Proceedings Report: Infrastructure Financing in Nepal

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Introduction

As a country at the cusp of least developed country (LDC) graduation, Nepal is committed to the development of infrastructure, and consequently, understanding how such infrastructure expenditures are financed has become a prominent topic of discussion in the country. According to the Public Debt Management Office, as of April 2022, Nepal’s total outstanding debt stood at NPR 1.86 trillion, 53% of which (NPR 0.976 trillion) is external and the rest (NPR 0.884 trillion) is internal.  National debt most notably has seen a significant increase in the recent years; outstanding debt was less than half of today’s amount in 2017/18 (NPR 0.917 trillion). Given the country’s reliance on foreign sources for financing, and amid public discourse about large development projects such as BRI, Millennium Challenge Corporation, Nijgadh Airport, Buddha Airport, etc., understanding how bureaucratic and political incompetency can hinder our ability to utilise foreign funds for economic prosperity is highly relevant.

Given this context, Centre for Social Inclusion and Federalism (CESIF) organised a seminar on the 17th of June on the theme, “Infrastructure Financing in Nepal” at the organisation’s premises in Kumaripati, Lalitpur. The speakers for the event were Lal Shankar Ghimire, former Secretary of Finance for Nepal, and Saumitra Neupane, Executive Director of Policy Entrepreneurs Incorporative. About 40 people attended the seminar including journalists, scholars, and experts from various fields.

Ambassador Vijay Kant Karna, CESIF’s Executive Chairperson, commenced the seminar with a brief background on the topic, followed by an introduction to the objective of the session: to discuss the status of infrastructure funding pattern in Nepal, the current status of dependence regarding infrastructure funding, the current gap between funding for development need and domestic revenue sources, current level of national debt and debt servicing, and the potentiality of debt trap. The two speakers each gave their presentations on the issue, followed by a question-and-answer session at the end. 

This proceeding report aims to summarise the key issues raised in the seminar.

The Significance of Infrastructure for Nepal and Its Current Status of Financing

The importance of infrastructure financing for Nepal stems from the importance of infrastructure itself. Both the speakers, Mr Ghimire and Mr Neupane discussed the importance of infrastructure development for Nepal, a country that consistently targets above-6% economic growth rates.

Mr Neupane shared that while Nepal took a big leap in development of big infrastructure in the 1950s, our goal of becoming a middle income country requires a leap almost 3 times greater. For this, we need development in every sector. Apart from promoting productivity and the manufacturing sector, investments in infrastructure like connectivity, transportation, network, and markets are crucial for eased flow of goods and services. He stressed the importance of infrastructure for an efficient transformation of the economy, which marks the importance of infrastructure financing.

Mr Lal Shankar Ghimire mentioned that the primary financier of infrastructure in Nepal is the government whereas private investments account for a comparatively smaller share. As enlisted in the federal budget, the various sources of financing for the government include revenue, foreign grants, domestic borrowing, and foreign borrowing. Private financing on the other hand occurs through foreign direct investors and domestic investors. Mr Ghimire noted that since the 1990s, government revenue has been on a decreasing trend. Foreign grants, likewise, have also been declining. As such, the significance of borrowing (especially foreign borrowing) has grown steadily.

Gap in infrastructure financing and lack of related studies

While it is intuitively understood that there is a gap between the resources required for infrastructure development and its availability in Nepal, there is a lack of comprehensive studies on this issue, and this was a topic of discussion as well.

Mr Neupane explained that the government invests borrowed money whereas the private sector has limited engagement in infrastructure other than hydropower projects. Mr Ghimire also noted the absence of government-led or private research work in this field.

Mr Ghimire was able to provide some data on the financing gap based on international studies. A 2019 study by the Asian Development Bank (ADB) reported a funding gap of USD 7721 billion in the South Asian region. Likewise, another 2017 Asia-wide study estimated an annual deficit of 1.5 trillion whereas the World Bank estimated a gap of 10-15% of the country’s GDP. A study conducted by Confederation of Nepali Industries (CNI) and Institute of Integrated Development Studies (IIDS) that relates financing gap to growth rate estimated that to achieve a growth rate of 10%, Nepal requires additional USD 9 billion annually. Given that the government usually targets an economic growth rate of around 6-7%, it is evident that the financing gap in Nepal is huge, and in the billions.

Current status of public debt and vulnerability to foreign exchange loss

Mr Neupane provided some data to portray Nepal’s current status of public debt. From the reference period of 2013/14 to current 2021, public debt has increased from 553 billion (28.51% of GDP) to 1737 billion (40.72% of GDP) .The share of foreign debt is about 60%. Of the foreign debt, 90% is from multinational organisations like ADB and World Bank. Regarding the bilateral loans, Japan has been the highest financier (4-5% of total foreign debt) followed by China and India.

As around 90% of the country’s debt liabilities is in USD, Nepal is vulnerable to foreign exchange loss. Mr Ghimire asserted that since infrastructure projects are long-term, the steady depreciation of the Nepali Rupee with respect to the US Dollar results in additional costs that more than offset the concessional borrowing rates. He gave an example of Melamchi Drinking water project. Between 2002, when the project was undertaken, and 2022, the exchange rate of NPR with USD has increased from 73 to 125. This loss offsets any concessions provided by the lender.

The need for thorough verification of contracts when acquiring loans

The nature of conditionalities on foreign loans and grants, and their suitability to Nepal’s requirements was a fundamental topic of discussion for the session.

Mr Ghimire argued that concessional loans, although attractive due to their low interest rates, need to be thoroughly assessed. Both speakers noted that projects funded by external lenders often include conditions that allow them to hire the contractor of their choice or that requires using their resources and labour. Mr Ghimire remarked this has hindered Nepal’s opportunity to use its national resources and foster productivity growth. It was however Mr Neupane’s assertion that diplomacy and infrastructure financing are inseparable. Conditions are a part of the trade-off that occurs when we undertake concessional loans, and Nepal should be able to harness diplomatic efforts to denefit the most out of such contracts. He gave an example how projects built on Indian or Chinese loans require using resources, both human and capital, to be imported from the lending country. Pokhara International Airport, built under Chinese loans, with an interest rate of 2% and repayment period of 13 years, is not profitable for Nepal. Likewise, Sindhuli Highway project, built under Japanese loans, was one of the most expensive projects for both parties.

Mr Ghimire additionally raised the issue of Engineering, Procuring, and Commision (EPC) contracts modality that most infrastructure projects based on foreign loans follow. He insisted that due to lack of proper verification, the terms and conditions, and use of resources end up being inappropriate and costly for us. He strongly condemned Nepal’s practice of overlooking feasibility reports, insisting on a thorough and earnest verification.

The Uncertainty of Debt Trap Vulnerability

The current debt-to-GDP ratio for Nepal stands at around 37%. However, there is no standard measure or threshold to compare the figure to, and there has been no consensus regarding what the appropriate amount of national debt should be. As a rule of thumb, the standard practice is to ensure that the rate of return exceeds the costs of borrowing (cost of capital). Mr Ghimire remarked that while a debt trap is not imminent for Nepal, the current practice of investing borrowed money without an assessment of the returns makes the country vulnerable in the long run.

Mr Neupane argued that vulnerability to debt trap should not be assessed based on mere numbers, but whether borrowed money is invested on projects with high rate of returns should be assessed

He summarised his views on Nepal’s vulnerability to a debt trap by posing the following question: Given that Nepal acquires the funds required to finance infrastructure and ensures its optimal usage, is it guaranteed that Nepal can achieve its development goals? His answer was no. He believed that infrastructure financing is a part of a bigger development strategy.

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