The global bond market dwarfs the equity market by at least three times, with an estimated worth of $126.9 trillion. As Nepal will be spotlighted during the upcoming Investment Summit on April 23-24, we need to seize the opportunity and not limit ourselves to funding only via equity instruments.

Nepal is projected to require a minimum of $40 billion over the coming decade to fulfil ambitions in the energy sector, including infrastructure investments. At least $20 billion is needed to invest in energy projects to meet exports and rising domestic demand. It is unlikely that investments of such magnitude can be secured domestically. The total lending capacity of the local banks is around $46 billion, which is growing, on average, by 12 to 15 percent annually. However, investment demand is more than double the growth rate. Their ability to fund larger projects is also limited due to their internal concentration risks. Further, there are demands from other competing sectors. Consequently, renewable energy projects must actively seek external funding, recognising that reliance solely on equity investments is impractical, given that debt constitutes 70 to 75 percent of renewable energy projects’ financing.

This sets the stage for targeting the huge international bond market. With the current momentum in the global green bond market, coupled with Nepal's prowess in hydroelectric and solar power and vulnerability to climate change, Nepal finds itself with a significant tailwind. The choice lies with Nepal: Resist the wind or embrace it. Ironically, it seems more difficult to resist.

The global GSS+ (social, sustainability, sustainability-linked, and transition-labelled) bond market boasts a staggering value of over $3.5 trillion. The demand for green bonds consistently outstrips the available supply, and the market share has surged from a mere 0.3 percent in 2012 to a substantial 3 percent in 2022. This growth is remarkable, considering the rapid expansion of the overall bond market. Nepal can tap into this burgeoning climate finance pool by leveraging international bond markets. This can help Nepal address energy funding shortfalls. This read focuses on corporate or non-government issues of bonds to address the gap. However, this strategy has its challenges, and it'll take some elbow grease to make it happen.

Nepal doesn’t have a credit rating, which is an anchor for international bond investors to assess country risk and decide whether they want to take the risk of lending to Nepali projects. If they do, it determines the price they’d be willing to pay. The absence of such a rating could make investors not bother due to uncertainty. While efforts are underway to secure that, there's concern about the potential consequences. Some fear that obtaining a rating might open the floodgates to excessive government borrowing, potentially leading Nepal into a cycle of unsustainable debt.

Nepal's guardians harbour more anxiety about the skill of the sword master—the handler of borrowed funds—than they do about the blade itself (the loan). As of July 2023, Nepal’s debt-to-GDP ratio stood at 43 percent, with external debt comprising 22 percent of GDP, indicating a healthy status compared to the cautionary threshold of 50 percent. Furthermore, this figure is effectively lower, given that all debt thus far has been concessional, with an average interest rate on foreign loans of less than 1 percent and a total outflow of less than 4.5 percent of outstanding debt, including the principal. Additionally, current account receipts outweigh external debt outflows by a factor of 35, demonstrating robust financial health. However, the well-wishers perceive Nepal's cautious borrowing practices as an outcome of necessity rather than a choice, expressing scepticism about the ability to exercise prudence when granted greater discretion. They fear that obtaining a credit rating could open the door to higher-cost commercial market debt that exceeds the current low rates.

The absence of a robust history of bond issuance by both Nepal and its corporate entities is another problem, resulting in a perceived lack of credibility. Bond investors/lenders find themselves in a fog of uncertainty about the reliability of bond offerings coming out of the country. They also grapple with the daunting task of pricing various risks while struggling to replicate a dependable structure. This could result in absurdly high-risk premiums higher than what the Nepali market would be or ‘should be’ willing to pay. All these conundrums can be tossed into the broad basket of the missing country-specific yield curve. But remember, broad strokes sometimes miss the quirks that complete the picture.

The international bond investors are also unaware of the track record of the sole off-taker of energy in Nepal, the NEA. While the NEA has yet to default, its reliability has yet to be convincingly demonstrated to international bond investors. Even if investors harbour confidence in the NEA's track record, the unpredictability of government policies in developing countries, the dearth of effective governance structures and the absence of contract adherence could prompt investors to search for an umbrella even on a sunny day. While the sun may be shining now, you never know when a sudden downpour might catch you off guard.

It's not the intention to state that these problems plague Nepal. Yet, as a developing nation, Nepal bears the weight of generalised labels and conceptions. The burden of proof to shake off these labels falls squarely on Nepal's shoulders. The effective way to shake off these labels is to have a history of successful bond issuances. However, this means that the inflated risk premiums in issuances before having a ‘history’ burden the bonds with a weightier price tag.

Now that it appears having a history of bond issuances will kickstart a chain reaction, fuelling further bond issues and setting in motion a positive feedback loop, a question persists: How to start? For every ‘history’, there must have been a first move. Common sense dictates that these initial steps be deliberate, cautious, and accompanied by ample support. Could the rise in commercial foreign public debt and private sector bond borrowing, influenced by the country's credit rating, exhaust foreign currency reserves or plunge the nation into a debt trap? The second (final) part of the article to be published next week will discuss this.