Foreign Investment Climate

All of a sudden Nepal has been bombarded by summits. In the past few months, different organizers have held several investment/infrastructure summits so hastily. The objective of those summits was to attract foreign investment in the country but the outcomes were not that satisfactory. However, ‘Investment Summit 2017’ organized by Investment Board, Nepal last week did draw world’s attention. Investors pledged a jaw-dropping FDI commitment of US $ 13.51 billion.

                                                         Source: The Himalayan Times 

                                                    

Organizers are calling it a grand success, and rightly so. No summit has been able to grab so much attention. However, the real challenge lies ahead. To translate the total commitment amount into reality is not an easy task.  

Honestly speaking, I am very skeptic. 

Summits are not that productive in Nepal as Nepal always ignores the fundamental requirement, i.e., interest of investors. The only reason why investors invest their money is to get returns, and I do not think Nepal has to advertise aggressively if it is able to present a proven track record of earning profits. Guarantee return is what investors are after. (A satirical example of an industry that is booming in Nepal without any advertisement whatsoever would be illegal poaching. We never invited poachers by the way:))

The first question any investor ask is, why the developers of Bhotekoshi hydropower (American) and Khimti hydropower (Norwegian) did not invest further? These two projects were constructed decades ago. Well, the answer is not that straightforward but the question is very obvious. One sentence answer to that question would be another counter question, 'weren't we too sensitive towards dollar PPA?'

There are some technical issues that hinders the influx of FDI apart from political instability, lack of coordination between the ministries, laid back attitude of our government employees, local problems and so on (the list can go on and on). First, we have not adopted international practice. For instance, no investor will invest in a highway project without minimum vehicle guarantee. It is as simple as that. Also, we have not been able to propose a convincing mitigation measure for forex risk so far.

Second, Nepal is a complex country. Unlike other poor countries, foreign investors have to compete with local investors. A lot of projects, especially hydropower, have been constructed by domestic resources and the appetite is ever increasing. Project up to 100 MW by Nepali private sectors seems to be within the range. Nepal government, on the other hand, is constructing 450+ MW project. In such situation, foreign investors are not in a position to bargain for a better tariff since locals are constructing projects in cheaper unit costs. 

And now, talking about the FDI commitment in Investment Summit 2017, the commitment is mostly for hydropower. This to me is not surprising for obvious reasons but a convincing reason for me to believe that the total FDI commitment made last week will not actually translate into reality. After all, where is the market for electricity? 

Like it or not, many high ranking government officials have already come to a conclusion that there is no need for more energy during wet season. They claim that there will be excess energy during wet season once Upper Tamakoshi (456 MW) comes into operation. This assumption led to 'Take and Pay PPA' decision instead of 'Take or Pay PPA' which was later revoked by the government. But these officials have not given up yet, and now they are coming up with new proposals that reflects their underlying intention, i.e., no more wet energy. 

We have been talking about the possibility of exporting electricity to India for some time but nothing concrete has happened after signing the Power Trade Agreement (PTA) on 2014. Let's be honest, there are not enough cross boarder transmission lines to support it. Only god knows when our proposed cross border transmission will be completed. The only cross boarder transmission line, i.e., Dhalkebar-Muzzaffarpur which has a capacity of 1000 MW for import/export has been already proposed by India to export its electricity generated by Arun III 900 MW until it builds its own transmission line. source Republica (it is for exporting its own electricity, not ours). On top of that, the current import price of electricity from India which is as low as IRs. 3.50 suggests that our aim of becoming a prosperous nation by exporting electricity to India is just a dream.

I am not the only one who is complaining. Not so long ago Statkraft, a Norwegian company, pulled out of Tamakoshi-III (650 MW) citing a lack of viable off-take option, lower electricity price forecast, insufficient transmission line capacity for power evacuation and a serious concern over the operationalization of Power Trade Agreement with India.

Well, I may sound too pessimistic but I believe this is the reality. We are still not ready for that level of investment. Summits in Nepal are always organized in a very high spirit without addressing the fundamental demands of investors first. No investors will put their money just because our country is beautiful and our people are hardworking and friendly.

By the way, this is not how I intend to end this blogpost. Don't despair if you think the only way to exploit our resources is through FDI. Every dark cloud has a silver lining. And I am saying this because something is brewing up recently. It has come to my notice that many Chinese investors are showing interest in Nepal's hydropower after the completion of a 50 MW Marsyangdi hydropower by Power China Resources Limited. Obviously, I am not talking about mega projects which to me is not realistic anyway due to our geopolitics. (Let's leave Investment Board of Nepal to do the talking for mega projects:))

Chinese investment on the rise 

To find out why Chinese are attracted towards Nepali hydropower, let's check how Chinese model works. 

Chinese companies are entitled to get a lot of benefits from their banks, particularly from Exim bank. In order to promote Chinese businesses abroad, it offers interest rate as low as 2 percent. Although it comes with some clauses like use of made in China products, Chinese contractors, use of Chinese equipment during construction and so on, Chinese developers do not have any problem in it as China has all the resources required for hydropower construction. 

On the other hand, our hydropower projects with a sound hydrology typically earn a yearly revenue of NPR 30 million per MW at the existing PPA rates. This is more like a rule of thumb. Hence, a hydropower project can easily service debt up to NPR 240 million per MW with a repayment schedule of 12 years after COD assuming 4 percent interest rate (I am going for a higher interest rate here). The yearly installment (principal and interest) is about NPR 25 million leaving about NPR 5 million per MW for O&M and royalty payment which is more than enough. 

Upper Marsyangdi Hydropower (source: The Himalayan Times)

Developer	Power China Resources Limited
Type of Project	RoR
Status	Operation
Equity	NPR 4 billion
Loan	NPR 12 billion
Project Cost	NPR 16 billion
Per MW Cost	NPR 320 million
Loan per MW	NPR 240 million
PPA Rates	5.99 Cents per kWh (Dollar PPA)

*The revenue of this project is surely going to be more than NPR 30 million per MW.

Recently completed project/to be completed soon

Projects	Capacity	Status	per MW Cost
Naugarh gad	8.5 MW	Operation	NPR 165 million
Lower Modi-1	10 MW	Operation	NPR 214 million
Siuri	5 MW	Operation	NPR 185 million
Khani Khola	6.36 MW	Operation	NPR 184 million
Kabeli B-1	25 MW	Construction	NPR. 172 million
Upper Tamakoshi	456 MW	Construction	Less than NPR 110 million

*IDC is one of the major cost components in Nepali hydropower projects. Above projects are constructed at 10 to 12 percent interest rate.

It should be noted that a simple subtraction of per MW cost of Nepali projects from the per MW cost of 50 MW Marsyangdi projects will not indicate the actual benefit (the purpose of this comparison between the Chinese project and our local projects is not for profit calculation. No one should misinterpret this comparison). We should be aware that hydropower project cost is site specific. My whole intention is just to give a rough idea. 

The Chinese model is working. This is the reason why the same company (developer of 50 MW Marsyangdi project) is now keeping eye on Upper Kali Gandaki Hydropower Project (65 MW). To go for another project when its previous per MW cost is as high as NPR 320 million suggests that there is a substantial profitability. 

The trend has been set and I will not be surprised to see other Chinese investors jumping into Nepali hydropower in the days to come. However, few things need to be done from our government side to get this momentum going. 

First, the government should immediately implement  'Energy Crisis Reduction and Electricity Development Decade (2016-2026)' in reality.

Second, government should not hesitate to provide sovereign guarantee. It doesn't make any sense to invite foreign investors without making them comfortable. Neither equity nor loan investors are comfortable with NEA's financial health. Sovereign guarantee can boost their confidence to some extent.

Third, it is not just for foreign investors but also for domestic investors, i.e., attractive PPA rates. Developers (domestic and foreign) have been demanding a hike in PPA rates for a long time without success. (I did an assessment last year to find out the ideal PPA rates which you can read here)

It looks like government is not in a hurry to revise the PPA rates any time soon. Fair enough! But there are some possible adjustments in the existing PPA that government could implement. It could be a win-win situation for both parties (NEA and developers)

Existing PPA rates for projects up to 100 MW

Year	Wet Energy Rate	Dry Energy Rate
1	4.80	8.40
2	4.94	8.65
3	5.09	8.90
4	5.23	9.16
5	5.38	9.41
6	5.52	9.66
7	5.66	9.91
8	5.81	10.16
9	5.95	10.42
10	5.95	10.42
11	5.95	10.42
12	5.95	10.42
13	5.95	10.42
14	5.95	10.42
15	5.95	10.42
16	5.95	10.42
17	5.95	10.42
18	5.95	10.42
19	5.95	10.42
20	5.95	10.42
21	5.95	10.42
22	5.95	10.42
23	5.95	10.42
24	5.95	10.42
25	5.95	10.42
26	5.95	10.42
27	5.95	10.42
28	5.95	10.42
29	5.95	10.42
30	5.95	10.42
Average	5.78	10.11

*There is 3% escalation for 8 years

In an average, the NEA buys electricity at NPR 5.78 per kWh and NPR 10.11 per kWh for wet and season respectively. So, why not flat rates of NPR 5.78 per kWh and NPR 10.11 per kWh for wet and season respectively from the very beginning without any escalation whatsoever? NEA will have nothing to loose since it is willing to buy energy at those rates anyway. But this adjustment will be beneficial for developers for few reasons 

1 More attractive project: - IRR (Internal Rate of Return) will increase slightly (roughly by 1 percent) because of time value of money. Also, PBP (payback period) will be comparatively shorter. 

2 Higher DSCR (Debt Service Coverage Ratio) in initial years: - This is very important. Interest is charged in diminishing method. So normally interest payment is higher in initial years, leaving less amount for principal payment (ballooning method). But by adopting this PPA rates, project will be in a better position to pay a larger sum of principal in initial years too which will decrease the overall sum of interest payment.