Nepal Water and Electricity Development Company (NWEDC) threatened to pull out from Nepal after the government asked it to contribute a hefty sum to a hedge fund to be used as a cushion against exchange rate risks. A hedge fund is an insurance like mechanism that helps to mitigate the risk of additional liability arising from fluctuations in foreign exchange rates.
Sources close to the Korean joint venture company, which is the potential developer of the 216 MW Upper Trishuli-1 Hydroelectric Project, told the Post that it wouldn’t execute the project if it was forced to give half of the fund.
“They say that if they contribute what the government is asking, the cost of the project will swell and make it unbankable,” a source said. “As per the developer, the initial agreement was to contribute only a nominal amount to the fund.”
When the Nepal Electricity Authority signed a power purchase agreement (PPA) with NWEDC a year ago to purchase the electricity generated by the project, the state-owned power utility agreed to pay in US dollars for a period of 10 years or until the portion of the investment made with foreign loans is recovered by the developer, whichever comes first.
In order to mitigate exchange rate risks while making payment in US dollars, the electricity authority and the Korean joint venture also agreed to hedge the investment by creating a fund with both parties contributing to it. However, the pact doesn’t say how much the developer is required to contribute.
The Finance Ministry, which is the designated authority to create the fund, is asking NWEDC to contribute half the amount. According to the electricity authority’s estimate, it will be exposed to a foreign exchange risk of around $300 million if the exchange rate of the US dollar rises at 3 percent annually. Therefore, as per the ministry, the developer has to contribute $150 million to the hedge fund.
The developer, according to a highly placed source at the electricity authority, is ready to contribute only $5 million to the fund. “We are not in a position to accept NWEDC’s proposal. Without a significant contribution from the company, we will be exposed to unmanageable foreign exchange risks,” said the source. “We are in talks with the developer and Finance Ministry officials to reduce its contribution.”
Experts said the electricity authority should pass on the cost to the consumer instead of asking developers to contribute hefty amounts to the hedge fund. “As newly-formed Nepal Electricity Regulatory Commission will be fixing the retail price of electricity, it should consider the exchange rate risk that the power utility is exposed to while setting the tariff,” said Semanta Dahal, a lawyer who advises the government on infrastructure projects. “If the Nepal Electricity Authority is allowed to pass on the foreign exchange risk it is exposed to while purchasing electricity from foreign developers to its customers, the current problem will be solved.”
The Kathmandu Post