Wed, July 17, 2024

Rethinking The Ban On Outward Foreign Investment For Nepali Businesses

Pratikshya Dahal
Pratikshya Dahal June 30, 2024, 11:43 am
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 It has been interesting reading various success stories of momo businesses in India. Particularly how WOW Momo currently valued at INR 2,400 crores began with a capital of Rs 30,000 and now has over 200 shops in India. One could easily say that momo the ‘unofficial national food’ has been one of the greatest culinary exports of Nepal. However, Nepal gets no benefit from this export except a vanity claim. Could the story have been different if Nepali entrepreneurs were permitted to set up momo businesses in India? Possibly. 

One of the most quoted challenges faced by Nepali entrepreneurs is inability to achieve ‘economy of scale’. The explode in entrepreneurship has brought with itself a superfluity of competitors scrabbling for customer acquisition in a population of less than three crores. Another widely cited problem is to find adequate human resources with the requisite skills and the subsequent struggle to retain them especially when the number of skilled resources is increasingly leaving Nepal. A resolution to these problems is to open outward foreign direct investment (OFDI) for local businesses enabling them to secure a bigger market, technology and resources. 

Opening up the borders for business set ups also allows for choice of a strategic location that can enable businesses to benefit from the subsidies provided to investors and businesses in the investment jurisdiction which is unlikely to be available for exporters. Likewise, businesses could also save on costs related to logistics and customs and access quality services like business consulting, advertising, and marketing without having to go through a myriad of regulatory approvals for making payments. 

It may seem counterintuitive, but OFDI can also facilitate the influx of FDI into Nepal. Local entrepreneurs can establish a fundraising entity via OFDI in the investor’s preferred jurisdiction, like a holding company, which can subsequently inject the collected funds into local businesses. This offers considerable flexibility and instills confidence in the investors for both entry and exit from Nepali market. This structure is likely to be preferred by most foreign investors due to their familiarity with the jurisdiction of the fundraising entity and because it would limit their exposure to risks that would have been unavoidable when making a direct investment in a Nepal domiciled company like delay in repatriation, limited investment instruments (e.g. investors have been rejected approval to invest in convertible debt), etc.
While relaxing OFDI has been an issue of discussion, it remains restricted by the prevailing laws. OFDI is regulated by two primary legislations: Act Restricting Investment Abroad 1964 (ARIA) and Foreign Exchange (Regulation) Act 1962 (FERA). Almost 60 years ago, ARIA provided a broad-ranging restriction for Nepali citizens and entities to invest in foreign securities including shares, stock, bonds and debentures, open bank account, purchase real estate and enter into partnership outside Nepal. Similarly, FERA was amended more than 18 years ago to introduce a provision that restricts Nepali entities and citizens to invest outside Nepal. However, these legal restrictions have likely not prevented capital flight from Nepal through informal channels, resulting in a significant loss of dividend income for the country.
On April 28, 2024 the Foreign Investment and Technology Transfer Act 2019 (FITTA) was amended by way of ordinance concurring with the Investment Summit to allow Nepali companies to set up branch offices or units in a foreign country for the purpose of transferring technology by way of franchise agreements, provide management and marketing services, reverse engineering, etc. to foreign companies. To put it into context, a local company like Barahsinghe can as an alternative to exporting its beer, licence its trademark, secret formula, specific know-how regarding production and manufacturing of its beers to a manufacturer outside Nepal in exchange of royalty. While this was not prohibited even before the recent amendment, FITTA has for the first time allowed local technology-transferors to have presence outside Nepal. However, setting up a local office in relevant jurisdiction for transferring technology may not be a requirement or even add a lot of value for technology transferors.

ARIA allows the government to open certain sectors for outward foreign investment by publishing a notice and specifying the kind, extent and period of the permitted investment. Likewise, FERA allows Nepal Rastra Bank (NRB) to open up OFDI by issuing a public notice. As of now, neither the government nor NRB has published any such notices. Some of the key concerns expressed by regulators related with relaxing OFDI are balance of payment difficulties, the effect of capital flight on local capital seekers and money laundering. For similar reasons, OFDI has not traditionally been popular among developing countries. However, the share of developing countries in the total global OFDI pool has significantly increased in the recent decades. In the 1900s, developing countries contributed to less than 10% of the global OFDI, this figure rose to over 50% during the Covid 19 pandemic and as of 2022 is at 30%. The figures are evident of how developing countries have incorporated OFDI as a component of their economic strategies. 

Many developing countries have designed OFDI policies that best suit their economy while managing their country specific risks. For example, Bangladesh on January 9, 2022 introduced the Capital Account Transaction (Overseas Equity Investment) Rules. These rules permit residents to engage in OFDI, allowing them to invest up to 20% of their average annual export earnings for a period of five years. To qualify, investors must demonstrate that the OFDI will complement their existing domestic investments, contribute to increased exports and employment, and be economically sustainable. Furthermore, any debts incurred abroad, such as profits, dividends, interests, and other financial transactions, must be repatriated to Bangladesh within 30 days of receipt.

It is evident that trade and market, within and outside Nepal, have undergone dramatic changes in recent years. There has also been a lot of demand from local businesses, particularly the IT sector for opening OFDI. With soaring foreign reserve, this is a good time for the government to experiment with OFDI without over-stretching the national foreign reserve pocket in a way that helps both local businesses and the government income (from the taxable investment income coming into Nepal). Having said that, OFDI promotion should coexist only with effective regulation policies in place. Legislations do not work in isolation, so it is important for the government and regulators to create a regulatory landscape that support and enable OFDI. Other important things to consider is to increase the administrative capacities of the relevant authorities and to expedite signing of double taxation treaty with key jurisdictions. 

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JUNE 2024

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