Capital markets: Nepal seeks the right rating

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By:
Elliot Wilson
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Chaos and upheaval in Nepal have given way to growth and stability, and investors have taken note. Capital is flowing in from India and China, while the government pushes ahead with securing its inaugural credit rating, but can the good times last?

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Nepal barely features on investors’ radars. It has no credit rating and has never issued a sovereign bond, so investors – be they venture capital or private equity, institutional or sovereign wealth fund – cannot rate them against their frontier-market peers.

Nepal’s capital markets are tiny, and its financial sector, overloaded with roughly 250 licensed institutions, is an example of quantity over quality.

But now the government wants to change all that, starting with the credit rating.

Moody’s Investors Service has already been to visit, and Kathmandu hopes to have a credit rating in place by the end of 2019.

“A sovereign credit rating will help put Nepal on the global financial markets map, allowing it to gain the attention of both sophisticated capital markets investors as well as foreign direct investors,” says Anirvan Ghosh Dastidar, country chief executive of Standard Chartered Bank. “A rating could ultimately pave the way for greater investment into the country.”

Anil Shah, chief executive of Kathmandu-based Nabil Bank, is equally enthusiastic.

“This is the right time for Nepal to get a sovereign rating,” Shah says, adding that this will “open the doors for interested parties around the world to consider Nepal for investment, which is much needed to finance the economic growth the government aims to deliver”.  


We are now at the start of an economic and financial transformation that we have never seen before 
 - Anil Shah, Nabil Bank

Bankers familiar with the discussions say a large delegation from Moody’s New York office spent several weeks in Kathmandu in November and December last year, running the rule over the country’s books.

“There are many interested investors who want Nepal in their portfolios and macro-economic indicators,” says Dastidar. “The government is very serious about [getting a sovereign credit rating]. It will massively boost Nepal’s profile and allow it [to] access major new sources of global investment capital.”

Advisers to the sovereign say Moody’s was heartened by what it saw. Yes, Nepal needs to tackle its grisly finances. The sovereign recorded a budget deficit equivalent to 8.9% of GDP in 2018 and is set to post a current account deficit of 9.6% in 2019 and 12.5% in 2020, according to IMF projections.

But investors love a positive and clean-lined growth story, and ratings agencies appreciate sovereigns willing and eager to pay to be assessed.

A senior Kathmandu banker who is advising the sovereign on its strategy admits it won’t be easy: “The challenge will be to get everyone singing from the same song sheet, and to agree on and then hone the narrative. In the Philippines, the narrative sold to investors was tourism. In Indonesia, it was infrastructure. My sense here is that it will be not infrastructure or tourism, but hydropower.”

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Working on the Chinese dam


The question is what rating will Nepal get, and indeed, which one will it seek? This is a tricky one. Typically, a client goes for the highest possible rating. After all, why would a government willingly put itself in the position of needing to pay more to sell its debt securities to global investors?

But in Nepal’s case, advisers say the sovereign is treading carefully. For a country at its stage of economic and financial development, its metrics are surprisingly good. Per-capita GDP is higher in Bangladesh and India, yet Nepal is hindered by a higher rate of absolute poverty and level of national debt as a share of economic output. Nepal’s financial sector is well managed and regulated, while its cities are almost entirely free of begging or crime. It is a country of proud people who want to work.

Some analysts believe Nepal would obtain a sovereign rating of Caa if it were rated by Moody’s, or possibly a notch lower at Ca, tagging it as a country that is expected to default on its bonds, while others say it would merit a rating of Ba3, placing it on a par with Bangladesh’s inaugural rating, from April 2010.

But there is a complication. As one banker puts it, Nepal is “keen to remain seen by the outside world as a frontier market with huge but untapped long-term potential for as long as possible”. 

That explains why the ruling party has fought tooth and nail to remain on the UN’s list of least developed countries, which includes Bhutan, Myanmar and Bangladesh.

The reason for this is simple. Nepal wants to attract foreign investment, is aware of its huge potential, notably in hydropower and tourism, and prizes its status as a geopolitical pinch-point, fought over between two Asian superpowers, China and India. But it is also poor and underdeveloped, and highly dependent on the $6 billion it receives each year from multilaterals and global aid agencies.

So Nepal’s government is desperate to keep its rating low, and certainly lower than India’s, in order “to keep the aid money flowing in,” the banker says. “That’s the ideal outcome.”

Once Nepal secures a credit rating, it can push ahead with plans to print an inaugural dollar-denominated sovereign bond.

Constancy

The question that remains is: can the good times last? Investors love a good, clear growth story, but they also prize political stability. And it is this constancy, according to Standard Chartered’s Dastidar, that led to “a lot of the interest” in the country. 

“This is the first time that a government has lasted this long,” he says. “Stability has been the turning point for Nepal. Whether it will last is anyone’s guess.”

That’s an important point given Nepal’s history over the last two decades. Grinding poverty, an unbalanced economy and a series of natural calamities made it more attractive to well-meaning aid agencies than to foreign investors. Economically, this landlocked state enjoyed little or no spillover effect from reforming India to the south and booming China to the north. Politically, it was chaotic for most of that period. Following the blood-soaked demise of a once-popular royal family, Nepal saw a series of governments come and go, each shorter-lived and more chaotic than the last.

That all changed in 2017 with the election of a surprisingly sturdy government. Led by the Nepal Communist Party, the new administration set out to build a fairer and more balanced economy propelled by a strong and inclusive banking sector.

New rules overseen by the central bank, Nepal Rastra Bank (NRB), aim to hasten financial inclusion by building branches in remote regions and ensuring that by 2022 every family has access to a formal bank account.  


When India put a stop to petroleum imports, China helped out. That made China look more helpful and friendly 
 - Manoj Gyawali, Jyoti Bikash Bank

Another long-standing complaint – that the country has too many financial institutions – is being addressed, by encouraging larger or more aggressive lenders to gobble up their smaller peers.

Another recent action taken by the central bank suggests an answer to the question on the lips of everyone from local and foreign lenders to digital payment specialists and institutional investors: what kind of economy does Nepal want to be?

Not long ago, the answer would have been, at best, a collective shrug. Nepal had a thriving tourism sector based on hiking, mountaineering and spiritual pilgrimage. The only other big money-spinner involved people leaving the country and sending back their pay: according to IMF data, inward remittances accounted for 25% of total economic output in 2018.

But in July 2017, the central bank raised the share of loans that commercial banks must channel each year to priority sectors, to 25% of all new lending, an increase of five percentage points. Three sectors stood to benefit most. Agriculture accounted for 10% of all new annual lending, with tourism and hydropower soaking up 5% each. The remainder targeted a host of additional priority sectors, including clothing, pharmaceuticals and cement production.

Each is considered vital, not just to the country’s economic and financial health, but also to Nepal’s ability to generate consistently high rates of growth, to sell global institutional investors on its long-term story, and if all goes to plan in the months ahead, to secure its inaugural sovereign credit rating.

Economy

How realistic are these ambitions? Let’s start with the economy. After years of plodding growth rates, Nepal’s economy has finally taken off. Output expanded at an annual average rate of 3.5% in the five years to the end of 2016. If predictions, published in the IMF’s World Economic Outlook in April this year are borne out, the average rate of growth will nearly double over the four years to the end of 2020, to 6.8%. 

That’s slightly above the IMF’s prediction of a 6.4% growth rate over the same period for the area encompassing ‘emerging and developing Asia’. It’s also the kind of data point guaranteed to pique the interest of global lenders and investors.

Bankers are quick to tout the country’s credentials.

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Anil Shah, chief executive of Kathmandu-based Nabil Bank


“We have seen some big changes in politics, society and culture in the last few years,” says Nabil Bank’s Shah. “We are now at the start of an economic and financial transformation that we have never seen before.”

Dastidar, who took over at Standard Chartered in Kathmandu in March 2019 after long stints with the London-based lender in Bangladesh, the Philippines and Brunei, agrees: “I’ve clearly come at the right time. It feels like it’s a case of now or never for Nepal.”

Frontier states, particularly poor, landlocked ones with few natural resources, need to work hard at making their case to investors, and Nepal is clearly up for the challenge. 

This year’s Nepal Investment Summit, held in Kathmandu over two days in March, attracted a global cross-section of companies, from Australian gaming operators (Silver Heritage Group) to US technology giants (Amazon, Microsoft) and development finance institutions (UK-based CDC Group), all keen to test the waters in a fast-growing, consumption-oriented economy.

But as has so often been the case this millennium, the event was dominated by the rising power on the far side of the Himalayas.

“The majority of investors at the summit were Chinese,” says Shah. Delegations came from an array of mainland state enterprises, including cement producers and construction firms, as well as a scattering of privately run hotel and restaurant chains. 

“In 30 years in banking, I have never seen so much interest from one country,” Shah adds.

India and China

The fight to fund and profit from Nepal’s future is a straight one between India and China, Asia’s largest and third-largest economies. Nepal is considerably smaller: its population of 30 million is on a par with Malaysia’s, and the country covers an area roughly the size of Bangladesh. The lack of a sea border means it will always be, in Shah’s words, “a little stone trapped between two big stones”.

India looms larger than China in Nepal’s psyche. The two are bonded by culture, religion and sheer weight of history; locals instinctively head south, to New Delhi, Mumbai and Kolkata, to shop, attend college and seek work. But in recent years, the balance of power has shifted.

India protested vigorously, even aggressively, against Nepal’s new constitution, approved in 2015. New Delhi claimed, not without reason, that the document failed to protect the Madhesi, a large minority of Indian ancestry. But its reaction was disproportionate. 

What Nepal needed in the wake of the earthquake that shook the country in April of that year, killing 9,000 people and stunting growth for several quarters, was financial and institutional support from an old friend.

Instead, its chief trading partner and the single largest source of inward foreign investment imposed a damaging embargo on its neighbour.

“There was huge devastation, yet because of the blockade we had no fuel or medicine for almost a year,” says Ashoke SJB Rana, chief executive of Himalayan Bank. “We were down to chopping trees, just [because India wanted] to punish us and demand we relent and amend our constitution.”

All it did was make New Delhi unpopular and open the door to Beijing. 

“When India put a stop to petroleum imports, China helped out,” says Manoj Gyawali, chief executive of Jyoti Bikash Bank, a national-level development bank. “That made China look more helpful and friendly.”

China needed no second invitation, and a trickle of investment from mainland firms has turned into a flood. During a trip to Beijing in July 2018, Nepal’s prime minister KP Sharma Oli signed eight cooperation deals worth $2.4 billion, including a mandate to link Kathmandu by rail with the Tibetan city of Lhasa by 2025. Another key project, the construction of a new airport in Pokhara, built by China CAMC Engineering and funded by a $216 million loan from the Export-Import Bank of China, is nearly finished.

Beijing won’t have everything its own way. A backlash against the Belt and Road Initiative is under way in Asia and beyond, and Nepal is well aware of the dangers of addiction to soft mainland loans. 

At the IMF conference in Bali in October 2018, finance minister Yuba Raj Khatiwada told Euromoney it was vital for Nepal to develop its own projects, and not to “suffer from a [Chinese] debt overhang”.

Besides, for all its intransigence over the blockade, and despite its remarkable ability to fall out not only with Nepal but all of its south Asian neighbours, India looks set to remain the country’s chief trading partner for years to come. New Delhi lies 250 kilometres from India’s closest border with Nepal, while the two nations share a long and easily accessible land border. 

“Open borders are crucial,” says Jyoti Bikash Bank’s Gyawali. “Nepal people can go to India without a passport and vice versa.”

And while Chinese firms are busy building hydroelectric dams across the country, the fruits of their labours are likely to be shared by Nepal and India. Some, particularly those who profit from a tourism sector that employs millions, may beg to differ, but Nepal’s investment story is ultimately all about hydropower, classed by most as a renewable source of energy.

Nepal currently generates less than 1,000 megawatts of power a year from its abundant riverine sources, the government-owned Nepal Electricity Authority says. Most people are reliant on primitive sources of fuel to heat and light their homes, notably wood and kerosene lamps.

But the NEA reckons that just four key river basins, the Karnali, Mahakali, Gandaki and Koshi, could, if exploited to the maximum, generate up to 80,000 MW of power a year, enough to power 60 million homes, or equivalent to the entire city-state of Singapore twice over.

No wonder bankers are optimistic.