Why Nepal needs FDI and Foreign Loan?


Pic Credit: The Himalayan Times
I used to dislike the idea of Foreign Direct Investment (FDI). I used to reason, if we can mobilise the investment potential of people within Nepal, we do not need to seek investment abroad. For example, the amount of money that is poured into the IPOs and FPOs of Nepal give an indication that there is some good amount of capital with Nepalese people that can be channelled into the various large scale projects and business opportunities. It took me a while but I eventually understood why FDI and Foreign Loan are quite important despite the fact that Nepalese people have high equity investment potential. 

Macro-Economic Perspective

In order to understand the significance of injecting foreign capital into Nepal we need to look it from macroeconomic perspective. It is equally important to understand the capital budgeting of the projects and their debt to equity ratio. The  source of financing big projects is largely debt with some portion of equity (which is again the savings of the public that is stored in bank and mobilised as loans by these big projects). With the provision that projects can acquire loan as much as four times of their equity, it is no wonder that they will try to acquire as much loan as possible to leverage the project as well as reduce the overall cost of capital. Now, the private equity in macroeconomic perspective is not essentially different from debt, as it also returns to the banking channel in the form of savings. Therefore, no matter what we do, our overall investment potential within the country is limited to our overall liquidity (or loosely the amount of money in circulation). 

What is our overall liquidity?

The savings (capital formation) that is collected by all types of financial institutions forms the basis of capital formation of the country and it signifies the overall liquidity. If we combine the total amount of deposits received by each bank, then we can easily get to that number which signals the upper ceiling of our fiancial resources. Let us say this amount is X, equal to the sum of all the savings in all the financial institutions.

This overall saving will definitely help us grow our economy at a certain rate, if we utilised/invested it wisely in various projects. However, this rate will be limited to certain rate because by employing a given amount of capital, X, we can only generate a given amount of surplus. The overall production of goods and services is known as country's Gross Domestic Product (GDP). Therefore, we can only grow our GDP at a given rate. 

However, we want to achieve economic prosperity more quickly. For that we need to have higher rate of GDP growth. The desired rate of GDP growth of Nepal Government is double digit growth rate, that is, more than 10% growth rate sustained over a period of time. Now, given that the overall supply of money or overall amount of deposit within the economy is fixed, if we want to achieve higher growth we need to inject more money from outside our economy. This is where the FDI and Foreign Loan comes into play. When FDI enters Nepal, it will increase the sum of all savings, X by the amount of additional capital received as FDI or Loan. Now, the economy has higher amount of capital that can be utilised for generating even higher amount of wealth or GDP. 

What happens if we take loans from domestic market?

Taking loans from within the domestic market will only change the borrower. It won't essentially change the amount of liquidity within our economy. Foreign Direct Investment is the injection of additional liquidity in the economy. Let's suppose that a mega project such as Arun III, wants to borrow loan from the banks of Nepal. It's estimated cost according to the article in the link above, is $1.6 Billion which is roughly 190 billion (or 1.9 Kharba) Nepalese Rupees. Now, let's look at the deposit collection and loan disbursement of commercial banks of Nepal in this article. From this article we can see that Rs.190 Billion is more than the entire deposit collection of 2 quarters of 23 banks out of 27 banks. So, only 4 banks were able to collect deposit more than 190 arba (billion). Banks cannot loan out all the deposits, which means their lending capacity is much less. So, bank financing a project such as Arun III with 70% debt means 133 Arba of loan taken from domestic banks. However, we don't have only Arun III to finance! We have several other big projects, thousands of existing big companies and hundred thousands of Small & Medium Scale enterprises that are leveraging their businesses with bank loans. Other loan categories like home loan and auto loan, are also big. One big project such a Arun III is enough to give liquidity crunch to the whole banking sector in the macroeconomic level. There are  definitely other financing organisations like development banks, and finance companies but their capacities are limited. Naming a few other big projects like Nighgadh Airport, Budhigandaki Hydroelectric Project, Upper Tamakoshi, etc and we can realise how big are the financing requirements for these projects and the limitations of our financial sector to meet all those needs. Therefore, FDI holds due importance.

FDI also brings in Technology

Liquidity isn't the only thing we want to bring in, we also want to introduce modern technologies in manufacturing, information technology, and many other sectors. FDI not only brings in money, but also these new technologies that we desperately need if we want to take advantage of the latest inventions and innovations to make stride in our economic development. With our goal of achieving economic prosperity at the fastest rate, FDI or government borrowing from foreign countries has any other feasible alternatives. If we want to avoid it, then we need to opt for organic growth of our economy at a slower rate and be content with it.


FDI and government borrowing seem scary, undesirable, unreasonable or simply unpopular if we look from a common-sense perspective. Nevertheless, if we are desperate to achieve a double digit economic growth rate, we need to facilitate the inflow of Foreign Direct Investment by giving prerefence to those companies that are willing to introduce latest technologies (technology transfer). Likewise, the government should also borrow foreign loan as much as it can acquire.

Your thoughts and feedback are highly welcome in the comment section below.

Additional Reading: https://thehimalayantimes.com/opinion/fdi-flows-to-nepal-benefits-and-challenges

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