Policy for Financing Infrastructure PPP Projects in Nepal

Submitted to

Nepal Bankers Association & Public Private Partnerships for Urban Environment (PPPUE), Nepal
March 2010 By

Infrastructure Development Finance Company Limited

India PPP Capacity Building Trust

2nd Floor, Capital Court, Olof Palme Marg, Munirka, New Delhi 110 067 Telephone: +91 11 43311100 Fax: +91 11 26713129

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Table of Contents
1. 2. 3. 4. 5. 6. 7. 8. Background ..........................................................................................................3 Infrastructure scenario in Nepal ........................................................................4 Overview of Nepals financial sector ..................................................................5 Existing policies/ incentives for infrastructure financing................................7 Gap analysis..........................................................................................................9 What needs to be done? .....................................................................................11 Draft Policy .........................................................................................................13 Going forward ....................................................................................................18

Summary of Discussions..............................................................................................21

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1. 1.1.

Background The use of Build, Own, Operate and Transfer (BOOT) frameworks for infrastructure development was envisaged in Nepal's plan document as early as 1992; however, actual use of BOOT frameworks was low for various reasons. The Three-Year Interim Plan (2008-10) mentions that, despite the BOOT policy being adopted to promote private sector investment in the development of physical infrastructure including roads, expected levels of the same could not materialise. The growing need for more infrastructure and effective service delivery in the country has put the Public Private Partnership (PPP) format for development of infrastructure projects once again in focus. A need has been felt to facilitate a uniform approach to PPP financing by banks and financial institutions (FIs), under a well-defined financing policy framework. Public Private Partnerships for Urban Environment (PPPUE), a project supported by UNDP, together with the Nepal Bankers Association (NBA) have decided to put together a financing policy framework that could be recommended to the Government of Nepal (GoN) and for this purpose had sought the services of Infrastructure Development Finance Company Limited, India (IDFC) for preparation of the same. IDFC and its associate concern - India PPP Capacity Building Trust (I-Cap) have prepared the policy framework as per the terms of reference set out below: a. Review the existing provisions for lending/ project financing by banks/ financial institutions and tax/ fiscal incentives available to infrastructure projects, based on relevant extracts of such legislation (including income tax regulations) as would be provided by NBA. b. Prepare a draft policy document related to PPP Project Financing with a view to i. incentivise banks and private sector investors to invest in/ finance infrastructure projects; and identify products that could be useful for banks in financing infrastructure projects.

1.2.

1.3.

ii.

1.4.

The first deliverable envisaged under the assignment i.e. Draft PPP Financing Policy and Background Report was submitted on November 11, 2009. After incorporating certain comments from NBA, a stakeholder consultation workshop was organized on February 5, 2010, at Kathmandu. The list of participants and minutes of the consultation have been set out at Annexure 1.

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1.5.

Following the discussions and suggestions given by various stakeholders at the aforesaid workshop the final PPP Financing Policy and Background Report i.e. this document has been prepared. Infrastructure scenario in Nepal Nepals GDP rose by 5.6% in 2007-08, contributed to by agricultural growth of 5.7%, industrial growth of 1.8% and growth in services of 6.9%. The government has set a target of achieving annual economic growth of 8.3% by 2016-17, of which 5% growth is projected in the agriculture sector and 9.7% in non-agriculture sector1. The relatively high growth in agriculture in 2007-08 was due to a favorable monsoon that year. In order to maintain this growth in a sustainable manner, it would be crucial to improve irrigation which is currently extended to around two thirds of the land, of which less than half has year-round irrigation. GoN has embarked upon a plan to increase the total year-round irrigated area to 67% by 2027, at an estimated cost of USD 3.6 billion (at 2003-04 prices). Within industry, manufacturing declined by 0.9% whereas electricity, gas and water rose by 3.4%, construction by 3.1% and mining by 2.8%. Broadly the infrastructure sector (which is dominated by hydro-power projects) has seen heightened activity. However, of the estimated exploitable hydro-power potential of 42000 MW (out of total estimated hydro-power potential of 83000 MW)2, installed capacity is only about 560 MW (only 40 % of the population has access to electricity). The target set by the government is to generate 4000 MW of electricity from hydropower 2027 to meet the projected domestic demand3. This by itself would need a fairly substantial amount of investment, estimated at about USD 6 billion4. Given the natural scenic beauty of the country and the substantial role that the tourism sector would have in generating employment, increasing foreign exchange earnings and maintaining external sector stability5, it is crucial for Nepal to speedily develop its tourism-related infrastructure including the connecting infrastructure. Financing of tourism sector also has a strong economic impact, given the significant positive relationship between tourism financing and GDP growth6.

2. 2.1.

2.2.

2.3.

2.4.

http://www.erg.com.np/documents/Hydro_Nepal_Vol_I_Issue_1.pdf http://www.erg.com.np/hydropower_national.php 3 From a presentation titled Legal and Policy Environment for Private Sector Participation in the Power Sector in Nepal by Anup Kumar Upadhyay, Joint Secretary, Ministry of Water Resources, Government of Nepal 4 Based on estimates of ~ USD 1 million per MW for plus at least 0.5 - 1 x the investment value in transmission and distribution 5 Nepal Monetary Policy, 2008-09 6 Economic Impact of Tourism Finance in Nepal, Bishnu Prasad Gautam, Ph. D., Assistant Director, Research Department, Nepal Rastra Bank
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2.5.

If one were to look at the increasing levels of urbanisation which puts pressure by way of increased demands on physical infrastructure and urban services, the need for higher levels of investment in urban infrastructure (water supply and sanitation, solid waste management, education, healthcare facilities, urban transport and other urban amenities) is clearly evident. At present, around 50% of the urban population has access to water and sanitation services. This is targeted to increase to 100% by 2027. The levels of investment would be further enhanced if the investment in urban areas is coupled with the need to provide similar facilities in scattered rural areas. Unlike hydro-power projects which have attracted substantial private sector interest, urban infrastructure projects are almost entirely funded by urban local bodies (ULBs) which are significantly cash-strapped and also unable to access finances from commercial banks and capital markets due to their poor financial condition. Hence, financing of infrastructure projects across various sub-sectors from non-government sources would be a major challenge and would require a significant level of push and sustained support through investor-friendly policy initiatives in the coming years. Overview of Nepals financial sector Banking and financial services

2.6.

3. 3.1.

3.1.1. The banking and financial services sector in Nepal is fairly mature, with 25 commercial banks, 58 development banks, 78 finance companies and 12 micro-finance institutions. The sector mostly lends to retail clients who are perceived as more creditworthy. In the banking sector, deposits (mostly savings) dominate the sources of funds. 3.1.2. As per statistics of the Nepal Rashtra Bank7 (NRB) for mid-July 2009, of the total liabilities of the banking system, the contribution of capital funds was only 3.74%, whereas deposits contributed 69.4%. Within deposits, savings accounts comprise 46.1%, followed by fixed deposits at 25.1%. As, only a quarter of the deposits are time deposits, long term lending constitutes roughly the same proportion. Lending to the corporate sector has is largely collateralbased. 3.1.3. Many development banks have been set up with active participation of private sector after the Development Bank Act, 1996 came into effect. The main objectives of this Act are enhancing agriculture, industry and commerce by extending credit facilities to the public. 3.2. Mutual funds

3.2.1. NCM Mutual Fund is one of the two mutual funds in the country. In the fiscal year 2007-08, under the NCM Mutual Fund, 2002 total investment reached a
7

The Central Bank of the country 5

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level of Rs.194.7 million. Investors in mutual funds are mainly institutional investors who invest on the basis of fundamental analysis rather than speculation. Retail investors normally follow their lead in making investments. 3.2.2. It is estimated that mutual funds have a potential market worth Rs 5-10 billion in Nepal8. Mutual funds offer a good opportunity for retail investors to take part either in the primary market through Initial Public Offers (IPO) or the secondary market (through stock exchanges). Given the fact that retail investors may not be very equity savvy, mutual funds offer good intermediate avenues for accessing secondary markets. 3.2.3. Going ahead, it is expected that high net-worth individuals (HNIs) and Non Resident Nepalese (NRN) can contribute to the growth of mutual funds. These funds would be regulated by SEBON and managed by professional and experienced fund mangers having operational flexibility and independence. 3.3. Insurance and employees provident funds

3.3.1. Until mid-July 2008, there were a total of 25 insurance companies operating in Nepal, all established under Insurance Act,1992. The number of life, non-life and composite (both life and non-life) insurance companies were 8, 16 and 1 respectively. The total assets of these companies increased by 27.8 percent from the previous year and reached Rs. 40.07 billion in mid-July 2008. 3.3.2. The Employees Provident Fund (EPF) is an autonomous entity, established on September 16, 1962 under the Employees Provident Fund Act,1962. The total assets/liabilities of the EPF increased by 14.7 percent and stood at Rs. 67.94 billion. Similar to insurance companies, provident funds are also typical sources of long term funds. 3.3.3. Worldwide insurance and provident fund companies are seen as steady sources of long term capital for infrastructure. However, in Nepal, statutory provisions do not permit these companies to invest in the equity capital of projects. Within prudential norms, there is scope to utilize a portion of the corpus either by of loans to or as investment in the equity capital of infrastructure projects. 3.4. Primary markets

3.4.1. A total of 64 public limited companies raised funds amounting to Rs.10.67 billion by issuing securities in the fiscal year 2007-08. In 2006-07, 34 companies raised Rs.2.30 billion. However, only a few of these were nonfinance companies. 3.4.2. The market needs to become more mature and attract companies from core sectors. The infrastructure investors/developers would then have a deeper

http://www.nepsenews.com/2008/06/govt-inaction-puts-mutual-funds-in.html 6

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source of funding for the equity portion of their project costs, after demonstration of a successful track record. 4. 4.1. Existing policies/ incentives for infrastructure financing So far the focus of the private sector and government has been in mostly in exploiting the hydro-power potential of the country. In a span of one decade, the private sector has succeeded in mobilizing $322.6 million into the power sector9. At present the power generating capacity of independent power producers (IPPs) from the private sector accounts for only about one fourth of the installed capacity. Given the vast amount of unexploited hydro-power potential and the huge demand for power both in Nepal and India, in future it is expected that the hydro-power would continue to be an area of focus. However, the development of other sectors would also need to be a priority given the overall requirement for infrastructure. To boost private sector participation, in 2001, GoN introduced a Hydro Power Policy. Further, vide the monetary policy, 2007-08, single obligor limits for loans to hydro-power projects has been relaxed from the existing limit of 25 percent to 50 percent of the core capital for fund-based loans and non-fund based facilities. This is subject to a power purchase agreement (PPA) being signed with the concerned agency buying the power.10 The same provisions were continued in 2008-09 as well. Various initiatives related to infrastructure have been proposed in the Monetary Policy of 2008-09 as under: a. Credit flow of commercial banks and financial institutions to micro-hydro projects are to be counted as loans to the deprived sector. b. With a view to address the issue of financial inclusiveness and expand micro-credit, the deprived sector credit requirement for development banks has been increased from 1 percent to 1.5 percent of the total credit. c. Recently, commercial banks have come up with a proposal for establishing subsidiary companies under their ownership which would provide/ arrange for credit flows to deprived sectors; NRB has considered this positively. d. The requirement of maintaining additional 20% loan loss provision has been released for the loans provided directly or indirectly to the deprived sector where group/personal/ institutional guarantee(s) have been provided. Such provision has been continued this year also. e. GoN has allocated an amount of Rs. 250 million in the budget of 2008-09 for establishing an infrastructure development bank with a view to raise
Investment in Hydropower Sector: Opportunities and Risks, a presentation by Mr. Ratna Sansar Shrestha, a member of the Board of Directors of Everest Bank Ltd. 10 Nepal Rastra Bank, Economic Report, 2007-08 7
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4.2.

4.3.

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resources within the country for development of infrastructure. NRB would develop special regulatory standards for capital, investment and loan loss provisions for such banks. f. Since financial institutions have been resorting more to borrowings rather than to deposits for resource mobilization, a provision would be made whereby the financial resource mobilization from borrowings will be no more than one-third of the deposits (except for category D institutions). g. NRB would encourage the merger/ acquisition of existing banks and financial institutions to significantly expand the capital base in order to finance the infrastructure sector which requires a huge amount of financial resources. h. The refinance facility to commercial banks and development banks against the securities of credit provided to small and cottage industries have been continued at existing refinance rate of 2.5 percent. This could perhaps be extended to small urban infrastructure projects as well. 4.4. Further in the 2009 budget, the following concessions are envisaged11; a. b. VAT and customs duty exemptions have been given for construction materials, machinery, equipment, tools and spare parts. Revenue policy12 formulated with objective of, inter alia, attracting and giving incentive to investment in hydroelectricity and huge infrastructure works. Private Sector Promotion Program to address, inter alia, the following: i. The need to get excise licences for the production, import, export, storage, sale and distribution of all items except certain items has been annulled. ii. Arrangement has been made not to look into the income source of manufacturing industries using more than 50 percent indigenous raw materials, employing more than 300 national workers or those of national importance such as hydro electricity projects, international airports, tunnel ways, road ways or railways until mid-April 2019 (essentially infrastructure projects). Although GoNs efforts to channelise and facilitate investment in hydro-power have been commendable, in the light of the wider infrastructure requirements there is clearly a need to broad base such concessions/incentives to attract investment in other infrastructure sectors as well.

c.

4.5.

11 12

http://www.nepalnews.com/archive/2009/jul/jul13/budgetspeech_english.pdf Details to be obtained 8

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5. 5.1.

Gap analysis Traditionally, as governments start facing cash flow problems to fund capital intensive infrastructure projects, alternative and innovative means of project financing are sought. PPPs are such an alternative solution; however, it is important that the underlying projects are commercially viable or can provide the desired level of returns on equity investment to private investors through a small viability gap contribution from the government. Funds for huge infrastructure projects are sourced through a combination of debt funds (usually from banks and other debt investors) and equity funds from the private promoters/ sponsors. The equity component varies from 25% to 40% of total project cost, depending on the level of risk perceived for the project. Usually around 70% of the funds are provided as loans/ subscription to debt securities by banks/ FIs and timely financial close of projects depends on successfully sourcing these funds. The decision of a bank/ FI to lend depends on its risk bearing capacity (loan exposure is linked to the level of equity capital of bank/FI and prudential norms of the Central Bank) and its ability to objectively assess the risks in a project. This is diagrammatically set out in Figure 1 below:

5.2.

Figure 1: Project Financing Considerations

Capacity to invest Prudential Norms

Sources of Funds: Capital Deposits Borrowings

Financial Intermediary

Equity

Ability to appraise
In-house/outsourced expertise

Debt

5.3.

While analysing various documents available in the public domain (and which are referred to the report) it is felt that broadly there are certain issues that influence lending decisions to projects. These issues are broadly discussed in this report and the recommendation on policy to promote PPP financing is based on these key issues. Sources of funds for banks Although savings deposits are generally lower cost resources, their uncertain tenor poses a challenge for banks in managing their asset liability mismatches. This would have an impact on the ability of banks to provide long-term
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5.4. 5.4.1

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funding for infrastructure projects. As the banking sector evolves innovative structures to enhance the level of longer term deposits13, these funds could be effectively channelised for infrastructure financing. 5.4.2 A recent NRB study14 has suggested that closer links between formal and informal financial markets should be developed by encouraging formal financial institutions to mobilize deposits and allocate credit through informal and community-based banks and micro-finance agents in areas where the reach of formal banks is limited. Fiscal policies, as well as regulatory and supervisory structures, should be designed to encourage these developments. This can be helpful for small rural based projects providing infrastructure facilities. Prudential norms

5.5.

5.5.1. In terms of the Banks and Financial Institutions Act (BAFIA), commercial banks in Nepal are required to make a loan provisions up to 100% and allocate 150% risk weight (accordingly to the new BaselII capital adequacy framework adopted by NRB) on any loan not supported or on high risk investments. This provision may deter banks from providing non-recourse project financing and seek additional collateral security from borrowers. This may be difficult to provide. 5.5.2. Investment by banks/ FIs is permitted only in listed equities and so greenfield infrastructure projects implemented by dedicated special purpose vehicles (SPVs), always unlisted, would not have access to bank funding in equity. 5.5.3. NRB also stipulates that loans overdue for over a year need 100% provisioning. In infrastructure projects (especially in hydro-projects where geological surprises could lead to some overrun in time and costs necessitating re-schedulement of loans) this could result in huge provision and charge to the P&L statement. As a result most banks are rather averse to lend to long gestation infrastructure projects. 5.6. Financing instruments and types of financing:

5.6.1. Although significant volumes of funds could be raised through lower cost deposits, there is a need to channelize these into long term funding for infrastructure projects. This would depend on the regulatory requirements for various instruments. 5.6.2. For instance if funding to infrastructure is incentivised (through deprived sector lending criterion) but if banks are not capable of appraising projects and
As per RBIs statistics (June 2009), time deposits constituted roughly 87% of the total deposits of Indian banks 14 Nepalese Financial System : Policy Developments and Challenges, Dr. Bhubanesh Pant, Acting Director, Research Department, Nepal Rastra Bank, in special publication of NRB- Nepalese Financial System: Growth & Challenges 10
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hence unable to take informed decisions, then credit guarantees or other credit derivative instruments could be introduced. Similarly refinancing of loans by banks or take out financing by specialised banks or even multi-lateral agencies could help address these problems. 5.7. Project Finance: Banks in Nepal prefer to provide short term loans backed by securities (charge on assets) and collateral (personal guarantees) recoursebased finance. Large infrastructure projects need project finance (usually on non-recourse or limited recourse terms) based purely on the cash flow projections of the project. Given peculiar and unique nature of each type of infrastructure project, banks/ FIs need to possess/ procure specialised technocommercial skills to appraise the project and estimate project cash flows. Only Rashtriya Banijya Bank (RBB) has a separate project finance department. Tax incentives

5.8.

5.8.1. Tax incentives would attract not only small depositors, who could provide funds to intermediaries by investment in tax-free savings instruments like bonds and debentures, but also project promoters, who would seek fiscal incentives like tax holidays, tax-free dividends and accelerated depreciation. Tax incentives could be a useful tool in attracting investors to infrastructure projects as well as in raising low cost, long term funding for such investments. 5.8.2. The provision of tax incentives would need to be stable and for a reasonably long term for it to be effective. It has been reported that a tax holiday proposed in Nepals 2031 Income Tax Act was withdrawn in 2058 such policy reversals would have a negative impact on investor sentiments. 5.8.3. Tax incentives for financial intermediaries like banks, FIs and non banking finance companies (NBFCs) could help in directing the flow of credit to infrastructure15. There is a need to provide such incentives and the experience in India which initially used such incentives has been fairly positive. 6. 6.1. What needs to be done? Appraisal skills

6.1.1. A detailed appraisal of a project is necessary for a bank to evaluate the risks involved in lending to the project. This would enable appropriate pricing of the loan and the various covenants to be stipulated. The view on a projects viability is the outcome of the appraisal process followed by the bank. 6.1.2. In the short run the banking sector would need external expert help for appraisal of infrastructure projects; in the long term banks would need to

In the absence of extracts of tax legislations, the proposals on the subject are based on the assumption that there are no such provisions in the current fiscal regime in Nepal 11

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systematically develop appraisal skills specific internally, through appropriate training. 6.2. Sources of funds

6.2.1. The traditional sources of funds for the banking system have largely been savings and time deposits. However, going ahead there is clearly a need to identify and develop alternative sources to fund the long tenor need of infrastructure loans. This would need appropriate policy and fiscal measures. 6.2.2. In order to help local entrepreneurial talent and nurture ideas in the infrastructure sector, it would be useful to have sector specific private equity/ venture capital (PE/VC) funds which would invest in the equity of projects or in the holding companies set up by promoters to invest in projects. Such PE/VC funds would usually work with promoters who would gain from their professional management, brand equity, marketing support (where needed) sector specific knowledge and skills and thus promote profitable growth. 6.3. Secondary market for loans

6.3.1. While capacities are being built to make financial intermediaries self sufficient to take investment decisions, in the transition period, the effort can be supplemented by making loan assets created by an intermediary, capable of taking investment decision, transferable to another intermediary. This transfer would address two aspects; a. An intermediary not capable of taking investment decision on its own can own the asset on its balance sheet, b. More assets are funded for a given set of appraisal abilities. 6.3.2. Credit derivatives also help in achieving the same objective as transferring the loan assets. Although this is a more complex structure and would require statutory changes by NRB, in the long run this would help in creating wider and deeper secondary markets for loan assets in infrastructure. This would help in banks/FIs in lending more to the sector when there is assured secondary market to trade in assets thus created. 6.3.3. While other measures are being put in place, a new or a significantly large existing bank/ FI could be entrusted with the task of providing take-out financing. Another possibility would be for such a bank to provide full/ partial credit guarantees on loans. In the absence of adequate players in the system to undertake such activities, it would be useful to permit multi-lateral lending agencies16 to provide such products. This would enable local banks lend to infrastructure projects, without having to take the entire credit risk.

World Bank, International Finance Corporation, Asian Development Bank and KfW Development Bank 12

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6.4.

Prudential Norms

6.4.1. The existing provisions of Deprived Sector Lending (DSL) obligation seem rather low especially when compared to a similar counterpart in India priority sector lending17 obligations of commercial banks. Since the objectives are somewhat different and there is clearly a need to move away from directed lending as a practice it may not be prudent to bring infrastructure financing under the scope of priority sector lending. 6.4.2. However, in order to give impetus to infrastructure lending, a similar but new form of obligation under a new category can be conceived. As was discussed at the stakeholder workshop, instead of making it mandatory, infrastructure financing can be encouraged by providing suitable incentives to banks and other financial investors. 6.4.3. There is a need to enhance lending capacity of banks through prudential norms. For instance, in India, for infrastructure, the prudential limit on lending is to single borrower and to a group of entities has been increased from 15% to 20% and from 40% to 50% of the banks capital for infrastructure projects. 6.4.4. Looking at the peculiar nature of infrastructure projects in general and large infrastructure projects in particular, an individual bank/FI would need to take a call on what is the acceptable time overrun in a project, without significantly compromising on its viability. Accordingly asset classification and related provisioning norms could be suitably relaxed for the loan account, and left to the Banks Board to decide upon. 7. 7.1. Draft Policy Preamble: (A suitable background on infrastructure in Nepal and the need for a financing policy for encouraging private investment may be included) Objective of the Policy: In order to enhance private sector investment in the infrastructure sector this policy intends to: a. b. c. d. encourage and facilitate financial intermediaries provide financing to infrastructure projects; address the need to develop specialised skills for appraisal of infrastructure projects; address capacity constraints to fund projects, through more liberal prudential norms for banks and financial institutions; and set broader norms within which financial intermediaries would have operational flexibility for faster decision making suitable to the situation and circumstances.

7.2.

NRB stipulates DSL at 2%; in India the Reserve Bank of India (RBI) stipulates priority sector lending at 60% of the total advances 13

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7.3.

Infrastructure finance to PPPs

7.3.1. A loan facility extended to a borrower or any equity or debt investment in an existing company or a special purpose vehicle (SPV) incorporated under relevant provision of law, to implement an infrastructure project or operate an infrastructure facility would be considered as infrastructure finance. 7.3.2. The said company or SPV18 should essentially be engaged in either one or more of the following activities in relation to the infrastructure project or facility, under an agreement entered into with a government department or entity at national or sub-national level: a. Development, construction, operations and maintenance; b. Construction, operations and maintenance; and c. Operations and maintenance. 7.3.3. The benefits extended by this policy would be available only to those projects where the finance extended by the bank is secured mainly by the cash flows and assets of the project. Where collateral security or any other contingent support is taken, the value of the same shall not in aggregate exceed 25% of the amount financed. 7.3.4. Projects in the following areas would be considered as infrastructure projects that could avail of the benefits under this policy: a. b. c. d. e. f. g. h. i. j. k. l. Power generation, transmission and distribution systems; Airports, air cargo complexes, airstrips and helipads; Roads and bridges; Railways; Dry ports, inland container depots and container freight stations; Industrial parks, information technology/ bio-technology parks, special economic zones and industrial townships; Water supply, treatment & distribution, sewerage & drainage systems Solid waste management; Tourism and related infrastructure; Hospitals and healthcare facilities; Schools, colleges and specialised educational institutions; Urban infrastructure such as multi-level car parks, bus/ truck terminals, urban amenities such as foot over bridges, subways and public conveniences, and urban transport systems; and Entertainment and recreational complexes.

m. 7.4.

Enhancing of appraisal skills

7.4.1. In the long run it would be necessary to build in-house capacity of the banking sector to appraise and finance infrastructure projects. In the short term though
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That would be commissioned after a particular date say on or after April 1,2010 14

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it may be useful to procure the services of a specialised agency/ firm which would assist banks and financial institutions in appraising projects. 7.4.2. In order to develop appraisal skills and capabilities the following provisions are being stipulated: a. Every bank and financial institution with total assets above Rs. ____ million would prepare a time bound plan (the Plan) to enhance its capacity for appraisal of infrastructure projects within 6 months from issue of this policy. The Plan shall be submitted to (a designated department of NRB). To facilitate monitoring of the Plans implementation the respective bank shall establish a project finance cell and identify a nodal officer to oversee the working of the cell, within 3 months from the date of submission of the plan.

b.

7.4.3. The actual appraisal procedure to be developed by each bank and financial would be guided by following broad principles: a. The focus of the appraisal process would primarily need to be on financing commercially viable infrastructure projects. While government guarantees (for off take obligations) may enhance the creditworthiness of a project, these should be primarily not be considered as a substitute for commercial viability. Project specific risks need to be identified, their impact assessed and suitable mitigation measures should be stipulated as part of loan/ equity covenants. As far as possible the banks effort should be to effect necessary changes in the various project contracts so that responsibilities are shouldered by the party best suitable to manage them.

b.

c.

7.5.

Sources of funds

7.5.1. In line with other developing countries in the region domestic savings have helped the banking system in garnering required funds to fund the growing capital expenditure in the country. 7.5.2. However, going ahead to address growing needs of infrastructure investment there is a need to enhance the resource mobilisation through various instruments. In this regard the following provisions are stipulated; a. To mobilise domestic savings, long tenor tax savings infrastructure bonds could help in addressing the asset-liability management issue of infrastructure funding. A bank or financial institution would be permitted to issue bonds for periods (duration) not less than 7 years19 for subscription by wholesale and retail investors. The interest paid to

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This would be the duration of the instrument 15

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investors on such bonds may be at a fixed or floating rate and would not be taxed at the hands of investors. b. As the primary market for equities is not yet mature there is a need to bring in effective intermediation to enable the flow of funds from retail investors to infrastructure projects. In order to promote the flow of funds to the equity of infrastructure projects, asset management companies (AMCs) registered with SEBON, would be permitted to issue infrastructure-specific, open- ended20 mutual funds. Keeping in view the large requirement of funds for infrastructure projects, insurance companies and Provident Funds (PF) would be permitted to invest in the debt and equity capital of infrastructure projects, subject to an aggregate ceiling- 5% of their investible corpus in the first year, increased to 15% in the third year. Venture capital/ private equity funds would be permitted to register themselves with SEBCON and start operations in Nepal.

c.

d.

7.6.

Transfer of loan assets: In order to create a secondary market for loan assets and debt securities the following transactions would be permitted: a. Banks and financial institutions would be freely permitted to transfer infrastructure loans/ debt securities to other willing and interested banks/ financial institutions subject to the condition that both entities observe the instant prudential norms applicable. Banks will be allowed to cover their loan assets through various forms of credit enhancement products full/ partial risk guarantees/ participation certificates and take out finance and re-financing arrangements with other willing and interested banks, financial institutions and multi-lateral lending agencies.

b.

7.7

Prudential Norms: Infrastructure Finance would be considered as priority sector lending and banks are hereby encouraged to extend funding to infrastructure projects. To this end, the following changes to the prudential requirements for banks and financial institutions would be made: a. An additional 1% per annum of interest would be payable on funds deposited by banks with NRB, to the extent of the respective banks aggregate term loans/ investment in the infrastructure sector. For instance if the funds deposited by a bank (having aggregate term loan/ investments in infrastructure of Rs. 500 million) with NRB is Rs. 750 million, Rs. 250 million of the deposits would carry normal interest rates while, that the balance Rs. 500 million would carry an additional interest at 1% per annum over the normal rates. The computation

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would be based on the average daily balances and this facility would be available for a period of 5 years from the date of this policy. b. i. In order to enhance the lending capacity of banks, the credit limit to a single borrower and to a group of entities would be increased to 30% and 60% of the net worth, respectively, for infrastructure projects. The infrastructure bonds referred to at 7.5.2.a above would be considered as special debt instrument under Tier II capital of the banks, provided the bond is a plain vanilla instrument (nonconvertible, without put/ call options) and the duration of the bonds is at least 7 years. The rate of interest payable to investors would be decided by the Board of the bank. Provisioning norms: Keeping in view the construction period risks specific to the sector, on loans to the infrastructure sector, accounts overdue by more than 2 quarters could be classified as standard assets, based on the decision of the credit committee of the bank/ financial institution. Such reclassification would be supported by justifications and should be reported to NRB within 15 days of such classification. The requirement of 12.5% provision for rescheduling/restructuring of loan may be done away with in case of infrastructure projects. The credit committee of board of directors of banks may be allowed to re-define the construction period for which interest capitalization is allowed on case to case basis. Equity investments: Banks would be permitted to invest up to a total of 30%21 of its paid up equity capital and reserves in equity shares of infrastructure projects, with a ceiling of 30% of share capital of a single SPV.

ii.

c.

d.

e.

7.8

Fiscal incentives: The following fiscal incentives would be available to infrastructure projects set up on or after _____, where the total project cost exceeds a sum of Rs. 150 million: a. The income earned by notified infrastructure projects would be exempt from payment of tax for a period of ten years from the date of commissioning of the facility/ commencement of services under the contract (Appointed Date) with the particular government department/ agency. This tax holiday of ten years could be availed as a

21

In line with RBIs: In terms of Section 19(2) of the Banking Regulation Act, 1949, no banking company shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding 30 percent of the paid-up share capital of that company or 30 percent of its own paid-up share capital and reserves, whichever is less, except as provided in sub-section (1) of Section 19 of the Act. Shares held in demat form should also be included for the purpose of determining the exposure limit. This is an aggregate holding limit for each company. While granting any advance against shares, underwriting any issue of shares, or acquiring any shares on investment account or even in lieu of debt of any company, these statutory provisions should be strictly observed.

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block within a period of 20 years from the Appointed date. Individual projects would need to be suitably notified by (specified authority) to avail of the benefit if tax exemption under this policy. b. Income earned by way of investment in the debt (including by way of loans) and equity capital of notified infrastructure projects by way of interest (computed on a net basis i.e. gross interest earned less the average cost of funds of the bank or financial institution), dividend and long term capital gains (profit from sale of assets held for over a year) would be fully exempt from payment of tax in the hands of the investor for a period of ten years from the Appointed Date. Banks and financial institutions may make a one-time transfer to a special loan loss reserve an amount equivalent to 25% of the value of a loan made to/ debt investment in notified infrastructure projects. Such amounts may be transferred to the general reserve after a period of 5 years. Where banks are unable to accurately estimate the quantum of interest that may be received on bad loans/ debt investments in notified infrastructure projects, interest income from such assets would be recognised only when it is received as against on accrual basis. VAT and import duties should be made exempted to construction materials and other equipment used for building infrastructure projects. (In case of Hydro Projects, however, even civil items, which would form bulk of capex, may also be considered for VAT/Import Duty exemption.)

c.

d.

e.

8. 8.1

Going forward The appropriate agencies Ministry of Finance and NRB, may need to make the appropriate notifications/ legislative changes to make the financing policy/ incentives effective. Apart from addressing issues specific to the banking sector, both in the short term and long term, there is a need to consider issues which are structural in nature. These structural issues are critical to make the environment conducive to private sector participation, specifically in infrastructure. A dedicated infrastructure department should be established at Nepal Rastra Bank and Ministry of Finance. This department should be made responsible for overseeing infrastructure financing activities in the country, extending all possible support / assistance to the ongoing projects and review/ monitor compliance with policies. Even within each relevant ministry a dedicated PPP cell may be set up to support/align ministrys key decisions and wherever, possible, to adopt the PPP route.

8.2

8.3

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8.4

Once a decision on setting up a project is taken at central level, for the monitoring of performance of the project during the O&M period at local/regional level a specialised consulting firm may be engaged to provide an expert at each of the district headquarters who would work closely with the district administration. The bankability (commercial viability) of any project is crucial for it to secure finances from banks and FIs. The bankability of a project depends not only on the revenue (profitability) of the project but also on the fairness and transparency observed in the process of selecting the private investor for the project and the manner in which the underlying contract (concession agreement in most cases) between the private investor and the concerned government authority allocates risks between the parties. To address various issues it may be useful to develop a model concession agreement after wider stakeholders, which would clearly set out the framework for allocation of general risks between the contracting parties so that these do not become a matter of negotiation subsequently. This would give confidence to financial investors and enable focus on project-specific risks in the appraisal process. Nepal needs dedicated infrastructure-financing institutions licensed by the Central Bank to finance infrastructure projects. This will propel infrastructure development in the country. A dedicated infrastructure catalyst like IDFC in India, may be considered for setting up on an immediate basis. This institution would provide take out financing to various banks/NBFCs for the infrastructure assets. To incentivise banks to create more infrastructure loan assets, after the loan is taken-out by the dedicated infrastructure financing institution, the bank/NBFC would be paid a nominal loan asset sourcing fee, (say @ 0.5% of the loan amount taken out). Insurance Companies and Provident Fund organisations may be permitted/ mandated to make investments in the debt and equity capital of infrastructure SPVs (listed or unlisted, new or existing), subject to an aggregate ceiling- 5% of the investible corpus in the first year, increased to 15% in the third year. A major concern in the development of infrastructure development is of land acquisition. The responsibility of land acquisition should rest with the concessioning authority. A Condition Precedent clause in the Concession Agreement that at least 80% of the land required would be acquired by the authority before the agreement becomes effective would boost investor confidence, and more developers would come forward to take up projects with a major hurdle being taken care of by the development authority. Given recent political developments, perceptions about the political stability and hence the investment environment need to be restored (especially for international investors) by demonstrating the implementation of a few visible infrastructure projects on an expeditious basis. Even representatives of the banking fraternity have expressed their inability to trust government

8.5

8.6

8.7

8.8

8.9

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machinery given their past experience22 and so a series of confidence building measures and appropriate communication would be necessary. 8.10 To give an initial boost to the infrastructure investment programme it would be necessary for GoN to set up a dedicated national infrastructure fund which could be utilised to make capital grants, loans, equity contributions and other forms of financial support to individual PPP projects. Such fund could be managed professionally and the extent of support that a project requires could be determined in a transparent manner through a competitive bidding process. The experience of India would suggest that the Central Road Fund or the viability gap funding scheme of the Ministry of Finance would give investors a high degree of confidence while investing in projects. In the long term it would be necessary to develop internal capacities within banks and financial institutions to undertake the appraisal of infrastructure projects. This could by way of both short-term and long-term capacity building programmes for existing officials at all levels as well as for officers and fresh graduates to appraise and finance projects. In this regard a comprehensive capacity building programme for all relevant ministry officials may be engaged from a specialized agency in the field. There is also a need to promote the attractiveness and need for responsible infrastructure investment among domestic investors through awareness workshops/ meetings undertaken in a sustained manner. This would also need to address the preparation of projects in a sound manner. For instance banks have voiced a concern regarding the problems that they face due to poor technical studies and project management efforts in hydro-power projects23.

8.11

8.12

Based on the field research findings as reported in Diagnostic Study of Banks and Other Financial Institutions on Project Financing by Synergy Development and Management Consult (P) Ltd, Katmandu, submitted to PPPUE 23 Bankers Perspectives on Hydropower Development in Nepal: Problems & Prospects, Anil K. Shah, CEO, Nabil Bank Ltd. 20

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IDFC and ICAP

Annexure 1 Minutes of Stakeholder Consultations A stakeholder consultation workshop was organized by NBA and PPPUE at Kathmandu on February 5, 2010. It was chaired by the Vice Chairman, Nepal Planning Commission. Other distinguished participants included Chairman, SEBON, Joint Secretary, Ministry of Finance, Ms. Anne-Isabelle Degryse-Blateau, Country Director, UNDP and President, NBA. A wide cross section of participants from various member banks of the NBA and other stakeholders actively participated in the consultations. The list of participants is attached. Summary of Discussions 1. Concerns were raised as to how infrastructure development would take place in Nepal in the absence of established capital market capital market. a. It was clarified that in India, the initial thrust for infrastructure financing was mostly through bank lending, with capital market interventions through public offerings of equity coming in much later. With renewal in equity markets during the last five years private developers have tapped primary market but mainly for equity.

2.

The possibility of setting up a dedicated infrastructure financing intermediary was suggested. Along with the process of liberalising various statutory requirements to incentivise infrastructure lending, banks need to enhancing share capital keeping in mind the BASEL norms to be adhered to in the near future. It was felt that at least 10% (or higher) of corpus of employees provident fund (EPF) may be earmarked for investment in infrastructure. Instead of making infrastructure lending mandatory (part of DSL) it can be encouraged through right incentives. IDFC clarified that this was the intention. The threshold size of project can be kept on the lower side to accommodate the smaller urban infrastructure projects (like solid waste management, parking facility etc) for the purpose of availing fiscal incentives. A limit of Rs. 150 million was suggested and agreed to. However, the requirements of small projects and availability of finance to these projects also should be addressed in the policy. It was appreciated that NBFCs do not have access to low cost deposits and need to rely on commercial borrowings but have lesser regulatory formalities. However NBFCs would have lower operating costs and higher efficiencies which could off set this disadvantage.
21

3.

4.

5.

6.

7.

8.

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Final- PPP Financing Policy Document

9.

It was strongly emphasized that land availability is the key to on-ground development of viable projects. Any government intervention to assist project development would be a welcome move. There is a strong need to encourage non-collateral based lending in infrastructure projects. As in hydro power appraisal (where there are agencies like Winrock), similar agencies need to be identified and appointed for other sectors to help banks in appraising projects. The Town Development Fund has operational for more than 20 years, however, recently it has to compete with various grants available from government. There is a possibility of having a revolving fund mechanism (part of profits from operations to reinvest in the fund) to be developed for the Fund. While appreciating the limitations of the government, it was felt necessary to assess the expertise and capabilities of the private sector, before getting on to infrastructure development through Public Private Partnership model. There is a potential to utilise the profit motive of the private sector to the benefit of infrastructure development and public-services delivery by suitably structuring the project in general and commercial structure in particular. It was recognised that there is a need to make the existing BOOT Act more comprehensive by amending it suitable for all types of PPP generic to all types of infrastructure. Moreover, subsequent to enactment of the Act, having a effective regulation is key to effective development and operations of each sector. Any concept paper for a project can not be developed on ground, unless it is based on comprehensive analysis of the financial viability and the project is made bankable from the financing perspective. It was noted that in the past, contrary to expectations, consortium finance has not succeeded in infrastructure and large industrial projects. (In fact a substantial portion has turned bad). This needs to be kept in mind and the reasons for failure critically analysed even as such lending practices are used for infrastructure. It was discussed that capital market can not grow by itself, unless participants come up with some attractive instruments that are welcomed by the market. Then the process of market becoming mature, wider and deeper automatically follows. For successful and effective execution of the projects, delegation of decision making to local levels would be helpful.

10.

11.

12.

13.

14.

15.

16.

17.

18.

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List of Participants at the Consultation Workshop

S.NO. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 NAME SHIVANTH PANDE K CHERIAN THOMAS KIRAN MALI K.P.PANDEY R R PANT ANUP GHIMIREH M.P.SHRESHTHA PRADIP PANDEY NABINA SHRESHTHA S. PANDEYAL S. MUSKEY SUSHIL GYEWALI BINOD NEEPANE ROBIN SANTOSH MAHA ADHIKARI KISHORE NABHA THAPA ANEE TAMANG LALIT CHAUDHARY KLAUS YUBRAJ ACHARYA DR. R.K.BHATT SHABINA SHRESHTHA SANDEEP GAUTAM RUKESH SHRESHTA RAJEEV GOPAL SAPJIB SUBBA ANUP K. SHRESHTA H.SHISHODIA KAMAL PANDE BISHAL RAJESH KUMAR B.N.GARTHI BADRI LAL AMETHA PETER ZIRNITE SITA GHIMIRE SIDDHANT RAJ PANDEY MANOJ KAJI TULADHAR PRABIN K. SHRESTHA KRISHNA B. BHATTARIA JANAK SHARMA ANUJ RAKESH R.K.UNNAT PURSHOTTAM HARI RAJAN ASHOK BYAJU SASHIN JOSHI LAXMAN PISAL KIRAN P. BHATTA ORGANISATION HIF IDFC/ICAP, INDIA IDFC/ICAP, INDIA FNCCI CIT KBL GLOBAL BANK HIF GTL UNDP SEBON L TDF TDF SUNRISE BANK M NRB PPPUE PPPUE PPPUE PPPUE TDFI/GTE UNDP ADB EPF NBA NEW BUSINESS AGE NEW BUSINESS AGE IFC PBTI NCC BANK WORLD BANK MOPPW MEDIA NBA KIST BANK NEPAL SBI BANK LTD. US EMBASSY NEPAL RASTRA BANK ACE BANK NCC BANK MBL NABIL BANK LTD GLOBAL BANK NIBL CNI EBL PPPUE/UNDP CITIZAN BANK MUAN NIC BANK/NBA BANK OF ASIA NEPAL LIMITED NBA E-MAIL SHIVANTH@NIBL.UM.NP CHERIAN@IDFC.COM KIRAN@IDFC.COM CONTACT NO. 9851049999 9855036111 9818101115 9711206560 9841317767 9851110985 9851041050 9851110568 9851058430 9741007853 3523200 4227894 9851025619 9851042727 9851026039 9841299227 9851036850 5013532 5013532 5013532

MAHESHPS100@GMAIL.COM NABINA.SHRESTHA@UNDP.NG

ED@TDF.ORG.NP BINITA37@HOTMAIL.COM

YACHARYA@ADB.ORG

GTNSANDEEP@HOTMAIL.COM FOTO.NBA@TAHOO.COM RGOPAL@IFC.ORG

4227779 9851074898 4241278 9841333343 9841214863 4226792 4236947 98107048681 4211699

HSHISHODIA@WORLDBANK.OR G

BNGHARTI@KISTBANK.COM BRCREDIT@NSPL.COM ZirnitePB@state.gov SITAGHIMIRE@NRB.ORG.NP SIDDHANT@ACE.COM. MANOJ@NCCBANK PRABIN@MBL.COM.NP KRISHNA.BHATTARAI@NABILB ANK.COM JANAK.SHARMA@GLOBAL BANK.COM.NP ANUJ@NIBL.COM.NP RAKESH@KRISHIPREMURA.CO M YKUMMAT@YAHOO.CO PURU@PPPUE.ORG.NP ASHOKBYAJU@GMAIL.COM SASHIN@NICBANK.COM LAXMAN.VISAL@BANK OF INDIA.COM KIRAN@NEPALBANKERS.COM

9851102728 9851107148 400-7200 XTN 4142 9841392799 4441110 9851039691 9851053859 9851032457 9851106509 9851031799 9851021259 9851021490 5013532 9851073175 9851031293 4241278

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Final- PPP Financing Policy Document