools and techniques of management. Employment: Foreign Company generates employment. Due to cheap labor in developing countries, outsourcing is on the increase by global companies. Worker acquires new skills. • Better Product: Foreign Company produces qualitative and branded products. They have high image. They assure quality and supply of product.

2.2 The OLI Paradigm for Foreign Investment Decision

The Ownership, Location, and Internalization (OLI) paradigm is generally viewed as the preeminent theoretical framework for foreign investment decisions (Dunning 1993) The OLI framework postulates that the decision to produce internationally is based on three conditions. First, a firm should possess ownership-specific advantages over firms in other countries. Possible examples include unique property rights or a broad variety of other intangible aspects, such as a product innovation or an advantage in marketing. Additionally, some location advantage must be gained by going abroad, such as a savings in transport costs, natural resources specific to the host country, proximity to a large market, or a need to get around trade barriers. Finally, a firm must desire to maintain possession of this advantage, rather than simply selling or licensing it to foreign companies. In other words, the firm must want to internalize its advantages across different markets.

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The political environment of a host state can affect the ownership, locational, and internalization aspects of the OLI paradigm. Through the proper regulatory environment, a state can enhance ownership advantages by helping a firm preserve its intangible aspects or monopolistic advantage over local producers. State credibility decreases political risk and cost of internalizing production as multinationals gain confidence that the state will not adopt policies after initial investment that negatively affect their operations (Jensen 2003). Yet the role of the host state is strongest as a location factor. Obviously, some locational criteria, such as natural resources and port access, are essentially fixed. There are various other ways, however, that states can make their location more desirable. They may offer preferential taxation policies and other financial incentives (Oman 2000). Moreover, as discussed below, the political environment of a host country and the education and skill levels of the workforce may also factor as locational criteria.

Dunning (1981) suggests that transnational corporations (TNCs) will invest in a foreign location only if the latter offers certain location-specific advantages in terms of resources and facilities that make it possible for the TNCs to explore their firmspecific ownership advantages. Various authors, such as Root and Ahmed (1979), Schneider and Frey (1985), Dunning (1993; 1994) and Burrell and Pain (1997), suggest that location decisions are influenced by a number of factors. Tuselmann, (1999) divides these factors into two groups: • • Supply factors (such as labor costs, skills level of the labor force, and corporate taxation); and Demand factors (such as market size and growth, and geographical location).

2.3 Why is Transparency Important for FDI?
Transparent economic policies are vital for foreign investors, and the reasons are several. The first reason is that non-transparency imposes additional costs on
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businesses. These additional costs arise as firms have to tackle the lack of information that should have been provided by the appropriate government department in the implementation of its policies and in the activities of government institutions. For example, firms bidding for a state asset expect to receive full information from the government about the company to be privatized. Any set of information that falls short of the expectation of the bidders will have to be supplemented – at extra costs, and the latter are typically incurred by the bidders.

Additional costs are also incurred because of corruption - another element of nontransparency identified above. In many countries, bribery is illegal. Bribery raises, therefore, the risks and the costs of non-compliance, and the companies will only take the risk if the rewards are sufficiently high. Corruption can indeed be very costly to firms. By way of example, bribes are estimated to have accounted for 7 percent of revenue of firms in Albania and Latvia in mid-1990's and in Georgia the corresponding figures was even higher – 15 percent (Kaufmann, Pradhan and Ryterman 1999) This process would lead to an investment selection that often has little to do with choices based on bona fide project appraisal but rather to projects selected on the basis of contacts, pressures, rent-seeking alliances etc. Moreover, the majority of law-abiding companies will typically avoid doing business in countries in which bribery is an inseparable part of business. In brief, the existence of strong legal provisions against bribery and their effective enforcement will go a long way towards inducing FDI flows.

The second reason why transparent economic policies are important for FDI is because they facilitate cross- border mergers and acquisitions. When firms decide to acquire companies abroad, they will often have to have their acquisitions approved by the Monopoly Commission or its equivalent in the host (i.e. foreign investment receiving) country. However, the practices of these competition commissions often vary from country to country and from region to region. For example, Neven, Papandroupulos and Seabright (1998) argue in their study of the European competition policy that the Competition Commission of the European
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Union enjoys high level of discretion with very little transparency. It is perhaps, therefore, not surprising that we have so far witnessed little of cross-border mergers and acquisitions within the European Union.

The third reason is closely related to the previous discussion of competition policies. Foreign investors require transparent protection of property rights. As we have argued above, investors generally require that their property be protected and that the protection be transparent. What holds for investors in general holds, of course, it holds for foreign investors in particular. This conclusion is intuitive but it also has a strong backing from business attitude surveys and from empirical literature such as the study of Rapp et al. (1990) who find that effective protection of intellectual property rights is strongly correlated with inflows of foreign investment.

The fourth argument for transparent economic policies is that they positively influence business attitudes. Virtually all surveys of business attitudes convincingly show that companies base their decisions to invest abroad on their perceptions of what economists like to call “fundamentals" (Hoekman and Saggi 1999). The latter include macroeconomic conditions such as low and predictable inflation, prospects of fast economic growth, healthy balance-of-payments position. They will typically also include factors such plentiful and relatively skilled labor force, access to natural resources, efficient infrastructure etc. Furthermore, and most importantly in the context of our paper, investors typically seek clear, open and predictable economic policies that minimize the risks of unpleasant and costly surprises. Open trade and investment regimes are particularly powerful instruments to attract investments in general and foreign investments in particular (Selowsky and Martin 1997). Clearly, transparency of economic policies and government institutions figures prominently on the minds of businessmen and in the meetings of corporate boards of multinational companies.

The absence of comprehensive and symmetrical legal provisions concerning business practices has a number of effects for companies. One of the most serious
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effects is arguably their impact on the competitive position of firms which may differ among countries as a result of these differences. For example, U.S. Federal law prohibits U.S. firms from using bribery to gain access to foreign markets. By contrast some European countries allow firms to treat bribes paid as deductions in calculating their tax liabilities. This asymmetry of rules poses a disadvantage for U.S. firms. Therefore, the elimination of corruption is an important issue for U.S. firms as a means to level the playing field.

Finally, there is another, and perhaps the most important reason why economic policies must be transparent if countries can establish favorable conditions for capital inflows. The reason is countries' policy performance and transparencies are monitored by outside agencies which have a crucial impact on decisions of foreign investors. These agencies include the IMF and various private credit rating agencies. Their influence is different – the IMF provides a “credit of approval" of sound economic policies while credit rating agencies evaluate the credit risk of the country concerned. Their similarity rests on the fact adverse judgment on government policies in a given country will typically lead adverse perceptions by foreign investors of that country. As frivolous as it might sound it is a well known fact from the business community that foreign investors would base their investment decisions on credit assessments and country rankings established by some credit rating agencies. The fact that we shall also heavily rely on country rankings in our empirical part further below is not, therefore, an entirely academic exercise but one that is strongly derived from the reality.

2.4 FDI and Corruptions
Foreign Direct Investment (FDI) plays a significant role in modern economies. World FDI flows have increased from $25 billion in 1973 (Drabek 1998) to $1.4 trillion in 2007 (Kekic 2007). For lesser developed countries, FDI flows often outstrip foreign aid and make-up a sizable part of local and national economies
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(Drabek 1998). In a highly globalized world, successful competition for FDI is a vital part of policymaking and a requisite part of developing states.

Various barriers limit FDI flows: lack of private property rights, poor infrastructure, excessive regulation, high tax rates, and - not surprisingly - corruption. Many authors focus on the question of whether corruption has a positive or negative effect on FDI, growth, and productivity. Responding to conventional wisdom and Samuel Huntington’s comment that "in terms of economic growth, the only thing worse than a society with a rigid, over-centralized, dishonest bureaucracy is one with a rigid, over-centralized, honest bureaucracy" (Huntington 1968), Kaufmann and Wei find that corruption does not "grease the wheels" of business. High levels of corruption are associated with greater capital costs and lower profits; bribe-paying may not be an effective strategy for business (Kaufmann and Wei 1999). Corruption is also associated with lower levels of development (Ades and Tella 1997), and there is considerable evidence that it limits private investment (Mauro, 1998). Much of the literature on corruption focuses on the negative impact of corruption and bribery on FDI, growth, education spending, and related topics.

One reason that corruption can preclude a partner state from receiving a high level of FDI is that with corruption comes uncertainty (Wei 1997). All else being equal, states would prefer to pay a higher tax rate in a partner country than contend with a high level of corruption because, with corruption, the total costs cannot be known (Wei 1997). Smarzynska and Wei demonstrate that moving from Mexico’s level of corruption to Singapore’s affects FDI more than a 20% tax rate increase (Smarzynska and Wei 2000).

Imagine building a large factory overseas, paying a few bribes to acquire land and infrastructure, and initiating production. A year later, the electricity goes out, and a government employee explains to the factory owner that he has two options: be without power for three months or pay an additional "fee." This "fee" could cost him anywhere from $1 to $100,000 (or more), but he had no reasonable way to prepare
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for it - all he knew was that corruption would be a business cost. His business is completely at the mercy of corrupt practitioners; new "fees" can crop up at any time. It is easy to see why the presence of corruption has a negative impact on FDI flows and private investment (Wei 1997, Kaufmann and Wei 1999, Mauro 1998). By contrast, transparency has a strong positive effect on FDI flows (Drabek and Payne 2001).

Corruption may also decrease FDI flows because it can lead to inefficiency (bottlenecks, high costs) and violations of business norms and best practices, making international investors more concerned with corruption than local investors (Habib and Zurawicki 2002). Habib and Zurawicki argue that the level of corruption in investor states will impact where their corporations choose to invest; businesses will try to do business in environments where they are comfortable. Corporations from corrupt states may feel more comfortable investing in corrupt states. To test their hypothesis, they interact the CPI score in host countries with the CPI score in investor states in a regression explaining FDI outflows using data from 1996-1998.

The data supports their hypothesis, but the data is limited because the CPI expanded greatly in the years following the conclusion of their project; between 1996 and 1998, CPI was only available for a small number of states. Also, the effect may have less to do with norms and more to do with comparative advantage: states from corrupt states may have fewer restrictions on their ability to pay bribes in host states, enabling them to out-compete states with strong anti-bribery laws for contracts abroad. This is better evaluated by using the Bribe Payers Index and OECD Convention Ratification to see which states frequently pay bribes overseas.

Two papers by Peter Egger and Hannes Winner look specifically at the question of how corruption and risk affect FDI flows (Egger and Winner 2003, 2006). In their 2006 paper "How Corruption Influences Foreign Direct Investment: a Panel Data Study," Egger and Winner examine how other factors impact corruption’s effect on bilateral FDI flows. Their observations are FDI country pairs from 1983-1999, and
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to assess level of corruption (or perceived level of corruption), Egger and Winner use the Transparency International Perceptions of Corruption Index (CPI). Their empirical model follows other corruption studies, regressing bilateral FDI flows on CPI and other variables. By building in variables to account for country size, location, factor endowments, and transport costs, they conclude that - while corruption has a negative impact on FDI flows - the interaction of corruption with other factors (factor endowments, location, etc.) can amplify or minimize this impact. Egger and Winner also conclude that corruption is more relevant for FDI flows between two OECD states and less so for OECD states investing in nonOECD states.

Taken as a whole, decreasing corruption leads to higher rates of FDI. But corporations from some states are less willing to pay bribes - Switzerland and Sweden, for instance - while others are more likely to pay bribes (Bribe Payers Index 2006). It therefore follows that the significance of corruption is different depending on a recipient state’s target investors and current investment partners. Corporations from states with a higher tolerance for bribery have a comparative advantage at investing in states with high levels of corruption because they are more willing to suffer the costs of doing business. Bribe-taking states should see a higher rate of investment from states that have a greater tolerance for bribe-paying. On the other hand, when an investor state makes it more difficult for its corporations to pay bribes overseas (through greater transparency, regulation, reporting, etc.), it will decrease its corporations’ ability to out compete corporations from states with lax bribe-paying laws for desirable contracts in corrupt states.

2.5 Factor affecting Foreign Direct Investment
Capital flow resulting from FDI change whenever conditions in a country change the desire of firms to conduct business operations there. Some of the more common factors that could affect a country FDI are identified here.
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High Transportation Cost

High transport costs arising from its unique geography are obviously a significant constraint faced by Nepal and put it at a disadvantage compared to many other lowwage countries in attracting export-oriented FDI. Apart from the long distance to Indian ports (the port of Calcutta is about 1,000 kilometers away by the shortest route), inefficiencies of the Indian railways and ports add to the cost of transport for potential exporters from Nepal. It is also alleged that shipments from Nepal are given low priorities at the highly congested Indian ports.4 However, focusing on high transport costs per se can lead to misleading inferences for Nepal’s potential in labor-intensive export industries for two reasons. First, the relative cost advantage of Nepal arising from low wages (less than $20 per month for the average factory worker) may, in certain cases, outweigh the relative disadvantage arising from high costs of transport. Second, landlocked economies, such as Nepal, can choose to specialize in “low weight per unit value” products, provided, of course, the overall economic environment is conducive for the production for such products (Srinivasan, 1986). Moreover, it is important to note that adverse cost implications arising from landlessness can be minimized through suitable government policy in the areas of land and air transport, and customs administration (Bagchi, 1998).

Changes in Restrictions During the 1990s, many countries lowered their restrictions on FDI, thereby opening the way to more FDI in those countries. Many US based MNCs including Bausch and Lomb, Colgate-Palmolive, and General Electric, have been penetrating less developed countries such as Argentina, Chile, Mexico, India, China, and Hungery. New opportunities in these countries have risen from the removal of government barrier.

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Privatization Several national governments have recently engaged in privatization, or the selling of the same of their operations to corporations and other investors. Privatization is popular in Brazil and Mexico, in Eastern European countries such as Poland and Hungary, and in such Caribbean territories as the Virgin Island. It allows for greater international business as foreign firms can acquire operations sold by national governments.

Privatization was used in Chile to prevent a few investors from controlling all the shares and in France to prevent a possible reversion to a more nationalized economy. In the United Kingdom, privatization was promoted to spread stock ownership across investors, which allowed more people to have a direct stake in the success of British industry.

The primary reason that the market value of a firm may increase in response to privatization is the anticipated improvement in managerial efficiency. Manager in a privatization is the anticipated improvement in managerial efficiency. Manager in a privately owned firm can focus on the goal of maximizing shareholder wealth, whereas in a stated –owned firm business, the state must consider the economic and social ramifications of any business decision. Also, managers of a privately owned enterprise are more motivated to ensure profitability because their careers may depend on it. For these reasons, privatized firms will search for local and global opportunities that could enhance their value. The trend toward privatization will undoubtedly create a more competitive global market place. Potential Economic Growth Countries that have greater potential for economic growth are more likely to attract FDI. When assessing the feasibility of FDI firms estimate the after tax cash flows that they expect to earn.

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Tax Rates Countries that impose relatively low tax rate on the corporate earning are more likely to attract FDI. When assessing the feasibility of FDI, firms estimate the after tax cash flows that they expect to earn.

Exchange Rates Firms typically prefer to direct FDI to countries where the local currency is expected to strengthen against their own. Under this condition, they can invest funds to establish their operations in a country’s currency are relatively cheap (weak). Then, earnings from the new operations can periodically be converted back to the firm’s currency at a more favorable exchange rate. Importance of factors influencing foreign investment decisions (Erdilek 1982) • • • • • • • •

Rapid expected growth of the economy and increase of demand for the foreign firm's product High expected rate of return in supplying primarily in the host market Increasing import restrictions, which began to endanger exports to host country Host country’s government incentives and other guarantees Foreign investment by other foreign firms in host country. Other considerations Incentives and guarantees provided by the parent firm's government Lower unit production costs for export base.

For a typical developing economy, labor-intensive, consumer goods manufacturing is generally considered to be the natural starting point in the process of export-led industrialization. While the availability of cheap and trainable labor is a prerequisite for attracting export-oriented FDI, the availability of a wider array of complementary inputs, including operator, technical and managerial skills, suppliers

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of intermediate goods, and high-quality infrastructure, are also essential. Also, given the large initial fixed costs involved, Transnational Corporations (TNCs) would be reluctant to establish assembly plants in a country without having confidence in the policy continuity and political stability of that country. For these reasons, so far, only a limited number of developing countries, mostly the high performing East Asian countries and more recently some transition economies in Eastern Europe, have been able to attract FDI in assembly operations. The so-called “life- cycle” investors who expand their production networks globally, largely on scale economy and efficiency considerations, rarely find low-income countries attractive locations for investment. (Athukorala, P. C. and Sharma, K., 2006)

2.6 Review of Nepalese Research in FDI

Nepal is situated in south Asia is bordered by Tibet Autonomous region of china in the north and India in the east west and south. the country is roughly rectangular ins shape, with at total land area of 147181 square kilometers (sq km), stretching 885 km from east to west and between 145 Km and 241 Km from north to south, with a mean width of 193 km.

Topographically, the country can be divided into three distinct regions from north to south: the mountainous region, hilly region and flat plains, known the Terai. Lying at an altitude ranging from 4877 to 8848 meters above sea level (masl), the mountainous region includes the Himalayas, world’s highest mountain chain. Nepal Himalayas comprises nine of the world’s highest peaks, including the highest, Mount Everest (in Nepali, Sagarmatha). The hilly region lies in the middle of the country, altitude varying between 610 and 4877 masl. Kathmandu Valley, where the country’s capital, Kathmandu is situated, and many other scenic valleys, basins and pockets are located in the region. The Terai, which is an extension of the Gangetic

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plains of India, forms a low flatland along the southern border. It comprises most of the fertile land and forest areas of the country, and rich and big river basins.

Nepal had attracted modest FDI in niche sectors such as tourism, herbal products, mineral deposits (lime stone), and light manufacturing apparel; hydro power and that it had positive impacts on exports, particularly garments. FDI has also enabled the country to export non-traditional manufactured products such as microtransformers and personal consumer products (UNCTAD, 2003b). Investment was mainly in low-technology, labor-intensive production. The impact of FDI had also been modest, primarily in job creation. According to the study, FDI inflow was constrained by political instability, outdated foreign investment law, rigid labor regulations and poor physical infrastructure. This situation remains current due to political instability and political transition.

FDI is considered beneficial in view of its contribution to technological transfers, enhancement of managerial capability and new opportunities for market access. FDI, particularly in the form of equity investment, adds to the capital stock of the country and thus enables the recipient country to achieve faster economic growth through momentum in capital formation. Increases in FDI are also seen as leading to increases in exports by creating international markets through new marketing and organizational skills.

The inflow of FDI in Nepal began in the early 1980s through the gradual opening up of the economy. From 1980 to 1989, FDI inflows to Nepal were minimal with an annual average of US$ 500,000. FDI inflow showed a distinct acceleration during the 1990s averaging US$ 11 million per annum during 1990-2000, peaking at US$ 23 million in 1997 (UNCTAD, 2003b and 2006). This was primarily due to Nepal’s more liberal trade policies, which comprised tariff rate reductions, the introduction of a duty drawback scheme, the adoption of a current account convertibility system and liberalization of the exchange rate regime. A reversal in the rising trend took place from the beginning of the 2000s. All in all, FDI inflow is the lowest in Nepal
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even when compared with other landlocked countries (World Bank, 2003). A comparison of other Asian countries, Nepal indicates a poor performance of FDI (UNCTAD, 2003b). The fact that Nepal is landlocked, coupled with its infrastructure and low level of labor productivity has also constrained FDI inflow into the country.

Many foreign investors in Nepal are individuals rather than corporate entities. Most of the FDI projects are of small size 72%, medium-sized 16.5% and large-sized industries 11.5%. Much of the FDI inflow is for joint ventures because of noncommercial risks by offering shares to local partners.

Most of the FDI in Nepal is Greenfield-type investment rather than acquisition. FDI is highly concentrated in the manufacturing sector, which accounted for slightly more than 45 per cent of approved FDI projects. Within the manufacturing sector, the textile and garment industry accounts for 28 per cent of total foreign investment, followed by the chemical and plastic industries at 25.3 percent. Tourism is second, accounting for almost 25 percent of total FDI projects, followed by the service sector with 20 per cent of FDI projects. Although the electricity, water and gas sector has just a few FDI projects, it ranks fourth highest in terms of the size of FDI inflow.

In total, FDI comes from 50 countries. But the scale and number of projects by each country vary considerably. Of that total, in terms of investment, India alone accounted for more than 40 per cent, followed by the United States and China. Those three countries alone account for two-thirds of cumulative FDI in Nepal. In terms of number of FDI projects, India ranks first, followed by China, Japan and the United States. Nepalese and Indian nationals do not need passports or visas when traveling between their countries. Similarly, the Indian currency is freely convertible in Nepal. A special relationship with India regarding preferential trade arrangements also provides an additional incentive to Indian investors.

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Legal and Institutional Framework

Nepal cannot be far from the benefits of Foreign Direct Investment (FDI). So Nepal has been given priority for the attraction of FDI and its development by different polices and rules in national and international level to promote foreign investment and technology transfer for making the economy viable, dynamic and competitive through the maximum mobilization of the capital, human and other natural resources.

Global level

Today, Nepal is one of the most liberalized countries in the South Asian region. However, growth performance has been very poor in recent years. In this context, a closer examination of the linkages between foreign direct investment and growth is critically important from a policy point of view. There are highly liberal FDI and GDP-related policies supplemented by important Acts. In the aftermath of liberalization that began in the early 1990s, FDI increased substantially. However, that could not be sustained for long. After becoming a World Trade Organization (WTO) member in 2004, Nepal has been pursuing further opening up and liberalization policies on the FDI. Nepal is also a member of the South Asian Preferential Trade Arrangement (SAPTA) and the Bay of Bengal Initiative for Multi-Scrotal Technical and Economic Cooperation-Free Trade Area (BIMST-EC FTA). New initiatives on FDI have been taken with the aim of enhancing sustained growth and reducing poverty.

Incentive Level

Although the Government of Nepal is open to foreign direct investment, implementation of its policies is often distorted by bureaucratic delays and inefficiency. Besides this, Nepal is still facing some problems for FDI because of
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lack of direct access to seaports, difficult land transport and lack of trained personnel, scarce raw materials, inadequate power insufficient water supply, nontransparent capricious tax administration inadequate and obscure commercial legislation, and unclear rules regarding labor relations.

In the pre-liberalization period, the investment regime was more restrictive. Investors had to obtain a government license before undertaking any production and business activities. The FDI was almost nil before 1980. Although some attempts to liberalize the investment policy were made from the beginning of the 1980s, it was speeded up only after 1990. To ensure investment, both domestic and foreign, the Government adopted various liberal policies, which are still in operation. These policies include the Industrial Policy, 1992, Industrial Enterprises Act, 1992 (first amendment, 1997), Foreign Investment and One-window Policy, 1992, the Foreign Investment and Technology Transfer Act, 1992, the Finance Act of 2002 and the recent Finance Ordinance 2004 (an annual budget act); the Immigration Rules of 1994; the Customs Act of 1997; the Industrial Enterprises Act of 1997; the Electricity Act of 1992; and the Patent, Design and Trademark Act of 1965. In a positive development, Nepal passed the Copyright Act in 2002 etc.

Development Level

Nepal is trying to attract FDI with the different rules and policies. Besides this, FDI has been involved in every five year‘s Government plan and also some institutional arrangements for FDI promotion have been implanted for its development.

In the recent decade, Nepal is well coming FDI and has been benefited .Some of the literature suggests that the FDI inflows have a positive impact on economic growth of host countries and other literature suggests not at all. However, FDI in itself is not a development but may act as a catalyst for the needed progress and therefore, warrant further study.
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2.6.1 Key policies of the Government of Nepal (GoN) for promoting foreign investment • Foreign investment will be encouraged in sectors such as hydropower, tourism, agriculture and non-timber based high value products, development of education and health-related facilities, financial services, information technology and biotechnology related industries. • FDI will be encouraged in export oriented industries, natural resources excavation, construction of tool roads and construction of goods management and terminal. • Individual interested in investing in the development of infrastructure for dissemination of employment technology, compatible with the existing economic structure, will be encouraged. • • • An appropriate policy will be adopted to attract capital, skills, efficiency, and technology of non-resident Nepalese. Nepalese diplomatic missions abroad will be mobilized to promote foreign investment. A high level investment promotion board will be established to facilitate foreign investment. This board will function as a ‘one-window’ shop for meeting the requirements of projects • • Opportunities will be provided to international oil companies for the exploration of petroleum at feasible locations. Effort to facilitate the entry of foreign investment and technology in the areas of comparative advantage and priority sectors will be made by creating an investment-friendly environment (DoI,2009) 2.6.2 Key policies of the Government of Nepal (GoN) on the industrial sector • Necessary amendments will be made in the policies related to industry, foreign investment and trade.
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• •

Procedure will be simplified to attract foreign investment and to establish new business. The government will be extend support for the promotion, identification and development of products having comparative advantage in areas such as hydroelectricity, herbal production and processing, organic farming, information technology and medicines.

• • • •

An industrial security force will be constituted incorporating the private sector for better industrial security. Multinational companies will be invited for the exploration and extraction as well as production of petroleum products. A law relating to special economic zones (SEZs) will be enacted. SEZs will also be developed in Jhapa ,Dhanusa, Birgung, panchkhal, Jumla and Dhangadi to accelerate the establishment of infrastructural industries to enhance Nepal’s export capacity as well as increasing industrial processing of local resources.

The government will reform Nepal Industrial Development Corporation (NIDC) as it is in a state of inaction due to inadequate capital and weak management.

• • •

The government will take initiative to establish infrastructure banks with the involvement of the private sector. Load-shedding will be ended in industrial corridors. The government will make available public and barren land on long – term lease to the private sector to establish dairy industries, amusement parks, tourist rest houses and resorts, hotels, universities and technical institutes with their investments.

To reduce dependence on petroleum products, industries locally producing biodiesel and using widely available plant Sajivan (Zatropha) and mixing ethanol in petrol by up to 10 percent will be encouraged. (DoI,2009)

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International Relations

Nepal foreign policy is guided by the principles enshrined in the Charter of the United Nations (UN) and the Non- Aligned Movement. As such, Nepal enjoys cordial relations with all countries of the world. This is manifested by her diplomatic relations with 128 countries, maintained though twenty-six residential embassies, three consulates and numerous honorary consul generals or consulates abroad. Similarly, twenty- two embassies, consulates, cooperation offices, country representatives of various international organizations, including the UN, World Bank, International Monetary Fund (IMF) and Asian Development Bank (ADB) , based in Kathmandu, have made significant contributions to help Nepal achieve its foreign policy and economic development goals. Economic diplomacy has been adopted as another significant dimension of Nepal’s foreign policy priorities in recent years. Its main objectives are to promote Nepal’s export trade, attract greater number of tourist to Nepal and enhance the flow of foreign direct investment (FDI) in to the country.

Nepal attaches considerable importance to the promotion of close economic cooperation in South Asia. Towards this end, it is actively working with other members of the South Asian Association for Regional Cooperation (SAARC) for the realization of South Asian Free Trade Area (SAFTA), and is also engaged in sub-regional cooperation in the form of the South Asian Growth Quadrangle (SAGQ), comprising, among others, Bangladesh, Bhutan and India. Nepal has also been a member of the Bay of Bangle Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC). Nepal acceded to the World Trade Organization (WTO) in 2004. Nepal has been member of the UN and its specialized agencies since 1966 and World Bank and IMF.

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2.6.1 Investment and Repatriation

2.6.1.1 Investment
Foreign investment may invest part of their equity capital in the form of either a convertible foreign currency acceptable to Nepal Rastra Bank, the central bank of Nepal, through proper banking channel or plant, machinery and equipment required for the approved industry. For investment in the form of plant and machinery, prior approval of the DoI is a must. Indian national may invest in Indian currency through proper banking channel.

Equity investment in Cash

Foreign investment must be brought inside Nepal only after obtaining the approval of the DoI. It is also necessary that the investment is brought inside the country only through proper banking channel and that the foreign investor or industry maintains the documentary proof of the investment brought-in. This proof must be produced at the time of repatriation.

Equity investment in Kind

If the foreign investor wants to invest in the form of plant, machinery and equipment, it must be clearly stated in the joint venture agreement. While opening a letter of credit to this effect, approval of the DoI must be obtained before the shipment. This is essential for custom clearance of the goods imported. For such approval, the company or the industry must submit to the DoI a copy of resolution of board of directors, along with the original manufacturer’s detailed invoice of machinery, indicating the quantity and the price of each unit of equipment. In any case, the supplier must guarantee that the price of the machinery is competitive, and it must be supported by the manufacturer’s invoice.

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Loan investment in Cash

If the foreign investment is in the form of a loan to an industrial firm or company, an agreement must be entered into by the investing foreign party and the Nepalese industry, stipulating the terms and conditions, including the amortization schedule and interest. Approval of the agreement must be obtained from the DoI before transferring the loan. Such loan amount must be brought through proper banking channel.

Loan investment in Kind

If industry wishes to obtain a foreign loan in the form of machinery and equipment or in deferred credit, an agreement to that effect must be entered into, stipulated the price of the plant and machinery, interest rate, mode of payment, along with a detailed list of the plant and machinery. Approval of the DoI must be duly obtained. The supplier must guarantee as to the competitiveness of the price of the machinery, and it must be supported by the manufacturer invoice. If no letter of credit is opened, approval of the DoI must be obtained before the shipment for the custom clearance. In case the machinery to be imported as part of investment is a second-hand one, a valuation and certificate of guarantee by an independent surveyor must be attached.

2.6.1.2 Repatriation
The foreign investment and technology transfer act 1992 allows foreign investor investing in a foreign currency to repatriate the following amounts out of Nepal: • • • Income from the sale of the share of foreign investment as a whole or part thereof Profit or dividend from foreign investment Payment of principal and interest on foreign loans
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Income from the agreement for transfer of technology in such currency as set forth in the agreement concerned approved by the DoI.

A foreign national who is working in an industry with prior approval of the Department of Labor and who is from a country where convertible foreign currency is in circulation may repatriate his/her salaries, allowances and emoluments in convertible foreign currency in an amount not exceeding 75 per cent of such salaries, allowances and emoluments.

To obtain the repatriation facility, the foreign investor or technology supplier or expatriate or the company concerned must obtain recommendation from the DoI.

Repatriation of sale of shares

For the repatriation of the amount earned from the sale of shares, the foreign investor or company concern should apply to the DoI, along with the following documents, for recommendation to Nepal Rastra Bank: •

Proof of investment made and number of shares owned (the proof of investment could be certificate from the commercial bank through which the investment was brought into Nepal.

Letter from the company certifying the completion of the transfer of the shares in question with the certification of the CRO or such an authorized body.

• • • •

Prior approval of the DoI, if the share was transferred to a foreign national Tax clearance certificate Custom declaration form and the approval letter if the investment was made in the form of plant, machinery and equipment Copy of board of directors’ resolution

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Repatriation of Dividend

A foreign investor wishing to repatriate his/her dividend from his/her investment as per the Foreign Investment and Technology Transfer Act 1992 has to obtain the recommendation of the DoI. For this, the foreign investor or company has to apply to the DoI, along with the following documents •

Documentary proof of investment, issued by a commercial bank. This document is needed only for the first time and again only when further investment is made by the investor.

• • • •

Custom declaration certificate for the import of plant, machinery and equipment, if the investment is in the form of capital equipment, Auditor’s report, including balance sheet and profit and loss account, Tax clearance certificate, and Proof of dividend declaration

Repatriation of Loans and Interest

The industrial unit with foreign loan has to apply to the DoI for sending out the principal and interest on foreign loan obtained with the approval of the DoI, along with the following documents: • • • • Certificate from the commercial bank regarding the transfer of loan amount into Nepal. Custom declaration certificate and invoice of the plant and machinery, if the loan was obtained in the form of machinery Letter of approval of the loan agreement, and Tax clearance certificate.

Income tax on interest on foreign loan should be deducted at source as per the prevailing law and is to be deposited at the tax office

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Repatriation of Technology Transfer Fee

The industrial unit with approved technology transfer agreement, trademark license agreement, management agreement, technical assistance agreement, etc can apply to the DoI for the transfer of fees as per the agreement. The company has to submit the calculation of the amount due to the foreign technology supplier, certificate by the auditor, along with the certificate of payment of income tax on royalty as per the prevailing tax rate.

Repatriation of Salaries and Allowances of Expatriates

For the repatriation of the salaries, allowances and emolument received by an expatriate, the industry has to apply to the DoI for the recommendation, along with the following documents: • •

Work permit issued by the Department of Labor Document showing the salaries and allowances received during the period for which repatriation is sought.

2.7 Concluding Remarks

The review of global, regional and Nepal’s FDI and trade reveals clear patterns and trends. The global environment of FDI and trade suggests a conducive environment if competitive one. The tremendous growth in the global FDI and trade as revealed by the data is testimony to this. On the one hand the trend and patterns for Nepal is erratic, negative and declining, which is contrary to and reverse of the global trends and patterns. This appears to suggest that the world economy is moving in one direction and Nepal in other. The reasons are not hard to differentiate. For private capital flows and FDI, Nepal has yet to create minimum and necessary preconditions that would attract private capital flows and FDI. To reverse this
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balance of trade gap, Nepal must create products and explore niches that have competitive advantage in the regional and global market. Failure to do so will lead to further marginalization in a competitive global economy of the 21st century. Instead of share of the pie of the global prosperity, Nepal may find itself bottom of the marsh of poverty.

Some causes of poor state of affair of FDI in Nepal are as follows: •

The government has announced FITTA in 1992, to attract foreign investment. The act is not clear on the definition of foreign investments and technology transfers.

Recent political disturbances have even threatened bilateral and multilateral development projects. With growing political instability the government has failed to control it. The disturbances have instead spread throughout the country. This is a serious problem in attracting FDI.

Nepal is suffering from lack of capital and advanced technology. FDI is an important source of bringing in capital and technology in a country.

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CHAPTER III METHODOLOGY

3.1 Introduction
When a particular research area has been identified, research problem defined, and the related literature in the area have been reviewed; the next foremost step towards the objective is to set research methodology.

Research methodology is the process of arriving at the solution of the problem through planned and systematic dealing with the collection, analysis and interpretation of facts and figures.

Research is a systematic and organized effort to investigate a specific problem that needs a solution (Sekaran, 1992). This process of investigation involves a series of well-thought-out activities of gathering, recording, analyzing and interpreting the data with the purpose of finding answers to the problem. Thus, the entire process by which we attempt to solve problems or search the answers to questions is called research.

Research is undertaken not only to solve a problem existing in the work setting, but also to add or contribute to the general body of knowledge in a particular area of interest to the researcher, research is thus a knowledge building process. It generates new knowledge, which can be used for different purposes. It is used to build a theory, develop policies, support decision-making and solve problems. With the opening of new frontiers of knowledge through research, new concepts and theories are developed to explain, verify, and analyze the social phenomena.

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The basic objective of this study “Foreign Direct Investment in Nepal: Patterns and Prospects” is to focus how foreign direct investment’s patterns is in Nepal and its future prospects.

3.2 The Research Design
The research approach is regularly either quantitative or qualitative. Selectivity and distance to the purpose of research characterize a quantitative approach where as a qualitative approach is characterized by closeness to the object of research. Both approaches have their strength and weaknesses and neither one of the approaches can be held better than other one. The best research method to use for a study depends on that studies research purposes and the accompanying research question (Yin 1994).

Based in the problem of the statement of this study above, the researcher gives better understanding of the research area, so it will get detailed information to describe the understanding of the objective of the research. It will use the frame of reference and aim to gain a deeper understanding of this phenomenon as well as analyze the data in the form of numbers statistically. This research is based on both quantitative and qualitative data. The description of the situation of FDI in Nepal, the historical background of FDI and account of different opinions of experts on FDI are all qualitative information. While the numerical data of inflows of FDI in South Asia, SAARC countries and Nepal as well the graphic representation of facts and figures are the quantitative information. So both qualitative and quantitative will be author inclination.

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3.3 Data Collection
Data may be obtained from several sources. However documentation, archival records, direct observations, interviews, questionnaires, participant observations etc are few of methods of data collection. Within the scope of research, author will use email, formal interviews, and other observation (interaction with website) as source of data collection. There are two source of data collection.

3.3.1 Source of Secondary Data

Secondary data are those, which have already been collected by someone else and have padded the statistical process. The secondary data are gathered in the form of World Bank Reports, UNCTAD reports, data from Department of Industry ,economic reports, various articles and publication dealing in the subject matter of the study, websites etc. The researcher has mostly depended upon the secondary source for the collection of data.

3.3.2 Source of Primary Data

Primary data are those, which are collected fresh and for the first time and thus happen to be original in character. For the collection of primary data, structured open-ended interview was taken in the various economists of the country based on the previous literature. The interview carried out where more or less a ‘free-floating conversation’ where a number of areas were covered. The information received from the interview are analyzed and presented in different chapter.

3.4 The Population and Sampling
Sampling is done to draw conclusion from the whole population. The population refers to the industries of same nature, services and product in general. The research
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is concentrated on the study of trend of inflows of foreign investment from 2001 onward till date. Purposive sampling was conducted due to time constraint with selective economist.

3.5 Data Gathering Procedure
The researcher has collected the annual trend of FDI inflow from Department of Industry and other related books. Primary data has been collected through formal interviews and reviews of literature. On some aspects, data has also been collected from the World Bank websites and reports.

3.6 Data Analysis
The goal of analyzing the data is to handle the evidence fairly, to produce convincing logical conclusion and to rule out alternative interpretations. Data analysis involves turning a series of recorded observation into descriptive statements (Yin 1994). Therefore, after the data is collected from different sources, the next step is to process, analyze and interpret them to drive meaningful conclusion.

The various data collected from different sources have been compiled condensed, analyzed and presented in the form of tables and diagrams, graphs and chart with the help of Microsoft Excel.

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CHAPTER IV PRESENTATION AND ANALYSIS OF DATA
In this chapter we analyze the data after converting the unprocessed data into an understandable form. The chapter covers particularly patterns and prospects of inflow of FDI in Nepal that has been analyzed into year wise and sector wise from 2001 to 2008. This chapter also presents the available facts and reviews related to foreign direct investment in South Asia and SAARC countries and analysis in context of Nepal.

4.1 Global Foreign Direct Investment
Both developed and developing countries have been attracting FDI by offering several incentive packages and concessions to foreign investors. The developing countries particular have been making extra efforts to create an environment, which is conducive for attracting such investment. In order to attract FDI on large scale, governments have taken several steps to remove the barriers and irritants, which hinder the flow of investment.

The global FDI flow in 1980 was around US $699 billion. IN 2007 it rose to US $ 1.833 trillion. Thus, almost a threefold increase has been recorded over a period of two and half decades. The high growth of global FDI flow can be attributed to increase to increase merger and acquit ions activity and higher share prices. The global macroeconomic situation during 2000-2007 also provides a favorable climate for expansion of FDI. The details of the global FDI are presented in the following table.

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Table No 1 Global FDI Inflows FDI Inflows Groups of Economics World Developed economies Europe North America Other Developed economies Developing Economies Africa Latin American and Caribbean Asia and Oceania South, East and South-East Asia Least Developed Countries 2005 958697 611283 505473 131740 -25930 316444 29459 76412 210572 167404 7142 2006 1411018 940861 599327 299466 42069 412990 45754 92945 274291 208902 12816 2007 1833324 1247635 848527 341494 57615 499747 52982 126266 320498 247840 13375

Source: UNCTAD, 2008

The US and Western European countries have continued to dominate as recipient of world FDI. Among emerging market, China is by far the main recipient of FDI flows.

The UNCTAD estimates of 2008 indicate the global FDI are expected to decrease by 10 percent in 2008 owing to the ongoing financial turmoil and consequent liquidity crunch. The global financial turmoil would impact the growth in merger and acquisitions (M&A) deals in the coming years. Hence, the global FDI outlook in the medium term doesn’t seems impressive as fund flow could be affected by the continued slowdown in growth and difficult market conditions in developed countries. However, UNCTAD estimates that the FDI flow to developing countries would remain largely stable.

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4.2 FDI to SAARC and Southeast Asia

The share of LDCs in the global FDI is very small. In 1980, the share of these countries in the global FDI was US $ 3 billion. In 2008, this increased to US$ 50 billion. Among the developing countries, countries like China, Egypt, Mexico, Malaysia, Argentina, Russia, and so on take the higher share. The share of the South Asian countries is very negligible. The FDI inflow in South Asian countries is given in the following table.

Table 2 FDI to South Asia and South-East Asia
Region South Asia Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka South-East Asia Brunei Cambodia Indonesia Laos Malaysia Philippines Singapore Thailand Viet Nam China FDI Inflows 2005 2006 12136 25780 273 242 845 793 9 6 7606 19662 9 14 2 -7 2201 4273 272 480 39091 51243 289 434 381 483 8337 4914 28 187 3967 6048 1854 2921 13930 24743 8048 9010 2021 2630 74406 72715 Source: UNCTAD 2008 2007 30620 288 666 78 22950 15 6 5333 529 60514 184 867 6928 324 8403 2928 24137 9575 6739 83521

Cross regional comparisons indicate that South Asia’s share of total FDI to developing countries is relatively very small. The share of South Asian countries in the global FDI was only US $31 billion in 2008. Of this too, India has taken about
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75 percent. So far India, Pakistan and Sri lanka are the largest percipient of FDI in South Asia. The other South Asian countries like Nepal, Maldives, and Bhutan have not been able to attract enough FDI despite several economic reforms and incentives.

All of the countries in South Asia tried to encourage FDI more aggressively in the 1990s, by making changes in their macroeconomic policies along with FDI and trade policies. As discussed in chapter 13, most of these countries have liberalized equity restrictions on FDI in the service sector. One hundred percent equity is allowed in many service sectors.

Of the limited FDI coming to South Asia, the manufacturing, energy and service sectors occupy the lion’s share. A relatively small portion of FDI has gone to export-oriented sectors. These trends toward the globalization of production.

South Asia relies on external resources for its economic development. With the decline in foreign aid, there is an emphasis on the role of FDI and foreign portfolio investment as channels of non debt creating flows of external resources. However, a number of challenges remain. Structural weaknesses, institutional bottlenecks, political movements, narrow nationalism and mutual mistrust are some of the factors that explain the failure of the region to exploit possibilities.

4.3 Foreign Direct Investment in Nepal
FDI in developing counties like Nepal seems to be a new terminology and issues. However, historical records and literature present its long history stating that FDI isn’t new phenomenon.

Nepal is the poorest of the poor country in the world with the per capita income of $300 per annum. In this situation, FDI has become a hope to Nepal for economic
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development. Today, almost all developing countries are trying to attract foreign direct investment with objectives of getting access to foreign capital, technology and market. Similarly, Nepal is no different than other countries. Nepal started its effort to attract foreign investment since early 1980s during the sixth plan (1980-1985). The industrial policy of 1981 has made a separate provision relating to foreign investment. In order to make legal provision relating to foreign investment. In order to make legal provision for a promotion and for the regulation of the foreign investment and technology a separate act entitled “foreign Investment and Technology Act 1981 (2038)” has been introduced in 1992. The act was again reviewed and a new act entitled “Foreign Investment and Technology Transfer Act (FITTA), 1992. After the policy reform it has been able to attract FDI from abroad (USA, EU, India, Japan etc) in different sectors.

The rules and regulations given by FITTA amended in 1996 prohibits foreign investment in certain areas like cottage industries, real estate business, travel and trekking business agency, poultry farming, fisheries, beekeeping and consultancy services such as management, accounting, engineering, and legal services. This act restricts potential competition from foreign competitor.

Although Government of Nepal (GoN) is open to foreign direct investment, implementation of its policies is often distorted by bureaucratic delays inefficiencies. Nepal has attracted modest FDI in niche sector such as tourism, manufacturing (apparel) and mineral deposits (limestone). The investment is mainly in low technology, labor intensive production. This impact of FDI has also been modest, primarily in job creation. Foreign affiliates have imparted skills to local employees, and in a few instances have introduced new export products and upgraded technology.

Though the inflow of FDI in Nepal started during 1980s but the flow started gaining momentum from 90s with start of economic policy reform and formulations of new Industrial Enterprises Act and FITTA at the same period. Nepal observed a steady
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growth during the initial years of liberalization; however, it is declining during last couple of years. The most influential factors are policy and political environment for the growth of the FDI for a particular nation. These are the necessary condition to attract the inflow of the FDI within the country. The otherwise cases seem to be ineffective for the fact that incentive and motivations are the prerequisite for the investors to invest. Generally the trend of FDI should be increasing to achieve and sustain economic growth.

However, statistics of FDI inflow in developing countries like Nepal is not appreciable level, expected level impacts. Therefore, it is most critical issue in aspect of its size and growth and impacts.

4.4 A Pattern Study of FDI in Nepal
Structural analysis is an important method for analyzing the trend of FDI in depth. An inflow of FDI from 2000 to 2008 has been explained into two groups. They are year wise and sector wise accordingly

4.4.1 Year Wise FDI Project in Nepal

The table 3 presents no of industries approved for foreign investment from the year 2046 to fiscal year 2064/2064. These data are taken from the “Industrial Statistics” which is published by the Department of Industries (DoI) each year.

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Table No. 3 Number of industries approved for foreign investment Number of industries approved for foreign investment by Fiscal year (up to fiscal year 2064/65 FNM) No. of Total Total fixed Foreign Total Fiscal Year Industries Project Cost Cost Investment Employment up to Ashad 2046 59 5425.92 4581.82 466.84 10586 2046/47 30 2438.19 2139.6 398.51 9515 2047/48 23 863.56 690.74 406.28 2974 2048/49 38 3508.17 2902.1 597.84 5615 2049/50 64 17886.22 16210.81 3083.67 13873 2050/51 38 3733.23 3175.66 1378.76 4734 2051/52 19 1627.28 1247.85 477.59 2386 2052/53 47 10047.47 9398.54 2219.86 8032 2053/54 77 8559.25 6692.15 2395.54 9347 2054/55 77 5569.38 5142.32 2000.28 4336 2055/56 50 5324.42 4380.17 1666.42 2146 2056/57 71 2669.09 1910.24 1417.61 4703 2057/58 96 7917.62 6122.49 3102.56 6880 2058/59 77 3318.53 1559.59 1209.65 3731 2059/60 74 4921.82 3608.25 1793.77 3572 2060/61 78 4323.74 3775.86 2764.8 2144 2061/62 64 1801.1 1150.89 1639.52 5576 2062/63 116 4121.08 3296.95 2606.31 7358 2063/64 188 3425.57 2650.56 3226.79 7389 2063/64 FNM 121 2690.21 2123.54 2453.12 5398 2064/65 FNM 139 16057.59 13664.93 7968.1 6604 Total 1423 113211.1 93989.88 40799.68 121484

Source: DoI, 2008

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Figure No. 1 Number of industries approved for foreign investment
Figure1 depict the trend of number of industries approved for foreign investment, we can find that there is not the constant trend some time it goes up and some time it goes down but in average the number of industries is increasing year by year. Nepal can attract more industries in coming days if it focuses to improve the determining factors like private property rights, infrastructure, regulation, tax rates, corruption transparency etc.

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Figure 2 Number of employment approved for foreign investment

In average no of industries is increasing year by year but the no of employment people are decreasing. The reasons behind it may be lack of skilled manpower and brain drain etc. Most of the companies which are invested by the foreign investors, are hiring foreign workers. In such scenario Nepal has to focus in technical and practical education, develop the policies to retain skilled and educated manpower to reduce the rate of brain drain as well as to focus in establishing the stable business environment.

4.4.2 Sector Wise FDI Project in Nepal

Table Foreign Investment Projects in Nepal- Sector wise from the beginning to (FY 2064/2065 FNM) (Rs in Million)

Table 4 Number of Industries Registered by Categories up to FY 2064/2064
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Categories Agro-Based Construction Energy Based Manufacturing Mineral Service Tourism Total

No of Industries 24 35 26 572 5 393 368 1423

Total Project Costs 525.85 3026.54 26660.42 42434.76 2436.02 21179.05 16948.45 113211.10

Total Total No of Fixed Cost Employment 446.49 1344 2286.36 2647 24947.36 5477 30765.34 69426 1980.70 1461 17558.97 22170 16004.66 18959 93989.88 121484

Figure 3 Number of Industries Registered by Categories

As we know that Nepal can attract more FDI in agro-Based, energy based and tourism industries than other sectors but here more investment is invested in manufacturing and service industries.

Table 5 Number of Industries Registered by Scale
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Number of Industries Registered by Scale (FY 2064/2065)
Scale No of Industries Total Project Costs Total Fixed Cost Total No of Employment

Large Medium Small Total

141 196 1086 1423

85621.41 14052.98 13536.71 113211.10

75493.92 10037.37 8458.58 93989.88

36232 25859 59393 121484

Figure 4 Number of Industries Registered by Scale

Though Nepal can attract foreign investment in large and medium scale projects, from the above chart we can identify that most of the foreign direct investment is belong small industries. The main reason behind this may be the Government of Nepal is not being able to establish the amicable and stable business environment to attract foreign investor as well as the foreign investment and technology transfer act is not clear and suitable to foreign investment.

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4.5 Nepal Goes From Bad to Worse

The Washington DC- based fund for Peace has fired yet another warning shot: Nepal has slid several points below its Failed State Index (FSI) this year compared to the previous year.

In its fifth annual FSI released recently, the Washington DC-based research organization has listed Nepal among the worst 38 countries, ranking it 25th. The level of statelessness in the 38 countries send “warning” signal, according to fund for peace. While countries such as Iraq and Kenya are seems to progressive, Nepal’s positions in the 2009 index (95.4) is deteriorating compared to the 2008 index (94.2) the study states.

Nepal stands in the category that includes countries like Somalia, Zimbabwe, Sudan, Iraq, Afghanistan, Pakistan and North Korea, which make up the list of worst governed countries reeling under conflict, corruption, poverty, impunity, and statelessness. Countries like Norway, Finland, Sweden, and Switzerland, which ranked 177th, 176th, 175th and 174th respectively are seen a best governed.

Table 6 Failed State Index (FSI) Demographic Pressure Refugees & Displaced Person Group Grievance Human Flight Uneven Development Economy Legitimacy of the State Public Services Human Rights Security Apparatus Functionalized Elite External Intervention Total Source: FSI, 2009 2008 B. 1 5.5 9 6.1 9.2 8.2 8.3 7 8.8 8.5 8.3 7.2 94.20 2009 B. 5 4.8 9.2 6 9.2 8.5 9.2 6.2 9.1 9 9 6.7 95.40

Social

Economic

Political and Military

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The study has attributed Nepal’s worsening condition to social, economic and political indicators such as weak and ineffective government, external intervention, economic decline poverty and widening inequality, impunity, deteriorating rule of law, violation of human rights and corruption.

Most indicators used to gauge Nepal’s status in the 2009 index show deteriorating governance. For instance, there is no let up in external intervention, which is as high as it was in 2008. The gap between poor and rich continues to widen to and the country’s overall economy shows a downward spiral.

4.6 Doing Business in Nepal
Nepal is ranked 121 out of 181 economies. Singapore is the top ranked economy in the Ease of Doing Business

Table 7 Nepal's Ranking in Doing Business 2009 Rank Doing Business 2009 Ease of Doing Business 121 Starting a Business 73 Dealing with Construction Permits 129 Employing Workers 150 Registering Property 28 Getting Credit 109 Protecting Investors 70 Paying Taxes 107 Trading Across Borders 157 Enforcing Contracts 121 Closing a Business 103 Source: “Doing Business 2009”, World Bank.

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4.6.1 Summary of Indicators – Nepal

Table 8 Summary of Indicator of Nepal's Ranking in Doing Business 2009 Summary of Indicator Procedures (number) Duration (days) Cost (% GNI per capita) Paid in Min. Capital (% of GNI per capita) Starting a Business Procedures (number) Dealing with construction Duration (days) Permit Cost (% of income per capita) Difficulty of Hiring Index Rigidity of Hours Index Difficulty of Firing Index Rigidity of Employment Index Employing Workers Firing costs (weeks of salary) Procedures (number) Duration (days) Register Property Cost (% of property value) Legal Rights Index Credit Information Index Public registry coverage (% adults) Getting Credit Private bureau coverage (% adults) Disclosure Index Director Liability Index Shareholder Suits Index Protecting Investor Investor Protection Index Payments (number) Time (hours) Profit tax (%) Labor tax and contributions (%) Other taxes (%) Paying Taxes Total tax rate (% profit) Documents for export (number) Time for export (days) Cost to export (US$ per container) Documents for import (number) Time for import (days) Trading Across Border Cost to import (US$ per container) Procedures (number) Duration (days) Enforcing Contracts Cost (% of claim)
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7 31 60.2 0 15 424 248.4 56 0 70 42 90 3 5 6.3 5 2 0 0.2 6 1 9 5.3 34 408 20.3 11.3 2.5 34.1 9 41 1764 10 35 1900 39 735 26.8

Time (years) Cost (% of estate) Closing a Business Recovery rate (cents on the dollar) Source: “Doing Business 2009”, World Bank

5 9 24.5

Starting a Business

Nepal is ranked 73 overall for Starting a Business. When entrepreneurs draw up a business plan and try to get under way, the first hurdles they face are the procedures required to incorporate and register the new firm before they can legally operate. Economies differ greatly in how they regulate the entry of new businesses. In some the process is straightforward and affordable. In others the procedures are so burdensome that entrepreneurs may have to bribe officials to speed the process or may decide to run their business informally.

Dealing with Construction permit
Nepal is ranked 129 overall for Dealing with Construction Permits. Once entrepreneurs have registered a business, what regulations do they face in operating it? To measure such regulation, Doing Business focuses on the construction sector. Construction companies are under constant pressure; from government to comply with inspections and with licensing and safety regulations and from customers to be quick and cost-effective. These conflicting pressures point to the tradeoff in building regulation; the tradeoff between protecting people (construction workers, tenants, passersby) and keeping the cost of building affordable. Striking the right balance is a challenge when it comes to construction regulations. Good regulations ensure safety standards that protect the public while making the permitting process efficient, transparent and affordable for both building authorities and the private professionals who use it. If procedures are overly complicated or costly, builders build without a permit, leading to hazardous construction.

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Employee Working

Nepal is ranked 150 overall for Employing Workers. Economies worldwide have established a system of laws and institutions intended to protect workers and guarantee a minimum standard of living for its population. This system generally encompasses four bodies of law: employment, industrial relations, social security and occupational health and safety laws. Doing Business examines government regulation in the area of employment.

Registering Property

Nepal is ranked 28 overall for Registering Property. Formal property titles help promote the transfer of land, encourage investment and give entrepreneurs access to formal credit markets. But a large share of property in developing economies is not formally registered. Informal titles cannot be used as security in obtaining loans, which limits financing opportunities for businesses. Many governments have recognized this and started extensive property titling programs. But bringing assets into the formal sector is only part of the story. The more difficult and costly it is to formally transfer property, the greater the chances that formalized titles will quickly become informal again. Eliminating unnecessary obstacles to registering and transferring property is therefore important for economic development.

Getting Credit

Nepal is ranked 109 overall for Getting Credit. Firms consistently rate access to credit as among the greatest barriers to their operation and growth. Doing Business constructs two sets of indicators of how well credit markets function: one on credit registries and the other on legal rights of borrowers and lenders. Credit registries, institutions that collect and distribute credit information on borrowers, can greatly expand access to credit. By sharing credit information, they help lenders assess risk and allocate credit more efficiently. And they free entrepreneurs from having to rely
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on personal connections alone when trying to obtain credit. Three indicators are constructed to measure the sharing of credit information:

Protecting Investor

Nepal is ranked 70 overall for Protecting Investors Companies grow by raising capital, either through a bank loan or by attracting equity investors. Selling shares allows companies to expand without the need to provide collateral and repay bank loans. But investors worry about their money, and look for laws that protect them. A study finds that the presence of legal and regulatory protections for investors explains up to 73% of the decision to invest. In contrast, company characteristics explain only between 4% and 22%. Good protections for minority shareholders are associated with larger and more active stock markets. Thus both governments and businesses have an interest in reforms strengthening investor protections. To document some of the protections investors have, Doing Business measures how economies regulate a standard case of self-dealing, use of corporate assets for personal gain. Paying Taxes

Nepal is ranked 107 overall for Paying Taxes. Taxes are essential. Without them there would be no money to provide public amenities, infrastructure and services which are crucial for a properly functioning economy. But particularly for small and medium size companies, they may opt out and choose to operate in the informal sector. One way to enhance tax compliance is to ease and simplify the process of paying taxes for such businesses.

Trading Across Border

Nepal is ranked 157 overall for trading across borders. The benefits of trade are well documented; as are the obstacles to trade. Tariffs, quotas and distance from large

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markets greatly increase the cost of goods or prevent trading altogether. But with bigger ships and faster planes, the world is shrinking. Global and regional trade agreements have reduced trade barriers. Yet Africa’s share of global trade is smaller today than it was 25 years ago. So is the Middle East’s, excluding oil exports. Many entrepreneurs face numerous hurdles to exporting or importing goods, including delays at the border. They often give up. Others never try. In fact, the potential gains from trade facilitation may be greater than those arising from only tariff reductions.

Enforcing Contract

Nepal is ranked 121 overall for Enforcing Contracts. Where contract enforcement is efficient, businesses are more likely to engage with new borrowers or customers. Doing Business tracks the efficiency of the judicial system in resolving a commercial dispute, following the step-by-step evolution of a commercial sale dispute before local courts. The data is collected through study of the codes of civil procedure and other court regulations as well as through surveys completed by local litigation lawyers (and, in a quarter of the countries, by judges as well). Closing Business

Nepal is ranked 103 overall for closing a Business. The Doing Business indicators identify weaknesses in the bankruptcy law as well as the main procedural and administrative bottlenecks in the bankruptcy process. In many developing countries bankruptcy is so inefficient that the parties hardly ever use it. In countries such as these, reform would best focus on improving contract enforcement outside bankruptcy. The data on closing a business are developed using a standard set of case assumptions to track a company going through the step-by-step procedures of the bankruptcy process. It is assumed that the company is a domestically owned, limited liability corporation operating a hotel in the country’s most populous city. The company has 201 employees, 1 main secured creditor and 50 unsecured creditors.
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Assumptions are also made about the debt structure and future cash flows. The case is designed so that the company has a higher value as a going concern—that is, the efficient outcome is either reorganization or sale as a going concern, not piecemeal liquidation. The data are derived from questionnaires answered by attorneys at private law firms.

To sum up from this chapter, the data on regional and Nepal’s foreign direct investment trends starkly reveal that Nepal, so far, doesn’t figure on the global map. Nepal has not even met the necessary preconditions for FDI and has a long way to go to make the environment investor friendly. It is therefore imperative that Nepal creates the necessary preconditions for an FDI framework. The most important and necessary precondition is to create “stability in the business environment”, an investment climate. With stability in the environment other condition must follow. They are: political stability, policy stability price level stability, foreign exchange stability and a dispute settlement regime that is stable and transparent. Above all, it is still important for the low income developing countries like Nepal to focus more on policy factors. These will include factors. These will include factors that could integrate them into the global trading system, fiscal and non-fiscal incentives, and improvement of infrastructure, human resources development, the creation and nurturing of local entrepreneurship. All of these will have to be creating consistent with the entrenchment of suitable political and legal framework and such other conditions for productive investment and private sector participation in order to set the stage for the process of growth and development. Only when these necessary and sufficient preconditions are in place, Nepal would be in a position to attract private capital flow and foreign direct investment.

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CHAPTER V SUMMARY AND CONCLUSIONS

The final chapter focuses on the proceeding of the earlier chapter. In this chapter the researcher is going to answer the research questions and get conclusions based on the theory and analyzed the data. Major findings are illustrated which followed by the conclusion and recommendations based on the findings and experiences of the researcher.

5.1 Summary of Findings
The above chapter i.e. data presentation and analysis indicates that the Nepal has yet to appear in the global FDI map. It has not been able to meet the necessary minimum preconditions for FDI. Nepal has a long way to go to make the environment investor friendly. A developed stock exchange, full convertibility of foreign exchange or free mobility of capital and easy repatriation of profits and deregulations are some of the preconditions for FDI. These preconditions are yet to be fully achieved in Nepal.

At the same time, political instability and social and political disturbances have affected the joint venture projects already operating in Nepal. Some of such undertakings have been withdrawing their capital. For instance, the French shareholders have withdrawn their capital from the Nepal Indosuez Bank. Similarly, the Kodak Company and Colgate- Palmolive have closed down their factories at Hetauda. Many of Indian business executives running garments and carpet factories in Nepal has also closed down their operations. These recent developments appearing in the Nepalese business scenario have been a big set back to the ongoing efforts of the government to attract foreign investment. The major findings of this study are as follows:

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1. The country at present lacks any long terms vision with internal security emerging as major issues. 2. The local investors have to be encouraged and foreign participation needs to be increased with the provision of adequate incentives for income tax holidays, repatriation of investment, and if possible, constitutional guarantee for private property rights. 3. Foreign aid has to be replaced by foreign investment, especially in export promoting high technology industries. 4. Security and Maoist insurgency was not only the reason for the declining trend for foreign investment in Nepal. 5. Failure of the government mechanisms for improving degree of effectiveness in FDI utilization. 6. Natural and domestic resources should be utilized at maximum. 7. Following the global trend and trying to implement them in context of Nepal is not going to work, as Nepal presents a different economic scenario and investment environment. 8. Foreign investment in Nepal has developed a wrong perspective among the people that is dependency and long term it is very dangerous for the growth and sustainability of the country. 9. There should be division of areas so that there arise no bottleneck for being landlocked country. 10. Furthermore, the results indicate that most of the causal links are found in developing countries which experience a higher level of corruption in the form of excessive patronage, nepotism, job reservations, “favor-for-favors”, secret party funding, and suspiciously close ties between politics and business 11. The policy makers, academicians, and politician should face the present reality of Nepal and do in depths study. PEST analysis to attract and restore Foreign Investment in the country rather than make only superficial study.

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Therefore, the main reasons for the poor inflow of FDI to Nepal are unstable government policies, bureaucratic hurdles, political uncertainties, weak financial sector and unsupportive investment environment.

5.2 Conclusions
The review of global, regional and Nepal’s FDI and trade reveals clear patterns and trends. The global environment of FDI and trade suggests a conducive environment if competitive one. The tremendous growth in the global FDI and trade as revealed by the data is testimony to this. On the one hand the trend and patterns for Nepal is erratic, negative and declining, which is contrary to and reverse of the global trends and patterns. This appears to suggest that the world economy is moving in one direction and Nepal in other. The reasons are not hard to differentiate. For private capital flows and FDI, Nepal has yet to create minimum and necessary preconditions that would attract private capital flows and FDI. To reverse this balance of trade gap, Nepal must create products and explore niches that have competitive advantage in the regional and global market. Failure to do so will lead to further marginalization in a competitive global economy of the 21st century. Instead of share of the pie of the global prosperity, Nepal may find itself bottom of the marsh of poverty.

When the research was started, the reason behind declining in FDI was assumed only the political instability. But after the research, I have found so many reasons as constraints for FDI inflow in Nepal. As we know political instability is becoming one of the major constraints to attract FDI in Nepal. And in other hand there are other so many bureaucratic hurdles which are also becoming one of the major constraints. Another major problem Nepal is facing is geographical constraint by it many multinational corporations think it as another hurdle. We know that transparency and corruption less state can attract foreign investment. Because it reduces the costs for MNCs but in Nepal it is also becoming a constraint to attract
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FDI. A good financial system can also play a vital role to establish amicable environment to attract FDI but in case of Nepal the financial system is not favorable to MNCs. The cost of financing from Nepalese financial system is higher than other countries. Another major determining factor to inflow of FDI is Labor laws and policies where the labor laws are liberal and stable there FDI and MNCs want to go. Nepal is the one where labor laws are not clear and labor unions are influenced by the political parties.

While talking about the prospects of FDI in Nepal, It is clear that in a such transitional and volatile period no bilateral and multilateral projects will come to Nepal. As we know Nepal is ranked in the poorest index according to “Doing Business 2009”, World Bank. These indexes are based on 180 countries and Nepal is ranked as that. In such scenario there is the probability of no more FDI in future.

The government has now constituted the board of investment under the chairmanship of the Prime Minister. The purpose of this body is to create a amicable environment in the country including policy and legal reforms for domestic as well as foreign investment. The safety of investment would also be the prime concern of this body. The government has also announced that a Monitoring Unit would be created in the office of the Prime Minister to supervise and monitor the investment climate in the country. •

The government has announced FITTA, 1992 to attract foreign investment. The act is not clear on the definition of foreign investment and technology transfers. It has yet to modify foreign exchange regulations and tax policies.

Recent political disturbances have even threatened bilateral and multilateral development projects. With growing political instability, the government has failed to control it. The disturbances have instead spread throughout the country. This is a serious problem in attracting FDI

Social tension and unrest are likely to grow due to rising unemployment among youths. Market flourishes when there is a peace, not in the midst of
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war and unrest. Nepalese economy has vast potential to grow. It needs foreign capital, which in the presence of political instability and social unrest would shy away. • The recent approval of the Indian government to allow its citizens to invest up to IC 600 million in Nepal, without prior approval, has opened new opportunities for foreign investment areas are yet to be explored. • There is lack of proper monitoring and supervision of the registered foreign projects. Most of such projects exist only in name. They have not yet started their project construction and operations. • As there is no strict rule to register only foreign companies, any individual can apply and get registration of the projects in Nepal. Such projects are never started; the purpose of the individuals is simply to get their stay extended in Nepal.

5.3 Recommendations
With the limitation of time and resources, this research could not explore the in depth study of FDI in Nepal. It is seen that most of the scholar and policy makers of the Nepal follow the global trend and try to implement in Nepal, which is not going to work. It is found that generally superficial study is done so there is room for in depth study to attract and restore foreign investment.

Nepal is very viable place for FDI in terms of natural resources and environment. If we want we can attract more FDI in Nepal, first we must take initiation to establish the stable political environment, we should focus on good governance as we know that good governance can establish so many stable variable which helps to inward FDI. Similarly Nepal is also lacking a smooth financial system. A good financial system can also help to attract FDI. In Nepal the cost of financing is higher than other similar countries. It should be taken under consideration. Another important factor is that our bureaucratic system. As the report published by World Bank i.e.
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“Doing Business 2009” expressed that it is so tough to establish and run the business in Nepal in such scenario no investors want to invest and run the business in Nepal. In one hand we have political instability and in other hand our labor unions are controlled by the political parties. Though labor unions have to work on behalf of welfare of labors and to establish the amicable environment to operate the business, are fighting for the muscle and money and due to this so many corporations have already closed down. Now we should focus on these factors and try to make these factors better. Then it is sure that we can be in the countable position in terms and FDI and economic growth rate.

We should bear in mind that not all types of foreign investment contribute to income and employment generation. The government should selective about FDI; the government should not discriminate against domestic investors. The industries using FDI should also be evaluated in terms of their potential to create employment, promote exports, transfer technology and encourage human development friendly activities. The industries having market prospects in India and other SAARC countries have to be promoted. The extended South Asian Market after the implementation of SAFTA need to be kept in consideration in providing public support to new industries.

Only when the above mentioned necessary recommendations are improved by the Nepal Government, Nepal would be in position to attract more private capital fund and foreign direct investment.

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