The Covid-19 pandemic has thrown a curveball to the global economy in the most unexpected fashion. Trade, travel, tourism, you name it, have all been adversely impacted. Well-heeled businesses have suddenly ceased to operate, people’s livelihoods have been thrown into disarray and the government’s revenue sources have taken a hit on multiple fronts. Rich countries, poor countries—no one is spared. Fiscal deficit has become the norm, even as governments whose accounts were already awash in red ink are having to run a bigger deficit. It is a double whammy—receipts are down while expenditures are up. The resulting mismatch is forcing many governments into a budgetary juggling act. Nepal is not an exception.

Last fiscal, the KP Oli government initially aimed at growing the economy at 8.5 percent. As the year progressed, this was already proving ambitious. Then the pandemic hit. Now, the economy is expected to have grown at a pace of 2.3 percent. In the current fiscal year, the government—once again—has set itself a lofty goal of 7 percent growth, which obviously assumes growth will pick back up in short order. Two months into the year, the virus is still going strong. Daily lives continue to get disrupted. If the growth target proves unrealistic—and it probably will—this will have adverse repercussions for the government’s revenue objectives.

Debt-to-GDP ratio not prohibitive

In late May, the federal government presented a budget of Rs1,475 billion. This compares with the initial allocation of Rs1,533 billion in the last fiscal year. This fiscal, the budget plans to raise Rs950 billion in revenue, including Rs60 billion in grants. The resulting deficit of Rs525 billion will be bridged by borrowing, made up of Rs300 billion raised externally and Rs225 billion internally. In the 2019-20 fiscal year, the budget deficit totalled Rs267 billion, so the red will have risen significantly this year. The current plan is to raise Rs913 billion in taxes, which will have risen substantially from Rs750 billion in the last fiscal year. Hence the importance of growth assumptions built into this year’s budget.

If growth and revenue targets fall short, borrowing is likely to go even higher. In recent years, reliance on debt has gone up meaningfully. As of mid-July this year, the outstanding government debt stood at Rs1,420 billion—with the country owing Rs806 billion externally and Rs614 billion internally. A year before that, the government owed Rs1,048 billion. Five years ago, in 2014-15, debt totalled Rs545 billion, of which Rs343 billion was external and Rs202 billion internal. Thus, within five years, the debt load jumped 161 percent, with external rising 135 percent and domestic debt 204 percent. As of mid-July, as a percent of the GDP, debt made up 40 percent, which is not prohibitively high. But, given the recent trend, it does need to be watched closely.

In the early 2000s, when the Maoist insurgency was taking a heavy toll on the economy, Nepal’s debt-to-GDP ratio exceeded 60 percent. That conflict ended in 2006, and the ratio gradually headed back down. Besides, there is no optimal debt-to-GDP ratio, which essentially measures a country’s ability to pay back its debts. Simplistically, the lower this ratio, the better. At the same time, there is good debt and there is bad debt. If an entity—be it an individual, company or government—takes out a loan at, say, 5 percent and earns a return of 7 percent on that loan, it does make sense to leverage. In many ways, developing countries can be likened to upstart companies with a lot of growth potential. Debt can help, if exercised judiciously.

In other words, the debt-to-GDP ratio is not the be-all and end-all. Japan’s is over 250 percent and holds the world record, while in the US it exceeds 100 percent. But these are also developed countries that are capable of printing their own money, with the US, in particular, enjoying the benefit of more than three-fifths of the world’s reserves being held in US dollars. Nepal does not have this luxury. Hence the importance of how a rupee borrowed gets spent or, better yet, invested. Of the proposed Rs1,475-billion budget, Rs949 billion is earmarked for recurrent expenditures, Rs353 billion for capital expenditures and Rs173 billion for financial management—respectively 35 percent, 48 percent and 31 percent over 2019-20.

The problem is that the government routinely fails to spend the allocated budget. In the last fiscal year, Rs239 billion was spent in capital expenditures, versus the initial planned outlay of Rs408 billion. Presently, one major way the government could ease the pain wrought by Covid-19 is by increasing investments in infrastructure. This will not only add to the nation’s capital stock but also create jobs during a difficult time. The new budget has set aside Rs125 billion for road and bridge construction, up from Rs81 billion in the last fiscal year. Even if we assume the allocated amount is spent in its entirety, this is probably not aggressive enough considering the current need. Of Rs125 billion, Rs67 billion will be sourced from abroad.

Cost of capital an important factor

Interest rates are low worldwide; they will probably stay low for some time to come. In recent years, countries such as Austria, Mexico and Argentina, and companies like Walt Disney and Coca-Cola, have issued 100-year bonds. Nepal lacks a developed fixed income market. Multilaterals such as the World Bank and the Asian Development Bank make up nearly 90 percent of the total funds coming from outside Nepal; being a least developed country, Nepal receives concessional loans. Private foreign investors, on the other hand, tend to be fickle and leave at the slightest signs of trouble. Plus, the share of internal debt is high. One reason why Japan’s debt bubble has not popped is that most of it is held within the country.

The Oli government’s increased borrowing has put upward pressure on the debt-to-GDP ratio. But what is important to monitor at this stage is the cost of capital. Debt service burden becomes acute when scarce resources are diverted toward principal and interest payments. The likes of Nigeria and Angola dedicate upwards of 40 percent of government revenue to interest payments, which is not on a sustainable path. In Nepal, in the last fiscal, out of total interest payment of Rs26 billion, Rs5.2 billion was paid to external creditors. At least until it graduates to developing-nation status, the policymakers’ focus should be on these loans. Nepal has room to borrow, and it should, provided the majority goes toward capital expenditures and not toward recurrent expenditures.

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