Liberalised by Law, Constrained by Regulation: Nepal’s Contract Manufacturing Challenge

Contract manufacturing allows a business to have its products manufactured by another enterprise using the latter’s production facilities, while the business may continue to control the brand, product specifications, technology, marketing and distribution. For businesses, the attraction is straightforward, it can reduce the time and capital required to launch new products while allowing existing manufacturers to make better use of unused production capacity.

The economic rationale is well recognised internationally. Research by the Organisation for Economic Co-operation and Development (OECD) on global value chains shows that businesses increasingly specialise in particular stages of production rather than developing every capability required to produce a finished product. Contract manufacturing is a practical expression of this division of production functions.

From Restriction to Permission

Nepal’s legal framework historically restricted this flexibility. The Foreign Investment and Technology Transfer Act, 2075 (FITTA) originally allowed a foreign-invested industry to contract out part of its production process or auxiliary goods and services but prohibited outsourcing of its main product. The Industrial Enterprises Act, 2076 (IEA) adopted a similar restriction for industries generally.

This created practical uncertainty. Neither law clearly defined what constituted a ‘main product’ or where the line should be drawn between the principal production process and a component of that process. For businesses with integrated manufacturing operations, this substantially reduced the commercial usefulness of contract manufacturing.

The position changed with the investment-facilitation reforms introduced in 2081. Section 50(1) of the IEA and Section 45(1) of FITTA were amended to remove the prohibition on outsourcing the main product. The amended framework now allows entities registered under prevailing law and having the same objective to enter into contracts or subcontracts with one another to produce goods or services.

This represents an important shift in industrial policy. Instead of determining which part of a product may or may not be outsourced, the law now recognises contract manufacturing itself as a legitimate method of production.

Department of Industry Standards and the Approval Question

Following the amendment, the Industrial and Investment Promotion Board adopted the Standards relating to Contract or Subcontract for Production of Goods, 2081 (Standards), administered by the Department of Industry (DoI). The Standards establish a mechanism for recording contract-manufacturing arrangements and prescribe matters that the agreement between the principal and the contract manufacturer must address.

In practice, however, the process involves considerably more than simply notifying DoI.

Businesses may be required to submit the manufacturing agreement together with the industry-registration documents of both parties, approved project schemes, company update letters from the Office of Company Registrar, tax-clearance certificates, trademark-registration certificates, environmental approvals where applicable, constitutional documents and board decisions. DoI also examines whether the objectives of the parties are compatible and whether the proposed production falls within the manufacturer’s approved production capacity.

This creates a potential tension between statutory liberalisation and administrative implementation. The amended IEA and FITTA do not expressly state that every contract-manufacturing arrangement requires prior DOI approval. Yet, a recording mechanism can effectively operate as an approval mechanism if businesses are expected to obtain DOI clearance before commencing production.

For businesses, the difference is significant. A recording system allows the regulator to know who is manufacturing what and where. A prior-approval system, by contrast, can determine when production may commence and can directly affect product launches, supply commitments and a business’s ability to respond quickly to changing market demand.

Where Businesses Still Face Friction

The first issue is the requirement that contracting parties have the same objective. The rationale is understandable; a private manufacturing agreement should not allow an industry to undertake activities entirely outside its legally approved scope. But an overly literal comparison of wording in registration documents may unnecessarily prevent commercially legitimate arrangements.

A more practical test would be whether the contract manufacturer is legally authorised, technically capable and appropriately licensed to manufacture the relevant product.

Second, the recording process risks becoming a discretionary approval exercise. One of the main advantages of contract manufacturing is speed. A business can respond to demand without investing in an entirely new production facility. Lengthy documentary review before manufacturing begins can erode that advantage.

The Standards also limit a contract-manufacturing arrangement to a maximum period of five years. Where both businesses remain legally compliant and the necessary regulatory approvals continue to remain valid, the commercial duration of the relationship should ordinarily be left to the contracting parties.

Third, businesses face documentary duplication. Corporate information, tax status, environmental approvals and industrial particulars are already held by various government agencies. Requiring businesses to repeatedly obtain and resubmit the same documents adds time and transaction costs without necessarily improving regulatory oversight.

Fourth, approved production capacity can itself become a regulatory bottleneck. Manufacturers may upgrade machinery, improve efficiency or reorganise production lines after their original project approval. Their actual production capability may therefore exceed the capacity reflected in government records. Contract manufacturing should not be unnecessarily delayed merely because the regulatory record has not kept pace with technological or operational improvements.

Finally, the framework does not adequately address cross-border contract manufacturing. It remains unclear, for example, how a foreign brand owner without an established industrial entity in Nepal may directly engage a Nepali manufacturer, particularly where the goods are intended for export. Greater clarity could help Nepali manufacturers integrate into regional and global production networks.

Contract manufacturing, however, does not displace sector-specific regulation. Food, pharmaceuticals, excisable goods, standards-certified products and other regulated products must continue to comply with applicable licensing, safety, labelling, taxation, intellectual-property and consumer-protection requirements.

Making Liberalisation Work

Nepal has already taken the important first step by removing the principal statutory restriction on contract manufacturing. The next challenge is ensuring that administrative procedures do not recreate the same restriction in another form.

For ordinary, non-sensitive products, DoI should move towards a digital notification and recording system rather than a discretionary prior-approval model. More intensive scrutiny can appropriately remain for sensitive industries involving greater public-health, safety, security or environmental concerns, including industries for which prior permission is required under Schedule 1 (Annexure 1) of the IEA.

Similarly, the ‘same objective’ requirement should be applied by examining whether the proposed manufacturing activity is legally and technically compatible with the manufacturer’s approved business, rather than requiring identical wording in registration documents. Information already available within government databases should also be verified digitally instead of repeatedly being requested from businesses.

The framework should further clarify cross-border contract-manufacturing arrangements, protect commercially sensitive manufacturing agreements and clearly define the regulatory responsibilities of both the product owner and the manufacturer.

The guiding principle should be simple: regulation should focus on whether the facility manufacturing the product is properly authorised, technically capable and accountable.

Nepal has liberalised the law. The remaining task is to ensure that the regulatory process becomes equally business-ready.