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Country Commercial Guides for FY 2000: Nepal Report prepared by U.S. Embassy Kathmandu, released July 1999 Note*

CHAPTER VII. INVESTMENT CLIMATE

* OPENNESS TO FOREIGN INVESTMENT

The Government of Nepal officially welcomes foreign direct investment, but policy implementation is often distorted by bureaucratic delay and inefficiency. At present, there are some 513 foreign investment projects in Nepal, worth a total of approximately 900 million (according to official GON statistics). Indian ventures lead the list with about 35 percent of the total number. U.S. ventures number about 52. Japan, China, Germany and South Korea are also prominent.

Government policy changes have signaled to foreign investors that Nepal is open for business. Private operations are now allowed in sectors that were previously government monopolies, such as telecommunications and civil aviation. Licensing and regulations have been simplified, and 100 percent foreign ownership is allowed. New banking institutions and a nascent stock exchange provide alternative sources of investment capital. Multinational investors based or looking to expand in the growing Indian market have also expressed an interest in Nepal.

Nevertheless, significant problems remain. They include: lack of direct access to seaports, difficult land transport, lack of trained human resources, few raw materials, inadequate electricity (especially outside the Kathmandu Valley), inadequate water supply, non-transparent and capricious tax administration, inadequate and obscure commercial legislation, and unclear rules regarding labor relations. Policies intended to establish a "one window policy" and simplify necessary interactions between investor and the host government have produced few results. Furthermore, a dichotomy exists between the letter of the law and the law's implementation. Foreign investors constantly complain about complex non-transparent government procedures and a working-level attitude that is more hostile than accommodating.

Still, conditions have tended to improve for foreign investors. The government is aware of the deficiencies in Nepal's investment climate and is moving towards liberalization. Policy shifts in regard to hydropower generation, for instance, has opened the sector to private development. Additionally, the abolition of the required minimal capital investment by the Foreign Investment and Technology Transfer Act, 1996 has eliminated a significant barrier to foreign investment. However, the same act that eliminated the minimal capital investment requirement also closed the Nepali market to foreign investment in the important areas of business and management consulting, and legal services.

Legislation

The most significant foreign investment laws are the Foreign Investment and One Window Policy Act of 1992, the Foreign Investment and Technology Transfer Act of 1992 and 1996, the Finance Act of 1996, the Immigration Rules of 1994, the Customs Act of 1997, the Industrial Enterprises Act of 1997, the Electricity Act of 1992, the Copyright Act of 1965 and the Patent, Design and Trademark Act of 1965.

The Foreign Investment and One Window Policy Act, 1992, restates the hoped-for benefits from foreign investment, lists the acceptable forms, allows for any foreign share (up to 100 percent) in any business area not on the "negative list," establishes currency repatriation guidelines, outlines visa arrangements, arbitration guidelines, and a special "one window committee" for foreign investors. The Foreign Investment and Technology Transfer Act, 1996, eliminates the minimal investment requirement, clarifies rules relating to business and resident visas, exempts interest on foreign loans from tax, and makes contract terms take precedence over Nepali law for investments over Rs. 500 million ($10 million USD). The Finance Act, 1995, outlines custom duties, export service charges, excise duties, sales taxes, air freight taxes, income taxes, and other taxes that affect foreign investment. The Immigration Rules, 1994, describes visa regulations. The Customs Act and Industrial Enterprises Act, as revised in 1997, establishes invoice-based customs valuations, eliminates many investment tax incentives, and installs in its place a lower, uniform rate. The Electricity Act defines special terms and conditions for investments in hydropower development. The Copyright Act and the Patent, Design and Trademark Act defines the terms and conditions surrounding intellectual property rights protection in Nepal.

Institutional Arrangements

The Investment Promotion Board (IPB), chaired by the Minister of Industry, is the primary government agency responsible for foreign investment. The IPB is intended to coordinate policy level institutions, to establish guidelines for economic policies, to approve or disapprove foreign investment proposals, and, if approved, to determine the investment incentives available to the proposed business.

The Department of Industry of the Ministry of Industry registers and classifies foreign investments. It also serves as the Secretariat for the so-called "one window committee," which manages the income tax and duty drawbacks to which some foreign investments are entitled.

Current administrative procedures do not allow for automatic approval of foreign investments. Foreign investors are required to obtain a license for any manufacturing or service sector investment, and each license request must be considered individually. On paper, investments under Rs. 500 million are referred to the Department of Industry and acted upon without involving the IPB. In reality, any unusual investment proposal goes to the IPB. Foreign investors frequently complain about bureaucratic delays and lack of transparency in procuring licenses for investment. For most investments, one to six ministries other than the Ministry of Industry may review the business proposal and give their opinion prior to consideration by the IPB.

Licensing of new investments can be a time-consuming process. Some foreign investors have said that the licensing process requires a good lawyer and plenty of patience. The law mandates, however, that the Investment Promotion Board is bound to make a licensing decision within 30 days, provided all necessary information has been submitted. At least early on in the investment process, Nepalese - exempt from the licensing process, except in the case of industries that are either related to defense, or affect public - are at an advantage.

Eligible Sectors

Foreign investment proposals must fall under existing industry categories, which include agriculture and forestry, manufacturing, electricity (water and gas), construction, hotels and resorts, transport and communication, housing and apartments, and a restricted range of services. Service industries in which investments are not permitted include business and management consulting and legal services. Foreign investment is also forbidden in the defense sector, in the production of alcohol or cigarettes, in "cottage industries", in travel and trekking agencies and in retail sales. Furthermore, the IPB will not license foreign investments that are judged to be either hazardous to general health or the environment

The Privatization Act of 1992 does not discriminate between national and foreign investors. However, in cases where proposals from two or more investors are identical, the government does give priority to Nepali investors. Altogether, through the close of 1998, 16 state-owned corporations have been privatized. Others - including the National Tea Estates, the Nepal Telecommunications Corporation; and Nepal's largest commercial bank, the Rastiya Banijya Bank - are now being prepared for privatization.

Visas

Visas in Nepal define the period for which a visitor has permission to stay. Six-month visas are provided to prospective investors for the purpose of conducting feasibility studies. To obtain a six-month visa, applicants must provide biographic information and a description of relevant work and professional experience. The process can be expedited if the person can be readily identified as a legitimate business representative.

In 1998, the Government of Nepal also began issuing five-year, multiple-entry visas to resident foreign investors and their families. In 1999, the fee for this visa was reduced to $250 USD.

* RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT

Foreigners are free to establish and own business enterprises and engage in all forms of business activity, with the exception of a few select industries. These include the defense industry, business and engineering consultancies, and legal services. In addition, the form of public participation is restricted in some areas. For instance, foreign insurance companies have not been allowed to sell life insurance or to open branch operations in Nepal.

Nepal is moving towards open competition in most sectors of the economy. Former public monopolies in banking, insurance, airline services, telecommunications and trade have already been eliminated and the remaining restrictions on private and foreign operations in these areas are slowly, but surely being scaled back.

Nepal does not have a law to guarantee free competition, or restrict unfair forms of competition. However, competitive equality is the official standard applied to private enterprises in competition with public enterprises with respect to access to markets, credit, and other business operations. That said, there are special subsidies and preferred credit arrangements for individual public and private companies in select sectors, such as rural electrification, fertilizer importation, and the provision of agricultural credit.

* PROTECTION OF PROPERTY RIGHTS

There has never been an effective contract law in Nepal and private contracts are not regularly enforced, either by the courts or the government. This may change in 1999. The Government of Nepal has drafted a new Contract Law, which it intends to present to Parliament in 1999.

Intellectual property rights protection is also inadequate. Patent registration is valid for only seven years and can only be extended twice for an additional total period of 14 years. In addition, Nepal does not automatically recognize patents awarded by other nations. The Copyright Law is similar. It covers most modern forms of authorship and provides adequate periods of protection. The law requires that products be registered in Nepal to receive protection. Enforcement is weak, with the result that almost all software, and most sound or video recordings now circulating in Nepal, has been pirated

Trademarks must be registered in Nepal to receive protection. Once registered, trademarks are protected for an initial period of seven years. Enforcement is very poor.

* ADEQUACY OF LAWS AND REGULATION GOVERNING COMMERCIAL TRANSACTIONS

Nepal is making progress in establishing a legal structure to govern commercial transactions. Enforcement of laws is uneven and court precedents are few. The Government of Nepal, in efforts to qualify for the World Trade Organization (WTO) and attract foreign investment, is working to bring its laws up to international standards.

* FOREIGN TRADE ZONES/FREE PORTS

Nepal has not established any foreign trade zones, free ports or export processing zones. However, any industry exporting 90 percent or more of its products is entitled to import raw materials and capital goods without payment of any custom dies, excise taxes or sales taxes. For qualifying industries, materials can be imported via an entry in a passbook. The same value of materials is deducted from the passbook upon export of the finished product without payment of taxes of any kind. Bonded warehouse arrangements are also available.

* PERFORMANCE REQUIREMENTS/INCENTIVES

Recent legislation has eliminated most tax incentives, regardless of whether they were connected with performance requirements or not. Exports, however, are still favored, as is investment in certain "priority" industries. There is no discrimination against foreign investors with respect to export/import policies or non-tariff barriers. There is also no local content or export performance requirement. Neither is there any requirement that nationals own shares, that the share of foreign equity be reduced over time or that technology be transferred. Nepal employs tax incentives to encourage industries to locate outside the Kathmandu Valley, due to pollution and overpopulation concerns, as well as the Government of Nepal's interest in developing poorer parts of the country.

In general, there is no income tax on profits from exports. Customs, sales tax, and excise duties are also reimbursed within 60 days on raw materials used in the production of export items. In addition, income in certain priority industries is taxed at a concessional rate of 10 percent, as opposed to the usual 20 percent rate.

Foreign investments in hydropower generation are governed by the Electricity Act of 1992. That Act allows such developers an exemption from income tax for the first 15 years of operation and a 10 percent reduction in income tax for the remaining years of a projects operation. It also provides for a flat 1 percent customs rate on all construction materials, equipment and spare parts.

* TRANSPARENCY OF THE REGULATORY SYSTEM

Foreign investors in Nepal face a non-transparent legal system. Firms complain that even the most basic legal procedures are not quick and routine. There is also a general reluctance of the bureaucracy to accept legal precedents. As a consequence, businesses are often forced to re-litigate issues that have been previously settled. Furthermore, recent legislation banning foreign investment in financial, legal, and accounting services have made it difficult for investors to find help for working through regulatory red tape.

Labor, health, and safety laws exist but are not properly enforced. Some companies report that the process of terminating unsatisfactory employees is very cumbersome, and that the protective labor laws make it very difficult to bring into Nepal skilled specialists such as pilots, engineers, or architects.

* CORRUPTION

U.S. firms and other foreign investors have identified pervasive corruption as an obstacle to maintaining and expanding their direct investments in Nepal. There are also frequent allegations of corruption by Nepalese government officials in the distribution of permits and approvals, in the procurement of goods and services and in the award of contracts.

Combating corruption is the responsibility the Commission on the Investigation of Abuse of Authority and of the Special Police Department under the Ministry of Home Affairs. The Parliamentary Public Accounts Committee has also played an active role in terms of publicizing cases of misconduct on the part of government officials.

Investigative commissions and committees are often formed to look into major cases of corruption that come to light. However, results to date have been disappointing. Officially, giving or accepting a bribe is a criminal act, punishable by imprisonment for one to six years, a fine, or both, depending on the degree of offense committed. However, few cases are investigated or prosecuted.

* LABOR

Nepal lacks a skilled and educated labor force. The overall literacy rate is only 33 percent and only 18 percent for females. Vocational and technical training is poorly developed and the national system of higher education is severely taxed by the large number of students enrolled. Many secondary and college graduates are unable to find employment in positions commensurate with their education. Those who pursue college education overseas seldom are able to find jobs in Nepal commensurate with their abilities and sometimes remain abroad. The employment of foreigners is also severely restricted. Under current law, the Department of Immigration must approve the employment of foreigners for all positions except those at the very top of a company or project.

The Constitution provides for the freedom to establish and join unions and associations. It permits restrictions on unions only in cases of subversion, sedition, or similar conditions. Despite the political transformation in 1990, trade unions are still developing their capacity to organize workers, bargain collectively, and conduct worker education programs. Union participation in the formal sector is significant, but it accounts for only a small portion of the total labor force. In 1992, Parliament passed the Labor and the Trade Union Acts, and formulated enabling regulations. However, the government has not yet fully implemented these laws. The laws permit strikes, except by employees in essential services such as water supply, electricity, and telecommunications. The laws also empower the government to halt a strike or suspend a union's activities if the union disturbs the peace or adversely affects the nation's economic interests. The government does not restrict unions from joining international labor bodies. Several trade federations and union organizations maintain a variety of international affiliations. While officially there is no government interference in union registration, unions have complained of registration difficulties when hostile political parties are in power.

Industrial actions are infrequent. However, efforts at collective bargaining are often hampered by unrealistic laws such as the Bonus Act, which provides that workers must receive 10 percent of yearly profits in bonuses regardless of productivity improvements.

The Child Act of 1992 provides legal protection for children in the workplace and in criminal proceedings. The Labor Act of 1992 prohibits employment of minors under 14 years of age, but employers, particularly in the informal sector or agriculture, widely ignore the law.

* EFFICIENCY OF CAPITAL MARKETS AND PORTFOLIO INVESTMENT

Credit is generally allocated on market terms, though special credit arrangements exist for farmers and rural producers through the Agricultural Development Bank of Nepal. Foreign-owned companies can obtain loans on the local market. The private sector has access to a variety of credit and investment instruments. These include public stock, and direct loans from finance companies and joint venture commercial banks.

Legal, regulatory, and accounting systems are neither fully transparent nor consistent with international norms. Though auditing is mandatory, professional accounting standards are low and many practitioners are either poorly trained or lacking in business ethics. Under the circumstances, published financial reports are unreliable and investors are better advised to rely on general business reputation except in a very few cases where companies have applied international accounting standards.

The Nepali banking system is small, fragmented, and, in individual cases, plagued by bad loans. Banking system assets total approximately $2 billion USD. Banking system capital totals less than 30 million USD. Foreign commercial lending is also scarce and expensive. At the moment, there are no resident or non-resident foreign commercial banks that have standing credit limits for loans of a maturity of more than one year.

There is no regulatory system to encourage and facilitate portfolio investment in the industrial sector. Only direct investment is permitted. Stocks for a few industrial firms are listed on the Nepal Stock Exchange. However, foreign institutions may not purchase more than 25 percent of the equity of firms, and then only in specified sectors such as tourism and power. Lack of transparency and regular reporting of reliable corporate information also present problems for foreign investors in equity markets.

There are no legal provisions with respect to firm defense against hostile takeovers.

* CONVERSION AND TRANSFER POLICIES

The Foreign Investment and Technology Transfer Act, 1992, permits foreign investors to repatriate all profits and dividends, all monies raised through the sale of shares, all payments of principal and interest on any foreign loans, and any amounts invested in transferring foreign technology. Foreign nationals working in industry are also allowed to repatriate 75 percent of their salaries, allowances, emoluments, etc. The above repatriation facilities are made available on the recommendation of the Department of Industry, which is normally provided with approval of the original investment.

However, convertibility is not as easy or as well guaranteed as the Nepali Government announcements would indicate. An overworked and inefficient banking system is to blame. The actual experience of American and other foreign investors suggests that there are discrepancies between the government's stated policy and that policy's implementation.

For repatriation of funds from sale of shares, foreign investors apply to the Nepal Rastra (State) Bank. For repatriation of funds connected with dividends, principal and interest on foreign loans, technology transfer fees, and expatriate salaries, allowances, and emoluments, the foreign investor applies to the Department of Industry, and then to Nepal's central bank (the Nepal Rastra Bank).

Services provided by the private banks are rated as good by foreign investors, but high ratings are not given to the Nepal Rastra Bank for its exchange regulations administration.

In general, Nepalese are not permitted to invest outside of Nepal. Exceptions, however, can be granted on a case-by-case basis. In 1995, a private airline was permitted to invest in a regional carrier based in Calcutta and represented the first instance of approved direct foreign investment by Nepalese nationals.

* EXPROPRIATION AND COMPENSATION

The Industrial Enterprise Act of 1992 states that "no industry shall be nationalized." Nepal constantly reiterates this point in negotiations with private sector firms interested in the hydropower sector. There have been no cases of nationalization in Nepal.

Companies can be sealed or confiscated if they do not pay taxes in accordance to Nepalese law. There are no official policies either extant or in the offing that would lead the Embassy to conclude that official expropriation should be of concern to prospective investors. There have been instances in the past where unscrupulous local partners have used the tax or regulatory system to seize control of a joint venture firm from the U.S. investor. Such cases have not involved major Nepalese business houses.

* DISPUTE SETTLEMENT

In the event of a dispute with a foreign investor, the concerned parties are encouraged to settle the dispute through consultation in the presence of the Department of Industry. If the dispute cannot be settled in this manner, it will be referred to arbitration in Nepal according to the arbitration rules of the United Nations Commission for International Trade Law (UNCITRAL) for investments less than Rs. 500 million (7.35 million USD) in value. For investments over this amount, the Government of Nepal will permit stipulation of legal jurisdiction other than Nepal in shareholder agreements and contracts.

All real property transactions must be registered and property holdings cannot be transferred without following procedures. Even so, property disputes account for half of the current backlog in Nepal's court system and such cases can take years to be settled. Moreover, laws and regulations are unclear, and interpretation can vary from case to case.

There is also a provision for liquidation in the Company Act. Claimant priorities are: 1) government revenue, 2) creditors, and 3) shareholders. Monetary judgments are made in local currency.

Nepal has adhered to the New York Convention of 1958 on the Recognition and Enforcement of Foreign Arbitral Awards and has updated its legislation on dispute settlement to bring its laws in line with the requirements of that convention. A new Arbitration Act, which allows the enforcement of foreign arbitral awards and limits the conditions under which those awards can be challenged, was passed by Parliament in 1998. In addition, legislation permitting Nepal to enter into mutual legal assistance treaties, which will allow the enforcement of foreign judicial decisions, is being prepared by the government for submission to parliament in 1999.

* POLITICAL VIOLENCE

There have been no civil disturbances targeted at foreign investors in the past five years. Public demonstrations and strikes are popular forms of political expression in Nepal and may occur on short notice. These demonstrations are usually non-violent and not directed at foreigners. During general strikes, many businesses close for one or two days and transportation and city services may be disrupted. These strikes rarely result in little or no damage to private property.

A violent Maoist insurgency in isolated Midwestern districts of Nepal has claimed approximately 888 lives since it began in February 1996. The violence has not affected the Kathmandu Valley to a great degree, but foreigners, particularly aid workers, in the Midwestern districts of Rolpa, Rukum, Jajarkot, Salyan and Gorkha have been threatened and, occasionally, attacked. Because of the potential for violence, the U.S. Embassy currently forbids travel of U.S. Government employees to or through the Rukum, Rolpa, Jajarkot, Salyan and Gorkha districts. The Department of State cautions Americans to also avoid travel to these districts. In addition, the Embassy restricts U.S. Government employee travel to or through the Dolpa, Dang, Sindupalchok, Kavrepalanchok and Ramechaap districts. Only essential travel is permitted in these areas. American citizens traveling in these districts are advised to exercise extreme caution. American citizens traveling to Nepal are strongly urged to check with the U.S. Embassy upon arrival or before traveling domestically to receive the latest information about the security situation, since the potential for violence now extends to areas that have in the past been relatively free of such activity.

* BILATERAL INVESTMENT AGREEMENTS

Nepal has signed bilateral investment treaties with India, Britain, Germany and Norway.

* OPIC AND OTHER INVESTMENT INSURANCE PROGRAMS

OPIC is free to operate in Nepal without restriction. OPIC is empowered to offer its "extended risk guaranty" facility to prospective U.S. investors in Nepal. Nepal is also a member of the Multilateral Investment Guarantee Agency (MIGA), which it joined in 1993.

* MAJOR FOREIGN INVESTORS

As of May 1999, India was far and away the most important foreign investor in Nepal, with over 35 percent of the projects. It was also involved in five of the ten largest foreign enterprises. In terms of number of investments, Japan is second; the United States, third; China, fourth; Germany, fifth; South Korea, sixth; and United Kingdom is at seventh place. Major private investments now underway include the U.S.-Nepal joint venture, Upper Bhote Koshi Hydroelectric Project, and Asian Development Bank/local venture, the Taragaon Regency Hotel.

* NEPAL'S CONTACT INFORMATION FOR INVESTMENT-RELATED INQUIRIES

Ministry of Commerce, Babar Mahal, Kathmandu
Tel: 977-1-223489, 224805
Fax: 977-1-225594

Ministry of Industry, Singha Durbar, Kathmandu
Tel: 977-1-226686
Fax: 977-1-220319

* FOREIGN DIRECT INVESTMENT STATISTICS (As of June 15, 1999)

Total No. of Projects			 	513

Agriculture and Forestry			 12
Manufacturing				263
Electricity Water & Gas			    	  7
Construction 				 12
Hotel & Resort					124
Transport & Communication			 18
Housing & Apartment				 11
Service Industries				 66

Total Project Cost: NRs. 61.29 billion    ($901.35 million)

Total Estimated Fixed Cost: NRs. 53.33 billion  ($784.31 million)

Total Estimated Foreign Investment: NRs.13.60 billion ($200.04 million)

Total Employment  Generated: 72,537

Source: Foreign Investment Division, Department of Industry, HMG/ Nepal.