financial resource | SMEs | Development finance institutions | equity investment | debt capital
How DFIs are investing in Nepal?
BII, a UK-based Development Finance Institution (DFIs) recently made an additional investment of $8.4 million in WorldLink Communications — Nepal’s leading private sector internet service provider in addition to its $12 million investment in 2019. What are these DFIs and how are they investing in Nepal?
The financing gap faced by Nepal’s MSMEs and infrastructure projects has put its economy in dire straits. Low investments bring lower growth — in turn increasing the gap.
The Asian Development Bank (ADB) says Nepal’s Small and Medium Enterprises (SMEs) face a financing gap of $1.06 billion.
Likewise, Nepal faces an annual development financing gap of $17.70 billion to achieve the sustainable development goals (SDGs) by 2030, accounting for approx 50% of the national GDP for the period leading up to 2030. At the same time, it is estimated Nepal needs an annual infrastructure investment of 10-15% of GDP in the next decade to become a middle-income nation.
In contrast to immediate needs for financial resources, FDI inflows have been dismal instead.
At less than 1% of GDP, Nepal’s current levels of FDI are the lowest among similar countries, said a 2016 World Bank report. Recent figures released by the NRB show that FDI fell to Rs 1.04 billion in the first seven months ended mid-February this fiscal year from Rs 16.29 billion y-o-y basis, while FDI commitment (or pledge) fell by 40% to Rs 18.65 billion.
And thanks to Covid and recurring credit crunch and interest rate fluctuations, private sector business confidence has also plummeted in recent times.
For the availability of long-term finance for infrastructures and strategic sectors such as agriculture, tourism, and ICT including SMEs and other entrepreneurial activities and to unlock Nepal's export potential, where will the financial resources come from?
One significant source can be investments from Development Finance Institutions (DFIs) where Nepal has seen a surge in recent times — the range of investments not only signals Nepal’s openness to foreign direct investment (FDI), they also serve as an alternative to foreign aid, which are often criticized for their economic and political ties. On the other hand, DFI investments also have the potential to catalyze more financial resources.
What are DFIs?
DFIs are specialized government-backed institutions that invest in or provide risk capital to commercially feasible private-sector projects in low- and middle-income countries — projects facing financing gaps and are unserved by private banks or local capital markets where the investments have greater risk management, a longer investment time horizon and are linked with development goals.
DFIs can be multilateral or bilateral.
Multilateral DFIs are established by more than one country. Examples include private sector arms of international financial institutions like the World Bank’s International Finance Corporation (IFC) and the OPEC Fund for International Development the OPEC works globally and the Asian Development Bank (ADB) works regionally.
In the case of bilateral DFIs, apart from making investments, they also serve to implement their government’s foreign and development cooperation policy like British International Investment (BII) (formerly CDC) owned by the public sector or FMO, a Dutch entrepreneurial development bank with mixed public-private ownership.
Examples of other public sector DFIs are DEG, SwedFund, Norfund, IDC, and OPIC.
Proparco, COFIDES, and SIMEST have mixed public and private ownership while the Swiss Investment Fund for Emerging Markets (SIFEM) is privately owned.
In recent times, Nepal has seen a surge of DFI investments driven by DFIs like BII, FMO, Finnfund, Swedfund, and the IFC.
How are DFIs investing?
DFIs usually finance through equity position, debt financing (provide debt capital), use of third-party fund managing intermediaries like PEVCs, and loan guarantees.
For equity financing, DFIs usually look for investment avenues that can absorb investments over $10 million — referred to as 'ticket size' — generally in large projects like the energy sector or financial institutions.
FMO’s investment in NMB bank beginning in 2008 is a crucial milestone of DFI investment in Nepal, which so far has made an equity investment of over $26 million into the bank.
In 2019, BII, formerly known as CDC Group, owned by the UK government, made a $12 million equity investment in Worldlink, one of Nepal’s leading internet service providers. Just a week back, it chipped in another $8.4 million investment alongside a $6.9 million investment by Dolma Impact Fund II (DIF II), a Private Equity (PE) fund managed by Dolma Fund Management (DFM).
Another way of funding is through debt investment, a preferred choice for DFIs investing in Nepal.
For instance, BII has provided $15 million in debt to NMB Bank and $25 million to Global IME Bank. Similarly, IFC has provided a $20 million loan to Sanima Bank and $25 million to NMB Bank Limited.
One of the main goals behind this debt financing to commercial banks has been to fund Nepal’s SMEs, a crucial driver of Nepal’s economy. According to a 2016 strategic paper by the Ministry of Finance, SMEs contribute 22% to the GDP and employ around 1.7 million people.
For larger projects, there are also instances where multiple DFIs have come together to finance through consortium debt financing.
In a landmark consortium financing model, several DFIs structured a debt financing of $453 million for the construction of the 216 MW Upper Trishuli-1 hydro project.
Investors include FMO, BII, the Export and Import Bank of Korea, the Asian Development Bank, the Asian Infrastructure and Investment Bank, the Korea Development Bank, the OPEC Fund and Proparco, a DFI partly owned by the French Development Agency.
The project is believed to be a benchmark investment for other FDI investors once it finishes.
Some key DFI investments
Further, IFC has extended a trade finance facility as a part of the Global Trade Finance Program (GTFP) to Global IME that includes a special provision for green trade financing.
Apart from equity and debt financing, DFIs finance through intermediaries like private equity firms providing small ticket-size risk capital to SMEs.
Business Oxygen (Bo2), a PE fund backed by the International Finance Corporation (IFC), a multilateral DFI invested $500,000 in MedPro International Nepal, a healthcare tech company.
Other investments from BO2 include Meera Biotech (healthcare); Karkhana (Education); homegrown brands like Dalle and Knit and Weave; Bakas, Saral Urja, and Gandaki Urja (energy); Assabet Technologies, Genese Solution, and Fusemachines (IT); Rojgari Services (human resource and employment) and several other industries.
Dolma Impact Fund II which made a combined investment in WorldLink recently along with BII has raised funds from DFC, FMO, CDC Group, Swedfund, and IFC bringing the fund to over $50 million.
The fund has already made its first investment in Upaya City Cargo, a logistics tech platform, and is finalizing deals with a restaurant aggregator food delivery platform and a 100-bed, multi-specialty hospital.
Overall, between 2014 and 2021, DFI investments reached around $902.46 million, most of it absorbed by the energy sector (80%) followed by banks (10%) and PEVCs (8%) and hospitality and ICT sectors (each 1%) where NMB Bank is one of the largest recipients of debt capital.
Where does the investment focus lie?
DFIs focus on funding businesses that address real-world problems like economic challenges (like decent job creation) for low-income and developing countries, climate change, and environmental and social risks and focus on the nation’s strategic sectors like agriculture, energy, export potential, ICT, infrastructure, green industries and more.
In sum, the focus is to make an impact investment — provide risk capital linked with development goals — economic impact, and environmental, social, and governance (ESG) outcomes.
For that, DFIs strongly emphasize ESG for their investment analysis and encourage companies to improve their ESG practices as well.
For instance, DFIs' alliance with local banks would mean that local banks will have to change their ways of doing business. The alliance with FMO has led NMB Bank to shift its principles towards sustainable banking, evident from its increasing financing in renewable energy and agribusiness.
Keeping ESG needs and the need to shape the market, BII, FMO, and SDC collectively started Invest for Impact Nepal (IIN) — a 5-year market shaping initiative (2021-25) to accelerate responsible and impactful investment.
How are policy reforms happening?
Since DFI originates from international investors, DFI investments are treated as foreign investments as envisaged under FITTA 2019 meaning they are governed by the FDI regulation. For unlocking finances from these cash-rich institutions, policy reforms can go a long way.
For instance, previously, Nepalese banks were barred from raising capital from foreign investors due to restrictions on borrowing in foreign currency.
A policy reform in 2018 by the central bank, when Nepal faced a severe credit crunch, allowed licensed Class-A banks (commercial banks) to borrow from foreign BFIs in convertible foreign currency — up to 25% of their core (or Tier I) capital, which paved the way for banks like NMB, Global IME, and Laxmi Bank to benefit from their debt capital.
In June 2021, Nepal Rastra Bank enacted the ‘Foreign Investment and Foreign Loan Management By-Law’ introducing a number of provisions for approval of foreign investment and loans like waiving the requirement for NRB approval for fresh foreign investment and subsequent capital increment.
In the 2021/22 budget, the government reduced the withholding tax rate from 15% to 10% on payment of interest by resident BFIs on loans availed in foreign currency from foreign BFIs to encourage more DFIs to inject loans into local BFIs which could be invested in the areas specified by NRB. Withholding is a tax deducted at source from the individual/entity making the payment (often interest).
Further, the government lowered the minimum threshold for FDI to Rs 20 million from Rs 50 million in a bid to attract small investors.
Yet, many challenges remain for DFIs to accelerate their investments.
Foremost, policy and regulatory barriers around FDI. Simplifying procedures and fully operationalizing the one-stop service for investors, automatic approval mechanism for FDI, flexible business visa rules for foreign investors and their families, hedging funds to manage the risk for foreign investment, and provision of sovereign credit rating is either delayed or in limbo.
Further, IIN notes that there is a small investment pipeline (including for SME financing) limiting DFI investment possibilities. Another area of concern for DFIs is uncertain, unclear, and lengthy regulations and processes around equity financing, which is why DFIs are more inclined toward debt investment.
DFIs also see the need to extend understanding of and demand for growth capital and to standardize and encourage an approach to ESG principles in sectors including banking and hydropower.
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