KATHMANDU, AUGUST 18
Blended financing instruments can offer promising solutions to address risks and barriers related to sustainable investments in Nepal.
Blended finance is at the heart of international discussions as it caters to the need of mobilizing private investments to meet the Sustainable Development Goals (SDGs) within the set deadline. As the UN has estimated the annual SDG funding gap for developing countries at $2.5 trillion, the goal, now, is to unlock additional investments in the sustainable projects and close the financing gap which cannot be covered by the public sector alone.
The SDG- Progress Assessment Report 2016–2019, published by UNDP, has estimated that Nepal has annual funding requirement of NRs 2,025 billion to reach the SDGs by 2030, whereas the estimated annual investment gap is approximated at NRs 585 billion.
Nepal has also set the target to reach "net-zero" by 2045. With the release of a nation-wide net-zero plan i.e., "Nepal's long-term strategy for Net zero Emissions" in 2021, the country has laid out its sectoral strategies and funding estimates to reach the goal of emitting 'no net' carbon between 2022 and 2045, and becoming carbon negative thereafter. With these ambitious goals set out, there is a need to address the existing risks and barriers that are keeping private investors from financing sustainable projects in the country. This is where blended finance comes into play.
Blending is trending in LDCs
Among the various definitions given by institutions like International Finance Corporation (IFC), Organisation for Economic Co-operation and Development (OECD) and World Economic Forum, some common attributes of blended finance can be noted as: the use of concessional funds, the intent to mobilise additional finance (primarily private commercial finance) and rebalance of the risk-reward profiles of development-related investments.
Blended finance instruments include direct investments into projects and funds through concessional equity, concessional debt and/or grants; indirect support through guarantees, hedging, insurances, swap, and derivative instruments; and commercially oriented preparation support, which covers financial and technical support for early-stage development risks in project preparations, especially needed in developing economies like Nepal.
Each of these instruments address different risks and barriers faced in different projects.
Least Developed Countries (LDCs) like Bangladesh, Madagascar and Uganda have successfully applied blending structures in their projects through instruments like debts, guarantees and grants. Guarantees help mitigate risks related to credit risks and offtake risks in developing countries. For instance, as per a report published by Asian Development Bank (ADB) on Blended Concessional Finance for Private Sector Projects, Sahofika Hydropower Project, a greenfield 205 MW hydropower plant in Madagascar, was financed on senior debt ($90 million), while being partially guaranteed by African Development Fund (ADF) ($100 million) and funded by other Development Finance Institutions (DFIs) and private sector with the amount of $651 million and $2,471 million respectively. Another tool i.e., grants, can be used to address barriers like lack of access to capital, high transaction costs and operational risks for sustainable projects.
For instance, Centenary Bank in Uganda implemented a solar refinance facility, where the bank mixed the grants of approximately USD 265,000 (more than one billion shillings) from Uganda Energy Credit Capitalization Company (UECCC) with its own relatively expensive commercial finance (interest rate of above 20%), to underwrite solar projects at a lower fixed interest rate of 8.15% per annum. This is also an example of concessionality.
In India, REVIVE Alliance (a blended finance platform), led by Samhita-CGF in collaboration with several funders including UNDP, launched a $15 million multi-stakeholder platform in 2020, to support "high-risk" communities such as informal sector workers and micro-entrepreneurs facing severe liquidity crunch due to the pandemic.
Prospects of blended financing instruments in Nepal
Nepal is not new to the concept of blended finance. There have been a few projects in the country that have embodied the critical principles of blended finance in the past. A blended finance program named "The Covid-19 MSME Fund Nepal " was launched in October 2020, which leveraged grants from Swiss Agency for Development and Cooperation and FMO, the Dutch Entrepreneurial Development Bank. An attribute of blended finance i.e., concessionality was used in the project as it provided interest/ collateral-free loans to meet the working capital needs of businesses along with provision of technical assistance to the businesses. The Upper Trishuli 1 (UT1) hydropower project is another notable example, as it blended funds of around $650 million from different sources like IFC, ADB, and FMO, among others. Guarantees of $135 million had also been committed by Multilateral Investment Guarantee Agency (MIGA) to cover political risks for the sponsors. Both direct and indirect blending instruments have been used in this single project.
Such tools can be utilized in other sustainable projects as well.
So far, most of the projects that have employed blended structures have large investment portfolios. The small-scale projects (at local levels) might neither have the access, nor the capacity, to utilize the funds from large national/ international institutions.
Hence, despite the increasing discussions on blended finance at the policy level in Nepal, small scale projects have often been missing out, as they are more likely to face barriers such as lower access to finance, offtake risks, currency risks, liquidity risks and political risks. In such cases, instruments like grants can be utilised to cover discrete up-front costs to make these projects bankable.
Hedging instruments and payment security mechanisms can be used while partnering with international institutions to re-allocate risks and reduce costs. Insurances can be used to provide protection against political, construction and operational risks of the projects.
Opportunities ahead
According to Convergence, a global network for blended finance with above 200 member institutions and $4.7 billion funding sought, blended finance has mobilized approximately $166 billion in capital towards sustainable development in developing countries to-date. IFC's report has estimated that Nepal could have an investment potential of UD$ 46.1 billion by 2030, which the private sector, including the Multilateral Development Banks (MDBs), local and regional financial institutions could tap into.
The country has huge potential to deliver higher and more inclusive growth by utilizing the water resources available for generating hydropower. There is a large growth potential in the solar and bio sector in the country. This has been supported by the Specified Sector Lending (SSL) regulation laid out by the central bank, which requires the banking and financial institutions (BFIs) to lend 15%, 10% and 15% of their funds to three sectors i.e., Agriculture sector, Energy sector and MC SME sectors, respectively.
These policies provide opportunities for Nepal to extend its investments in green and sustainable projects through collaborative/ blending structures at local as well as international levels and achieve its sustainability goals.
Along with clear objectives, appropriate policies, frameworks, and implementation timelines should be in place to support collaborative structures like blended finance in Nepal. We need to address the most prominent risks and barriers preventing scaling up of private investment in clean energy in developing economies (offtake risks, currency risks, political risks, liquidity risks, and size/scale mismatches) in order to open our doors to sustainable investments in the country.
Views expressed are the author's own)