Common minimum infrastructure agenda (CMIA)

Why a common minimum infrastructure agenda?

If there is one thing that we can be certain off, it is that it will take time for Nepal to get its political act together.  Unless the public surprises us with a two-thirds or even a simple majority to a single party in the upcoming constituent election, we are resigned to a few decades of political instability.  The can of worms opened by the Maoists and other parties on secularism, ethnic based federalism, number of states in the Terai and other such issues will take a lot more time to resolve that we anticipate.  It is even not clear whether the next constituent assembly, if elected, will write a constitution if the state of affairs are to remain the same.  We can only hope for the best.

The political leadership takes the largest share of blame for getting us to where we are.  They also have the biggest responsibility to get us out of this mess they have created and move this nation forward.  If they have any sense of ethics, any sense of honesty and any sense of pride in their country, they should not keep this country hostage to the economic growth that its people want and are entitled to.  While they sort out their differences, the political leadership should have the vision and the courage to come above the fray and agree on some common economic agenda to move this nation forward.    An important one would be to come up with a “common minimum infrastructure agenda” (CMIA). I had written on this topic on July 16th, 2012 in a nepalnews.com column.  The objective here is to once again emphasize the need for this and to elaborate some more of my thoughts on the issue.

A robust basic infrastructure is a necessity for any country’s development.  When I talk about infrastructure

Figure 1: Benefits of Infrastructure (prod'humme 2004)

here I am basically talking about the transportation and electricity generation because these are the two key infrastructure components that have the largest impact on moving the economy forward.  As depicted in Figure 1, infrastructure provides benefits to households and industry and the government by its enabling feature of lowering costs and enlarging markets both of which help drive economic growth and thereby improve the living standards of the average citizen and the revenue base of the government which can be utilized to cater to the other services the government can provide to improve the living standards of its citizens.

One of the reasons why China is growing faster than India is because it has a stronger infrastructure base.  China consumes 4 times more electricity per capita compared to India.  Similarly, while the length of total roads is higher in India at 4.69 million km vs. China’s 4.2 million km, the expressway network of China at 84,946km overshadows India’s at only 500km and 3,000 km if you include expressways that are under construction. Nepal in comparison to its two neighbors and other countries in South Asia has a dismal record in these two area consuming per capita electricity one sixth of India and a total road network of 23,434 km with no expressways.  We are far behind both in terms of electricity consumption per captia, road length per square kilometer and road length per capita.

Need for Government to take ownership of infrastructure development

If Nepal wants to move up the income ladder, she as a nation must invest in her future. Thus far, in comparison to growing nations, we have taken a minimalist approach to investment in basic infrastructure. The capital investment by the government in the past 9 years was only 443 billion rupees, 23% of its total expenditure during that period which is relatively insignificant in the big scheme of things.

There is a need for a big bang approach where we need to front load investment in infrastructure in a large scale to meet our growth objectives.  Not 4 billion dollars in 9 years but more like 4 billion dollars in a year for the next 10 years if we can.   

Figure 2: Why government needs to be active?

The government needs to take a more direct and active interest in infrastructure development.  It cannot hide from its obligations to provide its citizens basic infrastructure in the name of trying to get the private sector involved.  The private sector can be involved but more in a build and operate capacity (BO) rather than build, own and operate.  By taking ownership a lot of hurdles are removed from providing PPAs to signing PDAs and all that come in between.  The expected rate of return for the government is much lower than the private sector and it is also by far the most credible institution that can borrow in international capital markets.  

Take politicization out and instil professionalism, transparency and accountability, state-owned companies can perform and they have a role to play in large scale infrastructure development.   Look at China where most if not all of the infrastructure are financed and developed by the state and state-owned agencies.  This is not however an endorsement for the state sector to be involved in the manufacturing and other service sectors where private sector is quite capable of providing the goods and services.

Most of our infrastructure, to date, whether they be roads, airports, and electricity generation facilities have been primarily, if not completely, developed through foreign assistance.  These development assistance come with strings attached and continue to keep us at the mercy of the donor countries or multilateral agencies.  If we had control of our own funds, then we could take appropriate action when companies fail to deliver on time because we would not have to justify those actions to the donor countries and agencies.  It is time we took serious stock on how we, as a nation, should move forward with the development of the country’s basic infrastructure.  

From a cash flow perspective, there are two types of basic infrastructure.  The first are those that generate significant cash flows and have the capacity to finance themselves over the life of the assets through these cash flows.  In this category would fall toll roads, railway networks, airports, and electricity generation facilities.  The second type are those which do not necessarily generate or only generate minimal direct cash flows but do help in the growth of the economy and thereby generate tax and other benefits through the enlarged economy.  In this category, would fall non-toll roads, water, sewerage, irrigation and other such services.  It may be that some of these can pay for themselves but the general belief is that the government often provides them as a service at subsidized rates.  For the latter we should continue to use the current mix of foreign aid in the form of grants and development loans to finance them until we develop our own capacity to fund them.  For the first category, however, we should use the international capital markets to source funds and finance their development.

Getting a political consensus

Getting a political consensus is probably easier said than done in today’s political environment.  However I do not see why the political parties cannot sit down and agree on a portfolio of infrastructure projects that we as a nation should finance for the benefit of our country.   Let us label this the CMIA portfolio.  

Figure 3: Coming to a consensus

First, the Investment Board of Nepal (IBN) should come up with a list of projects encompassing the transportation sector and the power sector with the relevant ministry and agencies that would be part of the CMIA portfolio.  The projects in this portfolio should include only those projects whose cash flows should at the minimum provide a positive NPV at the government’s expected rate of return but exclude any project for which financing has already been closed. 

Second, once the possible set of projects have been identified, IBN, with assistance from relevant ministries and agencies, should create a detailed business plan for each project including the nature of costs, revenues, cash flows anticipated over the life of the projects and anticipated IRRs and NPVs.

Third, this list of projects with their detailed plans should be submitted to the relevant parliamentary committee, if we are lucky to have one by then, or presented to an all-party committee for review and discussion.  It should also be provided to the public domain for interested parties to comment on.  

Fourth, through repeated discussion, the list of projects should be finalized and if possible approved by the parliament or all-party committee for the nation to proceed with and take necessary steps to seek financing in international markets and implement them.

Tapping international capital markets

Fifth, with the approval obtained, IBN should seek the help of a reputed international global investment banking firm to determine the nature of the fund that should be created and the instruments that could be issued to finance the portfolio of projects.  IBN with the financial advisor will need to determine the issue schedule, how the proceeds would be invested and how it would be returned to each category of investor.  A detailed prospectus providing all the details would have to be prepared. It should also clearly let the investors know the companies that will be involved in the actual implementation of the projects and their operation once completed.

Figure 4: Financing and Implementing CMIA portfolio

Sixth, with a detailed prospectus, IBN along with the nation’s finance minister and if possible the prime minister should go on a road show to market the fund in  London, New York, Tokyo, and other financial centers to global investors.

Finally, the nation then should issue the securities as per the prospectus and follow the prospectus diligently in the implementation of the infrastructure projects, proper management and operation of the infrastructure assets and return of investment plus returns to the investors during the lifecycle of the fund.

Some of the securities of the fund could be rated and the securities listed in some of the international exchanges for trading.

One might think that Nepal may not be able to pull this off but I think otherwise.  I know from experience that many of the investments marketed by investments banks globally are more risky than that what is proposed here which is an exposure to a basket of infrastructure projects backed by cash flow generating hard assets on the ground.  They are a lot less risky than investment in hedge funds, repackaged instruments, such as collateralized debt obligation where billions have been invested and then written off.  We just need to be able to sell our story the same way other emerging markets have been doing.

In April of this year, Rawanda issued 400 million USD of 10 year bonds at 6.875% which was oversubscribed 7.5 times.  Similarly Nigeria’s1 billion USD bond issue in July 2013 and Petrobras’s 11 billion USD bond issue in May 2013 were oversubscribed 4 times.  Ghana and Senegal are looking into entering the market.  So if Rawanda and Nigeria can, why can’t Nepal?   For global pension funds (30 trillion USD), global mutual funds (28 trillion USD) and Sovereign funds (6 trillion USD) Nepal would provide a good investment that would allow them to get better return leading to a more diversified investment portfolio.  If we wait too long we might lose out on the low yield environment that still exists in the international capital markets today.  With the US Federal Reserve now signaling the end to their quantitative easing policy, we might be headed for a higher interest rate environment.

Are the political leaders going to continue to keep this country’s economic growth a hostage to their political maneuverings or are they going to step above the fray and give this country’s economic growth a boost by agreeing to a common minimum infrastructure agenda? While this is unclear, the time to act is now and I sincerely hope our politicians feel the same way.

Let the People Decide

There has been tremendous coverage in all forms of media on how our political leaders and the past constituent assembly failed us in giving us a constitution even after four years of formal existence.  How can we expect a system that failed us once to do the same job again if the actors are mostly going to remain the same? Why isn’t anybody, especially the political leaders, bold enough to say, why not ask the people in the upcoming election what they have to say regarding the critical issues that could not be decided upon by the defunct constituent assembly.

A lot of important issues from secularism to becoming a federal republic were decided without following a proper process.  I do not know about the others, but I certainly believe that our constituency did not send Mr. Hridesh Tripathi to make ad-hoc decisions. We sent him to write a constitution and if he along with the other assembly members had incorporated these issues in a new constitution and that had been ratified by the people then we would honor it and abide by its provisions.

As it is, the previously elected constituent assembly failed us in this regard but went on and made some important decisions that changed the identity of our country without having those decisions backed by a popular mandate.  We saw plutocracy in action and not democracy.  Given the past experience, what is there to prevent the new constituent assembly from being bogged down with the same issues and fail us again?  This is a more likely event given we are talking about the same political faces and leaders that existed before and will exist after the election unless we come up with some novel mechanism to move the process forward.  This is what I propose and I say this knowing full well that nobody is going to take it seriously and nothing is going to come out of what I say.   However, it is presented so it can start a debate.

First, let us use the up-coming election and give the people the right to decide on major issues that could not be decided upon or were decided without following due process.  This includes the issue of secularism, removing constitutional monarchy, quantifying the number of states, how they should be delineated, and so on.  This can be done with a small incremental additional cost and a round table meeting of political parties can come up with a list of questions to ask the people.   Let us hope the people are not as divided as the political parties are and will by their votes give the new constituent assembly direction on how they should proceed on major issues.  It should also make it easier for any new constitution that is drafted to be ratified.

Second, if this is going to be an election of a constituent assembly then let us give them just that one mandate.  By this I mean, the new constituent assembly will have no other obligations but to draft a constitution.  They cannot elect or participate in the government, make other laws and engage in other activities that a normal parliament would do.  There is no reason why the current government cannot go on for one more year under the current amended interim constitution.  In fact, this arrangement may push the political parties to act and draft a constitution so they can elect a normal parliament and take part in the responsibilities that come with it.

Third, this limited constituent assembly will only have a life of 1 year and no more from the first day the parliament is called. Since they have only one task to do with much of it already having been done by the previous assembly and the contentious issues having been defined by the referendum, this is sufficient time if the political parties have the will to write the constitution.  Frankly if they had the will, the constitution would have been written years ago.

Fourth, once the election is completed and the assembly is called, let us sequester them, i.e. the assembly members will not be permitted to leave the capital until the constitution is written.  In fact, I would strongly argue that they should be sequestered in the parliamentary premises and permitted to leave the premises only in the event of emergency, tasks related to the constitutional drafting process, or after their daily work is done.  Presence in the parliament should be mandatory every day and any prolonged absence by any parliamentary member without due cause should void their seat in the constituent assembly and their right to participate in the constitution drafting process.  Such voided seats should be left vacant and not be filled.  The government should arrange for members to stay in select hotels and bus them in and out of the parliament and provide for their daily needs.

Finally, when the final constitution is drafted, the government will call a referendum to have it endorsed by popular mandate followed by an election to a new parliament as envisioned by the new constitution.

Without some drastic measures as mentioned above, I have no confidence that our existing political leaders will ever take the writing of constitution seriously.  Nepal will again muddle through another four years of political bickering and shortsightedness without achieving anything substantial.

I am fully aware that none of this is going to happen because many of things I propose are not envisioned by the current interim constitution and more importantly, I strongly believe that the political parties and the so called social commentators who support the actions to date of the political parties are very afraid that the general people might have a substantially different view from their own on many of the issues.  They talk about democracy, people power, but are afraid to practice it.  I say LET THE PEOPLE DECIDE and let us then have the courage to abide by the PEOPLE’s DECISION.

To Buy or Not To Buy - Apartments

Ad in Kantipur of 2013/08/18

Today’s Kantipur had an ad by Vibor Bikash Bank advertising the sale of apartments in Shushri Apartments in Kamalpokhari.   The price for the three types of apartments quoted ranged from 18.5 to 19.2 million rupees.  It also mentioned that 2/3rd of the purchase price could be financed. This blog is to provide you the reader with some analysis so that you can make an informed decision on whether you want to purchase one of these units or not?

I categorize buyers into two buckets: first time home buyer who wants to buy a home and move in and the rest who are essentially looking at these apartments as short or long term investments.   While there may be slight differences in the requirements of the two types of buyer, the analysis that should go before making the decision to purchase would be quite similar.

First you want to get a good understanding of the legal structure of the units being sold in relationship to the entire housing development.  Essentially you want to know the legal set up of the housing development and how the various stakeholders (promoters, creditors, and committed residential owners) rights are defined in the legal structure and how that relationship changes during the various stages of development and ownership transfer.  A study of the legal structure should give you an idea of what you are actually purchasing?  Are you only purchasing the right to live in the specified apartment in perpetuity or do you get proportional ownership on the land on which the apartment resides in some legal form?  This is a very important question especially when the legal realm surrounding apartments in Nepal are not very clear.

Second you want to get a grip on the management of the facility and the costs involved. You want to seek answers to questions such as:  Who is going to manage the facility? What are the common costs including periodic maintenance and how are they going to be apportioned to the residents?  How are these management structure and costs going to change during various stages of occupancy?

Third you want to consider other costs which include property taxes and any insurance costs that might be obligatory in the purchase agreement or which you might consider separately even if it is not obligatory. These are additional operating costs of owning the property.

Fourth, you want to consider whether your disposable income after deducting all your other monthly expenses will be sufficient to cover any financing costs if you choose to finance the purchase through a mortgage.  Even if you were to completely finance it though equity, there is an opportunity cost involved which, at the minimum, is the interest income that you might earn if you were to have left the funds in a fixed deposit. Let us assume that you take them up on their offer and seek financing for 2/3rds of the purchase price of 18.5 million.  This means that you will be taking on a mortgage of 12.395 million.  A 20 year fixed rate mortgage for this amount at 11.0% (current home loan rate advertised by some Class A banks) means you will have a monthly payment of about 127,940 rupees.  In addition to this you will be giving up monthly interest of 55,962 for the equity portion that you will need to put in the property if your anticipated return is the same as the mortgage rate.  Basically you are paying in excess of 183,000 per month to live in the apartment.  This does not include the common and other ownership costs discussed above.

Finally you want to determine whether what you are buying is worth the value that you will be getting by the purchase especially with respect to other alternatives that might be out there on the market.

For the first time home buyer, the alternative includes purchasing an individual home or purchasing land and building a house on it.  The advantage there is that there is clarity on ownership and you have control on the operating costs.  Continuing to rent is yet another option especially if markets do not justify the fundamentals.

For the short or long term investor there is additional analysis that needs to be done on the potential income the property can generate during the holding period and the capital gains the investor can obtain upon exit at the end of the holding period.  At the minimum the rental income should be sufficient to cover the financing cost of the property and the investor must be able to sell the property at the purchase price plus tax at the end of the anticipated holding period of the investment.  Remember whatever the financing mix, both equity and debt have cost.  Usually equity will require a higher rate of return than debt because of its last claim on the asset.  Regardless if you assume your weighted average cost was 11%, then the annual rental income should be in excess of 2.035 million if you factor in the common operating costs, insurance premium and property taxes that will be applied to the property for the units whose purchase prices are 18.5 million rupees.  This is in excess of 169,000 rupees per month.  If you factor in potential vacancy say 25% then the rent has to be in excess of 226,000 rupees per month to come out break-even.  Here we are assuming that the investor will pay the principal in one shot through the sale of the property. If on the other hand, the investor needs to make partial principal payments, then the rental income should probably include that as well which would make the monthly lease rents substantially higher.

Now let us look at the issue of potential capital gains from the property’s sale.  Essentially another investor would be willing to pay a higher price for the property if the new investor believes that the property can be either leased at a higher rent or can be sold at a much higher price during the new investor’s holding period.    How likely this is in the current market situation given the income analysis that has been done above is something that you has a potential buyer need to determine.  When markets mature and in situation where new apartments are coming up and there is abundant supply, the trend generally is for apartments to lose resale value over time.  There might be some exceptions for apartments that are in certain prime locations which are always in demand.  You as an investor need to determine whether the apartment you are buying is such an apartment.

What I have tried here is to provide potential investors in the Nepalese real estate market some insight on how to look at properties so they can make a better informed decision on their investments.  So should you buy a Shustri Apartment? An analysis has been presented but the decision has to be yours.