Nepal Infrastructure Sector Assessment Private Sector Solutions For Sustainable Infrastructure Development

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
INFRASTRUCTURE DEVELOPMENT
PRIVATE SECTOR SOLUTIONS FOR SUSTAINABLE
SECTOR ASSESSMENT
NEPAL INFRASTRUCTURE
SECTOR ASSESSMENT
PRIVATE SECTOR SOLUTIONS FOR SUSTAINABLE
INFRASTRUCTURE DEVELOPMENT
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Acknowledgements
T
his Infrastructure Sector Assessment Report cialist, and Razvan Purcaru, Senior Infrastructure Fi-
for Nepal has been prepared by a team led by nance Specialist, for their guidance.
Shyamala Shukla, Task Team Leader and Se-
nior Specialist, Infrastructure Finance, Public-Private Qimiao Fan, Country Director, Nepal, Bangladesh,
Partnerships and Guarantees; and Sanjay Srivastava, and Bhutan; Idah Pswarayi-Riddihough, Country
Task Team Leader and Program Leader. Director, Nepal, Sri Lanka and Maldives; Faris Ha-
dad-Zervos, Country Manager, Nepal, World Bank;
The core team consisted of Bipul Singh, Energy Clive Harris, Head, Maximizing Finance for Devel-
Economist; Dhruba Raj Regmi, Consultant; Harsh opment; Abha Joshi-Ghani, Senior Advisor, Infra-
Goyal, Urban Development Specialist; Lopa Shah, structure Programs and Analytics; Ranjit Lamech,
Investment Officer; Nick Jivasantikarn, Consultant; Director, Energy; Sebnem Erol Madan, Manager, Fi-
Pankaj Sinha, Senior Investment Officer; Pratyush nancial Structuring and PPPs; Richard Bernard Mc-
Prashant, Consultant; Rupinder Kaur Rai, Analyst; George, Lead Infrastructure Finance Specialist; Jason
Roland White, Lead Urban Specialist; Sri Kumar Z. Lu, Head, GIF; Demetrios Papathanasiou, Sector
Tadimalla, Senior Transport Specialist; Sujatha Sriku- Manager, Energy; Bigyan Pradhan, Senior Opera-
mar, Consultant; Takaaki Masaki, Junior Professional tions Officer, World Bank; Jordan Schwartz, Direc-
Officer; Xiaoping Wang, Senior Energy Specialist; tor, IPG; Shamsher Singh, Chief Investment Officer,
Yoonhee Kim, Senior Urban Specialist; and Yuge Ma, IFC; Lubomir Varbanov, Manager, IFC; and Wendy
Young Professional. Jo Werner, Country Manager, IFC provided valuable
guidance.
Key contributions were provided by Franck Bessette,
Program Manager; Kene Ezemenari, Senior Econ- The World Bank team thanks the Federal Ministry
omist; Drona Raj Ghimire, Senior Environmen- of Finance, specifically the Government of Nepal
tal Specialist; Ajay Gundecha, Consultant; Ashim InfraSAP Working Group; National Planning Com-
Nepal, Financial Sector Specialist; Bhola Shrestha, mission; Investment Board of Nepal; Ministry of
Consultant;; Caroline Mary Sage, Senior Social De- Physical Infrastructure and Transport; Department
velopment Specialist; Deepak Man Singh Shrestha, of Roads; Department of Transport Management;
Senior Transport Specialist; Pinki Chaudhuri, Con- Department of Electricity Development; Nepal Elec-
sultant; Pravin Karki, Senior Hydropower Specialist; tricity Authority; Ministry of Energy; Hydroelectric-
Sabin Raj Shrestha, Senior Financial Sector Special- ity Investment and Development Company Limited;
ist; Sandeep Kohli, Senior Energy Specialist; Santosh Civil Aviation Authority of Nepal; Ministry of Federal
Pandey, Country Officer; Siddharth Sharma, Senior Affairs and Local Development; Department of Local
Economist; Subodh Adhikari, Energy Specialist; Infrastructure Development and Agricultural Roads;
Sudyumna Dahal, Economist; Suvekshya Bhandari, Kathmandu Metropolitan City; Town Development
Consultant; Umesh Agrawal, Consultant; and Volker Fund Board; Roads Board of Nepal; Nepal Natural
Treichel, Principal Country Economist; Resources and Fiscal Decentralization Commission;
and the Government of Nepal, for providing valuable
The following peer reviewers provided valuable guid- support in the implementation of this project.
ance and advice: Aijaz Ahmad, Kamal Dorabawila,
Moazzam Mekan, Peter Mousley, Yogita Mumssen, The team thanks Arnab Datta for technical writing
Volker Treichel, and Andre Van Hoeck. The team also and editing, Sandra Gain for editing, and Victoria
thanks Don Purka, Senior Infrastructure Finance Spe- Adams-Kotsch for the layout, and formatting.
iii
Abbreviations
ADB AsianDevelopmentBank
IPO initial public offering
BAU business as usual
IPP Independent Power Producer
CAAN Civil Aviation Authority of Nepal
KM kilometer
CIT Citizen Investment Trust
LRN local roads network
DFI Development Finance Institution
M meter
DOLIDAR Department of Local Infrastructure Development and Agriculture Roads
MDB multilateral development bank
DOR Department of Roads
MOCTCA Ministry of Culture, Tourism and Civil Aviation
DOTM Department of Transport Management
MOEWRI Ministry of Energy, Water Resources, and Irrigation
EGCL Electricity Generation Company Limited
MOF Ministry of Finance
EIA Environmental Impact Assessment
MOFA&GA Ministry of Federal Affairs and General Administration
EPA Environment Protection Act
MOFALD Ministry of Federal Affairs and Local Development
EPR Environment Protection Regulation
MOFEP Ministry of Finance and Economic Planning
ERC Electricity Regulatory Commission
MOLJP Ministry of Law, Justice and Parliamentary Affairs
FCCL Fiscal Commitments and Contingent Liabilities
MOPIT Ministry of Physical Infrastructure and Transport
FDI Foreign Direct Investment
MOU Memorandum of Understanding
FITTA Foreign Investment and Technology Transfer Act
MOUD Ministry of Urban Development
GDP Gross Domestic Product
MOWSS Ministry of Water Supply and Sanitation
GESI gender equality and social inclusion
MW megawatt
GWh gigawatt hour
NEA Nepal Electricity Authority
HIDCL Hydroelectric Investment Development Company Limited
NIDFI Nepal infrastructure development finance institution
IBN Investment Board of Nepal
NPC National Planning Commission
ICAO International Civil Aviation Organization
iv
NEPAL INFRASTRUCTURE SECTOR ASSESSMENT
NPR Nepalese Rupee

IE independent engineer
NPTCL Nepal Power Trading Company Limited
IFC International Finance Corporation
NRB Nepal Rastra Bank
IIF Indonesia Infrastructure Finance
O&M operation and maintenance
InfraSAP Infrastructure Sector Assessment Program
ODA official development assistance
IPG Infrastructure Finance, Public-Private Partnerships and Guarantees
OSR own-source revenue
PIM Public Investment Management
SBN Securities Board Nepal
PMO Prime Minister’s Office
SOE state-owned enterprise
PPA Power Purchase Agreement
SPV special purpose vehicle
PPI Private Participation in Infrastructure
SRN Strategic Roads Network
PPP Public-Private Partnership
SWM solid waste management
PPPI Act Public-Private Partnership and Investment Act
T&D transmission and distribution
PROR peaking run-of-the-river
TDF Town Development Fund
PV present value
TIA Tribhuvan International Airport
RBN Roads Board of Nepal
UNCDF United Nations Capital Development Fund
ROR run-of-the-river
WHO World Health Organization
RPGCL Rastriya Prasaran Grid Company Limited
v
vi
Table of Contents
Acknowledgments iii
Acronyms & Abbreviations iv
Executive Summary x
Priorities xi
Energy Sector xiii
Transport Sector xv
Urban Sector xvi
Introduction 3
Country Environment 6
Macro-Fiscal Environment 6
Overview 6
Constraints and Areas for Reform 9
Governance and Public Investment Management 9
Overview 9
Recommendations 10
Private Participation in Infrastructure and Infrastructure Finance 11
Overview 11
Recommendations 13
Financial Sector and the Investment Environment 14
Overview 14
Recommendations 17
Gender Equality and Social Inclusion 19
Overview 19
Recommendations 19
Environmental and Social Management 20
Overview 20
Constraints 20
Recommendations 21
Proposed Recommendations for the Country Environment 22
Reforming the Energy Sector 27

Introduction 27
Nepal’s Energy Sector at a Glance 28
Financing Needs (2018–40) 28
Binding Constraints to the Scale-Up of Financing 34
Constraints Affecting Capacity and the Enabling Environment 35
Constraints Affecting Financial Viability 38
vii
Constraints Affecting the Availability of Long-Term Financing 38

Constraints Affecting Foreign Investment 40
Roadmap to Unlock New Sources of Finance 41
Build the Institutional and Regulatory Environment 41
Strengthen the Financial Viability of the Sector 43
Increase the Availability of Long-Term Finance 44
Create an Enabling Environment for Foreign Investment 47
Reforming the Transport Sector 51

Introduction 51
Nepal’s Transport Sector at a Glance 51
Roads 51
Airports 53
Urban Transport 56
Sector Constraints 57
Roads 57
Airports 58
Urban Transport 59
Roadmap 60
Summary of Recommendations for the Transport Sector 64
Reforming the Urban Sector 67

Introduction 67
Nepal’s Urban Sector at a Glance 67
Core Urban Services 67
Institutional Framework 68
Legal and Regulatory Framework 68
Funding and Financing 69
Investment Environment 69
Investment Priorities for the Focus Cities 70
Sector Constraints 71
Institutional Structure, Planning, and Implementation 71
Funding and Financial Management 72
Commercial Borrowing 72
Public-Private Partnerships 73
Land Value Capture 74
Roadmap 74
Summary of Recommendations for the Urban Sector 78
viii
List of Figures
Figure 1: Indicators of public/publicly guaranteed debt under alternative scenarios, fy2017–FY2037 8
Figure 2: Actual and Projected Electricity Demand (GWh) 28
Figure 3: Electricity Sector Investments in Nepal with Private Sector Participation (US$, millions) 31
Figure 4: Nepal Electricity Authority’s Net Income (US$, millions) 39
Figure 5: Developing an Asset Recycling Framework 46
Figure 6: Institutional framework for roads 53
Figure 7: Financing needs in the road sector, 2020–30 (US$, millions) 54
Figure 8: Institutional framework for airports 55
Figure 9: Conceptual project structure of a hybrid-annuity model PPP 63
Figure 10: Urban: Recurrent and CAPEX Per Capita 69
List of Tables
Table ES.1: Cross-cutting areas – Short-term priority actions (up to 3 years) xiii
Table ES.2: Short-term priority actions – Sectors xvii
Table 1: Cross-Cutting Areas Roadmap 22
Table 2: Historical Investments (2010–17) and Projected Investment Needs (2018–40) 29
Table 3: Nepal electricity authority Debt Financing Requirement (US$, millions) 30
Table 4: Sources of Financing in the Electricity Sector (US$, Millions) 33
Table 5: Build the institutional and regulatory environment – Recommended actions 45
Table 6: Improve the financial viability of the sector – Recommended actions 46
Table 7: Increase the availability of long-term finance – Recommended actions 48
Table 8: Increase foreign investment – Recommended actions 49
Table 9: Road Maintenance budget needs, allocation, and funding gap in the past five years (NPR, millions) 53
Table 10: Major investments and financing needs for Airports (US$, millions) 56
Table 11: Indicative sources of investment and the potential funding gap for roads, 2020–30 (US$, millions) 59
Table 12: Indicative sources of investment and the potential funding gap for airports, 2020–30 (US$, millions) 60
Table 13: Transport Sector Roadmap 64
Table 14: Access to core infrastructure in four cities 68
Table 15: Financial gap scenarios for 217 municipalities, 2016–31 (NPR, millions) 70
Table 16: Urban Sector Roadmap 78

List of Boxes
Box 1: Upper Tamakoshi Hydropower Project 30
Box 2: Current dollar–denominated PPA and Foreign Exchange Risk Hedging Mechanisms 32
Box 3: International experience with large hydro projects 35
Box 4: Private Sector experience with large hydro projects 36
Box 5: Building Effective Institutions 37
Box 6: PT Indonesia Infrastructure Finance 40
ix
Executive Summary
Despite several severe shocks in the past—conflict, the government from fully publicly financing its in-
unstable governments, earthquakes, and trade frastructure needs.
disruptions—Nepal has made strong progress in
reducing poverty and boosting shared prosperity. For Nepal to achieve its growth aspirations, it must
With the decade-long peace and constitutional pro- close its infrastructure gap. By 2022, Nepal wishes
cess concluded, the Government of Nepal is keen to to graduate from its least developed country status
accelerate economic growth and become a middle-in- and soon after to achieve its vision to become a mid-
come country by 2030. Between 1996 and 2011, the dle-income country. However, currently, Nepalese
proportion of households living in extreme poverty citizens do not have reliable and adequate access to
fell from 46 to 15 percent. Nepal’s macroeconomic infrastructure services. For real benefits to accrue, the
fundamentals have remained sound. quality and sustainability of services need to improve,
with substantial and efficient investment. Under the
Nepal’s historic transition to a federal state system right conditions, infrastructure development can play
is expected to increase public expenditure, part- a role in promoting growth and equity by providing
ly due to higher infrastructure spending, but the access to basic services, jobs, and markets. In a geo-
stock of public debt is projected to remain low. In graphically challenged country like Nepal, it will also
2017, Nepal transitioned to a federal state system with help create reliable supply chains, allowing for more
about 3,400 village development councils consolidat- efficient movement of goods and services.
ed into 753 local government units. In the next three
years (2019–21), on average, total expenditure is like- Investment needs are quoted at 10-15 percent of
ly to grow by 3-4 percent of gross domestic product GDP annually in the next decade, and they will
(GDP) per year, because of the implementation of require timely and appropriate solutions. The gov-
the federalism structure. In addition, increased bor- ernment recognizes the magnitude of the infrastruc-
rowing of around 5 percentage points (between 2018 ture gap and the urgency of addressing it. However,
and 2021) is required. However, despite the projected despite a relatively low debt-to-GDP ratio, meeting
increase in the fiscal deficit, the stock of public debt is the required investments is a challenging goal. Al-
projected to remain low, increasing from 30 percent though public investment will continue to play a key
in FY2018 to 36 percent by FY2021. role for infrastructure delivery, a stronger emphasis
on private sector participation in infrastructure sec-
Although the government’s prudent fiscal manage- tors could increase efficiencies by introducing private
ment and revenue collection have played a part in sector management expertise, technologies, and com-
keeping debt levels low, underspending of capital petition, and by transferring risks. No matter the de-
expenditures has been a factor. The system runs livery mechanism, value-for-money should be at the
into chronic underspending of the capital budget, forefront of decision making.
with spending averaging about 70 to 80 percent.
According to the list of projects compiled from the Experience and current project preparation have
Annual Development Plans of the National Planning shown scope for infrastructure development and
Commission, projects have been ongoing on average service provision through private sector solutions,
for more than 11 years. In addition to delays, cost including public-private partnerships (PPPs), in
overruns mark the delivery of infrastructure and ser- the energy, transport, and urban sectors, encom-
vices. The lack of capacity to spend efficiently and passing a range of contract types. The nature of the
effectively and future fiscal constraints will inhibit project types currently found in Nepal ranges from
x
PPPs to operation and maintenance contracts. In a unique and unprecedented opportunity to estab-
2015, the Government of Nepal introduced a PPP lish clarity of functions, expenditures, and revenue
Policy, which emphasizes the importance placed on assignments, as well as changing jurisdictions across
infrastructure development and, where appropriate, various levels of governments and agencies, includ-
through private sector participation. A PPP Law is ing as they interface with the private sector. The new
currently under preparation. Elevating Nepal’s PPP government is in place and emphasizing the need for
program, which has had a mixed track record thus stronger cooperation between the public and private
far, will require focused policy actions and reforms sectors. Against this background, this report assess-
to introduce private finance efficiently and effectively es the energy (electricity generation, transmission,
where it fits the government’s strategy and planning and distribution), transport (roads, airports, and ur-
and is fiscally prudent. ban transport), and urban (water supply, sanitation,
and solid waste management) infrastructure sectors.
Unlocking private sector financing and expertise The report recommends interventions that combine
will require creating a conducive environment short-term and longer-term structural and policy
for private participation through (i) sector-level changes with tailored project implementation ap-
groundwork, (ii) sustainable project structures, proaches. Completing projects will help stress test the
(iii) systematic and strategic public investment framework and system and identify potential bottle-
management and project selection, and (iv) in- necks that can be corrected. Such a learning-by-doing
vestment-friendly policies and regulations. Public approach will further help prioritize the implemen-
investment will remain key for infrastructure delivery tation of the initiatives proposed in this report and
in certain subsectors, particularly to ensure viability target capacity development initiatives in the areas of
and affordability. In the short-to-medium term, this greatest need.
may be particularly true where there is no precedent
for private finance. Some of this public investment
could be in the form of viability gap funding in large Priorities
projects. Therefore, each project should be carefully Several legal instruments related to good gover-
assessed for its most appropriate procurement mech- nance have been introduced in Nepal over the past
anism in light of the government’s capacity and stra- two decades, but gaps in governance and the pub-
tegic planning. The government may focus on con- lic investment management (PIM) system remain.
tracting out the operations, maintenance, and service Building on recent interventions, such as the creation
delivery of infrastructure assets, particularly for of public bodies to monitor and enforce good gover-
public investments that require careful maintenance nance, it is suggested that the Government of Nepal
over a longer period. For example, in hybrid-annuity improves its procurement and PIM system, including
models in the road sector, a majority of the capital critical functions such as transparent project selection
expenditure is funded by the government, and the re- and budgeting, project implementation, adjustment
maining capital expenditure, annual operations, and of projects in construction, and ex post evaluation.
maintenance expenses are incurred by the private sec- Harmonization of the PIM and PPP processes could
tor in return for periodic availability payments. Such further improve project selection, as budgeting, af-
variant schemes would help Nepal deliver quality in- fordability, and fiscal impact may be readily assessed
frastructure, address delayed and incomplete projects and fed into the decision-making process. Delays and
in the sector, and create incentives and increase expe- gaps in policy implementation and accounting re-
rience among market participants to drive efficiency. quire equal attention from the government.
It is an opportune time to put in place mechanisms Building a robust PPP framework will help com-
to mobilize private sector solutions for infrastruc- municate Nepal’s commitment to PPPs and foster
ture development in Nepal. This report takes place efficiency, accountability, and transparency in the
as Nepal transitions to a federal structure. This poses PPP program. PPPs are not new in Nepal, and line
xi
ministries have been able to procure them. Howev- Nepal infrastructure DFI. Measures limiting foreign
er, scaling up PPPs will require that selected projects investment, including stringent foreign direct invest-
are aligned with the government’s strategy, generate ment (FDI) restrictions and procedures, offshore cap-
the greatest economic returns for society, and do not ital repatriation problems, and double taxation issues,
expose the government to excessive fiscal risks. Ne- need to be addressed by easing restrictions and har-
pal could achieve this by comprehensively reviewing, monizing regulations.
introducing, and improving its policies, procedures,
institutions, and rules that define how PPPs are iden- Building gender equality and social inclusion mea-
tified, assessed, selected, prioritized, budgeted for, sures into the planning and implementation of in-
procured, monitored, and accounted for, and who frastructure from the beginning can help include
will be responsible for these tasks. These actions will marginalized communities, including increased ac-
also help generate greater private sector interest and cess to basic services and jobs for all. Infrastructure
public acceptance of the PPP program. development requires combining supply-side issues
of technical design specifications with demand-side
Addressing constraints that limit the ability of the dimensions of who uses infrastructure, for what pur-
financial market to lend to infrastructure projects poses, how it is paid for, and with what impacts on
and improving the investment environment will individuals, households, and communities. Several
be key. Nepal’s domestic banks and financial ser- common entry points to improving gender equality
vices institutions are highly fragmented and require and social inclusion outcomes in the energy, transport,
consolidation to enable more efficient deployment and urban sectors exist: (i) incorporating gender-spe-
of capital. Banks in Nepal have a small capital base, cific features in infrastructure design, (ii) requiring
which limits lending to individual projects. Due to minimum representation of women in construction
an asset-liability maturity mismatch, banks have lim- and non-construction activities in projects, and (iii)
ited ability to lend in the long term. Identifying a collecting gender-disaggregated data on the use of in-
“champion” government commercial bank (for ex- frastructure services.
ample, Nepal Bank Limited) that can take national
leadership in the domestic commercial bank lending Key priorities for environmental and social issues
market where new tenors, structures, and products within infrastructure development include the pro-
may be deployed (outside a development finance in- tection of cultural heritage and indigenous peoples;
stitution (DFI)) may help address this issue. labor management, including labor health and safe-
ty; land acquisition; slope instabilities (landslides
In addition, the fixed-income and equity capital and erosion); forests, wildlife, and biodiversity;
markets require the government’s attention. The integrity of river ecology and environmental flow;
primary market for government bonds is available and waste management and pollution. It is impera-
for corporates and retail customers, but these bonds tive that environmental and social protection and the
are not often traded, and there are few investors out- resilience and adaptability of infrastructure assets are
side financial institutions. The lack of active trading taken into account when projects are planned and se-
results in no meaningful yield curve. Equity capital lected. To do so, compliance with already existing en-
markets are small. Foreign investors/lenders should vironmental and social frameworks can be improved.
be encouraged to invest/lend in foreign currency, Furthermore, it is recommended that Nepal reviews
which is currently not the case due to the provisions the forest clearance processes and improves legislative
of the Banks and Financial Institutions Act. Obtain- provisions for land acquisition and land entitlements,
ing a sovereign credit rating in the short-to-medium to protect project-affected persons and intangible cul-
term could help the government gradually gain access tural heritage. Other measures include improvement
to funding in international bond markets. Alternative of the protection of workers in infrastructure projects
sources of financing could be developed, including a (table ES.1). Energy Sector
xii
Energy Sector pace, electricity sector investments will need to ac-

The electricity sector is one of the most strategical- celerate substantially to an average of US$1.3 billion
ly important areas of Nepal’s economy for two rea- to US$2.1 billion annually between 2018 and 2040.
sons. First, the lack of adequate electricity is a barrier
to higher economic growth and, accordingly, increas- Nepal has historically relied on a mix of public and
ing access to electricity will pay significant economic private financing in the electricity sector. A twofold
dividends. Second, Nepal’s vast hydropower potential to fourfold increase in public and private investments
creates an opportunity for the country to earn reve- is needed to meet the projected demand in the coun-
nues by exporting power to the South Asia region. try and utilize the sector’s export potential. Bearing in
Recognizing this, the Government of Nepal has set mind the risks associated with both types of financing
an ambitious target of installing 3 gigawatts (GW) of and the importance of careful risk assessment before
generation capacity in three years, 5 GW in five years, deciding on one or the other, the country must not
and 15 GW in 10 years. Recovering from a severe only efficiently utilize existing sources of financing,
electricity crisis, despite moderate economic growth, but also develop the capacity to access new sources
Nepal’s electricity demand has risen rapidly. To keep of financing from domestic and international capital
TABLE ES.1: CROSS-CUTTING AREAS – SHORT-TERM PRIORITY ACTIONS (UP TO 3 YEARS)

Governance and Create infrastructure unit to drive strategic planning and delivery of priority projects; establish public invest-
public investment ment management mechanism; create processes for project screening, selection, and prioritization; establish
management budgeting mechanisms; establish performance management reporting; develop FCCL management framework;
and establish internal audit systems.
PPPs Enact PPPI Act; develop PPP Guidelines; develop PPP project pipeline; establish clear institutional setting;
resource the PPP Centre; harmonize existing PIM/PPP processes; develop PPP FCCL framework; roll out commu-
nication strategy; strengthen disclosure of information framework and communicate key information on the PPP
Centre website.
Financial sector Stimulate consolidation of the local private commercial bank market: Increase paid-up capital requirements to
NPR 16 billion.
Develop the domestic banking sector’s capacity to finance infrastructure projects: Provide training to progres-
sive local commercial and development banks; and issue and implement a code of best practice for infrastructure
project financing.
Increase the availability of long-term financing: Permit state-owned/led banks to offer partially amortizing
loans for 7-to-10-year tenors supported by a Government of Nepal/MDB refinancing guarantee instrument; and
provide relief from restrictions to domestic and foreign lenders taking full charge of key assets of projects.
Stimulate participation of foreign lenders and investors: Provide foreign lenders pari-passu treatment with lo-
cal lenders; provide relief from approvals from the Department of Industry and NRB for foreign lenders providing
limited recourse project finance to priority projects in specific infrastructure subsectors; obtain sovereign credit
rating; establish a hedging facility within a DFI with Government of Nepal/MDB support; and amend FITTA and
Foreign Exchange (Regulation) Act 1962 to ease entry and exit restrictions.
Consider developing alternative sources of financing: Consider developing a Nepal infrastructure DFI (NIDFI) to
(i) provide debt and equity financing and risk management instruments, and (ii) provide HIDCL access to capital;
and issue guidelines for the use of hybrid instruments.
Gender Incorporate gender-specific design features in infrastructure; ensure minimum representation of women in
construction and non-construction activities in projects; and collect gender-disaggregated data on the use of
infrastructure services.
Environmental and Review and simplify forest clearance guidelines; prepare national guidelines for determination of environmental
social flow; revise EPA, EPR, and EIA Guidelines to strengthen the Environmental Assessment system and capacity;
conduct a capacity needs assessment in the context of federalism; improve compliance with established Acts
and regulations for managing environmental and social risk; draft the Land Use Act; introduce a performance
indicator on compliance with inclusive programs for new projects; and improve consultation with, and participa-
tion of, indigenous peoples affected by infrastructure projects.
Note: DFI = development finance institution; EIA = Environmental Impact Assessment; EPA = Environment Protection Act; EPR = Environment Protection
Regulation; FCCL = fiscal commitments and contingent liabilities; FITTA = Foreign Investment and Technology Transfer Act; HIDCL = Hydroelectric Invest-
ment Development Company Limited; MDB = multilateral development bank; NIDFI = Nepal infrastructure DFI; NRB = Nepal Rastra Bank; PIM = public
investment management; PPP = public-private partnership; PPPI = Public-Private Partnership and Investment Act.
xiii
markets and investors, including institutional inves- provide confidence to private investors that they will
tors. be treated fairly in a rule-based sector and increase
investments.
Public and private financing will be key for ad-
vancing the sector, and appropriate solutions will Pillar 2: Strengthen the financial viability of the sec-
have to be sought based on value-for-money and tor. The financial situation of Nepal’s electricity sector
least-cost planning. The domestic private sector and has been very weak in the past. Yet, a sustained focus on
financial sector can continue to take the lead in the increasing revenue, reducing system losses, and financ-
development of small hydropower projects and solar ing costs will be necessary to enable the NEA to meet its
and wind energy projects. There is also potential to obligations and maintain robust financial health. This
mobilize private investments in transmission. The can be achieved through policy actions to (i) improve
public sector, with multilateral assistance, will have the creditworthiness of electricity sector institutions,
to play a strong role in structuring these projects, us- including through cost-reflective tariffs, reduction of
ing long-tenor public financing and risk mitigation transmission and distribution losses, and the NEA im-
instruments to leverage financing from local and in- plementing its financial viability plan; and (ii) strength-
ternational investors and capital markets. It will also en the enabling conditions for electricity trade with
be important to create an enabling environment for Nepal’s neighbors through establishing the appropriate
foreign investment and financing to flow into the sec- legal, regulatory, and institutional environment.
tor in a sustainable way, while managing fiscal com-
mitments and contingent liabilities risk. Suggested Pillar 3: Increase the availability of long-term fi-
interventions in the electricity sector are outlined as nance. Electricity sector projects would benefit from
follows: greater availability of long-term, fixed-interest local
currency finance through the domestic debt and capital
Pillar 1: Build the institutional and regulatory markets. However, at present it is not possible to mobi-
environment. There is a need to build the capacity lize significant amounts of local financing, due to vari-
of new public sector agencies in the electricity sector able interest rates, short tenors, inefficient regulations,
and assist them in mobilizing financing, including and low capacity. First, addressing these will call for a
private and commercial financing. To improve pub- concerted effort to deepen and broaden Nepal’s capital
lic investment management, it is suggested that Ne- markets as an alternative channel of long-term finance,
pal establishes a well-resourced central coordination by addressing the capacity constraints faced by local
mechanism, ideally in the Prime Minister’s Office. In commercial banks and enabling non-recourse project
addition, it is necessary to strengthen the planning finance. Second, Nepal is advised to strengthen sub-
function to improve decision making. An effort to stantially the Hydroelectric Investment Development
incorporate a planning culture, coupled with regu- Company Limited’s capacity to support hydropower
larly updating the river basin plans and generation, development in the country, and to support greater in-
transmission, and distribution masterplans, is neces- vestment from institutional investors. Finally, there is a
sary. Furthermore, there is a need for creating a level need for creating conditions that would enable Nepal
playing field in the private sector, as private indepen- to raise financing from capital markets as needed.
dent power producers are expected to bring large-
scale investments in hydropower generation, but are Pillar 4: Develop an enabling environment for for-
disadvantaged in transmission access, dispatch, and eign investments. It is advisable that the government
Public Procurement Act negotiations with the Ne- undertakes targeted policy actions to increase the role
pal Electricity Authority (NEA), which prioritizes its of foreign investors and financiers in the sector while
own power plants. In addition to structural reforms, closely monitoring the fiscal commitments and con-
Nepal needs to develop a strong regulator by making tingent liabilities that arise from such arrangements.
key appointments in the near term and supporting Until Nepal’s capital markets are sufficiently developed
its institutional development in the medium term. to support market-based hedging instruments, such as
An efficient and effective regulatory framework will cross-currency swap transactions, it is recommended
xiv
that the country takes the following steps. First, the for basic daily goods and services. Therefore, the key ob-
Nepal Rastra Bank would establish a hedging facility jective of Nepal’s transport sector in the medium term
to reduce foreign currency risks and help attract for- will be to address effectively chronic underinvestment,
eign finance for projects. The regulator would incorpo- to improve connectivity, reduce travel time, and improve
rate provisions in electricity tariff guidelines that allow safety.
automatic pass-through of normal foreign exchange
devaluation costs in electricity tariffs. Second, learning Sustainable and affordable transport infrastruc-
from past efforts, Nepal can facilitate foreign invest- ture is necessary for Nepal, and it will require judi-
ment and financing by establishing a one-stop window cious use of public and private sector resources. For
for obtaining all government clearances for private roads, achieving all-weather connectivity to district
sector investments above NPR 10 billion (equivalent headquarters, ensuring adequate lane capacities in all
to US$88.5 million). The single window must be well high-density highways, and improving road safety are
resourced and have political support at the highest lev- crucial goals. For airports, Nepal seeks world-class air-
els of the government. Third, to facilitate borrowing ports in Kathmandu and Pokhara, encourages region-
in foreign currency, the government would address al air transportation, wishes to make airports disas-
foreign lenders’ rights by facilitating the enforcement ter-ready, and aims to conform to International Civil
of collateral through local agent banks, and ease lim- Aviation Organization standards on safety and airport
its on foreign currency borrowings. This will enable operations. For urban transport, enhancing road den-
greater participation by foreign lenders and access by sity in the Kathmandu Valley, establishing efficient
investors to broader and competitively priced sources public systems for mass movement, maintaining road
of funding. To ease restrictions on foreign ownership safety, and planning for disaster management are key
and borrowings by domestic investors, the government goals. Achieving these goals will require the following
would facilitate foreign exchange–related transactions, focused policy interventions:
including foreign investment–related funds transfer
and repatriation, and promote the orderly develop- Pillar 1: Strengthen the legal, regulatory, and insti-
ment of a foreign exchange market. Fourth, to increase tutional framework for the road sector. It is advisable
foreign investors’ confidence, along with harmonizing that the Government of Nepal improves the planning,
legal and regulatory inconsistencies and improving the prioritization, and funding practices of public and pri-
legal framework for FDI, the government would equip vate projects, and strengthens institutional and corpo-
the current legal system with experts who are capable rate governance arrangements for the road sector.
of handling FDI-related issues and disputes. Fifth, it
is also important to listen to investors’ concerns about Pillar 2: Improve the Strategic Roads Network
the current dollar power purchase agreement/project through a programmatic approach. Within the
development agreement and the gaps therein, and to Strategic Roads Network, the government may fo-
consider improving certain aspects for improved bank- cus attention on the most important elements of the
ability and attracting greater FDI. network through a programmatic approach to con-
struction and maintenance. Such pathfinder projects
could be used as test cases to help shape the legal and
Transport Sector policy changes that may be required, as well as the
The transport sector is vital for Nepal’s development. contract arrangements to implement them.
Safe roads and airports help connect the population to
markets and opportunities. The tourism sector, which Pillar 3: Strengthen the airport sector. Given the de-
contributes over 8 percent to Nepal’s GDP, and is there- velopment of new airports and the planned upgrade
fore one of the country’s biggest job creators, also relies of the existing Tribhuvan International Airport, this
heavily on adequate connective infrastructure. Cur- is an opportune time for the Government of Nepal to
rently, however, roads are often congested, not properly partner with the international private sector to deliver
maintained, and often result in high vehicle operation airport management and operations expertise to run
cost. Consequently, the population pays higher prices its airports in a safe, efficient, and profitable manner.
xv
In addition to exploring PPP options for individual In the SWM subsector, the National Urban Devel-
areas of operations, there is also significant potential opment Strategy aims to promote integrated SWM
for full-scale private management of selected airports. projects, wherever feasible, as well as a cluster-based
Separating regulatory and operational duties in the approach to achieve economies of scale. In the water
sector will further help strengthen the sector. supply and sanitation subsectors, minimum water
provisioning, water security, and sanitation coverage
Pillar 4: Strengthen the urban transport sector. are articulated as part of the sector objectives. Recom-
Undertaking a detailed and comprehensive assess- mended interventions in the urban sector focus on
ment of the needs and opportunities in the sector is the following three pillars:
suggested.
Pillar 1: Improve the creditworthiness of local gov-
ernments (one to three years). The urban sector will
Urban Sector not attract additional necessary capital unless local
Nepal is one of the world’s least urbanized and governments can demonstrate their creditworthiness.
fastest urbanizing countries. This intense pressure Therefore, it is imperative to strengthen the technical,
on core urban infrastructure creates an important financial, and managerial performance of local gov-
challenge: how can Nepal provide urban infrastruc- ernments, to enhance their borrowing capacity and
ture services to its citizens in a more effective man- ability to make timely payments to vendors and PPP
ner? The answer will lie in the nation’s ability to solve partners. Subnational borrowing will also require a
problems creatively, strengthen the capacity of its well-designed legal and regulatory framework. Al-
government, and encourage a mindset for efficiently though the process of improving creditworthiness is
managing public resources. likely to extend beyond five years, the process should
to be initiated over the next one to three years.
The paramount challenge facing Nepal’s urban in-
frastructure sector is the ongoing transition to fed- Pillar 2: Encourage PPPs in the urban sector
eralism. To overcome this challenge, it is imperative (short and medium term). Although a few PPP
that the federal government works with local govern- projects involving public funding and private man-
ments to provide clarity on how the legal and reg- agement could possibly be implemented over the
ulatory frameworks affect various stakeholders, the next few years, private sector investments in urban
division of responsibilities between the various levels sector projects will increase only if sector viability is
of government, and how resource distribution occurs established in the form of adequate user charges and
within the new structure. The top priority is to cre- a stable and conducive regulatory framework. Local
ate an enabling environment for local governments governments are responsible for solid waste, water
to take charge of their responsibilities under the new supply, and sewerage under the new Constitution.
Constitution. Nepal’s short-to-medium-term focus Therefore, it is recommended that the government
should be to complete the process of transferring establishes greater clarity about the responsibilities of
functions to local governments and amend/enact local governments entering into and regulating PPP
new legislation to ensure clarity and less ambiguity arrangements. In the medium term, consideration
in taxation powers, functional responsibilities, and could be given to establishing PPP centers in select-
regulatory roles, in addition to compliance with the ed key municipalities as well as allowing local gov-
new Constitution. ernments to tap into national-level funds, including
viability gap funding, project preparation funds, and
The solid waste management (SWM) and water land acquisition revolving funds.
supply and sanitation subsectors in four cities—
Kathmandu, Pokhara, Damak, and Lahan—were Pillar 3: Establish a framework for local government
examined. The National Urban Development Strat- borrowing (three to five years). In light of the ongoing
egy includes key objectives in all three subsectors. devolution process, in the medium term, the govern-
xvi
ment could support interventions aimed at improv- tion and regulations. The framework should enable
ing the “bankability” of urban projects. This would local governments to tap into appropriate blended
include obtaining credit ratings of local governments, financing, for example, from commercial, bilateral,
developing a policy framework for local government and multilateral sources, and capital grants through
borrowing, as well as developing appropriate legisla- intergovernmental fiscal transfers.
TABLE ES.2: SHORT-TERM PRIORITY ACTIONS – SECTORS

Energy Institutional and regulatory environment: Address capacity constraints in the private sector; prepare business plans
for new institutions; carry out a diagnostic of NEA; outsource certain functions; corporatize distribution companies/
explore options for private sector participation; develop bidding framework for PPP procurement; adopt competitive
bidding guidelines for hydropower and solar; establish central coordination and investment management mechanism;
prepare river basin plan; and prepare least-cost generation and distribution masterplan.
Financial viability of the sector: Issue new electricity tariff guidelines; approve Loss Reduction Masterplan; implement
NEA financial viability action plan; adopt electricity trading as a licensed activity; issue open-access guidelines, trans-
mission guidelines, and grid code; and adopt NPTCL business plan and operating procedures.
Availability of long-term finance: Improve capacity of domestic banks; make legal/regulatory revisions to enable
non-recourse project finance; undertake twinning arrangements for HIDCL with similar institutions in more advanced
countries; adopt capital increase plan for HIDCL; issue revised investment guidelines to increase opportunities for
insurance companies; develop strategy to raise financing from international and/or local capital markets using risk
mitigation instruments; prepare strategy to pursue equitization of public shareholding in generation entities/assets;
prepare bond market development roadmap; and prepare communication program on share investments in hydropower
targeted at retail investors and local communities.
Enabling environment for foreign investment: Adopt foreign exchange hedging guidelines; develop guidelines for
addressing foreign exchange risks in IPPs with FDI components; adopt regulations to facilitate equitable treatment of
foreign lenders and increase limits on foreign currency borrowings; adopt framework to manage large PPP investments
through a one-stop shop; and improve capacity of the legal system to manage FDI issues and disputes.
Transport Roads: Prepare a National Transport Masterplan; allocate sufficient budget to projects; improve capacity and business
processes in MOPIT; identify high-priority corridors through prioritization; ensure adequate funding for programs and
establish credible financing plans; adopt suitable contracting structures; develop five-year annual road management
plan; introduce performance-based program for road maintenance; create sustainable funding to support RBN; and
produce and publish annual report for RBN.
Airports: Enact an Integrated Civil Aviation Bill; separate OpCo from CAAN; develop appropriate regulatory models;
prepare 10-year business plans for hub airports; prepare model O&M contracts; launch O&M contracts for upcoming
airports and Tribhuvan International Airport; launch development of the Second International Airport.
Urban: Undertake comprehensive assessment of urban transport in Kathmandu.
Urban Creditworthiness of local governments: Pass appropriate legislation governing the local government functional domain
to ensure consistency with the new Constitution and Local Government Operations Act 2017; build capacity; implement
common accounting standards; improve own-source revenue collection; implement a multi-year fiscal transfer system;
prepare long-term capital investment plans; and improve project planning, procurement, and execution.
PPPs in the urban sector: Pass the PPP Act and/or other legislation and guidelines with adequate recognition of the
constitutional role of local governments in the urban sector; and clarify the roles of various institutions involved for
entering into contractual arrangements with the private sector.
Framework for local government borrowing: Evaluate local government financial performance as a precursor to the
credit rating process.
Note: CAAN = Civil Aviation Authority of Nepal; MOPIT = Ministry of Physical Infrastructure and Transport; O&M = operation and maintenance; PPP = pub-
lic-private partnership; RBN = Roads Board of Nepal.
xvii
xviii
SECTOR ASSESSMENT PROGRAME
ROADMAP FOR INFRASTRUCTURE DEVELOPMENT
1
2
Introduction
Despite several severe shocks in the past—conflict, fiscal constraints will inhibit the government from ful-
unstable governments, earthquakes, and trade dis- ly publicly financing its infrastructure needs.
ruptions—Nepal has made strong progress in re-
ducing poverty and boosting shared prosperity. For Nepal to achieve its growth aspirations, it must
With the decade-long peace and constitutional pro- close the infrastructure gap. By 2022, Nepal wish-
cess concluded, the Government of Nepal is keen to es to graduate from least developed country status,
accelerate economic growth and become a middle-in- and soon after to achieve its vision to become a mid-
come country by 2030. Between 1996 and 2011, the dle-income country. However, currently, Nepalese
proportion of households living in extreme poverty citizens do not have reliable and adequate access to
fell from 46 to 15 percent. Nepal’s macroeconomic infrastructure services. For real benefits to accrue, the
fundamentals have remained sound. quality and sustainability of services need to improve,
with substantial and efficient investment. Under the
Nepal’s historic transition to a federal state system is right conditions, infrastructure development can play
expected to increase public expenditure, partly due a role in promoting growth and equity by providing
to higher infrastructure spending, but the stock of access to basic services, jobs, and markets. In a geo-
public debt is projected to remain low. In 2017, Ne- graphically challenged country like Nepal, it will also
pal transitioned to a federal state system, with about help create reliable supply chains, allowing for more
3,400 village development councils consolidated into efficient movement of goods and services.
753 local government units. In the next three years
(2019–21), on average, total expenditure is likely Investment needs are quoted at 10-15 percent of
to grow by 3-4 percent of gross domestic product GDP annually in the next decade, and they will re-
(GDP) per year, because of the implementation of quire timely and appropriate solutions. The govern-
the federal structure. In addition, increased borrow- ment recognizes the magnitude of the infrastructure
ing of around 5 percentage points (between 2018 and gap and the urgency of addressing it. However, de-
2021) is required. However, despite the projected in- spite a relatively low debt-to-GDP ratio, meeting the
crease in the fiscal deficit, the stock of public debt is required investments is a challenging goal for Nepal.
projected to remain low, increasing from 30 percent Although public investment will continue to play a
in FY2018 to 36 percent by FY2021. key role for infrastructure delivery, a stronger empha-
sis on private sector participation in the infrastruc-
Although the government’s prudent fiscal manage- ture sectors could increase efficiencies by introducing
ment and revenue collection have played a part in private sector management expertise, technologies,
keeping debt levels low, underspending of capital and competition, and by transferring risks. No mat-
expenditures has been a factor. The system runs into ter the delivery mechanism, value-for-money should
chronic underspending of the capital budget, with be at the forefront of decision making.
spending averaging about 70 to 80 percent. According
to the list of projects compiled from the Annual Devel- This Infrastructure Sector Assessment Program is a
opment Plans of the National Planning Commission, structured diagnostic and pragmatic joint planning
projects have been ongoing on average for more than exercise that informs how Nepal, in partnership
11 years. In addition to delays, cost overruns mark the with the World Bank, can improve infrastructure
delivery of infrastructure and services. The lack of ca- access and performance through mobilization of ap-
pacity to spend efficiently and effectively and future propriate solutions—public, private, or a combina-
3
tion of both. The exercise requires assessing and sys- options, the report recommends interventions that
tematically addressing how infrastructure is planned, combine short-term and longer-term structural and
procured, delivered, funded, financed, and governed, policy changes with tailored project implementation
and how markets are operating, at the country and approaches. The report draws heavily on existing
sector levels. Strengthening this “upstream” environ- documents, in particular ongoing World Bank Group
ment contributes directly to sector performance and work, such as the Country Private Sector Diagnostic.
is integral to a “cascade approach” to infrastructure
financing and delivery—in which the potential for It is an opportune time to explore private sector
commercial financing is optimized and public and solutions for infrastructure development in Nepal.
concessional resources are deployed judiciously. The report takes place as Nepal transitions to a feder-
al structure. This poses a unique and unprecedented
Against this background, this report assesses the opportunity to establish clarity over functions, expen-
energy (electricity generation, transmission, and ditures, and revenue assignments, as well as changing
distribution), transport (roads, airports, and urban jurisdictions across various levels of governments and
transport), and urban (water supply, sanitation, and agencies, including as they interface with the private
solid waste management) infrastructure sectors. The sector. The new government is in place and empha-
report includes a diagnostic analysis of the conditions sizing the need for stronger cooperation between the
and constraints for investment in infrastructure: at public and private sectors. Completing projects will
the sector level, for each priority infrastructure sec- help stress test the framework and system and iden-
tor or subsector, and at the country level, considering tify potential bottlenecks that can be corrected. Such
the broader macro-fiscal, market, and governance en- a learning-by-doing approach will further help prior-
vironment. Based on this assessment of the current itize the implementation of the initiatives proposed
state of infrastructure and the binding constraints by this report and target capacity development initia-
on pursuing the preferred financing and delivery tives on the areas of most need.
4
5
Country Environment
The analysis of the country environment assesses 2017, the worst flood in decades contributed to a
“cross-cutting” areas that are key for sustainably reduction in the agricultural growth rate, translating
maximizing finance in the energy, transport, and to a reduction in overall GDP growth from 7.9 to
urban infrastructure sectors. These areas are (i) the 6.3 percent. With continued growth in hydropower
macro-fiscal environment, (ii) the governance and capacity as well as earthquake reconstruction activi-
public investment management environment, (iii) ties, the construction and industry sectors continued
private participation in infrastructure and infrastruc- to expand to meet the demand gap. On the demand
ture finance, (iv) the financial sector and investment side, investment contributed the most to growth.
environment, (v) gender equality and social inclu- Gross fixed capital formation reached 30 percent of
sion, and (vi) environmental and social management. GDP in FY2018, with over 80 percent of this in-
For each area, an overview and a section on key con- crease coming from private investment. However,
straints are provided. The end of the section provides consumption will continue to ease with a slowdown
a table of key recommendations, with corresponding in remittances.
short- and medium-term actions.
The share of remittances in GDP continues to
decline and was estimated to reach 23.4 percent
Macro-Fiscal Environment in FY2018. The main destinations for Nepalese mi-
grants are countries in the Gulf (Qatar, Saudi Arabia,
Overview and the United Arab Emirates) and Malaysia. Fol-
Nepal’s macroeconomic fundamentals have re- lowing the oil price slump in 2014 and subsequent
mained sound despite severe shocks in the past, austerity measures in host countries, the demand for
including conflict, unstable governments, earth- migrant workers from Nepal weakened.
quakes, trade disruptions, India’s demonetization,
and introduction of the general services tax. Ne- Deposit mobilization eased due to the slowdown
pal’s nominal GDP reached US$28.81 billion in July in incoming remittances, leading to a squeeze on
2018, compared with US$24.9 billion the previous the availability of loanable funds in banks. Credit
year.1 A projected increase in the fiscal and current ac- growth in February 2018 stood at 16.7 percent (year-
count deficits is supporting the needed spending for on-year), a significant decline from the peak of 31.9
reconstruction following the floods and earthquake percent in February 2017. The credit-to–core capital
and the transition to a federal structure (including and deposit ratio of the banks (capped at 80 percent)
transfers to subnational governments). Although reached 78.1 percent in January 2017. The Nepal
increased borrowing of around 5 percentage points Rastra Bank (NRB) responded by introducing tem-
(between 2018 and 2021) is required, the nominal porary restrictions on bank lending and temporarily
share of debt to GDP will remain below 40 percent. changed the method of calculating the credit-to–core
In addition, a drawdown of reserves to the level of capital and deposit ratio of banks. Although these
five months of imports over the medium term and measures provided breathing space for banks, the
reliance on concessional borrowing and grants will fundamental issue of the credit crunch persists.
support the needed investments and spending for re-
construction and decentralization. Political risks are The banking sector remains adequately capital-
partially mitigated by the new government being in ized, with an estimated capital adequacy ratio of
place and committed to federalism. In mid-August 14.1 percent, compared with 14.72 percent in
1 IMF DataMapper, 2019; World Bank Open Data, 2019
6
FY2017. The capital position of banks has improved a part in keeping debt levels low, revenue collection
significantly, because of the retention of earnings, is- has been the key factor (annual growth of revenue of
suance of rights to shares, and mergers to meet the 0.5 percent of GDP), coupled with under-execution
new capital requirement of NPR 8 billion. The non- of capital expenditure. The Joint World Bank–Inter-
performing loan ratio remains low, at 1.74 percent of national Monetary Fund Debt Sustainability Analysis
the total loan portfolio (although it increased slightly (2017) maintains the “low” risk rating of debt distress.
from a historic low of 1.54 in FY2017). Loan loss The baseline macroeconomic projections underlying
provisions are more than adequate to cover the im- this Debt Sustainability Analysis assume a pickup in
paired assets. government spending and an increase in deficit levels
over the medium term. However, Nepal’s risk of debt
Nepal’s transition to a federal state system is ex- distress is expected to remain low in view of the contin-
pected to increase public expenditure, partly due ued high level of concessionality of official borrowing
to higher infrastructure spending. In March 2017, and limited scaling up of capital spending due to weak
Nepal transitioned to a federal state system, with implementation capacity. In addition, the government
about 3,400 village development councils consol- remains committed to fiscal prudence and recent-
idated into 753 local government units. Govern- ly formed the high-level Public Expenditure Review
ment spending as a percentage of GDP jumped by Commission to carry out a spending review and sug-
5.5 percentage points between FY2016 and FY2017, gest measures to cut spending, particularly consider-
primarily driven by a higher wage bill, larger trans- ing federalism. Under the baseline scenario and stress
fers to local bodies to implement federalism, and tests, the indicators of the public external debt stock
earthquake-related cash assistance and reconstruction and public debt service ratios remain well below the
activities. The transfers to local governments are es- policy-dependent indicative thresholds (figure 1).
timated to increase to around 5 percent of GDP per
year over the medium term (compared with 3 per- Since the 1950s, Nepal’s state-owned enterprises
cent in 2017). This is expected to increase to 7 per- (public enterprises) have played a strategic role in
cent of GDP beyond FY2021. In the next three years the government’s social and economic development
(2019–21), on average, total expenditure is likely to plans. To drive growth, the government adopted a
grow by 3-4 percent of GDP per year, because of the series of five-year economic plans, in which public
implementation of the federal structure. Although enterprises were established as the principal drivers in
there is considerable uncertainty around the scope building infrastructure, stabilizing prices, supplying es-
and pace of the implementation of fiscal federalism sential goods, and creating jobs. Subsequently, during
(particularly given underspending), higher spending the 1970s and 1980s, the government established pub-
is expected because of: (i) the establishment cost for lic enterprises in almost all sectors, with international
state and local governments, (ii) increased infrastruc- assistance. Nevertheless, underperformance and limit-
ture spending by state and local governments, and ed efficiency led to a policy shift toward privatization
(iii) additional fund transfers for decentralized service in the 1990s. The 1991 Privatization Policy and the
delivery. 1994 Privatization Act initiated asset sales, equity sales,
and liquidations of public enterprises. By the end of
Despite the projected increase in the fiscal deficit, 2008, the government had fully or partially privatized
the stock of public debt is projected to remain low, 30 public enterprises. Public enterprises operate in
increasing from 30 percent in FY2018 to 36 per- most key sectors of the economy and are prominent in
cent by FY2021. Public debt as a share of GDP has the energy, financial, and utilities sectors. Eleven of the
fallen dramatically, from around 64 percent in 2002 41 public enterprises in Nepal belong to the financial
to around 27 percent in FY2017. Although prudent sector and hold 62.37 percent of the public enterprise
fiscal management by the government has played sector’s total assets.
7
FIGURE 1: INDICATORS OF PUBLIC/PUBLICLY GUARANTEED DEBT UNDER ALTERNATIVE SCENARIOS,

FY2017–FY2037
a. Debt accumulation b.PV of debt-to-GDP + remittances ratio
5.5 52 40
51
4.5 30
50
3.5 49
20
2.5 48
47 10
1.5 46
45 0
0.5
44
0.5 2017 2022 2027 2032 2037 -10
43
1.5 42 -20
Rate of Debt Accumulation
2017 2022 2027 2032 2037
Grant equivalent financing (% of GDP)
Grant element of new borrowing (% right scale)
c. PV of debt -to-export + remittances ratio c. PV of debt -to-revenue ratio

150 300
250
100
200
50 150
100
0
50
0
-50
-50
-100 -100
2017 2022 2027 2032 2037 2017 2022 2027 2032 2037
e. Debt service -to-exports + remittances ratio f. Debt service -to-revenue ration

20 25
20
15
15
10
10
5
5
0 0
-5 -5
2017 2022 2027 2032 2037 2017 2022 2027 2032 2037
Baseline Historical Scenario Most extreme Shock 1/ Threshold
Source: World Bank/IMF Debt Sustainability Analysis.

Note: The most extreme stress test is the test that yields the highest ratio on or before 2026. In panels b, c, d, and e, it corresponds to a
combination shock, and in panel f, it corresponds to a one-time depreciation shock. GDP = gross domestic product; PV = present value.
8
Constraints and Areas for Reform to subnational governments. This gap will be bridged
Public expenditure and investment are marked by intergovernmental transfers, but weak public fi-
by inefficiencies, compounded by a low level of nancial management capacity at the subnational level
public investment. Nepal’s public investment has will constrain the management and local provision of
averaged 4 percent of GDP, which is below average public services.
among South Asian and low-income countries. From
2001 to 2007, the Incremental Capital-Output Ra- Currently, there are no performance agreements or
tio for Nepal was 5.7, the highest among comparator other monitoring tools in place for public enterprises.
countries, with an unacceptable level of 29 for ener- Memoranda of understanding were used in the past
gy and 9 for transport.2 Inefficiency is manifested as ex ante bilateral agreements between public enter-
in the public investment process, which fails to de- prises and the government, but the government has
liver completed productive assets and infrastructure. gradually moved away from this practice. Ministries
The system runs into chronic underspending of the and regulatory agencies monitor public enterprise
capital budget, with spending averaging about 70 to performance, but the structured systems and tools to
80 percent. Several challenges have led to a lack of do so effectively are lacking. Although external audits
completion and cost and time overruns of projects. of public enterprises’ annual financial statements are
According to the list of projects compiled from the legally required, the 2016 Yellow Book indicates that
Annual Development Plans of the National Planning only two of the seven industrial sector public enter-
Commission, projects on average have been ongoing prises had submitted their audit reports in 2014/15.
for more than 11 years. Some road and irrigation Similarly, only three of the six public enterprises in
projects have been ongoing for more than 30 years. the trading sector, one of the seven in the services
To address the problems faced by various nation- sector, and one of the five in the social sector had
al-level projects, in 2012 the government initiated completed audits.
“national pride projects.” Although this is a recent
development, these projects on average have not been
implemented more swiftly than other projects. Governance and Public
Investment Management
The budget does not sufficiently support service
delivery or allocate resources for development pri- Overview
orities. The main drawbacks include (i) an incremen- Gaps in governance are a key binding constraint.
tal budget preparation process that is not anchored Poor governance is reflected in Nepal’s low ease of
in a strong, multi–fiscal year framework; (ii) low and doing business, which, across indicators, was worse
poor quality of expenditures, manifested in a poor in 2016 compared with 1996. The 2018 Doing Busi-
public investment management process; and (iii) ness report, which ranks 190 countries on the ease of
erratic budget execution. The public financial man- doing business, ranked Nepal low on Dealing with
agement challenges are compounded by the move Construction Permits (157), Enforcing Contracts
toward federalism. Local governments are not yet ful- (153), Paying Taxes (146), Getting Electricity (133),
ly functional. The Public Finance Law has not been and Starting a Business (109), with an overall ranking
voted on yet, although the Parliament has approved of 105.47.3
core bills related to intergovernmental fiscal trans-
fers and other areas. On the revenue side, although Several legal instruments related to good gover-
most buoyant taxes (including the value-added tax, nance have been introduced in Nepal over the past
income taxes, and certain duties) have been assigned two decades, leading to the creation of public bod-
to the federal government, the costliest expenditures ies to monitor and enforce good governance. These
(health, education, irrigation, and roads) are assigned legal instruments and institutions are necessary tools
2 The Incremental Capital-Output Ratio is inversely correlated with efficiency.

3 The 2013 World Bank Enterprise Survey suggests that the number of major business climate issues is unusually high in Nepal. Several issues that were
ranked by more than one-quarter of the respondents relate to governance.
9
but have proven to be insufficient to ensure good The public investment management (PIM) system
governance in Nepal. Political will and commitment in Nepal is missing critical functions, such as proj-
and consensus among political leaders to fight cor- ect screening, prioritization and budgeting, assess-
ruption and maintain good governance can enhance ment and management of fiscal risks, project imple-
the impact of these laws and bodies. The Good Gov- mentation, adjustment of projects in construction,
ernance Act (2008) aims to ensure good governance and monitoring and ex post evaluation.5 The PIM
by making the public administration of the country process in Nepal represents a mix of formal rules on the
accountable, transparent, inclusive, and participato- one hand, and a lack of application of the same rules
ry, and by making its outcomes available to the gener- at various stages of the process on the other. There is a
al public. The Act lays out responsibilities for various disconnect between planning, policy, and budgeting.
authorities, including ministers and departmental Various sectors may develop their own guidance for
heads, for maintaining good governance within their technical screening and appraisal of projects, but the
jurisdictions. Although the Act includes information process is not uniform and—more importantly—does
about acting in case of nonperformance, a clear defi- not form an integral part of financing decisions. Mon-
nition of accountability and a specific provision for itoring of project execution is weak and does not link
punishment are absent. onward financing decisions. The parallel functioning
of the National Planning Commission (NPC) and
Constraints and Areas for Reform the Ministry of Finance (MOF), without an overarch-
Nepal’s political culture needs to be more inclusive ing medium-term expenditure framework, leaves the
and policy driven. The World Bank’s 2017 Risk and capital and recurrent budgets functionally and proce-
Resilience report and the 2017 Country Economic durally fragmented and perpetuates the missing link
Memorandum highlight the need to depoliticize the between multi-year investment and annual needs for
civil service, create a functional incentive system, and maintenance and operation of assets.
improve capacity, particularly at the local level. In ad-
dition, the institutions of the state intended to rein in Policy implementation is slow and requires better
political corruption need to be strengthened. coordination. This is related to misaligned incen-
tives, weak capacity in government agencies, and co-
Public procurement requires increased oversight ordination weaknesses across government agencies.
and accountability. Despite an increase in pub- Government employees face high turnover, limited
lic procurement volume, the Public Procurement delegation of responsibility, and a lack of effective
Monitoring Office lacks adequate capacity, resulting performance evaluation. There is ambiguity about
in weak compliance and enforcement. The Public the roles and responsibilities of different government
Procurement Monitoring Office has not been able agencies, resulting in coordination challenges.
to play a lead role in the enforcement of the Public
Procurement Act/Public Procurement Rules in the Nonfinancial asset management is weak. This in-
face of a challenging governance environment and cludes reporting on nonfinancial assets, which suffers
rising fiduciary risk associated with public procure- from low adherence to international standards of ac-
ment. Nepal’s governance issues have also led to pro- counting.6 Nonfinancial assets usually provide bene-
curement practices and policies that are implemented fits through their use in the production of goods and
inconsistently.4 Global evidence suggests that such a services or in the form of property income.
governance infrastructure increases the chances that
procurement and policies are “captured” by a narrow Recommendations
group of larger firms. Polarized between a few large First, it is recommended that the Government of
business houses and many small firms, Nepal’s private Nepal establishes a central coordination mecha-
sector is prone to this problem. nism for infrastructure. The unit, preferably located
4 World Bank Group, Country Private Sector Diagnostic, 2018.

5 This is compared with a standard World Bank assessment of PIM systems, which identifies eight key institutional features that countries need to adopt to
ensure that public investments support growth and development.
6 Although the Nepal Financial Reporting System, which is based on the International Financial Reporting System, is mandated for most major businesses,
it is not applied. Government accounting is cash-based.
10
in the Prime Minister’s Office, would support (i) stra- plan investment programs and maintenance. The
tegic infrastructure planning; (ii) project screening same applies to nonfinancial assets held by public en-
and prioritization and maintenance of a rolling pipe- terprises, which are significant.
line of priority infrastructure projects; (iii) coordina-
tion of government agencies, the Investment Board
of Nepal (IBN), and the Public-Private Partnership Private Participation
(PPP) Centre (as necessary); and (iv) transparent per- in Infrastructure and
formance monitoring. Depending on province and Infrastructure Finance
project size as well as other criteria, local governments
may or may not work through the centrally coordi- Overview
nated unit. Given low stock of and access to infrastructure,
low-quality service provision, and low levels of
Second, it is recommended that the government spending, there is potential for private solutions,
aims to achieve high-quality screening, appraisal, including private financing to complement pub-
and prioritization of capital projects. This can be lic and concessional sources, including in the en-
done by: (i) strengthening guidelines and processes ergy, transport, and urban infrastructure sectors.
for capital project screening, appraisal, and prioritiza- Generally, public-private arrangements encompass a
tion and introducing sector- and scale-specific guid- range of contract types. Most PPP projects present
ance; (ii) targeting capacity building to implement a contractual term between 20 and 30 years; others
the revised guidelines in the NPC and selected large have shorter terms; and a few last longer than 30
spending ministries; (iii) developing adequate data years. The precise length of the contract depends on
structures to establish an integrated database under the type of project and policy considerations. The
the NPC’s responsibility; and (iv) improving collec- “whole-life” approach, considering whole-life costs
tion of data on the physical and financial progress of and whole-life benefits, maximizes the efficiency of
capital projects for selected subsectors. There would service delivery.7 A shift toward private investment
be merit in the government ensuring that funds are or commercial finance in infrastructure investments,
delivered in full to the amount approved where pub- where relevant, could introduce efficiencies by trans-
lic funding has been approved for an infrastructure ferring risks, inducing competitive pressure, and
body. It is important that the budgeting process is introducing management expertise. For example,
credible and has integrity. This is desirable for inves- PPP models can generate new revenue streams from
tors, particularly where public funding is needed to greater asset utilization, which would in turn improve
co-finance or is a prerequisite for private investment. users’ willingness to pay and facilitate cost recovery.
PPPs can also increase revenue streams through better
Third, it is recommended that the government utilization of user fees by, for instance, creating incen-
manages assets and liabilities better through a tives for operators to maintain roads at a quality level.
multifaceted and phased approach. Effective man-
agement of assets and liabilities ensures that public The Government of Nepal supports scaling up pri-
investments provide value-for-money, assets (particu- vate participation in infrastructure. Infrastructure
larly nonfinancial assets) are recorded and managed, development in Nepal has been traditionally funded by
and fiscal risks are identified and managed. Better government expenditure but, since 2015, the govern-
reporting on fiscal risks involves better monitoring ment has been promoting private sector participation
of fiscal commitments and contingent liabilities of in infrastructure. The 14th Three-Year Plan (2016/17–
public enterprises and subnational governments. 2018/19) provides a policy platform for infrastructure
Maintaining a register of fixed assets would allow the projects, with a focus on developing infrastructure in
government to improve its utilization of assets and the energy, roads, and airport sectors. The importance
7 World Bank, Public-Private Partnerships: Reference Guide Version 3 (World Bank: Washington, DC, 2017), © World Bank. https://openknowledge.
worldbank.org/handle/10986/29052 License: CC BY 3.0 IGO. There is no standard, internationally accepted definition of PPPs, and different jurisdictions
use different nomenclature to describe similar projects. For more information, please refer to the PPP Reference Guide Version 3.
11
of facilitating infrastructure development through nership and Investment Act introduces a PPP Unit
PPPs was further recognized in 2015, when the gov- and an Investment Board. If and where more than
ernment approved a PPP Policy. The policy emphasizes one government entity must be involved, it is imper-
the importance placed on infrastructure development, ative that responsibilities do not overlap and are clear.
particularly the role of private sector participation, and
allows for a range of PPP structures. Priority sectors in- Several issues are primarily related to the lack of
clude physical infrastructure, the electricity sector, the coordination, standardization, capacity, and over-
information and communications sector, the urban sight. A lack of standardized project preparation pro-
and rural environment, education and health-related cesses and contract design prevents PPPs from being
infrastructure and services, and urban amenities. truly effective. In addition, inadequate tender pro-
cedures, characterized by a lack of competition and
Constraints and Areas for Reform transparency, prevent the most qualified bidders from
Although the government passed a PPP Policy in success. There is also a lack of capacity among institu-
2015, Nepal requires additional features for a com- tions to drive the PPP process. More recently, projects
prehensive PPP program. Sector-level regulations are often drawn from unsolicited proposals and con-
and institutions that are conducive to infrastructure ducted in an opportunistic manner rather than being
growth with private sector solutions are missing, embedded in project planning and public investment
and there is no systematic pipeline of projects in key management. The most recent projects that were
sectors. Capacity within line ministries for effective closed (five projects) were unsolicited proposals.
preparation and implementation of projects is in-
sufficient, and the local financing market is subscale Certain bottlenecks deter foreign investors. These
for delivering sufficient financing to a PPP program. include the need for multiple approvals, delays in
There is a pressing need for experience in project fi- capital repatriation above US$10,000, absence of
nance beyond the hydropower sector and a need for clear provisions in Nepalese law to protect the rights
training various stakeholders, including the commer- of foreign lenders on loan collateral assets (exception:
cial bench in the court system, in dispute resolution hydropower projects), challenges to enforce judicial
and the protection of creditor rights. awards against the government, wide-ranging author-
ity of Nepalese courts to revise or revoke the enforce-
PPPs are not new in Nepal, and line ministries ment of arbitral awards (Article 30 of the Arbitration
have been able to procure PPP projects despite the Act), and relatively weak corporate governance and
absence of a uniform PPP Law. A draft Public-Pri- quality of disclosure.
vate Partnership and Investment Act is ready to go
to the Cabinet.8 An initial review of the draft sug- Finally, the combination of previous political in-
gests significant gaps and need for clarity on, among stability and institutional gaps has created a high
other things, institutional arrangements, procedures, level of economic uncertainty for firms, deterring
scope, procurement regime, and contract manage- investment. According to the World Bank’s Enter-
ment mechanisms.9 prise Survey, nearly 49 percent of Nepalese firms cite
political uncertainty as the biggest constraint to their
There is a risk of weakening the market perception business—a share that is considerably higher than the
of and appetite for PPPs in Nepal by having more average for South and East Asia. Most Nepalese firms
than one entity claim it is coordinating, managing, are small and do not have the resources needed to
or leading Nepal’s PPP initiative. At present there survive periods of policy disruption. Their response
are at least three entities: line ministries, the PPP to the uncertainty is to remain small and not under-
Centre, and the IBN. The draft Public-Private Part- take large-scale, risky investments.10
8 As of December 2018.
9 A high-level review of the draft law was conducted and shared with the Government of Nepal.
12
Recommendations
This report recommends a learning-by-doing ap- The type of asset, functions of the private party, and payment
proach to help stress test Nepal’s PPP framework. mechanism are characteristics that can be combined in various
With the PPP Policy in place, the Draft PPP Law in ways to create a wide range of PPP contracts. These contracts can
preparation, and some experience in PPPs, the gov- be thought of as a continuum between public and private provision
ernment can (i) identify, prepare, and complete PPPs of infrastructure—transferring increasing responsibilities and risk
that deliver concrete improvements in the energy, to the private sector. Services contracts, turnkey design-build con-
tracts, and short-term management contracts are not considered
transport, and urban sectors; and (ii) continue mak-
PPPs, as they are generally not performance or output based, nor
ing progress on expanding and solidifying the foun-
do they transfer significant risk to the private sector.
dations of a sustainable PPP program. As Nepal’s
Source: World Bank Group et al. (2017), PPP Reference Guide Version 3.
PPP program matures, further actions can be taken,
including the development of standardized docu-
ments, risk allocation matrixes, and templates, and
a framework for managing fiscal commitments and grate its PIM and PPP processes11 such that bud-
contingent liabilities; the introduction of disclosure geting, affordability, and fiscal impact may be readily
guidance; and the establishment of a Project Devel- assessed and fed into the decision-making process.
opment Facility to provide sustained financing and The initial PPP pipeline would seek to incorporate
quality assurance to project preparation in Nepal. new projects prioritized under the PIM framework,
as well as projects identified as potential PPPs by line
First, it is recommended that the government final- ministries and contracting authorities, which are al-
izes and enacts the PPP Law. Following international ready under discussion and have undergone a PPP
good practice for PPP legislation, it is recommended screening process to assess their suitability for fur-
that the draft law defines PPPs, how the government ther detailed preparation. Under an integrated PIM
will use PPP projects, how PPP projects should be struc- and PPP framework, the government can work on
tured, and what financial support the government may prioritizing PPP investments by allocating financing
lend to a PPP project. Furthermore, the law should be according to risk, with commercial financing taking
as concise as possible in its terminology and only ad- priority (if such financing is available and cost-ef-
dress general principles, for two reasons. First, laws are, fective). This recommendation applies to all three
by their nature, inflexible, and therefore should not sectors covered by this report and is highlighted in
include any details that may subsequently need to be each roadmap. For example, the Transport Sector
adapted to a country’s changing (PPP) needs. Rather Roadmap recommends launching a pathfinder PPP
than including details within the law itself, the PPP Law program for the priority Strategic Roads Network,
should define the need for issuing secondary legislation using a hybrid availability-based payments approach.
(such as regulations), standards, guidelines, and stan- To move this forward, it will be key to plan and prior-
dard contract terms. Second, limiting the law to general itize these projects systematically vis-à-vis other road
principles ensures that the principles are clearly commu- projects.
nicated and understood, and ambiguity is avoided. To
build this consensus, it will be key to communicate and Third, it is recommended that the government cre-
educate stakeholders on the benefits of PPPs and the ates the enabling frameworks and strengthens in-
specifics of the law. stitutional arrangements for PPPs. PPP Guidelines
will be important for clearly articulating the func-
Second, it is recommended that the government tional roles and responsibilities of the PPP Centre
develops a PPP pipeline based on a clearly defined vis-à-vis the contracting authorities. It is essential to
project screening, scoring, and prioritization pro- achieve consensus on the treatment of local projects
cess. In support of the development of a robust PPP and other small projects in the PPP Law and Guide-
pipeline, the government would harmonize or inte- lines. Other areas of clarity include details on effective
11 In many countries, governments have sought to implement a centralized PIM framework to guide the project planning process.
13
commitments to PPPs. An appropriate institutional

framework and methodology will be needed, with the
Nepal has a mixed track record of implementing PPP projects.
MOF playing a key role. Given that FCCL may also
Since 1990, according to the Private Participation in Infra-
structure Database, 40 transactions in Nepal have reached fi-
arise from municipal and local PPPs, the framework
nancial closure, generating a total investment of US$2.5 billion. will need to apply equally to those projects. This will
Thus far, experience with private investment and commercial allow the government to manage and assess all PPPs on
finance in infrastructure has been focused on electricity gen- a programmatic basis, with robust criteria for the ap-
eration, with total investment of active projects ranging from proval of all government financial commitments. The
US$0.5 million to US$200 million per project. The majority of rollout of the FCCL framework should be accompa-
these projects (29) are categorized as small hydropower gen- nied by appropriate training for the relevant agencies.12
eration (<50 megawatts); and seven as large projects (>50
megawatts). Two information and communications technology Fifth, it is recommended that the government
projects are recorded as well as one transport (greenfield high- builds awareness and capacity around PPPs. The
way) project and one water project (management contract).
PPP Centre would need to address public perception
Of the 40 projects, 39 are “active”; one project, NEA Tanahun
and increase stakeholder engagement to ensure that
HPP (financial closure in 2012), is recorded as “distressed.” This
is also the largest project in investment amount (~US$460
bidders and investors know that the PPP Centre is the
million). Of the 40 projects, 24 closed between 2010 and 2017. go-to place for PPP matters in Nepal. To demonstrate
commitment and ownership of the PPP program, the
Source: PPI Database, 2019. government would design, deliver, and implement a
communication plan for PPPs. The communication
strategy should contain detailed content on the govern-
ment’s objectives, an implementation timeline and ap-
procurement and implementation of projects, institu- proach, stakeholder mapping, and key messages for dif-
tional coordination, project preparation, affordabili- ferent stakeholders. The government would undertake
ty, value-for-money and fiscal impact assessments, consultations with market participants and key stake-
details on processing unsolicited proposals, upstream holders on PPPs, to improve the regulatory, delivery,
project screening, and guidance on project disclo- and operating environments and maintain investment
sures. Learning from regional and global examples interest and stability in the market. The government
can support this process. Institutional arrangements would plan and roll out a capacity-building program
need to be strengthened. The PPP Centre needs to be for public and private sector stakeholders. In addition,
sufficiently resourced and have a clear mandate in the there is a need for training the commercial bench in the
PPP environment. Sufficient funding and appropri- court system in dispute resolution and the protection
ate staffing of the PPP Centre with experienced staff of creditor rights. Although some capacity-building
is essential to progress PPPs and ensure consistency of programs have already taken place, following a needs
development. Better collection and disclosure of data assessment, a structured and targeted training should
on the physical and financial progress of capital proj- be designed and offered to relevant stakeholders in-
ects for selected subsectors with large capital spending volved in upcoming projects.
can help to improve project monitoring and mitigate
risks in a timely manner. Under the PPP Centre and/
or the NPC’s responsibility, adequate data structures Financial Sector and the
should be established so that past and ongoing proj- Investment Environment
ects can be properly tracked and monitored.
Overview
Fourth, it is recommended that the government The ongoing Fourteenth Development Plan has ac-
develops a fiscal commitments and contingent li- corded high priority to mobilizing the investment
abilities (FCCL) framework to support the long- required for infrastructure development from pub-
term sustainability of the government’s financial lic and private sources. According to the Develop-
12 Per international best practice, it is recommended that institutional responsibilities and processes for the assessment and management of financial com-
mitments to PPPs are included in the PPP Law prior to its finalization and enactment. If this is not possible, detailed guidance should be included in PPP
14 Guidelines.
ment Plan, of the total investment requirement of the market potential to support hydropower and the
NPR 2,425 billion (US$23.55 billion) in the Four- broader infrastructure sector. As per a U.S. Agency for
teenth Plan period, around 55 percent is expected to International Development study, the domestic banks
come from the private sector. Tapping foreign inves- and financial services institutions have made an invest-
tors and the Nepalese financial system is crucial for ment of US$755.60 million in hydro-electric power
meeting the targeted investment by the private sector. projects, against their full ability to lend US$3,058
million (as of 2016) to the segment.14
Constraints and Areas for Reform
The financial sector currently lacks scale and depth Banks have a small capital base, which limits lend-
and is dominated by commercial banks. The total ing to individual projects. Currently, given pruden-
assets of the financial sector stood at NPR 3,137 bil- tial norms, local banks are unable to finance projects
lion (US$30.46 billion) as of 2018Q1 (mid-October above US$40 million. In the hydropower sector,
2017). Commercial banks account for 86 percent of meeting the levels of planned installed capacity re-
the sector’s assets. As of the end of 2017, bank cred- quires increased capacity for domestic banks to lend,
it to the private sector equaled 77 percent of GDP, increased (ease of ) market access to foreign sources
significantly above the South Asia region’s average of of capital, systematic issuance and trading of govern-
47.6 percent of GDP.13 ment bonds domestically and offshore, and develop-
ment of new sources of capital focused on the infra-
The involvement of institutional investors in Ne- structure sector.
pal is relatively high, but, as in other developing
countries in the region and globally, they lack the Due to an asset-liability maturity mismatch, banks
capacity to underwrite loans to large projects and have limited ability to lend in the long term, as
suffer from regulatory constraints. There are do- evidenced by the 5-to-10-year average tenure of a
mestic institutional investors, including the Employ- term loan. Bank lending is further limited by high
ees Provident Fund, the Citizen Investment Trust, collateral, considerable sponsor support require-
and the insurance sector, but they rely on consortium ments, and a lack of experience and capacity in struc-
partners and lead banks for credit appraisals. Regula- turing, assessing risk, and (leading) financing initia-
tory constraints make investing difficult, increase risk tives for limited-recourse financings.
and costs, and limit profits.
Domestic Debt and Equity Capital Markets
The financial market can only lend limited capital The fixed-income and equity capital markets are
because of several constraints. Infrastructure proj- highly underdeveloped. Although there is some po-
ects face higher interest rates, a result of high-risk tential to raise currency bonds, the market is nascent.
perception, particularly in the hydropower sector. The bond market is almost entirely dominated by
The key risk sources are political risk and process in- Nepalese rupee government debt (>95 percent), of
efficiencies, regulatory risk, increasing credit risk, and which 97 percent is Treasury bills and development
weak corporate governance. bonds. Development bonds dominate volumes and
have durations of between five and 15 years, with an
Domestic Bank Market average duration of around 9.5 years (2017). Howev-
Nepal’s domestic banks and financial services insti- er, issuance tranches are small, at US$40 million to
tutions are fragmented, subscale, and constrained US$45 million and on the rare occasion extend to ap-
in their capacity to finance, including those in the proximately US$75 million. Where they are issued,
electricity sector. Of the 151 bank and financial ser- corporate bonds are available for trading through
vices institution entities that are regulated by the NRB, the local exchange. However, there is no liquidity to
only commercial banks and development banks lend speak of, and pricing remains at or near par, provid-
to hydropower projects. They fall significantly short of ing an unreliable reference.
13 Nepal Rastra Bank’s Monthly Statistics: FINSTATS, 2015.

14 U.S. Agency for International Development (USAID), “Nepal Hydropower Development Project (NHDP): The Role of the Nepali Banking, Financial
Services & Insurance Sector in Financing Hydropower Investment” (Deloitte, 2016).
15
The primary market for government bonds is banks). Other issues include restrictive administra-
available for corporates and retail customers. tive approval procedures for repatriating capital, divi-
These bonds are not traded often and, outside fi- dends, and interest.
nancial institutions, there are very few investors.
Treasury instruments are bought largely by banks The equity capital market environment is weak and
to satisfy statutory liquidity requirements. Some de- unsuitable for private equity investments. Nepal
velopment partners, such as the Asian Development does not have a specific legal and regulatory frame-
Bank (ADB) and International Finance Corporation, work for private equity and venture capital, although
are trying to support raising local currency bonds. As a few private equity funds operate in the country. In
there is no active trading of government bonds, there the absence of a specific framework, a combination
is no meaningful yield curve, as understood in the of laws and regulations (for example, Company Law,
context of international finance. Laws on Banking, foreign direct investment (FDI),
and so forth) regulate private equity and venture cap-
Equity capital markets are small, with a market ital funds. It is unclear whether private equity and
capitalization of approximately US$12 billion venture capital funds can provide capital in the form
(July 2018) and daily trading volumes of ap- of debt rather than equity, given that these funds are
proximately 1.2 million shares across 196 listed not licensed under the Banks and Financial Institu-
companies. Shares in five hydropower companies tions Act. Stock market initial public offering (IPO)
are available for trading and represent around 4 to 5 rules are inadequate for private equity exits for several
percent of the overall market, which has declined by reasons. First, only new shares can be listed—existing
around 22 percent in the past year. Recent missteps shareholders are not allowed to divest their shares at
in well-intentioned technology upgrades have result- IPOs and are subject to a three-year lock-in period.
ed in reduced trading volumes and impacted investor Second, shares can only be priced above book value
confidence.15 if the company has at least three consecutive years
of profits and dividends; even in this case, pricing is
Foreign Capital not determined by the market but by the valuation
The provisions of the Banks and Financial Institu- rules of the NRB. The Securities Registration and Is-
tions Act do not encourage foreign investors/lend- suance Regulation 2016 (2073) allows shareholders
ers to invest/lend in foreign currency. Borrowers are of unlisted shares to exit through an offer document
hesitant to borrow in foreign currency due to cur- and with approval from the Securities Board of Ne-
rency risk and the high cost of hedging. In addition, pal. However, this provision has not yet been tested,
the central bank has set strict limits on lending by and it presents a risk to promoters seeking to offload
foreign institutions, which is allowed only in the case unlisted shares. In addition, there is a limited track
of unavailability of domestic debt and is subject to an record of IPOs outside the banking sector (75 per-
interest rate cap of LIBOR +5.5 percent. Moreover, cent of stocks are financial institution stocks); trading
a foreign lender does not enjoy the same level of pro- volumes are low (US$7 million daily average around
tection as the local banks in terms of creditors’ rights. October 2017); and foreign investors are not allowed
Hence, international lenders have to partner with a to trade actively.
local bank or a consortium under a pari-passu securi-
ty arrangement and would need to depend heavily on Several factors hinder the investment environ-
the capability of a local partner/consortium lead bank ment, including FDI restrictions and procedures,
for debt recovery. Foreign currency lending is further offshore capital repatriation problems, and double
constrained due to the lack of a cost-effective foreign taxation. FDI restrictions and procedures in Nepal
currency hedging facility (except for short-term/trade are stringent, stemming from a general distrust of for-
finance transactions that are offered by commercial eign investment and desire to protect local industries.
15 Automating trading and settlement is a given direction of evolution for young/small exchanges. In the case of Nepal, upgrading the technology for automa-
tion was a positive move, but its execution was poor, resulting in reduced trading volumes (unplaced/missed orders rather than just normal market moves
up or down). When implementing operational advancements in exchanges, this increased risk will naturally cause investors to hold off entering the market
for fear of not being able to enter/exit trades as they would like. This impacts liquidity, which may normalize only once the risk and the perception of the
risk have diminished.
16
Foreign entities are not allowed to invest in the retail and involvement in specific priority projects, could
and trading sector or in a negative list of 21 manufac- be exempted.
turing and services sectors. For sectors that are eligi-
ble, a laborious approval process is in place. Offshore Second, along with consolidation, it is recom-
funds and onshore vehicles with foreign shareholders mended that the government helps ease the
are considered foreign investors. They require FDI nonfinancial constraints faced by the domestic
approval for each investment in a Nepalese compa- banking sector. Capacity building of local banks
ny, despite having sought initial entry as a foreign for underwriting infrastructure project financing is
investor. Approvals are granted by the Department essential, given the low level of knowledge of these
of Industry (Ministry of Industry, Commerce and transactions. It is suggested that the NRB issues
Supplies) and the central bank and can take several a code of best practice for infrastructure project fi-
months. Strict blacklisting rules are in place for the nancing for banks lending to the sector. Best practice
domestic shareholders and directors of any Nepalese would include the application of risk matrixes, clarity
company that defaults on a loan. These include the on and guidelines for pricing credit with special pur-
seizing passports and cessation of any financial activi- pose vehicle structures, and building-in meaningful
ties. For a fund, it implies the cessation of activities if credit protection concepts, appropriate calculations,
only one investment in the portfolio goes sour. This and levels for covenants. A best practice code could
is a major impediment to private equity investments, draw from experience and lessons in the hydropower
which are typically funded with a mix of equity and sector. Furthermore, in the medium term, a “champi-
debt. Nepal has several double taxation agreements, on” government commercial bank (for example, Ne-
but there has been some uncertainty about enforc- pal Bank Limited) would be identified that can take
ing them, which could result in yet another layer of national leadership in the domestic commercial bank
uncertainty for foreign investors when exiting invest- lending market, where new tenors, structures, and
ments. products may be deployed (outside a development
finance institution (DFI)). During the first year, ca-
Recommendations pacity-building efforts would focus on areas such as
First, it is recommended that the government seeks project credit analysis, structuring, and risk manage-
to consolidate the banking sector to enable it to ment. Similar efforts could then be rolled out to other
become a focused and more efficient deployer of banks. The government would expect the champion
capital. At present, the subscale size and high market bank to promote actively and engage in taking lead
fragmentation leads to market destabilizing behavior local currency infrastructure lending roles, includ-
and low loan volumes relative to lending capacity, es- ing those alongside multilateral development banks
pecially to the infrastructure sector. The balance sheet (MDBs), domestic DFIs, and international banks.
size of commercial banks needs to increase to enable In addition, given the new federal structure, it will
them to offer sensible loan volumes to support the in- be essential to prepare banks and nonbanking finan-
frastructure sector. Reducing the number of commercial institutions for subnational financing. This will
cial banks from 28 to fewer than 15 would start to require a degree of decentralization of expertise and
reshape the sector and provide banks with scale and enhancement of risk management capacity.
efficiency to deliver consistent loan volumes. Further
consolidation should be encouraged over the medi- Third, it is recommended that the government
um-term horizon along with partnerships with inter- takes focused measures to increase the availabili-
national banks to achieve up to 10 local banks. This ty of long-term sources of finance for large infra-
can be achieved by increasing the “paid-up capital” as structure investments. These include shorter-term
defined by the NRB to over NPR 16 billion. Banks and longer-term measures. As an example, the provi-
with a clear commitment to lend to the infrastruc- sion of government refinancing guarantees for seven
ture sector, as demonstrated by loan commitments to 10 years, partially amortizing loans in year one to
17
enable tenors to be extended without requiring banks requiring Department of Industry (Ministry of In-
to book longer-tenor loans, could help increase the dustry, Commerce and Supplies) and NRB approvals
availability of long-term finance. The guarantee may would be advantageous for foreign lenders providing
then be limited to longer tenors as the market devel- limited recourse financing to specific infrastructure
ops. Another example would be where a project is subsectors where there is a dearth of public or con-
financed on a limited recourse basis, the government cessional financing relative to the requirement, for
could provide relief from any limitations or restric- example, in energy and transport. Initially, such relief
tions to lenders being able to take full charge over key could be applied narrowly to projects on a priority
(fixed) assets of the project, such as land and build- infrastructure pipeline and, as liquidity and interest
ings. These measures would be instrumental in de- builds, over a two-to-three-year period. Gradually,
veloping a market for longer-tenor financing. Finally, the pipeline condition should be entirely relaxed to
in the longer term, consideration should be given to make it a sector-wide exemption. Third, there should
deepening the debt capital markets and creating a be a move toward market-based loan pricing with the
plausible yield curve over the longer term, through removal of regulatory caps on interest rates charged
assessment of and planning for the cash needs of the to corporate entities involved in and financing the
government. This could be followed by the imple- infrastructure sector. Fourth, hedging facilities to en-
mentation of a systematic program of government able investors to manage liquidity constraints during
Nepalese rupee and U.S. dollar bond issuances at periods of (excessive) exchange rate and/or interest
2-5-10-15-year tenors to a regular timetable, subject rate fluctuations should be established. Such facilities
to fiscal responsibility and prudent budget manage- could be supported by government/MDB funding
ment. To support this, (i) primary dealer(s) should and be managed centrally by the NRB or another
be appointed to allow a market to be made on such suitable entity that has an understanding of foreign
securities involving systematic collection of trading exchange markets. Fifth, the Foreign Investment
data, and publishing relevant parts of it for market and Technology Transfer Act and Foreign Exchange
consumption; (ii) selected tax concessions could be (Regulation) Act 1962 should be harmonized to en-
offered to target holders of new government issuanc- sure consistent interpretation. This could be readily
es; and (iii) in the medium term, and with assistance achieved in the form of supplemental guidance to
from international rating agencies, capacity could be authorities, to ensure rapid harmonization and allevi-
developed within the local rating agency community ate immediate administrative bottlenecks. Legislative
to apply rating methodologies that are more consis- amendments may follow in due course. Sixth, a revi-
tent with those of international rating agencies. sion and expansion should be undertaken of the val-
uation rules for repatriation of proceeds to accommo-
Fourth, it is recommended that the government date infrastructure assets and businesses for varying
enables the participation of foreign providers of types and stages of development, to ensure that infra-
capital as required. To expand the pool of capital structure businesses are optimally valued when they
available to support infrastructure development in are sold or purchased. Seventh, tax rebates should be
Nepal over and above the available public and con- permitted for investors on the portion of proceeds of
cessional financing, the government can take steps a sale that is reinvested (into the infrastructure sector)
to enable and encourage international capital par- within 12 months from the date of completion of the
ticipation. Establishing a conducive environment sale. This would remove a disincentive (or hurdle) for
will require several sequenced actions in the medi- an investor to exit and reinvest, thus hampering the
um-to-long term. The first is regulatory reform to ability of the market to trade infrastructure assets eas-
provide foreign lenders pari-passu treatment with ily and attract additional sources of capital. Eighth,
local lenders for creditor rights in creating and en- private equity/venture capital investment could be
forcing security. Greater comfort for foreign lenders promoted by having a regulatory framework for this
would follow, knowing that they are a senior creditor pool of investors to help them clearly navigate and
on project and corporate lending. Second, relief from implement capital deployment in Nepal. This would
18
include but would not be limited to having the ability progress has been made in addressing GESI issues, a
to establish various fund structures with accompany- lack of awareness hinders progress.
ing tax treatments to attract public and private insti-
tutional investors and retail clients. Constraints and Areas for Reform
Infrastructure development requires combining
Fifth, in the medium term, the government could supply-side issues of technical design specifica-
consider developing alternative sources of financ- tions for provision of infrastructure services with
ing, including a Nepal infrastructure DFI (NID- demand-side dimensions of who uses the infra-
FI). The NIDFI would provide financing to “plug” structure, for what purposes, how it is paid for,
the capital structure of projects with debt and (mi- and with what impacts on individuals, households,
nority) equity capital, as needed. It would initially be and communities. Infrastructure development is not
capitalized to at least US$1.5 billion, primarily with neutral. Policy choices regularly have disparate im-
government and MDB funding, with minority in- pacts on women and other marginalized communi-
terests held by selected international project finance ties. For example, the unequal division of roles in the
banks. This offering would expand to permit hybrid labor market and division of time spent on domestic
instruments as regulators become familiar with its tasks can have an impact on the way in which women
operations, rolling project pipelines for each sector and men use or need certain types of infrastructure.
are established, and NIDFI financing gains momen-
tum. The NIDFI can be established as the implemen- There are several common entry points to improv-
tation arm of an infrastructure unit and act as the ing GESI outcomes within the energy, transport,
counterparty for refinancing guarantees and as the and urban sectors. A key one is building policy and
provider of hedging facilities. In addition to a pro- institutional capacity to address GESI-specific issues.
vider of capital and financial instruments, it could be This can be achieved by training government staff
the go-to entity in Nepal for developing knowledge in key GESI issues and setting minimum targets for
and structuring financial instruments to support the women and other marginalized groups in policy de-
sector. Generally, global experience with such institu- sign and decision making.
tions has been mixed. The establishment of NIDFI
should follow a comprehensive plan that includes Infrastructure design and construction must also
best-in-class governance and decision-making struc- be approached from a GESI-specific perspective.
tures and a strong capacity to monitor and enforce Women and marginalized groups should be included
robust environmental and social standards. in decision making, and targets for employment with-
in design and construction should be set. To facilitate
employment in the sector, women should be provided
Gender Equality and Social with vocational and technical training. In addition,
Inclusion infrastructure should be designed with GESI-specific
physical design features that meet the needs of women
Overview and other marginalized groups.
Nepal’s legal and policy frameworks that govern
infrastructure issues are largely silent on recogniz- Recommendations
ing gender equality and social inclusion (GESI) It is recommended that the Government of Nepal
as a factor requiring specialized treatment. Gen- builds gender equality into the planning and im-
der-neutral laws and regulations inadvertently exac- plementation of infrastructure by including the fol-
erbate existing gender and social biases. Key issues in- lowing requirements in bid documents and contracts
clude a lack of representation in decision making and for all infrastructure projects: (i) incorporation of
policy design, a lack of GESI issue awareness within gender-specific design features in infrastructure, (ii)
the policy and political community, and a lack of ac- minimum representation of women in construction
cess to information. Even where legal or institutional and non-construction activities in projects, and (iii)
19
collection of gender-disaggregated data on the use of Water resource projects, including hydropower
infrastructure services. projects, face the challenge of determining and
releasing the minimum downstream flow (or eco-
logical flow), which is directly linked with the
Environmental and Social economic and financial viability of a project. Wa-
Management ter diversion from rivers may make the downstream
stretch completely dry, creating adverse impacts on
Overview the aquatic and terrestrial ecosystem as well as affect-
Across all environmental and social priorities, ing livelihoods, cultural practices, and other water
there is a need for timely, efficient, and meaningful uses. Although certain provisions may form a basis,
citizen engagement throughout the infrastructure clear legal guidance is not available on the environ-
project life-cycle. Key priorities for environmental mental flow or minimum downstream release. Com-
and social issues within infrastructure development pliance with minimum water release is poor—the
include the protection of cultural heritage, the protec- amount released is inadequate or there is no release of
tion of indigenous peoples, labor management, labor environmental flow. The approach currently used for
health and safety, land acquisition, slope instabilities quantifying the e-flow is not scientific.
(landslides and erosion), forests and wildlife and bio-
diversity, integrity of river ecology and environmental Nepal’s existing environmental safeguard system
flow, resilient and adaptable infrastructure, and waste needs further strengthening and improvement.
management and pollution. There is no requirement for strategic Environmental
Assessment, and when Environmental Assessments are
Constraints conducted, they typically identify direct potential im-
Nepal’s mountainous terrain is fragile and sus- pacts from the infrastructure project; indirect impacts
ceptible to landslides and erosion. Without proper are rarely or weakly covered. Consideration of strategic
consideration, construction may trigger or exacerbate alternatives is not an explicit requirement for the Envi-
slope instabilities or mass movement. Technical plan- ronmental Assessment process, and specific provisions
ning and design in infrastructure projects are often for projects located in areas prone to natural hazards
found to be inadequate in assessing and addressing are not available. Environmental monitoring to check
this issue, and mitigation measures in the Environ- performance and compliance is rarely conducted.
mental Assessment/Environmental Management
Plans lack site-specific details. Experience in infrastructure construction reveals
that compliance with workers’ health and safety
Nepal is rich in biodiversity, and infrastructure standards is weak. Generally, there is a lack of ad-
development is one of the causes of pressure on herence to safety standards among workers and con-
forests, wildlife, and biodiversity, as development tractors, a lack of formal processes around terms and
is increasingly pushed to forest areas to avoid conditions for workers, unsatisfactory living condi-
private land and property. Pressure on forests and tions provided to workers, inconsistencies in what
natural habitats may be in the form of direct loss or constitutes child labor across relevant laws and guide-
degradation; loss or pressure through illegal activities, lines, lack of equality in employment and employing
encroachment, and poaching due to improved acces- local labor, and inadequate mechanisms for raising
sibility; and fragmentation of habitat and obstruction grievances. Lack of clear contractual provisions and
of wildlife movement routes. construction oversight and inadequate enforcement
mechanisms are other reasons for inadequate compli-
Delays in obtaining forest clearance are often cit- ance with health and safety.
ed as a cause for delays in infrastructure project
development. It is a lengthy bureaucratic process, The absence of an all-embracing regulatory frame-
further compounded by the low quality of technical work on land acquisition and concomitant issues
planning and design. of resettlement and rehabilitation and benefit
sharing is one of the longstanding challenges to
20
NEPAL INFRASTRUCTURE DEVELOPMENT FINANCE INSTITUTION (NIDFI)
NIDFI’s role could also include the following ly provide some contribution to viability gap
(based on global best practice): funds/grants and funding to the national PPP
• Issue its own debt across various tenors for Centre for procuring feasibility studies.
purchase by domestic and international insti- • Hold and disburse direct government and donor
tutional investors and retail customers. funds in accordance with the terms of such sup-
• Cooperate with Hydroelectric Investment port, for example, to provide funds/grants to re-
Development Company Limited (HIDCL) to duce the cost of construction, acquire land, and
cover and expand capital available for devel- pay for bid costs or major rehabilitation.
oping the hydropower sector. • As NIDFI matures and stabilizes, it may rein-
• Eventually acquire HIDCL to create a single, vest a dedicated but minor part of its profits
cross-sector national development finance into providing a consistent source of funds for
institution (DFI) focused on infrastructure; supporting target subsectors, and also directly
provide countrywide leadership in infrastruc- into selected social funds/programs to support
ture finance under a single DFI; and deliver the advancement of communities affected by
efficient management, operation, coordina- infrastructure development. NIDFI could stand
tion, and deployment of capital. out as a destination for investment funds from
• Reinvest any surplus into contributing to the domestic institutional investors, providing long-
deployment of finance, hedging and guaran- term, relatively stable exposure to the infra-
tee instruments, and/or facilities; develop structure sector without investors needing to
infrastructure finance products fit for the develop the inhouse capability to assess each
Nepalese market; and, thereafter, potential- project, which would be addressed by NIDFI.
Source: Nepal InfraSAP Team.
infrastructure development projects in Nepal. In ment projects. Although the current policy and regu-
the absence of an official land valuation system, land latory framework is broadly supportive of indigenous
valuation in Nepal is ad hoc and does not have clear peoples, gaps exist, including the failure to recognize
guidelines or methods. The current legal regime does indigenous peoples’ rights over land. A key issue is weak
not recognize the difference between taking land mainstreaming and participation of indigenous peoples
from people who live on (and from) it and taking in development projects. Considering the gaps, there is a
land from individuals or organizations for which it is need to ensure consultation with and input from indige-
only an “asset.” Land records and measurements are nous people in infrastructure decisions.
often ill-maintained or inaccurate.
Recommendations
Despite constitutional acknowledgment, there is First, review forest clearance processes and compen-
a lack of effective legal provisions protecting in- satory plantation. There is a clear need for simplifi-
tangible cultural heritage. In many cases, concerned cation of forest clearances, given the complexity and
communities, agencies, and institutions have devel- steps involved in the current process.
oped their own programs to help bridge this gap in
formal legislation and enforcement. To address dis- Second, issue national guidelines for determining
putes over approaches to the conservation of heritage environmental flow. Clear guidelines and a techni-
sites in Nepal, it is crucial that meaningful consulta- cal manual for Nepal for determining minimum eco-
tions are carried out to identify cultural heritage that logical flows as well as training professionals in water
may be affected by infrastructure projects. resources and environmental management are an im-
portant subject for water resource–related projects,
Nepal does not have a stand-alone policy on protect- particularly hydropower projects, which are a focus
ing indigenous peoples from the impacts of develop- area for the development of Nepal.
21
Third, improve compliance with already existing for payment of compensation jointly to male and
environmental and social frameworks and guide- female members of the family. The practice of land
lines. The Environmental Assessment system and zoning should be introduced. Furthermore, in the
capacity should be strengthened. A good Environ- short term, the Guthi Corporation Act 1972 should
mental Assessment and an Environmental Manage- be amended to include mandatory consultation with
ment Plan that identifies specific risks and impacts stakeholders in all infrastructure projects, to identi-
and their respective mitigation measures are key to fy and protect intangible cultural heritage. Consul-
preventing erosion-related issues. There is need to tations with indigenous peoples should be required,
improve technical planning and design as well as including obtaining free, prior, and informed consent
the Environmental Assessment and Environmental for all projects.
Management Plan, including carrying out alternative
analysis of potential sites (selecting better sites), se- Fifth, improve protections for workers under in-
lecting less destructive construction methods, man- frastructure projects. There would be merit in im-
aging surface runoff water, using controlled disposal proving the occupational health and safety of the la-
of spoils and mucks, developing environmental buf- bor force on construction sites. The Labor Act 2017
fers, and increasing vegetation cover. should include provisions for penalties for violations
of health and safety standards, including cost alloca-
Fourth, improve legislative provisions for land action by the contractor for occupational health and
quisition and land entitlements, to protect proj- safety–related measures, and mandatory training in
ect-affected persons and intangible cultural her- occupational health and safety should be required for
itage. To do so, it is advisable to amend the Land all contractors.
Acquisition Act to include the following: transparent
consultations with project-affected persons in project
design and implementation arrangements; landless Proposed Recommendations for
persons’ and indigenous people’s customary right to the Country Environment
land without title and their right to compensation on Several issues affect the whole infrastructure sector.
acquisition of such land; requirement for free, pri- Mindful of that, in table 1, the focus is limited to a few
or, and informed consent; recognition of vulnerable cross-cutting recommendations that will have the wid-
groups among affected populations and their need est impact. Within each recommendation, actions are
for special attention; provision of upfront budget limited to the short term (those that can be executed
for projects for use in payment of compensation and within one to two years) and the medium term (those
rehabilitation of affected populations; and provision that can be executed within two to five years).
TABLE 1: CROSS-CUTTING AREAS ROADMAP
SHORT-TERM ACTIONS MEDIUM-TERM ACTIONS

RECOMMENDATION
(UP TO 3 YEARS) (3-6 YEARS)
GOVERNANCE AND PUBLIC INVESTMENT MANAGEMENT
1. Establish a central coordination Create a highly visible infrastructure unit directly
mechanism for infrastructure reporting to the PMO to drive strategic planning
and delivery of priority projects.
2. Improve the quality of Establish public investment management Create an integrated project bank of strategic and
investment decisions mechanism through issuance of appropriate economically viable investment projects.
guidelines.
Create and implement a project performance
Create methodologies and processes for tracker.
screening, selection, and prioritization of capital
projects.
Establish appropriate budgeting mechanisms.
22
3. Improve management of Sign MOU with all public enterprises and Assess the stock of existing liabilities.
assets and liabilities through subnational governments on performance
Complete one round of internal audits for all
a multifaceted and phased management reporting.
provincial and at least half the local governments.
approach
Establish an FCCL management framework for
fiscal commitments and contingent liabilities of
public enterprises and national and subnational
governments.
Establish internal audit systems for all layers of
government.
PRIVATE PARTICIPATION IN INFRASTRUCTURE
1. Finalize and enact the PPP Law Seek market feedback on the Draft PPP Law and
consider amendments accordingly.
Enact the PPP Law.
2. Develop the PPP pipeline Adopt robust screening criteria to filter and Train project implementing agencies in screening
prioritize PPP projects. methodology.
Include selected PPP projects in the national
rolling pipeline of priority projects. Keep the rolling PPP pipeline updated (e.g., semi-
annually) and feed into the national rolling pipeline
of priority projects.
3. Create and implement enabling Develop PPP Guidelines. Adopt and implement PPP Guidelines.
frameworks and strengthen
Ensure clarity of roles of different institutions Disclose information, including performance
institutional arrangements
involved in the PPP process. information, on at least 50% of operational projects
and all new projects.
Harmonize existing PIM/PPP processes.
Strengthen the framework and processes for
collection and disclosure of information at all
stages of the PPP process.
Resource the PPP Centre appropriately.
4. Manage fiscal commitments Develop the PPP FCCL framework. Train debt management, PPP, and project
and contingent liabilities implementing agency staff in FCCL methodologies.
Implement FCCL assessment in all new projects.
Assess the stock of FCCL in operational projects.
Include FCCL reporting in the annual debt
statement.
5. Increase stakeholder Roll out the communication strategy to Roll out the capacity-building program customized
engagement by designing and emphasize institutional structure. to different stakeholder groups.
delivering a communications
Establish the PPP Centre website to disclose key
strategy and capacity-building
information on policy and projects.
program
FiNANCIAL SECTOR AND INVESTMENT ENVIRONMENT
1. Stimulate consolidation of the Increase paid-up capital requirements for private Target market consolidation to 15 banks.
local private commercial bank commercial banks to NPR 16 billion.
market
2. Develop domestic banking Provide focused training in credit assessment, Identify one bank with substantial government
sector capacity to finance due diligence, and loan management to at ownership (e.g., Nepal Bank Limited) to champion
infrastructure projects least 10 progressive local commercial and commercial bank lending to infrastructure projects
development banks. and co-lead arranger roles on larger projects
alongside MDBs and international project finance
NRB to issue and implement a code of best banks.
practice for infrastructure project financing in
Nepal.
23
3. Increase availability of long- Permit state-owned/led banks to offer partially Year 2: Roll out the guarantee to selected local
term financing amortizing loans for 7-to-10-year tenors private commercial banks that have a credible
supported by a Government of Nepal/MDB appetite for lending to economically viable
refinancing guarantee instrument to keep infrastructure projects.
domestic lender(s) whole in the event there is no
market at maturity. Year 3: Apply guarantee only to tenors greater than
or equal to 12 years, if the market demonstrates
Provide relief from restrictions to domestic and
sufficient depth and liquidity at the year 10 tenor.
foreign lenders taking full charge over key assets
(e.g., land and buildings) of projects. Develop domestic capacity to provide credit ratings using
methodologies consistent with international practice.
To develop a yield curve, implement a systematic

program of local and foreign currency government
bond issuances and establish a primary dealer/market
maker to create a market in government bonds.
Implement a tax rebate for investors on any portion

of sale proceeds that are then reinvested into the
infrastructure sector within 12 months from the
date of sale completion.
4. Stimulate participation of Undertake regulatory reform to provide foreign Move to market-based loan pricing and remove
foreign lenders and investors lenders pari-passu treatment with local lenders. caps on interest rates charged on foreign currency
loans made to entities extending financing to the
Provide relief from approvals from the Inland infrastructure sector.
Revenue Department and NRB for foreign lenders
Implement legislation to enable limited partnership
providing limited recourse project finance to priority
structures.
projects in specific infrastructure subsectors.
Create a regulatory framework to attract and
Obtain sovereign credit rating. retain private equity/venture capital investments
in Nepal.
Establish a hedging facility within a DFI with
Government of Nepal/MDB support to enable Streamline and automate repatriation processes.
projects to overcome liquidity constraints Implement a program to educate investors,
during periods of (excessive) foreign exchange including retail, on bonds, in preparation for
rate fluctuations, and interest rate hedging for issuances of DFI retail debt tranches.
priority infrastructure projects.
Amend FITTA and Foreign Exchange (Regulation)
Act 1962 to ease entry and exit restrictions,
reduce documentation requirements, and ensure
consistency between regulations.
5. Develop alternative sources of Develop a Nepal infrastructure DFI (NIDFI) Develop and implement Alternative Investment
financing capitalized with US$1.5 billion to (i) provide debt Fund Regulations.
and equity financing and risk management
instruments to projects, and (ii) provide Year 2:
HIDCL access to capital to optimize project i Initiate a program of 10- and 15-year debt
development in the short term. issuances in NPR and US$ by NIDFI for
international and domestic institutional investors.
Issue guidelines for the use of hybrid instruments ii Expand product offerings to include hybrid
to facilitate private sector investment. instruments.
iii Harmonize operating best practices from NIDFI
and HIDCL, including integration of selected
common support services.
Year 3:
i Combine HIDCL with NIDFI to focus on
infrastructure finance and financial products
relevant to each subsector.
ii Expand the investor base to include stronger
domestic and (selected) international commercial
banks to become minority investors in NIDFI.
iii Issue retail-focused securities (NIDFI).
24
GENDER EQUALITY AND SOCIAL INCLUSION

1. Build gender equality in Incorporate gender-specific design features in
planning and implementation of infrastructure.
infrastructure
Ensure minimum representation of women in
construction and non-construction activities in
projects.
Collect gender-disaggregated data on the use of

infrastructure services.
ENVIRONMENTAL AND SOCIAL MANAGEMENT
1. Improve forest clearance and Revise guidelines for forest clearance. Create an entity for compensatory plantation.
compensatory plantation
2. Issue national guidelines for Commission a study to prepare the guidelines. Issue guidelines.
determination of environmental flow Organize training.
3. Strengthen the Environmental Revise EPA, EPR, and EIA Guidelines to Develop robust internal environmental and social
Assessment system and capacity strengthen Environmental Assessment system guidelines.
and capacity
Introduce Strategic Environmental Assessment,
Conduct a capacity needs assessment in the Cumulative Impact Assessment, and Basin Planning.
context of federalism.
Implement system- and capacity-strengthening
Improve compliance with established Acts and measures.
regulations for managing environmental and
social risk.
4. Improve legislative provisions Draft the Land Use Act. Amend the Land Acquisition Act.
for land acquisition and land
Introduce a performance indicator on compliance Adopt the Land Use Act.
entitlements to protect project-
with inclusive programs in reporting norms for all
affected persons and intangible Ensure that 50% of new projects include inclusive
new projects.
cultural heritage programs.
Improve consultation with, and participation of,
Amend the Guthi Corporation Act 1972.
indigenous peoples affected by infrastructure
projects, and ensure meaningful engagement Ensure that all projects obtain Free Prior and Informed
throughout the project life-cycle. Consent from indigenous peoples where required.
5. Improve protection for workers Amend the Labor Act 2017.
under infrastructure projects
Provide for penalties for contractors that do not
provide contractual arrangements for workers
outlining their rights and entitlements.
Introduce mandatory transparent, timely, and
meaningful citizen engagement throughout all
stages of the project life-cycle.
Provide a grievance redress mechanism in all
projects for project-affected persons.
Note: DFI = development finance institution; EIA = Environmental Impact Assessment; EPA = Environment Protection Act; EPR = Environment Protection
Regulation; FCCL = fiscal commitments and contingent liabilities; FITTA = Foreign Investment and Technology Transfer Act; HIDCL = Hydroelectric Investment
Development Company Limited; MDB = multilateral development bank; MOU = memorandum of understanding; NIDFI = Nepal infrastructure DFI; NRB = Nepal
Rastra Bank; PIM = public investment management;PMO = Prime Minister’s Office; PPP = public-private partnership.
25
26
Reforming the Energy Sector
Introduction struction periods that are conducive to private sector

The electricity sector is one of the most strategical- investment and commercial financing. However, Ne-
ly important areas of Nepal’s economy for two rea- pal’s domestic private sector does not yet have the ca-
sons. First, the lack of adequate electricity is a barrier pacity to mobilize large amounts of long-term financ-
to higher economic growth. The Nepalese consume, ing and appraise and manage the significant technical,
on average, just a twentieth of the global average and hydrological, and environmental risks of large-scale
a fifth of the South Asian average. Load shedding projects. Public sector entities and foreign investors
imposed economic costs of up to US$1.6 billion per can play a strong role, with assistance from multilat-
year during 2008–16. Accordingly, increasing the eral development agencies, in structuring large hydro
electricity supply would create a large economic ben- projects. Public and private financing may be used
efit. Second, Nepal has an opportunity to earn reve- for large hydropower; risk mitigation instruments
nues by exporting valuable hydropower to the South can be applied to leverage significant commercial fi-
Asia region. Recognizing this, the government has set nancing from local and international investors. Such
an ambitious target of installing 3 gigawatts (GW) of large infrastructure provides an opportunity to also
generation capacity in three years, 5 GW in five years, deepen local capital markets (see, for instance, box 1
and 15 GW in 10 years. The government is pursu- on the Upper Tamakoshi project and box 3 on inter-
ing reforms to increase the capacity of public sector national experience with large hydropower projects).
institutions and improve the investment climate in A more integrated regional electricity market, which
the sector. will enable selling electricity produced in Nepal to
other countries in South Asia, will open further op-
Achieving the full economic potential of the elec- portunities for commercial debt and equity financing
tricity sector will require a paradigm shift in the of Nepal’s large hydropower, while mitigating the sec-
way Nepal approaches electricity sector financing. tor’s exposure to foreign currency fluctuations. Nepal
Nepal has historically relied on a mix of public and has already awarded some larger hydropower projects
private financing in the electricity sector. The country’s to foreign investors (private and state-owned) and is
installed generation capacity is now almost equally di- accumulating experience through these investments.
vided between the Nepal Electricity Authority (NEA) A significant number of large hydropower projects
and independent power producers (IPPs)—the latter have been constructed with the private sector glob-
mostly in the form of small hydropower projects de- ally and can provide valuable lessons on how foreign
veloped with local investments. However, a twofold investment and financing can flow into the sector in a
to fourfold increase in investment is needed to meet sustainable way, while managing associated risks and
the projected demand in the country and utilize the contingent liabilities as compared with direct liabil-
sector’s export potential. For this, Nepal must not only ities in public sector projects (see box 3 on private
efficiently utilize existing sources of financing, but also sector experience with large hydropower projects).
develop the capacity to access new sources of financing
from domestic and international capital markets and This roadmap attempts to lay the groundwork
investors, including institutional investors. for maximizing the financial resources for Nepal’s
electricity sector. The report identifies financing
Nepal will need to deploy a wide range of PPP needs and constraints for the power sector in the
models in the electricity sector. In general, small short-to-medium term and outlines a roadmap for
hydropower projects and most solar and wind energy overcoming these constraints and seizing opportuni-
projects have a risk profile and relatively short con- ties to achieve sectoral transformation over time.
27
Nepal’s Energy Sector at a FIGURE 2: ACTUAL AND PROJECTED ELECTRICITY

DEMAND (GWH)
Glance 70000
Nepal has recovered from the severe electricity 60000

crisis that adversely affected the country between
50000
2008 and 2016. Yet, substantial new investments
40000
are required to avoid another crisis. Nepal’s electric-
GWh
30000
ity imports from India have increased fourfold since
2010 and now comprise more than a third of the elec- 20000
tricity consumption in the country. Combined with 10000
more efficient management of existing generation 0

1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
resources and reduced transmission and distribution Actual (1995 to 2015) and Business as Usual Scenario (2015-2040) Reference Scenario (2015 to 2040)
(T&D) losses, the NEA has resolved load shedding.

Source: Nepal Electricity Authority and Water and Energy Com-
The NEA has also achieved progress in improving its mission Secretariat.
financial performance and creating a robust pipeline Note: GWh = gigawatt hours.
of public and private sector projects, by signing pow- concentrated in the power generation segment, and
er purchase agreements (PPAs) for more than 4 GW almost all of this went to hydropower projects. Two-
of new projects. However, questions remain on how thirds of the investment in generation was undertak-
many projects from this 4 GW of pipeline are pro- en by NEA subsidiary companies, followed by local
gressing and how they will be financed through local IPPs and NEA. Although it is significant, the sum
sources. In any case, Nepal would need to increase in- falls short of the required annual investments for
vestment in the electricity sector substantially beyond 2018–40.
this pipeline, to realize the government’s ambitions
for the sector and achieve higher economic growth. To keep pace with demand, electricity sector in-
vestments will need to accelerate substantially to
an average of US$1.3 billion to US$2.1 billion
Financing Needs (2018–40) annually between 2018 and 2040.16 The total in-
Despite moderate economic growth, electricity de- vestment need in the power sector for the forecast
mand in Nepal has risen rapidly. Since 1995, the period of 2018 to 2020 is estimated at US$29 billion
compound annual growth rate of demand has been to US$46 billion. This includes total investments of
8 percent, resulting in a doubling of electricity con- more than US$16 billion in transmission and distri-
sumption every eight years. The government is tar- bution and US$2 billion in solar and wind energy
geting an acceleration of average economic growth during 2018 to 2040. The estimated annual need
to 7.2 percent during 2018–40, from 4.5 percent for US$1.3 billion to US$2.1 billion is two to four
during 1998–2018. Under the Reference Case Sce- times higher than achievements in the recent past. Al-
nario, the government expects electricity demand to though run-of-the-river and peaking run-of-the-river
increase at a compound annual growth rate of 12.0 hydro continue to dominate generation investments
percent, implying a doubling of electricity consump- (60 percent of the generation mix), there is increased
tion every six years. Under the Business as Usual Sce- prioritization of storage hydropower plants (30 per-
nario, economic growth and electricity demand are cent of the generation mix) and new renewable ener-
expected to increase at historic rates of 4.5 and 10.0 gy (10 percent of the generation mix).
percent, respectively (figure 2).
Moreover, incremental investments of between
From 2010 to 2017, Nepal’s electricity sector US$0.5 billion and US$1 billion may be required
achieved investments of US$527 million per year annually in large, export-oriented hydropower proj-
on average. Over 70 percent of this investment was ects. The takeoff of export-oriented projects will depend
16 The investment amounts of US$1.3 billion and US$2.1 billion correspond to the government’s Business as Usual and Reference Case Scenario demand
projections, respectively. The breakdown of investment in the reference scenario is provided in table 2.
28
on the underlying economics of these projects as well as panies. Between 2010 and 2017, the NEA’s entire
the development of an effective institutional and regula- capital expenditure, amounting to US$1.4 billion,
tory framework for electricity trade (table 2). was financed by the government. Four-fifths of this
investment was estimated to have gone into transmis-
Under the Business as Usual Scenario, the NEA will sion and distribution, and the remaining fifth into
continue to play an important role and be responsi- generation. About half of the NEA’s capital expendi-
ble for about a third of the total sector investment ture and investment was loaned to the NEA by the
requirements until 2030. Over 95 percent of NEA government, which had borrowed it from a variety of
capital expenditure is expected in the transmission and development partners. The remaining half was passed
distribution network. The NEA will also continue to to the NEA as government equity. The NEA’s long-
make equity investments in subsidiary companies to term debt obligations to the government increased
develop generation projects. About half of the addi- from US$0.5 billion to US$1.1 billion, and the gov-
tional generation capacity between 2018 and 2030 is ernment’s equity contributions to the NEA increased
expected to be developed by NEA subsidiary compa- from US$358 million to US$961 million in this pe-
nies. From 2019 to 2025, NEA debt financing require- riod.
ments to meet capex needs range between US$250
million and US$500 million annually (table 3). How- The Government of Nepal is using NEA subsidiary
ever, by removing constraints to greater private sector companies to develop large hydropower projects,
participation—in the ownership, operations, and fi- by leveraging financing from institutional investors
nancing of power projects—the government can lever- and state-owned enterprises. Projects led by NEA
age its public sector resources by utilizing a range of subsidiary companies invested US$1.5 billion and
PPP models. Sources of Financing (2010–17) accounted for more than a third of the sector’s in-
vestments from 2010 to 2017. The NEA’s equity in-
vestment in its six subsidiary companies increased by
Sources of Financing (2010–17) US$232 million between 2010 and 2017. NEA sub-
The electricity sector relied on state financing for sidiary companies mobilized an additional US$1.1
more than two-thirds of its investment program billion of equity and debt financing from institution-
between 2010 and 2017. This was almost equally al and public sector investors in addition to IPOs on
divided between the NEA and NEA subsidiary com- the stock market during this period. More than 800
TABLE 2: HISTORICAL INVESTMENTS (2010–17) AND PROJECTED INVESTMENT NEEDS (2018–40)
Average Annual Investments (US$, millions, 2018 Prices) Total investment
financing needs
Historical Investments Forecast Periods -Reference Scenario (US$, millions)
2010–17 2018–25 2026–30 2031–35 2036–40 2018–40
Hydro-storage - 393 404 631 1,017 13,012
Hydro (ROR+PR0R) a
372 301 485 757 1,221 14,424
Solar - 43 34 54 87 1,177
Wind - 26 23 36 58 768
T&D 156 414 539 842 1,356 16,587
Total 527 1,177 1,487 2,320 3,739 45,968
Total (% of GDP) 2.1 2.7 2.4 2.6 3.0 2.0-3.0
Sources: Historical investments based on PPI database and NEA Annual Report 2018. Projected investments are World Bank estimates based on the Water and Energy Commission
Secretariat’s 2017 reference case electricity demand projections.
Note: GDP = gross domestic product; NEA = Nepal Electricity Authority; PPI = private participation in infrastructure; PROR = peaking run-of-the-river; ROR = run-of-the-river;
T&D = transmission and distribution.
a. Run-of-the-river hydroelectricity is the type of hydroelectric generation plant whereby little or no water storage is provided. Peaking run-of-the-river hydropower plants are defined
by the NEA as hydropower plants that can provide at least four hours of electricity during peak hours.
29
TABLE 3: NEPAL ELECTRICITY AUTHORITY DEBT FINANCING REQUIREMENT (US$, MILLIONS)
2019 2020 2021 2022 2023 2024 2025
455 476 435 413 421 270 305
megawatts (MW) of generation projects developed tion during 2010 to 2018. A third of this was equity
by NEA subsidiary companies reached financial clo- investments, and the remaining two-thirds was debt
sure between 2010 and 2017 and are currently under financing from local and foreign financial institu-
construction. The 456 MW Upper Tamakoshi Hy- tions and bilateral and multilateral donors. The NEA
dropower Project, Nepal’s largest hydropower project offers differentiated PPA rates ranging from US¢4 to
to date, accounts for half of this capacity. This project US¢8 for run-of-the-river projects of less than 100
is being developed with debt and equity investments MW capacity in the dry and wet seasons, respectively.
from the Employees Provident Fund, Citizens Invest- The NEA has signed local currency PPAs for more
ment Fund, and Rashtriya Beema Sansthan (box 1). than 2,000 MW of new capacity with the domestic
NEA subsidiary companies have raised or have provi- private sector. Most of these projects are looking to
sions to raise at least 25 percent of the equity financ- reach financial closure or in the early stages of con-
ing from local communities, employees of sponsor struction.
agencies, and the public through IPOs.
There was limited foreign investment in the elec-
The domestic private sector, alone and in joint ven- tricity sector between 2010 and 2017, all in the
ture with foreign partners, is an active participant form of a joint venture with local companies, ac-
in the development of hydropower projects that counting for approximately a tenth of the sector
are less than 100 MW (figure 3). IPPs contributed investments. Although the first hydropower project
about a fifth of the total electricity sector investments in Nepal was built in 1911, until 2000 state-owned
between 2010 and 2017. They invested more than utilities had added less than 280 MW total cumu-
US$700 million in 406 MW of hydropower genera- lative generation capacity in the country, while in
BOX 1: UPPER TAMAKOSHI HYDROPOWER PROJECT
The Upper Tamakoshi Hydroelectric Project is a ployees Provident Fund, Nepal Telecomm, Citizens
456-megawatt peaking run-of-the-river hydro- Investment Fund, Rashtriya Beema Sansthan, and
electric project on the Tamakoshi River, near the the Government of Nepal.
Nepal-Tibet border. The project is being devel-
oped by Upper Tamakoshi Hydropower Limited, The project has run into significant cost and time
a subsidiary of the Nepal Electricity Authority overruns due to disruptions caused by the 2015 earth-
(NEA). The majority shares (51 percent) of the quake, the subsequent blockade at the Indian border,
company are held by four public entities: NEA and depreciation of the Nepalese currency. The project
(41 percent), Nepal Telecom (8 percent), Citizens cost was initially estimated to be US$305 million, but
Investment Fund (3 percent), and Rashtriya Bee- it is now expected to reach more than US$430 million
ma Sansthan (3 percent). The remaining shares (US$565 million including interest during construc-
(49 percent) were issued through initial public tion). Nevertheless, the project continues to be one of
offerings to Employees Provident Fund contribu- the lowest-cost developments in the country in US$/
tors, employees of Upper Tamakoshi Hydropower megawatt terms. The commercial operation date of
Limited, NEA, lending institutions, local commu- the first four units of the project has been delayed,
nities, and the public. The debt is provided by Em- from December 2015 to July 2019.
30
2002 the NEA completed the country’s largest, plant FIGURE 3: ELECTRICITY SECTOR INVESTMENTS IN NEPAL WITH PRIVATE
Kali Gandaki (144 MW), with ADB financing. Ne- SECTOR PARTICIPATION (US$, MILLIONS)
pal’s first two IPPs, the Himal Khimti Hydropower 1200
Project and Upper Bhotekoshi Hydropower Project, 1000

were developed by foreign investors in the late 1990s,
800
with dollar-denominated PPAs, and provided an ad-
ditional 86 MW by 2001. These two IPPs not only 600
increased the generation capacity by 30 percent with- 400
in a few years in a country with significant generation

200
capacity deficits, but also helped to promote an alter-
0
native way to build generation and developed signif- 1994 1996 1998 2000 2003 2004 2005 2008 2010 2011 2012 2014 2016 2017 2018
icant domestic technical capacity outside the NEA. Joint Venture Local IPP NEA Subsidiary
The government’s decision not to allow increases in Source: PPI Database 2018.
the electricity tariffs throughout 2001–12, combined Note: IPP = independent power producer; NEA = Nepal Electricity Authority; PPI = private
participation in infrastructure.
with increasing payment obligations in local curren-
cy terms under these two dollar-denominated PPAs,
contributed to a continuous decline of the NEA’s fi- lej Jal Vidyut Nigam Limited with the backing of the
nancial condition. In this context, the NEA decided Indian government, has reached financial closure and
to sign only a few partially dollar-denominated PPAs is under construction. The US$1 billion project has a
between 2000 and 2016.17 In 2017, under newly ad- 30 percent equity contribution from Sutlej Jal Vidyut
opted PPA guidelines, the NEA signed two new par- Nigam Limited. Indian and Nepalese commercial banks
tially dollar-denominated PPAs. The level of currency are providing 60 and 10 percent of the debt financing,
exposure in these PPAs is not likely to be adequate to respectively. Under the terms of the agreement of the
attract foreign investment in the sector going forward project, Nepal will receive 22 percent of the electricity
(see box 2 on current dollar–denominated PPAs). generated by the project as free power. Sutlej Jal Vidyut
Nigam Limited will hand over the project to Nepal after
The flow of private investment to transmission, dis- 25 years. Although the project has faced many challeng-
tribution, and solar and wind generation was lim- es, this is an important milestone and achievement for
ited, but it is likely to increase. The government is the expansion of the sector in Nepal and the region, and,
keen to attract private investment to these areas and is at a high level, this model has key features that can be
gradually putting in place a framework to attract in- replicated successfully to facilitate other such developers.
vestments. The NEA has established a feed-in tariff of The government has also signed a Project Development
US¢6.3/kilowatt hour for solar energy and has issued Agreement for the development of the 950 MW Upper
net metering policy for grid-connected rooftop solar. Karnali project with India’s GMR Group, which is seek-
The NEA is also providing viability gap funding to ing to reach a PPA with Bangladesh.
solar projects under an ADB project. In transmission,
the government used PPP arrangements to build the Domestic commercial banks have provided local
Dhalkebar-Muzzafarpur interconnection between In- currency debt to projects led by the domestic private
dia and Nepal. Going forward, the government would sector. Nepal’s central bank requires the country’s
like to use build and transfer and engineering procure- banks to lend at least 5 percent of their loan portfo-
ment construction finance arrangements to develop lio to hydropower. Yet, only about 4 percent of their
transmission infrastructure in the country. loan portfolios, or US$784 million, was channeled
to the hydropower sector as of FY2018,18 indicating
After years of delay, Nepal finally broke ground on its some upside potential in the domestic debt market
first export-oriented hydropower project, with US$1 (table 4). However, the willingness and ability of local
billion in Indian investment. The 900 MW Arun 3 financial institutions to finance hydropower projects
hydropower project, developed by state-owned Sut- is limited. Local banks are constrained in financing
17 These include the 50 MW Upper Marshyangdi Hydro Electricity Project ‘A’ and Kabeli A hydropower project.
31
BOX 2: CURRENT DOLLAR–DENOMINATED PPA AND FOREIGN EXCHANGE RISK HEDGING MECHANISMS
Current dollar–denominated power purchase Foreign exchange risk hedging mechanisms. The
agreements (PPAs). In 2017, the Nepal Electricity Government of Nepal is keen to establish a hedg-
Authority (NEA) adopted new guidelines on foreign ing mechanism for better management of foreign
currency–denominated PPAs and subsequently exchange risks in the sector. One current proposal
signed partly dollar-denominated PPAs with two where foreign financiers would lend to Nepal Rastra
new projects: the 216 megawatt (MW) Upper Tri- Bank, which would then onlend to the beneficiary
shuli Project and the 120 MW Rasuwa-Bhotekoshi projects through a commercial bank, has several
Hydropower Project. Under these new dollar-de- structural flaws and cannot be implemented. An-
nominated PPAs, in addition to the coverage of other concept that is currently under discussion—a
the debt financing being limited to the first 10 hedging facility (or “hedge fund”) approach, in
years of operation and the portion of foreign debt which developers/lenders are also required to par-
financing, the developers/shareholders’ equity in- ticipate—is complex and has not been observed in
vestments are fully exposed to currency devalu- power sectors in other countries.
ation risk. Furthermore, as currently structured,
the terms of the recent dollar PPAs require equity Global experience. Global experience has shown
investors to share one-third of the NEA’s exposure that as countries are able to establish contractu-
to limited dollar purchase obligations by making al structures to attract foreign direct investment,
additional financial contributions to a hedging the developers are willing to take an increasing-
mechanism or to foreign exchange risk exposure ly greater proportion of currency devaluation risk
of the NEA. Dollar-denominated PPAs with this on their equity investment. Foreign exchange risk
risk allocation and level of exposure for the devel- management of the remaining investment—wheth-
opers have not been seen elsewhere.a The current er through a pass-through to the end-consumer or
risk allocation is not likely to be adequate to at- a government subsidy—is often managed at the
tract investment by sponsors in foreign currency. sector/country level rather than at each individual
Nevertheless, compared with the sector’s trajec- project level (except in countries where long-term,
tory over the past 15 years, the structure is pro- cross-currency swap markets exist).
gressing in the right direction.
long-term hydro projects with their mostly short- the investments in hydropower during this period.
term deposits. Moreover, local financial institutions Institutional investors have provided debt and equity
perceive hydropower to be riskier than other sectors. financing to hydropower projects developed by NEA
Banks have a small capital base, which limits lend- subsidiary companies. The Employees Provident
ing to individual projects. Currently, given pruden- Fund, which manages the pensions of government
tial norms, including the single-borrower limit, local and army staff, is the most prominent of these in-
banks are unable to finance projects above US$40 vestors, followed by Citizens Investment Fund and
million.19 Rashtriya Beema Sansthan. Given that the combined
asset size of the local institutional investors is more
Nepal’s institutional investors have shown a grow- than 15 percent of GDP (US$4 billion), there is po-
ing appetite for hydropower investments. Their tential to mobilize higher amounts of financing from
exposure to hydropower investments stood at about Nepal’s institutional investors by addressing regulato-
US$300 million as of FY2017, about 8 percent of ry and institutional barriers.
18 Since some banks meet their hydropower lending requirements through short-term import letters of credit, not all of this is long-term loans for hydropower
projects.
19 The single-borrower limit of 50 percent of the banks’ equity capital constrains lending from many of the banks and necessitates lending from a consortium
of banks for projects above US$40 million.
32
Nepal’s capital market had a limited role in mobiliz- (US$13.2 billion) in Nepal is around 4.7 percent; 19
ing sector investments during this period, although of the 242 listed companies in the Nepal Stock Ex-
it could become an important source of funds. The change are hydropower companies.
government is keen to establish broad-based owner-
ship of the country’s hydro assets through the stock Nepal’s bond market is underdeveloped and domi-
market under its “People’s Investment in Nepal’s Wa- nated by government securities. To meet short-term
ter Resources” program. From 2010 to 2017, 11 hy- financing needs, the government issues short-term
dropower companies went public and raised approx- Treasury bills and national savings certificates. The
imately US$19 million through their IPOs from the government also issues longer-tenor instruments,
public and another US$10 million from local com- development bonds, which are admitted for trading
munities. The IPOs of another 10 hydropower com- through the Nepal Stock Exchange. However, devel-
panies, including three NEA subsidiaries, have been opment bonds are rarely traded, and the size of the
completed or were underway in 2018 and could raise bond is small to satisfy institutional investor demand.
another US$50 million from the share market. The Moreover, under the prevailing market conditions,
market capitalization ratio of the hydropower sector fixed deposits with banks provide the highest rate of
(US$624 million) to the total market capitalization return compared with government securities and are
TABLE 4: SOURCES OF FINANCING IN THE ELECTRICITY SECTOR (US$, MILLIONS)

Hydro
Institution Instrument Benchmark fund Share (%) Comments
Financing
Commercial banks Debt 21,717 784 4 FY2019 monetary policy requires 5% of total
loan portfolio of commercial banks to be in
hydropower.
If a PPA has been signed, banks can invest up to
50% of their core capital in a single project; 25%
of core capital otherwise.
Insurance companies Equity & debt 1,643 20 1 Insurance companies can have up to 5% of their
total investments in hydropower projects as
share capital.
Employee Provident Fund Equity & debt 1,070 230 21.5 Investment up to a maximum limit of 25% of
issued debentures.
Provides loans to companies against guarantees
of banks or financial institutions.
Investment in any area against securities or
guarantees and after obtaining the government’s
approval.
Citizen Investment Trust Equity & debt 920 28 3 Invest in securities up to 20% of share capital of
the company or 20% of Investment Fund of CIT,
whichever is lower.
Invest in a consortium with banks up to 20% of
total fixed assets (up to 50% if company owned
by Government of Nepal) or 20% of Investment
Fund of CIT, whichever is lower.
Hydroelectricity Equity & debt 99 50 50 HIDCL can invest in a consortium with banks up
Investment and to 25% of its capital fund.
Development Company Company can invest up to 20% in the hydropower
Limited company’s shares or 25% of its capital fund,
whichever is lower.
Company can invest up to 25% of its capital
fund in hydropower project as loans, bonds, or
debentures.
Sources: NRB Annual Report 2018, Economic Survey 2018, EPF Annual Report 2018, CIT Annual Report 2018, World Bank estimates.
Note: CIT = Citizen Investment Trust; EPF = Employees Provident Fund; HIDCL = Hydroelectric Investment Development Company Limited; PPA = power purchase
agreement.
33
thus an obvious choice for investment managers. The vate sector interest and may lead to additional foreign
government has on several occasions taken the ini- investment.
tiative to mobilize funds by issuing remittance and
foreign employment bonds targeted at overseas Nep- The specific risk characteristics of large hydropow-
alese, but, due to poor design and marketing, these er mean that the public sector will need to have a
have been undersubscribed. strong role in developing these projects. All elec-
tricity projects face common issues. However, large
Nepal is embarking on a significant infrastructure hydropower faces additional risks and constraints re-
expansion program in the electricity sector that will sulting from: (i) site specific nature of the projects; (ii)
require two to four times the level of investment high construction risk and long construction periods;
achieved in the recent past. This expansion program (iii) the capital-intensive nature and long payback pe-
seeks to correct the chronic underinvestment in the riods; (iv) broader water management constraints; (v)
sector over many decades, which left the country with environmental and social issues; (vi) political sensi-
a severe electricity crisis and substantial suppressed tivities; (vii) multipurpose benefits such as irrigation
demand. The Government of Nepal envisions roles for agriculture; and (viii) unpredictable hydrology
for the public and private sectors in the infrastructure and geology. Many of these risks (e.g. i, ii, iii, v, viii)
expansion, based on their respective comparative ad- have been managed successfully by experienced pri-
vantages. The NEA has signed local currency PPAs vate sector developers globally but the public sector
for more than 2,000 MW of new capacity under these may retain a critical role in: (i) the preparation and
guidelines with the domestic private sector. Most of due diligence of large hydropower projects; (ii) the
these projects are looking to reach financial closure development of realistic public-private risk-shar-
or are in the early stages of construction. The NEA ing arrangements; (iii) targeted long-term financing
anticipates developing more than 4,000 MW of hy- support; (iv) broader water management; (v) land
dropower projects between 2020 and 2030 through acquisition in some cases; and (vi) management of
subsidiary companies. multipurpose benefits (see box 3 on international ex-
perience with large hydropower and box 4 on private
This will require a paradigm shift in the way Nepal sector specifics). The specific context of Nepal will
approaches energy sector financing. Recently, Nepal determine the final structure that prevails.
has poorly utilized the public and private sources of
financing available to the sector. Prolonged political
instability and poor governance have undermined Binding Constraints to the
public investments and de-incentivized private in- Scale-Up of Financing
vestment. On average, power sector projects have To achieve its sector goals, Nepal needs to achieve a
taken more than nine years to implement. The effi- twofold to fourfold increase in investments. It will
ciency of power sector investments has been low, with be critical for Nepal to address the constraints that
an Incremental Capital-Output Ratio of 29 for the are currently limiting the scale-up of financing in the
power sector as opposed to 5.2 economywide. The electricity sector. Constraints in four main areas affect
financial viability of the sector has been weak in the the mobilization of additional finance in the sector:
past, undermining the bankability of power projects. (i) capacity and the enabling environment, (ii) finan-
The institutional and regulatory framework has been cial viability, (iii) availability of long-term financing,
inadequate. These factors have increased the risk and (iv) foreign investments.
perception of the electricity sector and limited the
amount of commercial and private sector financing The seasonality of Nepal’s hydro sector offers win-win
available to the sector. However, the return to polit- opportunities for Nepal and its neighbors but requires
ical stability, the government’s ambitious plan to in- substantial investments and regulatory and institu-
crease generation capacity, and recent improvements tional reforms. Once the extensive pipeline of run-of-
in the dollar-denominated PPA structure are encour- the-river projects comes online by 2020, Nepal could
aging and steps in the right direction for greater pri- have a surplus in the wet season but a shortage in the
34
dry season. Electricity trade with its neighbors would Strict visa regulations for foreign workers, the lack
improve the efficiency and reliability of Nepal’s electric- of a distinction between temporary and permanent
ity system in a cost-effective way. Furthermore, Nepal movements of workers, and the nontransparent and
could benefit from the growing market for hydropower expensive visa process exacerbate the situation. Lack
to provide ancillary services to balance variable renew- of international developers in the recent past has also
able energy resources, such as solar and wind in India. reduced the knowledge transfer that took place with
the early IPPs.
Constraints Affecting Capacity and the There is a need to build the capacity of new pub-
Enabling Environment lic sector agencies in the electricity sector and assist
Nepal is embarking on a significant infrastructure them in leveraging additional financing, including
expansion program at a time when local capacity private and commercial. The government has es-
to undertake these investments is limited and the tablished new institutions in the electricity sector—
efficiency of sector investments is low. Two decades NEA subsidiary companies, Electricity Generation
of conflict and political instability together with de- Company Limited (EGCL), National Grid Trans-
pletion of pay and benefits have sapped the morale mission Company Limited, Nepal Power Trading
and culture of government agencies. There has been Company Limited (NPTCL), and Nepal Engineer-
a massive outmigration of skilled and unskilled labor. ing Services Limited—to support the infrastructure
There is a scarcity of medium-to-high-skilled techni- expansion program (see box 5 on building effective
cal and managerial workers in Nepal, and this poses a institutions). NEA subsidiary companies have mo-
challenge for the sector expansion program. Nepalese bilized substantial resources to develop priority hy-
firms will increasingly need to compete at the region- dropower projects, but they need capacity building
al and international levels for expertise and talent. to manage risks and complete complex hydropower
BOX 3: INTERNATIONAL EXPERIENCE WITH LARGE HYDRO PROJECTS
Given their unique risk characteristics and the Benefits of project phasing. Given high capital ex-
additional work and time involved in structuring penditure costs and long construction times, inter-
and delivering a public-private partnership proj- est during construction can significantly increase
ect, most large hydro projects in the world have the cost of the project when financing is committed
historically been publicly financed. More than before it is required. Sequential financing can help
70 percent of the hydro projects that are larger remedy this, where the funding is raised when re-
than 100 megawatts and were commissioned quired. Of the 10 largest hydropower projects in the
between 2014 and 2016 involved some form of world, eight have been constructed in more than
public ownership; 90 percent of the largest were one phase, thereby raising financing in sequences
exclusively public projects. The private sector and using early generation as a source of income.
proportion increases as the scale diminishes. For instance, in the case of the Grand Renaissance
Dam, the Government of Ethiopia is progressive-
OWNERSHIP PROJECTS COMMIS- SHARE ly raising bonds to finance different phases of the
SIONED, 2014–16 (%) project. Similarly, the Government of Pakistan is
Wholly public 42 58 using sequential financing to develop the Dasu hy-
Wholly private 21 29 dropower project. A phased approach can be adopt-
Public-private 1 1 ed by public and private sector projects to save on
Foreign state-owned 11 interest during construction.
enterprise involvement
Source: International Hydropower Association 2017.
35
BOX 4: PRIVATE SECTOR EXPERIENCE WITH LARGE HYDRO PROJECTS
With power market liberalization and increased sessment, careful selection of parties with strong
private sector participation in emerging markets experience in hydro development, and significant
over the past few decades, governments have engagement in project implementation and super-
welcomed private developers to develop, finance, vision. Furthermore, robust contingency and spon-
construct, and operate hydropower projects, in- sor support arrangements have helped to mitigate
cluding large hydropower projects around the financing risk. With the right approach and the
world. There are several such examples, including right sponsors, private developers and lenders have
many financed by International Finance Corpo- helped drive success in the development and execu-
ration, such as the 500 megawatt (MW) Pangue tion of private sector–led hydropower projects. Al-
Hydroelectric project in Chile, the 500 MW Boy- though the risks are more pronounced in hydro de-
abat project in Turkey, and the 690 MW Barra velopment, project sponsors have a strong financial
Grande project in Brazil. Since 2000, 54 giga- incentive to deliver projects on time and on budget,
watts (GW) of large hydropower projects have which also helps to align interests.
been developed with private sector participation The most successful projects are often those that
in World Bank markets, with investment volume are cost competitive in the country’s power gener-
totaling over US$73 billion.a Among the larger ex- ation mix and have low cost overrun risks or highly
amples is the 3,000 MW Engie-sponsored Jirau committed sponsors, falling into one of the follow-
project in Brazil. ing categories: (i) greenfield hydros with limited un-
derground works (for example, the 250 MW Bujagali
Given the geological, hydrological, seismic, en- project in Uganda); (ii) privatization and/or rehabil-
vironmental, social, and other complexities and itation/expansion of existing hydros, where reha-
associated uncertainties related to the con- bilitation/expansion requires limited underground
struction of hydropower projects, cost overruns works (for example, the 404 MW Vorotan hydro
and construction delays are a common feature of project in Armenia); and (iii) more complex green-
greenfield projects. Governments and public sec- field projects with highly committed sponsors that
tor utilities have been able to allocate a signifi- have the technical sophistication, balance sheets,
cant portion of such risks to the private sector in and dedication to address problems as they arise
hydro independent power producers, alleviating (for example, the 300 MW La Higuera and La Con-
the risk to the public sector and end-consumers. fluencia projects in Chile, where Norway’s Statkraft
For private developers and lenders, managing played such a role in a commercially-driven struc-
such risks has required thorough project as- ture, voluntarily injecting additional equity and ex-
pertise when it was needed most).
a. World Bank PPI database.
Table 1 - Breakdown of investment in PPI database for all countries

Type Investment ($ million) Capacity (MW) Share of investment Share of capacity
Foreign SOE 16591.7 9844 23% 18%
PPP 40488.18 31330 55% 58%
Private 16417.09 13155.4 22% 24%
Grand Total 73496.97 54329.4 100% 100%
Table 2 - Breakdown of investment in PPI database for IDA countries

Type Investment ($ million) Capacity (MW) Share of investment Share of capacity
Foreign SOE 13987 8614 87% 91%
PPP 2160 900 13% 9%
Grand Total 16147 9514 100% 100%
36
BOX 5: BUILDING EFFECTIVE INSTITUTIONS
The performance of institutions depends not just Therefore, institution-building efforts must focus on
on formal organizational rules and structures, shaping incentives in addition to providing knowl-
but also the informal norms and incentives of edge, training, and modern equipment. Effective
people responsible for implementing these rules. institutions need to be incentive compatible. Insti-
Once poor systems are in place, they can be very tutions with internal enforcement mechanisms are
difficult to dislodge. Strong interests develop in effective because there is a mutually recognized sys-
maintaining the status quo, however inefficient tem of rewards and penalties. An important issue in
or unfair. the design of public institutions is ensuring that the
incentives that are created lead to desired behavior.
Source: World Development Report 2017.
projects on time and within budget. EGCL needs to field against the NEA. NEA functions include power
be developed as a specialized agency with in-depth generation and system dispatch in addition to own-
technical and project development expertise in stor- ing and operating the national transmission and dis-
age hydro projects, which the NEA and IPPs current- tribution system. Private IPPs are expected to bring
ly lack. NEA subsidiary companies and EGCL need large-scale investments into hydropower generation,
to be enabled to leverage additional financing from but they are at a disadvantaged position in transmis-
different sources, including private and commercial, sion access, dispatch, and PPA negotiations with the
for the development of the sector. NEA, which prioritizes its own power plants. Private
developers do not have unfettered access through the
The public investment management and planning transmission system to large buyers in the domestic
process is highly inefficient and has recently failed and regional markets and are thus not able to develop
to deliver completed productive assets and infra- projects without a PPA with the NEA.
structure on time. Power sector projects on average
have taken more than nine years to finish, signifi- The absence of a strong, transparent, and profession-
cantly longer than international benchmarks. In- al regulatory agency has increased the risk perception
vestments are selected on a project-by-project basis of the sector among investors. A strong regulatory sys-
without adequate consideration of the technical and tem is designed to ensure fair treatment of customers
economic merits of the projects or coordination with and investors. It gives confidence to investors that their
other investment decisions. The use of formal river investments will be safeguarded to earn a fair return.
basin plans and least-cost plans to inform the priority Despite consensus on the need for an independent reg-
order of investments is absent. The public investment ulator, Nepal had not been able to establish one for the
management process in Nepal is relatively weak com- past decade. Nepal’s Parliament passed the enabling
pared with similar countries. Nepal has failed to en- legislation for an independent regulatory agency in
force public investment management features such as September 2017. The regulator needs to be operation-
project selection and budgeting, project implementa- alized to ensure the development of a receptive invest-
tion, adjustment of projects in construction, and ex ment climate. In Nepal’s context, it is urgent that the
post evaluation. regulator comes up with guidelines on electricity tar-
iffs, transmission pricing, grid code, and open-access/
The private sector is eager for a greater role in the third-party access, to send the right signals to investors
development of the sector but lacks a level playing and facilitate competition in the sector.
37
Constraints Affecting Financial Viability With improvements in its operational and financial
The financial viability of the sector needs to be performance, the NEA would increasingly be able to
strengthened to enable it to mobilize the resources raise its own capital directly from commercial banks
it needs from debt and capital markets. The finan- or by issuing corporate bonds, reducing the need for
cial situation of Nepal’s electricity sector has been direct budgetary support from the government. The
very weak in the past. In the years leading to FY2017, NEA would need to demonstrate sound financials
the NEA posted large losses due to below-cost retail through a combination of efficient performance, a sta-
electricity tariffs and high system losses. The NEA’s ble but flexible tariff regime, and reliable budget sup-
cumulative losses between 2008 and 2016 (US$643 port, as quantified by an adequate credit rating from a
million) equaled 3 percent of GDP (figure 4).20 T&D reputable risk rating agency.
losses in Nepal, at 25.8 percent in FY2016, were
significantly higher than regional and international
benchmarks. This severely limited the NEA’s ability Constraints Affecting the Availability of
to make new investments and sign PPAs with IPPs, Long-Term Financing
which contributed to the country’s electricity sector The ability of banks, which dominate the financial
crisis. After 10 years, the NEA turned from operating sector, to intermediate and provide long-term fi-
at a loss to a profit in FY2017, largely because of a nance to the electricity sector is constrained by sev-
14 percent increase in tariffs and implementation of eral factors. Nepal’s banks face a significant asset-lia-
a financial restructuring plan. Yet, a sustained focus bility mismatch in lending to long-term hydropower
on increasing revenue, reducing system losses, and projects because of the banks’ mostly short-term de-
financing costs will be needed in the coming years posits. There is a lack of non-recourse project finance
to enable the NEA to meet its PPA obligations and in the sector, because NRB regulations discourage
maintain robust financial health. non-collateral-based lending. Bank lending is fur-
ther constrained by the limited capacity of banks to
This will mean developing a framework and capaci- conduct detailed due diligence; the high-risk percep-
ty for electricity trade with Nepal’s neighbors. Elec- tion of the hydropower sector, given past cost and
tricity trade will have an important role in improving time overruns; high collateral requirements; and the
the affordability of electricity in Nepal and ensuring prevailing weak standards of corporate governance,
the financial viability of the sector. The average cost especially relating to timely corporate actions and re-
of electricity in Nepal’s electricity system is projected lease of information. With loan growth far exceeding
to be at least 30 percent lower with electricity trade deposit mobilization, electricity sector projects face
than otherwise. Without a strong institutional and reg- high interest rates. The single-borrower limit of 50
ulatory framework to manage the country’s electricity percent of the banks’ equity capital constrains lend-
trade, Nepal will not be able to find markets for its ing and necessitates lending from a consortium of
surplus generation in the wet months and cheap im- banks for projects above US$40 million.
ports in the dry season. As a result, the average cost of
electricity served to Nepal’s consumers would increase, Sector-specific financiers cannot fill the gap left by
which could adversely affect the sector’s financial vi- commercial banks. In 2011, the Hydroelectric Invest-
ability. Nepal currently lacks a dedicated institution ment Development Company Limited (HIDCL) was
to manage the country’s electricity trade, and a legal set up as a special purpose vehicle to make debt and
and regulatory framework for electricity trade at the equity investments in medium-size and large hydro-
national and regional levels is lacking. power projects. It has authorized capital of US$435
million and paid-in capital of US$87 million. The
With financial viability, the NEA would improve its company is majority-owned by the Government of
ability to mobilize financing from debt and capital Nepal (50 percent), with institutional investors (30
markets on its own without government support. percent) and public investors (20 percent) making the
20 There was no increase in electricity tariffs between 2001 and 2012 and then again until 2016. Tariffs were perennially below the cost.
38
FIGURE 4: NEPAL ELECTRICITY AUTHORITY’S NET INCOME (US$, MILLIONS)

40.0
20.0
0.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
-20.0
-40.0
-60.0
-80.0
-100.0
-120.0
-140.0
Source: NEA Annual Report 2018.
remaining equity contributions. So far, HIDCL has in the primary market, and negligible liquidity in the
provided debt and equity financing of about US$50 secondary market all contribute to the lack of a liquid
million to 11 hydropower projects. The sizes of the sovereign benchmark. Nepal’s policies and regulations
commitments range from US$1.7 million (Bagmati governing the financial markets, banking sector, and
Small Hydropower project, 20 MW) to US$5.2 mil- government securities tend to discourage the develop-
lion (Lower Sulu, 82 MW). Furthermore, HIDCL has ment of the bond market. Secondary trading is negligi-
invested in the Nepalese portion of the cross-border ble, due to the lack of an investor base and inadequate
Dhalkebar-Muzaffarpur transmission line. It has in- clearing and settlement systems. Attention needs to be
corporated a fully owned subsidiary, Remit Hydro given to improving laws, regulations, and supervision
Limited, to raise funds from the Nepalese diaspora for bond market development.
for investment in hydro generation and transmission.
Similar to domestic banks and financial institutions, The equity market is shallow, limiting the govern-
HIDCL’s institutional and financial capacities need to ment’s ambitions to utilize it to mobilize investments
be strengthened substantially to support the infrastruc- in hydropower. The stock market needs moderniza-
ture expansion program in the sector (box 6). tion. The Securities Board of Nepal lacks autonomy
and capacity to provide effective risk-based supervi-
Nepal’s capital markets are at an early stage of de- sion. Private equity and venture capital lack a specific
velopment and need deepening to play a significant legal and regulatory framework. The government has
role in the provision of long-term finance to the elec- launched a program to broaden the ownership base of
tricity sector. Long-term, committed funding for in- hydropower in the country through requirements for
frastructure projects is best supported by a mature and public projects to issue 10 percent of the shares to lo-
vibrant bond market. Nepal’s bond market remains cal communities and at least 15 percent of the shares
constrained, accounting for about 13 percent of GDP to the public through IPOs. This investment model
at the end of 2017. The debt market is dominated by offers great potential to create local ownership and in-
short-term government debt, and there is no active crease public support for hydropower projects. How-
yield curve. There are few investors in debt instru- ever, it will be important to address the widespread
ments, and Treasury instruments are bought largely by lack of understanding of how the market mechanism
banks to satisfy statutory liquidity requirements. The works and institute effective safeguards to reduce risk
lack of a reliable issuance calendar, minimal volumes to investors and local communities.
39
BOX 6: INDONESIA INFRASTRUCTURE FINANCE
PT Indonesia Infrastructure Finance (IIF) provides To enhance IIF’s project appraisal and risk manage-
a model for Hydroelectric Investment Develop- ment capacity, Sumitomo, Japan was introduced
ment Company Limited’s future development. IIF as a strategic investor, which helped to bring in in-
is a quasi-private, nonbank financial institution ternational best practices, and staff received inter-
that was established in 2010, under an initiative national training. With the improved capacity com-
of the Government of Indonesia, in cooperation bined with deep local knowledge, IIF now provides
with the World Bank, Asian Development Bank, advisory services for project planning, financial
and other international multilateral agencies. IIF structure, risk management, policy consultation,
provides a wide range of long-term, fund-based and capacity building to the private sector in addi-
products, such as senior loans, mezzanine fi- tion to its investment business.
nance, hybrid securities, refinancing, and equity
investment, in addition to non-fund-based prod-
ucts, such as guarantees and standby finance.
Local institutional investors are underdeveloped and for 10 years. The government is also keen to establish a
mostly invest in short-term instruments. The assets hedging mechanism for better management of foreign
of insurance companies, pension funds, and mutual exchange risks in the sector. Although both mecha-
funds can be critical in safely funding long-term in- nisms are progress in the right direction, as currently
vestment. There are potential domestic institutional structured, they are not expected to be adequate to at-
investors, including the Employees Provident Fund, tract foreign investment (box 3).
Citizen Investment Trust, and the insurance sector,
with a combined asset size of around 15 percent of FDI inflows have been hurt by unclear policies,
GDP. An important factor inhibiting the development complex procedures, and inadequate investment fa-
of institutional investors is the capacity of the regu- cilitation. Offshore funds and onshore vehicles with
lator, with priority needed on risk-based supervision foreign shareholders are considered foreign investors;
along with risk-based capital, as well as stronger as- therefore, they require FDI approval for every new
set-liability management. Insurance companies need investment in a Nepalese company. FDI approvals
capacity building to underwrite loans to large projects can take several months and include lengthy process-
and PPPs, product diversification, and price diversity. es to hire foreign workers. Many of these problems
derive from practice more than from the law itself.
For example, although firms are formally allowed to
Constraints Affecting Foreign open U.S. dollar–denominated accounts, small firms
Investment and individuals report that this is difficult in prac-
Foreign exchange risks significantly constrain the at- tice. Even with such an account, it is difficult to pay
traction of foreign investment to the sector. In recent for services in U.S. dollars, due to caps on the size
years, the government has shown greater appreciation of U.S. dollar–denominated contracts. In addition,
of the importance of foreign investment for meeting many FDI guidelines are only available in Nepalese
sectoral investment targets and receiving skills and and have not been translated into English.
knowledge transfer in the hydropower sector. The gov-
ernment adopted PPA guidelines in 2017 that offer There is limited access to foreign currency lending.
partial foreign currency–denominated PPAs for proj- The provisions of the Banks and Financial Institu-
ects larger than 100 MW with foreign financing, with tions Act make foreign currency investment and lend-
a provision to cover the foreign debt incurred by de- ing difficult. The central bank, the NRB, has set strict
velopers through U.S. dollar–denominated payments limits on lending by foreign institutions, which is al-
40
lowed only in the case of unavailability of domestic Build the Institutional and Regulatory
debt and is subject to an interest rate cap of LIBOR Environment
+5.5 percent. Moreover, foreign lenders do not enjoy Any effort to increase financing in Nepal’s electricity
the same level of protection as local banks in terms sector must start by improving the utilization and
of creditors’ rights. Although land and buildings are efficiency of available financing. This will help lower
the main forms of collateral for lending, mortgaging the risk perception of the electricity sector in Nepal
of property in favor of foreign lenders needs cabinet and enable additional sources of financing to come
approval, and enforcement of security requires a court into the sector. By addressing the knowledge and ca-
order. Furthermore, foreign lenders are subordinated pacity gaps in the sector and providing a level playing
to local banks in priority of repayment, and borrowing field to the private sector, the government will enable
is capped in terms of amount and pricing. the private sector to increase its role in the electricity
sector (see table 5).
Nepal has a complicated process for offshore cap-
ital repatriation. Nepal has a fixed currency regime Address Knowledge and Capacity Gaps
(pegged to the Indian rupee). Offshore funds require • In the private sector. Nepal’s private sector cur-
approval of the NRB to repatriate the proceeds of their rently lacks the contractor capacity, technical
divestments. Approvals are granted only for amounts and managerial expertise, project appraisal and
calculated under valuation rules set by the regulator, risk management expertise, and trained work-
not for the actual proceeds. Strict foreign exchange ers that are necessary to undertake successfully
controls create an incentive for undervaluing transac- a large infrastructure program in the electricity
tions so that less foreign exchange leaves the country. sector. There is a need to assess and address the
Furthermore, despite the country’s many double tax- workforce, contractor capacity, education, and
ation agreements, there has been uncertainty about training constraints in the sector. For FDI proj-
their enforcement, which increases uncertainty for ects, partnerships between local developers and
foreign investors when exiting investments. experienced international developers can enable
development of this local capacity in the areas of
project management, technology transfer, con-
Roadmap to Unlock New tract management, and construction methods.
Sources of Finance
A coordinated policy effort in four areas is required • In the public sector. The Government of Nepal
to meet the financing needs of the electricity sector. established EGCL and National Grid Transmis-
Nepal’s investment needs are two to four times higher sion Company Limited to support electricity
than its recent investments in the sector. Nepal needs sector expansion. These institutions need to be
to utilize available financing, but this will not be suf- developed into modern, capable, and efficient
ficient to meet the large financing needs of the sec- institutions that can attract and retain talent. At
tor. To do so, the country must develop and tap into the same time, the NEA should be corporatized
newer and larger sources of local and international and modernized in preparation for its planned
financing. To seize this opportunity, the government restructuring. It is recommended that the gov-
is advised to exert a sustained and concerted policy ernment ensures that the functioning of these
effort in four main areas: institutions is not adversely affected by political
interference, and that these institutions have the
Pillar 1: Build the institutional and regulatory capacity and resources to deliver their mandate.
environment Public sector companies could outsource selected
Pillar 2: Strengthen the financial viability of operation and management functions to experi-
the sector enced private sector companies.
Pillar 3: Increase the availability of long-term
finance • In public investment management. It is advised
Pillar 4: Develop an enabling environment for that the government establishes a well-resourced,
foreign investment. central coordination mechanism for the energy
41
sector, preferably in the Prime Minister’s Office. September 2017. The regulator is expected to
The unit would support the following activities: set prices, ensure efficient provision of services,
(i) strategic planning, (ii) prioritization and se- monitor the abuse of market power, and ensure
lection of projects and maintenance of a rolling open and fair access to the transmission system.
pipeline of priority infrastructure projects, (iii) co- The government is advised to develop a strong
ordination of government agencies and the IBN, regulator, by making key appointments in the
(iv) transparent performance monitoring, and (v) near term and supporting its institutional devel-
preparation and implementation of initiatives in opment in the medium term. An efficient and
favor of private sector investment in priority infra- effective regulatory framework will help provide
structure. The new mechanism would apply a clear confidence to private investors that they will be
decision-making framework to prioritize private fi- treated fairly in a rule-based sector and help in-
nancing and leverage scarce public resources. crease investments. There is a need for greater
transparency and stronger regulations on the use
• In power system planning. There is a need for of the NEA’s transmission infrastructure by IPPs
substantial strengthening of the planning func- to export power. Currently, there is no transpar-
tion in the energy sector and using it to inform ency on how IPPs can access this physical infra-
decisions. It would be advisable for the govern- structure, and there is no regulation, for example,
ment to complete and regularly update the river on wheeling charges.
basin plan and the generation, transmission, and
distribution masterplans. Moreover, there is need • Complete the sector restructuring process. It is
for a concerted effort to incorporate a culture of recommended that Nepal pursues structural re-
planning in electricity sector institutions. The forms in the electricity sector to increase invest-
NEA should introduce competitive bidding in ments. Given the prospect of surplus generation
the next wave of IPPs in hydropower and solar in the wet season and the inability of the NEA
and bid out selected high-voltage transmission to offer take-or-pay contracts to all developers,
lines to the private sector using the build-and- investors’ access to large domestic customers
transfer model. and the Indian and regional electricity markets
would ensure the viability of their investments.
• In environment and social inclusion. As Nepal A new Electricity Act to redefine the roles and
prepares to develop large run-of-the-river and responsibilities of different sector institutions
strategically important storage hydropower proj- and a sector restructuring plan are crucial for
ects, it will need clear and consensus-based guide- ensuring unfettered access to the domestic and
lines for resettlement and rehabilitation, land regional electricity markets for private develop-
acquisition, and other mitigation support for ers. For instance, a single buyer could negotiate
people affected by the projects. It will also need PPAs with IPPs rather than the NEA, which
strengthened and streamlined environmental and has its own generation assets and PPAs with
social provisions for investment. It would be ad- semi-private subsidiaries and a potential conflict
visable for the government to adopt new forest of interests. Alternatively, the government could
clearance guidelines, right-of-way, and gender consolidate all the public generation companies
and social inclusion guidelines and strengthen its into a single entity, which would not be the
capacity to implement these guidelines. off-taker for IPPs.
Create a Level Playing Field for the Private Sector • One-stop window for private sector IPPs. It is
• Operationalize an independent regulator. Until recommended that the government sets up a one-
now, Nepal has not had an independent elec- stop window for private sector IPPs or enhances
tricity regulator. Nepal’s Parliament approved the role of IBN to act effectively as a single pro-
the Electricity Regulatory Commission Act in cessing entity.
42
Strengthen the Financial Viability of the NEA and its subsidiaries, strengthening the power
Sector trading and export strategy, waiving past liabilities
Improved financial viability would increase the of the NEA, separating transmission and system
ability of electricity sector institutions to mobilize operation functions, and implementing energy ef-
financing from the capital market (table 6). A finan- ficiency measures. Going forward, the NEA needs
cially viable sector means full recovery of the cost of to update and implement the action plan on a
electricity services, reasonable revenue for reinvest- consistent basis. Once it has established a sustained
ment, system losses on par with international bench- track record of positive financial performance, the
marks, and a subsidy mechanism in place to ensure NEA can explore options to be rated on local and
affordable electricity services for the poor. This can be international capital markets.
achieved through policy actions to improve the cred-
itworthiness of electricity sector institutions and by Strengthen the Framework for Electricity Trade
strengthening the enabling conditions for electricity • Through new regulations and guidelines. Elec-
trade with Nepal’s neighbors. tricity trading will have an important role in im-
proving the affordability of electricity in Nepal
Improve the Creditworthiness of the Sector and ensuring the financial viability of the sector.
• Ensure cost-reflective tariffs. The regulator will The average cost of electricity is projected to be
establish a cost-reflective tariff framework to im- at least 30 percent lower with electricity trade
prove the NEA’s financial health and provide pre- than otherwise. Adoption of electricity trading
dictability for sustainable investment in the pow- as a licensed activity in the proposed Electricity
er sector. This will improve the NEA’s ability to Act would facilitate electricity trading. The new
make new investments and sign PPAs with IPPs. electricity regulator will need to issue guidelines
on transmission pricing, open-access/third-party
• Reduce T&D losses. T&D losses in Nepal, at access to the transmission system, and the grid
20 percent in FY2018, have decreased in the past code. Nepal would also need to harmonize its
two years but are still significantly higher than guidelines and regulations with neighboring
global and regional benchmarks. To address this, countries.
the NEA should adopt and implement a Loss
Reduction Masterplan. This would entail assess- • Through the institutional development of NPT-
ing baselines and targets for the technical and CL. The Government of Nepal established NPT-
commercial losses in the distribution networks, CL in 2016, to promote domestic and regional
appraising investment needs to reinforce and trade of electricity. In the short term, NPTCL
upgrade the electricity distribution system and will focus on bridging the supply gap through
implementing comprehensive institutional and imports from India. In the medium term, once
investment measures. Loss reduction will help substantial generation capacity that is currently
reduce the cost of supply and thus improve the under construction comes online, NPTCL will
financial viability of the electricity sector. help find a market for the surplus generation
from NEA generation plants and take-and-pay
• Implement the NEA’s financial viability plan. IPPs. NPTCL will also have a role in maximiz-
The NEA adopted a financial viability action plan ing the revenues from the sale of free power al-
in 2018 to sustain the short-term improvement located to the Government of Nepal in various
and ensure the long-term viability of the sector. export-oriented projects and attracting viable in-
The NEA’s financial viability action plan, with a vestments by entering into commercial arrange-
10-year outlook, calls for actions to optimize (i) ments with sellers and buyers through back-to-
cost through integrated generation and transmis- back PPAs. Implementation of NPTCL’s business
sion planning, energy banking, reduction in T&D plan will facilitate the institutional development
losses, and appropriate management of foreign of NPTCL. Initially, the plan will be supported
exchange risks; and (ii) revenue through restruc- by NPTCL’s paid-in capital. Over time, its trad-
turing the financial arrangements between the ing fees and income will fund NPTCL.
43
Increase the Availability of Long-Term Strengthen HIDCL and Institutional Investors

Finance • Increase institutional capacity. In the near term,
There is an urgent need to increase the availabili- twinning arrangements with similar institutions,
ty of long-term local finance in the sector (table 7). training and capacity-building project due dili-
Electricity sector projects would benefit from greater gence, and financial structuring are recommended
availability of long-term, fixed-interest local currency for these institutions to strengthen their capacity to
finance through the domestic debt and capital mar- support hydropower development in the country
kets. Local currency financing is attractive because it (see table 1). In the medium term, the government
helps avoid the additional risks associated with ex- could invite a strategic investor that can improve
change rate variations and currency convertibility. HIDCL’s management and project appraisal ca-
Nepal’s public debt level, at 30 percent of GDP, is pacity, and/or pursue a close partnership or com-
low compared with regional and international bench- bination with a domestic commercial bank. Such
marks, indicating the potential to mobilize additional partnership with a commercial bank would help
financing. Nevertheless, at present, it is not possible HIDCL: (i) take advantage of existing financial risk
to mobilize significant amounts of local financing, management and governance mechanisms in the
due to variable interest rates, short tenors, inefficient commercial bank; (ii) improve the sectoral diver-
regulations, and low capacity. Addressing these will sification of the collective portfolio; (iii) overcome
call for a concerted effort to deepen and broaden some of the regulatory challenges, such as the need
Nepal’s capital markets, as an alternative channel of for a licensed commercial bank to deploy some of
long-term finance. Some actions for consideration are the financing; and (iv) quickly strengthen its capi-
highlighted as follows. tal base. Care must be taken not to put regulatory
functions or privileged resources (such state-backed
Address Constraints Faced by Local Commercial Banks hedging facilities) within one financing institution,
because this would stifle competition among finan-
• In project appraisal. Many local banks are unfa-
ciers and give an undue advantage to one financier.
miliar with hydropower projects. This makes it
difficult for them to appraise projects and manage
• Support greater investment from institutional in-
risks. For local banks to play a greater future role
vestors. Institutional investors, such as pension funds
in electricity finance, it will be important to under-
and insurance companies, have a greater capacity to
take capacity-building activities with the banks.
provide fixed interest rate, longer-term financing;
therefore, the entities need to be incentivized to pro-
• In non-recourse project finance. NRB regula-
vide further financing to the sector and provided
tions need to be revised to enable non-recourse
capacity-building exposure similar to domestic com-
project finance where future cash flows and the
mercial banks. The Insurance Board should issue re-
assets and rights of the project are the sole col-
vised investment guidelines for insurance companies,
lateral for lenders. Current regulations discourage
which provide for more investment opportunities
lenders from taking security for loans against in-
and partly address asset-liability mismatches.
tangible assets. Furthermore, enabling conditions
for project finance need to be developed, such as
Increase Financing from Capital Markets
due diligence capacity, alternative financial in-
• Use multilateral guarantees and other risk mit-
struments for debt and insurance products that
igation mechanisms. It is recommended that
protect against key risks during development and
the government develops a strategy to mobilize
operations, security arrangements (getting well
finance from capital markets, using multilateral
accustomed to the assignment rights and step-in
guarantees, stapled finance structures,22 and other
rights in the project), and waterfall mechanisms.21
risk mitigation mechanisms, and pilots the strat-
egy in a national priority electricity project.
21 A cash waterfall mechanism is the basis on which the various entities have the rights on the project cash flows in a project finance transaction. The lenders
monitor the project accounts and ensure that payments are made in line with the waterfall mechanism.
22 In a stapled finance structure, the entire procurement process is supported by pre-approved financing from development partners and credit enhancement
44 structures in conjunction with the government. It is available with the option of exploring financing outside the pre-approved structure, and removes the
risk of financing for the bidders.
TABLE 5: BUILD THE INSTITUTIONAL AND REGULATORY ENVIRONMENT – RECOMMENDED ACTIONS
KEY CONSTRAINTS
(RESPONSIBILITY)
LIMITED CAPACITY AND KNOW-HOW IN THE SECTOR
Private sector Prepare diagnostic and strategy to ad- Implement the strategy.
(MOEWRI) dress capacity constraints in the private
sector.
Public sector Prepare business plans for new electric- Implement the business plans.
(MOEWRI) ity sector institutions such as EGCL and
RPGCL. Implement the recommendations of the
Carry out an organizational stocktaking NEA diagnostic.
and diagnostic of NEA.
Corporatize distribution companies and
explore options for private sector partic-
ipation.
Develop a robust and transparent bidding
framework for procuring energy projects
by PPP, including developing internation-
ally bankable PPAs and Project Develop-
ment Agreements.
Adopt competitive bidding guidelines for
hydropower and solar.
Public investment management Establish a central coordination and Implement mechanism to ensure close
(MOF/MOEWRI) investment management mechanism for coordination between federal and provin-
energy projects. cial entities in implementation of energy
projects.
Planning Prepare the river basin plan. Monitor and update the plans.
(NEA/ERC)
Prepare least-cost generation master- Use competitive bidding for
plan. next wave of hydro and solar IPPs.
Prepare distribution masterplan. Use a build-and-transfer model to develop
transmission projects with private sector
participation.
Environment and social Adopt improved land acquisition, forest Strengthen the capacity of relevant agen-
(MOFEP/NEA/MOF) clearance, right-of-way, and gender and cies to implement these guidelines.
social inclusion guidelines.
ABSENCE OF LEVEL PLAYING FIELD FOR THE PRIVATE SECTOR
Independent regulator Appoint ERC Chairman and Commission- Implement ERC Business Plan that covers
(MOEWRI/ERC) ers. the points above on fixing a new tariff-set-
ting mechanism for IPPs and establishing
Prepare ERC Business Plan
power-wheeling charges for the use of NEA
transmission facilities.
Sector restructuring Prepare and approve the new Electricity Complete the separation NEA’s generation,
(MOEWRI) Act transmission, and distribution business
under a holding company structure. Clarify
Issue a sector restructuring plan. how the entities created from unbundling
NEA relate to the existing public sector
companies EGCL and RGPCL.
Note: EGCL = Electricity Generation Company Limited; ERC = Electricity Regulatory Commission; IPP = independent power producer; MOEWRI = Ministry of
Energy, Water Resources, and Irrigation; MOF = Ministry of Finance; MOFEP = Ministry of Finance and Economic Planning; NEA = Nepal Electricity Authori-
ty; PPA = power purchase agreement; PPP = public-private partnership; RPGCL = Rastriya Prasaran Grid Company Limited.
45
TABLE 6: IMPROVE THE FINANCIAL VIABILITY OF THE SECTOR – RECOMMENDED ACTIONS
KEY CONSTRAINTS(RESPONSIBILITY) SHORT-TERM ACTIONS MEDIUM-TERM ACTIONS

POOR CREDITWORTHINESS OF ELECTRICITY SECTOR INSTITUTIONS
Cost-reflective tariffs (ERC) Issue new electricity tariff guidelines. Approve tariff revisions annually based on
tariff guidelines.
Loss reduction (NEA) Approve the Loss Reduction Masterplan. Implement the masterplan.
Financial viability plan Prepare NEA to access capital and debt Explore options to get a credit rating for
(NEA) markets on its own by implementing the the NEA and its subsidiary companies.
NEA financial viability action plan.
WEAK ENABLING FRAMEWORK FOR ELECTRICITY TRADE
Regulations and guidelines Adopt electricity trading as a licensed Harmonize with regional trading guidelines
(MOEWRI/ERC) activity.Issue open-access guidelines, and codes.
transmission guidelines, and grid code.
Institutional development of NPTCL Adopt NPTCL business plan and operating Commence power trading through NPTCL.
(NEA/MOEWRI) procedures.
Note: ERC = Electricity Regulatory Commission; MOEWRI = Ministry of Energy, Water Resources, and Irrigation; NEA = Nepal Electricity Authority; NPTCL =
Nepal Power Trading Company Limited.
• Pursue divestiture/equitization of public entities/ for asset recycling tools (figure 5), including stock
assets. As part of the sector restructuring process, it market modernization and capacity building.
is recommended that the government pursues eq-
uitization of NEA generation assets. As a growing • Implement a bond market development road-
number of generation plants developed by NEA map. The government is advised to adopt and
subsidiary companies become operational, this implement a bond market development roadmap
strategy can also be extended to them. This would to enable raising bonds from domestic and for-
allow the government to release and recycle some eign markets (that is, diasporas) for the electrici-
of its capital for new T&D projects, while also ty sector. Progress on this agenda will be vital to
providing the opportunity to generate investor and provide channels for longer-term finance in the
lender interest in operating assets in addition to sector. Among the critical steps to be taken are
greenfield IPPs. As part of its equitization/divesti- (i) developing short-term benchmark interest
ture strategy, it would be advisable for the govern- rates, (ii) taking measures to increase liquidity in
ment to develop a comprehensive asset recycling the longer end of the government bond market,
framework and create an enabling environment and (iii) plugging regulatory gaps. The roadmap
FIGURE 5: DEVELOPING AN ASSET RECYCLING FRAMEWORK

Assess Selected the Best Recycling Tool Create Enabling Environment
Current Operations and

potential for efficiency gains Securitizing
l future
revenues Improve the regulatory
Issuing bonds
l environment, to include
Capacity of the SOE to manage resolutions to: (i) tax (ii)
Selling equity to
l
the asset,given expansion accounting and (iii)
strategic investors
plans ownership issues that
Limited concessions
l
Infrastructure funds
l have hindered asset
Debt needs and fiscal capacity Issuing public equity
l recycling
of the SOE, including how to on the capital
replace revenue streams in the markets
event of divestiture
Source: World Bank 2018
46
should investigate options for project companies with foreign exchange indexation reflecting the
and special purpose vehicles to issue bonds. actual foreign exchange risk being passed through
and maximizing local content with partial or full
• Reduce transaction costs in the stock market take-out financing after completion, provided this
and improve communication. To reduce the cost can be done cost-effectively. Until Nepal’s capital
of owning shares in hydropower projects for local markets are sufficiently developed to support mar-
communities and the public, the government is ket-based hedging instruments, such as cross-cur-
advised to decentralize the current brokerage ser- rency swap transactions, the NRB currently plans
vice, by requiring current brokers to offer services to establish a hedging facility to reduce foreign
at the district level and allowing banks to provide currency risks and expects this will help attract for-
this as an additional service. The government eign finance for projects (see box 3 for discussion
is advised to prepare and implement a well-de- on challenges and issues with currently proposed
signed communication program targeted at retail mechanisms).
investors and local communities on the obliga-
tions, risks, and opportunities of investing in the Facilitate Foreign Investment and
capital market and specific hydropower projects. Financing
• Establish a one-stop window for clearances. To
Create an Enabling Environment for ease and expedite the private investment approval
Foreign Investment process for large projects, it is recommended that
The large investment needs of the sector mean that the government implements a single window for
public and local financing alone will not be suffi- obtaining all government clearances for private
cient, and foreign investment and financing will be sector investments above NPR 10 billion (equiv-
needed (table 8). There is a need to mobilize for- alent to US$88.5 million). The window should
eign investment and financing for large hydropower make all policies, laws, and regulations related to
projects, utility-scale renewable energy projects, and FDI available in English and facilitate the efforts
transmission projects, while closely monitoring the of foreign investors to comply with them. Given
fiscal commitments and contingent liabilities that that past efforts at establishing a single window
arise from such arrangements. To increase the role of have not been successful, it will be important to
foreign investors and financiers in the sector, it is rec- learn from experience. The single window must
ommended that the government undertakes policy be well resourced and have political support at
actions in the following areas. the highest levels of the government.
Manage Foreign Exchange Risk • Remove barriers to foreign currency borrowing.

• Manage forex risk through foreign exchange risk To facilitate borrowing in foreign currency, it is
mitigation mechanisms. The risks of foreign ex- recommended that the government addresses
change movements should be shared between the foreign lenders’ rights by facilitating the enforce-
developer, the end-user, and the Government of ment of collateral through local agent banks,
Nepal. The regulator should incorporate provisions and eases limits on foreign currency borrowings.
in electricity tariff guidelines that allow automatic This will enable greater participation by foreign
pass-through of normal foreign exchange devalua- lenders and access by investors to broader and
tion costs in electricity tariffs. For catastrophic de- competitively priced sources of funding. To ease
valuation of currency, it is recommended that the restrictions on foreign ownership and borrowings
government considers a structural solution, such as by domestic investors, the government would fa-
establishing a facility like the Petroleum Products cilitate foreign exchange–related transactions, in-
Price Stabilization Fund, to bear this risk. Other cluding foreign investment–related funds transfer
mitigation mechanisms that the government could and repatriation, and promote the orderly devel-
consider include implementing rupee-based PPAs, opment of a foreign exchange market.
47
TABLE 7: INCREASE THE AVAILABILITY OF LONG-TERM FINANCE – RECOMMENDED ACTIONS
Key constraints
SHORT-term actions Medium-term actions
(Responsibility)
Limitations of domestic financing institutions
Project appraisal Implement a capacity-building program
(NRB) for domestic banks on project appraisal
of hydropower.
Project finance Make legal and regulatory revisions to Pilot non-recourse finance in a national
(NRB) enable non-recourse project finance priority project .
and issue a Code of Practice for Project
Finance.
Limited institutional and financial capacity of HIDCL and Institutional Investors

Institutional capacity Undertake twinning arrangements Use strategic investors and/or a part-
(MOEWRI/HIDCL/MOF) for HIDCL with similar institutions in nership or combination with a domestic
more advanced countries and carry out commercial bank to improve HIDCL’s
capacity building and training for HIDCL risk management and project appraisal
staff. capacity.
Financial capacity Adopt a capital increase plan for HIDCL. Strengthen the capital base of HIDCL
(HIDCL/Insurance Board/ MOF) through additional equity infusions
Issue revised investment guidelines to from the Government of Nepal and/
increase investment opportunities for or development partners and/or other
insurance companies and partly address strategic investors and/or a partnership
asset-liability mismatches. or combination with a domestic com-
mercial bank.
Adopt regulations related to asset-lia-
bility management and solvency capital
requirements of insurance companies.
Limited financing from capital markets
Multilateral guarantees Develop a strategy to raise financing Pilot the use of multilateral guarantees,
for the sector from international and/or stapled finance structures, and/or other
Stapled finance structures local capital markets using multilateral risk mitigation instruments to raise
(MOF/MOEWRI) guarantees, stapled finance structures, financing from capital markets in a
and/or other risk mitigation instru- national priority project.
ments.
Equitization Prepare a strategy to pursue equitiza- Implement the strategy and framework.
(MOF/MOEWRI/NEA) tion of public shareholding in generation
entities/assets (including an asset recy-
cling framework) in the electricity sector.
Bonds Prepare and adopt a bond market devel- Implement bond issuances (such as
(MOF/NRB) opment roadmap with a medium- and hydro and diaspora bonds) to meet
long-term vision. financing needs in the electricity sector
according to the calendar laid out in the
roadmap.
Stock market Prepare and implement a communica- Decentralize brokerage service by re-
(MOF/Securities Board of Nepal) tion program on share investments in quiring current brokers to offer services
hydropower targeted at retail investors at the district level and allowing banks
and local communities. to provide this as an additional service.
Note: HIDCL = Hydroelectric Investment Development Company Limited; MOEWRI = Ministry of Energy, Water Resources, and Irrigation; MOF = Ministry of
Finance; NEA = Nepal Electricity Authority; NRB = Nepal Rastra Bank.
48
TABLE 8: INCREASE FOREIGN INVESTMENT – RECOMMENDED ACTIONS
Key constraints
SHORT-term actions Medium-term actions
(Responsibility)
Foreign exchange risk
Risk mitigation mechanisms Adopt foreign exchange hedging guidelines. Include provisions allowing pass-through of
(NRB/MOEWRI) foreign exchange costs in electricity tariff
Develop appropriate and enabling guide-
guidelines.
lines for addressing the foreign exchange
risks in IPPs with FDI components, includ- Establish stabilization fund to smooth
ing a relevant review and recommendations tariff increases in the case of catastrophic
by an international expert. devaluation.
Foreign investment and financing
Foreign currency borrowing Adopt regulations to facilitate equitable Ease restrictions on foreign ownership
(MOF/NRB) treatment of foreign lenders and increase and borrowing by domestic investors and
limits on foreign currency borrowings. broaden the scope of foreign currency
transactions.
Simplify foreign exchange repatriation
guidelines.
One-stop window Adopt a framework to manage large PPP Use the framework to implement a national
(MOF/IBN) investments through a one-stop shop. priority project in the electricity sector.
Legal system Implement a capacity-building program to
(MOLJP) improve the capacity of the legal system to
manage FDI issues and disputes.
Note: FDI = foreign direct investment; IBN = Investment Board of Nepal; IPP = independent power producer; MOEWRI = Ministry of Energy, Water Resources, and
Irrigation; MOF = Ministry of Finance; MOLJP = Ministry of Law, Justice and Parliamentary Affairs; NRB = Nepal Rastra Bank; PPP = public-private partnership.
• Strengthen the legal system. To increase foreign • Listen to investors’ concerns. To tap the vast
investors’ confidence, along with harmonizing le- amounts of foreign capital, it is also important to
gal and regulatory inconsistencies and improving listen to investors’ concerns about the current dol-
the legal framework for FDI, it is recommend- lar PPA/project development agreement and the
ed that the government implements a capaci- gaps therein, and to consider improving certain
ty-building program to equip the current legal aspects for improved bankability and attracting
system with experts capable of handling FDI-re- greater FDI. To this end, the sector would bene-
lated issues and disputes. fit from a review of the dollar-denominated PPA
structure by an international expert, recognizing
the country’s generation expansion needs and do-
mestic funding and development constraints.
49
50
Reforming the Transport Sector
Introduction
The transport sector is vital for Nepal’s develop- Nepal’s road network comprises two major networks: the
ment. Safe roads and airports help connect the pop- central road network and the local road network. The largest
ulation to markets and opportunities. The tourism component of the central road system is the Strategic Roads
sector, which contributes over 8 percent to Nepal’s Network, which includes national highways, including Asian
GDP and is therefore one of the country’s biggest job Highways, as well as feeder roads and a few urban roads of
national importance. The local road network comprises urban
creators, also relies heavily on adequate connective in-
roads and local roads, including agricultural roads within the
frastructure. Currently, however, the roads are often
districts, and roads in urban and rural municipalities. The local
congested and not properly maintained, which often
road network is not discussed in this report.
results in high vehicle operation cost. The country’s
only international airport has exceeded capacity and
the road network does not adequately connect tour-
This report focuses on three selected subsectors, the
ism areas.23 Consequently, the population pays high-
Strategic Roads Network (SRN), airports, and urban
er prices for basic daily goods and services. Therefore,
transport. For roads, achieving all-weather connectiv-
the key objective of Nepal’s transport sector in the
ity to district headquarters, ensuring adequate lane
medium term will be to address chronic underinvest-
capacities in all high-density highways, and improv-
ment to improve connectivity, reduce travel time,
ing road safety are crucial goals. For airports, Nepal
and improve safety.
seeks world-class airports in Kathmandu and Pokha-
ra, encourages regional air transportation, wishes to
Sustainable and affordable transport infrastructure
make airports disaster-ready, and aims to conform to
is necessary for Nepal, and it will require judicious
International Civil Aviation Organization (ICAO)
use of public and private sector resources. This will
standards on safety and airport operations. For urban
take place in the context of the new federal system:
transport, enhancing road density in the Kathmandu
Nepal’s new Constitution places national highways,
Valley, establishing efficient public systems for mass
railways, national transport policy, civil aviation, and
movement, focusing on road safety, and planning for
international airports under the federal government’s
disaster management are key goals. Achieving these
responsibility. Provincial governments manage pro-
goals will require focused policy interventions.
vincial highways and provincial-level transport. Lo-
cal-level governments are responsible for local-level
roads in urban and rural municipalities, including
agricultural roads.
Nepal’s Transport Sector at a
Glance
This roadmap attempts to lay the groundwork for
improving the transport infrastructure environment Roads
in the short and medium term. To provide safe and In Nepal, the SRN (13,060 kilometers (km)) con-
reliable means for movement of people and goods, stitutes the primary road network. The SRN in-
there is an urgent need to assess the key challeng- cludes national highways, feeder roads, and a few
es in Nepal’s transport sector, identify opportunities urban roads of national importance. About 40 per-
to address the gaps, and formulate an action plan to cent (5,300 km) of SRN roads are national highways,
overcome them by mobilizing untapped potential which are considered commercial road infrastructure;
for harnessing private sector capital and efficiencies. of these, 60 percent are blacktop roads. Nationwide,
23 World Bank, Country Private Sector Diagnostic, 2018.
51
53 percent of roads are blacktop. The rest are gravel Likewise, the annual funding allocation for SRN
(16 percent) or earthen roads (31 percent). The road maintenance in the past five years has been, on av-
density of the SRN is 9.26 km per 100 square meters erage, 60 percent short of the annual requirement,28
(m2), compared with 50 km per 100 m2 for the SRN and spending efficiency can be improved. The
and local road network together. current sources of funding are primarily the annual
budget allocation and grants and loans from devel-
Transport costs are high due to poor road quality at opment partners. An alternative funding source is
high gradients, leading to long journey times and available through the Roads Board of Nepal (RBN),
high fuel consumption. Commercial vehicles face which, per the RBN Act, collects and allocates funds
constraints, including inadequate road width (many for road maintenance. On average, the funding gap
of the roads have intermediate lanes), narrow road was 68 percent between 2014 and 2018 (table 9).
curvatures, and high gradients. The quality of the In addition, of the allocated budget, actual spending
roads, including poor pavement, also directly affects by the RBN was on average 81 percent (2012–17;
vehicle operation cost.24 A survey assessing pavement during the one outlier year, 2015/16, only 68 percent
condition found that national highways were 77 per- of the allocated budget was spent).
cent bad or poor.25 Likewise, the condition of feed-
er roads was found to be 82 percent bad or poor.26 Due to the devolution process, the legal and institu-
Similarly, the cost and time related to transport/lo- tional setup for roads is currently in flux. For roads
gistics is an issue highlighted by many stakeholders, under the purview of the federal government, the
for example in the agribusiness value chain. Highly MOPIT is the apex body for the preparation of plans,
dispersed production locations, low road density, and policies, and programs. Under its aegis, the DOR
poor road quality create high access-to-market costs oversees the development, maintenance, and man-
and increased levels of post-harvest losses. Poor trans- agement of the SRN. The new Constitution and fed-
port infrastructure also increases the cost of trans- eralization may make a reclassification of roads nec-
acting among regional, central, and border markets, essary. Some national highways and feeder roads that
fragmenting Nepal’s value chains and undermining are currently part of the SRN would fall under the
the competitiveness of Nepalese products.27 jurisdiction of provincial- or local-level governments.
The RBN, also under MOPIT, manages funding for
The road sector has suffered from chronic under- the operation and maintenance (O&M) of the SRN
investment, creating a high investment backlog. and local road network. The MOF collects fuel levies
According to a study carried out by the National and vehicle registration charges and allocates funding
Planning Commission in early 2017, Nepal needs to to the DOR for construction, improvement, upgrad-
invest 2.3 to 3.5 percent of GDP annually in trans- ing, and rehabilitation of the SRN. The MOF is also
port infrastructure during 2010–20. As per the Stra- responsible for donor coordination (figure 6).
tegic Investment Plan prepared by the Department
of Roads (DOR) and the Ministry of Physical Infra- On the legal and regulatory side, the Public Roads Act
structure and Transport (MOPIT), the subsector will (1974) is one of the core legal documents regulating
require US$6.5 billion between 2016 and 2020. Giv- the SRN. The Public Roads Act lists different road
en the budgetary constraints and procurement, most classes and includes provisions on right-of-way, tempo-
of this will likely be delayed and spill beyond 2020. rary acquisition of land, and development tax collection
24 Traffic, Surface Distress and Road Roughness Survey on SRN, 2015.

25 According to the International Roughness Index.
26 The survey was conducted on 2,626.59 km of national highways and 1,952.36 km of feeder roads (total 4,878.94 km). Detailed results: national highways:
45 percent bad, 32 percent poor, 15 percent fair, and 8 percent good; feeder roads: 44 percent bad, 38 percent poor, 15 percent fair, and 3 percent good.
28 Available funding has been on average NPR 4 billion versus the average annual requirement of NPR 14 billion.
52
TABLE 9: ROAD MAINTENANCE BUDGET NEEDS, ALLOCATION, AND FUNDING GAP IN THE PAST FIVE YEARS (NPR, MILLIONS)
Fiscal Year Funding requirement Budget allocation Budget gap Budget gap (%)
2012/13 - 2,722 - -
2013/14 - 3,657 - -
2014/15 10,398 3,685 6,713 65
2015/16 12,135 4,960 7,175 59
2016/17 16,776 5,607 11,169 67
2017/18 16,186 3,099 13,087 81
Source: Department of Roads/Roads Board of Nepal.
from owners of land bordering the road. The law is Based on various government agencies’ plans, the
currently being amended. The Roads Board Act (2002) Government of Nepal estimates an annual fund-
and Regulations (2004) regulate the RBN, which is an ing requirement of US$1.15 billion per year until
autonomous body responsible for generating and man- 2025 to meet the investment backlog in the coun-
aging funds for routine, recurrent, periodic, and emer- try’s road infrastructure. Financing from a variety of
gency maintenance of roads. The Motor Vehicles and sources will be required to meet this gap (figure 7).
Transport Management Act (1993) and Regulations
(1997) are the only legal instruments dealing with road Airports
safety. The Road Safety Act has been drafted by the Nepal’s lack of adequate air connectivity is a con-
government and is currently awaiting approval by the straint to economic growth. The country’s only in-
Parliament.
FIGURE 6: INSTITUTIONAL FRAMEWORK FOR ROADS

Note: DOLIDAR = Department of Local Infrastructure Development and Agriculture Roads; DOR = Department of Roads; DOTM = Department of Transport Manage-
ment; LRN = local roads network; MOF = Ministry of Finance; MOFALD = Ministry of Federal Affairs and Local Development; MOPIT = Ministry of Physical Infrastructure
and Transport; RBN = Roads Board of Nepal; SRN = Strategic Roads Network.
53
ternational airport, Tribhuvan International Airport, International Airport, and air routes to enter Nepal
exceeds capacity. This is inhibiting economic growth are limited for long-haul markets. The number of
by stifling the movement of the domestic population airports serving mountainous areas is insufficient.
and hindering the tourism sector. Civil aviation pol- Operation and management of key airports is subpar.
icies are outdated and unpredictable, and the airline Nepal’s domestic carriers have a poor safety record.
sector has safety concerns and congestion issues. En- Currently, 25 international airlines fly into Nepal and
couraging regional air transportation, upgrading ex- two Nepalese airlines fly internationally. Nineteen
isting and building new international airports, mak- domestic carriers offer flights in Nepal.
ing airports disaster-ready, and conforming to ICAO
standards on safety and airport operations are the Recognizing the need for improvements, two new
principles that guide the analysis of this sector. international airports, in Pokhara and Bhairahawa,
are under development. Furthermore, a masterplan
The airport sector has not received sufficient at- has been prepared for the construction of a new in-
tention in the past decade and requires substantial ternational airport for Kathmandu, the Second Inter-
investment. International arrivals exceed the official national Airport in Nijgadh. Financing, implementa-
capacity of Nepal’s international airport, Tribhuvan tion, and operation modality have not been decided.
FIGURE 7: FINANCING NEEDS IN THE ROAD SECTOR, 2020–30 (US$, MILLIONS)
Sources: Strategic Plan of the Department or Roads, Ministry of Physical Infrastructure and Transport, 2016-2020; Investment Board of Nepal project profiles; Nepal
InfraSAP Team.
Note: Assumptions: Strategic Roads Network upgrading during 2030 assumed as ~50 percent of the 26,935-kilometer network needing paving or strengthening. Aver-
age cost assumed ~US$0.5 million per kilometer. Road maintenance expenditure based on average annual expenditure between 2012 and 2017.
54
The Civil Aviation Authority of Nepal (CAAN) rescue and firefighting, airport infrastructure devel-
manages and operates all 34 airports (one interna- opment, airport fee and tax collection, and air traffic
tional and 33 domestic) in the country. CAAN is control. Similarly, the regulator will be responsible
responsible for the overall development and man- for licensing and regulating aviation professionals
agement of airport infrastructure and services. The and pilots, engineers, air traffic controllers, airlines,
Ministry of Culture, Tourism and Civil Aviation is and aerodromes.
responsible for planning and monitoring all air trans-
port–related infrastructure and services. Figure 8 de- Estimates for various airport upgrades and new
tails the institutional framework for airports. developments indicate a funding requirement of
US$600 million per year until 2030. This includes
The Civil Aviation Act and Multimodal Transporta- funding for the anticipated expansion of Tribhu-
tion of Goods Act (2006) govern the development, van International Airport in Kathmandu (proposed
management, and operation of civil aviation, but a for funding by the ADB), and the development of
new bill is expected to be enacted soon. The transi- Pokhara Regional International Airport (with financ-
tion process in Nepal’s airport sector is expected to be ing from the Government of China) and Gautam
initiated with the enactment of the draft Integrated Buddha Regional International Airport in Bhair-
Civil Aviation Bill. The bill envisages splitting CAAN ahawa (presently, it is under land acquisition and
into a regulator and a separate service provider enti- proposed financing from the ADB and other devel-
ty for airport and air navigation services. The service opment partners). Due to the lack of data for other
provider, which will be a public limited company, airport investments, suitable assumptions have been
will be responsible for airport management, termi- made to estimate the government’s probable invest-
nal management, ground handling, airport security, ment needs during 2026–30 (table 10).
FIGURE 8: INSTITUTIONAL FRAMEWORK FOR AIRPORTS
Note: CAAN = Civil Aviation Authority of Nepal; MOCTCA = Ministry of Culture, Tourism, and Civil Aviation; O&M = operation and maintenance;
PPP = public-private partnership.
55
TABLE 10: MAJOR INVESTMENTS AND FINANCING NEEDS FOR AIRPORTS (US$, MILLIONS)
AIRPORTa 2020 2025 2030
1. Tribhuvan International Airport Upgradeb 90 120 395
2. Second International Airport (Nijgud) c
545 2,553
3. Pokhara International Airport 215
4. Bhairahawa International Airport 91
5. Other airportsd 290
Airports: total investment need 90 971 3,238
Sources: Strategic Plan of the Department or Roads, Ministry of Physical Infrastructure and Transport, 2016-2020; Investment Board of
Nepal project profiles; Nepal InfraSAP Team.
a. Since details for other airports were not available, suitable assumptions have been made to estimate their probable investment needs
during 2026–30.
b. Estimates for capital expenditure for Tribhuvan International Airport were based on the Asian Development Bank’s tranche for Phase
1: US$90 million, and the Investment Board of Nepal’s project note citing US$605 million is the capital expenditure estimate for all
phases.
c. Estimates for capital expenditure for the Second International Airport at Nijgud were taken from the Investment Board of Nepal’s
project note for Phases 1 and 2.
d. Estimates for capital expenditure for other airports assumed as: Nepalgunj and Biratnagar at US$50 million each (~50 percent of
capital expenditure at Bhairawa airport). Assumptions for other airports at ~US$20 million (for high-traffic regular domestic airports)
and US$5 million (regular domestic airports).
Urban Transport road congestion in Kathmandu Valley, establishing

Overall, the existing public transport system in Kath- appropriate mass transport systems, improving road
mandu Valley is complex and provides a low level of safety, and planning for disaster management are all
service to users.29 It is comprised of seven bus routes, key goals of the government and the project. The
93 minibus routes, 73 microbus routes, and 20 tempo Kathmandu Sustainable Urban Transport Project rec-
routes, totaling approximately 200 routes. The public ommends restructuring the current public transport
transport network suffers from an oversupply of vehicles routes into eight primary, 16 secondary, and 40 ter-
on some routes as well as a duplication of routes with tiary routes. The criteria for different routes are pas-
multiple uncoordinated operators. The complex and senger volume, directional distribution of passengers,
inefficient routes require a multitude of terminals and support for access to economic hubs and key infra-
loading areas, most of which are inadequate for passen- structure, road geometry, congestion, and operator
gers or in poor condition and contribute to ever-grow- structures. In addition to this route structure reform,
ing traffic congestion. The congestion is exacerbated by the report recommends implementing a business
many low-capacity vehicles operating on high-volume model based on bus service contracting. The business
routes, leading to poor air quality and environmental model proposed for use on the restructured public
degradation. Finally, weak regulation and execution al- transport network requires implementation of higher
low old, poorly maintained vehicles to operate and con- quality services operated by the private sector under
tribute to poor quality of service to users. contract to the public sector.
Under the Kathmandu Sustainable Urban Trans- In addition, the government has undertaken stud-
port Project, the possibilities for restructuring Kath- ies to assess options for improving urban trans-
mandu’s public transport system were assessed and port infrastructure in Kathmandu Valley by adding
restructuring was recommended.30 The project fo- new means of transportation. The options include,
cuses on addressing inefficiencies and correcting the among others, suburban and intercity railway sys-
imbalance between supply and demand. Reducing tems. At present, an ADB-funded study on “Mass
29 Asian Development Bank, “Kathmandu Sustainable Urban Transport Project: Public Transport Restructuring Report,” draft report, 2017.
30 Asian Development Bank, “Kathmandu Sustainable Urban Transport Project: Public Transport Restructuring Report,” draft report, 2017.
56
Transit Options and Prioritization in Kathmandu it is critical to strengthen the RBN, to enable it to
Valley”31 has recommended a metro rail system com- drive a reform agenda in road maintenance.
prising about 73 km as the most appropriate mass
transport option for Kathmandu Valley.32 The cost Available funds are not fully utilized, due to weak
is estimated at US$100 million per km, plus invest- capacity for procurement, contract management,
ment for rolling stock and operation cost (only indic- and implementation. Government agencies in pro-
ative numbers are available). No investment plans for curement management, construction supervision, and
the improvement of urban transport infrastructure in contract management suffer from weak institutional
the Kathmandu Valley have been firmed up. capacity. At present, funding made available through
the government budget (including approximately 40
percent of development partner financing) is not fully
Sector Constraints utilized. The primary reason is weakness in the pro-
Nepal’s transport infrastructure faces significant curement and contract management processes. The
challenges. To meet the needs of the country and its DOR faces lack of sufficient, qualified personnel for
short- and long-term development goals, Nepal will construction supervision and contract management.
have to address significant capacity constraints. Even low budget allocations are not fully absorbed: the
RBN only spends 81 percent of the funds that are al-
Roads located by the MOF. The funds allocated by the MOF
Planning and prioritization in the road sector re- have typically been about 30 percent of the actual
quire improvement. Capex planning and prioritiza- maintenance fund requirements. From the RBN’s per-
tion in the road sector tend to be strongly influenced spective, it could be argued that longer-term and better
by political priorities rather than objective criteria (performance-based) contracting could be undertaken
and planning processes. Funding is “shared” and if more funding was available and assured. It would
sprinkled over a large collection of road projects, with substantially improve the absorption and performance
these projects often taking several years to finish. This of maintenance expenditure. Notwithstanding which
has reduced the effectiveness and efficiency of road position one takes, it will be key to address issues on
sector investments. both sides by defining a medium-term corporate plan
that helps plan projects better. In addition, in the me-
For maintenance, the usual practice is for the DOR dium term, the RBN will need to explore additional
to prepare a National Integrated Annual Road sources of resource raising, such as additional toll roads,
Maintenance Plan based on expected availability of fines, additional fees (for example, on export-import
the budget ceiling set by the RBN. The funds are cargo, transporters, and the tourism sector), domestic
usually inadequate to cover the entire network, and bonds, and other external sources.
the process lacks careful prioritization and is unable
to cover the priority maintenance needs of the SRN. Private sector capacity is weak. Delays in project com-
pletion and poor-quality construction are common,
Although the RBN has its own board chaired by the and these are mainly due to inefficient management
Secretary, MOPIT, and has 13 members from the and low financial capacity. The role of international
public and private sectors, it currently has a limited companies in international competitive bidding con-
role in implementation. Furthermore, the frequency tracts has been limited to providing the necessary fi-
of board meetings and ability of the board to drive a nancial and experience-related documents to local
change agenda are limited, a problem further con- companies solely for bidding purposes and leaving the
strained by the small RBN team (17 staff ). Therefore, entire implementation responsibility to local partners.
31 This report is currently in draft form.

32 The lines would connect (i) Bhaktapur-Koteshor-Maitighar-Sahidgate-Lazimpat-Gongbu Buspark, (ii) Jorpati-Chabheel-Lazimpat-Tripureshwar-Kalan-
ki-Naikap, and (iii) Godavari-Lagankhel-Thapathali-Sahidgate-Lazimpat-Narayangopal Chowk-Budhanilkantha.
57
Combined financing sources from the government

Example of Delays in Road Projects: The Jajarkot Section of and development partners fall short of meeting the
the Mid-Hill Highway Construction began eight years ago, and funding requirements for Nepal’s road sector. The
the project is still to be completed due to inability to complete estimated funding shortfall in the road sector is stark
a 5-kilometer section that has been abandoned by the con- (table 11). The assumptions used in estimating total
tractor due to the presence of hard rocks. financing from various investment sources included
government funding and development partners. Giv-
Source: News report in The Kathmandu Post, December 17, 2017. en the institutional and financial constraints of trans-
port state-owned enterprises, commercial borrowing
was not considered. Based on these high-level esti-
The maintenance budget is low, and the MOF does mates, Nepal requires additional financing of US$4.2
not always transfer funds to the RBN. Maintenance billion by 2025 and US$5.6 billion for 2026–30 to
allocations are particularly low for periodic and spe- meet its capital investment requirements in the road
cific maintenance needs. The funding gap for main- sector.33 Tapping into commercial sources could help
tenance is estimated at NPR 11.17 billion (2016/17, fill the gap, subject to the ability of the sector and
real terms). Even if the RBN is provided all the reve- the government to mobilize the requisite additional
nue that it is entitled to, the funds would be insuffi- resources in due course to offer adequate returns on
cient to meet the network’s requirements. According such resources.
to the RBN, on average, only about 36 percent of
the total requirement was available for SRN main- Airports
tenance, leaving a funding gap of approximately 64 CAAN’s weak institutional and financial capacity
percent. In practice, the MOF transfers less revenue constrains its ability to respond adequately to needs
than what the RBN is entitled to, which, in turn, in the sector. CAAN represents the regulator and
affects the amount the RBN would provide to the owner of airport infrastructure in Nepal. CAAN’s
DOR for maintenance. This has resulted in a main- weak institutional and financial capacity constrains
tenance backlog. its capacity to make new investments in airports. The
DELAYS IN BRIDGE CONSTRUCTION IN THE POSTAL HIGHWAY PROJECT
Causes for delays for Postal Highway projects in-

Total bridges Delayed (%)
clude payment delays, design mistakes, approv-
PO Dhangadi 12 100
al delays, political interference, subcontractor
PO Nepalgunj 6 83 negligence, extreme weather conditions, over-
DRP Bhairahawa 6 83 committed contractor due to multiple contracts,
PO Birgunj 25 60 strikes, geological complications, poor inter-
PO Janakpuri 17 65 agency coordination and site management, and
inadequate planning.
PO Itahari 14 100
Total 80 78 Source: Journal of Advanced College of Engineering and Man-

agement, 2016: Causes of Delays of Motorable Bridge Con-
struction under Postal Highway Projects, Department of
Roads, Arjun Suwal, SDE Department of Roads, Santosh Ku-
mar Shrestha, Lecturer, Department of Civil Engineering, Pul-
chowk Campus, T.U.
33 Assumptions included: (i) Government: The projected funding by the Government of Nepal is based on historical averages for capital works and main-
tenance works and the amounts committed by development partners in the loan pipeline for roads. Given the institutional and financial constraints of
transport state-owned enterprises, no commercial borrowing programs have been considered as of now. (ii) Development partners: The estimates are based
on historical patterns of lending in roads and the loan commitments made or actively being proposed. Typically, the road sector has witnessed ~40 percent
as development partner financing.
58
TABLE 11: INDICATIVE SOURCES OF INVESTMENT AND THE POTENTIAL FUNDING GAP FOR ROADS, 2020–30 (US$, MILLIONS)
SOURCE 2020 2025 2030
Roads: total investment need 1,308 5,694 7,544
Private 0 0 0
Government (including SOEs) 502 1,255 1,255
Internal accruals 502 1,255 1,255
Spend toward capital works BAU 435 1,088 1,088

Spend toward maintenance BAU 67 167 167
Commercial borrowings 0 0 0
Development partners 290 725 725
Roads: total investment source 792 1,980 1,980
Roads: investment financing gap -516 -3,714 -5,564
Note: BAU = business as usual; SOEs = state-owned enterprises
transition process in Nepal’s airport sector is ex- needs is estimated at US$560 million by 2025
pected to be initiated with the proposed enact- and US$3.2 billion for 2026–30 (table 12).34
ment of the draft Integrated Civil Aviation Bill. Although there is potential for the government
The bill envisages splitting CAAN into a regu- to commit additional funding, private sector
lator and a separate service provider entity for capacity is largely untapped.
airport and air navigation services. The ICAO’s
Universal Safety Oversight Audit Program rec- Urban Transport
ommended the split to make the aviation sector Syndicates inhibit competition between oper-
more efficient. ators. Public transport in Nepal’s urban areas
is entirely managed by private operators. Op-
The absence of a clear sector strategy and erators’ associations have created a syndicate
roadmap to make sustainable investments in system, abandoning free competition. The
airports creates uncertainty. At this stage, the syndicate system is further strengthened by
absence of clarity on policy and legal issues weak monitoring of the regulating authorities.
impedes commercial investors. Tribhuvan In- This has led to deteriorating quality of service
ternational Airport serves as an example where for customers. Typically, transportation is not
investment delays and the lack of a business safe or reliable. This has become the primary
plan have negatively impacted performance and incentive for more and more urban residents to
improvement plans. A clear sector development purchase their own private vehicles, particularly
strategy and roadmap are required even with two-wheelers (there are almost one million in
an enacted Civil Aviation Bill. Careful priori- Kathmandu alone). The increasing number of
tization based on a masterplan will help create private vehicles contributes to congestion and
predictability of upcoming investments. poor air quality.
Financing from a variety of sources will be re- The urban transport system is poorly regulat-
quired to meet the funding gap in the airport ed and monitored. Public transport vehicles are
sector. The gap between funding and the capi- owned by individuals or private companies and
tal investment requirement to meet the sector’s cooperatives. Typically, these vehicles are very
34 Assumptions included: (i) Government: the projected funding by the government is based on historical averages for amounts committed by development
partners in the loan pipeline for airports. (ii) Development partners: the estimates are based on historical patterns of lending and loan commitments made
or actively proposed. Typically, the airport sector has had loan commitments for three larger airports.
59
TABLE 12: INDICATIVE SOURCES OF INVESTMENT AND THE POTENTIAL FUNDING GAP FOR AIRPORTS, 2020–30 (US$, MILLIONS)
source 2020 2025 2030
Airports: total investment need 90 971 3,238
Private 0 0 0
Government (including SOEs) 20 25 0
Internal accruals (committed for ADB-
20 25 0
TIA modernization loan)
Commercial borrowings 0 0 0
Development partners 70 388 0
Airports: total investment source 90 413 0
Airports: investment financing gap 0 -558 -3,238
Note: ADB = Asian Development Bank; SOEs = state-owned enterprises; TIA = Tribhuvan International Airport.
old and not well maintained, and the Department of and ensuring adequate fund allocation by fixing
Transport Management does not monitor or check completion targets.
the state of these vehicles or whether they are fit for
purpose. Furthermore, there are not enough routes • Allocate sufficient budget to projects and deliver
and public transportation vehicles covering urban all approved funds. Stipulate that at least 75 per-
areas, leaving many residents dependent on private cent of funding goes toward prioritized projects
vehicles. only and thereby eliminate “sharing” of the budget
between many projects. Where budget approval
has been given to fund a public entity, the MOF is
Roadmap to deliver the full funds in the amount approved.
The roadmap suggests that the Government of Ne-
pal, Ministry of Physical Infrastructure and Trans- • Improve capacity and business processes. This is
port, RBN, and CAAN combine short-term inter- critical in the areas of public procurement, finan-
ventions with long-term planning to address the cial management, ethics, contract supervision,
needs in the sector (table 13). and performance management. It can be grad-
ually achieved by improving internal expertise
Pillar 1: Strengthen the legal, regulatory, and insti- through deployment of adequate staff and train-
tutional framework for the road sector. The governing, simplification and automation of business
ment is advised to focus on improving the planning, processes, and introducing external expertise to
prioritization, and funding practices of projects and provide independent advice and augment depart-
strengthening institutional and corporate governance mental resources.
arrangements. This can be achieved by way of the fol-
lowing actions: • Develop a medium-term corporate plan for the
RBN and strengthen corporate governance and
• Prepare a National Transport Masterplan and performance management functions. The plan
update the Priority Investment Plan in line with should assess existing gaps and inefficiencies in
MOPIT’s Five-Year Strategic Plan in the trans- the RBN’s current operations and develop appro-
port sector. This would include identifying the priate interventions to address them. The funds
projects that will be financed by only the govern- received should be published in an RBN annual
ment and those that can be financed with the par- report by source, disbursements made, procure-
ticipation of the private sector, prioritizing fund ment and awards, and progress of work in the
allocation based on justified prioritized criteria, year, and made available to the public. The use
prioritization of the projects on a ranking basis, of independent engineers for a group of projects
60
could be explored. In addition to project-level su- to structure and fund such large projects, the gov-
pervision, the RBN could consider setting up a ernment could turn to variants of PPP contracts,
dedicated monitoring unit to focus exclusively on such as the hybrid-annuity model. In this structure,
overseeing the supervision and quality assurance a majority of the capital expenditure (for example,
of projects. Finally, independent external agencies 50 percent) is funded by the government, and the
could undertake periodic performance and pro- remaining capital expenditure, annual operations,
cess audits of contracts. and maintenance expenses are incurred by the
private sector in return for periodic (semi-annual
Pillar 2: Improve the SRN through a focused pro- or annual) availability-based payments (see figure
grammatic approach. Within the SRN, the govern- 9 for a conceptual project structure based on this
ment may focus attention on the most important model). This could help (i) reduce the burden of
elements of the network through a programmatic managing many contracts, and (ii) encourage the
approach to construction and maintenance. Such contracting industry to harness economies of scale
pathfinder projects could be used as test cases to help and adopt more efficient equipment, technology,
shape the legal and policy changes that may be re- and construction management practices.
quired, as well as the contract arrangements to im-
plement them. Specifically, the program would need • Undertake an evaluation and prioritization of road
to incorporate the following institutions and actions: maintenance needs. The RBN is advised to develop
a detailed five-year annual road management plan
• Identify high-priority corridors through prior- to cover a comprehensive maintenance and rehabili-
itization and launch a program with a credible tation work program for the road network, focusing
funding plan. The government is advised to es- on high-volume and strategic routes. Procurement
tablish a framework to identify and prioritize an should be synchronized with needs and resources as-
initial set of high-volume and strategic roads in the sessment to ensure that sufficient annual budgets are
SRN (for example, 30 percent of the network), allocated and fully used, and works are completed
with the objective of ensuring optimum working within the planned program year.
condition within five years. The pathfinder proj-
ects could be used as test cases to help shape the • Create sustainable funding to support making
legal and policy changes that would be required the RBN a performance-based road maintenance
and the specific modalities to implement them. To program. The RBN is advised to transition toward
be credible, it will be key to establish a funding a performance-based road maintenance program
plan and ensure it is available for the entire pro- and, to ensure sustainable funding for the same,
gram. Such funding may have to be fully based on explore additional means of resource raising. This
multi-year budgetary allocations spanning the en- may include tolls, fines, additional fees (for ex-
tire (initial) duration of the program. In addition, ample, on export-import cargo, transporters, and
the funding plan could include direct and indirect the tourism sector), and through other external
user charges, such as tolls and fuel or other specific sources. On the expenditure side, a move toward
levies. It is recommended to ring-fence the sources, performance-based maintenance contracts will
so they are non-lapsable and can be suitably de- also help improve the cost-effectiveness of main-
ployed and leveraged to support the program.35 tenance expenditures. Similarly, output and per-
formance-based road contracts could be used for
• Adopt efficient contracting structures. Given the upgrading and rehabilitating existing roads. Such
limited financial capacity and expertise of private contracts would be short-term (five to seven years)
road construction players and the financial sector and address specific sections of roads.
35 It is important to calibrate the expectations for such additional revenues in line with their feasibility in economic and political terms as well as their afford-
ability. For instance, although tolls and other road user charges may be very useful sources for meeting capital and operational expenditures, they would
require appropriate legislative actions/approvals. The same applies to other direct/indirect forms of user charges, such as levies on fuel, vehicle registrations,
and vehicle purchases.
61
• Explore additional funding sources, such as private ing international, hub, and high-traffic airports
sector financing, additional tolling, additional fuel in Nepal. The plans should also specify planned
tax, and vehicle tax in the medium term. Tolling investments and provide pro forma financial state-
is currently limited to four roads since 2002, which ments and airport-specific risk matrixes (including
could be increased, for example, by combining re- safeguards) for each airport. In addition to the
habilitation of roads with tolling. These additional masterplans for the three larger airports,38 it is rec-
funds should flow into an earmarked fund.36 ommended that the government also develops its
own airport sector roadmap that includes regulato-
Pillar 3: Strengthen the airport sector. Given the de- ry goals and specific actions related to regulation,
velopment of new airports and the planned upgrade safety, structural reforms, and management.
of the Tribhuvan International Airport, it is an op-
portune time for the government to partner with the • Produce a model form for airport O&M contracts.
international private sector to deliver airport manage- A model contract should be produced, which may
ment and operations expertise to run its airports in then be negotiated and amended on a case-by-case
a safe, efficient, and profitable manner. In addition basis for each airport or groups of airports. The
to exploring PPP options for individual areas of op- model should not materially depart from a risk allo-
erations, there is significant potential for full-scale cation matrix approved by the PPP Centre.
private management of airports. Therefore, the gov-
ernment could do the following: • Launch O&M concession contracts for new and
existing airports, including Pokhara Airport,
• Separate regulatory and operational duties. The which will be completed in 2019, and Lumbini
draft Integrated Civil Aviation Bill contemplates Airport. Both airports are currently under con-
separating CAAN into a regulator and a separate struction, with Lumbini scheduled for completion
operations entity. This is an important step in the in 2019 and Pokhara in 2020; therefore, there are
evolution of Nepal’s airport sector and should be no legacy issues. This should make negotiating and
progressed and expedited. The nonregulatory enti- commencing O&M contracts substantially easier.
ty (OpCo) should have its own management team An O&M contract for the Tribhuvan Internation-
reporting to a board. Board representatives should al Airport could be considered, to provide relief for
be experienced in the business of international poor asset management, safety issues, and conges-
airports to help drive commercial performance tion while expansion plans for the airport are being
and development of key airports in Nepal. It is developed.
recommended that the regulator (CAAN), under
consultation, develops and determines a preferred • Finalize modalities for the development of the
regulatory model that would attract private capital Second International Airport in Kathmandu and
to the airport sector. There is also a need to over- launch construction. The government has assessed
haul procurement practices to improve tendering and confirmed the need for an additional interna-
processes, contractor selection, and negotiation of tional airport in Kathmandu. To meet growing de-
contracts. mand, the appropriate development mode for the
Second International Airport (engineering, procure-
• Develop a strategy to prioritize development ment, and construction, or PPP) should be decid-
of airports and allocate funding. The existing ed as soon as possible, and construction should be
CAAN (or preferably OpCo) is advised to prepare launched in the short term.
a 10-year business plans for 12 airports,37 cover-
36 A move toward performance-based maintenance contracts can improve the cost-effectiveness of maintenance expenditure. Globally, substantial savings
from the use of performance-based road maintenance programs have been reported by New Zealand (15-22 percent), Australia (10-35 percent), Brazil (15
percent), the United States (10-18 percent), Finland (18 percent), and Alberta, Canada (20 percent).
37 These include Tribhuvan International Airport (international); Biratnagar, Gautam Buddha, Nepalgunj, and Pokhara (hubs); and Bharatpur, Chan-
dragadhi, Dhangadhi, Janakpur, Simara, Surkhet, and Tumlingtar (high-demand domestic airports).
38 Tribhuvan International Airport, Pokhara Regional International Airport, and Gautam Buddha Regional International Airport.
62
FIGURE 9: CONCEPTUAL PROJECT STRUCTURE OF A HYBRID-ANNUITY MODEL PPP

Note: GoN = Government of Nepal; IE = independent engineer; ODA = official development assistance; PPP = public-private partner-
ship; SPV = special purpose vehicle.
• Expedite plans for the Tribhuvan Internation- Pillar 4: Strengthen the urban transport sec-
al Airport. The proposed modernization of the tor. Many suggestions have been proposed by
Tribhuvan International Airport has witnessed different stakeholders, including gondolas,
setbacks due to the 12-month absence of perfor- ropeways, metro, and bus rapid transit, but the
mance by the contractor appointed to undertake sector requires integrated planning rather than
runway expansion works. The contract has been individual planning and development.
terminated. It is unclear what the approach and
timeline is to restarting work, and what claims will • Undertake comprehensive assessment of
be made for nonperformance. Although a short- urban transport in Kathmandu. A proper
term O&M contract for the Tribhuvan Interna- needs assessment is recommended, to iden-
tional Airport will help relieve some of the pres- tify and plan appropriate and cost-effective
sure, it is crucial that the government clarifies the interventions for urban transport in Kath-
expansion plans. mandu, and potentially beyond, for exam-
ple, in other bigger cities such as Pokhara.
Actions should be closely coordinated with
all key stakeholders, including donors.
63
Summary of Recommendations for the Transport Sector

TABLE 13: TRANSPORT SECTOR ROADMAP
PILLAR
Pillar 1: Strengthen 1. Prepare a National Transport Masterplan and update 1. Develop a medium-term corporate plan for the
the legal, the Priority Investment Plan in line with MOPIT’s Five- RBN and strengthen corporate governance and
regulatory, and Year Strategic Plan. performance management functions.
institutional
2. Allocate sufficient budget to projects. 2. Undertake an evaluation and prioritization of road
framework for the
maintenance needs.
road sector 3. Improve capacity and business processes.
1. Develop methodology and identify high-priority 1. Explore avenues for mobilization of additional
corridors through prioritization for program. Ensure revenues.
adequate funding for entire program and establish
credible financing plan. 2. Undertake preparation and implementation
2. Adopt efficient, suitable contracting structures, such of high-priority projects through suitable and
Pillar 2: Improve as such as hybrid-annuity models. efficient contracting structures, including those
the SRN through with potential for private participation.
a focused, 3. Develop a five-year annual road management plan
programmatic with maintenance and rehabilitation works for specific
approach routes. Introduce a performance-based program for
road maintenance.
4. Create sustainable funding to support RBN. Produce
an annual report showing funding, disbursements,
procurement, and status of work, and publish it on the
RBN website.
1. Enact an Integrated Civil Aviation Bill. 1. Complete separation of CAAN and OpCo.
2. Separate OpCo from CAAN, secure additional budget 2. Complete business plan preparation for seven
from the Government of Nepal, and build out OpCo. high-traffic airports.
3. Develop appropriate regulatory models for CAAN for 3. Expand and refine model contracts.
international, hub, high-volume, and other airports in
4. Expedite plans for Tribhuvan International Airport.
the country.
Pillar 3: Strengthen 4. Prepare 10-year business plans for five airports
the airport sector covering the international and all hub airports.
5. Prepare model O&M contracts based on the PPP
Centre risk allocation matrix.
6. Launch O&M contracts for upcoming airports and for
Tribhuvan International Airport.
7. Launch development of the Second International
Airport.
Pillar 4: Strengthen 1. Undertake comprehensive assessment of urban
the urban transport transport in Kathmandu.
sector
Note: CAAN = Civil Aviation Authority of Nepal; MOF = Ministry of Finance; MOPIT = Ministry of Physical Infrastructure and Transport; O&M = operation and
maintenance; PMO = Prime Minister’s Office; PPP = public-private partnership; RBN = Roads Board of Nepal; SRN = Strategic Roads Network.
64
65
66
Reforming the Urban Sector

Introduction threefold: (i) assess the current state of urban infra-
Although Nepal is one of the world’s least urbanized structure in water supply, sanitation, and SWM; (ii)
countries, its urban population growth is among the explain the key constraints facing the urban sector;
fastest globally, with an annual rate of 3.2 percent and (iii) provide a short- and medium-term roadmap
between 2010 and 2015.39 Nepal’s rapid urbaniza- for the government to improve urban infrastructure.
tion has increased pressure on the country’s core ur- The sector diagnostic relies on secondary data from
ban infrastructure, creating an urgent need to assess various reports as well as primary data collected from
key challenges in the country’s urban sector and iden- site visits to four municipalities: Kathmandu, Pokha-
tify opportunities to overcome them by maximizing ra, Damak, and Lahan.40 The scope of this report is
largely untapped private capital and expertise. limited to the provision of urban services through
private participation in SWM.
The country’s historic shift from a unitary to a fed-
eral government system has expanded the role of lo-
cal governments, particularly in the delivery of basic Nepal’s Urban Sector at a
public services, such as education and health, and Glance
core infrastructure, including water supply, sanita-
tion, and solid waste management (SWM). Howev- Core Urban Services
er, the ability of local governments to undertake these Core urban service delivery is insufficient. Just 62
newly assigned functions is extremely limited, due percent of municipal solid waste was collected as of
to institutional gaps and resource constraints. Local 2012, although the collection rate varied substantially
governments face a paradoxical situation: despite across municipalities (major towns had higher per-
huge unmet demand for urban civic services, they are centages than smaller ones). As of 2013, only six of
unable to spend capital grants and budget allocation 58 municipalities used sanitary landfill sites for final
is regularly below annual budgets. The private sector disposal; 45 municipalities practiced open dumping,
faces capacity constraints in implementing projects including riverside and roadside (table 14).41 Despite
and difficulty tapping financing, due to the low rev- near-universal access to drinking water,42 the quantity
enue-generating potential of many of the public in- and quality of the water supply in urban areas pose a
frastructure projects prepared by local governments. challenge. Access to piped water supply in urban areas
decreased from 68 to 58 percent from 2003 to 2010,
This roadmap delineates a strategy for strengthen- largely due to the rapidly growing urban population
ing the investment climate in the urban sector over adding pressure on water service infrastructure. Al-
the next five years, with the expectation that finan- though access to toilets in urban Nepal increased from
cially sound and well-managed local governments 81 to 85 percent from 2003 to 2010, many toilets
will be able to apply for commercial borrowing remain unsanitary. Only 48 percent of urban house-
or attract private sector investments in the medi- holds had toilets connected to septic tanks, many of
um and long term. The purpose of the roadmap is which are not designed properly.43
39 Currently, only 19 percent of the population lives in urban areas, compared with the global average of 54 percent. Furthermore, the global average annual
urban population growth rate between 2010 and 2015 was about 2 percent. The corresponding rate for Central and South Asia was 2.5 percent (United
Nations Department of Economic and Social Affairs, Policies on Spatial Distribution and Urbanization: Data Booklet, ST/ESA/ SER.A/394, 2016).
40 The World Bank team conducted interviews and consultations with mayors, finance officers, municipal planning officers, civil engineers, and/or other staff
at local government offices in Kathmandu, Pokhara, Damak, and Lahan, to identify their local priorities, investment needs and capacity gaps, and ongoing
engagement with the private sector in financing and implementing the delivery of core urban services. The World Bank team also consulted with private
construction companies and commercial banks to understand their perspectives on emerging opportunities and existing bottlenecks for their engagement
in financing and delivering core urban infrastructure. Some baseline budget data for the municipalities were also collected through the site visits.
41 Asian Development Bank (ADB), “Solid Waste Management in Nepal: Current Status and Policy Recommendations” (ADB, Manila, 2013).
42 UNICEF and World Health Organization (WHO), Progress on Drinking Water and Sanitation 2012 Update (Geneva and New York: UNICEF and WHO, 2012).
43 Ministry of Water Supply and Sanitation (MOWSS), Nepal Water Supply, Sanitation and Hygiene Sector Development Plan (2016-2030) (Kathmandu:
Sector Efficiency Improvement Unit, MOWSS, 2016): 34.
67
TABLE 14: ACCESS TO CORE INFRASTRUCTURE IN FOUR CITIES

Population Access
Population Population in Solid Waste Storm Sew-
City growth rate, to piped Toilet
In 2001 2011 Collection drain-age er-age
2001–11 water
Kathmandu 671,846 975,453 45% 64% 99% 91% 70% 79%
Pokhara 208,692 313,841 50% 94% 99% 31% 21% 39%
Damak 35,009 75,102 115% 35% 90% 21% 14% 0%
Lahan 81,918 91,766 12% 28% 59% 50% 6% 0%
Source: 2011 Census.
Institutional Framework mittees to undertake land pooling schemes. It states

In line with the 2015 Constitution and the Local that land pooling can be carried out in any part of the
Government Operations Act (2017), local govern- town planning area with the consent of a minimum of
ments now have greatly expanded functional man- 75 percent of the landowners. Land pooling can also
dates. The Constitution44 vests power in local govern- be initiated by local government bodies per the Lo-
ments to plan and provide services in basic sanitation, cal Self-Governance Act, 1999. The primary laws for
water supply, and local roads. SWM is separately reg- the provision of land use and valuation are the Coun-
ulated by the Solid Waste Management Act of 2011, try Code (1962), Land Survey and Measurement Act
which assigns construction, operation, and manage- (1962), Act Concerning Land (1964), Guthi Corpo-
ment of infrastructure for collection, treatment, and fi- ration Act (1976), Land Acquisition Act (1977), and
nal disposal of medical and solid waste to local bodies, Land Revenue Act (1978).
which include municipalities, sub-municipalities, and
village development councils. The 2015 Constitution The government’s 2017 National Urban Develop-
mandates that provincial governments oversee poli- ment Strategy provides strategic direction for urban
cy planning for statewide land use and infrastructure infrastructure development and guides investment
projects, specifically in managing province-level water decisions in the sector under the new federal struc-
supply and highway systems. The federal government ture of governance. The National Urban Develop-
is primarily responsible for national-level policy sur- ment Strategy articulates a long-term vision for urban
rounding urban planning, infrastructure development, development, including augmenting urban sector
national transportation, rail and highway manage- financing and changing the legal and institutional
ment, and land use. Urban planning and infrastruc- framework to facilitate project implementation. In
ture development policy are under the purview of the the SWM sector, the National Urban Development
Ministry of Drinking Water and Urban Development, Strategy promotes integrated SWM projects, wher-
while the Ministry of Federal Affairs and General Ad- ever feasible, as well as a cluster-based approach to
ministration (MOFA&GA)45 coordinates across tiers achieve economies of scale. In the water supply and
of government and provides technical advice and sup- sanitation sectors, minimum water provisioning, wa-
port for urban governance (for example, regulation ter security, and sanitation coverage are articulated as
and standardization) and administration. part of the sector objectives. The strategies for achiev-
ing these include protection of freshwater sources, in-
Legal and Regulatory Framework tegration of rainwater harvesting within the building
Two Acts dictate the regulatory framework for land permit system, promotion of community water stor-
pooling projects: The Town Development Act, 1988, age facilities, and facilitation of private sector invest-
and the Local Self-Governance Act, 1999. The Town ments in water and wastewater treatment systems and
Development Act authorized town development com- supply augmentation.
44 See Article 57 Clause (4).

45 MOFA&GA was created after the merger between the Ministry of Federal Affairs and Local Development and the Ministry of General Administration.
68
Funding and Financing ernments to plan capital expenditure effectively and

The 2015 Constitution grants local governments provide comfort to future lenders and investors.
the authority to impose a wide range of taxes and
fees.46 Such own-source revenue (OSR) collection is The allocation of intergovernmental fiscal transfers
conducive to the process of urban development and varies considerably across local governments. Larger
institution building, as it promotes accountability metropolitan cities receive lower levels of grants per
and strengthens taxpayer oversight. However, Nepal’s capita than sub-metropolitan or smaller municipalities.
local OSR collection capability is limited due to weak The inverse relationship between the size of cities and
tax administration and enforcement.47 Metropoli- the per capita transfer amounts could lead to greater
tan cities and larger local governments tend to have capital investment funding gaps for larger cities.
greater capacity to collect OSRs than smaller ones. A
higher concentration of wealth and economic activi- Investment Environment
ties, better access to public services, and more robust The current level of capital expenditure in ur-
fiscal institutions in place all coalesce to yield greater ban infrastructure expenditure is not sufficient to
local revenues, so this is not surprising. In FY2016, meet demand. The Ministry of Urban Development
Kathmandu and Lalitpur were in the top three local (MOUD) and Town Development Fund (TDF) es-
governments by per capita amount of OSR collec- timate that if municipal revenues were drawn solely
tion. OSRs account for roughly 10 percent of total from public sources, the investment gap would range
local revenues, but this share was projected to decline from NPR 372 billion (US$3.72 billion) to NPR 1.0
to less than 5 percent in FY2018, due to the project- trillion, depending on the target levels of physical in-
ed increase in intergovernmental fiscal transfers fol- frastructure.48 The depth of the investment gap varies
lowing the enactment of the new Constitution. depending on the sizes of the cities and their revenue
sources, but the current level of capital expenditure
In the short term, local government capacity to plan is not sufficient to “even close the high backlog of
and execute projects and use available funds judi- basic urban infrastructure.”49 For a municipality to
ciously is a major constraint. Intergovernmental fiscal achieve the minimum desired level of infrastruc-
transfers complement local government resources, ac-
counting for roughly 90 percent of local revenues. This
rate was projected to increase to 95 percent in FY2018. FIGURE 10: URBAN: RECURRENT AND CAPEX PER CAPITA
This is a significant jump of intergovernmental fiscal
transfers, from NPR 96 million (US$0.96 million)
estimated in FY2017 to NPR 330 million (US$3.30
million) budgeted in FY2018. Although overall urban
infrastructure funding needs more resources over the
long term, fiscal flows in the short term seem to be
greater than local government absorption capacity.
The Natural Resource and Fiscal Commission’s in-

tergovernmental fiscal transfer allocation process is
also evolving and moving from a system of untied
grants in the first year to a combination of untied
grants and earmarked funds in the second year.
Predictability of fiscal transfers will enable local gov-
46 Revenue sources assigned to local governments in the new Constitution include property tax, house rent tax, land tax, business tax, vehicle tax, entertain-
ment tax, advertisement tax, tourism fee, service charges/fees, and penalties and fines.
47 R. Bahl, “Intergovernmental Fiscal Transfers in Developing and Transition Countries: Principles and Practice” (World Bank, Washington, DC, 2000).
48 United Nations Capital Development Fund (UNCDF), “Designing a Framework for Sustainable Government Financing through Borrowing in the Con-
text of Fiscal Federalism in Nepal” (UNCDF, New York, 2017).
49 E. Muzzini and G. Aparicio, Urban Growth and Spatial Transition in Nepal. An Initial Assessment (Washington, DC: World Bank, 2013): 81.
69
TABLE 15: FINANCIAL GAP SCENARIOS FOR 217 MUNICIPALITIES, 2016–31 (NPR, MILLIONS)
Scenario 1 Scenario 2 Scenario 3
(60% of target) (75% of target) (90% of target)
Own-source revenue 622,600 622,600 622,600
Recurrent expenditures 389,040 389,040 389,040
Previous debt service 4,100 4,100 4,100
Revenue surplus 229,530 229,530 229,530
Unconditional grant 424,830 424,830 424,830
Revenue sharing 81,150 81,150 81,150
Conditional grant 277,560 277,560 277,560
Total intergovernmental fiscal transfer 783,540 783,540 783,540
Summary of Financing Sources
Revenue surplus 229,530 229,530 229,530
Total intergovernmental fiscal transfer 783,550 783,550 783,550
Market borrowing (25% of revenue surplus) 57,390 57,390 57,390
Amount Available for Capital Investment 1,070,470 1,070,470 1,070,470
Total Investment Need
Scenario 1: Meet 60% of physical target 1,397,940 - -
Scenario 2: Meet 75% of physical target - 1,747,430 -
Scenario 3: Meet 90% of physical target - - 2,096,910
Financing gap -327,470 -676,960 -1,026,440
Source: United Nations Capital Development Fund 2017.
Note: The table shows different financial gap scenarios for meeting 60, 75, and 90 percent of the physical infrastructure target set by the Department of Urban Devel-
opment and Building Construction. The Ministry of Urban Development and the Town Development Fund projected the amount of own source revenues, intergovern-
mental fiscal transfers, as well as recurrent expenditure and previous debt service to arrive at the estimated amount of available capital for infrastructure investments
in the next 15 years.
ture between 2015 and 2031,50 approximately NPR ities indicated a lack of systematic planning. Gener-
3,890 (US$39) of capital investment per capita (in ally, local officials considered urban roads and SWM
NPR 2015)51 would be required annually. As shown to be investment priorities, with SWM potentially be-
in figure 10, none of these municipalities spends the ing the most appropriate for PPP-type investment.53
capital needed to meet this number.52 Table 15 shows However, other infrastructure, like local roads, could
the financial gap scenario for all 217 municipalities. be financed by municipal borrowing under the right
conditions.
Investment Priorities for the Focus Cities
Kathmandu, Pokhara, Damak, and Lahan do not Water supply services are being re-organized to com-
have capital investment plans or expenditure frame- ply with the new Constitution. Two types of entities
works for the medium or long term. Under the new deliver water supply services: the Nepal Water Supply
Constitution, local governments are now responsible Corporation (which provides drinking water to 22
for water supply and sewerage in addition to SWM towns, including Pokhara) and one or more water user
and city roads. Discussions with the focus municipal- associations in smaller towns. The latter are mainly
50 Based on 2011 prices, MOUD and TDF (2016) estimate that a per capita investment requirement of about NPR 58,400 needs to be met to bring the
then-existing 58 municipalities (including Kathmandu, Pokhara, Damak, and Lahan) to the minimum desired level of infrastructure. To arrive at the annual
per capita investment needed until 2031, this amount was divided by 15 years, yielding NPR 3,890 per capita.
51 Ministry of Urban Development (MOUD) and Town Development Fund (TDF), “Municipal Finance Framework for the National Urban Development
Strategy (NUDS) of Nepal” (MOUD and TDF, Kathmandu, 2016).
52 Municipal budget data were collected by a consultant. The comparability across municipalities on spending patterns is limited because of the lack of
standardized budget codes assigned to different types of expenses in budget statements. Therefore, there may be significant inconsistencies in the types of
spending that are captured as capital (or recurrent) expenditure and the estimates should be treated with caution.
53 A PPP model for SWM is also being explored in the Dharaan municipality, which was referred to as a potential project finance deal by a commercial bank
70 that was interviewed for this study.
present where capital investment and O&M are driven adequate institutional capacity, including finan-
by user needs and may not be part of an overarching cial management, budget planning and execution,
capital investment and management plan for the entire procurement, and human resources to perform
town. Given that water supply is a core local govern- their newly assumed roles under the federal system.
ment function under the new Constitution, the Nepal MOUD recognizes these institutional deficits at the
Water Supply Corporation assets and staff will have to municipal level and defines the following constraints:
be transferred to local governments moving forward. (i) a shortage of qualified staff and lack of technical
Towns served by water user associations will need to and administrative capacity to plan, implement, op-
clarify contractual arrangements on the roles, responsi- erate, and maintain urban infrastructure facilities; (ii)
bilities, and service delivery benchmarks. These chang- inefficient delivery due to the overlapping/unclear
es will benefit from a clearer and strengthened institu- implementation mandates of implementing agencies;
tional structure. (iii) insufficient legal and administrative frameworks
for PPP; and (iv) lack of frameworks and processes
PPP schemes for water supply have been attempted for transparent and reliable planning and procure-
in Kathmandu and are forthcoming in other munic- ment processes and improved/accrual accounting
ipalities. Kathmandu Upatyaka Khanepani Limited systems in municipalities.55
was set up under a PPP model to operate and maintain
the water supply and sanitation system of Kathman- The responsibilities of the central government and
du Valley, which was previously operated by the Nepal local governments are unclear and not aligned to the
Water Supply Corporation. The shareholders of this new decentralized system. Most local bodies do not
company include the federal government (30 percent), perform many of their newly assigned constitution-
municipalities in Kathmandu Valley (50 percent), the al responsibilities. Their de facto responsibilities are
private sector (15 percent),54 and an employee trust constrained to funding small-scale local projects, due
with a contribution from the Government of Nepal to their lack of financial and institutional capacity to
(5 percent). Similar initiatives are under implementa- undertake larger infrastructure projects. These larger
tion in Bharatpur and Hetauda. These PPP initiatives projects are inevitably taken up by the central minis-
still rely heavily on public funding, even in the case tries and agencies instead. Even in major metropoli-
of water supply systems constructed and managed by tan cities, such as Kathmandu and Pokhara, the role
water user associations. The institutional structure and of local governments is limited to SWM, drainage,
tariff-setting mechanisms for the water sector need to and maintenance of small, local urban road systems,
be strengthened before PPPs can be taken forward. while the central ministries and agencies run larger
road projects and water systems. There seems to be
a lack of clarity on local governments’ new sectoral
Sector Constraints role in delivering public services like education and
Unlocking private sector investment in urban infra- health, which were under the purview of the central
structure development requires an understanding of ministries and agencies. Without further clarification
the key constraints. These include factors arising from about their sectoral responsibilities and a robust in-
the new federal system, as well as constraints specific to stitutional system in place, newly elected local gov-
the three typical private investment modalities for mu- ernments will continue to be unable to deliver these
nicipal infrastructure delivery: commercial borrowing, services.
PPPs, and land value capture.
None of the four municipalities has a medium- or
Institutional Structure, Planning, and long-term capital investment plan. There are no
Implementation clear guidelines on how local governments should
Institutional gaps and capacity constraints inhibit prepare or update their capital investment plans, nor
effective spending in and delivery of urban infra- is there a strong incentive for local governments to
structure. Most cities and towns across Nepal lack do so, given the limited or unpredictable nature of
54 FNCC- 3%, Lalitpur Chambers of Commerce – 1.5%, Nepal Chamber of Commerce – 9%, Bhaktapur Chambers of Commerce -1.5%.
55 MOUD 2017, p. 45.
71
future revenues. Necessary large-scale, citywide infra- tains various clauses that point to the right of states to
structure projects focusing on core urban services are borrow and receive guarantees from the federal gov-
largely absent in their project pipelines. Instead, local ernment and for local-level entities (municipalities
governments tend to focus their resources on financ- and villages) to borrow and receive guarantees from
ing many small-scale initiatives.56 the federal and state governments. However, Article
228 states that states and local governments can take
The existing procurement system suffers from a lack loans only after a new federal law is approved, which
of consistency. Manual and online procurement sys- allows state and local governments to borrow inter-
tems are currently used, depending on the size of the nally. However, this law, and the policy framework
project.57 underlying it, has not yet been drafted. Therefore,
municipal borrowing is restricted to loans from the
Funding and Financial Management TDF—whose sources of finance derive almost ex-
The Natural Resource and Fiscal Commission is in clusively from multilateral and bilateral donor agen-
the process of developing a system for transferring cies—until the revised regulations are put in place. In
funds from the Government of Nepal to the local addition, TDF’s relationships with commercial lend-
governments. Although the amount of fiscal transfers ers and local governments and its role in on-lending
to local governments has increased significantly, there activities are not appropriately defined.
is no predictability to this mechanism in the absence
of clearly defined guidelines for fiscal transfers. Weak institutional and fiscal capacities of local gov-
ernments sap the incentive for commercial banks to
Financial management systems currently in place finance municipal infrastructure. The 2015 Con-
at the municipal level are highly fragmented and stitution allows local governments to borrow funds
in flux. Kathmandu and Pokhara, for instance, are from private sources (for example, bonds and loans
currently using a manual billing system, which com- from commercial banks) to meet expenditure needs.
promises efficiency and accuracy in transactions and However, to date, commercial borrowing is virtually
tax administration. Although Kathmandu Metropol- nonexistent at the municipal level. Interviews with
itan City is prepared to implement an online billing commercial banks and private construction compa-
system (for example, a Municipal Administration and nies revealed a general lack of interest in extending
Revenue System), this transition has not been imple- loans to municipalities to finance their infrastructure
mented, mainly due to the inadequacy of trained investment needs. Most local governments have low
personnel for operating an information technolo- revenues and poor financial management systems and
gy–based public financial management system. The are therefore not attractive investment targets or cred-
lack of accountability, reliability, and transparency in it risks. Lack of predictability in intergovernmental
financial management systems also undermines the fiscal transfers also compounds the uncertainty of
creditworthiness of local governments, which in turn cash flows for potential lenders.
deters commercial borrowing at the local level. Al-
though the fragmentation is partly due to the ongo- Despite a growing banking sector, capacity to lend
ing transition to federalism, there is a pressing need to local governments is limited. The banking sector
for reliable and transparent financial management. has expanded rapidly in Nepal, registering a 140 per-
cent increase in assets between July 2009 and June
Commercial Borrowing 2016.58 The volume of domestic credit to the private
The legal and regulatory framework for local gov- sector increased from 33 percent of GDP in 2005
ernment borrowing is not yet fit for purpose. Sub- to 75 percent in 2016, due to the rapid growth of
national borrowing requires a well-designed legal and private commercial banks. However, several persist-
regulatory framework. The 2015 Constitution con- ing supply-side challenges undermine the capacity
text of Fiscal Federalism in Nepal” (UNCDF, New York, 2017).
57 Projects that are worth more than NPR 1 million are managed through e-procurement systems, whereas smaller projects are administered through the
manual procurement process.
72 text of Fiscal Federalism in Nepal” (UNCDF, New York, 2017).
of commercial banks to finance public infrastructure of bankable projects and implement them.62 Lack of
projects, including a shortage of savings and lon- transparency and accountability in the procurement
ger-term funds and an underdeveloped bond market, and contracting procedures has also generated signif-
including the lack of a yield curve. Banks are inexpe- icant skepticism among private companies about the
rienced in lending to local governments, as they lack fiduciary risks of PPPs.
financial information and means to evaluate local
governments’ creditworthiness.59 The relationships and divisions of responsibilities
between key bodies and provincial and municipal
The largely underdeveloped Nepalese capital mar- authorities are largely unclear. There is a lack of clar-
ket limits local governments’ ability to raise capital. ity on the powers of local governments to enter into
The capital market in Nepal has remained largely un- and regulate PPP arrangements, set tariffs, pledge
derdeveloped. Market capitalization is relatively low, revenues, provide resources (for example, land and
signaling low participation of companies in the stock labor), spell out authorizations and approvals needed
market (compared with the size of the economy) before contracts are signed, and stipulate the func-
and/or undervaluation of shares. The debt market tions of other government agencies, such as the IBN
in Nepal is mainly driven by short-term government and PPP Centre, in this process. In a similar vein,
debt, and no local government has ever issued debt, although the draft law mandates federal, provincial,
although they are permitted to do so.60 The private and local-level governments to identify and prepare
bond market is very small, and no trading takes place. PPP projects, the process for such projects is unclear.
In 2010, corporate bonds were 5 percent of the mar-
ket. Although most debt issues are well-subscribed, The integrated SWM project in Kathmandu Val-
investor interest in bonds is said to be still adversely ley could serve as a case study for the evolution
affected by the failure of some debentures to repay in of the legal and regulatory framework for urban
the 1980s and 1990s.61 Finally, local governments’ sector PPP projects. This project is one of the first
lack of creditworthiness also likely impacts borrowing PPP projects in the urban sector under the aegis of
from the market. the IBN.63 The potential project shows the need for
more clarity of the responsibilities of the various in-
Public-Private Partnerships stitutions involved.
Lack of capacity, frequent staff turnover, and bureau-
cratic inefficiencies hamper private sector involve- The private sector in Nepal faces technical and fi-
ment in the delivery of urban public services through nancial resource constraints to engage successfully
PPPs. Thus far, PPP experience in the urban sector in municipal PPPs. These constraints undermine the
has been very limited and restricted to a few contracts private sector’s ability to bid for and enter into PPP
for collection and transportation of solid waste. In ad- contracts for public infrastructure projects. There is a
dition to general constraints to PPP implementation, lack of access to credit, with high interest rates of 11-
there are several institutional and administrative bar- 14 percent from commercial banks, and trained per-
riers to private sector engagement in the urban sector. sonnel with entrepreneurial and managerial skills are
These include bureaucratic and political interference, scarce.64 Furthermore, a lack of price competitiveness
which delays the approval and implementation of such and difficulties meeting standards and requirements
infrastructure projects, as well as frequent staff turn- perpetuate the problem. And there is little appetite
over. Furthermore, there is a lack of capacity at the for private companies to finance urban infrastructure
national and municipal levels to prepare a pipeline projects because of their limited revenue-generating
text of Fiscal Federalism in Nepal” (UNCDF, New York, 2017): v.
text of Fiscal Federalism in Nepal” (UNCDF, New York, 2017): v.
text of Fiscal Federalism in Nepal” (UNCDF, New York, 2017): 66–67.
62 Based on interviews with private sector companies.
63 IBN promotes PPPs in integrated SWM, among other sectors.
64 According to interviews with private construction companies.
73
potential, particularly in the water supply and sew- a simple majority for land pooling from landowners
erage sectors. The private sector may prefer annuity has proven difficult.
payment–based projects linked to predictable local
government cash flows over projects involving dif- The policy and regulatory system for land value
ferent risks (revenue, financing, construction, perfor- capture does not contain a standardized land val-
mance, and other risks), as well as lack of efficiency uation system, nor does it guarantee the deeds of
and local government capacity to deliver projects. the land transaction process. There is no official and
standardized land valuation system in Nepal except
Land Value Capture ad hoc land valuation for compensation during land
Alternative financing through land value capture is expropriation.66 The valuation of land and housing
limited by institutional and regulatory gaps. Mu- hardly reflects actual market values, due to the defi-
nicipalities can potentially tap alternative sources of cient records kept at the local level. Various land acts
finance by leveraging development taxes, improve- and regulations are used for land valuation, creating
ment fees, development rights, construction density complexity and confusion and undermining the cred-
options, and regulations to capitalize on the value of ibility of the valuation system as a whole. The poor
land appreciation in fast-growing, urbanizing cities. quality of land valuation also stems from scarce and
However, these instruments often require sound land outdated information on land or property records
and real estate markets with secure property rights held by local governments. There is no formal land
and cadastral systems, which are not guaranteed in information system, and, in many instances, there is
Nepal. These instruments also often require con- a significant discrepancy between information in land
ducive legal and regulatory frameworks, which are ownership records and cadastral maps. As a result, in-
essentially absent in Nepal. Moreover, local govern- formation on land transactions is often not credible.
ments’ capacity to collect property taxes and impact/ Furthermore, the government does not guarantee the
development fees is weak due to poor enforcement deeds of the land transaction process, thereby putting
and valuation systems, incomplete or outdated rev- the investment of land buyers and sellers at risk. As
enue base information, and a lack of political will. MOUD (2015) highlights, “these factors add uncer-
The absence of capital gains tax mechanisms, which tainty to the land market to such an extent that the
would otherwise allow local governments to capture location decisions of the buyers often do not recon-
the real value of infrastructure development and pro- cile with rational choices.”67
mote benefit sharing of urban development, makes
it difficult for local governments to utilize land value
capture instruments. Supply-side barriers, including a Roadmap
lack of willingness of private land owners to contribute This roadmap focuses on creating an unambiguous
their land for development (often rooted in inadequate enabling environment for local governments to take
valuation of land, slow payments, and fear of displace- charge of their new constitutional responsibilities.
ment) also hinder land value capture.65 Private land is The roadmap suggests that the government should
the most dominant form of land tenureship in Nepal, ensure prompt completion of transferring functions
and there is a high level of skepticism among landown- to local governments and anchoring of functional re-
ers to contribute their land for land pooling projects. sponsibilities and regulatory roles through appropri-
Land acquisition negotiations with landowners often ate legislation. Furthermore, it recommends that the
falter because of speculative prices demanded by land- government, along with the Natural Resource and
owners, absent landlords, and indecision by family Fiscal Commission, puts transparent and predictable
members. In many cases, even acquiring consent from arrangements in place for fiscal transfers to local gov-
65 Ministry of Urban Development (MOUD), National Urban Development Strategy 2015 (Kathmandu: MOUB, 2015).
66 S. Ghimire, A. Tulandhar, and S. R. Sharma, “Governance in Land Acquisition and Compensation for Infrastructure Development” (American Journal of
Civil Engineering 5 (3), 2017): 169–78.
67 Ministry of Urban Development (MOUD), National Urban Development Strategy 2015 (Kathmandu: MOUB, 2015): 15.
74
ernments, with a longer time horizon than the cur- tion, land pooling, and use of other value capture
rent annual budgeting and transfer process. For ex- financing tools need to be enacted.
ample, the Natural Resource and Fiscal Commission
should announce the basis for fiscal transfers over the • Improve urban management capacity. New-
next three to five years, to allow local governments to ly elected mayors and councilors are becoming
prepare medium-term capital investment and financ- acquainted with their new responsibilities un-
ing plans. The roadmap recommends that the gov- der the new Constitution. There is a need for
ernment also transfers staff, completes recruitments, training in governance systems and planning for
and contracts specialist technical staff to overcome ca- economic development, including mobilizing
pacity gaps. These short-to-medium-term measures, private finance. In addition, the technical, con-
along with interventions aimed at strengthening local tracting, and project supervision capabilities of
government performance and creditworthiness, will technical staff need to be improved to facilitate
be key to improve the capacity of local governments timely execution of urban infrastructure projects.
before embarking on reforms aimed at addressing the This includes training accounts and administra-
demand- and supply-side constraints to maximizing tion staff in double entry accounting, long-term
finance for urban sector development. Within this capital investment planning and budgeting, fi-
broad context, the roadmap makes specific sugges- nancial management, cash flow management and
tions for enhancing potential private financing of ur- leveraging, and the use of geographic information
ban infrastructure through commercial borrowing by system tools to improve tax administration, value
municipalities and municipal PPPs (table 16). capture financing, tax increment financing, and
other approaches to improving OSRs.
Pillar 1: Improve the creditworthiness of local gov-
ernments (one to three years). It is imperative to • Improve procurement, financial management,
strengthen the technical, financial, and managerial and contract management frameworks. Each
performance of local governments, to enhance their of the cities in this study had different classifica-
borrowing capacity and ability to make timely pay- tions of revenue sources and expenditure items,
ments to vendors and PPP partners. Although it is which made comparing performance difficult. It
likely to extend beyond five years, the process needs is advisable that the government considers imple-
to be initiated over the next one to three years. The menting a double entry accounting system and
urban sector will not attract additional capital unless common accounting standards across all local
local governments can demonstrate their creditwor- governments. In addition, the government could
thiness. The following measures are worthwhile to improve OSR through better administration and
that end: collection, and it could collect additional reve-
nues through the use of value capture financing
• Strengthen the legal framework. The Gov- mechanisms, levies, and periodic revisions in user
ernment of Nepal has already passed the Local charges. These measures are needed to support
Government Operations Act, 2017, and the In- debt servicing and future investments in this sec-
ter-Governmental Fiscal Arrangement Act, 2017. tor. In addition, it is recommended that the gov-
But many of the earlier acts governing the ser- ernment implements a predictable and transpar-
vices and responsibilities of local governments ent system of fiscal transfers to local governments
may need to be amended for consistency with the through the newly created Natural Resource
new Constitution. It is important to make these and Fiscal Commission, to facilitate predictable
amendments within the next year or two, to give funding of local governments’ operating and
local governments clarity on their functional do- capital expenditures. Appropriate institutional
main, taxation powers, and regulatory responsi- frameworks for efficient project planning, pro-
bilities. Furthermore, laws relating to land valua- curement, and execution are key. For example, a
75
dedicated SWM unit within local governments, be established on a pilot basis where demand is
with adequate capacity to bid out projects, super- highest.
vise implementation, and carry out O&M post
implementation, could help in this process. • Allow local governments to tap into nation-
al-level funds, including viability gap funding,
Pillar 2: Encourage PPPs in the urban sector (short project preparation funds, and a land acquisi-
and medium term). Although a few PPP projects tion revolving fund. If targeted financial and risk
involving public funding and private management mitigation support to local governments is need-
could possibly be implemented over the next few ed, local governments should be able to tap into
years, investments by the private sector in urban sec- appropriate funds. It would be advisable for the
tor projects will increase only if sector viability is es- government to formulate frameworks and pro-
tablished in the form of adequate user charges and a cesses to enable municipalities to access such sup-
stable and conducive regulatory framework. port. The appropriate frameworks and processes
for municipalities to access such funds need to be
• Establish a legal and regulatory environment for in place.
PPPs in the urban sector. The draft PPP Act is
largely unclear on the relationship and division Pillar 3: Establish a framework for local government
of responsibilities between the key bodies and borrowing (three to five years). The following ini-
provincial and municipal authorities. Given that tiatives aim at improving the “bankability” of urban
local governments are responsible for SWM un- projects. It would be advisable for the Government of
der the new Constitution, greater clarity about Nepal to support the development of a policy frame-
the responsibilities of local governments to enter work for regulating local government borrowing, as
into and regulate PPP arrangements is necessary. well as appropriate legislation and regulations.
The PPP Act will need to be harmonized with
the Local Government Operations Act and other • Create a legal and regulatory framework for lo-
proposed amendments to other Acts governing cal government borrowing. The framework for
local governments’ functions and powers. local government borrowing should be based on
commercial principles whereby domestic lenders
• Establish provincial PPP Units. As stated in the and bond market investors are able to finance
PPP Policy and Draft PPP Act, a PPP Unit will bankable projects sponsored by highly rated local
be established at the national level. In addition, governments. The framework should enable lo-
consideration could be given to establishing PPP cal governments to tap into appropriate blended
centers in key municipalities. Potential roles for financing, including commercial, bilateral, and
these centers include supporting PPP project multilateral sources; capital grants through in-
screening, feasibility analysis, project structuring, tergovernmental fiscal transfers; and beneficiary
customizing model PPP contractual documents contributions for the long-term capital invest-
for each sector/project, and assisting local gov- ment program, as needed. Issues covered should
ernments in contract negotiations with the pri- include definition and types of debt, conditions
vate sector. The first step would be to undertake under which local governments may borrow
a study to examine the scope, benefits, costs, and (credit rating, limits for borrowing linked to debt
potential impacts of such centers, followed by servicing capacity, and so forth), loan tenors,
an in-principle decision on whether to proceed collateral, debt issuance process, whether local
or rely on a different approach (for example, the governments may borrow in foreign currency,
national PPP Centre) to provide the technical events in cases of default, and issues of informa-
support that local governments will require. If a tion disclosure and mechanisms to monitor local
“provincial urban PPP center” model is found to borrowing. In developing this framework, the
be desirable, one or more such centers could then government will need to consider the impacts of,
76
for example, opening access to local government municipal borrowing, the government will need
current accounts and tax collection facilities to all to review and appropriately define the role of the
commercial banks (as opposed to only govern- TDF in on-lending activities and its relationship
ment-owned banks). The transparency of local to commercial lenders and local governments.
government cash flows could support municipal This aspect needs further consideration and is
lending by commercial banks in the long term. not covered in detail in this roadmap.
• Create the necessary regulations for direct lend- • Develop a framework for the financial assessment
ing to local governments by banks and financial and credit rating of local governments. Two credit
institutions. Under the NRB’s leadership, local rating agencies, ICRA Limited and CARE Ratings
governments should be classified as a separate Limited (Nepal), are already registered with the Se-
borrower class, and capital provisioning norms curities Board of Nepal. These agencies should be
and security requirements must be brought out in engaged to develop a framework for local govern-
the guidelines. The Securities Board of Nepal is ment credit rating (although a system of intergov-
advised to pass regulations for issuance and listing ernmental fiscal transfers and national accounting
of municipal bonds. Regulations pertaining to in- standards must precede it), to develop the market
vestments by provident funds, insurance funds, for local government borrowing. In the interim, a
and the Citizen Investment Trust (the largest checklist/toolkit for evaluating local government
investment vehicle for citizens in Nepal) in lo- financial performance, including the ability to
cal government debt (term loans and municipal meet recurring expenditures (salaries and O&M)
bonds) will also need to be developed. from OSRs, collection efficiency for property tax
and other OSRs, days payable, and so forth, may
• Redefine the role of the TDF. In the context of be developed as a precursor to the credit rating
a broader policy and regulatory framework for process.
77
Summary of Recommendations for the Urban Sector

TABLE 16: URBAN SECTOR ROADMAP
PILLAR
Pillar 1: Improve the 1.Pass new/amend acts governing local government

creditworthiness of local functional domain or specific services to ensure consis-
governments tency with the new Constitution and Local Government
Operations Act 2017.
2.Transfer staff to local governments and fill vacant posts.
3.Build capacity of LG staff on financial management
systems, OSR mobilization, procurement and contract
management, and project design and implementation.
4.Implement double entry accounting system and com-
mon accounting standards across all local governments.
5.Improve OSR through better administration and collec-
tion and additional revenues.
6.Implement predictable and transparent multi-year sys-
tem of fiscal transfers to local governments through the
Natural Resource and Fiscal Commission.
7.Prepare long-term capital investment plans.
8.Create appropriate institutional frameworks in local
governments for efficient project planning, procurement
and execution.
Pillar 2: Encourage PPPs 1.Pass PPP Act and/or other legislation and guidelines with 1.Establish PPP Units in one/more provinces on
in the urban sector (short adequate recognition of the constitutional role of local pilot basis or rely on other models to provide
and medium term) governments in the urban sector. technical PPP support to local governments.
2.Clarify roles of various institutions, including IBN, the 2.Consider options for providing targeted
proposed PPP Unit and local governments in the proposed funding support to local PPPs, including via-
PPP Act (or other legislation) for entering into contractual bility gap funding, risk mitigation measures,
arrangements with the private sector. project preparation funding support, and land
acquisition support.
Pillar 3: Establish a 1.Evaluate local government financial performance based 1.Formulate policy, legal, and regulatory
framework for local gov- on a checklist as precursor to the credit rating process. framework for local government borrowing
ernment borrowing and related measures.
(3 to 5 years)
2.Nepal Rastra Bank to develop regulations for
direct lending to local governments by banks.
3.Government of Nepal to ensure level playing
field for government and private banks lending
to local governments.
4.Review and adjust the role of the TDF,
finalize business plan for TDF, and enable its
transition to the new role.
5.Develop credit rating methodologies for local
government borrowing. SBN and Ministry of
Federal Affairs and General Administration
with international credit rating agency sup-
port to oversee/facilitate the process.
6.SBN to announce guidelines for issuance
and listing of municipal bonds, including credit
rating requirements.
Note: IBN = Investment Board of Nepal; OSR = own-source revenue; PPP = public-private partnership; SBN = Securities Board of Nepal; SWM = solid waste
management; TDF = Town Development Fund.
78
79
The World Bank Group provides assistance to
governments in developing countries to improve access
to infrastructure and basic services through public-
private partnerships (PPPs). When designed well and
implemented in a balanced regulatory environment,
PPPs can bring great efficiency and sustainability to the
provision of such public services as water, sanitation,
energy, transport, telecommunications, healthcare, and
education.
The World Bank Group's unique value proposition rests

with its capacity to provide support along the entire
PPP cycle—upstream policy and regulatory guidance,
transaction structuring advice, as well as financing and
guarantees to facilitate implementation.
www.worldbank.org/np
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Nepal Infrastructure Sector Assessment Private Sector Solutions For Sustainable Infrastructure Development

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NPR Nepalese Rupee

Reforming the Energy Sector 27

Constraints Affecting the Availability of Long-Term Financing 38

Reforming the Transport Sector 51

Reforming the Urban Sector 67

Energy Sector pace, electricity sector investments will need to ac-

TABLE ES.1: CROSS-CUTTING AREAS – SHORT-TERM PRIORITY ACTIONS (UP TO 3 YEARS)

TABLE ES.2: SHORT-TERM PRIORITY ACTIONS – SECTORS

1 IMF DataMapper, 2019; World Bank Open Data, 2019

FIGURE 1: INDICATORS OF PUBLIC/PUBLICLY GUARANTEED DEBT UNDER ALTERNATIVE SCENARIOS,

c. PV of debt -to-export + remittances ratio c. PV of debt -to-revenue ratio

e. Debt service -to-exports + remittances ratio f. Debt service -to-revenue ration

Source: World Bank/IMF Debt Sustainability Analysis.

2 The Incremental Capital-Output Ratio is inversely correlated with efficiency.

4 World Bank Group, Country Private Sector Diagnostic, 2018.

commitments to PPPs. An appropriate institutional

13 Nepal Rastra Bank’s Monthly Statistics: FINSTATS, 2015.

NEPAL INFRASTRUCTURE DEVELOPMENT FINANCE INSTITUTION (NIDFI)

Source: Nepal InfraSAP Team.

TABLE 1: CROSS-CUTTING AREAS ROADMAP

SHORT-TERM ACTIONS MEDIUM-TERM ACTIONS

To develop a yield curve, implement a systematic

Implement a tax rebate for investors on any portion

GENDER EQUALITY AND SOCIAL INCLUSION

Collect gender-disaggregated data on the use of

Reforming the Energy Sector

Introduction struction periods that are conducive to private sector

Nepal’s Energy Sector at a FIGURE 2: ACTUAL AND PROJECTED ELECTRICITY

Nepal has recovered from the severe electricity 60000

tricity consumption in the country. Combined with 10000

more efficient management of existing generation 0

(T&D) losses, the NEA has resolved load shedding.

BOX 1: UPPER TAMAKOSHI HYDROPOWER PROJECT

Project and Upper Bhotekoshi Hydropower Project, 1000

increased the generation capacity by 30 percent with- 400

in a few years in a country with significant generation

TABLE 4: SOURCES OF FINANCING IN THE ELECTRICITY SECTOR (US$, MILLIONS)

BOX 3: INTERNATIONAL EXPERIENCE WITH LARGE HYDRO PROJECTS

BOX 4: PRIVATE SECTOR EXPERIENCE WITH LARGE HYDRO PROJECTS

Table 1 - Breakdown of investment in PPI database for all countries

Table 2 - Breakdown of investment in PPI database for IDA countries

BOX 5: BUILDING EFFECTIVE INSTITUTIONS

Source: World Development Report 2017.

FIGURE 4: NEPAL ELECTRICITY AUTHORITY’S NET INCOME (US$, MILLIONS)

Source: NEA Annual Report 2018.

BOX 6: INDONESIA INFRASTRUCTURE FINANCE

Increase the Availability of Long-Term Strengthen HIDCL and Institutional Investors

KEY CONSTRAINTS(RESPONSIBILITY) SHORT-TERM ACTIONS MEDIUM-TERM ACTIONS

FIGURE 5: DEVELOPING AN ASSET RECYCLING FRAMEWORK

Current Operations and

Source: World Bank 2018

Manage Foreign Exchange Risk • Remove barriers to foreign currency borrowing.

TABLE 7: INCREASE THE AVAILABILITY OF LONG-TERM FINANCE – RECOMMENDED ACTIONS

Limited institutional and financial capacity of HIDCL and Institutional Investors

TABLE 8: INCREASE FOREIGN INVESTMENT – RECOMMENDED ACTIONS

Reforming the Transport Sector

23 World Bank, Country Private Sector Diagnostic, 2018.