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Project Finance Cross-Border Risks in Nepal

2012-10-08

Project Finance structures are increasingly being used in Nepal as a method of financing energy and infrastructure projects. In the hydro-power sector, until now, most projects that have achieved financial close have been below 20MW capacity. Such projects have mostly been financed by large consortium of Nepali commercial and development banks. Other big projects operational or under construction in Nepal, have been supported by multilateral agencies such as World Bank and ADB. Most projects, sponsored by private sector around 50MW to 200MW, need foreign lenders to lend as the existing capital markets in Nepal is not developed and local resources are not sufficient to finance such projects.

Enter into the world of international project finance - the financier, project, and project sponsors may be located in different countries. This brings a host of “cross-border risks”. This article seeks to outline such potential cross-boarder risks that may hinder lenders to lend in projects being constructed in Nepal.

Political Risks
There is a degree of political risk involved in financing and building a project in Nepal. Firstly, we have seen that certain political groups campaigning against foreign financed hydro-power projects stating that they are “imperialist”. However, on the other side, there is a huge demand for infrastructure. Locals from Pokhara have been protesting to ensure that the international airport is build. The locals of the West Seti project have been complaining that the project have not been built.

Other risks are risks of nationalization. Currently, it seems that there is a consensus among government officials, leading politicians and business lobby that private businesses should not be nationalized. This is guaranteed by the Industrial Enterprises Act, and Electricity Act. Further, since the constitution of Nepal guarantees fundamental right to property, the courts will certainly be against any form of nationalization.

Currency Related Risks
There is a risk to the lender that there may be a mismatch between the USD and Nepali rupees, if the Power Purchase Agreement (or Off Take Agreements) are denominated in local currency and the loan is in USD. This may be remedied by entering into a currency swap transaction with an international bank. However, for Nepal, the rates quoted for currency swap with USD is around 6% to 10% which makes it unfeasible. Therefore, the best way to mitigate the currency risk will be to enter into PPA in USD. This may be risky for the purchaser. However, again the price reflects the risk.

Permit and License Risk
The project company must obtain obtain all the permits necessary for ownership, development, construction, operation and financing of the project. In transnational project, the very government that supports the project may, indirectly, remove the support later by slowing the process down or through outright denial of permits. This risk may be mitigated by an implementation agreement (or Power Development Agreement). There should be a specific clause that waives sovereign immunity, one should take advice from local lawyers on the validity and effectiveness of the permits.

Expatriation risk
There is a risk that the profits earned may not be transferred from Nepal to other countries. There may be two potential reasons for this. First, the government may deny expatriation if all regulations have not been followed by the company and the lenders. This may be mitigated by taking advise from local lawyers. Second, there may not be adequate foreign reserves with the central banks. In both circumstances, the company or the lenders may apply for judicial review to the courts.

Other risks such as legal system risks, collateral risk, and force majure events risks will be discussed in the next part of this article. For more information please contact info@neupanelegal.com

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