During the recently concluded visit of Chinese State Councillor and Foreign Minister Wang Yi, Nepali officials’ preference was grants from China to loans, as discussions were held surrounding the implementation agreements on projects under the Belt and Road Initiative.

The Nepali side insisted that even if a loan had to be taken, it should be a “soft loan” or “concessional loan”, which comes at a minimal interest rate.

Nepal’s concerns regarding loans stem from potential debt fears. Although the International Development Cooperation Policy-2019 allows the government to take commercial foreign loans, Nepal has not taken such credits yet.

“The government can mobilise commercial loans for mega projects of national priority having commercial viability with a high financial rate of return,” the policy states.

During Wang’s visit, there clearly was a push for some projects under the Belt and Road Initiative, Beijing’s gargantuan flagship infrastructure project that would stretch from Asia to Europe.

Since China offers loans under the BRI at a higher interest rate with a short payback period, the Nepali side was not quite keen, officials said.

“And we have also set a cap,” a senior Finance Ministry official told the Post on Saturday. “Soft loans for the projects to be developed under the BRI must not exceed 2 percent annual interest.”

Experts say Nepal’s debt concerns are justified and that it must tread carefully when it comes to accepting foreign commercial loans, given the country’s growing debt to gross domestic product (GDP) ratio in recent years.

As of the second quarter of the current fiscal year 2021-22, Nepal’s debt to GDP ratio stood at 40.53 percent, according to the Public Debt Management Office. The debt to GDP ratio was 25.65 percent in the fiscal year 2015-16.

In the early 2000s, when the Maoist insurgency was at its peak, the government’s treasury was under severe duress and the country’s debt to GDP ratio had reached as high as 63.9 percent for 2001-02. A senior government official at that time said there was not enough money in the state coffers to pay government employees and there was a high demand for budget for security agencies to fight the insurgency.

“The Nepal Rastra Bank used to send us the treasury status on a weekly basis. Only a few of us had access to those reports,” former auditor general Bhanu Acharya, who was the finance secretary in the early 2000s, had told the Post in past interviews. “We used to repay high-interest loans, which never came to public knowledge, to avoid the demand from security agencies.”

Nepal’s current debt situation is comfortable, according to officials and experts. But they warned against taking an extra burden in the form of foreign commercial loans.

“Around 60 percent debt to GDP ratio is considered the benchmark for developing countries,” said Prakash Kumar Shrestha, chief of the economic research department of the central bank. “Considering this, we still have room to widen both domestic and external debts. But we should not jump into debt without confirming the rate of return.”

Shrestha said that Nepal should avoid taking commercial loans for projects as long as the return from the projects concerned are not more than the interest to be paid on such loans.

He also pointed out how Sri Lanka is suffering from high indebtedness for borrowing loans in commercial terms and using such loans in some vanity projects. “Sri Lanka suffered from high indebtedness for taking oversized commercial loans whose use in certain projects failed to yield desired results,” said Shrestha. Sri Lanka had to hand over a majority share of the Hambantota port to a Chinese state-owned company on a 99-year lease for failing to repay the loans.

By the end of 2021, Sri Lanka’s foreign exchange reserves plummeted to $1.6 billion—barely sufficient for one month of imports, according to a report published by Nikkei in January.

Low foreign exchange reserves and high indebtedness have brought the Sri Lankan economy to its knees. Its public debt is projected to have risen from 94 percent of the GDP in 2019 to 119 percent of the GDP in 2021, according to the International Monetary Fund.

Sri Lanka’s Finance Minister Basil Rajapaksa admitted early this year that the island needs to pay $6.9 billion in total foreign debt this year, including a $1 billion sovereign bond maturing in July and interest payments to other foreign lenders, according to the report. Majority of Sri Lanka’s external debt has been taken in commercial terms.

Considering the examples of debt-ridden countries such as Sri Lanka, the government is apprehensive about taking commercial loans, which experts say is justified.

According to the public debt management report released by the Central Bank of Sri Lanka, the share of the commercial loans in Sri Lanka’s foreign debt was 56.8 percent in 2019. The average interest rate of overall external debt stood at 3.99 percent at the end of 2019 with commercial loan rates averaging 5.76 percent while bilateral and multilateral loans rates averaging 2.43 and 2.13 percent, respectively, according to the Sri Lankan central bank report.

A majority of the foreign commercial loans were borrowed from the international market. According to the report, the maturity period of commercial loans borrowed from the international market has remained short compared to other concessional loans.

Though Chinese “debt trap” has been blamed for Sri Lanka's malaise in certain quarters, the share of loans from China to overall external loans (both concessional and commercial) stood at around 10 percent as of 2019, according to the Sri Lankan central bank report. Sri Lanka received most of the commercial loans by issuing International Sovereign Bonds.

“Sri Lanka faced the current debt crisis because of irresponsible ways its leadership took commercial loans and used the fund in populist projects which didn't yield desired results,” said Posh Raj Pandey, a former member of the National Planning Commission.

Experts say Nepal should learn from Sri Lanka’s experiences while deciding whether to take commercial loans and how to utilise them.

“As long as Nepal receives Official Development Assistance from international donor agencies at a lower interest rate, it is not necessary for Nepal to jump to get commercial loans,” said Acharya, the former auditor general. “Even if the country takes commercial loans, it should accept it in a very limited amount and only after making sure that the rate of return from such projects is higher than loan interest.”

Hira Neupane, information officer at the Public Debt Management Office, says Nepal has not taken loans at interest rates above two percent yet.

“Because of the availability of loans on concessional terms, our debt sustainability situation has remained good so far,” Neupane told the Post. “Expensive loans will raise questions about our debt sustainability.”

According to Neuapne, the government has been more sensitive on the issue of commercial loans because of Sri Lanka’s experiences too.

Multilateral donors such as the World Bank and the Asian Development Bank have long been providing loans at concessional terms because of Nepal’s status as “a low-income country.”

Officials are discussing if loans from multilateral loans will be affected once Nepal graduates to a developing country from the least development country category.

In July 2020, the World Bank upgraded Nepal to a lower-middle income country in its country classification after Nepal’s per capita income reached $1,090.

“After Nepal’s upgrade to a low middle income country, the maximum interest rate to be charged by multilateral donors such as the World Bank and the Asian Development Bank has risen by 0.5 percentage points,” said Pandey. “Still, we should not pay more than 1.75 percent for the loans to be received from these development partners.”

According to him, Nepal should consider the interest rate offered by these multilateral agencies as the benchmark while negotiating loans with foreign countries, including China.

Western bilateral donors mostly provide assistance in grants. Countries like India, China and Japan are providing both grants and loans to Nepal, according to the Finance Ministry. However, the share of loan in total foreign aid has been growing rapidly after multilateral donors gave up providing grants, citing Nepal’s debt repayment capacity in the last few years.

“Despite growing share of debt to GDP, we are not facing a major threat immediately because of the concessional terms of loans,” said Shrestha of the central bank. “But Nepal may have to accept commercial loans too once the country graduates to a developing country from the current status of a least developed country.”

In November last year, the United Nations General Assembly approved a proposal to upgrade Nepal from a least developed country to a developing country by 2026.

A report titled 'Nepal Human Development Report 2020: Beyond LDC Graduation: Productive Transformation and Prosperity,’ has suggested a limited impact of Nepal’s graduation to a developing country in obtaining foreign aid on preferential terms.

“No major adverse impacts on ODA through multilateral financial institutions are likely as their concessional loans are on a Gross National Income per capita basis,” the report says. “Other support mainly through the United Nations system could be adversely affected.”

According to the report, Germany could switch its aid from grants to very concessional credits.

In the case of Japan, the terms of Japanese ODA yen loans will change depending on the recipient country’s income level and projects after graduation.

“For instance, the interest rate may increase from 0.01 percent to 0.25 percent for a medical care project, if the country graduates and is categorised as low income,” the report says. Aid from China, India, Norway, Switzerland and the US are unlikely to change.

“As Nepal’s majority of external loans have been taken from the multilateral donor agencies that do not recognise LDC and developing country categories, the graduation will not make a significant difference in interest rates to be paid to them,” said Pandey.

According to the Public Debt Management Office, as much as 87.37 percent of total outstanding external debt is owed to multilateral agencies as of the second quarter of the current fiscal year.

However, the government is considering conducting an additional study on potential impact on the concessional loans after Nepal’s graduation to the developing country category.

“Considering the Sri Lankan crisis, there has been informal discussion at the Finance Ministry about conducting an additional study on the potential impact of losing concessional loans to Nepal once it graduates to a developing country,” said Neupane of the Public Debt Management Office.

Officials and experts say if Nepal gradually loses low cost loans, it may have to go for commercial loans as the country’s revenue is not enough to finance major development projects.

“After graduation, Nepal may be forced to take commercial loans despite not wishing to do so,” said Acharya. “So I think Nepal decided to graduate to a developing country earlier than needed.”