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Financing power growth

  • Published at 09:52 pm September 9th, 2018
Powering the nation
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To produce power, broadening our financial options is a must

By 2041, it is predicted that Bangladesh will require investment of about $35 billion in the power sector. However, the country is likely to face huge challenges to finance such investment requirement. 

My experience shows that financing any large project in Bangladesh is a problem. Bangladesh money market does not have the depth, and building a long-term yield curve for taka is a serious challenge. 

Most of the term deposits are for three years, where the project break-even or payback period is much longer than that. We need longer terms or matching deposits to finance long-term projects, but savings, and both short and long-term deposit interest incomes are taxed at the same rate here. 

Lack of project finance

Globally, project finance is used as a means to finance large infrastructure projects involving a special purpose vehicle (SPV) structure. Usually, project finance is no recourse or limited course financing. This allows sponsors to protect their other assets. 

However, in Bangladesh, lenders sometimes demand corporate guarantees from sponsor shareholders as collateral besides project assets and, in some cases, assets of the sponsor shareholders outside of project assets. This tends to increase the cost of equity for sponsor shareholders.

Inadequate domestic funding options

Bangladesh’s bond market represents only 12% of its GDP, with government bonds dominating the market. 

Historically, a few corporate bonds (non-power sector) that have been issued in Bangladesh have been privately placed, with only one listed on the DSE. Most of the lending is for very short term periods. Further, the private equity industry (including venture capital) in Bangladesh is largely at a nascent stage.

As a result, the power companies typically fund the projects through accumulated earnings or long-term multilateral loans. However, accumulated earnings are often limited and long-term multi-lateral loans are bound by country and sector limits. 

Hence, companies often resort to financing long-term projects with short-term financing, thereby causing drastic asset and liability mismatches.

Poor financial performance of the utilities

Some of the public power utilities in Bangladesh, including BPDB, the bulk power purchaser, have not been performing well financially over the last few years. This decreases the overall attractiveness and viability of the entire sector and makes it difficult for utilities to raise finance.

Bangladesh debt sustainability

Although the government has been receiving funding from international development partners to finance public sector projects, it will not have headroom to borrow beyond a certain a limit as governed by its fiscal responsibility. 

So it may need to consider an appropriate mix of public and private sector power projects to avoid potential adverse impact on the country’s debt sustainability.

Alternative financing options

Given the scale of funding requirement over the coming years, Bangladesh may need to explore other sources of financing beyond the existing ones.

The current global financial market provides an opportunity to consider many options for financing which can be explored in the context of Bangladesh.

The issue of bonds in overseas bond markets to tap offshore capital markets can be a debt financing option. In this case, unlike external commercial borrowings (ECBs), where the issuer bears the risk of exchange rate fluctuations, the bond is issued in local currency in an attempt to shield issuers from currency risk and instead, transfer the risk to investors buying these bonds. 

Green funds

The government has extended policy support for the proliferation of RE in Bangladesh, targeting 2,470MW by 2021 and 3,864MW by 2041 as per PSMP 2016. 

In such a scenario, various green funds can be explored as debt financing options. Green funds are meant for financing activities in developing countries that target to reduce greenhouse gas emissions and support resilience to climate change. 

Overseas listing

Listing Bangladesh’s profitable public power utilities in overseas markets can be explored as an equity financing option to unlock value. As it is difficult to raise equity through listing for new generation projects (because of the multiple risks involved), utilities with proven track records of stable cash flows and profitability can be listed to raise funding for the new projects (eg transmission). 

This will, however, require adherence to international accounting and governance standards. In addition to enlarging and diversifying the equity base of the companies, listing would also lead to good corporate governance practices and transparency, because of the various disclosure requirements.

Power sector focused financial institution

Formation of specialized financial institutions to cater to the power sector’s specific need for competitive finance, with robust mechanism, guidelines, adequate capacity, etc can be explored. Such institutions can play a crucial role in the development of the power sector.

Incentivizing private participation

Given the investment requirement, the role of private participation will be important in Bangladesh’s power sector. This requires a clear framework and greater clarity for private investors. 

Private participation needs to be adequately incentivized. Many of these incentives have been extended earlier and may need to be continued. Bangladesh can also explore various PPP models. 

Regulatory reform

Interest rates charged by foreign banks, including international financing institutions (IFIs), are capped at 500bps inclusive of London Interbank Offered Rate (LIBOR) as per regulations/guidelines issued by Bangladesh Investment Development Authority (BIDA) as well as Bangladesh’s Foreign Exchange Regulation, 1947. 

As LIBOR is a market-driven variable rate, this often makes it difficult for international lenders to lend to infrastructure projects in Bangladesh, given the risk profile of the projects and availability of alternative competitive markets for lending. 

Thus, the government may consider capping such interest rate by allowing LIBOR and a margin as the ceiling for interest rates to be charged by foreign banks.

Remittances of loyalty

Project financing by lenders and investors often relies on third party advisors’ due diligence reports in making their investment decision. 

They are generally cross-border entities with expertise in the areas of law, environment, engineering, insurance, etc, who are appointed by project companies in the early stages of project implementation and involve outward remittance of fees.

To make the remittance payment, project companies need to apply to BIDA for permission. BIDA’s permission for such remittance is governed by Chapter 10, Para 25 of the Guidelines for Foreign Exchange Transactions Volume 1, which reads:

“No prior permission of the Bangladesh Bank or BOI is required by the enterprises for entering into agreement involving remittance of royalty, technical knowhow, or technical assistance fees, operational services fees, marketing commission etc if the total fees and other expenses connected with technology transfer do not exceed the following limits:

•    For new projects, not exceeding 6% of the cost of imported machineries;

•    For ongoing concerns, not exceeding 6% of the previous years' sales as declared in the income tax returns.”

If a project in the early stages of implementation fails to fulfill either of the conditions stipulated above, this creates significant challenges for investors and lenders as special permissions are required, resulting in delays and project cost escalations. 

There is a requirement for the relaxation of BIDA’s guidelines on remittance of fees to technical advisors, such as:

•    Globally, the issue of preference shares is one of the key modes for financing infrastructure projects. However, BIDA considers subscription of preference shares by banks as part of capital market exposure, which restricts the amount of preference shares that banks are willing to subscribe to. The government may consider a review of these guidelines to facilitate investments through preference shares in power sector projects.

•    BIDA requires a 70/30 debt-to-equity ratio for all foreign investments. To facilitate greater access to debt capital, especially for larger projects, the government may consider suitably relaxing this norm.

•    Given Bangladesh’s current credit rating and high-risk profile, there is a need for the government to issue sovereign bonds so that there is an adequate assessment of sovereign risk. This will facilitate issuance of bonds by investors for financing power projects.

•    The government may encourage development partners and IFIs to increase their presence in Bangladesh and continue to extend their support to facilitate financing of infrastructure sector projects. These institutions offer lower interest rates and prefer sustainable sources of power (eg RE and natural gas-based projects) and the government should provide an enabling policy and regulatory environment to promote such sources of generation.

Processing and approving foreign loan

Foreign currency transactions are regulated in Bangladesh with capital account convertibility not yet approved by the government. All foreign loans must be approved by the Hard Loan Scrutiny Committee (HLSC), administered by the Board of Investment and chaired by the Governor of the Central Bank. 

Before any loan is considered, an inspection is carried out by the Foreign Exchange Investment Department of Bangladesh Bank, and findings are forwarded to the HLSC for consideration. The typical time frame for this approval is about three months.

Local banks may increase their exposure towards lending for power sector projects with appropriate interventions by the government. For example, the government may consider making interest income from financing power projects tax free to incentivize local banks to increase their exposure. 

Similarly, it may also consider waiving of general provisions against loans (currently at 1% against the LC value) for local banks, which increases financing cost.

There is no doubt that Bangladesh power producers need to diversify and broaden their financing options. At the same time regulators need to immediately sit with the major operators and delineate a revised policy guideline to ease flow of long term funds to facilitate Bangladesh’s power and energy security.

Mamun Rashid is the managing partner at PwC Bangladesh. This article is an excerpt from PwC Bangladesh power note for Bangladesh Power and Energy Week 2018.