Nepal’s outstanding debt grew by 7.33 percent in the third quarter of the current fiscal year in the wake of continuous devaluation of the rupee against the dollar and costly domestic debt amid rising borrowing by the government.

Although the country received external debt only in limited amounts during the first three quarters of the current fiscal year, the debt liability in domestic currency terms surged due to depreciation of the Nepali rupee.

Since the end of the second quarter, the value of external debts has risen by 2.89 percent to Rs976.45 billion while domestic debt increased by 12.72 percent to Rs 879.15 billion, according to the latest third quarterly report on public debt released by the Public Debt Management Office.

The country’s overall outstanding debt reached Rs1.85 trillion, or 38.25 percent of the GDP, as of mid-April, according to the report.

“Although the size of the debt is on the rise in recent years, Nepal’s debt to GDP ratio is still sustainable,” said Prakash Kumar Shrestha, chief of economic research department at the Nepal Rastra Bank. “We can still absorb more debt. But to be able to repay the loans in the long term, we have to invest the debt money in productive sectors.”

According to the International Monetary Fund, Nepal witnessed a gradual decline in the debt to GDP ratio from 35 percent in the fiscal year 2011-12 to 25 percent in the fiscal year 2016-17, in a sign of improving economic health. But after the country’s transition to fiscal federalism, Nepal’s public debt rose over the last several years with the ratio reaching 42.2 percent in the fiscal year 2019-20.

The substantial increase in debt in the fiscal year 2019-20 is driven by the impact of—and responses to—the Covid pandemic, according to the IMF.

“But, the country’s debt liability (principal and interest) is on the rise due to devaluation of the domestic currency against the US dollar as well as rising interest rates on domestic debts,” said Shrestha.

In fact, if Nepal decides to clear all foreign debts now, then it will have to pay an additional Rs19.37 billion in domestic currency terms compared to the end of second quarter of the current fiscal owing to the rupee depreciation, according to the Public Debt Management Office.

This exchange rate loss was calculated based on differences in the exchange rates of Nepali currency against the US dollar on January 15 and April 13. On January 15, the exchange rate was Rs118.95 per US dollar and this had risen to Rs122.12 per dollar on April 13.

Hira Neupane, information officer at the Public Debt Management Office, said that the country had to pay more for loan instalments due to the rupee devaluation.

“And Nepal will have to pay even more in the fourth quarter because the currency depreciation is still continuing.”

The Nepali rupee plunged to an all-time low of Rs125.16 against the dollar on Tuesday, according to the Nepal Rastra Bank. Neupane, however, said that despite the rapid depreciation, the situation is still below the dangerous levels.

“We are still in a comfortable position in terms of the debt to GDP ratio, and interest rates on our external loans, which are long-term ones, are also minimal,” he added. Experts say it would not be unsafe for a country like Nepal to increase the debt to GDP ratio up to 60 percent.

As depreciation of domestic currency has emerged as a major concern for external debt, domestic debt is also on the rise as the country has been borrowing more at home than from abroad.

Nepal borrowed a total of Rs111.68 billion in debt between the start of the current fiscal year and the third quarter. Of this sum, only Rs12.21 billion is from external sources and the remaining Rs99.47 billion is from internal sources.

Between the end of the fiscal year 2014-15 and the last fiscal year 2020-21, domestic debt increased four times to Rs802.94 billion, according to the Public Debt Management Office.

“External loans are relatively cheaper than domestic ones although there is always the risk of foreign exchange fluctuations associated with foreign loans. But the interest liability towards domestic debts is more than that of foreign debts owing to higher interest rates,” said Shrestha.

For example, Nepal paid Rs1.39 billion in interest to external creditors in the third quarter, while Rs6.14 billion was paid to internal creditors although the total value of domestic loans is less than that of external loans.

Interest rates of domestic loans have risen due to the shortage of loanable funds at the banks and financial institutions, which are major creditors to the government. Banks and financial institutions buy government securities in the form of treasury bills and bonds. In fact, Finance Minister Janaran Acharya himself admitted that the government had to increase the recurrent budget for the next fiscal year owing to the need to repay more to domestic creditors in the next fiscal year.

For example, the government has allocated Rs59.79 billion for principal repayment of development bonds that are maturing next fiscal year, up from revised projected principal repayment of Rs17.1 billion, according to the Finance Ministry. According to the Ministry, the government has allocated Rs54.14 billion alone for paying interest on loans for the next fiscal year.

The government has allocated Rs43.73 billion and Rs10.41 billion for paying the interests on domestic and foreign loans, respectively.

Responding to the issues raised by lawmakers in parliament in early June, Minister Sharma said, “Compared to the current fiscal year, more funds will be needed for principal repayment for internal loans in the next fiscal year. Internal debts are maturing next fiscal year and the government has to pay as much as Rs50 billion in principal repayment.”