"PDF will help build up project financing skills among banks"
Shubhomoy Ray, Vice President of Fieldstone Capital Services, technical associates of the Nepal Bangladesh Bank for the administration of the USD 35 million Power Development Fund (PDF), was recently in Kathmandu in connection with a stakeholders' workshop on the guidelines for availing financing from the PDF. He shared some of his observations about the effort with New Business Age. Excerpts:
What will be the next step after this workshop?
As the operational manual is already in place, it has to be seen how and to what extent the suggestions collected during today's workshop can be accommodated in the manual. Based on that, the manual has to be revised and the amended guidelines have to be incorporated.
What is going to be the modality of providing financing from PDF?
There are two windows. In the first window, there are projects ranging from 10 to 50 MW (megawatt). Because the initial fund is hardly USD 35 million, I think only one project can be done to begin with under this window. There will be competitive bidding for that and the process has been already started. In the second window, there will be projects of size between one and 10 MW. There will be specific loan application guidelines to apply for loans under that window. The PDF will finance up to 60 percent of the project cost under that window, 20 percent will come from equity and 20 percent from other debt. That is the kind of structure being considered for now.
What specific problems do you see in funding hydropower projects in Nepal?
The fundamental problem is the lack of funds for the required tenor and volume. A development fund like PDF can try to do the best with what is available. In order to harness the full benefit of this fund, Nepal needs to move towards certain financial sector reforms as well, so that the depth of the financial market increases, making more banks capable of doing non-recourse project financing, in terms of both funding capacity as well as appraising skills. We expect that the financing under PDF through co-financing and the PCI route will help the financial sector build up skills to appraise projects for non-recourse financing. Over a period of time, local banks will develop the appetite as well as the resources for financing infrastructure projects.
The other thing, which needs to be considered by all developing countries that are starved of basic infrastructure, would be the nature of fiscal incentive that can be made available to the infrastructure sector by the government. For example, in India there is a 10-year tax holiday for power projects. For the mega-power projects, which are identified as projects with capacities of 1,000 MW and above, there is a complete waiver of central excise duties and customs duties. As there is no EPC equipment manufacturer in Nepal and every equipment for power generation will have to be imported, it is really important that the government considers providing such fiscal incentives, at least during the early period because that will reduce the project cost substantially, consequently having a positive impact on tariff.
It seems that many banks in Nepal don't know the opportunities in the hydropower sector. What is your observation?
If the banks do not know about these opportunities or the PDF mandate, one cannot really blame them because there hasn't been any institutionalised project financing in Nepal as such, especially through local currency funds, other than a few cases like Indrawati and Khimti. Even the existing power projects that are raising local currency financing are sourcing these funds more as corporate loans rather than as project finance. In project financing, Nepal is somewhere where India was in the early 90s. Strictly speaking, India had hardly done any non-recourse project financing till the IPP sector was opened up in 1991. They were still trying to learn how to do such financing. But once one gets involved, it is a very steep learning curve, and skills can develop rapidly.
One role that the PDF is going to play, other than administering the fund, is building up these skills. For that, the concept of Participating Credit Institution (PCI) financing has been introduced. Under this process, the PCI, which can be any eligible financial institution or commercial bank in Nepal, shall identify a hydropower project to finance and bring it to the PDF. Based on a preliminary appraisal done by the PCI, PDF shall undertake a detailed due diligence and if satisfied, shall take the project up for financing. But there are two conditions to it: one, the PDF will lend in the proportion of 3:1, i.e., for every three rupees PDF lends to the project, PCI will have to lend one rupee from its own sources. So, there is a commitment involved on the part of PCI. The second condition is that if a PCI brings a project to the PDF and the PDF approves it for funding in the 3:1 ratio, the entire risk of these four rupees lent to the project will have to be borne by the PCI.
There were lots of questions raised during the workshop today regarding why PCI would take the whole risk. But that is where skill building will come in because the PDF will share its appraisal with the PCI and there will be a lot of guidance and concurrent working during the due diligence stage. In this process, lots of skills regarding due diligence and project financing will be transferred to the PCIs. So I am hopeful that by the time a few projects are done by the PDF, there would be ground level of skills built among most of the Nepali banks to at least appreciate and understand non-recourse project financing.
What were the other major issues/questions raised today?
One major concern was about the interest rate under the first window being linked to Libor. The argument was that this would expose projects to both interest rate risk and foreign exchange risk, as the loan is proposed to be denominated in US dollars. Another issue was about PCIs taking the entire risk while lending only a quarter of the project's total debt under the PCI route. These concerns have to be discussed between the PDF Board and the PDF Administrator in order to see how best these could be addressed so that the stakeholders feel comfortable.
What is your suggestion to the bankers who feel that it is highly risky to invest in such projects?
The beauty of non-recourse project financing is that all the risks are segregated and unbundled and entrusted to respective parties that can best manage those risks. Project finance will have its own risks, especially as there is no recourse to any third party collateral or any promoter company balance sheet. But these risks are specific to the project. So, when risk analysis of a project is undertaken, each of the risk specific to that project is identified, segregated and allocated for acceptable mitigation. There are various ways to mitigate or minimise these risks: they can be insured, or balance sheet guaranteed, or covered through allocations backstopped by default liabilities or bundled and marketed as capital market products. So, from the banks' point of view, it is not the question of the risk; it is the question of understanding the risk, because once that is done, addressing them becomes simpler. The bigger problem is recognising the risks and then prioritising and deciding which risk is more potent and needs to be covered.
Do you think the bankers will be able to understand the intricacies after a few such sessions?
It is not that the bankers will be able to understand this after a few such sessions; but they will definitely understand it once they finance a few projects, and that is why PCI may be an important avenue. If the PDF and the bank are lending together, whether through the PCI route or through co-financing, the due diligence, the loan documentation and the inter-creditor agreements are all done together. Over a period of time, the banks will be able to understand the nuances of project financing and start exploring options on their own.
What other issues do you see as critical for the development of hydropower projects in Nepal?
There are a couple of issues that the international financing and investing community is apprehensive about. One is the political risk, which is two-fold: First, there is the old fear of insurgency and the physical risk to project safety, which pushes up insurance costs to unsustainable levels. The other part of the political risk is the advocacy in the country's general political scenario. In such a fast changing political situation, the whole exercise of project due diligence and cost analysis becomes futile. If the political situation remains volatile, investors will remain weary that a sudden change in something might make the whole initiative not viable! That can send a very negative signal.
The second concern is on the financial front. Some financial sector reform is needed urgently so that the utility companies and the banks can tap or raise financing internationally. This can happen with multilateral supports by way of Political Risk Insurance (PRI), and options need to be explored in this regard. Efforts also need to be made to develop the financial markets in Nepal and increase their depth, making way for liquidity in financial products and instruments. This shall enable the banks to source long-term funds, and structures can be built around which financing can be raised. There should be regulations permitting such sourcing of fund.
Another thing that Nepal needs to explore is the possibility of obtaining a country rating because the country does not have an international credit rating. Though none of the countries in South Asia has an investment grade rating, they still manage to raise financing internationally because the international financing community can peg the risks based on the rating these countries have. Whatever be the rating, it would help. An international credit rating makes loan pricing more efficient and removes subjective costs to a large extent.
You mentioned a couple of risks perceived internationally about Nepal. Don't you think that those risks are present in other counties as well? Or is it only the perception?
The risks mentioned above are mostly perceptions, but these perceptions have also been established to some extent by track records and evidences. There have been reports of insurgency-led damages caused to power projects in which there are foreign interests. The risk of large-scale nationalisation of projects under an emergency was real until recently. These are perceptions, which may not always materialise into risks and consequent losses, but continuation of these perceptions will mean that it will be difficult to attract people to come and invest here.
What about the possibilities of hydropower projects targeting India as the market?
There is the possibility, which is being explored. In North India there is a huge scarcity of power and there are a number of private as well as state-owned power trading companies in India which will be willing to buy power. But for that to happen, a transmission corridor has to be built first for evacuation of power from Nepal to India. That would be a project in itself, requiring financial support from multilateral agencies. There also has to be proper, bilateral arrangements for sale of power to India. However, this is beyond the scope of PDF. PDF is too small to undertake anything of this type as of now. Right now it is very clearly focused on financing under the two windows as stated earlier.
KT Mathew, Area Head, Financial Crime Risk, South Asia of Standard Chartered Bank was in Kathmandu early August. He made a presentation before a select group of Nepali policy makers and professionals about the risk-based approach for preventing money laundering.
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