Foreign Direct Investment in Nepal: Determinants and Role in Manufacturing Sector

Abstract

Foreign direct investment (FDI) is a long-term commitment for investment in developing host countries like Nepal as the major sources of capital for investment, the transfer of advance technology, and knowledgeable management skills. However, Nepal has received a very small amount of FDI compared with other developing countries during the study period. Thus, this dissertation, on Foreign Direct Investment in Nepal: Determinants and Role in Manufacturing Sector, explores the major determinants of FDI inflows and its contribution to the manufacturing sector. The main objectives of this dissertation are to investigate the trends, growth, and sources of FDI flows into Nepal with the special focus on the postliberalization periods; to explore the causes of the gap between actual and proposed FDI inflows; to analyze the determinants of FDI inflows; and to examine the contribution of FDI to the manufacturing sector of Nepal. To achieve these objectives, primary data from 100 samples, as well as secondary data (1995/96-2017/18), has been collected. To address the first objective, committed and actual FDI data have been used to show trend, composition, and growth of FDI flows into Nepal. The research has found that the trend and growth of FDI flows into Nepal is inconsistent during the study period. The magnitude of FDI from China is maximum, followed by India during the study period. To achieve the second objective, principal component analysis has been used to abstract crucial factors causing the high discrepancy between actual and committed flows of FDI into Nepal. To check the significance level of these abstracted factors, one sample t test has been made. The results show that high inflation rate, high volume of debt, high volume of trade deficit, and corporate tax rate are the pivot elements discouraging the foreign investors from investing their capital even after commitments. Similarly, the prominent factors causing the gap between actual and committed FDI flows are the low performance of bureaucrats in their respective fields, bureaucrats’ corruptive attitudes, unnecessary complex process created by bureaucrats for foreign investors, poor research and development facilities, less development of transportation facilities, and policy complications to approve the FDI. To address the third objective, OLS regression has been employed to investigate the key determinants of FDI flows into Nepal. The regression analysis reveals that the availability of infrastructure, corporate tax rate, political stability, human capital, openness, consumer price index, gross domestic product, NEPSE index, broad money supply, and tertiary education enrollment, infrastructure, market size, human capital, country-risk factors, and financial variables are found to be major determinants of FDI. To meet the fourth objective, instrumental variables and two stage least squares method have been used to explore the contribution of FDI to the manufacturing sector. The finding shows that the FDI has made a positive and significant impact on the manufacturing GDP and generated employment opportunities in the manufacturing sector during the study period. Finally, this dissertation concludes that FDI is a source of investment for a developing country—as well as main drivers of employment, technological progress, productive improvement, and ultimately economic growth of the nation. In order to raise the inflows of FDI, therefore, policy makers should develop infrastructure, moderate corporate tax rates, control corruptive attitudes of bureaucrats, reform policy complications to approve the FDI, and further liberalize the policies for foreign investors.