Economic Growth,Rule and Law and Nepal

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Economic Growth,Rule and Law and Nepal

The right comparator country that we should compare Nepal with is probably a country like Rwanda.


Nepal needs USD 10 billion of foreign investment a year to achieve double digit growth and take it to middle-income country status according to Finance Minister Yuba Raj Khatiwada in an interview he gave at the close of the Nepal Investment Summit in March.

Nepal received only USD 161 million inflows of FDI in 2018 (UNCTAD WIR 2019).  It’s trite to speak of multiple reasons for this large gap between aspiration and reality – the lack of adequate infrastructure, poor connectivity and the loss of skilled talent to foreign markets for instance - these are in fact, symptoms of low investment – part of a vicious cycle.  These are tough problems that government and other stakeholders have to solve as a part of the ‘Prosperous Nepal, Happy Nepali’ vision articulated by Prime Minister KP Sharma Oli just 16 months ago. There is however one area of intervention which merits priority – strengthening the ‘Rule of Law’. This is easy to implement because it is fully within the control of stakeholders and will help reduce the cost of capital for Nepal.

It is now well accepted that the big (and yet underrated) enabler of foreign investment inflows is strong rule of law. The World Justice Project (WJP) defines rule of law as a durable system of laws, institutions, and community that delivers four universal principles: Accountability (where both government and private sector, including foreign investors are accountable to law); Just Laws (that are clear, publicised, and, stable and applied evenly, and, protect fundamental human rights and property);  Open Government (laws are enacted and enforced, in an accessible, fair, and efficient manner);  and Accessible an Impartial Dispute Resolution (Justice is delivered timely by competent, ethical, and neutral judges).

The British Judge, Justice Tom Bingham in his seminal work, ‘Rule of Law’, describes it to mean “that all persons and authorities within the state, whether public or private, should be bound by and entitled to the benefit of laws publicly and prospectively promulgated and publicly administered in the courts.”

Nepal has done well in the World Justice Project Rule of Law Index Global rankings with the best overall score for South Asia, and better than India or Sri Lanka in most constituent indices barring the ‘absence of corruption’ index in which Nepal is marginally behind Sri Lanka. However, the right comparator country that we should compare Nepal with is probably a country like Rwanda – considered to be the rising star of Africa. Rwanda, like Nepal is a landlocked low income country. Rwanda has a population of 12.2 million people, but a population density more than twice that of Nepal. Nepal (149) is ahead of Rwanda (158) in the HDI rankings, but in the last 15-year period, Rwanda has enjoyed growth rates of 7-8 percent for several years. Both countries have had history of deep internal conflict – the Rwanda Genocide is still fresh in our memories.

Nepal and Rwanda had similar levels of foreign investment between 1995 to 2005, but FDI growth has taken off for both countries only over the last 10 years. For the past 5 years Rwanda has received between USD 350 – 450 million FDI inflows annually, but the highest Nepal ever received in the same period was USD 160 million. Rwanda’s economy is also more diversified, with lesser dependence on remittances (2.4 percent of GDP) than Nepal (28 percent). On the index of ‘Order & Security’ Nepal and Rwanda, do well, with Rwanda in the top 25 globally, beating even many developed countries.

Two indices explain a lot for where Rwanda has scored an advantage over Nepal – ‘Absence of Corruption’ and ‘Civil Justice’, where Rwanda’s indices are 35-40 percent better. Other indices like Transparency International’s corruption perception index and World Bank’s Ease of Doing business also validate the larger proposition. The Ease of Doing Business index reveals that Nepal is among the bottom third of all countries when it comes to ease of enforcing contracts and paying taxes, but Rwanda is not only in the first half in the rankings for paying taxes, but when it comes to ease of enforcing contracts, it is in the top 3rd of all countries. That said, Nepal is way ahead of many countries in other parameters. In the WEF competitiveness rankings for the freedom of press for instance, Nepal is 40 ranks ahead of Rwanda (and the best in South Asia by a significant margin of 20 ranks).

Cross country comparisons always have imperfections, and yet the data is an important tool for evaluation and learning what other countries have done right or wrong.

In Bingam’s definition there is an emphasis that “all persons” (including juristic persons like companies and investors) “should be bound by laws” “publicly and prospectively promulgated.” In 2014, an important international survey of c-suite leaders of over 300 companies that had significant global presence and had revenue of at least USD 1 billion, found that among the 10 factors related to Rule of Law, apart from physical threats to safety, it was ‘unexpected and/or retrospective changes to regulatory/legal measures’ that was most likely to lead them to withdraw foreign investments altogether. The survey titled Risk and Return - Foreign Direct Investment and the Rule of Law, interestingly points out that investors are relatively less concerned about ‘lack of transparency of rule-making processes’ -  that certainty of the existence and clarity about the content of a rule, is a higher order requisite for an investor than how the rule came to be formulated.

To be clear, I do not claim that Rule of Law is the pre-eminent determinant of investment. For instance Nepal outperforms Bangladesh in the World Economic Forum’s ranking of “Institutions” but several other factors have made Bangladesh a magnate for FDI - giving it a growth rate of 8 percent compared to 6.2 percent for Nepal.

Consumption fuelled by remittances, reconstruction, a stable constitution and the resilience of Nepalis, has enabled Nepal to not just recover from the earthquakes of 2015 but also make solid progress in economic development. I visited Kathmandu in June after a gap of over 12 years, and was impressed to see the progress, particularly in urban mobility and telecom that I experienced firsthand. My 4G connection experience in Kathmandu Valley was more reliable and consistent that what I have in New Delhi and I was able to hop on to a Tootle at the press of a button.  Creating high skilled job opportunities, improving productivity of services and deepening/widening services like tourism are now well accepted as some of the measures that are needed to take Nepal on the next trajectory of growth. FDI will be a key enabler here – it will not just provide capital to create high wage jobs, but more critically funnel the technology and skill transfers that are essential for productivity growth.

Women and men under the age of 24 constitute over half of Nepal’s people. The National Planning Commission of Nepal in a joint paper with UNICEF in 2017 mentioned that the demographic window of opportunity exists until 2047. To harness the demographic dividend and to achieve sustainable growth before the window starts to close in the next 28 years, the government policy focus should be to provide an enabling business climate that will skill its youth and create high productivity jobs within Nepal itself. Nepal has got other underrated factors which work in its favour – it is a very safe and pluralistic country that accepts and celebrates differences.

During my visit, I met several people who told me that it was safe for women and men to walk at night in Kathmandu – I did feel safe for the week that I spent there - not something I can say about the NCR of India which is home to me. Indeed, crime is an issue even in important business cities in the developed countries– Barcelona, which hosts the World Mobile Congress is an example in point. The BBC reports that Barcelona saw “Violent crimes were up 31 percent” and that “robberies with force against businesses were up 66 percent” in the first six months of 2019.  Nepal’s homicide rates have been considerably lower than not just the world average, but also compared to Europe and North America.

The ease of doing business environment in countries is also no longer the stuff that only businesses complain about. With increased levels of tension in international trade, countries are using international relations to seek strengthening of the Rule of Law. It was reported in February this year, that in an unprecedented move, the governments of Germany, the UK, the US, the Netherlands and Switzerland (countries which account for 75 percent of FDI in South Africa) wrote to the presidency of South Africa through their missions stating that there should be a "clear, unqualified and manifest political commitment to the rule of law, the independence of the judiciary and to honest and ethical business practices".

The government of South Africa protested the manner in which this communication was made. More recently, Mike Pompeo, US Secretary of State on a visit to New Delhi two months ago asked India the provocative question “can we help each other’s private industries disengage from countries with a weak rule of law and invest in partner nations eager to house our supply chains and our innovators?” The point is not whether these messages are right or wrong in the larger context of sovereignty and statecraft. The point is that Rule of Law matters more than ever before in the context of international relations.

Citizens, entrepreneurs in need of capital, foreign investors and the government, all have a lot to gain from the strengthening the Rule of Law. Failure to do so will continue to see low levels of foreign investment, because the hurdle rate for investment projects will continue to remain high in Nepal.

A system of governance by certain and well spelt out laws, whether it be in the realm of labour relations, taxation, health and safety, public interest, bespoke regulation or any other subject, is key to give confidence to foreign investors and reduce the cost of capital for Nepal. Effective implementation of sound macroeconomic policies, aided by a major strengthening of Institutions and the rule of law will help Nepal meet the goals set by the Finance Minister.

Karthikeyan is a Strategy Consultant and Founder Member of the Foundation for Good Governance.

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