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Formalizing MSMEs

Micro, Small and Medium Enterprises (MSMEs), despite their limited investment, knowledge and resources, have been the backbone of economies around the world. According to World Bank, 90% of all firms are MSMEs, and they contribute up to 60% of total employment and up to 40% of national income (GDP) in emerging economies. Nepal, where the industrial sector has not been able to grow as expected, consists mainly of small scale enterprises. The reason is that because people have very little capital at their disposal, and they do not have the skill sets or prior experience to run large scale businesses, people start off small. This is why least developed countries with poor economy (like Nepal) see more people starting with MSMEs.

                    MSME’s contribution in Nepal Percentage
1.       Share of industrial GDP 90
2.       Share of industrial sector value addition 70-80
3.       Share of industrial Employment 80
4.       Share of industrial Export 80

* Source: Federation of Nepal Cottage and Small Industries (FNCSI)

In Nepal, the trend of registration and setting up of new small-scale industries has also been interestingly going up in the past few years. More and more small-scale enterprises have opted to operate formally. If global figures are anything to go by, then they invariably mean that this is a good thing for Nepal as well, from an economic growth perspective.

Fiscal year 068/069 069/070 070/071 071/072 072/073
No. of cottage and small industries registered 18,022 15,556 22,129 17,654 24,317

 Source: Audhyogic Tathyanka 2072/73, Department of Cottage and Small Industry (DCSI)

A question to delve into, then, would be, what is causing this surge in the number of micro and small entrepreneurs entering the formal economy. Clear and convenient government policies and processes are the need of the day if the government seriously wants to see more of the MSMEs in Nepal.

Government agencies claim that the Industrial Enterprise Act, 2073 (2016)’s free registration and complete income tax waiver for first five years of operation provisions have motivated firms to register. This is a positive start. However, we must also be wary that income tax exemption for five years simply defers the problem for next five years, and does not necessarily solve complexities embedded in it. Likewise, wiping out the registration fee does not wipe out the problems of registration as it is still entangled with multiple paperwork. For instance, as long as MSMEs have to submit business schemes (which need business’s forecasts of break-even point, annual turnover, annual profits, etc.) to oversight bodies, procedural complexities will continue to exist.

Coordination is another challenging issue which lags in government agencies. Entrepreneurs are required to visit multiple offices during registration. Currently an entrepreneur needs to visit Inland Revenue Department (IRD) as well as municipality office only to pay taxes. As an entrepreneur, it would be much easier to pay all taxes at one agency. State institutions could devise a mechanism whereby they share such revenues. This is absolutely possible and even staffers of government offices acknowledge the possibility and benefits of such measures. Yet, it never happens.

Likewise, the unclear registration procedure, piles of documentation, inaccessible government offices have discouraged firms from registering in one way or another.  In order to avoid such complexities ‘online registration system’ available at fingertips can certainly be a solution to combat those problems. Countries like Azerbaijan, Thailand, Malaysia and many other countries have started this system the subsequent ease of doing business in these countries as a result of these reforms is clearly depicted in various global indices (like the World Bank’s Doing Business Report). Even our neighbouring country India has already started online procedure for registration and tax filing (even for micro enterprise).

This will obviously not be a quick hit across the country alike for not all Nepalese can access this service right away, but even then, that is no reason to hold back. We can run these systems (manual and digital) parallelly and independently, until other people are ready to switch to digital platforms.  Such a system would end the reliance on government agencies even for minor works and make government services more convenient and accessible.

In Nepal where more people are vying to open private enterprise, government should capitalize on this by making it easier for them to enter the formal market. Actionable and quick reforms like ones discussed above, if implemented, could motivate more and more enterprises to operate formally, and more importantly, inspire birth of new MSMEs.

 

Ashish Thapa

About Ashish Thapa

Ashish is working as a researcher at Samriddhi Foundation.

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The Trade-off Between Social and Economic Development

Nepal has recently adopted federalist approach with the aim to bring economic as well as social transformation. We aspire to become an egalitarian society, ensuring equitable economy, prosperity and social justice. We also aspire to achieve perpetual peace, good governance, development and prosperity. While as a political document there does not seem to be much of a problem with either one of these, from an economic perspective, there appears to be a slight bit of tension among these aspirations.

Both economic development and social development has been a leading concern for Nepal. On one hand Nepal aims for achieving high income equality and poverty reduction through inclusive growth, while on the other it aims for high economic growth with increased productivity. Both goals are such that, social development through inclusive growth needs economic compromises and economic growth through productivity enhancement is likely to create more unequal distribution of income and assets.

Nepal, since 2000 has been giving eminent priority to inclusive participation, gender mainstreaming and poverty reduction. A series of positive impacts – poverty reduction to 13% in 7 years from its initial 33%, decline in hunger by 22.5%, reduction in Gini Coefficient to 0.35, resolved gender issues with increment in household headed by females, increment in average household income by 2.5%, net primary enrollment ratio of 96.6% and improvement in overall health outcomes – to name a few, can be regarded as astonishing achievement for Nepal. These achievements portray the dedication of Nepal over the past decade towards social development. The government of Nepal allocated more than NRs. 33 billion for social security alone.

However, these achievements have not been able to tackle the underlying challenges of Nepalese economic concerns as in the same period Nepal also faced slow economic progress with low PCI of US$850 in 2017 and is still lying among the 48 least developed countries despite its goal to upgrade itself to developing nation by 2022. The decline in employment from 84.3% in 2000 to 81.7% today, despite of majority of people migrating for foreign employment shows lack of productive, employment generating activities. The slow industrial progress with decline in agriculture productivity with only 2/5th of arable land illustrates that Nepal has been deteriorating in terms of investment climate, industrial growth and agricultural productivity. The inability of government to invest in priority projects is hindering the expansion of other sectors as well, further leading to slow economic growth. This depicts a contradictory picture of Nepal’s progress than compared to social development.

We cannot completely deny the role of remittance, aid and migration in the various social achievements. Thus, we can say that there is food in our belly but yet we are not self-sustainable. Despite the deteriorating macroeconomic variables of Nepal, the indicators of social sector enhancement showed more positive results. This makes it apparent that in case of Nepal, the achievement of social progress is negatively correlated to the achievement of economic progress. One important question for Nepal to dwell over, at this juncture then would be, will it be rational to compromise, as a country, a fair portion of otherwise potential economic growth for social growth?

The achievement of both the goals together seems to be paradoxical. Economic growth being a pre-requisite, Nepal for social development can either aim for equality of opportunity or equality of outcome. Focusing on outcome equality is practically not a rational or possible goal and more equal distribution of income might create additional problems resulting in stagnant economy. Nepal can achieve economic growth and social development by focusing in equality of opportunity. However, we need to understand that this approach is likely to create social and income disparity. Equality of opportunity will hamper the equity and equality goals of Nepal as everyone is not equal and all will have different ways to avail the opportunities. Some will benefit highly while others might not. Which of the two is more logical approach, is for us to decide. It is a trade-off.

 

Ayushma Maharjan

About Ayushma Maharjan

Ayushma is working as an intern in the research department of Samriddhi Foundation.

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Import Substitution: A Hindrance To Economic Development

As Nepal’s imports vis-à-vis exports continue to surge, more and more voices in favour of import substitution through import substitution industrialization (ISI) have been gaining ground. The fundamental logic is, instead of depending on imports, these (imported) goods should be produced domestically. While it may be tempting to defend this policy on the grounds of reduced reliance on imports and promotion of domestic market, there are quite a few explicit and implicit costs such policy entails.

Developing countries generally adopt ISI with the objective of stimulating economic growth, ironically by setting up trade barriers – imposition of tariffs and/or import restriction through quotas. Protectionist mechanism as such inflates the price of otherwise cheap imports, which in turn induces people to consume domestic alternatives they otherwise would not have in the absence of import tariffs or quotas. Consumers are compelled to bear substantial welfare loss for the sake of protecting few domestic jobs. New jobs replace old ones as a result of technological advancement under what we call the process of creative destruction. Hence, domestic jobs being lost due to foreign competition is a normal phenomenon of “economic evolution”. One way to look at it is as a release of human capital to take on something else where this capital can be employed. The question then would be are the economic policies of a country conducive enough to facilitate that transition?

ISI has proved to be counterproductive time and again. Latin American countries suffered severe ramifications – ranging from overvalued exchange rates to high level of foreign debt – upon adopting this policy. Furthermore, dependence on imported capital goods intensified as a result of attempting to substitute imported consumer goods with domestic goods. There was no improvement on trade deficits whatsoever and in some cases worsened as high exchange rates discouraged exports. And finally, ISI failed to alleviate unemployment in all respects.

Nepal has witnessed soaring trade deficits over the years. A recent finding has shown that Nepal’s imports amounted to Rs.893.09 billion while exports lagged behind at Rs.67.35 billion. Experts have pointed out the need to focus on promoting import substitution industrialization. However, is enforcing import restriction really going to help domestic markets to grow? Gorakhkali Rubber Industry, a domestic tire manufacturing company, was established in 1992 with the goal of reducing dependence on imported tires from India. The price of tires manufactured by this company was more expensive than the ones offered by Indian brands, which are of course levied custom duties. Evidently, Indian brands had comparative advantage over the production of tires as they were able to manufacture them at a lower opportunity cost. Gorakhkali Rubber Industry had to eventually halt production as it faced a supply glut since no one was willing to purchase overpriced tires. The basic principle of trade – countries engage in production of goods that they have comparative advantage over – is entirely disregarded under ISI as it was the case with Gorakhkali Rubber Industry.

Export oriented industrialization (EOI) approach could be more economically viable in generating sustainable growth. Rather than imposing import restriction to retain inefficient domestic industries, Nepal should divert its attention towards industries that actually have comparative advantage in the world market and incentivize these industries to export their products. On the other hand, Nepal is still not at par with foreign producers when it comes to manufacturing capital intensive commodities, say cars. Instead of attempting to manufacture cars on its own to bring down trade deficits, the government should formulate policies that would attract foreign direct investments to establish a plant for manufacturing foreign cars in the country. This significantly shrinks the import-export gap but more importantly, technology transfer that follows foreign direct investment contributes to the extensive development of domestic industries.

Nepal needs to analyze the trade-offs involved in each case and construct policies accordingly – ISI could save a few jobs in the short run at the expense of consumer welfare, and EOI might fail to save those jobs in the short run but enhances productivity and fosters growth eventually. All policies are carved with good intentions; however, good intentions of a policy do not necessarily yield good consequences in the long run. We therefore need to get our priorities right in the first place.

About Sambriddhi Acharya

Sambriddhi is a researcher at Samriddhi Foundation.

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Cost of Unspent Capital Budget

A unique trend has emerged in Nepal over the last ten years or so whereby the success of a Finance Minister is measured by the amount of revenue generated by the state during his/her term rather than the soundness and impact of his/her policies. And interestingly, Nepal government has been able to generate higher and higher revenues with every passing year. But has the increased revenue been able to deliver real growth, or greater achievements in development indicators for Nepal? Not quite! And this is where another attribute of Nepal government comes into the scene—greater revenue collection but consistently low capital spending.

* Source: Financial Comptroller General Office & Nepal Rastra Bank

Fiscal year Percentage Capital Expenditure (CE) budget in total budget Actual capital expenditure (% of allocated budget for CE) 9-month spending (% of allocated CE Budget)
2016/17

30

23.75

2015/16

26

56.30

15.5

2014/15

18.9

76.09

17.5

2013/14

16.45

78.37

26.9

2012/13

16.33

82.56

* Source: Ministry of Finance & Nepal Rastra Bank

As can be seen above, the Government of Nepal (GoN) has been boosting revenue collection every year. Likewise, provision for capital expenditure—which is seen as the backbone of economic development—has also been growing. These ever-increasing revenue targets (and actual collection beyond the targets) are not necessarily problems in themselves; however, the fact that government consistently fails to employ these resources to development activities is definitely one.

With reference to this year’s data, only 31 percent of the total capital expenditure has been injected in the economy as we approach the end of tenth month of this fiscal year. Weaker spending capability pushes the deadline of the governmental projects and also increases the cost of the projects. The mega-projects like Pokhara Int’l Airport, Postal “Hulaki” highway, Melamchi drinking water project, ‘Madhya Pahadi Lokmarg’ and other national priority projects have been affected by weaker spending ability. Piles of billions of rupees worth of unspent capital expenditure prove that government is achieving its targets only in papers. And these sorts of failures only create bottlenecks for greater economic growth.

A question then arises—why does the government collect larger revenue every year despite being unable to utilize it fully? One possible reason is that politicians can easily promise growing revenues towards new welfare programs. Welfare programs are useful tools to become more popular among voters, and these programs can be implemented in quick span of time unlike infrastructure development.  In 2016/17, the GoN doubled allowances for old age, disable, single woman and endangered communities programmes. While there is no questioning intended benefits of these programs for genuine beneficiaries, it is also equally true that these are tools of vote-bank securing at the cost of other development activities that could create greater wealth in the economy. What is ominous about these programmes is that these are irreversible, for any politician who wishes to undo these programs will be committing a political suicide—they will become unpopular among voters. And obviously, these expenses need to increase over time.

On the other hand, every penny unspent by the government compromises the ability of economy to flourish. The frozen budget which is collected from taxpayers, if had not been collected in the first place, those funds would still be in the hands of private individuals. These private individuals could have consumed, invested or even saved this money at financial institutions. For entrepreneurs and credit seekers, this would mean greater availability of funds. All these could contribute towards wealth creation inside the economy. This is the alternative way by which the economy could have grown—leading to more new entrepreneurs, more jobs in the economy, and higher production of goods and services by the private sector. Unfortunately, some of these possibilities have been largely compromised in our country.

Therefore, what could be better for the economy is that every year, as our budget-making process begins, the government factor these other things that get compromised as the government looks to grow bigger (and create new welfare programs). There is a private sector in the economy, and every time the government grows, it shrinks the space for private sector as well. If the government is inefficient at utilising resources, then it should re-think exercising control over greater resources every year.

 

Ashish Thapa

About Ashish Thapa

Ashish is working as a researcher at Samriddhi Foundation.

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Remittance: Where is the money going?

It is hardly news for us that Nepal is one of the largest recipients of remittance (relative to the Gross Domestic Product); inbound remittance is equivalent to 30% of Nepal’s GDP, and continues to grow by the year. Yet, not much of this money is being channeled to productive activities, and that, many argue is a worrisome event for Nepal. But why could that be happening? According to one of the recent updates published in national daily, much of this money is spent on loan repayment, daily consumption, education and health, and some bit is being saved. A closer look at these headings clearly reflects Nepal’s ground realities, and offers cues to why not much is going into productive sector.

25% on loan repayment
The primary reason behind so many young people migrating to foreign lands is a search for economic opportunities—opportunities that are not available for most of them in Nepal. This migration, however, does not come free of cost. Since most of these economic migrants come from poor families that also do not have much savings in the first place, they acquire loans in hundreds of thousands to get themselves into these foreign lands. Obviously then, the first priority for them is to repay their loans so that they can secure greater disposable transfers for their families as soon as they can.

24% on daily consumption
Around 25 percent of Nepalese are living below the poverty line. For most of these people, it is daily battle—meeting their basic needs. Therefore, when the level of income increases, a large portion of the disposable income is spent on daily consumption. People cannot be expected to make huge proportions of saving and invest it while they do not even have a decent arrangement regarding their basic needs of food, clothing and shelter. And that is what we see so many poor Nepalese people doing with growing remittances. When disposable income increases, it’s a basic human behavior to uplift living standard for better and healthy life.

10% on education and health
While a large portion of Nepal’s budget is spent on health and education sector, access of people to quality health and education services are not satisfactory to say the least. The number of free public schools is high but large numbers of students are now slowly moving to privately-run schools for quality education. This is a manifestation of the fact that parents believe that quality education is a pre-condition for their children’s secure future, and that they perceive private schools as better educators.
Similarly, public health services are not accessible to all. That is not to mean that private health services are, however, the same services that the government has committed to offer to the people for free are non-existent in a lot of places, and people have to spend a substantial chunk of their income on accessing these facilities.
Combined, these expenses reflect the inefficiency of state institutions, and poor quality of whatever little services are available to the people.

28% on savings
The above-three major headings and some others (including trade, cultural and religious activities, etc.) account for 72% of remittances, leaving behind only 28% for savings. This is the amount that could actually go to productive sectors in the form of investments. And that is where the catch is, for Nepal. If nothing else changes, most of this money will go into purchasing land and gold as these assets guarantee a certain amount of return (which substantially greater than investing in other economic sectors in Nepal). However, if the goal is to have this money channeled to productive sectors, then Nepal will have to rethink its policies such that there are respectable returns to be earned from the productive sectors as well. And this will come through building a conducive environment for doing business, meaning stable and market-friendly policies that allow people to start their businesses with ease, protect their private properties, guarantee contract enforcement, allow for easy exit from the market, and ensure rule of law.

Sujan Regmi

About Sujan Regmi

Sujan is working as Research Intern at Samriddhi Foundation.

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Automatic Route – A Prerequisite for FDI Inflows

Nepal Investment Summit, 2017 raised the aspirations of many investors and business opportunists as it unlocked various possible alternatives to promote investment-friendly policies and practices. Among the many commitments, political stability to attract foreign investors, huge FDIs from various nations including China and USA, and the assurance of Minister of Industry to promote friendly regulatory framework for doing business in Nepal were the major outcomes of the Summit. Parallelly, the MoI had also been working on reforming the Foreign Investment Act, and the provision of granting permission to some investors via “automatic route” seemed to be a good complementary move; there were also some genuine arguments about why it was limited to only some, and why not all.

However, a recent move by the MoI to remove the provision of automatic route from the draft of Foreign Investment and Technology Transfer Bill (FITTB) countervails these commitments. The removal of this policy requires foreign investors to enter Nepal through a long and cumbersome process—submit multiple documents to the regulator (Department of Industries, Investment Promotion Board, or the Nepal Investment Board, depending on the scale of investment), and additional documents to Nepal Rastra Bank (NRB). This approval system for Foreign Direct Investment has been one of the biggest tailbacks for investors to make actual investments in Nepal.

Nepal does not need such a complex approval process. What Nepal actually needs is simple Acts and regulations to attract as many investors as possible in order to meet saving-investment gap, technology and skill gap and generate ample employment opportunities. The many goals of the GoN – completion of national pride projects, building of satellite cities, infrastructure development projects, energy development projects and an aim of achieving double digit industrial growth rate – cannot be fulfilled with limited domestic investments. Foreign direct investment is an irrefutable factor for the economic development of Nepal and thus, we cannot afford to offset our potential investors.

Nepal already ranks in the 109th position in the World Bank’s Index of ease of Starting a Business. Moreover, Nepal is the only country in South Asia to have a two-layer approval system and extensive paper-works to bring in foreign investments – a major comparative disadvantage which makes Nepal less attractive to the foreign investors. Foreign investors are likely to explore more favorable alternative investment destinations within the markets of South Asia rather than investing in Nepal. Nepal already lags behind in numerous ways than other neighboring countries. In such scenario, a policy change that enables easy entry of FDI in Nepal could be a competitive factor among its South Asian counterparts.

Automatic route could indeed be a defining factor for economic transformation of Nepal through which foreign investors could bring in investments without government approval, reducing the lengthy and cumbersome processes. Nepal, in this matter should comprehend India’s reform. After the adaptation of automatic route for FDI, India was able to attract $44.20 billion in 2015, a rise by 28%. The FDI contribution in GDP of India during that period was 14-15%.

It is apparent that Foreign Direct Investment is crucial for the economic growth of Nepal. Automatic route could be seen as the most rational step for the government to take in order to attract these FDIs for executing all its committed plans. However, the removal of this principal provision by the MoI is unconceivable.

Ayushma Maharjan

About Ayushma Maharjan

Ayushma is working as an intern in the research department of Samriddhi Foundation.

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