Although Nepal’s outstanding domestic debt is lower than external loans, the government spent more money to repay domestic debt compared to external debt in the last fiscal year 2020-21. This has raised a question whether the government should prioritise external borrowing over domestic debt.

According to the Annual Report on Public Debt 2020-21 released recently by the Public Debt Management Office, Nepal’s domestic debt totals Rs802.94 billion while external debt amounts to Rs934.14 billion. The country’s total outstanding debt liability stands at Rs1737.08 billion.

But, when it comes to the annual debt repayment, for internal loans the government made principal repayment of Rs36.9 billion and interest payment of Rs28.46 billion in the last fiscal year. And on the external loans front, the principal repayment amount stood at Rs23.26 billion and interest payment amounted to Rs6.17 billion in the last fiscal year, according to the report.

This means the amount of principal payment made to domestic creditors was 58.59 percent higher than the amount paid to external creditors. Likewise, the amount of interest payment to domestic creditors was 361 percent higher than the amount paid to external creditors.

“This suggests internal loans are more expensive than external loans,” the report says. But, the government over the last few years has been constantly borrowing more both from the domestic and foreign lenders.

But, officials and experts say that despite domestic debt appearing more expensive compared to external debt, Nepal should maintain a balance between domestic and external loans.

“On paper, it seems that domestic debt is more expensive than external debt. It is because the majority of loans that Nepal has taken from foreign lenders are concessional ones,” said Hira Neupane, information officer at the Public Debt Management Office. “But, whether domestic debt is too expensive compared to external debt is yet to be ascertained. For this we need to analyse the impact of the depreciation of Nepali currency against the US dollar.”

He said that the repayment period of external loans are usually longer and their overall cost could prove expensive because they are tied to the foreign exchange rate, which is unstable.

While the interest rates of foreign loans borrowed from major creditors like the World Bank and Asian Development Bank are less than one percent per annum, the interest rates of domestic loans are higher and constantly fluctuate depending on the liquidity situation in the banking sector.

Nara Bahadur Thapa, a former executive director at the Nepal Rastra Bank, said the two major risks associated with foreign loans are their interest rate and the foreign exchange rate but in Nepal’s case the interest rate risk is minimum as Nepal has so far been taking concessional loans only.

“There are benefits of foreign borrowing because there will be more financial resources available in the domestic banking system,” he said. “If the government borrows more from domestic banks then it will create a funds crunch and push the loan interest rates up.”

Currently, the Nepali banking sector is facing a shortage of loanable funds due to excessive lending by banks and financial institutions during the first quarter of the current fiscal year as well as the government’s failure to spend the budget. So, interest rates have gone up.

Until Friday, the government had spent just 17.11 percent of the annual budget while the capital spending stood at 4.65 percent of the target, according to the Financial Comptroller General Office, the agency responsible for keeping records of the government’s income and expenditure.

The government’s major local creditors are Nepali banks and financial institutions, which buy the government’s treasury bills and development bonds. The government raises internal loans by issuing various instruments including treasury bills and development bonds. A few such bonds include the Citizen’s Saving Bonds, National Saving Bonds, and Foreign Employment Saving Bonds.

As the Covid-19 pandemic has badly impacted the Nepali economy, experts have been suggesting that the government minimize domestic borrowing.

Heeding the suggestion, the new government has reduced the target of domestic debt by Rs11 billion to Rs239 billion in the revised budget presented in September through the replacement bill.

But, over the last five years, domestic debt increased more rapidly than external debt. In the fiscal year 2016-17, the outstanding domestic debt and external debt totalled just Rs283.71 billion and Rs413.97 billion respectively. The domestic debt amount has almost tripled (2.83 times) while external debt has more than doubled during the period.

But, Thapa, former official of the central bank, said that the current composition of domestic and external debt has remained largely balanced. “There still is no such risk to give priority to external loans as long as we take concessions loans only and use them in profitable projects,” he said.