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Financing Options for Private Sector Growth

Author: Bibek Shrestha and Monisha Shrestha, Invest for Impact Nepal
Original Publication Date: 4 November 2022

Nepal has embarked on an ambitious journey to achieve middle-income status by 2030 through the accomplishment of the Sustainable Development Goals (SDGs). The 15th Development Plan has prioritised agribusiness, tourism, energy, industry and business segments as key sectors that are crucial for powering Nepal’s economic growth. Private investment has played an important role in the country’s economic development. However, private capital investment remains low, with overall Private Fixed Capital Formation-to-GDP standing at just 23 per cent in 2020 (World Bank). According to Nepal’s National Planning Commission, the financing gap for SDGs in the private sector is estimated to be Rs. 367 billion.

Proliferation of actors

Foreign capital has remained an important source of development capital for Nepal. Over the last two decades, the nation has seen a proliferation of actors and institutions in the capital market, and more recently has witnessed the growth of private equity and venture capital (PE/VC) funds, some home-grown and others backed by foreign investors. The country also received Rs. 198.52 billion in foreign direct investment from 52 different economies in 2020, a figure up by 8.5 per cent from the previous year.

Development finance institutions (DFIs) – specialised development banks set up by developed countries or international development funds to support private-sector development in developing countries – have an increasingly large share of foreign investment in Nepal. Multilateral DFIs such as the Asian Development Bank (ADB) and International Finance Corporation (IFC) have invested in Nepal’s private sector development over the last four decades. Recognising Nepal as a frontier market, bilateral DFIs such as FMO, BII, SIFEM, DFC, DEG, SwedFund, FinnFund and others have entered the Nepali market more recently.

Bilateral DFIs invest in the market directly through businesses, as well as through financial intermediaries such as banks and PE/VC fund managers which provide growth capital to the private sector. One pioneering bilateral DFI is the Dutch entrepreneurial development bank FMO. FMO entered the Nepali market with an equity investment in NMB Bank, a leading commercial bank, in 2015. Similarly, the UK-backed BII made its entry with direct investments of $15 million in NMB Bank and $12m in World Link. In 2021, FMO, BII, SwedFund, DFC and IFC collectively invested $50m in a private equity fund, Dolma Impact Fund II.

Nepal’s private sector is dynamic, with business density particularly high in urban centres. There is clear evidence of increasing growth and growth opportunities, and an increased demand for capital. Traditionally, the corporate sector accessed short-term bank loans and trade credit financing through local capital markets dominated by commercial banks and finance institutions. Now, however, the corporate sector is exploring alternative financing to capitalise on growth opportunities. DFI and joint ventures are an attractive option, given the possibilities they offer for transfer of technology and know-how. However, challenges related to bureaucratic red tape, the repatriation of profits and limited currency exchange facilities, etc. act as deterrents. Together, these factors explain the large gap between commitments to invest and actual investments made. According to the Nepal Rastra Bank’s 2018/2019 survey, only 34 per cent of the Rs. 325.52 billion pledged between 1996 and 2019 actually reached Nepal.

On the other hand, scouting for investment opportunities in Nepal by DFIs, and the breakthroughs they have made, are in their infancy. Investment by DFIs has drawn the attention of corporates, but their visibility and presence within the private sector remain limited. To help DFIs understand the needs of the Nepali businesses, including access and alternative financing models, Invest for Impact Nepal conducted a market study in the fourth quarter of 2021 involving key informant interviews with second and third-generation business leaders, founders of corporate houses and senior level executives.

The study found that DFIs had minimal local presence or engagement with key business bodies such as the FNCCI and CNI. A concerted and institutional approach to engage, build confidence and establish introductory relationships was much needed. Lack of local engagement limited access of the Nepali private sector to DFIs, served as a disincentive to find out more about them, and fuelled various negative perceptions based on hearsay, such as reluctance to engage, lengthy compliance requirements, interference in corporate governance, absence of mutuality of objectives, etc.

Opportunity

A key finding that came out of the study was the corporate sector’s view of environmental, social and governance (ESG) issues, which are a requirement for DFI engagement. ESG was not perceived as an opportunity for businesses to integrate sustainability risks and factors into their risk management frameworks, but rather as a cost. With some exceptions, businesses across the board made it clear that they would be less competitive with ESG compliance for DFI investment. Most, if not all large businesses, are family-owned and are weak in corporate governance, transparency and financial management; all of which are of concern to DFIs. The family-owned business culture is here to stay in Nepal, but change could be in the offing, with third-generation and younger business leaders taking over the helms of businesses.

Against the backdrop of challenges, the private sector sees in accessing DFI investment, DFIs are yet to showcase a successful story to attract businesses. Corporates in Nepal are adequately served by local banks and financial institutions, most of which have long-standing relationships and flexibility in doing business. Among others, these established relationships could be key barriers for DFIs to penetrate the Nepali market. The country’s industrial growth plan will require investment in small, medium and mega projects, and the corporate sectors have the potential and interest to contribute. Mega projects will warrant equity financing due to the sheer size of their investments and will open a space for foreign investors. Despite the gaps in the private sector’s understanding of DFIs, and their limited presence in the country, the market study by the Invest for Impact Nepal points to unmet demand for growth capital, as well as an appetite, especially among younger generation leaders, for foreign investment in the form of equity and innovative hybrid investment structures.

(Monisha is a Senior Technical Advisor and Bibek is an Officiating CEO of Invest for Impact Nepal)