Is NOC, the Lehman of Nepal – the ticking credit time bomb!

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The reason someone saves or invests is because there is a prospect of return in future; the higher the risk, the higher the return. The same consensus guides anyone who parts with some of his/her monthly income to put it in institutions like Citizen’s Investment Trust (CIT), Employees Provident Fund (EPF) or even bonds issued by the Government of Nepal (GoN). The basic understanding is, as the government stands guarantee on these loans, there is not much risk involved, if any.  But how big a risk are we taking by not knowing which circle our money is circulating in?


Increasing Access To Funds

One among many circular paths of money in institutions here in Nepal is the loan to Nepal Oil Corporation (NOC). In the last 10 years, the only year NOC made any profit was 2009/10 (NRs. 3.31 Billion). The losses cumulated since 2002/03 until April, 2014 stands at NRs. 45.53 Billion. This amount is increasing with NOC’s increasing access to funds from CIT, EPF and The Government of Nepal (GoN). NOC has received NRs. 33.921 billion straight out of the taxpayers’ pocket. The total outstanding interest amount to this loan stands at NRs. 2.04 Billion.

The fact that NOC has losses in billions in the last ten years gives rise to the question – how will NOC pay the loan? Currently, NOC has been paying interests while not even a fraction of the principle has been re-paid. On the contrary, the loan amount has been increasing, with new imports from IOC as NOC fails to recover its investments on every import. This gap again is covered through loan from taxpayers’ money.

Can Noc Pay Back Loans?

NOC’s volume of transaction stands at NRs. 160 billion per year. It has absolutely no act governing its activities.Then there is loan worth another billion of Rupees. All these facts beg the answer to the fundamental structural question – How is NOC going to pay the taxpayers’ loans in future? Furthermore, what is the tipping point of taxpayers’ confidence? How much more loans are we to give before actually realizing that the bubble is too big? When will the bubble burst? How will we get our fuel in the future amidst the whole financial mess?

Credit Bubble

The financial crisis of 2008 also happened because of a credit bubble. The Lehman Brothers collapsed because their leverage ratio was so large that the decline in house prices wiped out their entire asset base. Their credit was largely based on the toxic credit (CDOs – Collateralized Debt Obligations) derived from the American housing market. The major difference here between NOC and Lehman Brothers is :

1.  Securitization- most of Lehman based loans were insured and sold (the securitization food chain);

2.  Lehman worked under market conditions and did not fix prices;

3. The American Government did not stand as guarantee on loans that the company acquired.

The major similarity between the failed Lehman Brothers and the soon to fail NOC (if no changes are made) lies in the fundamental financial structure of the two organizations – the leverage. According to Creditfix, the simplest and most widely known measure of the leverage ratio is the ratio of debt (total loans for that time period) to equity (the total value of the company at that time period) – known as debt to equity ratio.The leverage ratio of Lehman Brothers increased from 24:1 in 2003 to 31:1 in 2008. Having a leverage of 31:1 meant that a 3.3% decline in the value of assets was enough to wipe out the whole company.

Debt-Equity Ratio

If we look at the current leverage of NOC, the debt-equity ratio turns out to be 332:1 for the year 2012/13, and the estimated ratio for the year 2013/14 increases to 344:1. This means, for every Rs. 1000 of your money invested in CIT or EPF and given as loan to NOC, NOC takes a risk equivalent to Rs. 344,000. This means that even if there is a 0.29% decline in asset value of NOC, your Rs 1000 is rendered worthless – they simply go bankrupt. This risk is 10 times greater than the risk that Lehman Brothers took which brought them down in the 2008 financial crisis.

How big a risk is this really?

The debt-equity ratio, calculated by the Ministry of Finance is based on that fiscal year’s loan. The cumulated debt-equity, which is the ratio of the cumulated debt till date to equity, amounts to 405:1 (refer to the table). This means that in actual terms, a 0.25% decline in NOC’s asset wipes them out in totality.

The depreciation percentage given in the Yellow book published by the Ministry of Finance itself dictates that this is alarmingly larger than 0.25% of the total equity value.

This means, NOC has been theoretically wiped out many times already.

Negative Net Worth

In investment science term, NOC is worthless with a net worth of approximately negative Rs. 25 billion. In this context, the structural aspect of NOC and the price control regiment they practice – which makes even more losses, makes this body one of the most debated and politically protected bodies in Nepal.

NOC takes loans every year to import petroleum products, and this is increasing by the year. The risk of this loan is undoubtedly high. In addition to this, there is a convoluted bureaucratic labyrinth protecting this unacceptability. It is only a matter of time before the credit bubble bursts. When that happens, the government institutions including NOC will still be on a lower loss than what we consumers have to bear. How big a risk are we really taking?

Total cumulative loan and interest load to Nepal Oil Corporation

S.No Description Loans and outstandings in (Rs) Interest rate Yearly interest rate
1 Loan from The Government of Nepal (GoN) 12.641 billion 3% 379.23 million
2 Citizens’ Investment Trust (CIT) 8.93 billion 12.5% 1,116,250,000
3 Employees Provident Fund (EPF) 12.35 billion 12.5% 543.75 million
4 Commercial Banks (CB) 2.74 billion 7.75% 212.35 million
5 Indian Oil Corporation (IOC)  2.5 billion 10.4% 260 million
  Total  39,161,000,000

Source: Parliamentary study and recommendation committee (Presented with some calculation corrections)

Serene Khatiwada

About Serene Khatiwada

Serene Khatiwada is a Research Intern at Samriddhi, The Prosperity Foundation. He did his Economics Honors from Hansraj College, University of Delhi.