September 2007
Economy & Policy

There are easy methods to turn foreign employment as a boon to Nepali economy by reducing its aid dependence.

Foreign employment was one of the five pillars---others being investment, trade, water and aid---of Nepal's newly enunciated policy (1996) of 'economic diplomacy' by then Foreign Minister, Dr. Prakash C Lohani.

It has boomed to such an extent that it has contributed a remarkable 8-9 points out of the 11 points reduction in poverty incidence achieved between 1996-2004 alone. The remaining 3-2 points is estimated to be due to rural wage rate increase, which is probably also a result of migration of which some is due to foreign employment. It has also provided macro-economic stability largely through dollar remittances which has, in turn, helped to provide the foreign exchange stability against the Indian rupee.

Otherwise, the Nepali rupee would have been devalued long, long ago in the wake of stagflation and the onslaught of rising oil prices causing severe capital flights out of the country. Foreign employment also helped to boost banking profits and stock exchange bullishness and urban land prices to keep the macro-economy afloat during the civil war years (1996-2006).

It must be underscored here that our bilateral, preferential free trade with India, and maintaining open borders with it, have also contributed to overall macro-economic stability. One advantage has been the gift of petroleum prices based on India’s highly subsidized domestic prices.

Another has been the willingness of the Government of India and the Reserve Bank of India to settle the current account disequilibrium in US dollars even though they, themselves, are flushed with surplus dollars.

The sustained stability in the remittance earnings by Nepal has made the Nepal Rastra Bank confident enough to allow private traders to import Indian world class goods paid for in US dollars, which will mean much cheaper and better quality Indian imports for consumers as well as better returns on the NRB’s own (idle?) dollar reserves being held to safeguard forex fluctuations, given its fixed exchange regime.

It has also been the real source of the government’s newly announced policy to allow partial capital account convertibility where banks and financial institutions are being permitted to venture in portfolio investments in the Indian capital market, which will lead to higher interest rates on deposits and thus a boon for savers, especially those with fixed incomes.

The greatest boon from manpower exports can come, I believe, if economic diplomacy is taken a notch further henceforth (2007-12) to use it as a strategic tool to reduce dependence on bilateral aid. How?

By opting for the utilization of the vast sums of dollars being offered (that is significantly much more than bilateral and multilateral aid put together —free of their very stringent, costly terms and conditions) as very soft investment loan (0.75% and 40 years to repay with 10 year grace period) to Nepal from Japan, Korea and, of late, China too.

When I was Finance Minister, in 2005, I had brokered the idea with the ambassadors of Korea and Japan to move from aid to investment-loans for massive infrastructure development of Nepal. Of course, they welcomed the novel idea but could not respond to my proposal to have currency exchange risks arrangements made in such a way that we barter our manpower resources to guarantee payback in their own currencies—not dollars. It would imply that they should guarantee quotas for manpower imports from Nepal and the quota should be increased and adjusted, as the need arises, for repayment and to hedge against currency risks.

While in China, the Minister of Commerce advised me that we in Nepal should come up with mega-projects rather than relying on small aid grants as they had created a Development Fund of $ 10 billion for Africa to which, we too, were most welcome.

Additionally, talking of China, Tibet’s GDP growth rate is over 20% per annum and could be more with $ 20 billion in investment planned over 2007-10. Manpower shortages will be acute. Furthermore, China is under acute pressure from IMF and US is to curtail its exports. What an opportunity if our economic diplomats can negotiate relocation of such Chinese industries to Nepal’s SEZs, EPVs, EPZs and GPZs etc.

The fundamental strategic point is this: All East Asian countries are in dire need of manpower resources and, it is anticipated that China will face huge skill deficits by 2010 and India by 2015. All grand opportunities for Nepal, provided we engage in another kind of planning— integrated manpower and educational planning by looking at national, regional and global prospects for science, engineering, technology skills. By the way, a Deemed University Act is eminently needed. It would give a new thrust for economic diplomacy with far reaching consequences nationally—making Nepal as the supreme educational hub of South Asia.

NEPVCF for Second Generation challenge of migration

Many private centres of learning, established throughout Nepal as private trusts, under a Private Trust Act (that was fully drafted and ready for adoption in 2005 itself) coupled with the umbrella Deemed University Act will go a long way to meet the current challenge or the so-called ‘second generational’ need for a remittance economy and to develop small scale and middle scale entrepreneurship in rural and urban areas respectively which will be the driver of local economic growth and modernization.

As Finance Minister in 2005, I had—though unsuccessfully owing to vested interest of the ministries of commerce and local development which were sticking with the ‘business as usual development paradigm’ and the lack of support of the European Union aid bureaucracy— broached the idea that we should create a National Entrepreneurship Promotion Venture Capital Fund (NEPVCF), guided by the Ministry of Finance.

The purpose of NEPVCF would be to allow public enterprise employees being ‘right sized’, ‘downsized’ or ‘privatized’— and thus made redundant under voluntary retirement schemes to group together as business consultants to help promote micro entrepreneurs as well as SMEs in the rural and urban areas as profitable and prosperous entities for economic growth and modernization by using their acquired knowledge in trade, commerce, development and governance.

The innovative feature of the consultants to be funded by the NEPVCF is that these consultants will not loan monies borrowed at nominal interest from the Fund but invest in the equity shares of the entrepreneurs being promoted.

Such equities could then be sold by the consultants to the families who wish to fully own the enterprises or sold to outsiders through peri-urban stock markets to the public. This innovation in finance would also help solve the problem of land fragmentation caused when families break away from the joint family system causing an uneconomic partitioning of their assets (of land, house, livestock etc.). Equity shares would make fixed assets highly liquid and decomposable to save the integrity of the micro business and SMEs in cases of family disputes.

Fiscal incentives could be provided to the equity-consultants by way of tax exemption for the income received from shares transacted in the very first public transaction. It should be underscored that the target area for this model pilot project would be Arghakhanchhi which, along with Gulmi and Syangja, has perhaps the largest volume of remittance income from overseas’ migration. Such a model project would help to know how the ‘second generation’ challenges for the remittance-dependent economy could be addressed.

Study Needed

Longitudinal macro-economic and micro-economic case studies of migrant households’ consumption behaviour could be conducted and analyzed to examine their short and long run consumption. This way the precise relationship between their marginal and average propensities to consume can be determined. In this manner, one could estimate the volume of potential savings and investments that could be garnered from household above the poverty line but dependent on remittances to design appropriate financial packages (bonds, equity and mutual funds) for their savings and investment needs. Fiscal, foreign exchange, refinance policies could be further tailored to support their development.

To use the tool of international migration to eradicate poverty requires pro-poor migration policies. It can’t be left to the market forces only. Case studies from all SAARC countries show that the ultra-poor do not migrate because of the lack of financial resources, information and social networks. In such a scenario, government should step in with pro-poor interventions to target ultra-poor to empower them with social mobility through vocational education and skill training for targeted markets, as well as language and cross-cultural skills to prepare them to be prepared for migration, equipped with knowledge to grapple in-transit and upon-arrival processes with all the dimensions of ‘cultural shock’ so natural to any individual— rich or poor.

In short, government in the spirit of public-private-people partnership should, in cooperation with local communities, banks, financial institutions, manpower agencies and educational institutions join hands with the prospective migrants to plan for and programme their pre-migration, in-transit, in-migration and out-migration interventions to create a win-win scenario for all stakeholders.  

International migration benefits all nations. So, solidarity measures should be taken by SAARC countries to ensure that access to international labour markets are kept open just as access to product, financial and technology markets, which  are the other drivers of globalization. This solidarity should be extended to a unified stand to pressure the industrial countries, at the WTO, to remove all tariffs and subsidies in the agriculture sector in a time-bound manner and to include trade in services as an integral part of WTO negotiations.

Industrial nations benefited from the ‘old globalization’ with mass migration which unfortunately led to the colonization of the native peoples. The new globalization will be a win-win situation for all given the global demographic shifts, the need to maintain quality of life of the post-retirement workers in the industrial North, and the huge demand globally for intellectual capital that can be supplied by, perhaps, no more than 1% of the  world’s population of youth.

Yes, we need to ‘think local and act global’ in the information age. The above mentioned strategies are one way to do so. In this age of globalization, nations must extend themselves outwards in a two way process. As we are limited in financial capital, so we must do so with our human and intellectual capital.

The suggested integrated manpower-educational planning by the National Planning Commission will ensure that manpower export is never a bane for Nepal as, for example, doomsday economists, like Dr Raghab Dhoj Pant of the Institute for Development Studies seems to think (based on IFDs economic scenario analysis about the impact of remittance dependency).

Scientific, sophisticated manpower planning and strategic management of the economy alone can help create a better Nepal where we are no more hewers of wood and drawers of water or guards and mercenaries of yesteryears. A Nepal of 40 million citizens, by 2040, needs to be techno-savvy and agro-industrialized to be a better country; duly playing its role in world affairs as a middle-sized power in the context of a fully emerged Asia lying at the center of global geo-politics, geo-economics and geo-psychology.

(Rana is a former Minister of Finance)

Foreign Investment for Poverty Reduction

By Shiva Raj Bhatt

Nepal is a resource rich, but poor country. Poverty is extreme in many parts of the country, including the beautiful hills endowed with plenty of natural resources. There are many causes of it. The most important one is failure of the nation in exploiting its natural resources in sustainable way. Scarcity of capital and technology is the prime cause of ‘none’ or ‘under utilization’ of resources, both natural and human. Country’s capacity to save and convert it into productive investment is weak, basically because of low income level. As a result, we are trapped in ‘vicious cycle of poverty’.

To overcome this cycle, Nepal needs to attract foreign investments that can inflow in various forms, including, remittances, grants, loan, technology transfer, and direct investment. In Nepal, share of grants is declining continuously and burden of loan that mostly comes with conditionality is also painful. Similarly, long-term consequences of out-migration and thus remittances are also doubtful. Receiving Foreign Direct Investment (FDI) and technology are thus two prominent channels through which we can attract external resources to expedite our development. However, its pros and cons remain to be examined.

Early theories on the impact of foreign capital on host countries can be found in the writings of the “dependency school”. In their core-periphery hypothesis, proponents of dependency school argue that the FDI from the core (developed countries) to the periphery (developing countries) is harmful to the long-run economic growth of the latter. In their view, First World nations become wealthy by extracting labour and material resources from the Third World. This kind of capitalism perpetuates a global division of labour that causes distortion, hinders growth, and increases income inequality in developing economies. They further argue that developing countries are inadequately compensated for their natural resources and thereby sentenced to conditions of continuing poverty. Thus countries on the periphery cannot become fully modernized as long as they remain in the capitalist world system. To get out of this economically distressing relationship, Third World nations must develop independently of foreign capital and goods, concluded the dependency theorists.

The influence of the dependency theory peaked in the 1970s. However, its validity is debated beyond then. Many countries (most noticeably Latin American) strongly believed the dependency theory and adopted policies accordingly during the 1970s and 1980s. They adopted an import substitution strategy and demonstrated a hostile attitude toward FDI. These inwardly oriented policies had a harmful effect on Latin American economies. Their experiences contrast with those of some East and Southeast Asian economies that were designed to actively attract foreign investment into their domestic economies. These policies were accompanied by a period of rapid economic growth in East Asia during the 1970s and 1980s. This reality largely curbed the popularity of the dependency theory, shifting attention to the study of FDI’s contribution.

The supporters of FDI argue that FDI can potentially benefit the host country in many ways. In fact, it can bridge the resource gap in a resource scarce country like ours and push the economy on a higher growth path. Similarly, its spillover effect has been identified as an important benefit accruing to domestic firms, which also considered as an important mechanism through which FDI can promote growth in a host country. Employment opportunities to local people, technology transfer, capacity building, increase in revenue, rapid industrialization, import substitution, mobilization of local resources are the main benefits of FDI. Similarly, in Nepal’s case the possible benefits of her tremendous natural resources – water, tourism, herbal development and processing could be tapped through FDI.

Source: Department of Industry, Government of Nepal

Therefore, attracting FDI to assist and facilitate development activities should be the utmost priority of Nepal. This fact was recognized by our policymakers long ago. In 1990, after restoration of multi-party democratic system, Nepal intensified the process of liberalization and introduced new foreign investment policy, the ‘Foreign Investment and Technology Transfer Act (FITTA - 1992)’, but has not been able to attract much FDI (see Table). This is partly because a small, least developed, landlocked, mountainous country has little to offer to investors. In addition to these traditional factors, political instability, poor performing economic sector and armed conflict have also adversely affected foreign investment inflow into the country. Lack of timely reforms on policies was the other crucial factor that drove away foreign investors, as in the absence of favorable supporting policies. Facilities provided through FITTA alone is not sufficient to attract foreign investment.

In this context, it is a big challenge for Nepal to increase the volume of FDI. Nepal's advantages include privileged access to a well-disposed neighboring country with a large market; a low wage, trainable workforce; a flourishing local entrepreneurial culture in both small and large business; and an established internationally recognized tourist landmarks. Nepal's temperate climate is also ideal for cultivating medicinal herbs, whose market has seen phenomenal expansion in recent years. These advantages can make attractive investment packages possible.

However, there should be some restrictions on FDI. Basically, protection of few sectors and industries such as cottage and small scale industries, arms, ammunition, and security related industries; and restraining employment of foreigners are desirable to a certain level. But in Nepal, past experience shows that each and every sector wants to protect only their own sector or industry from foreign competition; neglecting the interest of economy and consumers. Therefore, Nepal now needs a clear and visionary FDI policy that on the one hand helps increase the inflow of FDI and on the other hand truly protects the interest of the economy and consumers.

Conducive environment is needed to attract more FDI. And all the determinants of business environment, including infrastructure, institutions, policies and polity are also basic prerequisites for FDI. Let us hope that the new investment policy, which the government is preparing now, will address these issues and work creates such environment.

(Bhatt is Trade Policy Analyst with Enhancing Nepal's Trade Related Capacity Programme, Ministry of Industry, Commerce and Supplies. Views expressed in this article are those of the author and do not necessarily represent UNDP or the Government of Nepal)