Nepal has announced its budget for the Fiscal Year 2020/21 in the middle of COVID-19 pandemic in May end. This article focuses on dissecting the reasons behind the policy shift on electric vehicles (EV) that has sent shock waves through the market. In recent years, the government had brought many supportive policies and publicized ambitious EV targets. The conducive policy signal has successfully leveraged private sector financing in EV sector development with much vigor until the budget announcement. There is a separate government narrative in its defense but in the course of this article, I have attempted to look at other probable reasons including our National interest.
To start with, let's look at the EV related official position of Nepal. Nepal has aligned its national target with the global effort to achieve climate-friendly public and private transportation system. They are reflected in various policies and plans including National Urban Policy, Environment-friendly Transport Policy, National Action Plan for Electric Mobility, Sustainable Development Goal (SDG) 2030 published by the National Planning Commission (NPC) in 2016, Nationally Determined Contribution (NDC)-2016 submitted by the government in compliance with ratification of 2015 Paris Agreement during the 21st Conference of Parties (CoP) of the United Nations Framework Convention on Climate Change (UNFCCC) and white papers published by the Energy Ministry in 2018. The specific targets related to EV are: a) Increase the share of EV by 20% from 2010 level by 2020 and provide subsidy to promote EV conversion of regular vehicles (NDC Clause 2.D); b) Reduce fossil fuel dependency by 50% in transport sector by 2050 (NDC Clause C.9); c) Substitute 50% of vehicle import to EV by 2024 (White Paper Clause 72); and d) 50% of public transportation as EV by 2030 (SDG).
The objective here is to dig deeper to understand what happened for EV sector in the 2020/21 budget and why that happened. Other aspects that have to be looked into, in conjunction, are energy sector, primarily hydropower and trade, mainly vehicle import from India.
Talking about hydropower, the sector that has been primarily focused for economic growth of Nepal and is construed as the growth engine for Nepali economy. Nepal intends to achieve 5,000 MW of installed capacity by 2024 and has set a target of 15,000 MW by 2030 (NPC, 2018). The current facts and figures on the status of Nepali hydropower sector include: a) Installed capacity of 1,127.8 MW with peak load demand of 1,320.28 MW (NEA, 2019); b) Power Purchase Agreement (PPA) signed for 6,044.05 MW of installed capacity; c) Planned and proposed projects at different development stages constitute 5,154.58 MW (IPP-2,869.38 MW, NEA-2,285.20 MW). The catch of hydropower narration is, Nepal will have installed capacity in excess of 6,000 MW by 2023/24. And the addition of 1,300 MW within upcoming fiscal year is declared in the budget itself.
Let's look at the demand side of electricity.
Peak load demand of Nepal had increased at the Compound Annual Growth Rate (CAGR) of 8% till 2016 but it has declined after recording 1,320 MW peak load demand for 2019. The NEA has projected that the peak load demand for 2020 is going to be 2,225.6 MW, 69% higher than 2019, which is highly questionable even without taking the pandemic into consideration. For 2024, the peak load demand is forecasted to be 3,703.3 MW, if we are to rely on the NEA's forecast, it still leaves demand vacuum for over 2,300 MW. At this point, it becomes relevant to look at investment angle of hydropower. Hydropower projects are 95% locally financed, commonly on 70:30 debt/equity structure. It means, for 5,154.58 MW of under-construction projects, Nepali private sector and banks and financial institutions (BFIs) have already committed $ 8 billion of capital at average cost of $ 1,492/KW and scheduled to be spent by 2024. A point to note here is that the, project construction starts only after sources of fund are finalized and legally contracted known as financial closure.
Coming back to EV, it has all the good things to say and talk about including environment, energy consumption, climate action, smart transportation etc. That is all fair and good but there are two major hindrances for EV in Nepal.
First is the Nepal-India trade relationship and possible role of private sector. Nepal is one of the big and long-standing vehicle markets for India. India has not achieved satisfactory progress in manufacturing of EV despite its initiatives. Whereas, looking at the global EV perspective, China seems to be the front-runner. In fact, strong position of China in the supply chain of EV is feared by even the West. Battery contributes to around 50% to 60% of the cost of EV and China has almost complete control over the raw materials required to make the lithium-ion battery used in EV. The discourse of Nepal, continuing subsidized EV policy, apparently is against the Indian trade interests. To India, Nepal is a sizable market to sell Indian products. Being specific to the vehicle and associates, as per a Nepal Rastra Bank report, total vehicle and spare parts import from India for 2018/19 was about $ 1 billion. The import of same in the first six months of 2019/20, was recorded at Rs 58 billion (around $ 550 million). The market size in current value terms of over $ 1.5 billion will be largely disrupted for India without even taking the transport sector fossil fuel substitution target of 50% by 2050 into account. India has a monopoly over fossil fuel in Nepal. Coherence to national EV target will lead to fossil fuel consumption avoidance of $ 54 million for 2020 which is projected to increase to $ 803 million by 2030. India is by far the largest export destination for Nepal contributing to 64.8% of total export in 2019. Nepal-India trade is governed by Nepal-India Trade Treaty renewed in October 2016 for seven years. As per the annual report of Indian Ministry of Commerce for 2019, the treaty provides duty-free access to almost all products imported from Nepal except tobacco, cosmetics etc. Hence, it is reasonable and rational to expect that, India would be interested to cause EV policy shift to protect its national interest. The policy shift has alleviated the business risks and reinvigorated the prospect for large Nepali corporate houses selling Indian-made vehicles in Nepal. To the government, tax on fossil fuels and fossil fuels-based vehicles is one of the largest revenue sources and maintaining that is in its interest too. Giving EV sector a shock, is an ideal confluence of interest protection, where India, Nepal and the Nepali private sector in vehicle business, all key stakeholders of economy, are benefitted.
Secondly, Nepal is in a situation where it must find a market to sell its energy as the national demand is not sufficient to consume all the generated energy. And, India or its cooperation is one and only option to sell surplus energy of Nepal and you would not want to offend India at this critical juncture, when in less than a year, you need them to buy your 800 MW plus of surplus energy. The rationale behind the stance is backed by an analysis based on available data to understand the energy need for EV. Relevant quantitative data required for energy estimation were financially modelled. Some data are discrete and explicit; like government targets, vehicle passenger capacity, battery efficiency. And some are continuous data like vehicle running kilometers (VRK), number of vehicles and its users. One may disagree on these numbers based on their own reference. It is undebatable, though, that the quality of analysis is dependent on data quality.
The outcome is interesting. EV is expected to raise energy demand but they will only consume small portion of energy for their battery recharge in comparison to what Nepal will need to sell in course of time. If we maintain the aggressive policy on EV in alignment with our national target, in this year of 2020 itself, EV battery recharging will consume 355.6 GWh or~ 76 MWof energy, to power 1.83 billion vehicle running kilometers (VRK), whereas the country will have to find a market for more than 800 MW this year itself. Similarly, in 2024, the energy required to recharge EV batteries would be 1816 GWh or ~ 392 MW of energy to power 9.5 billion VRK but Nepal will have more than 2,300 MW of surplus energy (NEA demand forecasted 3,703 MW). And in 2030, it will consume 6,744 GWh or ~ 1,456 MW of energy to power 35.3 billion VRK. If we are to trust NEA forecast, the demand will be 6,848 MW for 2030 and we will have more than 8,000 MW of surplus energy.
The critical issue related to hydropower sector of Nepal is a wide gap between demand and supply of energy. The situation has alarmingly questioned the ability of key stakeholders which have jointly crafted an enormous prospective stress to the financial system. It has questioned the forward thinking ability of government for compelling BFIs to invest in hydropower. It has questioned the NEA's ability to make realistic demand forecasting based on which it signed the PPA. It has questioned the technical competency of BFIs to understand hydropower business, which disastrously failed to assess NEA's creditworthiness before blindly making PPA unquestionably bankable. The private sector energy developers' ability of making rational choice for their capital understanding the market dynamics is also under question.
There is a lot to learn from the past to avoid mistakes in the future, but priority of the moment should be, how to rescue the financial system from the crisis. At this juncture, raising energy demand is a more daunting challenge. We can argue, debate, discuss, strategize on raising internal demand to consume generated energy at home but the reality is, it is not going to happen, at least in the coming few years. It is more evident, if we look at Nepal's peak load demand trend. But, the time is ticking for the projects under construction. Being the sole buyer of energy, the NEA has commitments to buy the energy generated by all of these projects and is legally bounded by PPA contracts. Except for a few hydropower projects, which have FDI portion in their capital structure, almost 95% of the hydropower sector has not used the counterparty risk guarantee instrument. Counterparty risk guarantee instrument is a hedging tool and like an insurance for hydropower developer who will be compensated for NEA failing to comply with its obligation of buying the generated energy with no market to sell. We can link the domino effect it will cause to the whole financial system and consequent stress it will induce. As per the second quarterly report of NRB for 2076, the core capital of A-class commercial banks is Rs 335 billion (around $ 3.3 Billion). It is over $ 4 billion including government banks. These BFIs have lent 29% of their loan to non-agriculture priority sector which is about $ 6.5 billion. Total non-performing loans (NPL) causing stress to financial system currently is reported as $ 357 million. If we just consider forecasted surplus energy as risky investment as NPL, $ 1.2 billion out of $ 6.5 billion lending this year will be under risk and will gradually escalate to $ 3.4 billion by 2024. The magnitude is beyond the stress level the financial system can take and eventually may bring the whole system down.
So, why did the government take the latest decision in EV sector? Did India cause the EV shock for Nepal?
Maybe, because such major shifts in policy is not possible without strong influence. Nepali business houses dependent on business of Indian-made vehicles may have a role. Either way, the result has protected India's trade interest. And, India has a rational motive by all means to exert its influence in the matter and is capable to do so.
Maybe not, because the justification Finance Minister Yuba Raj Khatiwada has presented defending the policy shift in pretext of tax subsidy missing equitable access, depleting foreign currency reserve, tax collection needs etc. to a large extent are convincing considering the characteristic of Nepali economy and present difficulty. Being empathetic to the Finance Minister, look at the situation in confluence with factors like surplus energy, unconfirmed market, tax collection requirement and prospective fallout, his decision has logical ground and rationality.
However, the government decision has shaken the already weak foundation of investment climate. Looking at the impact just from EV perspective would be naive. The government assurance of protecting investment to national and international investment fraternity offered through mega events like the investment summit turned out to be a rhetoric of no intent. It is an expensive government adventure against ratification of national and international policy, accords and self-determined targets. Public anguish is just complementary. Years of stimulating government narration has been reverted to hostile approach overnight and it has risked the investment and existence of many micro, small and medium scale enterprises (SME & MSMEs). Policy inconsistency (risk) and unpredictable regulatory regime are among the longstanding perceived hurdles which have hindered the FDI flow in Nepal. The EV policy of recent budget has made it more prominent. Whatever may the reasons and motive behind the EV policy shock be, the consequence is dearer for the short term and immeasurable for the long term. The government has failed to maintain the most rudimentary order required to incentivize economic activities. The timing of policy imposed is more peculiar considering insufficient internal revenue projection to cover the government's recurring expenses, and large part of capital formation to fund development is private sector dependent. The implication of policy shift is detrimental to fiscal health and has undermined the potential of private sector, which could have stimulated the economic vibrancy, much needed in the difficult aftermath of COVID-19.
Alternative and complementary rational discourse considering criticality of the present time is the objective of this write-up. What could be or should have been done, is a never-ending debate. It is undeniable that the NEA failed tremendously in forecasting reasonable power demand. But, the need of the hour is to rescue financial system and hydropower sector, and mitigate the risks of economic downturn. The EV policy shift may be due to the government's wish to collect more tax or Indian influence or corporate influence or maybe to appease the future energy market. Whatever the reason may be, the biggest winner of the policy shift is India.
Unfortunately, Nepal exposed itself to evidence of detrimental investment climate. But it can and must be instrumented to yield long term benefits for Nepal. I firmly believe that, Nepal's move on policy shift qualifies as a good gesture to Indian economy and must be leveraged as economic diplomacy. The objective is to have an access to Indian market to sell the energy of Nepalei hydropower sector. I personally would like to give this benefit of doubt to the government that the policy shift/shock in EV happened to protect larger national interest of power trade deal. The discourse fits inside the rationality and I choose to remain optimistic trusting the robust credentials of the Finance Minister. We have to wait to see. What we all must be clear is our economy will survive without EV on the roads but it may collapse if there will be no market for surplus energy from the hydropower projects.