Economic Analysis - Political Climate To Weigh On Infrastructure Development Plans - JUNE 2017

BMI View: While Nepal's plans to establish a PPP centre to facilitate PPP projects bode well for the country's infrastructure development over the long term, the fractious political climate will continue to undermine its establishment and development in the near term. With progress on the centre being slow, we expect the poor investment climate to continue to weigh and maintain our real GDP forecast for growth in FY2017/18 to come in at 2.3%.

The Nepali government's plans to establish a Public-Private Partnership (PPP) centre to make investment arrangements for infrastructure and service-based projects will be positive for infrastructure development in the country over the long term. The centre was scheduled to start from FY2016/17 (July-June), and will facilitate PPP projects that require investment of over NPR100mn (USD934,700). The government has also prepared a first draft of the planned PPP Act, which will replace the existing Private Financing in Build and Operation of Infrastructure Act. These steps bode well for the long-term development of the sector which had been hampered by delays, cost over-runs and low quality infrastructure. However, continued delays due to the fractious nature of Nepal's politics are likely to result in short term delays to the centre's implementation. We thus expect Nepal's investment climate to remain poor, and maintain our forecast for real GDP growth in FY2017/18 to come in at 2.3%.

PPP Centre Positive For Investment

According to the National Planning Commission (NPC), the centre will facilitate the implementation of legal provisions for PPPs, promote international practice and experience about PPPs and strengthen the capacity of government bodies. This will have a positive impact on project implementation and investor confidence. Details of the centre's structure are currently being finalised by the NPC in coordination with the Ministry of Finance (MoF) and the Ministry of General Administration.

In addition, to encourage private sector involvement under the PPP model, the MoF has prepared the first draft of the PPP Act. The government had formally started preparing the draft after the Cabinet endorsed the PPP Policy in October 2015, which includes measures such as addressing the viability gap funding to project developers, the provision of the creation of a revolving fund for land acquisition to facilitate project developers, and tax relief for developers. In particular, the government has pledged to create a mechanism to enable the private sector to obtain long-term financial resources. Furthermore, it will incorporate provisions on the sharing of risks and benefits proportionately between the government and the private developer during and after the construction of the project.

Domestic Politics Will Delay Centre's Establishment

While we note that the PPP centre will be positive for efforts to develop Nepal's underdeveloped infrastructure, we believe that the country's factious political scene will lead to considerable delays in the centre's implementation. This, in addition to the slow speed of Nepal's bureaucracy, will hinder the development of the PPP centre.

Despite having obtained a survey to identify the number of employees needed by the PPP centre, officials from the National Planning Commission (NPC) have called for a revision of the policy. The initial operations and management (O&M) survey had proposed to hire around 19 to 20 civil servants at the PPP Centre and carry out a chunk of its works by hiring independent and other experts based on demand. The centre would be headed by an executive director, who will be selected from among joint secretaries of the government. However, NPC officials have stated that they want an NPC member to chair the steering committee of the PPP Centre instead of the finance secretary. Similarly, it is for increasing the threshold for projects that require mandatory foreign investment from NPR1.0bn to encourage domestic companies.

Hydropower Projects The Most Prominent But Problematic

We believe that hydropower projects followed by roads, rail and airport infrastructure will remain the focus of the government. However, hydropower development remains problematic. While there is huge potential in the country's hydropower sector with a feasible generation capacity of more than 42,000 MW, only 800 MW of hydropower capacity has been commissioned so far. This lack of development can be partly attributed to the complex terrain of Nepal, which is prone to natural disasters such as landslides.

Furthermore, the clouded investment climate for hydropower development has the potential to result in project delays or cancellations. A case in point is Norway's state-run utility Statkraft who decided in January 2016 to cancel its plan to build the Tamakoshi-3 (TA3) hydroelectric project in Nepal due to a lack of policies over power sales and bureaucratic hurdles. The company took the decision after analysing commercial, technical and regulatory factors of the USD1.5bn project. These factors include a lack of viable power offtake option, lower electricity tariffs, insufficient transmission capacity for power evacuation and absence of necessary policies and regulatory framework for operationalising power sales, according to Statkraft Nepal Vice-President Sandip Shah. The new PPP framework and the PPP centre, however, could help address these issues in the coming years by deepening a dialogue between the public and the private sector.

Business Environment To Remain Poor Amid Downside Risks

The inability of the government to launch the PPP centre in the short-term will continue to weigh on Nepal's business environment and undermine economic growth. Nepal remains one of the most poorly connected countries in the region, scoring a paltry 35.0 (out of 100) in the logistics subcomponent of our Operational Risk index (compared to the regional average of 45.3). While infrastructure projects have remained the government's investment priority, the state's low spending capacity has resulted in low investment and raised the importance of private investment.

In addition, the country continues to be mired by political instability. The power sharing agreement between Prime Minister Prachandra and Sher Bahadur Deuba, the chairman of the Nepali Congress, suggests that there is little hope for stable governance in the near future, with the political environment likely to remain volatile. Under the terms of the agreement, Prachanda will serve as Prime Minister for the first nine months, and after which, power will pass to Deuba for the next nine months. In addition, the pair is to oversee constitutionally mandated elections to local, provincial, and national governments within the next 18 months. This also suggests that there is unlikely to be a significant improvement in the business environment over the near term amid continued political instability.