A country with a low level of public debt, much of it lent by international institutions on generous terms, would not normally be considered at risk of a fiscal crisis. Yet Nepal behaves as though it is on the brink. Its national debt stands at Rs2.72trn ($20.4bn), or about 45% of GDP. That is far less than India’s 83% and a fraction of Japan’s, which tops 250%.
Still, the government in Kathmandu borrows cautiously, underspends on public works and fails to use even the cheap credit offered to it. The problem is not the amount Nepal owes, but the fact that it makes such poor use of its borrowings.
A glance at the country’s debt profile suggests stability. Its obligations are almost evenly split between foreign and domestic lenders. Some 90% of its external debt comes from multilateral institutions such as the World Bank and the Asian Development Bank, which offer low interest rates and long repayment periods. Three-quarters of that is denominated in the IMF’s Special Drawing Rights, a basket of currencies that keeps costs down, albeit with some exposure to exchange-rate shifts. Debt-servicing payments are manageable. The government expects to repay Rs67bn (or 0.22% of GDP) to foreign creditors this fiscal year and has budgeted Rs344bn for domestic payments. Interest costs are concentrated on development bonds, which are intended to fund infrastructure. This all looks prudent.
The reality is less impressive. Although Nepal’s debt is low and its borrowing terms are good, its debt-mobilisation is sluggish. By mid-October the government had raised just 17% of its annual borrowing target (well below the roughly 25% expected pace), mostly from domestic sources. Disbursements from foreign lenders lag even further behind. Government ministries struggle to meet the conditions set by donors, to finish feasibility studies or to manage procurement. Nepal does not want for available capital. It lacks the administrative machinery to make use of it. The upshot is persistent underspending on development.
Domestic debt brings problems of its own. It consists mostly of development bonds (75%) and treasury bills (23%). These are mainly held by commercial banks (80.56%), which regard them as safe assets that provide a reliable return. The public holds very few. This creates a circular flow of money. Banks finance the state, the state pays interest to the banks and credit to private businesses is crowded out. Government bonds offer risk-free returns, which discourages banks from lending to productive but riskier parts of the economy, such as small and medium-sized manufacturers. The consequence is a lazy financial system, flush with cash but lacking dynamism.
The government’s fiscal restraint might look responsible. In a slow-growing economy with high underemployment it is anything but. The insight of John Maynard Keynes was that when private demand is weak, the public sector should borrow and spend to support economic activity until confidence returns. Nepal, with its stagnant private investment and chronic underemployment, fits that prescription. Yet the government borrows mainly to repay old debts. Principal and interest payments exceed new borrowing. This amounts to a disguised form of fiscal contraction, which limits growth and in turn deepens structural stagnation. What looks like discipline is in fact timidity.
The deeper issue is not how much Nepal borrows but how it spends the money. Public projects are often delayed, run over budget or fall victim to political meddling. Many loans are not disbursed because projects fail to meet conditions or reach milestones. Money that is spent often goes on schemes with low returns but high political appeal, such as roads that go nowhere, half-built airports or hydropower plants that stand idle. This wastes the growth that debt-financed investment might have generated. Nepal’s problem is inefficiency rather than fiscal irresponsibility.
Under-borrowing and under-spending in turn mean under-building. Gaps in infrastructure hold back productivity and job creation. Weak public investment also fails to attract private capital. Businesses must contend with high transport costs, unreliable energy and uncertain policies. Private investment remains low. Remittances from Nepalis working abroad are mostly spent or sent overseas, rather than invested at home. Economic transformation is stalled. The cost of caution is high. Each year that cheap credit is left unused means growth foregone, revenue lost and dependence on remittances deepened.
Debt can be a powerful tool for development if used wisely. Nepal should worry less about how much it borrows and more about how well it invests. Priority areas include the transmission and distribution of electricity, which would then allow the country to export hydropower; urban infrastructure, to raise productivity; and education and digital networks, to build human capital. Productive borrowing can increase long-term output and tax receipts, creating a virtuous circle. South Korea and Vietnam have shown how state-led infrastructure spending can stimulate private investment and boost exports. Nepal could follow their examples, if it could spend its borrowings efficiently.
True, borrowing is not without risks. Global interest rates could climb. A weaker rupee would increase the cost of servicing foreign debt. Domestic banks could face liquidity crunches. But these dangers look manageable, given Nepal’s access to cheap multilateral credit and its stable external position. The bigger threat is complacency: the mistaken belief that low debt is a sign of fiscal virtue and that low spending is the same as prudence. Fiscal space is not infinite but it does no good unused. ■
