To what extent does FDI contribute to the GDP growth in Nepal, and what are the main challenges that limit its impact?

Key Points

• Research suggests a positive but limited relationship between FDI and GDP in Nepal.
• FDI's impact on GDP growth is constrained by low investment levels and structural challenges.
• Political instability and poor infrastructure seem to hinder FDI effectiveness.
• Evidence leans toward FDI contributing to sectors like hydropower, but with modest GDP impact.

Overview

Foreign Direct Investment (FDI) and Gross Domestic Product (GDP) in Nepal show a complex relationship, where FDI can support economic growth, but its overall effect is not as strong as in other countries. Studies indicate a long-term positive correlation, yet the low scale of FDI and various internal issues limit its contribution to Nepal's economy.

Trends and Data

FDI as a percentage of GDP in Nepal has been low, typically around 0.1-0.2% in recent years, with a high of 0.5% in 2012 and a low of -0.1% in 2006.

Challenges

Factors like political instability, outdated laws, and poor infrastructure reduce FDI's potential to boost GDP. For instance, historical periods of unrest, such as the civil war, have negatively affected FDI inflows, and Nepal's lack of direct access to seaports adds to operational challenges.

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Detailed Analysis of FDI and GDP Relationship in Nepal

The relationship between Foreign Direct Investment (FDI) and Gross Domestic Product (GDP) in Nepal is a critical area of study, given Nepal's position as a developing economy seeking to leverage foreign capital for economic growth. This analysis, based on extensive data and research, provides a comprehensive overview of the dynamics, trends, and challenges associated with this relationship, offering insights for policymakers, economists, and stakeholders.

Historical Context and Trends

FDI represents investments from foreign entities into Nepal's economy, often bringing financial resources, technology, and managerial expertise. GDP, on the other hand, measures the total value of goods and services produced within Nepal, serving as a key indicator of economic health. Research suggests a positive but limited long-run relationship between FDI and GDP, with studies employing econometric models like time series analysis and Ordinary Least Square (OLS) confirming this correlation.

Historical data from various sources, including the World Bank and CEIC Data, indicate that FDI as a percentage of GDP in Nepal has been consistently low. For instance:

• In 2023, FDI net inflows were reported at 0.1829% of GDP.
• Historical figures show a peak of 0.5% in 2012, a significant drop to -0.1% in 2006, and stabilization around 0.1% in recent years (2023 and 2024).

In contrast, Nepal's GDP growth rates have shown variability:

• From 1996 to 1999, real GDP growth averaged less than 4%, rising to 6% in 1999 and slipping to 5.5% in 2001.
• More recent data indicate a growth rate of 1.95% in 2023, with projections suggesting an increase to 5.01% by 2029.
• The World Bank reported a 4.9% growth in the first half of FY25 (H1FY25), up from 4.3% in H1FY24, driven by agriculture and industry but offset by a slowdown in services.

This comparison highlights that while FDI and GDP growth both show positive trends, the scale of FDI relative to GDP remains small, suggesting a limited direct impact on overall economic growth.

Empirical Evidence and Studies

Several academic studies have explored the impact of FDI on Nepal's GDP, providing empirical evidence of the relationship. A study published on ResearchGate, covering the period from 1980 to 2008, used time series econometrics to establish a long-run positive relationship between real GDP and FDI stock. However, it noted that FDI inflows have been inconsistent, attributing this to Nepal's challenges in attracting foreign investment.

Another study, published in the Interdisciplinary Journal of Management and Social Sciences in 2021, analyzed data from 1990/91 to 2019/20 using the OLS model and found a long-run relationship between FDI and economic growth. This study aimed to examine FDI inflows and their impact on GDP, reinforcing the positive correlation but emphasizing the need for structural improvements to enhance FDI's effectiveness.

A comparative study exploring FDI and GDP across South Asian countries, including Nepal, found that FDI is instrumental in enhancing economic growth, but the quantum of flow varies due to differing economic policies. For Nepal, the study highlighted that trade openness and domestic savings have a statistically significant positive relationship with FDI inflows, while liberalization policies positively affect FDI but lack statistical significance.

Sectoral Distribution and Economic Contribution

The sectoral distribution of FDI in Nepal provides insight into its potential impact on GDP. According to the Nepal Rastra Bank's FDI Survey Report for 2022/23, released on August 30, 2024, the industrial sector accounts for 59.7% of total FDI, with hydropower comprising 30% and manufacturing 29.4%. The service sector receives 40.2%, with 26% invested in banks, financial institutions, and insurance companies. This concentration in key sectors suggests potential for GDP growth, particularly in energy and manufacturing, which are critical for industrial development.

However, the contribution of FDI to capital formation and employment is not significant, limiting its overall impact on GDP. The same report noted that foreign-invested manufacturing companies utilized only 60.69% of their capacity, indicating underutilization that could hinder economic output. Additionally, research suggests that while FDI brings benefits like technology transfer and market access, these have not translated into substantial GDP growth due to structural constraints

Challenges and Barriers

Several factors hinder the effectiveness of FDI in boosting Nepal's GDP, as identified in various studies and reports:

• Political Instability: Nepal's history of political turmoil, including the civil war, has deterred foreign investors. A Kathmandu Post article from March 16, 2023, attributed a 93.61% year-on-year drop in FDI during the first seven months of the fiscal year to political instability.
• Outdated Laws and Regulations: Rigid labor regulations and unclear foreign investment laws, as noted in the ResearchGate study, make Nepal less attractive compared to regional peers.
• Poor Infrastructure: Lack of direct access to seaports and inadequate transportation networks increase operational costs, with Gurung (2010) highlighting transportation difficulties as a major barrier.
• Security Concerns: Poor security, particularly during periods of conflict, adversely impacts FDI inflows, with studies noting a negative correlation during such times.
• Low FDI Relative to GDP: At less than 1% of GDP, Nepal's FDI levels are the lowest among similar countries, as per a World Bank report cited in the Kathmandu Post article, limiting its potential to drive economic growth.

These challenges suggest that while FDI has the potential to contribute to GDP, structural and political issues significantly constrain its impact.

Policy Implications and Future Outlook

Nepal's government has recognized the importance of FDI for economic growth and has implemented various incentives to attract foreign investment. The KIST College blog from March 2024 highlights the government's goal to mobilize FDI in large infrastructure projects and technological sectors to achieve Sustainable Development Goals (SDGs) and the vision of "Prosperous Nepal, Happy Nepali" by 2030. However, the effectiveness of these policies is limited by the aforementioned challenges.

To enhance the relationship between FDI and GDP, Nepal needs to address structural issues such as improving infrastructure, streamlining regulations, and ensuring political stability. Liberalization policies, while positive, require stronger implementation to attract significant FDI inflows. Additionally, focusing on sectors with high growth potential, such as hydropower and manufacturing, could maximize FDI's contribution to GDP.

Future projections, such as those from Statista, suggest that GDP growth could reach 5.01% by 2029, potentially creating a more conducive environment for FDI if structural reforms are prioritized.

Detailed Data Tables

To provide a clearer picture, below are tables summarizing key data points from the analysis:

Year	FDI as % of GDP		Source
2006	-0.1%		CEIC Data
2012	0.5%		CEIC Data
2023	0.1829%		World Bank Data
2024	0.1%		CEIC Data
Year		GDP Growth Rate		Source
1999		6%		Wikipedia
2001		5.5%		Wikipedia
2023		1.95%		Worldometer
2029 (Forecast)		5.01%		Statista

These tables illustrate the trends in FDI and GDP, highlighting the disparity between FDI's potential and its actual contribution to economic growth.

Conclusion

In conclusion, the relationship between FDI and GDP in Nepal is positive but not strong, with research suggesting a long-run correlation that is limited by low FDI levels and structural challenges. Political instability, outdated laws, poor infrastructure, and security concerns significantly hinder FDI's effectiveness, resulting in a modest contribution to GDP. To enhance this relationship, Nepal must prioritize reforms to create a more attractive investment climate, focusing on infrastructure development, regulatory streamlining, and political stability. Future projections indicate potential for GDP growth, but realizing this will require concerted efforts to maximize FDI's impact.

(Prepared by KD with the help of grokai)

Key Citations

• CEIC Data Nepal Foreign Direct Investment as % of Nominal GDP CEIC Data
• Foreign direct investment net inflows % of GDP Nepal World Bank Data
• Gross domestic product GDP growth rate in Nepal Statista
• Economy of Nepal Wikipedia page Wikipedia
• Nepal GDP Worldometer current and historical data Worldometer
• THE IMPACT OF FOREIGN DIRECT INVESTMENT ON NEPAL'S ECONOMIC GROWTH ResearchGate Study
• Impact of Foreign Direct Investment on Economic Growth in Nepal NepJOL Study
• Exploration of Relationship between FDI and GDP A Comparison Sage Journals
• Nepal receives FDI from 58 countries with industrial sector myRepublica
• Take holistic measures to boost FDI in Nepal article myRepublica
• Foreign Direct Investment Growth and Trends in Nepal KIST College
• Nepal Development Update April 2025 report World Bank
• Foreign direct investment falls 93.61 percent year-on-year Kathmandu Post