Nepal’s debt sustainabilityNepal has enough fiscal space to use more debt for development.
Last year, economic activities in Nepal remained at the lowest level in decades: the growth rate in 2020 was a negative 1.9 percent. Some of the economic sectors are still in shock. The tourism and entertainment industries (major contributors to the Nepali economy) are still in recession. Bottlenecks in international travel and fear of a third wave are causing the tourism and entertainment industries to remain in peril. However, the ongoing vaccination drive—about 23 percent of the population has been jabbed in Nepal—and a drop in fatalities and positive cases is increasing economic activities in South Asia and Nepal.
The Nepali economy is open now. There are no restrictions except for huge gatherings. Gradually, the economy is bouncing back to the pre-Covid level: The World Bank forecasts the economy to grow by 3.9 percent in 2021 and 5.1 percent in 2022. Yet, to have a resilient economy and inclusive growth, rapid vaccination programmes, private sector friendly policies and government spending are important for the Nepali economy.
Especially during the recovery period, fiscal spending has a significant effect on developing economies. The nation needs investment and consumption to increase the people's economic activities. For this, the government needs funds. However, countries such as Nepal, where government revenue is largely dependent on tax revenues, face difficulties in gross financing needs and investments. During an economic recession or recovery period, increasing taxation or tax bases are found to be counterproductive for the economy. Therefore, governments borrow money to finance their fiscal deficits. This is what Nepal needs to do for the time being.
Lowest credit risk
In the case of Nepal, there is still enough fiscal space available. Nepal’s external risk of public debt is very low though the debt has increased in recent years. According to World Bank indicators, Nepal has the lowest credit risk in South Asia. The current public debt of Nepal is 40.16 percent of the 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, which indicates a strong debt carrying capacity. The International Monetary Fund uses the DSA indicator for countries to analyse their external public financing risk. Three of four critical indicators under the DSA such as the present value of debt to GDP ratio, present value of debt service to export ratio, and present value of debt service to revenue ratio are projected to remain well below the threshold ratio. This indicates that currently falling government revenues can be backed by public debt financing for development needs.
However, one of the DSA critical ratios, the present value of debt to export ratio is projected to be very close to the threshold. Even though Nepal has been facing a large trade deficit for years, a strong base of remittances is helping its current account deficit to remain in good shape and reduce external debt stress as well. Similarly, since Nepal is still in the low-income category of the World Bank’s income hierarchy, it has some advantages in getting external debt under easy terms and conditions. For example, easy loans with minimum interest rates, long payback periods and considerable grace periods are provided by bilateral development agencies such as the World Bank.
Similarly, Nepal should also work closely with the private sector under public-private partnership for private external debt. Though public-private partnership-based private debt financing could be riskier than debt from bilateral agencies, if planned and used properly, the risk can be minimised significantly. For example, the interest rate risk can be minimised by investing in the productive sector with higher growth possibilities and returns. Since public-private partnership will be a project-based financing need with the involvement of the private sector, the chances of misuse are going to be less.
Nepal's remittance inflow can also be used as an internal public debt financing source, which is less risky than external debt. Nepal has been witnessing a large volume of remittance for years: The country's remittance inflow to GDP ratio is above 40 percent. However, there are still doubts if this amount is being used in development projects. It has reduced rural poverty significantly, but economists argue that remittance is largely consumed instead of being invested. Using short- and medium-term government bonds, especially for migrated workers, could also help the government in financing development needs. This tool, particularly in the case of Nepal, may need more convincing schemes. The government's reluctance to solve migrant workers' woes has created a poor image among Nepali migrants; selling public bonds to migrant workers for public investment might be difficult. But if the bond drive is linked to any specific development project or financing need, the remittance can be redirected towards the development sector.
All in all, Nepal has enough fiscal space for public borrowing. However, the debt needs to be credible. The government must gain the confidence of the public and make debt-related projects more transparent and increase investment activities. Project-based debt and completion within the time limit are very critical. Economists now believe 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 an issue.
Thus, to gain the confidence of the public and possible lenders, if needed, the government should also start working on the government debt market. For this, the government needs to ease the administrative process, maintain debt credibility and also apply for international debt rating. This is because an efficient debt market plays a key role in attracting foreign direct investment. Country-specific ratings in particular send positive and investment-friendly messages to foreign investors. However, if the debt is used mostly in consumption that doesn’t pay returns and debt credibility is not maintained, the debt market and international ratings will do more harm than good.