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www.samriddhi.org | 1
Economic Freedom has demonstrably remained at
the core of prosperity as shown by the Economic
Freedo...
2 | www.samriddhi.org
– beaten rice. Generally, beaten rice is sold right out
by the sack in the shops in weights as deman...
www.samriddhi.org | 3
the government without heeding several market
factors, also jumps at fixing the Maximum Retail
Price...
4 | www.samriddhi.org
income tax, these store owners are forced to
pay 3.5 percentage of their income as tax.
Other than t...
www.samriddhi.org | 5
time and cost consuming procedure. The problem of
complex documentation is further coupled by the
re...
1. WHAT IS KIRANA PASALS?
The biggest regulatory burden perhaps stems from
the fact that there is no clear definition in t...
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Does economic freedom affect micro and small enterprises? A look at Nepal's Kirana Pasals.

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As people who have lived in Nepal for a long time, we had often noticed that Kirana Pasals, small mom and pop stores that adorn every street faced building. They rarely grow to become medium or large-sized operations, like department stores or supermarkets. This observation called for this quest to find out what prevented the growth of these independent businesses run by entrepreneurial and hardworking people and if it had anything to do with economic freedom. Using both primary and secondary data sources, this research was conducted over the period of six months (April – September 2013) and it helped us understand an economic phenomenon which is part of the daily life of most Nepalese and yet, has rarely been studied before, let alone from the lens of economic freedom. During the course of this research, we reached out to more than two hundred and fifty Kirana Pasals and asked them to tell us their story. We also used a structured questionnaire asking them questions related to ‘Nature of the Shop’, ‘Enterprise Operation and Growth’, ‘Registration’, ‘Finance’, and ‘ Profit Generation and Distribution’

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Does economic freedom affect micro and small enterprises? A look at Nepal's Kirana Pasals.

  1. 1. www.samriddhi.org | 1 Economic Freedom has demonstrably remained at the core of prosperity as shown by the Economic Freedom of the World Report released by The Fraser Institute and the Index of Economic Freedom released by The Heritage Foundation annually. Nepal has always ranked on the bottom half of both the indices and for a long time in its history has remained a nation struggling with slow economic growth, poverty and poor quality of life for its people. At the same time, developing economies like Nepal are characterized by the ubiquity of micro, small and medium scale enterprises demonstrating the entrepreneurial nature of the population and their struggle to earn a living. Therefore, examining the relationship between the economic freedom and this ubiquitous entrepreneurship promised a better understanding for finding ways that could lead Nepal towards prosperity. For us at Samriddhi, The Prosperity Foundation, this was a very exciting task. As people who have lived here all their lives, we had often noticed that Kirana Pasals, small mom and pop stores that adorn every street faced building. They rarely grow to become medium or large-sized operations, like department stores or supermarkets. This observation called for this quest to find out what prevented the growth of these independent businesses run by entrepreneurial and hardworking people and if it had anything to do with economic freedom. Using both primary and secondary data sources, this research was conducted over the period of six months (April – September 2013) and it helped us understand an economic phenomenon which is part of the daily life of most Nepalese and yet, has rarely been studied before, let alone from the lens of economic freedom. During the course of this research, we reached out to more than two hundred and fifty Kirana Pasals and asked them to tell us their story. We also used a structured questionnaire asking them questions related to ‘Nature of the Shop’, ‘Enterprise Operation and Growth’, ‘Registration’, ‘Finance’, and ‘ Profit Generation and Distribution’ For the purpose of this research, Kirana Pasals were defined as micro or small enterprises that sell fast moving consumer goods, have basic infrastructure and use simple technology. The Industrial Enterprise Act (1992) of Nepal characterizes such retail shops under Small Service Industries. Enterprises with fixed asset of value less than or equal to 30 million rupees are designated under Small Industries in this act. Growing one’s business means an unexpected growth in regulations for Kirana Pasals. When Kirana Pasals consider growth, it means adding more value to products already being sold, adding the variety of products being sold (which include imported goods involving customs), falling under a higher tax bracket and so on. A simple example that came up during the research was of selling a local food item Introduction Economic Freedom Matters Does Economic Freedom Affect Kirana Pasals in Nepal? SUMMARY REPORT September, 2013 Samriddhi, The Prosperity Foundation
  2. 2. 2 | www.samriddhi.org – beaten rice. Generally, beaten rice is sold right out by the sack in the shops in weights as demanded by customers. However, for ease and protection from dust and other factors, many owners started pre- packaging the beaten rice in plastic bags in standard weights such as 500 grams, 1 kg, 2 kg and so on. However, this invited another regulatory compliance of labeling the packets. The shopkeepers that came up with this innovative idea were actually persecuted by the Standards department for not labeling the packets. This is a simple example that shows that as Kirana Pasal owners consider growing, there are many issues of formalization, standardization, taxes and other regulatory and non-regulatory issues. The Kirana Pasal Story Given current regulatory environment, survival of the business is a more pressing concern than growth for Kirana Pasals. Being a formal/ legal entity is important for Kirana Pasals to survive and grow. However, in the current regulatory environment, being legal is difficult. Enterprises are required to register with Department of Cottage and Small Industry, Department of Commerce, Inland Revenue Department, and Municipality/ Village Development Committee. As these authorities don’t share information on registrations with each other, enterprises are required to be registered with each one separately. The required documentation and processes differ for registration with each authority and this makes the process of formalisation cumbersome and costly. The laws and regulations that are applicable to Kirana Pasals are scattered across several acts, regulations and rules and are enforced through several government agencies (List of the laws, government departments in the detailed report). During the research, we saw that 74.8 precent of the Kirana Pasals surveyed were registered. However not all of those that were registered were registered with both the central authority (PAN) as well as the local authorities (Municipalities, Village District Committee). Some were registered only with the central authority, whereas others were registered primarily with the local authority. Of those that were not registered, 31.1% showed intentions of registering with these authorities in the near future 27.9% showed no intention of formalising their institutions and 41% were undecided. Also a serious issue is the minimum investment threshold Kirana Pasals (and other businesses) need to make in order to be able to start a business. This pushes small entrepreneurs like those running Kirana Pasals to not start businesses and when they do, to stay informal and consequently, forever small. Generally, Kirana Pasal owners are aware of few of those laws that are applicable to their business but there always remain minuscule provisions and clauses in about two dozen laws and policies which the businesses would not be in compliance with, simply because of the volume and scattered nature of those regulations, which keeps the business always on offence. This acts not only as a hindrance to growth but as a challenge in mere survival of Kirana Pasals. As inflation grows in the country and prices of commodities rise, especially during major festivals, Pavitra Bajracharya, who started working in a kirana pasal from age 10, is now the owner of “The Right Mart” which he aspires to franchise. He has opened number of kirana pasals in kathmandu for over three decades and he says he called his mart the “Right” mart because in this business, he wanted to do everything right in terms of following rules and regulations. But to his dismay, he says ‘it is just not possible’. He is also currently the chairman of nepal retailers’ association and shares several experiences of having to rescue many kirana pasal owners when they are held in custody for trivial reasons such as not having the price board hung on certain side of the wall.
  3. 3. www.samriddhi.org | 3 the government without heeding several market factors, also jumps at fixing the Maximum Retail Prices (MRP) of commodities generally based on the rates provided by the subsidy receiving state owned enterprise selling commodities. There have been instances of Kirana Pasal owners being held by government authorities for not selling under the government designated prices. Mr. U Shrestha of U. Shrestha Mart expresses how this affects a simple Kirana Pasal business. Taxes are also something which further suppress the growth of Kirana Pasals, especially those that are registered. According to the current tax code, enterprises with an annual turnover of less than NRs. 20, 000,000 are registered as having a Permanent Account Number (PAN) with the Inland Revenue Department(IRD).Currently,theKiranaPasalspayNRs. 5000 if located in Metropolitan or Sub Metropolitan Cities, NRs. 2500 if located in Municipalities and NRs. 1500 if located in other areas than the above two. Those with turnover greater than 2 million rupees or income greater than two hundred thousand rupees are eligible to pay VAT tax of 13% and Corporate tax rate for Private Limited Co., Limited Co., Partnership Firm in the retail sector – a total of 25%. As per the tax code the first 200,000 rupees for single and first 250,000 rupees of income for couples is subjected to no income tax. The next 100,000 thousand rupees for singles and couples and next 2,200,000 rupees for singles (next 2,150,000 for couples) are progressively taxed at the rate of 15 and 25% for singles. Above this, the income tax rate jumps to 40%. For Kirana Pasals, most of them fall below the annual turnover of Rs.20,00,00.00 threshold and the estimated average profit that they make is 5 percentage.1 This implies that their annual income is NRs.100, 000. According to the above stated tax regime, these firms should actually be exempt from any kind of taxation. However, in reality, these stores are currently required to pay Rs.3, 500 annually as tax which is 3.5 percentage of their annual income! While other citizens that report income less than a hundred thousand rupees are exempt from 1 Based on estimated calculation of our research and estimations of Association of Retailers, Nepal. Ms. Rupa dahal is 30 years old and she has been running a kirana store for 5 years now. She opened the store in order to supplement her husband’s income, as he earns only a small amount of money. She takes care of household activities and sends her kid to school in the morning and spends the rest of the day at the store. Her store is very small, selling only grains, cigarettes and some chocolates. Her store is registered and pays regular taxes to the government. However, she feels that the tax rate is too high. A lot of goods that she sells earn her a meager 25 paisa profit per unit and even in that she has to pay as high as 10% in taxes, she says.
  4. 4. 4 | www.samriddhi.org income tax, these store owners are forced to pay 3.5 percentage of their income as tax. Other than tax related compliance, standardisation is used an excuse to persecute Kirana Pasals on every aspect possible. Government standardisation includes weights, packaging and even published price list. This is often used as a measure whenever there is a political pressure from consumer groups after a bout of inflationary pressure. As a populist symbol of doing something, the government first tends to target the most accessible victims, Kirana Pasal owners, to pass the blame to these ‘evil middlemen’ who are apparently causing the inflation. Examples of the beaten rice case and the published price display case shared earlier in the paper aptly demonstrate this phenomenon. These ‘standardization’ raids also provide a rent- seeking opportunity for government officials, as claimed by Kirana pasal owners during our interviews. A Kirana Pasal owner we interviewed in Shankhamul, Kathmandu shared an encounter he had with a bureaucrat at his own store. It was seen during our research that the concerns for Kirana Pasals were not so much large bribes to high officials, rather numerous petty bribes to low level officials. It was noted that, when undertaking official work, Kirana Pasal owners were required to pay ‘tea money’ to low-level officials to get the processes done. From the survey data however, we found that only 2% of our respondents engaged in bribing government officials. Notwithstanding some response inaccuracies due to the reluctance to divulge correct information regarding partaking in bribery, the limited number of official process these shops undergo could account for the low involvement in bribery of government officials choosing to remain largely informal. As many of these shops are registered with at least one authority, this data would indicate that incidence of bribery during registration, that is, during the process of formalisation and with law enforcement bodies is low for Kirana Pasals in the Kathmandu Valley at any given government agency. However, being registered in each of the agencies as required by the several scattered laws is another story altogether! Accesstofinancewasanotherissueofimportance while learning about growth possibilities for Kirana Pasals. The main source of capital for Kirana Pasals is micro finance institutions, particularly part of the cooperative model. However, the capital available from micro finance institutions are limited and often more expensive than loans from commercial banks and other financial institution. While loans from commercial banks charge an interest of 12 to 15 percentage, loans from micro finance institutions cost within the range of 20 to 30 percentage and in some instances even go higher. To get access to loans from banks and financial institutions, owners are required to submit various documents that are rather complex for small entrepreneurs to produce. Banks require documents like business plans, balance sheets, rental contract, letter of approval from municipality, tax documents, asset valuation and so on. Since most owners/manager of Kirana Pasals have limited capital and little formal education in business, documents like business plans, balance sheet are hard to produce. Those that operate their stores from rented property don’t have formal rental contract and work largely on an informal basis with their landlords. The landlord often would not have undertaken proper procedures and received proper authorisation to rent out the property. As most of these stores often don’t function in a fully formalised manner, they face problems in presenting many of these documents. Getting asset valuation is an equally Mr. U shrestha of U. Shrestha mart grew his business to the level of mini-mart from just being a kirana pasal. He says, when you decide to grow, there are things like packaging, hiring- staff, etc. That lead to higher operation costs. But government does not regard these facts before setting price ceilings and complying with such standards drags the profitability down drastically.
  5. 5. www.samriddhi.org | 5 time and cost consuming procedure. The problem of complex documentation is further coupled by the requirement of collateral. The owners are required to produce personal property as collateral. 75% of all loans acquired by our respondents required personal property to be placed as collateral. We found this to be particularly true with smaller stores that don’t have much personal property to draw on in the first place. Barriers to exit are also barriers to growth as when entrepreneurs fail, they have to have an opportunity to wipe the slate clean and start again. This is almost not an option for retailers such as Kirana Pasal owners in Nepal. The World Bank’s Doing Business Report 2013 ranks Nepal 121st in the world in terms of ease of closing a business. As per the report, a firm heading towards insolvency can expect to lose 5 years of time, 9% of the estate as costs and a gain of less than 25%. They could close up operations but they would still be officially active. This also creates problems in keeping up to date information on these stores. Since it is more difficult to exit the business, this serves as a major barrier to registration of Kirana Pasals. If it is very difficult to get out of the business, there is no incentive to register the business in the first place. Based on this preliminary analysis of Kirana Pasals in Kathmandu, the regulatory environment pertaining to registration, taxation and standardisation are immediate areas of concern. In a country that practices progressive taxation and espouses the values of ‘social justice’ it is ironic to see the most vulnerable strata of entrepreneurs being victimized by regulations and bureaucracy simply to achieve populist ideals of ‘doing something about middlemen and inflation’. Therefore, based on the research and analysis presented forward, we propose the following recommendations that are easy to follow and implement: Milkyway Shopping Mart is a kirana pasal in shankhamul, kathmandu. During our interview, he recalled that a lady from one of the monitoring departments walked into his shop and asked for special discounts. When she was denied of such preferential treatment, she said that she worked with the monitoring office and even threatened to send a monitoring team just because the storeowner did not yield to her initial request. The storeowner refused to offer her any special treatment. From this experience, this entrepreneur drew a conclusion that the regulatory bodies are looking to take unfair advantage of the entrepreneur like himself and reiterated that they have created such a business environment where small and medium entrepreneurs just cannot make a decent living. It is very hard to even lawfully toil in nepal, he added.
  6. 6. 1. WHAT IS KIRANA PASALS? The biggest regulatory burden perhaps stems from the fact that there is no clear definition in the regulatory regime of what constitutes a ‘Kirana Pasal’. Therefore, any reform geared towards Kirana Pasals growth needs to start with a clear definition of what constitutes a ‘Kirana Pasal’. 2. WHERE TO REGISTER? The second step in reform requires defining a one agency that records the registration of Kirana Pasals. The fact that these agencies require to register in multiple agencies naturally render them informal even if they are registered with any one particular agency. Such an agency should be a decentralized body such that Kirana Pasals have an easy access to it. Any other government agency that requires this information can easily tap into the database of this one agency. In Nepal, the Municipality in urban areas and the Village Development Committee (VDC) in rural areas seem to be the most feasible option under the current governance structure. As long as the registration requirement is limited to being registered with this one particular agency, it would be easy enough for these entrepreneurs to understand and comply. This would also make them formal thereby rendering them the benefits of being a formal enterprise. 3. HOW MUCH TO PAY AS TAXES? The taxation regime currently in place seems to be in conflict with itself. While a plethora of regulations under income taxation requires Kirana Pasals to be tax exempt, another regulation requires them to pay 3.5 percentage of their income as tax. During the course of this research many shop owners expressed willingness to follow tax regime if it were simplified. Therefore, reforming the tax code and reducing it to simply have all Kirana Pasals pay 1 percentage of their annual profits as tax would widen the tax bracket and also help Kirana Pasals operate legally. This kind of regime can be administered through the Retailers’ Association such that the tax procedure is simple and facilitated by the association and any kind of shopowner can comply without having to hire brokers and lawyers to deal with the taxation complexity that exists today. This would also facilitate their growth. 4. WHAT STANDARDS TO FOLLOW? Kirana Pasals that we reached out during this research were also happy to comply with standards as long as they were rational standards. It would be highly presumptuous to imply that a government bureaucrat who has never operated a Kirana Pasal would be better able to fix standards for Kirana Pasals. Therefore, Retailers’ Association which is more than happy to take up this job could function as a voluntary standards organization and issue certification to Kirana Pasals that are willing to comply with its’ standards. This would benefit the consumers in providing them with assurance on the quality of the product they are buying at the price that they are willing to pay and also decrease the arbitrariness of persecution based on random standards set by bureaucrats. 5. WHERE TO GET THE INVESTMENT TO GROW? One of the primary issues of concern for Kirana Pasals is access to finance for being able to expand. In order to deal with this problem, one area to work in is to ease up regulations to establish insurance for Kirana Pasals. The Cooperative Model is a round-about way of approaching this problem. However, if the insurance industry regulations eased up, the risk associated with this sector would also be minimized. This would then provide an incentive for commercial banks to enter this market and provide loans on the basis of business plans rather than on collaterals. This requires reforming the regulation of directive lending as well which is not necessarily achieving any of its intended consequence but instead is perversely providing added benefits to micro finance institutions which do not get transferred to the ultimate beneficiaries that it is intended for. 6. HOW TO EXIT? Exit rules need to be simplified especially those pertaining to tax. The Kirana Pasals should be able to exit with relative ease as they have very less assets and should have the provision to declare bankruptcy when the enterprise fails. This would allow these entrepreneurs to move on from sunk enterprises while freeing up resources in the economy. This requires a major overhaul in the exit regulations of Nepal. P.O. Box. 8973 NPC 678 | 416, Bhimsengola Marga, Minbhawan Kharibot, Kathmandu, Nepal Tel.: (+977)-01-446-4616 / 448-4016 | Fax: (+977)-01-448-5391 | Email: info@samriddhi.org | www.samriddhi.org For more, see detailed report.

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