Foreign Aid and FDI in HEP Development

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--By Prof Dr Kamal Raj Dhungel

According to Rakishan, “Foreign Direct Investment (FDI) is defined as cross border investment done by foreign com-panies in a host country. It does not include investments made in the stock market. There are generally a couple of ways through which a company can make direct investments in a host country. A company can either buy a company located in the host country and make the company its wholly own subsidiary or start a joint venture with current owners. Companies venture with foreign investment in another country in order to take advantage of markets, efficiency, resources and strategic assets.”

Similarly, the OECD comprehensively describes FDI as, “FDI is a key element in this rapidly evolving international economic integration, also referred to as globalization. FDI provides a means for creating direct, stable and long-lasting links between economies. Under the right policy environment, it can serve as an important vehicle for local enterprise development, and it may also help improve the competitive position of both the recipient (“host”) and the investing (“home”) economy. In particular, FDI encourages the transfer of technology and know-how between economies. It also provides an opportunity for the host economy to promote its products more widely in international markets. FDI, in addition to its positive effect on the development of international trade, is an important source of capital for a range of host and home economies.”

Nepali Context
Nepal’s deficient economy has always lacked the ability to invest in projects that require huge investments. The basic industries have been established in Nepal with the investment of foreign governments. A number of key industries were established by FDI. The primary goal of these foreign investments was to make the country self-reliant. Accordingly, investments were driven by social motives rather than profit with Nepal responsible for the operation, maintenance and production and the sole owner of the return on foreign investment. This trend in industrial development has not changed much as industrial activities depend largely on FDI. However, over the last two decades of globalisation, FDI has gradually shifted from the government to the private source. Obviously, private sector investment puts the stress on profit rather than social welfare. Under this arrangement, the operation, maintenance, production and the ownership are either divided or solely owned by the foreign investors. For instance Surya Nepal, Dabur Nepal, Nepal Lever Limited, the different banks are the outcome of FDI. Similar other ventures are either operated through Nepali collaboration or through sole foreign entrepreneurship. 

Political Instability
BN Chalise has rightly remarked that, “The uncertainty that has accompanied Nepal’s prolonged political transition has discouraged both domestic and international investment. Political risks assessment has been found to be a critical factor to forms when deciding to invest in foreign countries. Political instability is also coupled with policy instability in Nepal which faces policy changes with the change of executives multiple times a year. This practice clearly does not offer the necessary policy stability required for FDI. Nepal’s poor performance has adversely affected foreign investment inflows into all sectors.”The reluctance shown by private sector investors to invest in infrastructure projects is a tradition common to all developing countries for two obvious reasons.

One, infrastructure projects will take a long period of time to show profit. And two, most developing countries have suffered from political instability in one form or the other. It surrounds investment with both observed and unobserved risks. It puts the expected return in peril. If the government fails to explore the appropriate methods to minimise such risks, domestic as well as foreign private sector investment diminishes. This leaves the country’s infrastructure development in the hands of the public sector, which of course is corrupt and inefficient.

For the past several years Nepal has suffered from political instability, leaving private sector investors nervous to invest. In the given situation, development activities are largely dependent on public sector investment.  All development activities in Nepal, small or big, have largely been influenced by foreign aid either in the form of grants or in the form of loans. 

Aid Alteration
At the beginning, aid in the form of grants played an important role in the construction of infrastructure projects and the establishment of some of the key basic industries. The hydropower projects then, under the sole management of bilateral donors, among others, were built from grants. Direct investment under donor management was found to be more effective in producing a desired outcome over a specified period of time. It not only helped to increase the stock of capital (capital formation) but also created numerous economic activities that helped to generate employment opportunities.  But foreign assistance in the form of grants has been changing over time. Gradually grants are being replaced by loans as bilateral donors are changing into multilateral ones. It also limits the discretionary power of the donor. 

The loan sanctioned by multilateral agencies for a particular project is less effective in comparison to the projects with direct investment. Under such an arrangement, the loan received from international financial institutions is often misused. An inefficient administration with poor governance, as in today’s Nepal, encourages corruption, hampering projects.

For example, the cost of the Middle Marsyangdi and Chamelia hydropower projects skyrocketed from the original project estimated cost.  The practice of taking commissions is behind the cost escalation rather than any technical one. This is one example of the critical misuse of aid. The Upper Trisuli 3A hydropower project also entered into controversy when the government decided to increase the electricity generation capacity from 60 MW to 90 MW in 2013. Protests from different corners forced the government to withdraw this decision. Neither of the projects operated under loans received from bilateral agencies have been completed in the pre-specified time period and at the original cost.  

Economic growth and development requires a number of things. FDI plays a major role in helping developing and emerging countries to tap their untapped resources, transferring capital and introducing new technology. The economic development of developing and emerging economies is primarily handicapped by the ineffective methods used in bringing in capital, technical know-how, organisational, managerial and marketing practices and global production networks. FDI is an effective way of bringing in such attributes for economic development.  

Sound policies can boost investor confidence. But social unrest prevents sound policies from being introduced. Incapacitation, incompetence, indetermination at the policy level will not attract FDI, which, if correctly enticed, with all proper attributes in place,could help transform the economy.

The author is retired Professor of Economics, Tribhuvan University

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