Nepal | July 09, 2020

Lack of forex risk protection could dissuade hydro investors

Rupak D Sharma
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Kathmandu, October 6

Foreign investors, who pour money into country’s hydroelectric sector without assurance of foreign exchange (forex) risk protection, stand to incur losses to the tune of 26 per cent of project’s capital cost, says a latest report prepared by Deloitte, one of big four consulting firms in world.

This implies adequate foreign investment may not flow into the hydro sector unless there is guarantee that the dollars that investors bring in are fully protected against currency variation risk.

Forex variation risk is high in the country, as Nepali rupee has been depreciating by 3.35 per cent per year for the last one decade. This means foreign investors are losing money every passing year while converting rupee-denominated earnings into dollar — the currency with which they originally invested. And investors, who are generally risk averse, do not like losing money.

“To promote foreign investment in power generation, the government will need to ensure that forex risk is covered while structuring (electricity) tariffs,” says the report prepared for the United States Agency for International Development. The report has now been handed over to the Ministry of Energy.

In the 1990s, state-owned Nepal Electricity Authority (NEA), the country’s sole buyer of electricity, was covering forex variation risk. This led to signing of dollar-denominated power purchase agreements with 60MW Khimti I and 45MW Upper Bhotekoshi hydroelectric projects.

But later NEA faced wrath for signing these agreements, as losses started mounting due to depreciation in the value of Nepali rupee. This bitter experience has prompted NEA to say ‘no’ to dollar-denominated power purchase agreements.

While dollar-denominated power purchase deals are being frowned upon, the country has not been able to mobilise enough financial resources of its own to build power plants. As a result, dependency on fossil fuel is increasing every day.

To generate 350 megawatts of electricity, the country needs to import 518 million litres of diesel a year.

“This translates to an annual outflow of $162 million in foreign currency and can result in foreign exchange variation impact of Rs 45.53 billion over 25 years,” says the report, adding, “Providing foreign exchange protection in electricity tariff is substantially beneficial, as foreign exchange variation impact for 350MW hydro project stands at Rs 15.24 billion over 25-year concessional period.”

In this regard, the report has suggested that the government look into two options to provide forex variation risk.

First is providing forex risk cover, or signing dollar-denominated power purchase deal, until long-term debt is fully repaid. Once the outstanding loans are paid off, tariff can be fixed in domestic currency and escalated every year by a certain per cent till the end of the concession period, says the report.

Second is providing forex risk cover for foreign currency loans and equity investment over the life of the project.

Under this option, NEA can sign power purchase deal with foreign-funded hydro projects using a higher reference rate so that it covers forex risk throughout the concession period. This means if NEA is currently purchasing electricity from power producers at, say, Rs 6.50 per unit, power purchase agreement could be signed at an escalated rate of, say, Rs 7.71 per unit.

But this is an ineffective means of structuring tariffs, as actual foreign exchange fluctuations may be different from year to year, says the report. So, this could be a risky proposition for NEA as well as the investor.

Another way of covering forex risk over the life of the project is to sign the power purchase deal without escalating the tariff, adds the report.

This means NEA can purchase electricity at existing market rate of, say, Rs 6.50 per unit and compensate losses emanating from forex variation by extending cash to investors during each billing cycle. The cash extended by NEA should fully offset lost equity earnings and extra debt servicing cost.

“In this regard, NEA should be allowed to pass through the currency risks to the final consumers by adjusting tariff every quarter,” says the report, adding, a facility, similar to petroleum products price stabilisation fund, should also be set up to contain risks emanating from catastrophic devaluation in currency.

Deloitte had laid these suggestions based on practices adopted by other South Asian countries where systems have been devised to provide protection against forex variation.

In Sri Lanka, for instance, Ceylon Electricity Board provides full coverage against forex variation risk if a portion of debt or equity is in foreign currency. In Bangladesh, the Power Development Board allows developers to quote power tariff in US dollars, meaning it bears foreign currency risk for both equity and debt. Pakistan also provides similar facilities to cover forex variation risks.

A version of this article appears in print on October 07, 2015 of The Himalayan Times.

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