Saturday, October 18, 2008

Pie in the sky (Mythical Hydro Dollars)

Nepal has a serious trade deficit with India. In the fiscal year 2005/6, the deficit was Rs 66 billion (imports Rs 107 billion and exports Rs 41 billion), according to the Economic Survey. The shortfall is very likely to rise if concrete mitigation measures are not implemented soon. And among them, hydropower export is being touted as being able to generate "hydro dollars." As Nepal Rastra Bank had to purchase a huge amount of Indian currency by paying for it with US dollars, the inflow of Indian rupees into Nepal's economy would conserve precious dollars. Hence, if the country does earn money by exporting hydropower, it will be as good as "hydro dollars."

Renowned economists (like Finance Minister Dr Ram Sharan Mahat and former vice chairman of the National Planning Commission Dr Shankar Sharma) have specifically claimed that earnings from the West Seti project alone would slash the trade deficit with India by 25 percent. One senior Indian bureaucrat has been assuring the elite and government bureaucrats that Nepal could earn a hundred billion rupees (10,000 crore in his words) by exporting electricity from 10,000 MW type projects. As he was referring to Indian currency, he must have meant Rs 160 billion in Nepal rupees. Therefore, it is time we examined whether power export from Nepal will really translate into hydro dollars, and, if yes, also assessed its magnitude.

Mitigating trade deficit
According to the Environmental Impact Assessment report publicized recently by the West Seti Hydro Ltd (WSHL), this 750 MW project will generate energy amounting to 3,636 GWh annually. The company is required to provide 10 percent of the energy produced (363 GWh) to Nepal free of cost under the project agreement signed with the government, which was renewed in October 2006. By exporting the rest, this project will earn US$ 158.9 million (at the rate of 4.865 US¢ per kWh) annually, which is equivalent to Rs 10.33 billion, or 15.5 percent of Nepal's trade deficit with India (not 25 percent). An in-depth analysis needs to be done to ascertain how much of the money will indeed percolate into Nepal's economy.

The project agreement authorizes West Seti Hydro to open accounts in foreign banks to deposit the export earnings. The revenue will thus not enter the Nepali economy in the first instance. Only the amount that absolutely needs to be remitted to Nepal will reach here. Therefore, the country's trade deficit will be lessened only to that extent, and only that amount can be called "hydro dollars".

Most of the export earnings will be spent on operation and maintenance, overheads, rates, taxes and royalties to the government and repayment of the principal and interest to lenders. The remaining will go to the equity holders as dividend. As hydropower is capital intensive, only about 2 percent of the export revenue will be expended on operations and maintenance of which less than one-fourth will be spent on salaries and wages. From the experience of the Khimti Project, we can assume that most of the high-salaried employees will be sourced from foreign countries while a few low-level staff will be hired locally. This means that only about 0.1 percent of the revenue will be distributed as salaries and wages in Nepal - about Rs 10 million.

Being a foreign direct investment project, the full amount of overhead expenses will be spent overseas. Moreover, the project agreement has waived income tax for the first 15 years, and the interest paid to the lenders and the dividend paid to the shareholders are not taxable. Therefore, West Seti Hydro will be paying a capacity royalty of Rs 100/kW and an energy royalty of 2 percent of the revenue during the first 15 years of its operation. It has to pay an export duty of 0.05 percent only. Hence, the government will be earning about Rs 287.9 million annually in royalties and taxes from the project.

Another major outlay is the repayment of a part of the principal and interest. As the project is borrowing from foreign agencies, these payments will never enter Nepal. The balance will be distributed as dividend. And since most of the project's equity comes from overseas - except for the government's 15% share - only 15 percent of the dividend will come to Nepal. However, as the government is borrowing from the ADB to invest in West Seti Hydro, even that 15 percent will disappear as interest.

Against this backdrop, only about Rs 297 million out of the total export revenue of Rs 10.33 billion will enter the Nepali economy. This comes to about 2.88 percent of the total export earnings. And by exporting electricity from this project, the country's Rs 66 billion trade deficit with India will be reduced by all of 0.45 percent. Thus the claim that this project alone will take care of 25 percent of the deficit is a myth.

Earning hundreds of billions
When politicos were canvassing for the Mahakali Treaty, they talked about Nepal earning hundreds of billions. They even liked to declare that the sun would rise from the west. A lot of water has flowed down the Mahakali during the last 10 years; but the sun is yet to change its habit, and Nepal is yet to receive even one percent of that fabulous amount. The contention of the Indian bureaucrat that Nepal would earn Rs 160 billion if it exported energy thus needs to be examined closely.

Projects aggregating 10,000 MW will generate 43,800 GWh of electricity, if designed at an average plant capacity factor of 50 percent. Using the West Seti format of 10 percent of the energy free for Nepal, one such project will export 39,420 GWh and earn Rs 124.65 billion. Superficially, at least, the gentleman seems to have been close to the truth.

Let's see how much of that money will actually enter Nepal. According to the West Seti system, only about 2 percent of the export revenue will be spent on operations and maintenance. Out of this amount, less than one-fourth will be expended on salaries and wages. The low-level Nepali staff will earn salaries amounting to about 0.1 percent of the export revenue, which is about Rs 125 million. The project too may be required to pay an export duty of 0.05 percent, that is, about Rs 3.55 billion into the government treasury annually.

Debt servicing is another major outlay. As these projects will be borrowing from overseas, Nepal will never see the full amount. The balance will be distributed as dividend, all of which will fly away to foreign shareholders as domestic investors don't have the clout to handle projects of this size. Doing some number crunching, we find that Nepal will get to keep only about Rs 3.68 billion out of the total export revenue of Rs 124.65 billion. This figure is about 2.95 percent of the country's total export earnings. Nepal's earning hundreds of billions by exporting electricity is thus as believable as the sun rising from the west.

(Published in The Kathmandu Post of January 9, 2008)

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