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July 2015 Economy and Policy

Published on: 2015-07-20 00:00:00     1263 times read    0  Comments
Breaking the FDI Barrier in Hydropower
Commitment, devotion, responsibility, accountability and self-determination are needed. In the absence of these attributes no country can successfully attract FDI. Politically stable countries such as China, Turkey, Malaysia, South Korea, India, Brazil, South Africa and even Nigeria, are successful in attracting FDI.
 
--By Prof Kamal Raj Dhungel
 
Foreign Direct Investment (FDI) is an essential key to hydropower development in Nepal. Multinational companies are searching for profitable areas to make their investment. The world is facing a crisis of clean energy. Hydropower is a form of clean and renewable energy. The development of this industry, to some extent, can fill the vacuum of clean energy.  In this context, global investors could pour a large amount of money, through FDI, to harness the hydropower potential of Nepal. 
 
“Nepal is dependent on foreign investment for hydropower development. Both China and India have negotiated with the Nepalese Government to invest in large-scale hydropower projects. While this investment is positive for the Nepalese economy, China’s and India’s investment interests have wider geopolitical implications for the region. Economic development in both China and India requires more energy than either country can produce domestically. Competition over access to the Nepalese energy sector has the potential to create conflict between the two powers as they compete for regional hegemony.” 
 
But the inflow of FDI through third country investors is conditional.  
 
Good Governance
The first condition is good governance.  Good governance requires many things. Political stability is one. Political instability does not encourage good governance nor does it attract FDI. Commitment, devotion, responsibility, accountability and self-determination are needed. In the absence of these attributes no country can successfully attract FDI. Politically stable countries such as China, Turkey, Malaysia, South Korea, India, Brazil, South Africa and even Nigeria, are successful in attracting FDI from the large international companies.
 
Law and Order
Maintaining law and order is essential in attracting FDI. Weak law and order acts as a barrier for the FDI to come. A stable government having all the essential parts of good governance can provide a sense of security to foreign investors. Past history does not show any strong evidence that Nepal is committed to provide adequate security to projects particularly operated through FDI. For example, the basic infrastructure of the Upper Karnali project was destroyed by locals. This helps to spread the negative message to international investors that Nepal is an insecure place to invest. Thus, every effort must be made to improve law and order. 
 
Policy
A stable and consistent policy is also essential. Frequent changes in policy only serve to discourage investors. Income tax exemption, incentives and subsidies to be provided, profit to be repatriated, double tax avoidance, power purchase agreement, transmission line construction, addressing social and environmental issues, process and provision of licensing, etc should be spelled out clearly in the policy. Otherwise, instability could disrupt the homogeneity. It could break the system. Politicians and decision makers can impose their own policy to serve their own interests differently to different investors. Such action discourages genuine investors. Thus, Nepal needs to formulate investor-friendly policies. 
 
Market
Investors want to profit from their investment. The profit is the difference between revenue and cost. Revenue can be generated through the sale of electricity.  The size of the revenue depends primarily on the size of the market and scale of production. Market accessibility is a prerequisite for the new product to generate income.  This also requires an adequate market. Nepal must search for possible markets in which electricity generated from large hydropower projects can be sold.  Presently, Nepal has limited market accessibility and is constrained by inadequate infrastructure.  
 
 Income sensitive
The association between commercial energy consumption and economic development is direct and proportional. However in a growing economy like Nepal, it is natural for the demand for commercial energy to grow faster than the income or any other indicator of economic development. An annual growth rate of 7-8% is required to make Nepal a prestigious and prosperous nation. For this to happen, Nepal should seriously take on its development missions. 
 
In particular, the anticipated economic growth depends primarily on the availability of energy. In the Nepali context, electricity consumption is highly associated with economic growth. Various studies reveal that a one unit economic growth requires a production of more than three units of electricity. It shows that electricity consumption in Nepal is income sensitive. The reason for the high sensitivity in electricity demand may be because households and other production outlets prefer electricity over other energy resources. 
 
As the income of the household sector increases they move from lower quality fuels to higher quality ones. Electricity is a cleaner, easier to use, efficient and environmentally benign source of energy. Other factors such as increasing urbanization, increasing industrial activities and people’s increasing consciousness towards the social services (health and education) may lead to an increase in the demand for electric energy. 
 
From this perspective, it is possible to predict the high income sensitivity of electricity demand in Nepal.  A causality test suggests that the causality is running from per capita real GDP to per capita electricity consumption. It shows that it is the GDP that drives the electricity consumption and not vice versa. The implication is that energy conservation will not hurt economic growth and development, though it is sometimes argued that energy conservation may adversely affect economic growth. 
 
Hence energy conservation can be a feasible policy tool for Nepal because the country is severely constrained by adequate investment needed for exploiting its hydropower potential. 
 
Given that electricity supply in Nepal is insufficient to meet the growing demand as reflected by the frequent load shedding, a well designed conservation policy can play an effective role in managing the energy supply sector. 
 
The growth elasticity of foreign aid (FA) and GDP is 0.27 and 2.22 respectively. It indicates that a 1% change in foreign aid and GDP will change the electricity consumption by 0.27% and 2.27% respectively. The elasticity coefficient of FA is less than 1 indicating a less proportional change in electricity demand associated with the change in FA. 
 
However, the elasticity coefficient of GDP is greater than one indicating a more than proportional change in electricity demand associated with the change in GDP. It implies that change in electricity consumption is more sensitive when associated with the change in GDP rather than the corresponding change in FA.
 
It leads us to conclude that the demand for electrical energy is highly sensitive to the changes in gross domestic product (GDP). The average annual growth rate of electricity consumption has been found to exceed the growth rate of GDP, indicating that people or households have the intensity to climb up the highest ladder in spite of their income status. The Law of the Market, “Supply creates its own demand” is relevant to this particular product. 
 
Domestic Market
Presently, over 90% of electricity is consumed by the residential sector. The demand is increasing at an annual growth rate of 8-12%. However, supply remains stagnant. Demand outstrips supply. The supply deficit is less than a thousand MW. It has resulted in long power outages. A tiny volume, ranging from 500 to 800 MW of electricity, is required to make Nepal a load shedding free economy. Evidently, it limits the domestic market and only serves to discourage any FDI involvement. But there are signs of better things to come. 
 
Nepal needs to gear up a pace to bring its development goals forward to enable the economy to grow at a faster rate and to compete with its neighbors. Both India and China are trying to take their economy to newer heights. 
 
But to meet its neighbours is a challenging task. Nepal has to plan and aim for a higher economic growth rate for several more years. As discussed above, electricity demand is income sensitive. High economic growth requires large volumes of electricity. Obviously, economic prosperity would create the market for the hydropower to be generated.  
 
Among other things, in order for the electricity market to expand it must have a plan to build electric railway lines along the east-west highway, ropeways to link one hill to another to facilitate the movement of goods and people and to introduce tram ways in metropolitan cities like Kathmandu. It should also continue to establish basic industries in the country’s southern corridor. And finally, it should provide irrigation facilities to modernize the agricultural sector. 
 
Nepal is importing gas to meet household demand. Gas can be substituted by electricity. This will save hard currency that can be spent elsewhere. Reform in the domestic power market is a necessary condition for attracting foreign and domestic investment in the electricity industry for the simple reason that private power producers will seek a greater power market. Industrial development is a prerequisite for power market expansion and in turn it seeks a reliable and adequate supply of electric energy. 
 
Hydropower for Export
Obviously, hydropower if fully developed would need a foreign market. In this context it would be appropriate to quote, “The development of Nepal’s hydropower sector is not a question of if but, rather, when and by whom.  A number of studies suggest that the total capacity of viable hydropower in the country is as much as 42,000 megawatts (MW). The maximum domestic demand, meanwhile, is projected at less than 7,000 MW in a high growth scenario over the next 25 years. This creates considerable potential for the export of hydro-energy.” 
 
Electricity trade is one of the possible ways to integrate the market of these countries in a meaningful way. Nepal and its neighbours particularly India should take advantage of this opportunity. The alignment of mutual interests and win-win opportunities for trade and cooperation should be particularly strong in the energy sector in general and hydropower sector in particular. Nepal is closely connected with the thickly populated areas of energy deficit (UP, Bihar, Uttaranchal, Haryana, Punjab, Delhi etc). 
 
Thus, Nepal should be in a position to supply electricity through energy trade to fill the gap by harnessing its hydropower potential for the benefit of India and derive significant gains for its own economy from energy imports and electricity export as it has been facing long hours of power cuts.  However, there are obstacles to overcome in the way of electricity trade.  One is the almost total lack of an ‘energy infrastructure’ linking the markets of these countries despite holding strong matching hydroelectric resources. 
 
Cost of Generation
Past evidence reveals that electricity generated through hydro incurred high costs. Per unit electricity cost in Nepal has exceeded the per unit electricity cost of India and China, generated under identical circumstances. This clearly proves that hydropower generated in Nepal would lose its competitive edge if it is exported. Neighbors will not buy expensive electricity when it is available in their own market at a cheaper rate. In the light of this, Nepal should review the method it has adopted to generate electricity in order to regain a competitive edge. Proper modern technology could help to reduce the unit cost of electricity generation. FDI helps to bring in better technology to reduce the unit cost of electricity generation. 
 
Pricing Strategy
Tariff rate revision is one precondition to increase domestic electricity consumption. The prevailing exemption limit for residential electricity consumption does not allow the demand for electricity to increase. Reliability is another factor that sharply affects the consumption of electricity. With the increase in the reliability of the supply of electricity and sharp revision of the tariff rate with a reasonable exemption limit, the majority of households in the urban areas would be able to shift from using liquefied petroleum gas (LPG) and kerosene to electricity. 
 
However consumer preferences would be guided by price. Therefore, this must be resolved by decision makers and planners in order to increase the domestic consumption of electricity. A market mechanism rather than an administered one would be a better device for setting the energy price. 
 
There are various other options too. Small size hydropower projects ranging from a kW to a MW can be installed by mobilizing local resources particularly from the direct beneficiaries. Development and implementation of such projects will bring economic prosperity at the local level leading to poverty reduction.
 
Conclusion
Nepal is trying to exploit its hydropower potential in the face of an acute power shortage. Unfortunately, Nepal’s failure rate is much higher than its success rate. There are visible and invisible factors that hold back the development of hydropower. These include non-commitment, policy failures, water politics, lack of vision in how to effectively use water resources, non-transparency, unaccountability, insecurity, political instability and pointless debate over export and home consumption. And add to this, poor domestic resource mobilization. 
 
Obviously, Nepal is always bound to seek foreign capital to make its hydropower projects work. But foreign capital requires a number of prerequisites, as outlined above. Nepal is passing through a volatile phase. It must make bold decisions to correct all types of anomalies in order to ensure foreign investment rolls in, in the days to come.  
 
The author was Professor of Economics at the Tribhuvan University.

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