KATHMANDU, JAN 28 – The Ministry of Industry is planning to declare the forthcoming fiscal year 2015-16 as Foreign Direct Investment Year (FDI Year). Obviously, the objective of this move is to promote FDI in the country. This means that potential investors from abroad will presumably get special treatment from the government, and that starting an FDI venture in Nepal will be smooth as silk and totally hassle-free, leading to the inflow of FDI swelling into a torrent. However, the idea of marking FDI Year appears to be quite dubious.
This is because investment cannot be attracted simply by holding a year-long event. For investment to thrive, an enabling business environment is essential. A congenial environment is crucial to lure investors. Whether domestic or foreign investors, they will look for a business environment that is economically profitable, politically stable, legally protective and socio-culturally acceptable before pouring their money into any venture. Creating such a hospitable environment is not possible in a year or in the short run. This involves a long-term process for in-depth analysis and management of the determining environmental factors so that the proper policy intervention can be made. However, the government comes across as short-sighted since it has focused on a formality instead of a long-term plan by overlooking the root cause of the investment problem.
Liquidity trap
The key issue in the current investment scenario is not a dearth of capital. There is overflowing liquidity in the banking sector as shown by the plunging borrowing rates of banks and financial institutions. The average interest rate has dropped to the lowest level since the financial sector was liberalized two decades ago. Paradoxically, there is no shortage of depositors in banks in spite of the marginal returns from their savings. Nor is there any indication of the interest rate rising despite the central bank’s intervention requiring banks to maintain an increased cash reserve ratio (CRR). Thus cash under the speculative motive of individuals is overflowing and this points to the situation of a “liquidity trap”.
In economics, a liquidity trap is a situation where an increase in the money supply results in idle cash balances having no effect on the interest elasticity of demand for money. Accordingly, individuals believe that bond prices are too high and will, therefore, fall. And correspondingly, interest rates are too low and must rise. They, therefore, believe that buying bonds would be inviting a capital loss, and as a result, they hold only cash. Consequently, an increase in the money supply
merely increases idle balances and leaves interest rates unaffected. In the same way, uncertainty in Nepal’s investment climate has made investors cautious and induced them to hold cash in liquidity instead of investing it, thereby preventing interest rates from rising.
Vent for idle liquidity
Against this backdrop, the biggest challenge for the government is to provide a vent for the idle liquidity in the economy. How successful it will be in this task will depend on its assurance of a stable economic, political and legal environment. However, unstable politics and lack of political commitment to business has jeopardized other determining factors of the country’s business climate.
The World Bank’s Ease of Doing Business report has ranked Nepal at number 105 among the 189 countries studied. Nepal scored low marks with regard to starting a business , protecting investors and enforcing contracts. The country also received poor grades in terms of trading across borders, paying taxes, resolving insolvency, dealing with construction permits and getting electricity. The only thing in which Nepal has done well is registering property with a rating of 24. Hence, Nepal has to improve these indicators to convince potential investors that the investment environment in the country is better. Since these indicators are central to attracting investment, whether domestic or foreign, the government should move decisively with a plan to improve these parameters instead of spending time on trivial things.
Long-term approach
It seems quite absurd to think about promoting foreign investment by observing FDI Year in the same way as past events like Visit Nepal Year and Tourism Year which were held to lure tourists. Attracting foreign investors is not like enticing tourists. Tourists visit our country for a short stay for leisure and pleasure. Foreign investors look for secured investment opportunities and lucrative returns, they are not interested in going on a shopping spree. So promoting investment will not be possible without a long-term plan that ensures a stable investment climate. For this to happen, the government should expedite the passage of all investment related acts and regulations in the forthcoming fiscal year as they have long been hindering the investment environment. This process should continue for as long as it takes, and that may be one year or many years.
– Bijendra Man Shakya specializes in the economic and trade interests of Nepal and the LDCs
