Infrastructure development, especially in developing economies, is a key parameter in enhancing quality of life, bolstering employment, and achieving sustainable economic growth. A 2013 World Bank Report on “Reducing Poverty by Closing South Asia’s Infrastructure Gap” revealed that Nepal’s development in infrastructure is among the poorest in South Asia.

According to the report, an estimated investment of at least USD13 billion was required to bridge the existing gaps in infrastructure by 2020. This figure was estimated prior to the massive earthquake that struck Nepal in 2015. The devastation caused by the earthquake  has no doubt increased the need for infrastructure investment in the country.

Transitioning from a unitary system of government to a federal system has bestowed the local governments’ with unique privileges and responsibilities. Decentralisation reforms have created seven provinces and 753 local units, each of which oversee infrastructural development and economic growth in their regions.

Publicly elected representatives leading these local units now have substantially greater ownership of development in their respective municipalities. To that end, several municipalities have devised ambitious plans to stimulate developmental efforts in their areas. However, a key catalyst of economic growth at all levels is access to adequate and sustainable sources of financing.

From conducting small scale projects such as the construction of bus parks, public toilets and street lights to large scale projects such as development of roads, solid waste management facilities and cold-storage units–managing sufficient financing is of paramount importance. It is evident that municipal income sources, primarily compromised of Own Source Revenues and designated funding from the federal government, is insufficient to meet the investment needs of infrastructure projects. This make it  crucial to assess alternative financing mechanisms to ensure the availability of adequate and sustainable funding for local development.

The alternatives

Town Development Fund (TDF) is a tried and tested means of municipal financing that could provide reasonable impetus in meeting the financing deficit. As an autonomous financial intermediary institution, TDF has been providing funding to municipalities in the form of loans, soft loans and grants since 1997. Last year, TDF funded around 100 projects ranging in amounts from approximately Rs6 million to Rs220 million. However, TDF lending is bound by rigid regulations and the processes for securing funding has historically been cumbersome. TDF is also limited by its relatively small capacity with a capital base of approximately Rs3 billion as of 2017. Acknowledging this limitation, TDF has recognised capital base expansion as one of their major priorities in their five year business plan for 2016-2020 where it  aims to expand its capital base to Rs20 billion by 2020.

Projects at the municipal level may also seek funding in the form of loans from private sector banks. As the government has been actively working towards expanding the presence of private sector banks in all local units, banks could be an important source of capital in municipal financing. Nepal Rastra Bank (NRB) has not prohibited banks from taking debt exposure on municipal projects, provided that the needs of funding for these projects meet other lending criteria for compliance.

The newly registered Infrastructural Development Bank is also expected to help bridge the gaps in infrastructural financing. While the working modalities and detailed lending criteria of the institution are yet to be public, its inception has given a ray of hope for improved access to capital for various types of infrastructure projects.  

In practice, however, financing municipal level projects through loans from private sector banks have been virtually non-existent. A major bottleneck for municipal financing is the inherent need for private sector banks to seek collateral before being able to effectively provision loans.  To mitigate these challenges, NRB should work towards streamlining collateral management and other procedural guidelines so that banks have clarity on providing debt financing to municipal projects. Furthermore, given the crucial need of capital for development in local units, NRB must devise policies that would encourage lending from private sector banks to local governments in financing commercially viable infrastructure projects.

Way forward

Local governments can also seek funding in the form of loans from the federal government. The Inter-Government Fiscal Management Act, 2017 allows local level governments to submit a proposal for loans from the federal government. However, the framework for intergovernmental loans still lacks clarity on key features such as eligibility criteria, any caps that may be in place for the amount that can be disbursed, and the interest rate structures of these loans. It is imperative that National Natural Resource and Fiscal Commission (NNRFC) develops these procedural guidelines in a timely manner to ensure effective implementation of inter-governmental loans.

The Inter-Government Fiscal Management Act also allows federal, provincial and local governments to seek internal loans provided they satisfy the conditions mandated by NNRFC. The federal government and provincial government can generate internal loans by issuing bonds by satisfying the conditions laid out by existing laws. Municipal bonds have had considerable success in raising capital around the world and are becoming increasingly popular in developing economies such as India and China. However, as of now, no directives on bond issuance have been determined. It is important to acknowledge that issuing municipal bonds is a rather elaborate endeavour requiring detailed assessments of credit worthiness, probability of default, and guarantors of public debt.

Municipal projects that ensure sustainable long-term development can also be financed through grants or loans from international bodies. However, the Inter-Government Fiscal Management Act, 2017 has made provisions only for the

federal government to take loans and grants from foreign bodies. As a result, the funding process for financing local

level projects through foreign loans/grants must be channeled through the federal government.   

Furthermore, funds received from international bodies in the form of loans/grants must be deployed in national priority sectors including infrastructural development, public private partnerships, education, health and human capital development, local production and disaster management among others. Foreign grants/loans have historically played an important role in infrastructure development in Nepal. As a result, an efficient system of channeling funds from foreign sources to the local levels would be conducive to sustainable infrastructure development across the recently devised federal structures.

The need for alternative sources of financing to bridge existing gaps in municipal financing cannot be over-emphasised. Current legal frameworks and provisions have provided a broad high-level overview. However, there is a critical need for all stakeholders, particularly Ministry of Finance and NNRFC, to delve deeper into these provisions to devise implementation mechanisms that are practical, accessible and applicable. Proper procedural guidelines and access to alternative financing will allow ample space and opportunity for local governments to grow and push for infrastructural development in their regions.  

Siddhartha Pant is an analyst at VRock and Company.