A potential public debt crisis is building in Nepal. The risks stem from the government’s increased use of debt without adequate focus on policy reforms or productive investments, which are essential for long-term growth.
There isn’t much that donors can do directly about government’s domestic borrowing. But on external debt, donors, particularly the World Bank and the Asian Development Bank, Nepal’s largest lenders, must do more to hold the government to account on policy reforms, and ensure that debt is correctly deployed to enhance productivity and competitiveness.
Nepal has had plenty of one-off reasons to borrow in recent years: rebuilding after the devastating earthquake, financing the federal structure, and now the pandemic. All this in addition to its large ongoing needs for infrastructure and investments.
By the first half of the current fiscal, Nepal’s total public debt (domestic and external combined) had increased to Rs 1.5 trillion, approximately a three-fold increase over the past five years. Public debt-to-GDP ratio is projected to be around 43 percent by the end of the fiscal year.
Current projections suggest that debt-to-GDP could climb to about 49 percent by 2025, perhaps even marginally above 50 percent if economic growth turns out lower than expected. But these levels are well below Nepal’s benchmark debt carrying capacity of about 70 percent debt-to-GDP that the International Monetary Fund (IMF) set in April 2020. The IMF concluded that Nepal remained at low risk of debt distress, well below their indicative threshold values, even under stress tests.
Nepal’s robust debt carrying capacity masks a vulnerable darker side.
The growth in public debt has not correspondingly resulted in policy reforms that enhance domestic productivity, competitiveness, and economic growth. Over the first half of the fiscal, for example, approximately 85 percent of development assistance (loans and grants) were allocated to roads, governance, and energy. Across these segments, it is hard to find meaningful reforms.
On roads, for instance, increased expenditures have not translated into kilometres on the ground. Transport costs and connectivity constraints continue to impair trade and commerce. On governance, the nexus between the state and contractors has hardened. Accountability, and transparency have degenerated. A large part of road construction budget goes to local governments, where planning, design, oversight, and fiduciary control nearly absent. Nepal’s marquee road project, the fast track, is being led by the army—really, what more is there to say!
The story about the energy sector is the same. Money has merely amplified the government’s monopoly in the sector. Donors have whitewashed the challenges in the sector, mistaking the government’s unrealistically ambitious plans as signs of opportunities. This is a sector is deep distress, where reform efforts to increase consumption, diversify energy sources, export electricity, enhance energy security, and integrate private sector have stalled.
Without policy reforms that enhance domestic productivity and competitiveness, how will Nepal repay its public debt? Its tax base is already heavily reliant on consumption expenditures, which accounts for approximately 60 percent of all revenues. The tax base growth is slowing down, declining from an annual growth of about 70 percent five years ago to near zero this year. All of this puts additional burden on remittances from Nepalis working abroad that are now the only real income source available to finance debt. The social costs of relying on remittances to repay debt and finance the economy are staggering.
The government’s access to public debt, particularly external borrowing, without having to deliver on reforms has also magnified the importance of political power. The government is the only game in town. The nature of debt and development funding is, in part, enabling this. Appropriately 85 percent of development assistance (loans and grants) is now channelled through the government’s budget. In just two years, between 2018 and now, the portion of donors’ budgetary support doubled to 30 percent.
Channelling development investments almost entirely through government budgets would be fine if governments were selecting enough productive projects or undertaking meaningful reforms. But they are not. The ability to sustain patronage through projects financed by public debt has intensified political rivalry and marginalized change-makers seeking to build pressure for reforms.
Even the wealthiest gamblers will eventually go broke if they continue to place senseless bets. Financing debt without adequate policy reforms is a bit like financing the gambler. Nepal’s external lenders must ensure that their loans are meaningfully employed to enhance productivity, competitiveness, and growth.