Financing infrastructureBeing ambitious about it is okay, but it should not be used to score political points founded on misplaced nationalism
Prime Minister KP Sharma Oli-led government surprised everyone a few weeks ago by proposing to initiate key large-scale infrastructure projects, including the much-touted fast-track road and Budi Gandaki hydroelectricity project, using domestic resources. The intention was to stoke a renewed sense of nationalism—high in rhetoric but low in substance—and to extricate the government from binding hooks that come with bilateral financing of such large-scale projects. One unruly leftist party even fervently argued for financing of all hydropower projects through domestic resources and floated a premature idea to raise money from local shareholders.
Meanwhile, some politically aligned experts are throwing their weight behind such half-baked proposals without properly analysing the available domestic financial and knowledge capacities. As it stand now, the country’s economy simply does not have the required financial resources, stock of knowledge, management capabilities or competent institutions to initiate such large-scale projects. Acquiring such ability requires close collaboration on financing, research and management between external and domestic sources.
Unfavourable macro picture
Politicians and their intellectual cheerleaders quickly point to low public debt (in other words fiscal space) to finance large-scale infrastructure such as hydroelectricity, roads and airports domestically. The outstanding public debt has decreased sharply from about 52 percent of GDP in 2005 to around 25.7 percent of GDP at present. It means Nepal could theoretically borrow more without jeopardising fiscal stability (say up to 40 percent of GDP). However, borrowing an additional $3.5 billion or more from domestic and external sources requires the government to drastically enhance its absorption capacity, which unfortunately is eroding.
The outstanding domestic borrowing by selling government bills and bonds amounts to 9.5 percent of GDP and external borrowing of 16.2 percent of GDP, mostly on concessional terms. The government is mostly selling treasury bills (with maturity of less than one year) to finance recurrent spending, multi-year infrastructure projects and to manage excess liquidity. This is not a good fiscal practice as large-scale infrastructure projects are financed typically by issuing specific construction bonds, which have long-term maturity and lower risk of asset-liability mismatch. Higher domestic borrowing to fulfil politicians’ whims will crowd out private investment by pushing up interest rates and put unnecessary debt burden on the future generation. The recent budget falls in this category.
Using excess liquidity and treasury savings are identified as alternative sources that could be tapped to finance infrastructure projects. The constant excess liquidity is the result of higher growth of deposit compared to the growth of credit. It arises when there is lack of investment-ready projects and unfavourable investment climate, thus constraining the capacity of banks and financial institutions (BFI) to increase credit. Meanwhile, the large growth of deposit is due to the increasing remittance inflows and the government’s inability to spend allocated capital budget on time. While the former is starting to slow down as demand for the migrant workers is decreasing, the latter is expected to improve due to relatively better budget execution from this year onwards. Transient and volatile excess liquidity and treasury savings cannot be reliable sources for long-term infrastructure financing.
Another related argument on the adequacy of domestic resources is the potential to pool in savings. This argument has its roots in the remittance-backed large deposit growth and oversubscription of shares in the stock market. First, the remittance-backed savings are of a short-term nature and using them to invest in projects with long gestation lags creates asset-liability, which is a mismatch for the BFIs. This is one of the reasons why the BFIs as well as pension funds are being used to finance medium to large scale projects through a consortium, which minimises the risk arising from overexposure to one sector. Second, the oversubscription during share issuance is essentially to reap quick profits by trading the shares in the secondary market. This quest for short-term gain does not indicate that there is an excess of long-term saving, which could be used for multi-year large-scale infrastructure projects. Nepal’s financial system is not yet mature enough for that.
Regarding external financing, the government will not be able to drastically increase borrowing because it directly depends on absorption capacity, which stands at a mere 75 percent of budgeted capital spending. Frustration is already running high among Nepal’s key multilateral and bilateral donors owing to the government’s inability to timely use the committed grants and loans. Furthermore, concessional lending from multilateral donors might be drying up. The Asian Development Bank and the World Bank are gradually phasing out concessional lending, which means that Nepal might have to borrow at a rate between concessional and non-concessional terms. Bilateral donors may not be as generous as the multilateral donors, as they usually insert binding hooks on procurement and the utilisation of funds.
Rhetoric vs reality
Hence, the prospects for domestic and external borrowing may not be as rosy for Nepal as has been claimed by some politicians and their cheerleaders. Being ambitious about financing infrastructure projects is okay, but it should not depart much from what is realistically possible and, most importantly, should not be used to score political points founded on misplaced nationalism.
The most realistic option for now is to improve the country’s investment climate to facilitate private investment (including lowering of investment risk premium) and enhance the absorption capacity to accelerate capital spending. It would require addressing the constraints to private investment and low capital spending (including contract management) with an aim to finance large-scale infrastructure projects domestically in the future. Practically, such projects should be financed by issuing long-term construction bonds instead of relying on short-term treasury bills. An appropriate environment to boost confidence on such long-term bonds is needed. Achieving all these would require tough reforms, which may not be as politically palatable as the lofty rhetoric on economic development.
Sapkota is an economist