Nepal’s debt sustainability

Last year, economic activities in Nepal remained at their lowest level in decades: the growth rate in 2020 was negative at 1.9%. Some economic sectors are still in shock. The tourism and entertainment industries (major contributors to the Nepalese economy) are still in recession. Bottlenecks in international travel and the fear of a third wave are putting the tourism and entertainment industries at risk. However, the current vaccination campaign – about 23 percent of the population has been affected in Nepal – and a drop in the number of deaths and positive cases is increasing economic activities in South Asia and Nepal.

The Nepalese economy is now open. There are no restrictions except for large gatherings. Gradually, the economy is rebounding to the pre-Covid level: the World Bank forecasts economic growth of 3.9% in 2021 and 5.1% in 2022. However, to have a resilient economy and inclusive growth , rapid vaccination programs, supportive private sector policies and government spending are important to the Nepalese economy.

Especially during the recovery period, fiscal spending has a significant effect on developing economies. The nation needs investment and consumption to increase the economic activities of the population. For that, the government needs funds. However, countries like Nepal, where government revenues depend heavily on tax revenues, face challenges in terms of gross financing and investment needs. During an economic recession or a period of recovery, increasing taxes or tax bases is counterproductive for the economy. Therefore, governments borrow money to finance their budget deficits. This is what Nepal needs to do for the moment.

Lowest credit risk

In the case of Nepal, there is still sufficient budgetary space available. Nepal’s external public debt risk is very low although debt has increased in recent years. According to World Bank indicators, Nepal has the lowest credit risk in South Asia. Nepal’s current public debt represents 40.16% of gross domestic product. A joint Debt Sustainability Analysis (DSA) of the World Bank and the International Monetary Fund shows that Nepal’s debt sustainability indicator is 3.28, indicating high debt carrying capacity . The International Monetary Fund uses the AVD indicator of countries to analyze their external public financing risk. Three of the four core DSA indicators, such as the present value of debt to GDP ratio, the present value of the debt service to exports ratio and the present value of debt service to revenue ratio, are expected to remain strong. below the threshold ratio. This indicates that currently declining government revenues can be supported by financing public debt for development needs.

However, one of the critical DSA ratios, the present value of debt to exports ratio is expected to be very close to the threshold. Even though Nepal has faced a large trade deficit for years, a solid remittance base helps its current account deficit to stay in good shape and also reduce external debt stress. Likewise, since Nepal is still in the low income category of the World Bank income hierarchy, it has certain advantages in obtaining external debt on easy terms. For example, easy loans with minimum interest rates, long repayment periods, and considerable grace periods are provided by bilateral development agencies such as the World Bank.

Likewise, Nepal should also work closely with the private sector through a public-private partnership for private external debt. Although private debt financing based on a public-private partnership can be riskier than borrowing from bilateral agencies, if planned and used correctly, the risk can be significantly minimized. For example, interest rate risk can be minimized by investing in the productive sector with opportunities for growth and higher returns. Since the public-private partnership will be a project-based financing requirement with the participation of the private sector, the risks of abuse will be less.

Remittances from Nepal can also be used as a source of financing for internal public debt, which is less risky than external debt. Nepal has witnessed a large volume of remittances for years: the ratio of the country’s remittances to GDP is over 40%. However, doubts remain as to the use of this amount in development projects. It has significantly reduced rural poverty, but economists argue that remittances are largely consumed instead of invested. The use of short- and medium-term government bonds, especially for migrant workers, could also help the government finance development needs. This tool, especially in the case of Nepal, might require more convincing diagrams. The reluctance of the government to solve the problems of migrant workers has created a bad image among Nepalese migrants; selling public bonds to migrant workers for public investment could be difficult. But if the bond campaign is linked to a specific development project or to a financing need, remittances can be redirected to the development sector.

Public loan

Overall, Nepal has sufficient fiscal space for public borrowing. However, the debt must be credible. The government needs to gain public confidence, make debt-related projects more transparent and increase investment activity. Project-based debt and on-time completion are very critical. Economists now think that the amount of debt is not the problem, but its use is. If we use it in the productive sector, then debt is not a problem.

So, to gain the confidence of the public and potential lenders, the government should also start working in the public debt market. For this, the government must relax the administrative process, maintain the credibility of the debt and also request an international debt rating. Indeed, an efficient debt market plays a key role in attracting foreign direct investment. Country ratings in particular send positive and investment-friendly messages to foreign investors. However, if the debt is mainly used in non-profitable consumption and the credibility of the debt is not maintained, the debt market and international ratings will do more harm than good.

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