INTERNATIONALIZATION OF NEPAL 'S FINANCIAL SERVICES
ROLE OF WTO
By Shiva Raj Bhatt
Despite the promising results achieved through the financial sector reform in the last-two-and-a-half decades, this sector still faces problems due to insufficient competition, low efficiency, lack of modern banking technologies and facilities especially outside urban centers.
The prime responsibility of the financial sector is converting savings into productive investment. A well functioning financial system allocates savings to the best possible use, i.e. productive investment. This crucial role established the financial system as the 'brain of the economy' that determines what gets done and what does not.
The roles and responsibilities of the financial sector grow as societies develop. As a result of unprecedented world development in the last century, the financial sector has grown dramatically and emerged as one of the most important as well as the most dynamic sectors of the world economy, both in developed and developing countries. On an average, at the global level, financial sector contributes nearly 10 per cent to GDP and equal percentage in the export of commercial services. In Nepal , too, the financial sector contributes over 10 per cent of the GDP. But the sector contributes only 0.2 per cent of Nepal 's commercial services exports in the year 2003.
It is empirically proven that the growth and stability of an economy largely depends on the capacity and efficiency of her financial system, and the capacity and efficiency of financial system is largely influenced by its internationalisation (See Box 1). Internationalisation of financial services usually refers to the elimination of discrimination between foreign and domestic providers of financial services and removing barriers to the cross-border provision of financial services.
Financial liberalisation in Nepal
Recognising the importance of foreign participation in the financial sector, the Nepal government has allowed foreign banks to enter and operate in the country since 1984, a landmark year in Nepal 's financial sector history. In 1984, Nepal had only two state-owned commercial banks. Significant progress has been achieved in this sector after that. As a result, presently, despite the country's small and under-developed economic base, Nepal has a reasonably diversified financial sector. During the last two-and-a-half decades a number of financial institutions came into existence with varied nature of operations, offering a wide range of services. In mid-July 2005, the country's financial sector comprised 17 commercial banks, 34 development banks (including five rural development banks), 59 finance companies, 19 cooperatives (carrying out limited banking activities) and 47 non-government organisations (carrying out limited banking activities), and some other non-bank financial institutions that includes insurance companies, provident fund, mutual fund and others.
Although financial institutions have proliferated, the Nepali people have not yet fully reaped the potential gains of the liberalisation and reforms of the financial sector. A World Bank study ( Nepal : Financial Sector Study 2002) identified a number of weaknesses in services provided by the financial institutions. These are: excessive government involvement in the financial sector, a weak central bank, a poor banking environment (including weak and fragmented legal framework, weak corporate governance, lack of competition, poor banking culture, information asymmetry and lack of financial sophistication, and corruption) and a lack of adequate banking services for the poor.
Therefore, it can be said that despite the promising results achieved through the financial sector reform in the last-two-and-a-half decades, this sector still faces problems due to insufficient competition, low efficiency, lack of modern banking technologies and facilities especially outside urban centers.
In this context, deeper reforms that help increase competition and competitiveness of the sector, increase the coverage of the sector and foreign participation at grass-roots level (rural areas), among others, are desirable.
Nepal 's financial sector related commitment at WTO
Nepal 's commitments related to the financial services can be broadly divided into two categories: general commitments (that applies to all services sectors) and specific commitments (that applies only to the financial services sector).
a. General commitments
In general commitments section, Nepal has extended market access to all - both for imports and exports - in a specified manner except a restriction of providing only US$ 2,000 for Nepali citizens while going abroad. Nepal has also committed that supply of services by an existing foreign supplier will not be made more restrictive than they were at the time of Nepal 's accession to the WTO. Movement of natural person (movement of people to deliver services) has been made unbound or restrictive except in the categories of services of sales persons, persons responsible for setting up a commercial presence, and intra-corporate transferees. Nepal has also committed to provide national treatment (no discrimination between foreign and domestic suppliers), without any limitation. It is committed that the present limit of providing foreign exchange to Nepali citizens will be continued. Regarding commercial presence, no limitation on national treatment has been placed on foreign investments and reinvestments except under two conditions that both of these require approval from the Department of Industry (DOI) and incentives and subsidies provided, if any, will be available to wholly-owned Nepali enterprises only. With respect to presence of the natural person, it has been made unbound or restrictive, except for as specified in the schedule. The present Civil Code prohibits selling, mortgaging, gifting or endowing or disposing real estate in Nepal to foreigners. The schedule also restricts foreigners to buy and sell real estate in Nepal . Additionally, Nepal has committed to provide decisions within 30 days of the date of application for investments except in the case of need of environmental impact assessment. In case of repatriation of investment in foreign currency, repatriations facilities have been committed to: the amount received by the sale, in part or whole, of the investors' share of equity; the amount received as profit or dividend as a result of an equity investment; the amount received as the payment of the principal of and interest on any foreign loan; and the amount received under an agreement to transfer technology approved by the DOI or Department of Cottage and Small Industries.
b. Specific Commitments
Nepal has also made specific commitments in financial services sectors. As per the schedule of Nepal 's specific commitments in services, the following are the major commitments (general conditions) of Nepal in financial services:
l All the commitments are subject to entry requirements, domestic laws, rules and regulations and the terms and conditions of the Nepal Rastra Bank, Insurance Board and any other competent authority in Nepal, as the case may be, which are consistent with Article VI of the GATS and paragraph 2 of the Annex on financial services.
l The commitments in insurance services are given to the nationals and financial institutions of the members, whose law and policies do not bar the provision of similar commitments to the Nepali nationals and financial institutions. No such limitation will exist as of 1 March, 2004 .
l Financial services in the form of operations identified in the schedule can be carried out in Nepal only through a locally incorporated company.
l Branches will be allowed for insurance services and wholesale banking as of 1 January, 2010 .
l Only a licensed commercial bank, a licensed specialised bank or a registered finance company may accept deposits, which are repayable upon demand.
l Only financial institutions with rating of at least 'B' by Credit Rating Agency e.g. MOODY, Standard and Poor can have commercial presence in Nepal .
l The total foreign shareholding in any institution providing financial services is limited to 67 per cent of the issued share capital. It has, nevertheless, relaxed for the existing foreign financial services providers as to their scope of operation and equity structure.
l The share held by foreign nationals and foreign financial institutions in their locally incorporated companies are not transferable without the prior written approval of the Nepal Rastra Bank or any other competent authority as the case may be.
l Representative office may not be engaged in a commercial business.
l The members of the Board of Directors of a financial services supplier will be in proportion to equity representation of that financial services supplier.
Box 1 : Benefits of internationalization
Despite of risks that internationalization of financial services may carry, particularly in the absence of adequate regulatory structures, there has been considerable support for the view that this favors the building of financial systems that are more stable and efficient. It is argued that policies that impede competition, such as entry restrictions and restrictions on foreign banks, have been shown to raise the cost of financial services and hurt economic performance. Studies from the WTO and elsewhere found that increased competition through foreign supply contributes to financial sector stability and efficiency and helps improve transparency of regulatory regimes. It is found that the countries with fully open financial services sectors grow on average one percentage point faster than other countries.
It is argued that opening up of financial sector to foreign participation and competition not only introduces innovation and technology, but also can help to bring down the cost of financial services. It thus improves the competitiveness of domestic companies. In today’s global economy, internationally competitive services, including financial services, sector is essential for a country’s development.
Internationalization of financial services, therefore, can help Nepal build more robust and efficient financial systems by introducing international practices and standards; by improving the quality, efficiency and breadth of financial services; and by allowing more stable sources of funds. Increased competition may imply a reduction in domestic bank profits, but banking customers gain through reduced net interest margins, lower costs of fee-based services and the availability of a greater variety of services.
Sources:
- Marchetti Juan A. (2004), Developing Countries in the WTO Services Negotiations, Staff Working Paper ERSD-2004-06, WTO Geneva.
- Mattoo, A. R. Rathindran and A. Subramanian (2001), Measuring Services Trade Liberalization and its Impact on Economic Growth: An Illustration, World Bank Research Working Paper, No. 2655, Washington , D.C. : The World Bank.
- Shiv Raj Bhatt (2005), Service Trade Liberalization under WTO: Implications and Strategies for Nepal , a report submitted to Nepal Window II Trade Related Capacity Building Project of UNDP Nepal, 2005.
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Box 2 : WTO and internationalization of financial services
The discussions to include services trade in international agreements dates back to the late 1970s when US aimed to expand GATT rules to facilitate the expansion of the global operations of transnational corporations within a predictable and universal framework. But, with a few exceptions, developing countries did not support the idea of bringing trade in services into trade negotiations, because they thought that doing so was a veiled attempt to introduce investment into the negotiations. Recognizing the growing importance of services as well as the various constraints impeding the globalization of this sector, the Uruguay Round broadened the scope of multilateral trade negotiations to include services for the first time in the history of trade negotiations. Under Uruguay Round a Group on Negotiations for Services was established, with the aim to promote orderly and transparent trade and investment liberalization in services. In the Punta del Este declaration of 1986, developing countries accepted the inclusion of trade in services only on the condition that negotiations on trade in services would occur separate from those on trade in goods, with a clear development orientation. At the Montreal midterm ministerial meeting in 1988 it was agreed that the definition of trade in services should include movement of factor of production where such movement was essential to supplier. Between the Montreal and Brussels Ministerial Meetings (in 1990) much work was done to refine the definitions both of trade in services and of ‘barriers’ to such trade. General Agreement on Trade in Services (GATS) is the final result of negotiations under Uruguay Round. The GATS entered into force with the establishment of World Trade Organization (WTO) on 1 January 1995 . GATS intended to establish a framework within which liberalization commitments in the area of services are to be undertaken and implemented. Under WTO, the GATS provide a framework within which liberalization commitments in the area of services, including financial services are to be undertaken and implemented.
Source: United Nations Development Programme (2003), Making Global Trade Work for People, Earthscan Publications Ltd., UNDP.
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Implications and the way forward
Nepal 's WTO membership has institutionalised the process of financial liberalisation in Nepal . Therefore, the membership has set impetus for further financial deepening, integration and accelerated liberalisation. Though many foreign banks have already been operating in Nepal , it is anticipated that the role of these banks will become even more significant in the future because of policy stability which resulted from the WTO membership. The increase in foreign banks' presence is hoped to bring positive spillover effects or demonstration effect on domestic financial institutions that will ultimately help promote efficiency. Their presence can also help speed up domestic institution building as they bring both human capital and technology needed to the sector and the economy as a whole.
But, the domestic banks should keep 1 January, 2010 in mind after which branches will be allowed to do wholesale banking and insurance services in Nepal . Such entry of foreign banks and insurance companies would definitely bring additional competition for them. Similarly, the policymakers should be aware that once the financial services are opened up for foreign investors, it may tend to render existing capital control regime less effective.
(Bhatt specialises on foreign trade and development)
Revenue Proposals for 2006/07
Ambitions & Implications
By Dr. Puspa Kandel
The budget has withdrawn those facilities that were actually being enjoyed by businesses and that had actually helped in business growth. The facilities now promised are meaningless as they cannot be practically enjoyed.
The new coalition government has drawn up a budget for the financial year 2006/07 with an estimated expense of around Rs. 144 billion. Targeting a 5 per cent growth rate, the budget estimates the rate of inflation to be around 6 per cent and plans to collect around Rs. 85 billion as revenue including Rs. 70 billion from taxes and Rs 15 billion from non-tax sources of the total tax revenue estimated, 26 per cent is from customs, 40 per cent from VAT, 18 per cent from income tax, 12 per cent from excise and 5 per cent from others. Since the tax revenue expectation is 16 per cent higher as compared to last year’s revised estimate, people have taken it as an ambitious plan.
It would be appropriate to analyse how realistic or ambitious these proposals are. For that purpose, studying the details of the proposals would be helpful.
New Tax Proposals in the Budget
l The income tax rate for industrial units related to liquor and tobacco have increased to 30 per cent from 25 per cent in previous years.
l The industrial units to be established in special economic zones are given tax holiday of five years from the date of operation. From the sixth year, the tax rate for such units is to be 10 per cent in case of special industry and 15 per cent in case of liquor and tobacco related ones.
l There is blanket tax holiday of 10 years to industrial units established in specified remote areas from the date of operation.
l There is 25 per cent tax exemption to IT industries set up within IT Park specified by the government.
l The proposal has abolished the facilities of tax exemption to cottage industries. This facility was provided by Industrial Enterprise Act, 1992 and it was reiterated by last year’s finance ordinance.
l The proposal has withdrawn the 2 percentage point income tax rebate given by last year’s budget to companies listed in the stock exchange.
l Also the 50 per cent tax rebate facility to cooperatives in urban areas given by finance ordinances of last two years is withdrawn from this budget.
l This year’s budget has increased the personal tax exemption on income of disabled persons by 50 per cent. In future, the personal exemption to the disabled will be Rs. 1.50 lakhs for individual and Rs. 1.875 lakhs for couple and widow and widower with minor children.
l The private schools which have not cleared their tax dues up to Financial Year 2004/05 are given a chance to clear it up. The clearance will be without any fee, penalty and interest
l It is proposed to form two committees – a High Level Tax Arrears Settlement Commission (to resolve the dispute between tax office and tax payer) and a tax clearance committee (to revise the tax amount in pending cases).
l The income of the King and the royal family is made taxable in line with the May 18 Proclamation of the House of Representative. Accordingly, it has abolished the provision of VAT and excise exemption given to royal family.
l The budget proposal has slightly increased the customs rates on those items in which the rates were slashed by the royal regime in the finance ordinance of January 2006. The excise rate is increased slightly on excisable items also. Some new items like noodles and imported packed foods are brought within excise net. However, there are some items as well in which the customs rate is decreased.
l There are provisions for government purchasing the goods that are suspected to be under-invoiced and making effective the post clearance audit system to reform the customs valuation system.
l There is provision for voluntary declaration of income by those who have not declared their income in the past. The person will have to pay tax on such income and the authorities will not ask for the source of the income so declared.
Implications of Some of the Proposals
One can easily see that the government wants to minimise the tax rebate and increase the tax net while at the same time creating an illusion that it is generous to grant facilities to the business community. For example, the government has abolished the tax concessions given to companies listed in the stock exchange, to the cottage industries and to the cooperatives located in urban areas. These were the facilities which were actually being utilised by the business. Moreover, the facilities given to listed industries were useful to encourage the privately held companies to go public. This would have improved the transparency of the private sector. Similarly, the facility given to cottage industry was very much useful for the promotion of cottage industries in the country. These facilities were given by the autocratic royal regime. Therefore, abolishing these by the democratic government may indicate to the business community that the autocratic regime was more favourable while compared to a democratic one. It would have been prudent not to abolish these facilities right now.
Compare this with the tax holiday given to the industries to be established in remote areas. These facilities will not be used in practice. For example, no industry will be established in the region where there is no road transport facility. We have tested it over the last 40 years when generous tax holidays were given to set up industries in such areas but no genuine industries were actually established there. From the point of view of tax burden also, the tax holiday is not appropriate to those industries which are running under loan. During the period of tax holiday, the interest deduction facility and depreciation facility has no meaning. Therefore, the tax burden after the expiry of tax holiday period is increased. The same applies to tax holiday given to industries in special economic zones. All these mean that the tax holiday system has only a cosmetic effect. It only increases the chance of tax avoidance through tax planning.
Also the tax exemption limit increased for disabled persons means nothing since very few of them have an income as high as Rs. 150,000 and Rs. 187,500. The facility given to IT industry would face the same fate due to the remoteness of IT park from the Kathmandu Valley . It will remain vacant in future years as it is today. The 25 per cent tax rebate would not attract investors to this park since it is not the tax rebate that attracts investment but it is the chance of profitability which attracts the investor. The facility of fee, penalty and interest waiver to private schools if they submitted the income statement up to financial year 2004/05 would also have no effect in tax compliance because their demand was for a total waiver of income tax from fiscal year 2001/02 to fiscal year 2003/04. It would have been better for the government to bring all private schools under the tax net by granting total waiver for those years. Also the proposal of improving the customs valuation system would have no effect due to the complicacies involved in it in real life. If post clearance audit is made effective, it would be more than sufficient in the present situation of the country.
Besides these, there are other lacunas as well in the tax proposals which may hinder the growth of the private sector. The major one is the lack of a clear vision for tax administration reform. Right now, the major reform area in the tax system lies in tax administration. Increasing the number of offices under the IRD, controlling unauthorised import from India , improving excise system and implementing reward and punishment system are the grey areas in this respect. Also the scheme for voluntary declaration of income has little chance of success, as was the fate of such a scheme in the past.
(Kandel is Reader in Faculty of Management of Tribhuvan University and has conducted several studies in Nepal ’s taxation system )
Suggestions on how to prepare for renewal and revision of Nepal India Trade Treaty scheduled to expire on March 2007.
The five-year cycle of Nepal-India trade treaty will be over in the first week of March 2007, i.e. in less than nine months from now. The treaty deals with the trade in goods and provides a framework for reciprocal treatment in terms of customs duty and quantitative restriction to the primary and agricultural goods while unilateral preferences is provided to Nepali manufactured articles in India except for a very short negative list items. The renewal of the treaty in 2002 also added some extra provision to the existing treaty, defining the rules of origin where value addition and substantial transformation with sufficient processing were adopted as the criteria in determining the origin of the product. Tariff rate quota was applied for four products: vegetable fats, zinc oxide, copper products and acrylic yarn. The provisions on joint verification through joint inspection of the manufacturing units were introduced so as to satisfy any reasonable doubt of the customs authority to the certificate of origin issued by the competent Nepali authority. The safeguard measures against injury and threat of injury to the domestic industry could be invoked from both sides in a reciprocal basis if such an injury or imminent injury is attributable to the surge in imports. The treaty will, of course, follow another cycle of five years in a status quo ante if no amendment is initiated by the signing parties.
India has remained the single largest trading partners over a long period in the past. The trade volume with India has gone up in an unprecedented way after 1996 thanks to the treaty of 1996 that provided space for increment of export and corresponding import of raw materials and finished products from India . Foreign trade composition of Nepal shows that export to India has gone up to 39.4 billion NPR (67 per cent) in 2004/05 from the level of 26.0 billion (47 per cent) in 2000/02. Similarly, import level jumped to NPR 85 billion (59 per cent) from 45.2 billion (38 per cent) during the same period. This is a substantial jump in trade volume in less than a decade; with the corresponding figure of 5.23 billion (23 per cent of total export) worth of export and 24.9 billion worth of import (27 per cent of total imports) made to and from India during 1996/97. The steady increase in the volume of trade (see table-1) also postulates increased dependency, high stake and vulnerability of Nepal 's trade to its neighbour.
However, the trade with India has not been hassle-free in a sense that factors other than tariff remained contentious issues in the forefront of trade. Export of plant and animal products always faced the row under scrutiny of quarantine. Food standard requirements, quality of the manufactured articles, luxury tax, state taxes, special additional duties etc. have, in one way or another, affected the export trade of Nepal . Compliance costs of these have remained generally higher, often resulting in clamour and frustrations among Nepali exporters or often times resorting to informal channel for trade in a bid to get rid of the hassles of formal trade.
The traditional trade agreement also derelicts the border trade that is taking place along the 1,700-km long and porous border between the two countries. Many people in the vicinity of the international border frequently get into another territory as small traders, visitors to their relatives, and for earning daily wages. Such movement of natural persons also induces bilateral trade in goods as well as in services which has gone unaccounted for in the history of trade. The existence of minor customs check points (Chhoti Bhansars), in the Nepali territory, has also lost relevance in the realm of Nepal-India trade.
The simplified provision for export after the 1996 treaty was supposed to bring substantial investment in the country. However, this was not realised due to various reasons mainly attributable to the looming political instability and conflict along with the slow development process in creating a favourable investment climate. However, India occupies the top rank in terms of the investment size among the foreign investors in Nepal . Currently, there are 331 industrial establishments run as joint ventures with Indian investment which makes one third of the total foreign investment projects. The total project cost of these establishments adds up to Rs. 34.1 billion of which Rs. 11.5 billion has been in the form of foreign investment. These establishments provide employment to around 43,000 people. The investments are mainly in the manufacturing sector 225 (68 per cent) service 57 (17 per cent), tourism 35 (11 per cent), and remaining 14 in number (4 per cent) in other sectors.
Nepal being between two emerging economies and big markets of the globe is itself an advantage that provides opportunity of economic integration through increased trade and investment. However, a well planned incentive package needs to be in place in order to bring in more external investment which in turn will help in optimising the benefit from niche markets. Some of the important measures for promotion of foreign investment would include the provision on avoidance of double taxation, ensuring national treatment to the establishments, securing intellectual property rights in accordance with the WTO provisions and a fair and equitable justice based on the rule of law. The investment measures should be implemented in a way that would help in promoting productive employment and reducing poverty through sustainable economic growth.
The trade agreement between Nepal and India has to be looked at from the perspective of bringing benefits to both countries in the sphere of changing scenario of world trade and regional trading arrangements. Nepal and India are now part of WTO, SAFTA and BIMSTEC communities which bring them under various obligations of trade in goods, trade in services and the facilitation of cross border flow of investment and factors of production. This would require a fresh look on the existing trade arrangement that may need realigning and making new provisions in order to maintain a harmony with the agreements concluded after the latest renewal of Nepal-India trade treaty.
It is obvious that the trade agreement in the changing scenario should go beyond the periphery of tariff benefits. Experience has shown that concessions on tariff are generally offset by other restrictive but non-tariff measures of trade. Hence the focus will be required mainly on four areas, i.e. removal of non-tariff barriers, promotion of investment, technology transfers and research and development for product promotion and diversification.
Nepal 's exports have often times faced serious problems in market access due to stringent quarantine regulations and food quality standards imposed from the importing country. While recognising the legitimate right of protecting the health of its citizen by the government through enforcement of food quality and quarantine measures, it cannot be forgotten that these have remained barriers to market access and hence they are dealt under various trading arrangements. The initiatives of collaboration on harmonisation of the quarantine, food quality standards and relevant regulations would help in facilitating bilateral trade in such a way that certification of the authorised agency of the exporting country is accepted without any hitches by the respective agency of the importing country. An appropriate institutional mechanism may be worked out to iron out the differences in approaches and implementation of para-tariff measures without undermining the legitimate interest of the partnering countries.
Investment is closely related to trade. This is particularly important to a country where there is paucity of capital and other resources. Hence, collaboration on investment for industrial ventures and trade related infrastructures would pave the way to increased trade. Moreover, there should be collaboration in promoting information and communication technology particularly development of human resources and promotion of internet based commerce, learning and e-government. The development of physical infrastructures: road, railroad container freight stations, inland clearance depots and border facilities may be created to enhance bilateral trade. Besides, the use of electronic data interchange in customs processing and clearance of bilateral cargo, simplification of the customs documents, and harmonisation of working hours at the land customs stations are some of the simple but key issues in facilitating the flow of goods.
Nepal-India trade treaty provides for across the board duty free access to the Nepali manufactured articles in India except a small number of negative list items. This provision has remained the soul of the whole arrangement as this provides opportunity to develop various industries and bring in more investment in Nepal . However, there is need of achieving specialisation in manufacturing, focusing in the area of comparative and competitive advantage. Currently the product base of Nepal 's export is narrow which needs to be expanded for achieving reliability and sustainability of trade. The framework of the trade treaty should be able to provide support in the development of new products in Nepal particularly in the area of agriculture, horticulture, production of medicinal herbs, condiments and spices and promotion of small and medium scale enterprises. Tariff concessions may be provided on the import of industrial raw materials and intermediary goods which will help trigger manufacturing and export trade. Thus there is a need to look at the issues from a broader perspective so that complementarities in economies are achieved through meaningful collaboration in trade and investment. There is a need to change the mindset of stakeholders on both sides, a departure from the conventional approach of tightening all loose ends and making trade and investment regimes more restrictive in one way or another. The businesses and traders, who are at the centrestage of the implementation process, should accept the reality of thriving on a fair and competitive regime rather than seeking an excuse for easy money. A comprehensive deal is the need of time if we wish to develop complementarities in trade and make the bilateral economic relations more meaningful.
Think Over a Comprehensive Deal