Nepal stands at a pivotal point in its economic development journey, with a commitment to realizing the vision of a "Happy Nepali, Prosperous Nepal." However, the current trajectory of economic growth remains insufficient to fulfill this aspiration. Over the past three decades, Nepal's growth rate has hovered around a modest four percent per annum. This sluggish pace is inadequate to meet the country's long-held development goals.
To achieve Nepal's development aspirations, it is imperative to invest massively in infrastructure and the productive sector. The 16th Development Plan (BS 2081/82-2085/86) estimates that Rs 9.482 trillion is required over the next five years to achieve an average annual growth rate of 7.1 percent. Given the limited sources of financing, traditional methods alone cannot meet this colossal funding requirement. A sustainable financing strategy is more important than ever.
One potential strategy could be to establish a Sovereign Wealth Fund, SWF, for Nepal. SWFs are normally established to save and invest national wealth more effectively, to ensure economic stability, promote sustainable development and preserve future interest of a country. Countries with current account surpluses and having excess foreign exchange reserves use SWFs to manage such resources prudently.
According to the World Bank, a well-governed SWF, with a sound mandate and professional management and staffing, can possibly improve the quality of the public investment program. But its mandate should not duplicate that of other government institutions with investment mandates, such as the budget, the national development bank, the investment authority, and state-owned enterprises.
SWFs, which serve as vehicles for long-term investment, have been successfully implemented in countries such as Norway, UAE, China, Singapore, Saudi Arabia, Qatar, Australia, and South Korea, among others. The 26 founding members of the International Forum of Sovereign Wealth Funds in 2008, have also agreed the “Santiago Principles”, which are the globally accepted standards for governance, investment and risk management practices for sovereign wealth funds. The Principles are designed to promote good governance, accountability, transparency and prudent investment practices.
This article seeks to initiate a discussion on the potential for establishing an SWF in Nepal, a crucial step toward securing the nation's economic future, addressing the funding gap, and realizing the vision of a "Happy Nepali, Prosperous Nepal."
The Rationale for a Sovereign Wealth Fund
The International Monetary Fund (IMF) defines SWFs as special-purpose investment funds created and owned by the general government for macroeconomic purposes. These funds hold, manage, or administer financial assets to achieve financial objectives and employ a range of investment strategies. As indicated earlier, SWFs are commonly established from balance of payments surpluses, official foreign currency operations, proceeds from privatization, fiscal surpluses, and/or receipts from commodity exports.
The current financial situation of Nepal provides a convincing ground for the establishment of an SWF. The latest current macroeconomic and financial condition report out from the Nepal Rastra Bank, based on the annual data of fiscal year BS 2080/81, demonstrates a high level of foreign currency reserve and a strong external sector surpluses. Remittances, which are the major sources of forex reserve, have increased by 16.5 percent in Nepali rupees and 14.5 percent in US dollars (USD). The remittances alone are higher than the entire import that the country did last year. Balance of payments remained at a surplus of Rs 502.49 billion compared to a surplus of Rs 285.82 billion last year. Gross foreign exchange reserves have stood at USD 15.27 billion. The current level of foreign exchange reserve is sufficient to cover the goods and services imports for 13 months. This reserve far exceeds the traditional monetary policy target of 6 to 7 months of import sufficiency. Such a strong external sector balance is rare in Nepal. Setting aside a portion of this excess reserve could also serve as a buffer during crises and provide resources for long-term investments. Perhaps, there is no better time to consider and initiate an exercise for the establishment of an SWF than now.
The budget statement of the fiscal year BS 2081/82, in Article 274, has already announced government’s policy for the establishment of an SWF to channel the excess remittances into the productive sector. The proposed SWF will operate through a special-purpose vehicle to complement the investment needs for public infrastructure development. This marks the first time the government has recognized the need and potential for an SWF in Nepal. The policy announcement and the growing reserve complement to each other and provide a favorable background for the establishment of an SWF.
Remittances have been a growing sources of foreign currency in Nepal for many years. Unfortunately, the use of remittances in the productive sector is negligible, with about 90 percent used in consumption. This trend must be changed and it has to be channeled toward productive sectors. After spending so much on consumption for so many years, time has now come that Nepal creates a mechanism to channel remittances into the productive sector, which can contribute to generate employment opportunities inside the country, including creating a buffer that could be used at times of crisis. This is the need of the hour, and emerging opportunity as well to create job opportunities domestically. Since the funds are already held in the central bank's account, developing a financing instrument to use these reserves for infrastructure development and job creation is a prudent step. It is essential to remember that the current reserve is temporary; if not diversified and used wisely, and in productive sector, the cycle of import and consumption could deplete it again, like in the past. Thus, establishing an SWF by utilizing a portion of remittances is an emerging and promising option. Such opportunity may not be available all the time.
In addition to remittances, there are other potential sources of funding for an SWF. These could include revenue generated from natural resources, such as a portion of earnings from hydropower exports, one of the most promising sectors of Nepal's economy. Similarly, a portion of taxes and fees collected from tourism activities could provide a stable source of funding for an SWF. Revenue from the privatization of state-owned enterprises, the infrastructure development tax currently levied on petroleum products, and profits or dividends generated from existing government investments and assets could also be funneled into the SWF. These are just a few examples; by exploring diverse funding sources, Nepal can create a well-capitalized and sustainable SWF. A detailed study in this regard is essential though.
Moreover, an SWF could serve as a buffer against economic shocks, providing the government with a financial cushion at times of crisis. By supporting infrastructure development and promoting economic stability, an SWF could become a vital tool in achieving Nepal's long-awaited development aspirations.
Challenges and Lessons
Nepal can draw valuable lessons from both the successes and failures of SWFs globally. Norway's Government Pension Fund Global, Singapore's Temasek Holdings, the UAE's Abu Dhabi Investment Authority, and India's National Investment and Infrastructure Fund (NIIF) are a few examples of successful SWFs. Studying their legal frameworks, mandate, governance, and organizational structures could offer best practices to learn when Nepal considers to establishing an SWF.
Conversely, the 1Malaysia Development Berhad (1MDB) scandal in Malaysia provides critical lessons on the risks and consequences of mismanaging an SWF. The 1MDB scandal highlights the dangers of weak governance structures in managing an SWF. Similarly, lessons can be learned from the Philippines' recently established Maharlika Investment Fund (MIF), funded by remittances from Filipinos working abroad and contributions from the Philippines' central bank. Critics have raised concerns about the MIF's governance and transparency, drawing parallels to the 1MDB scandal, which is why the MIF has yet to become fully operational. The World Bank in one of its working papers, 2014, has also cautioned about the risk and has presented a conceptual framework to create a system of checks and balances to help ensure that the sovereign wealth funds do not undermine macroeconomic management or become a vehicle for politically driven "investments." Therefore, for an SWF to be effective in Nepal, robust governance mechanisms, a clearly defined scope and mandate, independence from any type of political intervention, backed up by a strong legal foundation and independent oversight and audits, are very essential.
Before moving forward with an SWF, comprehensive background work, public engagement, and awareness-raising efforts are crucial. An informed public can demand accountability, ensuring that the fund is used for the nation's benefit.
Conclusion
As outlined above, establishing an SWF in Nepal is not only a viable option for financial management but also a strategic necessity for the country's future. By harnessing remittances and other potential sources, Nepal can address its infrastructure deficits, mitigate economic risks, diversify its economy, and scale up its productive capacity, create employment opportunities, thereby transforming the economy toward prosperity. The SWF represents a forward-looking approach to national development. To realize its potential, however, a robust debate, public awareness, and thorough background work are essential. This article is a modest contribution toward that goal.
(Madhu Kumar Marasini is a secretary with the Government of Nepal. The views expressed are personal)
