Hydropower Policy – A Critique

Ratna Sansar Shrestha, FCA

G overnment of Nepal (GoN) formulated

Hydropower Development Policy1 in 1992
and also promulgated Electricity Act and Water
Changes based on Lessons Learnt
In 200,1 a new policy (Hydropower Development
Resources Act. The following four reasons were cited Policy, 2001) was formulated to revise and improve
as the rationale1 for the formulation of the Policy: the hydropower policy based on the (a) experience
gained in the course of implementing the principles
1. “It is necessary to make alternative arrangement
to meet the interim demand of the country till followed by the original policy, (b) emerging concepts
the above projects come into operation”. In this in the international market and their impacts, (c)
excerpt, the words “above projects” were used in technological development, (d) possibility of export
reference to Arun-III (402 MW2)3 and Kali Gandaki of hydropower, (e) possibility of foreign investment,
(100 MW)4, which were expected to “be executed and (f) commitment to environmental protection
within a period of 7-12 years.” with a view to making it clear, transparent, practical,
2. “It is also necessary to construct new small and investment-friendly. It was formulated to
hydroelectric projects to meet the demand of those achieve following objectives5:
hilly and remote Himalayan regions where the 1. To generate electricity at low cost by utilizing the
national electricity system has not been extended or water resources available in the country.
would not be extended in the near future.”
2. To extend reliable and qualitative electric services
3. “It is utmost necessary to extend proper distribution throughout the Kingdom of Nepal at a reasonable
system in the rural areas where electrification price.
has not been done, and
3. To tie-up electrification with the economic
4. In order “to develop hydropower of the country by activities.
motivating national and foreign private investors in
the electricity sector.” 4. To render support to the development of rural
economy by extending the rural electrification.
The first two rationales, basically, focused on making
alternative arrangements to meet the interim demand 5. To develop hydropower as an exportable
commodity.
while Arun-III and Kali Gandaki A projects were under
construction, by ensuring construction of small projects
to serve hilly and remote Himalayan areas. However, the Salient Features
enabling law, the Electricity Act, 1992, does not suffer The new policy concept lays down strategies for its
from such limitation; it was not intended to address just implementation. It has made provisions concerning
the interim requirement. Under this legal environment the environment, water rights, investment in
Khimti, Upper Bhote Koshi, and Indrawati III (totaling generation, transmission, and distribution, power
112.5 MW) were constructed with foreign investment purchase, etc. to attract investments from within
while a number of other projects have been built with and outside Nepal. It stipulates mandatory release
local finance. of at least 10% of the minimum monthly downstream
discharge of the river or stream by a project as
It is hear warming to note that the policy heralding environmental flow. In case it’s Environmental
private investment in the power sector in Nepal have had Impact Assessment (EIA) study report calls for higher
a successful trial. However, it needs improvement in a quantum as environmental flow, then the project is
stratified manner so that each improvement reinforces obliged to release that quantum of and low. There
the policy for the betterment. The policy works as a is also provision for acquiring necessary private
fulcrum in attracting private investments in the sector. and public land for implementation of the project,
Nepal is facing power shortage herself, and the huge and the government is obliged to assist developers
power deficit in the neighboring India also affords a in this respect. A developer is made responsible for
market for the excess hydropower generated in Nepal. the rehabilitation and resettlement of any family
In order to ensure that the planned capacity addition is that is displaced in the course of construction of
realized to enable NEA to meet ever-increasing demand power plant, transmission and distribution network,
for electricity domestically as well as in the neighborhood, as specified by the GoN, at the cost of the project
the policy needs to be rationalized and also made more proponent.
responsive to the needs of potential private investors
from Nepal and abroad. The policy has also made provision for preventing
adverse impact on the availability of water or water

HYDRO NEPAL | ISSUE NO. 20 | JANUARY 2017 11

rights of the project for which license has been obtained Fiscal Provisions
or license is not required. It envisages issuing licenses The policy provides for two-tier capacity and energy
for study or survey as well as implementation of royalty with annual escalation of the latter by 5%. The rate
projects for generation, transmission and distribution regime is different for up to 15 years and after 15 years.
of electricity, including captive generation. The policy Unlike the previous policy, it prescribes different rates
stipulates specific timeframe within which license are to for projects of different sizes, like 1 to 10 MW, 10 to 100
be issued. The survey license is for a period of five years MW, above 100 MW, captive use project, export-oriented
while generation license will have a term of 30 to 35 project, storage project etc. In India, an IPP is required
years. Similarly, the term of the electricity transmission to pay nominal water use charges and, additionally, has
and distribution license is to be 25 years. The policy has to provide 12% free power to the host State. However,
waived the license requirement for projects of up to 1 an IPP in Nepal has to pay only a combined capacity
MW. and energy royalty and no free power is required to be
provided. Compared to the nominal rates in Nepal, what
There is provision for providing 50% of the royalty an IPP has to pay in cash and kind in India is exorbitantly
obtained by GoN from hydropower projects to the high, which has far-reaching implications for the
VDCs and districts that are directly affected by the economy-from high development costs to high prices
power projects. The policy also envisages handing over that consumers have to ultimately pay for electricity or
responsibility of operation and management of small the macro economy has to internalize.
hydropower plants in mountainous rural areas outside
the national power system to community groups. The policy has made provision to charge only
a nominal 1% custom duty on the import of plant,
Build, Own, Operate and Transfer machinery, equipment and spares for the construction or
The policy’s fulcrum is the provision related to Build, erection of the project. It has also made provision for the
Own, Operate and Transfer (BOOT) concept, making it exemption of VAT on the import of these items.
mandatory for the transfer of the project to GoN in good
running condition after expiry of license period without According to the policy, custom duty and VAT
any compensation. Under the policy, a hydropower site facilities are also available for upgrading the capacity of a
has been treated in parallel to a concession and owner’s plant or for its necessary repair and maintenance because
title right over the power plant devolves to GoN upon of exigency or natural calamity. It also guarantees that
completion of the term of the license. In order to ensure no tax, duty or governmental revenue in any form or title
“good running” condition of such assets, the regulatory other than those levied in accordance with the agreement
body (yet to be constituted) has been empowered to executed at the time of issue of license will be levied.
prescribe guidelines for repair and maintenance of
main electric equipment and structure. The policy has Moreover, the policy has made provision for
also made provision for the involvement of GoN in the exemption of income tax (also included in previous
operation two years before the handover of the project. policy also). However, it was withdrawn by Income Tax
Act, 2001 only to be reinstated with some modification by
Except in the case of captive plant, and where the plant Finance Act, 2009 under which projects commissioned
owner directly uses the electricity, the policy has made by April 13, 2019 are entitled to income tax holiday for
it mandatory to execute a PPA to sell energy. By doing first 7 years and a reduction by 50% for next 3 years.
so the policy has failed to recognize that private sector
investors also do implement merchant plant which will
not sign PPA in advance; rather such plants are operated Repatriation
during the times of high tariff and are not operated when Under this policy, GoN makes firm commitment to assure
the tariff affords marginal return. The policy also has repatriation for debt servicing (payment of interest and
stipulated that the PPA shall be transparent. repayment of principal) and as return on equity, and
the proceeds from the sale of such equity in the case of
In order to encourage foreign investments in the foreign investment.
sector, provision has been made for granting non-tourist
visa and work permit to investors, their representatives,
experts, skilled personnel, and their families. Besides, Institutional Mechanism
the policy encourages hydropower projects to use Nepali The policy envisages developing the Electricity Tariff
labor, skills, means, and resources to the maximum Fixation Commission (ETFC) into a regulatory body
extent possible in order to ensure that the benefit to regulate the sector and also fix electricity tariffs
accruing from the backward linkage does percolate into and wheeling charges6. Under the policy, the private
the economy. Similarly, it also guarantees against the sector is entitled to use the national grid on payment
nationalization of power plants and against revocation of a fee (wheeling charge). Similarly, it has reposed the
of a license in contravention of the terms of the license. responsibility of study and promotion to Department of

12 HYDRO NEPAL | ISSUE NO. 20 | JANUARY 2017

Electricity Development (DoED), which is also a licensing some marginal sites, the impact of having to pay income
authority. Water and Energy Commission Secretariat tax at the rate of 20% (a concessional rate against the
is to prepare a national load forecast, carry out system corporate rate of 25%) may not be that substantial. But
planning study, conduct preliminary identification of the issue is that of stability and predictability of the policy,
hydropower projects, conduct various policy research, and the issue of income tax is just an example. Investors
etc. Electric Energy Management Research Institute is all over the world look out for stability and predictability
also to be set up. in the policy under which they have to operate. This
holds true more so in the case of infrastructure projects
Incidentally, Electricity Act 1992, promulgated to that are capital-intensive with relatively long gestation
implement previous policy, has not been updated/ (construction) period and are long-term investments
changed to make it compatible with new policy. (recovery of investment with return possible only over
a long time). Therefore, this particular step has been
discouraging potential investors.
Critique of Policy
There are a number of areas in the policy that warrant Lack of Vision for Energy Security
improvement. This paper tries to deal with some Electricity is one of the sources of energy, and other
important ones in the following sections. non-renewable and unclean sources of energy are also
used in Nepal, besides other renewable sources like
Enforceability of the Policy solar, wind, biogas/biomass, etc. Traditional sources
The Electricity Act, 1992 was promulgated to make like firewood, agricultural residue, animal residue,
previous policy enforceable. In other words, the Act etc. constituted 55% in FY 2015/16 and 40% of energy
“implements” the vision enshrined in the Policy. In requirement is met by modern but unclean sources like
October 2001, GoN promulgated new policy, which coal and petroleum product. Electricity and renewable
supplanted the earlier policy. However, GoN is yet to constitutes only 5%.
effect changes in relevant legislation, including in the
Electricity Act, 1992, thereby rendering the new policy The nature has endowed Nepal with water resource
(of 2001) unenforceable. aplenty but “forgot” to provide any fossil fuel like coal,
gas, etc. Therefore, this policy should have focused
There are contradictions between the new Policy on achieving energy security by harnessing water
and the existing Act. This is sowing a lot of confusion in resource for most need, including displacement of fossil
the private investors, and, therefore, inhibiting it from fuel and firewood; not only for lighting but also for
playing a significant role in hydropower sector. The new industrialization, electrification of transportation and
policy has made several changes to the existing policy, but electric cooking, But sadly the policy has failed badly in
when it comes to implementation, it is still the Electricity this respect.
Act of 1992 that gets implemented. As an example, we
can take the case of royalty. The new policy stipulates Failure to Capture Positive Externalities
that energy royalty of 1.75% and 1.85% respectively to be Hydropower development does not mean building
charged to projects from 1 to 10 MW and from 10 to 100 only run - of - river projects; reservoir projects play much
MW sizes for first 15 years. But GoN is still charging 2% important role in meeting dry season demand (generates
energy royalty to projects of all sizes in accordance with high value electricity). Such projects also generate
Electricity Act, 1992. Such a state of affairs discourages positive externalities like lean season augmented flow in
private investors. the downstream areas availing much needed water for
human consumption, irrigation, fisheries etc. besides
Lack of Stability and Predictability in Policy controlling flood during wet season. But the policy has
Section 12(3) of the Electricity Act, 1992 stipulates completely ignored this facet of water use, which is
“hydro electricity generation, transmission and criminal as there is no alternative to fresh water for water
distribution shall be exempted from income tax for 15 security and food security while there are both clean and
years from the date of generation, transmission and unclean alternative for energy generation.
distribution of electricity for commercial purposes.”
A number of projects have been built, being attracted Faulty Licensing Policy
by this exemption, and they are already enjoying the By November 30, 2016, GoN has already issued 276
“income tax holiday.” But this facility was withdrawn in licenses for an assortment of projects of various sizes7 in
March 2001. total for about 5,914 MW as detailed below:

Income tax is a tax that is paid only if there is some

income: no income, no income tax. Therefore, revenue
officials have been doing their best to downplay the
impact of the withdrawal of such exemption. Except for

HYDRO NEPAL | ISSUE NO. 20 | JANUARY 2017 13

 Capacity Total Installed Subsection (4) was added to Section 7 of FITTA in
Number of Projects January 1996, in order to afford foreign investors
Range capacity
an opportunity to choose foreign jurisdiction for
Up to 1 MW 172 121.98 dispute settlement. As Nepal has already signed the
1 to 25 MW 75 626.03 New York Convention on Arbitration, an arbitral
25 to 100 MW 16 933.61 award made in any country is enforceable in Nepal
as long as the arbitration is conducted under the
Above 100 MW 13 4,232.7
laws of the country where the venue of arbitration is
Total 276 5,914.32 located. This is one of the effective modes of dispute
settlement. But the same cannot be said of other
Table 1: Status of Survey Licenses Issued modes of dispute settlement.
Although, such a foreign investor is entitled to
And 117 Generation Licenses were issued for total
choose laws of any country, the decision of the foreign
installed capacity of 3,340.95 MW. However, so far only court is not enforceable in Nepal. The point can be
50 projects with total installed capacity of 324.446 MW illustrated with an example of a foreign investor,
have been commissioned, while the country is facing having exercised the right to choose English Law, will
load shedding problem caused by demand and supply have to go to a court in England to settle dispute if s/
mismatch. While only 91 projects with total installed he opts for the judicial settlement of dispute instead
capacity of 1,721.53 is under construction. A sad show of arbitration. If the English court were to hand
compared to licenses issued for almost 400 projects with down a verdict in her/his favor, s/he would need the
installed capacity totaling over 7,500 MW. assistance of a Nepali court to enforce the verdict of
English court in Nepal. However, the verdict of the
This is one of the main problems in the licensing English court, for that matter any foreign court, is
not enforceable in Nepal.
policy. The current policy is to issue license for
hydropower projects, irrespective of whether for Similarly, the liberty to choose foreign law implies
domestic consumption or export, on “first come first that the investor exercising such choice will be
serve” basis. People approaching GoN for license for any entitled to adjudication under the law of that country
particular site can walk away with one if they are able to even in the host country, too, where the project is
satisfy certain requirements. located. But it is not even worth imagining that a
court of Nepal will apply, for example Norwegian
laws in the settlement of disputes; most in Nepal
There is not much to show for the huge number of don’t even understand Norwegian language. In view
licenses that have been issued. One meets people ranging of this, the liberty to choose foreign jurisdiction
from wanting to sell a license for a “price” to looking for becomes ineffective.
a partner while the license holder is not able to mobilize
Once foreign jurisdiction for the settlement of
even 10% of the required equity (even under the 75:25
disputes under a contract has been chosen, a court
debt equity ratio) on their own. On the other hand those
in Nepal will not adjudicate a dispute under such
who have financial strength to build hydropower projects contract even under Nepal law, as the governing
have no access to licenses. law of the contract, freely chosen by the contracting
parties, is the law of a country other than Nepal.
This phenomenon exists due to the fact that the policy
is bereft of a mechanism to ensure that the applicant Import duty Facility at the Cost of the Economy
has access to necessary resources to implement the Pursuant to Clause 6.14.2 of the HDP 2001, no
project. This problem has deprived genuine investors of VAT is levied on the machinery, equipment, and
potential sites and blocked the generation of electricity spares thereof imported for a hydropower project.
and thus the development of power sector thereby Similarly, Clause 6.14.3 of the policy waives customs
duty on the import of machinery, equipment,
exacerbating power crisis. Similarly, such rent-seeking
and spares (except for the nominal 1%). This is a
attitude of the license holders without financial strength
welcome provision in as much as attracting private
is also additionally depriving the national treasury of the investment is concerned. But due to such waiver,
royalty revenue, which would have started flowing in had imported machinery, equipment, and spares become
the policy made better provision to screen the applicants’ cheaper compared to domestic production because of
financial capabilities to implement a project. which, Nepal fails to take advantage of the backward
economic linkage. The investments made in the
Hindrances to Dispute Settlement hydropower project will not percolate into Nepal’s
The Foreign Investment and Technology Transfer economy by way of backward linkage.
Act (FITTA), 1992 had no provision for the selection
of foreign governing law for dispute settlement. For Sovereign Guarantee and PPA
the proponents of the Khimti project, pioneer foreign It is well known that government guarantee
investors, it was a sine qua non; they were unwilling is met with disapproval from multilateral FIs in
to invest in Nepal unless they were allowed to choose general. However, in order to perfect the security
foreign law to govern various contracts. Therefore, for hydropower projects, like Khimti and Upper

14 HYDRO NEPAL | ISSUE NO. 20 | JANUARY 2017

Bhote Koshi, GoN had to provide counter guarantee, conduit for a developer to approach various other
without which these projects would not have been agencies within the government system. This has
implemented (these were financed by multilaterals resulted in cumbersome processes, taking unduly
like International Finance Corporation, Asian long time, which has disenchanted/discouraged the
Development Bank, etc. who themselves generally existing IPPs as well as potential investors.10
frown upon GoN issuing sovereign guarantee). In
providing the sovereign guarantee as such, GoN has
unconditionally and irrevocably guaranteed that Regulatory Body
NEA shall perform all of its obligations in time under Regulatory body is the pivot of implementation of
the PPA to the proponents of these projects. If NEA hydropower development policy. It simply doesn’t
is to fail, GoN is committed to pay the IPP the dues exist, nor has legislation for it been promulgated.
owed by NEA to the extent that GoN even foregoes Electricity Tariff Fixation Commission regulates just
its right of immunity as a sovereign government, the tariff.
citing the reason that the transaction contemplated
by the PPA is of commercial nature. Recommendation
However, such guarantee has not, generally, been 1. In order to eliminate existing anomaly, obviously,
available to domestic investors. It shows lack of a new law conforming to HPD, 2001 needs to be
level playing field, as well. promulgated forthwith.
2. The new policy assures that no change that will
Autonomy of NEA adversely impact the investors will be effected. But
Pursuant to Section 4(1) of the Nepal Electricity for want of legislation, this welcome piece of policy is
Authority Act, 1984, NEA is an autonomous corporate not enforceable yet. The legislation which will make
entity. But, in practice, NEA does not get to exercise the policy that has this clause enforceable should be
such autonomy most of the time. As the entire passed forthwith.
ownership of NEA vests with GoN, it is logical for it to
receive policy directions from GoN through the board 3. The policy needs to “shift gear” to achieve energy
of directors (either ex officio representative of GoN security in Nepal rather than excessive focus on
or nominees of GoN) from time to time. But, NEA export. Obvioulsy, energy security doesn’t just mean
receiving executive instructions (non policy related) no load shedding not only in the case of people with
at times from GoN functionaries, oral or otherwise, access to electricity but also to those without. It
amounts to the impairment of its autonomy. should focus on displacemnet of fosssil fuel in the
transport sector and kitchen including fire wood.
The total installed capacity in NEA system is
855.886 MW8, of which it owns hydropower plants 4. License for hydropower projects should not be
with total installed capacity of 531.44 MW making issued to anyone and everyone walking in with an
it responsible for operation of these power plants application. GoN needs to develop a mechanism
totaling while it needs to take care of the transmission whereby license is issued to only those who can
and distribution of the total installed capacity in the show proof of their ability to invest a substantial
system. In view of this, its 10,000-strong workforce portion of the estimated cost of the project. This can
is a case of over-staffing. With the change of every be implemented by requiring, for example, bank
government, a number of people are invariably hired guarantee covering 10% of the estimated project
(with a few exceptions). When Rajiv Gandhi, late cost. Such bank guarantee should be forfieted if
prime minister of India, declared, “These are not the applicant doesn’t implement the project, which
Electricity Boards, but Employment Boards,”9 he could be tantamount to recovery of royalty revenue
could very much have been referring to NEA. to GoN, that it is deprived from by the failure of the
licensee to implemnt the project.
Even the appointment of NEA’s board members
is done by MoE in a non-transparent and non- Moreover, project licenses should be awareded
competitive manner without regard to academic on the competitive basis such that project is
qualification, experience and exposure. Furthermore, commissioned sooner and better revenue to GoN is
the Board has no say in the appointment of assured.
chief executive. All these are manifestations of 5. In order to make the liberty to choose foreign
encroachment on the autonomy of NEA, and it jurisdiction for the settlement of disputes effective,
reflects poorly on the sector. GoN should make arrangements to allow the private
sector investors to avail of all avenues of dispute
settlement by, for example, allowing courts in Nepal
One-Window policy to implement the verdicts of foreign courts.
It is a common practice to set up a “one-window”
institution to develop a particular sector. In 6. In order to enable the economy to absorb the
Nepal, too, the policy envisages setting up such a investments in capital-intensive projects, thereby
window and designates DoED as the one-window reaping the benefits of backward linkage, GoN needs
for hydropower projects. However, investors need to provide import duty facility to only those items
to secure permits and approvals from many other that cannot be manufactured or produced in Nepal
agencies under the GoN, and DoED just works as a in a cost-effective manner and of required quality in

HYDRO NEPAL | ISSUE NO. 20 | JANUARY 2017 15

 necessary quantum and when needed. Ratna Sansar Shrestha, FCA is a management
professional specializing in financial/economic,
7. As GoN furnishing soverign guarantee causes
legal and managerial aspects of Hydropower
distortions and also because the instrument does
projects, renewable energy technologies,
not belong to the age of economic liberalization,
environmental enterprises, carbon trading, etc. He is
it should not be provided at all. If GoN thinks
also fellow of the Institute of Chartered Accountants
that soverign guarantee needs to be provided to
of Nepal and a corporate lawyer accredited to the
accelerate the development of the power sector,
Nepal Bar Council. He also worked as a member
then it should be provided only for a limited fixed of board of directors of Nepal Electricity authority
duration and ensuring level playing field. from December 2002 till August 2004.
8. In order to ensure that NEA actually enjoys the
autonomy guaranteed to it by legislation, political Corresponding E-mail: [email protected]
interference of any type should be prohibited in the
NEA. GoN should constitute a professional board
comprising memebers with requisite education, Footnotes
experience and exposure for a fixed term. The board 1. GoN (1992). Hydropower Development Policy, 1992
should be allowed to manage NEA professionally
and also should be held accountable. 2. One thousand kilowatt constitutes one megawatt
(MW).
One reason behind the high level of political
interference in NEA is that a minister chairs the 3. The project, downsized to 201 MW and called “baby”
board. Both the chairperson and other members, Arun III, was planned to be built with financing from
as well as the executive director, should be chosen multi-laterals including the World Bank, which
through a transparent and competitive process cancelled it on 3rd August 1995.
with provision for public hearings. 4. Although the capacity of the Kali Gandaki Project
9. It makes no sense to make provision for “one- is listed as 100 MW in the policy, the project was
window” agency when such an agency is actually not commissioned in 2002 with the installed capacity of
able to function as one. In order to ensure that the 144 MW.
power sector projects move on a real fast track, the 5. GoN (2001). Hydropower Development Policy,
one-window system should be implemented in the 2001
real sense. The turf wars between various agencies
of the government can be eliminated by letting all 6. A bill to establish Nepal Electricity Regulatory
departments concerned delegate necessary authority Commission was tabled in previous constituent
to DoED at the time of issuing license itself. assembly, but has yet to be passed.

10.
Legislatin for regulatory body needs to be 7. Source: http://www.doed.gov.np/index.php
promulgated forth with and such a body needs to be 8. NEA (2013). Fiscal Year 2015/16 – A Year in Review.
formed with further delay.
9. Ruet, Joël (2005). Privatising Power Cuts?,
Academic Foundation, p 82.
Conclusion
It goes without saying that having a policy that cannot 10. People have quipped in the lighter vein that the one
be implemnted does not make sense. Besides, as Nepal window policy requires investors to climb through
one window just to have to traverse many a doors.
is not endowed with mineral resource while nature has
bestowed her with ample source water resources, Nepal
should strive to achieve energy security by harnessing
water at the optimum level.

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16 HYDRO NEPAL | ISSUE NO. 20 | JANUARY 2017