Alternative investments to attract FDI

In the past few weeks as Nepal faces trying times with falling growth and high inflation, Kathmandu has witnessed numerous seminars, conferences and workshops with the discourse revolving around the economy and investments. 

The consensus that Nepal needs foreign direct investments (FDI) to grow was once again repeated, and the familiar litany of reasons about why it has not been able to. Policy advocates and regulators have understood that the lack of urgency is compounded by procedural inconsistencies and added to the already deficient investment environment in the country.

It is a welcome change from what used to be flippantly accepting things as given that there is now a sense of urgency, with procedural inconsistencies and lack of harmonisation between various Acts and regulations openly discussed. 

Furthermore, the desire from government stakeholders to learn and attempt to be part of the solution is also beginning to happen.  Whatever policy changes have been introduced in the past have been piecemeal and address the few rather than the entire industry, thus leaving dual regulatory approaches aimed at similar players.  

To attract FDI in a competitive global market means Nepal has to demonstrate that it is serious about bringing in investments with a more consultative and collaborative approach with investors.  A departure from procedural to a result-oriented focus is needed. 

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To put issues in perspective, Nepal needs US$20 billion in investments to meet SDG (the UN’s Sustainable Development Goals) targets by 2030. If net-zero decarbonisation targets are to be met by 2045 another US$7 billion will be required annually. 

Looking at our investment history and poor government capital expenditure, the gap is long and wide.  Last week’s budget showed that in the nine months of this fiscal year, Nepal was able to book a lamentable US$9 million in FDI (equity) investments, a decrease of 98% from the corresponding period last year. 

Nepal is in fact the lowest market in South Asia for FDI with 0.3% of the regional average.  What is it that we can do to fill the gap? 

First: we need to move away from the notion that Nepal only needs large investments. This has proven to be a mistake, and time series data have proven that smaller investments, in aggregate, make a larger impact to economies. 

We talk about an ‘enabling environment’ but without the right tools.  We place restrictions on interest on debt ceiling (Libor +5.5), without risk premium adjustments, we do not have an active secondary market for bond trading, nor do we have a yield curve, an integral part of the bond market.  

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In order to attract green financing, Nepal needs to develop its bond market. Billions of dollars of green climate funds are waiting to be tapped. Sovereign risk rating has been mooted, but to be rated in an adverse economic environment could further deteriorate investment potential due to a lesser than expected rating.  

Hedging is another instrument that needs further research on. A commercial bank recently showcased the first risk hedging mechanism for an investment of $8 million.  This can be the beginning to expand on its modality.   

Subordinated debt instruments have been introduced, but on a special nod basis, this now needs to be institutionalised as it is the most applicable form of investments after equity in a market that has volatile forex reserves. 

Viability Gap Funding has yet to be implemented and has been in active discussions for a few years now.  This needs to come into effect to encourage solar installations in the country.

Moving forward, to attract FDI, Nepal needs to tap into the funds that are available for the growth of small and medium enterprises (SMEs) and climate change.  Alternative investments such as Private Equity Venture Capital (PEVC) have been around in a structured manner in Nepal for nearly a decade now. These funds have blended finance components and have attracted climate funding as well.  

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PEVC is a new asset class and can address the issues of penetrating into SME financing by incorporating environment, social and governance issues into their investment process.  SMEs are the backbone of any economy, PEVC comes with the ability not only to scale up the enterprise with risk capital, but with the ability to bring technical know — how to enhance not only the enterprise, but also the entrepreneur.  A differentiator from all other forms of financing available till date in Nepal. 

Blended finance is a way of de-risking investments especially in frontier markets. Business Oxygen (BO2) is an example of blended finance with subordinated debt investments of IFC (World Bank Group) taking the lead and Climate Investment Funds along with FCDO as co-investors.  

On a larger scale, the 216MW Upper Trisuli1 is another example of blended finance with IFC, a Korean consortium and local investments.  So far, we see that development finance Institutions have been taking the lead in Nepal as their risk appetite is greater than commercial investors and they are eager to help develop the financial markets.  

In order to be sustainable, we need to step on this and attract commercial capital from all over the world. To do this there has to be political will to make that pivot. 

The recent budget has tried to address some issues in a cosmetic manner, and once again it lacks the overall approach to the problem.  Nepal has outdone many countries in its macro-economic indicators, with sound forex reserves and a stellar history of debt payments to its creditors. This story needs to be propagated along with the drive for change to attract potential investors. 

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