Extractive State, Costly Government Overreach

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Extractive State, Costly Government Overreach

The government is stifling business innovation in Nepal by expanding its reach.


Despite its failure and poor performance in sectors where it is involved, the government seeks to expand its reach and role. The government is perpetuating its exploitative and extractive character through heavy taxation, discretionary power and overregulation, stymieing business innovation and growth in Nepal.

Shree Prakash Khanal runs a small eatery at Sorakhutte, Kathmandu. He wants to open his eatery round the clock to cater to visitors coming to a hospital that is just opposite his restaurant. However, he can’t do that. The restaurant must be closed by 9 pm. If he is late to bring the shutters down even by a few minutes, police, patrolling the town, would come and taunt him. His desire to grow his eatery’s revenue by extending the service to 24 hours a day has been restrained by the local administration’s restriction.

“The police should have told us ‘Do your business without any worries. We are here to provide the necessary security for you.’ Instead of assuring us of the law-and-order situation, they force businesses to shut down by 9 pm, citing safety and security concerns,” Khanal told New Business Age.

“Businesses pay taxes to the government which is responsible to extend them police protection. Unfortunately, that’s not the language of the police. They treat those restaurants who serve diners after 9 pm like they are security threats,” Khanal said, calling for a change in the approach of the law enforcement agencies.

Though there are no laws and regulations that govern the nighttime business, the local administration’s response to those who want to provide services during nighttime has remained inconsistent. Sometimes they allow businesses to remain open till late at night, while Kathmandu–the capital city–becomes quiet after 8 pm most of the time as police do not want businesses to remain open till late at night.

The government’s treatment of a nighttime eatery or store is a microcosm of what is happening to the overall business sector of the country. Instead of support or facilitation, businesses have been subject to exploitation and extraction by the state.

Private sector leaders complain about hassles at every step in doing business in the country. From starting a business to winding it up, businesses encounter multiple obstacles from the state machinery. While authorities, policymakers and politicians are never tired of talking about prioritising the private sector,  they have been perpetuating the system that has long thrived on its exploitative behaviour. The government’s attitude or approach toward the private sector is one of the major reasons blamed for underinvestment, low innovation, and slow economic growth for years. Unlike in other economies, capital and ideas alone are not enough in Nepal for any business to succeed, say private sector leaders.

The experiences of Rudra Pandey, an information technology entrepreneur, at the Office of the Company Registrar (OCR) exemplify the hurdles posed by the state machinery for businesses.  Pandey tried to register a business in Nepal with the name ‘Hamro Patro Nepal Pvt Ltd’, a subsidiary of Hamro Patro Inc that is registered in the US. However, officials at the OCR refused to register the company stating that names bearing prefixes like ‘Hamro (Our), Timro (Your) or Mero (My)’ cannot be registered. Frustrated with the response of the OCR officials, he tweeted: “We have gone to the OCR to set up a subsidiary for the US-based Hamro Patro, Inc with the name ‘Hamro Patro Nepal Pvt Ltd’. But they have turned us back, citing that a company cannot be established with a name that includes words ‘our, your, my etc. It's really frustrating to see such an approach.”  

This is not an isolated or a rare case in the OCR where Pandey and other entrepreneurs encounter hassles while availing its services. Through his tweets, Pandey exposed the ‘highhandedness’ of the OCR. Stating that the registrar of the OCR refused to sign the annual general meeting’s report of his company Deerwalk Education for not having an independent director in the ‘unlisted public company’, he wrote: “I meant he did not approve AGM and pushed us to the wall. This is a true hypocrisy of the Nepal government. Ministers and secretaries invite investors with open arms and people working for them harass investors every step of the way. This is too sad.”  

Following his tweets, the OCR’s Director General stepped in to settle the issue, Pandey twitted.

However, all entrepreneurs or directors do not dare to speak out about the excesses of the OCR. Those who have experienced the services of the OCR say that the agency is a real mirror of the government. As the agency where companies are registered, OCR is not only the first interface between the government and a business. It also gives a sneak peek into the government’s treatment toward the business sector or investors. Investors complain the hassles that they encounter at the very first stage of starting their business in Nepal have been discouraging investments in the country. These hassles have been so deeply embedded in the state’s culture and character, experts and private sector leaders say, that they amount to extraction.

Growing Government Overreach
Despite expectations that the state's role will gradually shrink in line with the ‘limited government’ concept, the government has been increasing and expanding its reach on multiple fronts. From education to health and security to energy sectors, the government has been assertive in making its presence felt. The constitution, promulgated in 2015, envisions the country oriented towards socialism. By expressing a commitment ‘to create the bases of socialism’, the constitution has listed 31 fundamental rights to its citizens. Then there are directive principles and policies that ensure the state’s presence in almost all facets of citizens’ life. From guaranteeing social security to all labourers to establishing libraries, the constitution envisions Nepal as not only a ‘welfare state’ but also promises to its citizens that it would do almost everything for its citizens.

“Getting everything from the state may sound appealing. But who is going to pay for that? It's ultimately the people. If the government becomes more active or expands its role, it will disproportionately put more financial burden on the people,” said Deependra Chaulagain, director at Sambriddhi Foundation - an independent economic policy think tank.  

The growing role of the government is also reflected in its annual budget which has been expanding continuously. The government’s annual expenditure has almost doubled in five years to Rs 1.54 trillion in the previous fiscal year 2021/22. Nearly half of the budget is spent on recurrent expenditures like salaries and social security allowances. The government forks out over Rs 100 billion every year for the social security handouts alone. These expenditures are ultimately borne by the taxpayers. In line with the expenditure, the government has also increased its tax revenue. When the government expands its role, public expenditure goes up. Then, it is the taxpayers who bear the brunt. This is why Nepal’s tax rates are one of the highest in South Asia. Nepal’s tax-to-GDP ratio stood at around 24% in 2021. High taxes have been discouraging investments and businesses in the country, according to private sector leaders. The growing role of the government would add further financial pressure on taxpayers including businesses and investors. Higher revenue has not resulted in better and more efficient services.

A dysfunctional healthcare system and a poor-quality education system illustrate the government’s utter failure. Even the driver's licence, passport and government identity card distribution is a mess. People have to wait for months to get a driving licence or passport after paying hefty fees.  

Not a single sector or area, where the government is involved, is free from hassles. Development projects take years to complete. Almost all public-financed projects face cost and time overruns. But that is not the case in similar projects built by the private sector. Barring some, most of them get completed on time. So, why is it only the government projects that get delayed or see cost increases? Experts point to corruption as well as the weak execution capacity of the government.  

These failures demonstrate the government’s limitations. Growing public frustration and disenchantment stemming from poor performance or underperformance has not led it to realise its limitation. Rather, it is bent on spreading its wings at the cost of the taxpayers. Bigger government risks perpetuation of the extraction from the private sector as well as the general people.   

It is the political parties who are enabling the environment for the state’s exploitative practices.

Like in the recently concluded general election, political parties and their candidates deluded voters with empty promises.  Their election manifesto is a long wishlist of fancy programmes and promises. From free health to free education, building roads to the construction of view towers and farming subsidies to cash allowances, they make lofty promises to the voters. Analysts say that such promises have built up expectations among the public that there is a government that would do everything for them, or the government is their saviour. Legislative or economic reform does not become an agenda during the election where political parties and leaders sell promises of handouts and distributive programmes.

The sorry state of affairs of public enterprises speaks volumes about the state’s capacity. A large number of public enterprises have become economically unviable and chronically loss-making or sick. Except for a few, most of them have cumulative losses. The price of their products is high, while the private sector is providing the same services or commodities at competitive prices. Monopoly enjoyed by some of these public enterprises like Nepal Oil Corporation and Nepal Electricity Authority have hurt consumers. The private sector that wants a level playing field terms the government support, financing and favours to these public enterprises a foul play. Above all, these loss-making enterprises have become liabilities to the taxpayers.

“It has failed to perform its roles. The government has enough on its plate. If the government simply moves out from these roles, we can expect things to automatically improve there or become better. But, the government wants more, making it costlier for the people,” said Chaulagain.

Those in state power seldom relinquish their roles. The case of Rastriya Banijya Bank Ltd exemplifies the reluctance of the government to shed any role or privilege it enjoys. Though this government-owned bank should have gone public in line with a law that requires banks to issue at least 30% of shares to the public, the government decided to amend the provision in the law and prevent it from going public. Except for a rhetoric that the government ‘should have at least one bank’, there was not any convincing logic to retain the ownership. This is the same bank that had to be bailed out by pumping in billions of rupees loaned by the World Bank and IMF a few years ago.     

Private sector leaders say that the government should make its role clear. “Our government is playing three roles at the same time. It is a facilitator for businesses by developing infrastructures or lending other support. It is also a regulator to make regulations and implement them. As an entrepreneur, it has also been doing business,” said Gokarna Awasthi, Director General of the Federation of Nepalese Chambers of Commerce and Industry (FNCCI). “The government in multiple roles does not support growth. It should be clear on its role and act accordingly so that we have an environment where innovations and ideas flourish,” he added.  

Licence Regime
Licensing has become a government tool for the exploitation of businesses and investors. Though the government has made a commitment to gradually end the licensing regime, one still needs to require a licence to start a new company, bring new products to market, and expand production capacity in many sectors. After handing out licences haphazardly for years, Nepal Rastra Bank (NRB) imposed an indefinite moratorium on licensing in the banking sector. But, that moratorium did not matter when it decided to issue licences to new microfinance institutions a few years ago. The insurance sector also faces a similar problem. There is a lack of transparency over the process of licensing insurance companies.

This is also the case with the energy sector where genuine developers struggle to acquire the licence as most of the licences are occupied by those who want to make a profit by selling licences.

The licensing regime has been hurting investment and businesses in the country by either discouraging or limiting their entry. The problem is more severe in the mining sector. Dangote Group’s exit from Nepal is a case in point. The Nigerian multinational conglomerate came to Nepal in 2018 to set up cement plants. It, however, had to leave the country after it was denied a licence to mine limestones - a raw material used in cement manufacturing.       

The state has used licences to not only make money from companies or industries from their early inception but also to assert its control in that sector, analysts say. The licensing system has not only perpetuated exploitation of the private sector, but has also fueled red tape, corruption, and irregularities in the country.

Corrupt officials tend to make decisions on the licence or permit based on the opportunity for bribes and kickbacks they present. Private sector leaders also blame the government of misusing the licensing system to assert its control in the business sector. The state extracts hefty fees from the licences and permits in various sectors. Industries or businesses pass on the cost of such fees to the consumers. This is one of the factors contributing to the high cost of products or services in Nepal. For example, the tariff on phone calls could have been way lower had the government’s licensing or licence renewal fee been not so high. A telecommunication company has to pay the licence renewal fee to the tune of Rs 4 billion annually.   

According to the Cement Manufacturers Association (CMA), the high fee to get a licence of limestone is one of the major reasons that increase their cost of production.  

Compliance and Regulation
It is Nepal’s archaic laws and regulations that has been most problematic for investment. Authorities use these laws and regulations to exert their control on businesses. Regulations are meant to establish standards. However, in Nepal, they have been a source of power for the authorities to exercise their control. Rather than using regulations to facilitate businesses, authorities or enforcement agencies use them to exert their control. Though the regulation is a must to ensure fair play, the over-regulation has harmful effects on the businesses of Nepal, say private sector leaders. Many regulations on the books legitimise the state’s exploitative character, say analysts. Those in authority, who draft or formulate these laws and regulations, always do so in a way that consolidates their control or power. Those who have been exercising their power on businesses or the private sector through laws and regulations are always against the idea of ceding their control.

Private sector leaders say that Nepal’s labyrinth of laws and regulations has been driving away investors and businesses. Some of these laws and regulations contradict. For example, some of the incentives announced by the Industrial Enterprises Act have not come into implementation because of contradictory provisions in the Financial Bill. There is a lack of harmony among various laws and regulations related to the businesses. That is why private sector organisations have been lobbying for repeal and rewriting of nearly two dozen Acts that have adversely impacted the investment climate in the country. The Black Market and Some Other Social Offences and Punishment Act prevent businesses from charging the sales price over 20% of the purchase price. Authorities often use the provision to harass and embarrass traders who are in the business to make profits.

Complying with these all laws and regulations is burdensome and involves heavy cost for businesses.

The government presents itself as a collector of tax. The government officials view the private sector only from the lens of tax. Their approach toward the private sector is largely guided by a mentality that businesses are only a cash cow for the state to extract revenue as much as possible. They care less about the idea or innovation that businesses and the private sector foster. The technology they introduce or develop is not worth consideration for the state machineries. Likewise, the contribution they make to accelerate growth, advance development and create jobs is less important for them while comparing with the revenue. Any company or startup is just a source of revenue for the government even before it starts doing business.    

Discretionary Power
It's not only the laws and regulations that are extractive. Authorities are entrusted with so many discretionary rights that they use to exert their control. Such discretionary power has promoted corruption, bribing and kickbacks. It is the government officials who decide what a business entity should do, how much tax it should pay or how it should operate not on the basis of existing laws or regulations, but from his personal whim or judgement.

The ridesharing business in Nepal is a case in point. Citing a provision that prevents private two-wheelers or cars to be used for ridesharing, officials decided to crack down on ridesharing platforms Tootle and Pathao in 2019. They, however, were forced to backtrack due to a huge backlash. But after a few months, authorities at the Department of Transport again started to restrict them from providing services. Following widespread criticisms of the crackdown, the department was forced to retreat again. These episodes highlight how the authorities use archaic laws to kill business innovation. The authorities draft the laws and regulations, assigning discretionary power to themselves. Most of the laws are designed in a way that gives authorities a wide latitude of space to play. Most of the acts include a phrase ‘the authority may or can’, giving government officials discretionary power to use their judgement. Be it for the issuance of licence or assessment of taxes or providing any approvals, the authorities use their discretionary power.

“Regulation does not mean repression. It should all be about facilitating businesses. In regulation, there should be a definite set of rules, not discretion,” Nara Bahadur Thapa, an economic analyst, said. “Nepal’s administration or governance enjoys a big element of discretionary power which has become costlier for the private sector or public at large,”

The officials or authorities entrusted with the discretionary power are often found dragging their feet while making decisions. Discretionary power gives a room for the authorities to misuse their power. If they do not see any incentive to act based on the discretionary power they are entrusted with, they might not take decisions or make decisions that harm businesses.

“Those countries, who have eliminated discretionary power and implemented a rule-based system, moved ahead on the economic fronts. Countries like Nepal, which assign discretionary power to authorities, are lagging due to misuse of such power and corruption,” Thapa added.

As the elections are over, the new parliament should prioritise economic reforms that create an enabling environment for investors and businesses. The focus of the new government should be on facilitating private sector growth rather than expanding government interventions. Cutting back on its role will not only foster innovation and stimulate private sector investment, but also accelerate economic growth in the country.

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