Capital shortages reveal opportunities for ESG-aligned businesses

Nepal’s private sector appetite for capital is growing. With GDP growth now above 7% and demand for credit constantly above 20% over the last four years, local resources are struggling to address local demand for capital.

In order to achieve its Sustainable Development Targets (SDGs), Nepal will rely on accelerated GDP growth for long term inclusive growth. According to the Nepal Planning Commission, the Nepali private sector requires investment of around USD 4-5 Billion annually to achieve its SDG goals. The government has accepted that FDI will play a key role in meeting its ambitious economic development target. 

The government recently passed the new FDI bill and other relevant ancillary bills. However,  introducing new regulations is a mere first step if the government and the private sector are serious about inviting foreign investments. With foreign capital comes new sets of requirements which Nepal’s private sector might not be ready to fully accommodate. Is Nepal’s private sector structured to evaluate and adjust to the new regime of disclosure, transparency and commitments required by foreign institutional investors? 

A growing fleet of foreign institutional investors already have environmental, social and governance (ESG) risk mitigation requirement as an internal part of their investment process. Contrary to pure commercial investors these investors look beyond financial statements to identify ESG issues for both risk mitigation and value creation opportunities. Numerous studies have shown that proactively managing ESG risk can have a positive financial return. A recent IFC study found that companies with good environmental and social (E&S) practices outperform companies with worse E&S practices by 210 basis points on return on equity (ROE). No wonder DFIs, including FMO, CDC, IFC, already active in Nepal require borrower to follow their prescribed ESG compliance standards. As more investments flows into the country -- IFC alone have plan to invest more than USD 1 BN in the next four years – ESG will continue to be an evaluation criteria. 
Companies seeking equity from international private equity funds or directly from DFIs should not be taking ESG merely as a box ticking exercise. When done correctly, ESG is a long-term value creating and risk mitigation tool. Implementing the strategy might have some short-term challenges in terms of both time and corporate culture, but the value created and risk mitigated in the long term far exceed the cost.

Even companies not interested in foreign capital would gain an advantage over peers were they to introduce or enhance their basic corporate hygiene, including environmental, social and governance standard. It is a matter of time before ESG becomes mainstream. If not for equity investment, even future borrowing from local commercial banks may soon require compliance with the ESG standards. Some of the banks have already begun streamlining this. NMB, with funds coming from DFIs, has begun asking borrower to comply with ESG requirements. Nepal Rastra Bank has developed Environmental Social Risk management systems and will soon require all the borrowers of Nepali commercial banks to comply with it. 

Today companies are either highly leveraged, or have exhausted sufficient fixed asset to borrowfrom the banks. A lack of long-term financial products is also driving business owners to go to private equity partners or stock exchange listings as an alternative source of capital. But these investors want to see at least the basic ESG provisions in place. Some low hanging fruits that are within reach for companies involve hiring real independent directors whose job is to provide real strategic input beyond simply pandering to their founder’s ego; setting up audit committee; smart succession planning; and improving employee health and safety. 

As the wheels on Nepal’s upward economic trajectory keep spinning, the broader business community must learn to reform as local capital shores up and compliant international capital becomes the only option. Companies who react by implementing international best practice, regardless of their interest for DFI capital or not, will witness positive growth prospects and can be sure to be competitive in tomorrow’s world of ESG aligned targets.

Shabda Gyawali, Investment Director
Dolma Impact Fund

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