Question

Many farming households in the developing world use traditional biomass, kerosene and liquefied petroleum gas (LPG) for cooking and lighting. Domestic biogas – generated from the dung of farming animals – has the potential to replace other fuels for meeting basic energy needs. However, high-quality systems such as fixed-dome plants1 can be relatively expensive – especially if constructed in remote areas, where not all building materials are readily available, and where perhaps no skilled masons are located. Farmers might not have either the required capital for cash purchase, nor the required income or creditworthiness for raising – and paying back – a credit. A current debate – particularly in international development cooperation – deals with the question of how local financial institutions (FIs) can be integrated in the financing process. It is debatable, and it may differ from case to case, if lending for biogas is a viable business (and FIs have not yet realised the market potential), or if the lending potential is limited and an involvement of the private financial sector is rather more wishful thinking than a realistic option. There have been several attempts for introducing local FIs to biogas finance. Besides technical assistance (such as trainings, capacity building, business development support), different financial support mechanisms have been considered for making the investment affordable for the farmer, and for introducing local FIs to biogas lending. This assignment should assess if and under which conditions i) a biogas plant is a financially viable investment; ii) local FIs can be involved in the development of a sustainable biogas market.

BASIC ASSUMPTIONS • A 6m3 fixed-dome biogas plant (size for a small farmer family) costs 600 USD, and has a 15 year economic life-time; • By using biogas instead of kerosene and LPG, and by using the resulting bio-slurry to replace chemical fertiliser for agricultural needs, a farmer can save on average 147 USD p.a. (given fixed prices); • Interest rates for annuity loans under 1,000 USD are 36 percent p.a. (monthly equal instalments); the loan tenor is 12 months.

Please show formulas and explanations

1. Given the high interest rates (36 percent p.a.), an international donor institution temporarily offers an ‘interest softening’ mechanism, reducing the interest for ultimate borrowers substantially to 9 percent p.a.3 The donor implement this mechanism by contributing 27 percent p.a. to the interest. Following this, local FIs expand the loan tenor to 3 years (still monthly equal instalments).

a. What impact do these new loan conditions have on the farmer’s annual instalments?4 How much household income (in addition to fuel and fertiliser savings) would be required per year for paying back the loan? (10 points)

b. How much would the donor contribute to financing of the biogas plant, both in absolute terms (USD), and relative to the initial investment costs (CAPEX) of the plant?5 What could be the concerns of subsidising a large share of the investment costs through this interest softening mechanism? (approx. ½ page) (10 points)

c. In what way does the interest softening mechanism, combined with the extended loan tenor, improve the farmers’ access to finance, and justify the involvement of the financial sector? (approx. ½ page) (10 points)

2. Building upon the scenario established in question 3, we move to the next level. Given the high demand for domestic biogas plants, and assuming that – even with interest softening and tenor extension as described under task 3 –many farmers still cannot afford a loan, the same donor institution decided to additionally provide a 30 percent CAPEX subsidy.

a. What impact does the CAPEX subsidy have on loan amount, annual instalments, required household income, and the donor’s contribution to financing of the biogas plant? (10 points)

b. What are the pros and cons of providing a one-time (up-front) subsidy payment? (approx. ½ page) (10 points)

Answer 1

Monthly instalment with 36% interest

Loan amount

$600

Annual interest rate

36%

Monthly interest rate

3%

(36/12=3%=0.03)

Loan tenor

12

months

Monthly Instalment

$60.28

(Using excel PMT function with Rate=3%, Nper=12, PV=600)

Monthly instalment with 9% interest

Loan tenor

36

months

(3*12)

Annual interest

9%

Monthly interest

0.75%

(9/12)=0.75

Monthly Instalment

$19.08

(Using excel PMT function with Rate=0.75%, Nper=36, PV=600)

a.

Reduction in monthly instalment=(60.28-19.08)=$41.20

Reduction in annual instalment=$41.20*12=$494.40

Annual instalment payment required=19.08*12=

$     228.96

Saving in fuel and fertilizer=

$147

Annual Household income required to payback loan

$        81.96

(228.96-147)

Monthly instalment with 36% interest for 3 year tenure

$27.48

(using PMT function with Rate=3%,Nper=36,PV=600

Amount financed by donor per month

$8.40

(27.48-19.08)

Total donor contribution

$         302.49

8.40*36)

Donor contribution relative to CAPEX

0.5041

(302.49/600

Donor contribution relative to CAPEX

50.41%

With interest softening mechanism and extended loan tenure , it will be easier for the farmer to

pay for the cost of biogas plant

2

CAPEX subsidy

Capex subsidy=30%

Capex subsidy amount=0.3*600=$180

Loan amount

$420

(600-180)

Monthly instalment

$13.36

(Using PMT function with rate=0.75%, Nper=36, PV=420)

Annual instalment

$160.27

(13.36*12)

Annual Saving

$147

Required household income

$13.27

(160.27-147)

Monthly instalment with 36% interest

$19.24

(Using PMT function with rate=3%, Nper=36, PV=420)

Donor contribution per month

$5.97

(19.24-13.27)

Donor contribution for instalment

$214.81

(5.97*36)

Donor contribution for CAPEX

$180

Total donor contribution

$394.81