Why hydropower development is slow in Nepal despite huge potential?

It was Dr. Hari Man Shrestha who concluded that Nepal has a capacity of 83,000 MW during his PhD research at Moscow Power Institute; USSR in 1966 A.D. Nepalese finally saw the light at the end of the tunnel and hoped that the generation of energy will lead towards prosperity. After so many decades, we are still generating less than 800 MW only. This has forced people to face the scheduled power cuts for up to 16 hours a day.


Hydropower has become a favourite topic for Nepalese politicians and business houses. Every now and then, we (Nepalese) seemed to be very concerned about harnessing our hydro resources. So many promises had been made in the past by our leaders. But the reality is different. The progress is at snail's speed.

If you ask the reason for the slow progress; then the obvious answer you would get is "Political Instability" and it is rightly said to some extent. However, the answer is not that straightforward. I do not believe that the political situation is that worse. I remember interacting with a Sri Lankan investor in Kathmandu few years back. He boldly said that "at least Nepal does not get bomb attacks like in Sri Lanka" What he had implied is that he had constructed project during Sri Lankan civil war.

Having said that, I do admit there are lots of flaws in government level. Licensing anomalies, local problems, lackadaisical government and "so many agencies to be taken care of" are some problems to name few. These are typical characteristics of least developed country. Emerging frontier market is risky by nature.

In the context of Nepal, these factors are somehow manageable. There is a proven mechanism. Operation of two hydropower projects (foreign owned) and few private hydropower projects (domestic) are the living examples. And without any surprise, the return on the hydropower investment in Nepal is very high so far. The higher performance and valuation of the listed hydropower companies in Nepal Stock Exchange (NEPSE) is the basis for understanding the return prospect.

Now question arise; why hydropower development is so slow when we have a huge hydro potential backed by a great demand for electricity? Well I do not want to talk about the opportunities of exporting electricity to India. Maybe in another post.

The main reason is the government policy. As we know, Nepal consumes about 90 percent of GDP, leaving only 10 per cent for saving and investment. In such case, the best option for Government of Nepal (GoN) is to encourage private developers to join hands. The technical and financial viability of a hydropower project depends not only on power related factors (e.g. discharge and head) but also the existence of proper supporting infrastructure such as access road and transmission line. As such, GoN should invest its limited resource on these areas in order to attract private developers.

Besides basic infrastructure, the availability of fund required for hydropower construction within the country is also problematic. Hydropower is capital intensive project and it requires huge upfront investment. A proper mix of equity and debt is required (up to 80% debt). The banking sector in Nepal is the major credit intermediation mechanism. The pension and insurance sector has traditionally provided funds to banks rather than direct financing of the projects.

With single exposure limit of 25% imposed by Central bank of Nepal, the total banking capacity of Nepal has enough funds to finance not more than 300 MW at present. Not only has the banking sector limited capacity, but also the capital market of Nepal is still at nascent stage.

Developing hydro sector through multiple sources of investment may serve well for Nepal. One of the major sources of investment is foreign direct investment (FDI). For economies like Nepal, with low tax GDP ratio, it is very difficult for the government to provide long-term investment and implement capital investment infrastructure projects. FDI in the form of both equity and debt is the right approach for speeding up the development.

Sadly, FDI in hydro sector has not seen expected growth in recent years. This has to do with lots of factors. First and foremost is Nepal Electricity Authority's (NEA) financial health. NEA, the sole power purchaser, is a loss making organization. Let's admit it. It has a cumulative loss in billions. It is obvious for any investors including foreign to be concerned about "what if NEA is declared bankrupt?" In such case, sovereign guarantee is the must to minimize payment risk.

Second reason is foreign exchange risk. Nepalese currency against US dollar is constantly depreciating. To mitigate this risk, NEA should do Power Purchase Agreement (PPA) in US dollar  However, NEA does not want to take the US dollar burden on its shoulder at present. Without PPA in US dollars, no foreign investor will invest in Nepalese hydro. It is simple as that.

NEA claims that by doing PPA in US dollars in the past for two foreign owned projects, it has suffered a huge loss. Fair enough! At the same time, everybody should understand that hydropower projects in Nepal are constructed in BOOT model. Developers have to handover the project to government after thirty years of operation. Foreign investors who bring debt in foreign currency cannot afford to take the foreign exchange risk as it will be a suicidal step. So the common meeting point for foreign investors and GoN is to do PPA in US dollars at least for loan tenure.

Finally, the most important factor for foreign as well as domestic investors is the PPA rates. The PPA rates is not scientific. Here is a short assessment. The PPA rates for the projects that were constructed 10 to 15 years back is about NPR 4.00 per kWh (weighted average). As of today, the standard PPA rates for the project below 25 MW are NPR 4.80 and NPR 8.40 per kWh during wet and dry season respectively. That makes a weighted average of NPR 5.10 per KWh assuming 60 percent Plant Factor (a typical characteristic of run-of-river hydro scheme in Nepal designed at Q40%).

There is an increase of 28% in PPA rates as compared to 15 years back. It looks like a fair amount of increase to general people. But, it is not the case in reality. The price of cement is more than double, reinforcement/steel is more than double, wages of unskilled/semi-skilled/skilled workers is more than double, price of diesel is more than double and price of Electro-mechanical equipments (European) is around US$ 400 to US$ 500 per Kilowatt where the exchange rate is 1US$=NPR 100 (almost). In such situation how on earth all hydropower projects would be feasible with the current PPA rates?


Santosh Thapa
Analyst