Why has Bhutan failed to attract More FDIs

I. Introduction—-Making the Case for Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI) is an investment made by a foreign individual or a company into business interests located in another country. FDI takes place by establishing foreign business operations or acquiring foreign business assets in a foreign company. The FDI is important for various reasons such as it stimulating economic development and benefiting the host country in myriad ways. To make the private sector the engine of growth, FDI is one of the most important catalysts. Realizing its importance and inviting FDI for the first time in 2002, the Government of Bhutan has been doing well in terms of introducing reforms, creating a public information and credit register, and simplifying the procedures necessary for business establishment. In 2015, the Government relaxed FDI regulations and foreign investors are now able to buy land and invest in Bhutan with a minimum stake of 10%. In selected sectors like service sectors, the ownership is permitted up to 100%. In recent years, a measure has been introduced which makes it easier to exchange local currency with foreign currencies.

Despite these reforms, why has Bhutan failed to attract more FDIs? FDI Annual Report 2018 shows that the total number of FDI projects since 2002 is only 73 with more than half of them in the (42) hospitality service sectors that lack diversification with only 5307 Bhutanese people employed. The net inflow of FDI in the year 2018/19 was just 6.2 million whereas in neighboring countries like Nepal, the annual net FDI inflow is approximately 185 million. This essay will explore various reasons why Bhutan fails to attract more FDI because regulatory reforms may not only be the essential attracting stimulus for foreign businesses and critically analyze them to understand the barriers and opportunities constraints created by them.

II. Are the regulatory reforms enough?

Bhutan follows a pragmatic nationalist view when it comes to FDI where it believes that it has both benefits and costs. Allow FDI if benefits outweigh costs and restrict if the consequences are otherwise—-that harms indigenous industries. To understand why Bhutan attracts the least number of FDI in Asia, it might not be useful to look at the issue solely from the policy perspective. The Foreign Direct Investment Policy 2019 contains the essential provisions guaranteeing equal treatment, protection against nationalization and expropriation, repatriation of dividends, repatriation of capital, freedom of disposal, dispute settlement mechanism, and intellectual property rights after numerous reforms that are at par with other nations. 

Despite the policy reforms, there are several reasons why Bhutan is not getting significant FDI inflows. It must be noted that the sole reason for FDI is to establish a business in a country that poses the lowest risks (guarantees business thriving conditions) and creates conditions that would help them generate marginal profits. In short, they want to establish FDI to make profits without having to break bones to do it. 

For Bhutan, besides overall investment environment issues, there are a number of administrative and policy challenges. First, the approval process remains complex and there is no single window or focal point for investors for starting a FDI company. The Ministry of Economic Affairs is the main institution involved. For example, foreign investors are required to deal with numerous administrative procedures from name clearance to applying for work permits including sectoral clearance. The policy revision looked into streamlining services related to FDI through a single window that will house all key FDI service providers. However, until 2020, it was not implemented. 

Second, there remain ownership restrictions, especially in manufacturing that make it hard for foreign companies to come and be able to find a joint venture with an eligible local partner. The FDI policy allows both greenfield and brownfield investment. However, the maximum Foreign Investor’s Equity is only 74%. and 49% in Small Scale Activities. This is instituted to protect domestic investors but this might be one major bulwark in inviting new foreign investors.

Third, until 2018, the minimum investment size does not allow for potentially important investment, especially in the IT and services sector. The FDI policy sets minimum project costs for priority areas in both manufacturing and services sectors ranging from Nu. 20 million in agro and forest-based sectors to Nu. 50 million in other priority manufacturing sectors and Nu. 200 million in health, education, infrastructure, and so on. Recently, a new provision was promulgated that allows small-scale business activities with a minimum investment of $5 million. When this was not introduced, it was a major bulwark to introducing FDI in Bhutan which may hopefully change in the coming years. 

III. Other Barriers

However, outside the policy reasons, there are various factors that affect the attraction of FDIs. It has more to do with low population, poor workforce, relatively 'high wages', having to rely on neighboring countries for most expertise, poor market within, relatively high production cost as compared to our neighbors, and the 'landlocked' tag. This is further analyzed and elaborated on below.

A. The Geographical Limitations

The country has a small territory, is landlocked, and very mountainous, thus making infrastructure construction very difficult and costly. An official with the U.N. Economic and Social Commission for Asia and the Pacific stated "[Bhutan's] FDI potential will likely remain limited due to geographical factors. Bhutan's current production base is small and only partially integrated into regional and global supply chains." This can be a significant factor because the production and worldwide transport and freight is a major challenges for establishing FDI for Bhutan. 

B. Population and Market

The reasons for not establishing FDI are because the population and the market for the FDI’s goods and services are very concentrated and small. What are the compelling reasons an FDI should be established in Bhutan and not in the neighboring countries like India and China where the market opportunities are expansive and the consumer base is diverse? FDI loves the free market and big market opportunities compared to small markets that may not meet the scaling ambitions of these companies. 

C. Experts and Workforce

The shortage of skilled labor is also a hindrance to development. A limited supply of skilled labor constrains the development of high-value-added products. After access to finance, labor was the second most frequently cited constraint in the 2015 WBES, a complaint likely triggered by the limited access of firms to skilled labor. The domestic supply of skills—such as auditing, accounting, and information technology—is limited.

D. Scope for FDIs in terms of Niche Ventures

In addition, FDI development is limited by a controlled system to a great extent. The policy makes it clear that the FDI’s are not allowed in the manufacturing sector, especially in areas where the focus is to extract our minerals, make use of our power (negative lists) and take advantage of these without necessarily adding high value which is different in other countries. This was a carefully thought-out strategy to protect ourselves from Multinational Companies (MNCs) and other corporate capitalist takeover but on the hindsight may have effectively kept the MNCs and Corporate giants to venture into Bhutan. 

E. Not being a part of Major Institutions like the World Trade Organisation (WTO)

Notwithstanding the negative and positive impacts of being a member of WTO from the Bhutanese perspective, it is discouraging for foreign businesses to invest in Bhutan if they have to follow a double taxation regime. Bhutan has to sign “An Avoidance of Double Taxation Treaty” with each country to have mutual benefits which otherwise would not be possible if there is no treaty. Being a member of WTO would have given more export diversification, transparent, predictable and attractive investment regime among others.

IV. Conclusion

Bhutan is ranked 89th out of 190 countries in the World Bank's 2020 Doing Business Report, eight spots lower than a year earlier. However, the score is relatively high for the country's income category (lower middle income) and region (south Asia). The culprit behind attracting the least FDIs is not only because of restrictive regulations but also other factors like the late establishment of FDIs, geographical factors, small markets, less niche business opportunities, huge production costs, and less expertise. 

These findings are solely oriented to understanding why Bhutan attracts less FDI compared to other countries and not necessarily that we should make the changes as per the finding. This means Bhutan must explore and weigh the pros and cons of allowing FDI in certain sectors like distribution services including wholesale, retail, and micro trade to name one from the negative lists and maintain the status quo even if it attracts no FDI because allowing it would have far grimmer repercussions than not having one. 

In the concluding note, as stated earlier, the time-consuming administrative hurdle is not a big barrier. The MNCs with the profit motive won’t be kept at bay if the investment environment is good and the market is viable and flourishing for them.

1. References

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