Mar 132014

Foreign capital means the inflow of foreign resources in the form of money, technical knowledge or technology transfer and human resources as well. The capital flow linked with technical know-how has contributed tremendously in the progress made by the developing countries. The international flow of capital promotes world economic efficiency and helps the countries with balance of payment problem. The foreign capital helps the country to suppress the internal problems like the failure of crop and the external shocks like the great fluctuation in the prices of external goods or recession in industrial countries.

Roles of Foreign Capital

Foreign capital plays a crucial role in the economic development, social development, technology transfer, market development of under developed countries like Nepal. The importance of foreign capital in Nepal can be analyzed as below:

  1. Solving the problem of capital deficiency: Nepal is an underdeveloped country, characterized by capital deficient, which is cause as well as result of their underdevelopment. The rate of domestic saving in Nepal is very low and insufficient to meet the requirement of economic development. Most of the people in Nepal are living at the bar subsistence level. Besides, it is not possible to increase the rate of domestic saving to any significant extent. Due to this fact, it is not possible for them to develop rapidly with their domestic resources alone. Foreign capital helps to bridge the gap between the domestic saving and required investment.
  2. Improving the balance of payment problems: Most of the developing countries like Nepal are suffering from the continuous pressure on their balance of payments. This is due to the fact that they are the primary goods producers and finished goods importers. Besides, as they are at the initial stage of economic development, they have to import machinery, equipments, capital goods etc. heavily from abroad. Their consumption pattern is not conductive for economic development because their consumption pattern is characterized by conspicuous consumption.
    These factors lead pressure on balance of payments. Hence, foreign capital helps to sole the foreign exchange crisis to a great extent, which is conductive to solve the problem of balance of payment crisis.
  3. Maintain the production level: Foreign capital also helps to maintain the level of production in underdeveloped countries by providing essential raw materials, semi-manufactured goods, machines, tools and equipments. These countries are not in the position to import their requirements out of their own foreign exchange earnings. As a result, they have to resort to foreign borrowing in order to maintain the level of production in the country.
  4. Technical know-how and specialized capital equipments: Underdeveloped countries like Nepal are economically poor and they are poor in capital. They require trained personnel, technical know-how, professional experts, modern machinery and equipments and so on to speedup the process of economic development. Foreign capital can help to solve the problem of technological backwardness of these countries because foreign capital is an effective way to transfer the technology. Therefore, foreign capital is significant not only as the source of additional saving but also as a supplier of the technology and specialized capital equipment to underdeveloped countries.
  5. Socio-economic development: Developing countries like Nepal re also backward in terms of economic and social overheads such as roads, power, canals, transport and communication and so on. Since their development requires a huge capital investment and a long gestation period, these countries are unable to undertake these heavy projects with the aid of domestic resources. In this time, foreign capital can be very helpful to speed up the pace of economic development. It leads to lay down the foundations of rapid economic development.
  6. Check the vicious circle of poverty: Low capital formation is both cause and result of the vicious circle of poverty. Due to very low level of capital formation, they are poor; and due to the poverty, their capital formation is low. Poverty is the multidimensional problem, alleviation of poverty which requires multidimensional attack. Due to very low level of capital formation, it is not possible from domestic resources. Hence, foreign capital is very much useful to break the vicious circle of poverty.
  7. Utilization of natural resources: In developing countries, capital is very low and private enterprises are incapable to undertake risky projects like the exploitation of untapped natural resources. Foreign capital covers up this deficiency by new ventures and new are of the business activities. It goes into pioneering enterprises involving all risks. Thus the investment of foreign capital results in opening up inaccessible areas and tapping up of new and exploited natural resources in the country.
  8. Controlling inflation: Developing countries are generally suffering from inflationary pressure during the initial stage of economic development. Inflation in these countries is the outcome of the disequilibrium between demand and supply. Huge public investment in the mass scale generates demand a head of the supply of the goods and services, which in turn generate inflationary pressure in the economy. Foreign capital is helpful to minimize the inflationary pressure through the import of food and other consumer goods. Similarly, it helps to develop industrial sector in the economy. In either way, foreign capital keeps inflationary pressure under control.
  9. Correct adverse balance of payments: Foreign capital is also very important from the side of its favorable effect on the balance of payments of the recipient country. These countries are generally involved in unfavorable balance of payments. Economic development tends to affect the balance of payments adversely as the huge imports of capital goods, technical know-how and raw materials are required to carry on the development programs. On the other side, the exports from these countries are sluggish because of high cost of production and increased domestic consumption.
  10. Increase productivity, income and employment: With the inflow of foreign capital, the labor of the country is equipped with modern tools which in turn raise its productivity. A rise in productivity results in higher real wages for the worker and cheaper goods and services for consumers. Besides these, with the increase in foreign capital, industrial development takes place, which provides greater employment for its growing population.

Defects of Foreign Capital in Nepal

If any country fully depends on foreign capital, it is not always positive. It means, the inflow of foreign capital may invite serious negative effects in the nation as follows:

  1. Continuous increase in loan pressure: If a country fully depends on the foreign, it increases foreign dependency and the country cannot utilize the internal resources. The government may totally be dependent on foreign countries because of foreign capita. Most of the developing countries in the world are depending on foreign aid. But the donor countries and agencies are giving more emphasis on debt rather than aid which increases the burden of foreign loan to the developing countries. Finally the developing countries should pay principal and interest by utilizing the internal resources.
  2. Unfavorable balance of payments: If the foreign capital inflow is in terms of loan which increases the burden in the long run. If the foreign capital is utilized in the production sectors, it will boost up the economic performance of the country, but it is not always possible in all the countries. There may be the outflow of capital from the nations for paying foreign loan which in turn invites unfavorable balance of payments of the country.
  3. Minimize the role of domestic investors: The foreign capital increases the foreign dependency of the government because the foreign can be easily obtained. On the side, foreign capital decreases the utilization of internal resources and the other; it discourages the domestic investors in the field of industrialization due to the foreign capital. The domestic investors cannot compete with the foreign investors because they have sufficient capital and modern technology.
  4. Hinders in the development structures: The utilization of foreign capital and technology decreases the use of traditional technology and resources. The development activities conducting with the help of foreign capital might not be sustainable. People may fully depend on foreign assistance and local resources may be unused. It means, it increases laziness, which adversely affects the development structure in the country.
  5. Economic exploitation: The overuse of foreign capital, technology and foreign investors invites the economic exploitation in the country. Establishment of large industries and large scale of production by the foreign capital, the people in the developing countries like Nepal may be economically exploited.
  6. Danger for economic and political freedom: There may be danger of possibility of foreign intervention of the poor countries like Nepal. The countries which use the foreign capital have obedience towards the donor countries. More use of foreign capital increases more dependency which results foreign intervention in the country. The existence of a country might disappear due to the foreign capital.
  7. Substitutes domestic saving: Because of high dependency on foreign, domestic saving propensities decline. The government may not be serious to mobilize domestic saving on the belief that foreign aid is easily available. This trend is not good from long term development point of view.