Generate the Energy or Pull the Plug
By A. R. Bhattarai
Nepal is facing formidable challenges in meeting its power and energy needs and providing adequate power of desired quality in a sustainable manner and at reasonable costs. Meeting the increasing demand of 8 -10 percent (around 50-60 MW) annually requires incremental investment in the range of Rs.7-10 billion. The difference in need and availability of finance is obviously huge. Clearly a lot more is needed to bridge this gap. In many cases, arranging financing will be an important obstacle in developing a small hydro project, the most important reasons being:
1. Large up-front investment and very limited possibilities of gradual development;
2. The long-term nature of hydropower does not match the typical financial terms well. The risks involved in hydropower are not well understood by lenders;
3. There is a wide gap between demand and supply of power in the country. Serious efforts are required to finance projects to meet this wide gap and,
4. Despite the government’s expectations of a high investment from private players in energy sector, private sector is still wary due to current non-economic situation. There has also been difference between public generation targets and achievements, which has seen many ups and downs.
Strategies for Small Hydro
Many projects around the world are structured and financed on the BOT model. There are a great number of varieties (and accompanying acronyms) and some of the more common are:
DBFO – design, build, finance, operate
DBOM–design, build, operate, maintain
BOT–build, operate, transfer
DBOT–design, build, operate, transfer
FBOOT–finance, build, own, operate, transfer
BOD–build, operate, deliver
BOO–build, own, operate
BOOST–build, own, operate, subsidise, transfer
BOL–build, operate, lease
BRT–build, rent, transfer
The basis for all projects structured on the BOT model is likely to be the granting of a concession or license (or similar interest) for a period of years involving the transfer and re-transfer of all or some of the project assets. The concession agreement will, therefore, be the key project document and as such is likely to be examined with considerable care by the lenders. Under the concession arrangements, the project developer company will usually own and operate the project for the duration of the concession. The revenue generated by the project will be used by the project company to repay the project loans, operate the concession and recover the investment of the sponsors plus a profit margin. A very common variant of the BOT model is the BOO (Build, Own, Operate) project which is structured on similar lines to a BOT project but without the re-transfer of project assets at the end of the concession period.
Financing can be a major problem in many small hydro projects. In many cases, the developer does not have sufficient funds for self-financing, nor sufficient assets to provide security for a bank loan. The essential factors that must be considered when selecting the financing strategies and government incentives for promoting small hydro are summarized below.
In-house funds
The developer’s accumulated reserves may be used to finance a project. This may involve developer’s in-house funds or personal reserves. As hydropower projects involve relatively large up-front investments, the use of in-house funds as the sole source of finance is only possible for the smallest hydropower projects.
Ordinary bank loans (on balance sheet financing)
A bank loan supplies the majority of the required capital (60 – 80 percent). Loans are secured against assets or property owned by the developer. Bank loans are relatively simple to arrange if the developer can provide sufficient security for the bank’s involvement. As the lender’s interests are well secured the need for a tight network of contracts to control risk can be relaxed, making the financing structure more flexible. This reduces the time and cost involved in arranging the loan. In addition, good security for the lender will normally result in lower annual borrowing costs.
Co-development with a financially strong partner
The project is developed as a joint venture with a financially strong partner. A strong partner may provide equity capital and offer security for bank loans (assets/property). In addition to their risk-sharing potential, the partners may also be selected on the basis of their ability to provide expertise that is important for the project (engineering, finance and power market).
Limited recourse project financing
According to the historians, project financing techniques were actively used during Roman times. Sea voyages on the Mediterranean ocean were extremely dangerous adventures in Greek and Roman times, mostly on account of the dual perils of storms and pirates. As a result of these nautical perils, some risk averse merchants would take out a fenus nauticum (sea loan) with a local lender to share with that lender the risk of a particular voyage. The loan was advanced to the merchant for the purpose of purchasing goods to be carried on the outward voyage, and that loan would be repaid out of the proceeds of the sale of these goods and other goods bought overseas with these proceeds.
If the ship did not arrive safely at the home port with the cargo in question on board then, according to the terms of the fenus nauticum, the loan was not repayable. This, at that time was viewed essentially as a form of marine insurance, but it can just as easily be classified as an early form of limited recourse lending, with the lender assuming the risk of the high seas and the accompanied perils. History also recounts that, in order to protect their interests, these brave lenders would often send one of their slaves on the voyage to ensure that the merchant was not tempted to cheat on the lender (an early ancestor of the security trustee perhaps).
In modern times too there is plenty of evidence of project financing techniques being used by lenders to finance projects around the world. There is no universally accepted definition of project finance. A typical definition might be: ‘The financing of the development or exploitation of a right, natural resource or other asset where the bulk of the financing is to be provided by way of debt and is to be repaid principally out of the assets being financed and their revenues.’ The overriding aim behind this rather complex definition is to make it clear that the repayment of the loan in question is, essentially, limited to the assets of the project being financed.
The expressions ‘non-recourse finance’ and ‘limited recourse finance’ are often used interchangeably with the term ‘project finance’. In strict terms, non-recourse finance is extremely rare and in most project finance transactions there is some (limited) recourse back to the borrower/sponsor beyond the assets that are being financed. These security may amount to full or partial completion guarantees, undertakings to cover cost overruns or other degrees of support (or comfort) made available by the sponsors/shareholders or others to the lenders.
Security plays an important role in project financing and problems encountered in perfecting security can often necessitate changes in how a project is to be structured. As in most project financings the lenders will have no recourse to the project company’s assets, other than the project assets, and will look primarily to the cash flow generated by the project to repay loans to the project company, it is crucial in project financing for lenders to ensure that valid and effective security interests are taken over all of the project assets. If problems do arise with the project and the lenders are forced to pursue their security then, in the absence of any shareholder guarantees or other tangible support, the enforcing of their security over the project assets will be the only opportunity for the lenders to recover their loans.
Therefore, one of the key differences, between project financing and corporate financing lies in the recourse that the lender has to the assets of the borrower. In project financing this recourse is limited to an identifiable pool of assets, whereas in corporate financing the lender will have recourse to all the assets of the borrower (to the extent that these assets have not been charged to other lenders).
Leasing
In general, the types of leases available in the market today can be classified as either operating leases or financial leases. An operating lease is written for a short period of time, from a few months to a few years. The lessor assumes most of the responsibilities of ownership including maintenance, service, insurance, etc. The operational lease is not a long-term financial commitment, and is unlikely to be used for financing equipment in hydropower projects. A typical example is the rental of an office copying machine.
A financial lease (capital lease) is a long-term contract by which the lessee agrees to pay a series of payments that in sum will exceed the purchase price of the asset, and provide the lessor with a profit. The lessee takes on the fundamental ownership responsibilities such as maintenance, insurance, property taxes etc. Normally, the agreement is not cancelable by either party, but may provide clauses that allow canceling should certain circumstances occur. Upon termination, the asset is returned to the lessor. Leasing is most suitable for high-volume standard equipment, and is rarely used to finance hydropower equipment. However, this can be an option.
Pay-back using electricity or other goods
As an alternative to paying the debt in cash, the lender may accept payback in electricity or other goods. For example, a company with high power consumption may agree to finance a hydropower project. In return, it receives electric power from the developer (captive generation).
Suppliers’ credit
Suppliers are often willing to provide financing for their equipment. The purchase price is often closely linked with the financing terms. The conditions are subject to negotiation, and a competitive situation can significantly improve the terms available.
Factors which affect the project financing
The developer’s financial resources are the first things to consider. The principal question for the developer is: should the project be financed by the use of in-house funds, by co-development with a financially strong partner, by ordinary bank loans secured against the developer’s other assets or property, or by limited recourse project financing? The financing strategy will affect the developer in several ways. Risk, revenue, and control over the project are all closely related to the financial arrangements.
A financially strong developer can use in-house funds or ordinary bank loans. This gives a large degree of control over the project, which may be an important consideration, particularly if the project is a part of the developer’s core activity. However, it also means tying up financial resources for a long time. Management of the project risks is another important consideration. In general, a high level of debt means a high cash-flow risk. Debt service has first claim on project earnings. In project finance, the cash flow risks are higher. In a non-recourse project, the developer’s involvement is limited to the equity. In a limited-recourse project, the developer has accepted additional undertakings, but the involvement is still limited. The developer will have to pay a price for reducing the risk. The arrangement costs are high and third parties accepting a risk will require a premium.
Securing financing may be a major obstacle in developing a small hydro project, and the efforts involved should not be underestimated. Large-scale capital-intensive projects usually require substantial investments up-front and only generate revenues to cover their costs in the long term. Therefore, matching the time profile of debt service and project revenue cash flows implies that, on average, project finance loans have much longer maturities than other syndicated loans.
Financing conditions
For decades, project finance has been the preferred form of financing for large-scale infrastructure projects worldwide. Several studies have emphasized its critical importance, especially for emerging economies, focusing on the link between infrastructure investment and economic growth. The question whether longer maturities are a source of risk per se is crucial to understanding the distinctive nature of credit risk in project finance.
All aspects of the project should be arranged to control the risk for the lenders, who will wish to see evidence of the project’s economic viability. Lender should ask an independent technical report by a credible consultant or document vetted by specialized development agencies. Lender should scrutinize important agreements such as the power purchase agreement, the operating agreement, shareholders’ agreement etc.
The developer may not have sufficient assets to secure a bank loan, or the developer may not wish to bear all the project risk involved in the development. As the lenders cannot rely on the liquidation value of the project (or sponsors) as a means of securing repayment, they tend to exercise tight control over most aspects of the project development:
Charge over the physical assets
Assignment of the project contracts
Contract undertakings
Shareholder undertakings
Insurance
Bonding
The lenders must put conditions that the project should employ contractors, suppliers and operators that have a strong record of accomplishment in their field. Whenever possible, the risk is transferred to third parties. A contractor working on a turnkey fixed-price basis can be used to minimize the completion risk. A long-term Power Purchase Agreement mitigates the market risk. The lenders have to even ensure that they have the right to step in and operate the project in case it is not paying its debts. Limited-recourse project financing involves a series of complex contractual agreement. The initial arrangement costs are relatively high. In turn, this results in a higher interest rate. For limited-recourse arrangements, several additional elements must be considered:
1. Initial arrangement fee: The financiers will require an up-front fee for covering the arrangement expenses of financing;
2. Undertakings: The lenders may restrict the payment of dividends to shareholders. This is done in order to provide a buffer against unforeseen problems and may amount to half a year of debt service. Payment of dividends may also be cancelled in case the project is performing badly;
3. Conditions precedent: A number of conditions must be met before the loan can be drawn. Normally this requires that all contracts be to the bank’s satisfaction, that all permits are in place, the existence of a favorable review from an independent technical consultant, all insurances in place etc.
4. Fees to external experts: The financiers will require all fees to external legal and technical advisers to be paid by the developer.
Financing conditions depend on the individual project, the financing institution and the general conditions in the bank market. In general, 50 to 80 percent of the total cost can be provided as debt. The level of debt that is acceptable to the lender depends on how the loan is secured. A large debt component means increasing the lenders’ risk. In turn, this results in a higher interest rate. Financing is a critical activity in developing a small hydro project. Key points for successful project financing are discussed below:
Consider the need for external advice
The lender should seek professional advice at an early stage in order to determine how to arrange the financing. Key advisers are legal and technical advisers.
Verification of available resources
Lenders should verify evidence of the water flow available for power production. Reliable assessment of the water flow may be difficult, in particular at small hydro projects. The developer should have at least 12 months of flow data. Correlating them with long-term stream flow or rainfall data from nearby gauging stations should extend the flow measurements.
Careful structuring of the contractual arrangements
The lender and their advisers should analyze the project risks and ensure that there are adequate plan for mitigating these risks. The principal agreements that the lender should focus on are:
Engineering, procurement and construction agreement
Power purchase agreement
Operating and maintenance agreement
Site agreements
Shareholder agreement
Insurers
The essence of any project financing is the identification of all key risks associated with the project and the apportionment of those risks among the various parties participating in the project. Without a detailed analysis of these project risks at the outset the parties would not have a clear understanding of what obligations and liabilities they may be assuming in connection with the project and, therefore, will not be in a position to consider appropriate risk mitigation exercises at the appropriate time. Considerable delays can occur and expense be incurred, should problems arise when the project is under way and arguments ensue as to who is responsible.
Insurers play a crucial role in most projects. If there is a major catastrophe or casualty affecting the project then both the sponsors and the lenders will be looking to the insurers to cover them against loss. In a great many cases if there was no insurance cover on a total loss of a facility then the sponsors and lenders would lose everything. Lenders in particular, therefore, pay close attention not only to the cover provided but also to who is providing that cover. Most lenders will want to see cover provided by/or reinsured with large international insurance companies.
It is almost certainly impossible to list all the potential problems that could arise with the insurance aspects of a project, but some of the principal concerns from a lenders’ perspective might be the following:
1. The policy may be cancelled, either in accordance with its terms, by agreement between the insured and the insurers, or by the brokers for non-payment of premiums;
2. The policy may expire and not be renewed;
3. The policy may be changed so as to adversely affect the cover provided, e.g. the scope of the policy may be narrowed, policy limits may be reduced or deductibles may be increased;
4. The loss may be caused by a peril which was not insured thus, a policy which covers political risks such as war, revolution and insurrection should be checked further to ensure that it also covers politically motivated violent acts such as terrorism or sabotage;
5. The policy may be avoided by the insurers, on the grounds of breach of warranty by the insured;
6. The insured may not make any (or any timely) claim for indemnity under the policy;
7. The insurers may be insolvent and unable to pay a claim and
8. The claim may be paid by the insurers to the brokers but somehow lost in the brokers’ insolvency.
Information and access
There is often a danger that the project company becomes overwhelmed with the information requirements from the lenders and that the lenders themselves get bombarded with excessive information, a lot of which they don’t really need. The supply of reliable and accurate information in connection with a project is of crucial importance for the lenders. Likewise, access to the project and its facilities will also be important for the lenders to be able to check regularly on progress and to monitor compliance with the terms of the documentation. The project loan agreement will contain detailed provisions on the type of information required and the frequency of delivery. The following are examples of the type of information usually required by lenders:
1. Annual accounts and financial statements;
2. Periodic (e.g. monthly) progress reports during project construction;
3. Architect’s certificates etc., accompanying drawdown requests together with supporting invoices;
4. Copies of material notices and communications received under all project agreements;
5. Copies of communications from relevant authorities;
6. Details of all disputes and claims in connection with the project;
7. Periodic reports from experts;
8. Copies of all insurance documentation and claims;
9. Copies of all consents and permits relating to the project and
10. Certificate of compliance with cover ratios etc.
Conclusion
Lender should obtain comprehensive financial model of the project’s economy. The financial model should focus on project cash flow. The assumptions should be conservative, and a sensitivity analysis should demonstrate the viability of the project for a range of scenarios. The developer should maintain and update a checklist of the outstanding items and issues that must be resolved in the project, together with a plan for how to make progress on each outstanding item.
Private involvement in the energy sector is becoming increasingly important as public funding diminishes. Hydropower projects involve large up front investment, and are often regarded as high risk. Therefore, the financing situation for small hydro projects should be improved in the following ways:
1. By supporting developers during an early stage ( providing high quality stream flow data, lessening regulatory processes, providing open access policy in transmission);
2. By reducing the risk to the developer and the financier (government incentives and guarantees reducing the risks involved in small hydropower development and operation to make projects more attractive to developers and lenders);
3. By public incentives (various incentives to promote small hydro development);
4. By cost reduction (providing fiscal incentives to make the project more profitable) etc.
If these prospects are realized, the challenging dream of ‘Empowering Nepal’ could become a ‘shining reality’!
(Bhattarai is a Chartered Accountant and till recently was the General Manager of Clean Energy Financial Institution)
NEED OF CREDIT RATING AGENCY IN NEPAL
A cry for Nepali CRA initiated during late 1990s. Initiatives to establish CRA came from Vishal Group Limited and Citizen Investment Trust but these initiatives did not materialize. Since then the need for CRA is increasing. However, Nepal has not been able to witness establishment of any CRA till date. At a glance, it seems that Nepali financial market is not attractive enough for CRA to operate. However, this is primarily due to lack of awareness among all stakeholders of financial market and supportive rules and regulations. Vibrant bond market and use of standardized approach to measure credit risk under Basel II will demand CRA’s service. At present, Nepal lacks both.
Service of CRA will have major impact in Nepali debt market, which is still in its infancy, and is expected to grow rapidly in future. CRA does not affect equity market directly. However, CRA has recently been developing innovative products such as corporate governance rating and IPO grading. These new ratings have considerable effect in equity market.
Analysis of probable users of CRA in Nepal shows that reasonable demand for its service can be induced. Moreover, there is general agreement between regulators (Nepal Rastra Bank, Securities Board of Nepal and Beema Samiti) that service of CRA is a must to further develop Nepali financial market. However, the probable CRA in Nepal will have to lobby for favorable rules and regulations and have to obtain support from regulators. Present rules and regulations are made without consideration of credit rating service. The probable CRA should also make considerable effort on educating regulators, business community and general investors about activities and benefits of credit rating.
Credit Rating Agency (CRA) is an organization that issues opinions on future creditworthiness of a particular company, securities or obligations as of given date. These opinions tend to be relied upon by investors, lenders and other stake holders. Standard & Poor’s, Moody’s and Fitch have firmly established themselves as the pioneer credit rating agencies through out the world, and are called global CRA. There are also various Domestic Credit Rating Agencies (DCRA) specific to a particular country.
Issues like corporate governance, accounting standards and auditing standards assist in operation of CRA. However, these issues evolve over a period of time, and are not necessarily a pre-condition for setting up a CRA. Even though corporate governance has not been implemented satisfactorily in the Nepali corporate sector; banks and financial institutions are found to be more eager and compliant to it. Initiatives taken by Nepal Rastra Bank to ensure corporate governance among Bank and Financial Institutions are quite satisfactory. Accounting and auditing standards developed by Accounting Standard Board and Auditing Standard Board are also found to be at par with international standards. However, its implementation has been found unsatisfactory.
Analysis of probable suppliers of credit rating service suggests that Citizen Investment Trust, Credit Information Bureau and Business Information Service Nepal Pvt. Ltd. (correspondence agent of Dun & Bradstreet, India) as the probable suppliers of CRA service in Nepal. However, it is important for Nepalese CRA to have strategic alliance with South Asian or South East Asian DCRA which have affiliation with global CRAs. This will ensure recognition of Nepalese CRA by international market.
(This is an executive summary of a report titled ‘Need assessment of Credit Rating Agency in Nepal’ which was prepared by students of MBA program at Kathmandu University School of Management. Name of Students: Raju Uprety and Udeep Lal Shrestha).
Nepali Banking in Comparison to Global Banking Sector
By Pramod Pandeya, CFA
In the recent past, there has been structural shift in Nepali banking sector due to the changed eco-political landscape of the country, expanded business areas, deregulation and globalization of financial activities, emergence of new financial products and increased level of competition which in turn, have necessitated for an effective and structured risk management practice, innovativeness and consolidation in Nepali banks. But still, Nepali banks are far behind in comparison to their global counterparts in these parameters.
Risk management practices:
The acceptance and management of financial risk is inherent in the banking business. Risk management as commonly perceived does not mean eliminating risk, rather, the goal of the risk management is to optimize risk-return trade off.
Though domestic banks are in the verge of implementing BASEL II accord, just conforming to regulatory requirement wouldn’t be enough in this dynamic industry but should work proactively to adopt some tailor made risk management systems. Ironically, among nearly two dozens banks, very few have specialized risk management unit or department. Even if there are, they are primarily focused on the risk elimination rather than risk management.
Product innovation and branding:
Innovation is the key to the future sustained growth of the banking industry. However, innovation can’t be limited to products and brands alone. Successful financial service players are required to have innovation in every aspect of their functioning, ranging from products and process to even people, systems and business partners. While product innovation gives competitive edge to an organization for few months or years, process innovation can lead to competitive advantage for the innovator organization for much longer period.
But very few Nepali banks have shown their ability/interest to be product innovator. More interestingly, in this competitive age, very few are working to establish their brand in the market. As we are in the verge of WTO regime and expecting multinational players in the domestic turf, this could be fatal for the local banks in the days ahead. So, it is the need of the hour in the banking industry to initiate the brand building measures and even take the advantage of the first mover in the market with innovative products.
Consolidation and convergence:
Consolidation and convergence are the natural phenomena in the global banking sector. Even in the recent past, we have witnessed many consolidations in global banking industry. Although banking sector consolidation has been the subject of corporate gossip in the last couple of years, we have still to witness the concrete results. If analysts are to be believed, academic perception about the consolidation which local banking honchos idolize would be major hindrance for the banking sector consolidation even if it would provide Nepali banking sector much needed strength in terms of economies of scale and scope which would help banks to grow in competitive environment. So, it would be better if the banking honchos realize the ground reality and initiate the consolidation on merit basis viz; organization culture, HR issues, geographic concentration and technological compatibility.
In spite of these lacunas, Nepali banking sector is set to continue with tremendous growth in the days ahead as Nepal needs huge capital investment to stimulate its economic growth. But, it is achievable only when the eco-political situation of the country supports it.
(views expressed are personal)
Are commercial banks parasitic?
Lower interest rate on Trust Receipt Loan is subsidizing big corporates by exploiting the poor workers who send in remittance.
By Bipin Hada
As the name suggests, commercial bank’s major component of business comprises of commercial activities. Significant portion of the business comes in the form of trade finance. Some of the credit products extended for financing working capital need are overdraft, demand loan, cash credit, hypothecation loan etc. These credit products are the sources of financing stock and receivables of most business enterprises, especially bigger ones.
In an import based country like Nepal, the most popular credit product being offered by banks to finance working capital needs of business enterprises is the Trust Receipt Loan. Trust Receipt Loan is provided against endorsement of title documents (Bill of Lading) of consignment of imported goods by the import letter-of-credit issuing bank. Against this endorsement, the applicant of import letter of credit will be eligible to take possession of imported goods in transit on behalf of the bank from the shipping liner/ transporter.
Technically, Trust Receipt Loan should be extended for a transit period of imported goods during which it is off-loaded by shipping liner at the port of entry and moved to the final destination to the importer’s country. Going by the same line, in case of Nepali import business, this should not be more than 15 days duration considering the port of entry as Kolkata and Kathmandu as the final destination. Once the possession of goods is taken over by the importer (import LC applicant) and the goods reach the godown of the applicant, the technical validity of ‘Trust Receipt Loan’ ceases to exist and the imported goods simply become stock in hand of the borrower. All such stocks in possession of borrowers with proper title are to be generally financed by other credit products like overdraft, demand loan, cash credit, hypothecation loan etc. Is this the case in Nepal? Going by the evidences, the answer is quite obvious.
In Nepal, almost all commercial banks are extending Trust Receipt Loan for a period up to 180 days to importers, both manufacturing as well as trading enterprises. This tenure is very much comparable with the loan tenure of demand loan/ working capital loan provided to industrialist and trader to hold stock considering the average trade cycle of most of the industrial raw materials and trading goods. The time period of 180 days is very much more than enough compared to the general trade cycle comprising of ‘import, stock, sales, receivables and recovery of receivables’ of any industrial or trading enterprises. Industrial as well as trading enterprises are utilizing Trust Receipt Loan for longer period as far as possible due to lower cost tag attached to this loan product.
Almost all commercial banks are extending Trust Receipt Loan at an interest rate as low as 6.00 percent per annum for tenure up to 180 days. However, the appropriate credit products to finance stock and receivables are overdraft, demand loan, cash credit, hypothecation loan which are tagged with an interest rate of around 8.00 to 10.00 percent per annum. Due to this low cost of Trust Receipt Loan, borrowers are diverting this source of short term financing to finance long term capital expenditures. This technical mismatch leads to situation where borrowers more often request bank for time extension of Trust Receipt Loan deal even after the lapse of 180 days. In a way, this has led to erosion in financial discipline of the borrowers. Banks have been lenient on this issue mainly because of fear of losing business in the ever-increasing competitive market and borrowers have been enjoying a free-ride capitalizing on commercial banks’ fear factor.
It is a universal assumption that the interest rates quoted against loans and advances should equal to the sum total of cost of fund, risk premium and profit margin. Cost of fund depends on the sources of fund, while the tenure and risk premium primarily depends on security arrangements whereas profit margin depends on profit goal of the service provider and of course, the market scenario. In the present context, the main source of funds of a commercial bank is saving deposit where cost of fund is somewhat lower than real rate of inflation. The tenure of saving deposit and working capital financing are convincingly comparable as saving deposit is considered to be stable source of fund and the above referred working capital financing are extended for period less than one year. Regarding risk premium, security arrangement available for Trust Receipt Loan as well as other working capital loan products are the same, i.e. hypothecation of stocks with insurance coverage in almost all cases except for some small borrowers. Regarding profit margin, this will not be a differentiating factor among commercial banks in the context of present competitive market scenario. Therefore, there is no obvious difference between Trust Receipt Loan and other credit products to properly justify the disparity in interest rate.
The main reason for this disparity in interest rate between Trust Receipt Loan and other working capital loans is the other incomes that can be earned by trade finance activities. The foreign exchange income from import letter of credit business is a good attraction. Import letter of credit business mainly generates revenue in the form of letter of credit issuance commission and foreign exchange gain. A straightforward estimation implies that around 80 percent of revenue from import letter of credit business is from foreign exchange gain. In the prevailing Nepali banking market, letter of credit issuance commission is around 0.10 percent of letter of credit value whereas foreign exchange gain is around Rs. 0.30 per USD, which is about half of the difference between the buying rate and selling rate of Foreign Exchange. At this rate, letter of credit issuance commission and foreign exchange gain per USD 100 value of import letter of credit will be Rs. 6.55 and Rs. 30.00 respectively at the exchange rate of Rs. 65.50 per USD. In order to take maximum benefit out of the foreign exchange gain, commercial banks are trying to get more and more import business by offering lower interest rate on trade financing. This effort has been reflected as leverage shown by banks in Trust Receipt Loan by allowing lowest interest rate compared to other credit products available to finance stocks and receivables. The question that immediately comes to mind is how do we explain this leeway provided by commercial banks?
One of the main sources of the country’s foreign exchange is inflow remittance coming from the Nepali workers working in foreign countries. The import business is primarily being supported by these remittances. Commercial banks are capitalizing on the almost a fixed margin, i.e. difference between foreign exchange buying and selling rates. Banks are doing this in order to achieve their goal of profit maximization. Looking at this from the consumers’ perspective, commercial banks are reaping substantial returns by subsidizing a loan product that primarily goes to big corporate houses at the cost of individuals selling/ surrendering their hard earned foreign exchange. This is not at all a fair treatment.
To mitigate this, the difference between the foreign exchange buying and selling rate has to be rationalized and interest rate applicable to each loan type has to be rationalized on the basis of facility’s nature, risk, tenure and security arrangement.
Opportunities & Challenges in Nepal’s Telecom Sector
By Dinesh Mahur
The years 1997 & 1998 can be considered as the dawn of a new era in the telecom sector in Nepal. These were the years when the Telecommunications Act 2053 (1997) came into force and the telecom regulator i.e. Nepal Telecommunications Authority (NTA) was established. The establishment of regulator was a clear signal from the Government to introduce competition in the telecom.
During the long era of the monopolistic environment, the tariffs were high and penetration of telecom services was low. The telecom services were mostly concentrated in the urban areas primarily in the capital city of Kathmandu. The progress was slow but steady. License to the second basic service operator was issued in the end of year 2002 and to the second mobile service operator was awarded only towards the end of the year 2004.
The regulator or the Government has taken a cautious approach in opening of the telecom sector. A safer way of limited competition was adopted as some times it may happen that the sector collapses if opened suddenly to the unlimited competition (as large number of operators jump into the market while due to prevalent economic conditions, the demand is not created at the same pace).
Opening of the telecom sector has created opportunities for the direct consumers, business community, government, operators etc. With the entry of new operators, the direct and indirect employment opportunities for the youths of the country have increased and the overall life conditions have improved. Now, people are not required to queue up and wait long to get a telephone connection, at least in the big cities. The telecom connectivity is no longer a luxury, it is a necessity now.
The telecom penetration though increased times over past six years, still remains at low levels. The growth in the telecom sector has spiraling effect on the growth of economy of the country. Growth in economy creates demand for telecom services and growth in telecom sector has direct effect on the economic growth of the country. This is a win-win situation for all stake holders i.e. government/ regulator, operators, economy and foremost for the consumers.
There is usual thinking among the incumbent operators that the new operators will take away their cream and they will be left with the crust of dry bread. It may happen, if the incumbents watch the developments passively. However, the reality is otherwise. The incumbents also gear up to take the challenge head on and in this process, they improve their customer support, staff as well as network efficiency, decision making process etc. which are generally their weaknesses otherwise and remain unchallengeable for long periods of their monopoly. Thus, the incumbent operators should perceive the opening of the sector to the competitive forces as an opportunity in disguise. Live example is in this country itself. We can witness the rapid developments in the incumbent operator (Nepal Telecom) after the sector was opened for the competition.
In the multi-operator environment, the most critical issue is the making available of adequate interconnections in time by the incumbent operator to the new operators. Inadequate and untimely interconnections from the incumbent operators generally occur due to long decision making process in procurement of equipments for capacity augmentation to cater the requirement of the new operators. Interconnections with the new operators open up new revenue streams to the incumbent operator. They should provide interconnections to the new operators as liberally as possible. However, experience has been that the incumbent operator is normally reluctant to provide the interconnections, perhaps, in anticipation of unknown.
IUCs (Interconnection Usage Charges) are other critical issues in the multi-operator environment. Generally, in the absence of clear guidelines from the regulator, these charges remain a bone of contention between the operators. In case of Nepal, though we had well drawn interconnection guidelines from the regulator with detailed IUCs; still it was not a smooth transition from monopoly to duopoly regime. The regulator needs to play an important role in managing the situation in favour of overall development of telecom sector in the country. A large part of the regulator’s responsibility is to manage the incumbent operator in turning the hostile attitude to facilitating one. IUCs are not a thing which can be kept fixed for long time. Thus, the regulator needs to periodically revise the IUCs in consultation with stake holders. However, this is not happening.
Providing telecommunications access in the rural and in-accessible areas of the country is one of the most challenging issues for the government, regulator as well as for the operators. Still large part of the country remained unconnected. The country cannot achieve economic stability unless the majority of the population living in rural areas get opportunity to be part of economic development of the country. Little could be done for providing telecom facilities in the rural or in-accessible areas of the country. License for providing RTS (Rural Telecom Services) could be issued only in one development region i.e. Eastern Development Region though it is perhaps now extended to cover all parts of country.
Collective efforts from the Government, Regulator, Operators, NGOs etc. are required to be put together to carry out this responsibility. However, NTA as the regulatory body will have to take a lead and the incumbent operator will have to play a supportive role. All the telecom service providers are making contributions to the RTDF (Rural Telecom Development Fund). This fund should be suitably and wisely used for providing telecom services to unconnected areas. There seems to be some movement in NTA in this matter.
One of the major problems the operators are experiencing in extending the services to the rural areas, is the long distance connectivity due to difficult terrain of the country. Because of the terrain, it is not always possible to build up parallel infrastructure by individual operators in the initial stages. The regulator should promote or rather enforce (upon the operators) sharing of the infrastructure available with them, of course on cost basis. Incumbent operators naturally have quite good infrastructure. However, they are not quite willing to share the same. NEA is doing quite appreciable job by leasing out the dark fiber (overhead) hanged on their HT lines. However, the cost remains high due to no competition and unregulated environment. Creating parallel infrastructure may be viable once the telecom market is matured. The Government or NTA may also think of issuing license on minimum subsidy basis for creating national infrastructure for connecting various places in the country or licenses may be considered on regional basis. Prices for the infrastructure sharing should be defined by the regulator on annual basis. This will facilitate various service providers to rapidly expand their services to various parts of the country.
The local call charges for the basic telephones are, perhaps, the lowest which seemingly make the calls affordable even for the lower strata of the country. But, reality is not that. What make the cheaper call rates dearer to the consumers is the taxes levied on the basic call charges which are, perhaps, the highest. The call charges are subjected to 10% TSC and 13% VAT which make total taxation of over 24% on the basic call charges. The earlier decision of government to reduce TSC from 15% to 10% shows that the government has recognized this high level of taxation on the use of telecom services. It is the need of the hour to drastically reduce the taxation on use of telecom services so that fruits of lowest tariff reach to the telecom end users.
High taxation is one of the aspects that makes the telecom services unaffordable to the lower strata of the country and is a stumbling block in the way to achieve universal service obligations. The other and even more important is the entry barrier of one time ownership tax of Rs 1000 (recently reduced from Rs. 1500) charged at the time of providing new connection to a customer. Recognizing this as barrier, the government considered reduction of this amount for the prepaid services and allowed Rs. 20 initially and on every re-charge coupon of pre-paid services and subsequently on the basis of percentage denominations of pre-paid cards. This made the pre-paid services highly popular even though the call charges for prepaid are higher when compared to post-paid services. The government/ NTA should consider revising ownership tax for post-paid services also. Such a decision will go a long way in the overall development of telecom sector in the country.
It is a matter of pride for all of us that this country, perhaps, became the first country in south Asia to allow customers to choose their operators for making ISD calls by implementing the CAC (Carrier Access Code). I remember that special date i.e. March 20, 2006. Though, that was a special achievement for the country, it got little importance obviously from the operators, but surprisingly from the regulator. Only, Nepal Telecom and UTL implemented the CAC for their customers while other operators remained passive to this achievement, perhaps, in the absence of clear directions from the concerned authorities. Regulator, being the protector of telecom consumer rights, should put in more efforts to make CAC a success in the overall interests of the customers.
The technological advancements happening elsewhere around the globe can be explored and roped in for the benefits in the country. Use of IP technology is becoming more and more popular due to lower costs. People of this country should also not be kept away from the technological developments around the globe. This has been under discussion in Nepal for past many years. However, a decision in the matter is yet to be taken. There are two different activities; one is using IP as technology option by the facility based operators like Nepal Telecom and UTL and another is allowing Internet telephony. Regulator should promote use of IP as technology option by the existing facility based operators. Recently, the regulator has permitted UTL and Nepal Telecom to provide VoIP (Voice over IP) based international long distance services. However, without any commercial arrangements between various operators (mainly incumbent operator), it remains a theoretical exercise. Using IP directly or indirectly implies reduction in costs and also operators’ shares. The regulator should see that proper commercial arrangements are done between various operators for catering the VoIP traffic. In case of internet telephony, the regulator need to take vary cautious approach as the tracing of the internet calls is difficult if not impossible. The security monitoring of the calls have become very important in view of rising global terrorism.
International incoming call bypass has become perennial problem for the country. Lots of revenue leakage is there from the international incoming call bypass. Call bypass is also security threat to the country as the bypassed call cannot be traced for its origination as it generally make use of public internet as transport media. In most of the cases, it happens that the caller is not aware that his call is going through the grey route and he is charged at the normal call rate. Thus, it would not be exaggeration, if we call it as socio-economic evil for the country. NTA/ government are required to lay stringent laws so that the perpetrators involved are not be spared.
For long time, we have been hearing that the new Ordinance (now in the form of an Act) will come and sort out all the major problems that the telecom sector is facing at present. I remember, it has now been more than two years and still it seems to be a distant future. Stakeholders have been consulted recently and there have been some development in the matter in recent time. Though, the government may have other pressing priorities, still it need to spare some time for telecom sector as it is one of the major accelerators to the economic growth in the country.
For the development of telecom sector at accelerating speeds, the funds from the government alone are not sufficient. Private participation is must. Private players are attracted once the regulatory environment in the country is strong and able to safeguard their interests. The opening of the telecom sector to the competition should be viewed as the opportunity by all the stakeholders. Sharing of infrastructure should be promoted. NTA should lay down guidelines in this matter. It is the moral responsibility of all the operators to follow guidelines laid down by the regulator. NTA/government should take appropriate steps to reduce the taxation on use telecom services and ownership tax to meet the objective of universal service availability in telecom sector. The government should give due priority to the telecom sector and bring out the new Act as soon as possible. All round development in the telecom sector at a rapid pace is possible only if all the stakeholders are working in unison with each other with healthy competition.
(Mahur is a General Manager of United Telecom Ltd.)
