Perceptions and Reality: An Analysis on Hydropower Financing in Nepal

Nepal is said to have one of the highest hydropower potentials in the world, however, at the same time, it continues to suffer from energy crises with over eighteen hours of load shedding every day during the dry seasons. The financial resources and management capacities of the government continue to remain underdeveloped. Considering that the country’s GDP is lower than the estimated costs for the envisaged hydropower development, the government is in no position to focus only on hydropower as there are still other key areas that need to be addressed, such as health and education. The Government of Nepal (GoN) has been steadily increasing the budget allocated for the energy sector with the budget almost doubling over the past four years; the allocated budget however continues to remain severely underutilized.

While the Government’s shortcomings partly contribute towards the country’s inability to harness its hydropower potential, one of the key factors is also its underdeveloped financial system. Growth in the finance sector in Nepal until the 1980s was minimal due to the lack of proper financial systems; however liberalization and major structural changes resulted in the involvement of the private sector, and subsequent development of the financial sector. The entry of the private sector in the financial market helped in the efficient mobilization of local resources, and boosted the financing capacities of Banking and Financial Institutions (BFIs). Additionally the introduction of the Build, Own, Operate, Transfer (BOOT) framework acted as greater incentive for the involvement of the private sector.

Nonetheless, the Nepali financial market as a whole continues to remain underdeveloped and lacking in terms of its capacity to meet large scale investment demands which acts as a major bottleneck for hydropower development. This study aims to understand the hydropower sector in congruence with financing for hydropower development. It delves into the financing capacities off the Nepali financial market, as well as foreign direct investment, and legal provisions for investment in the hydropower sector.

Incline in hydropower financing; however not sufficient to meet goals
A review of the financial market over five years indicates that there has been a steady incline in capital, credit and deposit over the years. Data from the NRB indicates that a total credit of NPR 21.38 billion (USD 213 million) was extended to the energy sector as a whole for the FY 2013/14, with NPR 17.35 billion (USD 173 million) being extended to the hydropower sector. However taking into consideration the Hydropower Development Plan and its budget of NPR 3.3 trillion (USD 33.61 billion) over a period of 20 years, a yearly budget of at least NPR 165 billion (USD 1.68 billion) will be required for the development of 25,000 MW of hydroelectricity within 20 years.

It, therefore, seems unlikely that domestic finances will be enough for the development of the hydropower sector as per the Hydropower Development Plan. While the domestic financial market is still underdeveloped in terms of meeting the needs of large-scale hydropower development projects, it is still able to develop relatively smaller projects. The private sector realizing this is working to develop such micro-hydro projects to meet domestic demand. According to the Independent Power Producer Association Nepal(IPPAN), as of 2010, BFIs have invested in about 25 hydro projects, totaling NPR 55 billion (USD 550 million). However, while BFIs have emerged as a key financing intermediary, the absence of adequate project financing models means that domestic BFIs often seek additional collateral for the security of their investments, therefore limiting the number of projects funded.

Constraints towards hydropower financing
There are various factors that act as bottlenecks and constrain financing for the hydropower sector. Some of the key constraints are:

1. Hydropower projects are generally highly capital intensive and have longer gestation periods as well as repayment periods. BFIs are therefore often less interested in such long term infrastructure projects as their deposits are of short term nature
2. Weak project financing among BFIs due to it being a relatively new concept. BFIs therefore prefer short term loans based on securities.
3. Limited experience and lack of in-house expertise to conduct due diligence of hydropower projects often result in BFIs only looking at the financial aspects in hydropower financing. Reliance on external consultants also results in inadequate due diligence and therefore higher risk in decision making.
4. Lengthy decision-making process resulting from the involvement of various ministries, departments and government authorities in granting approvals and licenses at different stages of development also act as bottlenecks for the hydropower project.
5. The various regulatory compliances for BFIs on hydropower financing such as the regulatory cap on a single corporate obligor of 50% of the core fund, sector exposure limits and provisioning of 100% for non-performing loans and advances also deter BFIs from providing non-recourse or project financing to hydropower projects.
6. Weak financial viability or project feasibility of hydropower projects arising from poor Power Purchase Agreement (PPA) rates also result in lower involvement of BFIs.

Legal provisions to boost hydropower financing
Various legal provisions have been introduced for hydropower financing such as the Hydropower Development Policy-1992, Hydro Power Policy-2001, and NRB’s Unified Directives. Key provisions that might directly or indirectly affect BFI financing towards the hydropower sector have been listed below:

1. Directive to increase exposure limit of BFIs to 50% of core capital fund for hydropower projects.
2. Directives to BFIs to increase lending to productive sectors which also constitute energy (hydropower and renewable energy) by 20% of their total loan portfolio by mid-July 2015.
3. Special concession for restructuring and rescheduling of hydropower loans, provided BFIs can provision for 1% before rescheduling or restructuring loans for hydropower projects.

The aforementioned provisions are hoped to encourage BFIs towards increasing their lending in the hydropower sector.

Increased role of capital market in hydropower financing

While the Nepali capital market is still at its nascent stage there is a growing interest, with IPO subscriptions generally being oversubscribed.

There has been an increased role of capital markets in the hydropower sector with companies raising finances through IPOs. The overwhelming response has resulted in hydropower companies collecting a total of NPR 53.6 billion (USD 536 million) from the primary market, with the IPOs generally oversubscribed by almost 100%. This therefore demonstrates the general mindset of investors and their confidence in the hydropower sector.

Way forward
In conclusion, while BFIs have the capacity to finance medium to small scale hydro projects; the Nepali financial market lacks the depth to finance large scale hydro projects. Additionally the participation of BFIs in the hydropower sector has not been encouraging due to various bottlenecks identified above. Listed below are some recommendations to improve the investment climate for hydropower financing.

1. Role of Government: A supportive legal and institutional framework needs to be developed to attractprivate investment in hydropower. Similarly bottlenecks such as bureaucratic delays and lengthy decision-making processes need to be resolved, and tax incentives introduced for investments in the hydropower sector.
2. Nepal Electricity Authority: Existing power tariff structures for electricity needs to be revisited with adequate rate of returns for investors. Unbundling of the utility also needs to take place so that there is a distinct electricity – Distribution, Transmission and Generation companies, with NEA focus primarily on transmission.
3. Private Investors: Local stakeholders and project developers should be trained in project management and business skills as they are often less aware about various aspects of hydro projects and their implications.
4. Nepal Rastra Bank:Provisioning requirement for hydropower financing needs to be further relaxed. The current consolidation drive to merge BFIs should be continued as it creates a larger capital base and enhances capacity to finance large and capital intensive infrastructure projects.
5. BFIs: BFIs need to improve capacity and work on enhancing efficiency in managing longer term deposits which could be effectively channelized for infrastructure financing. Internal project appraisal systems need to be developed to conduct adequate due diligence for hydropower projects. Instruments such as credit derivatives should be introduced with support from NRB to encourage higher lending to hydropower projects.
6. Power Trading: Deregulation of NEA should be considered for efficient and transparent power trading.