Understanding Nepal’s Public Debt and Fiscal Deficit: Challenges and Pathways Forward
Nepal is a landlocked country in southern Asia, and suffers from a plethora of economic challenges, the least of which is rising public debt and continuing fiscal deficits. As a developing economy, with its debt levels embarking on a path towards risks to its financial stability and development, Nepal is struggling to lower its debt load, especially as a country that heavily relies on imports, remittances and foreign aid. In this article we look into the details of Nepal’s public debt as well as fiscal deficit elaborating about the causes, impacts and forecasting the remedy for the same.
1. Overview of Nepal's Public Debt and Fiscal Deficit
Public Debt
Total amount of money that the government owes to domestic and international creditors is public debt. It covers both internal debt (debt to domestic issuers, financial institutions) and external debt, debt to foreign issuers and institutions. Public debt of Nepal stood at approximately NPR 2.23 trillion as of the end of 2023, about 40% of Nepal’s GDP. The concern is that this growth hasn’t kept pace with the country’s economy, and in the long term, they are burdensome to service without pinching resources or choking off economic growth.
Fiscal Deficit
Fiscal deficit happens when government expenditure goes beyond its revenue. The fiscal deficit has been a longstanding problem in Nepal, averaging around NPR 265 billion for the fiscal year 2022/23 (around 5% of GDP). The country has been stuck in a vicious cycle of debt with an even more difficult ending because of persistent fiscal deficits that forced Nepal to borrow more.
The drivers of fiscal deficits in Nepal’s case include funding of infrastructure projects, public service programs and programs for post disaster recovery (For instance. 2015 Earthquake recovery programs). But, with few sources of revenue, the country has often depended on external borrowing to finance this gap, increasing public debt and making the country more vulnerable to cyclical fluctuations of the external economy.
2. Key Drivers of Nepal's Public Debt and Fiscal Deficit
The major factors contributing to the rising public debt and fiscal deficit are:
a. Limited Revenue Base
Total government revenue in Nepal is largely derived from indirect taxes including customs duties and VAT, as a share of total revenue. The presence of a narrow tax base and high levels of informal employment restrict income tax collection, making it less than expected. For this reason, the government has to resort to external borrowing to meet up with its spending needs.
b. High Reliance on Imports
Nepal’s economy is highly import dependent with dependence on imports for essential goods like fuel, construction materials and consumer goods resulting in a trade imbalance of currency outflows and pressure on national reserves. Nepal's trade deficit for 2023 was recorded at about NPR 1.4 trillion, and such a gap has proved to be difficult to address. There are also fluctuations in global price of these goods which will turn out to be another burden for Nepal’s economy and a dent on Nepal's government revenue.
c. Post-Disaster Reconstruction
In 2015, the earthquake caused extensive damage to infrastructure, homes and public services requiring lots of reconstruction funds. The spending they had to go through to rebuild and recover was disproportionate and the government had to borrow more in order to pay. While many rebuild projects are stunted by bureaucratic delays and high costs, even as of 2024, Nepal continues to finance the rebuilding efforts.
d. Infrastructure Development Needs
Being a developing nation, Nepal has successfully used infrastructure projects to drive economic development and create connectivity. Investments in recent years, beyond hydropower projects such as the 456 MW Upper Tamakoshi Project, include improved road and airport infrastructure. These are necessary projects for long term growth, however, the initial costs and operational costs often can’t be covered without borrowing, adding to public debt. The best example would be Pokhara International Airport which was funded by the Chinese Exim Bank, where the bank provided Nepal with a preferential loan of about US $215 million to finance the construction of the airport.
e. Political Instability
Inability of economic reforms and also effective policy implementation has been hampered due to political instability in Nepal. In the past few years, Nepal has witnessed several coalition governments and at least one of them had an economic agenda point that was slow or which reversed an ongoing economic initiative. This instability has deterred foreign investment, so that government borrowing is needed to finance economic activities.
3. The Impact of Rising Public Debt and Fiscal Deficit
a. Debt Servicing Costs
The more public debt grows, the higher are costs to service such debt — the cost paid for interest and repayment of principal amounts. Debt servicing to Nepal’s annual budget was roughly over 15 % for the FY 2022/23. This is a vicious cycle; high debt servicing costs can lead to the government having to borrow even more to pay out of debt obligations. It only makes matters worse.
b. Reduced Investment in Public Services
If a significant portion goes into paying for debt servicing, it doesn’t allow the government to spend on public services, reflecting the high opportunity cost of debts. That means the Ministry of Education, Healthcare, etc and its agencies won’t receive the same funding that it has always enjoyed, which means areas like education, healthcare and social welfare schemes will be starved of funds. This adversely impacts the well being of the people and further stops long-term economic growth.
c. Vulnerability to External Shocks
Nepal has been so dependent on external borrowing that it is now vulnerable to changes related to global interest rates and foreign exchange rates. The cost of international debt servicing, one of Nepal’s biggest expenses, has also surged in to 402.85 billion which is 21.65 percent of the budget for FY 2024/25, and rising global interest rates play a significant role, which puts further pressure on repayment of debt and increases the likelihood that debt will go into default or be restructured. This can evacuate investor trusts and complicates Nepal's future dealing terms.
d. Inflation and Currency Depreciation
If it’s a persistent fiscal deficit, there are inflationary pressures because to spend substantial money, the government needs to print money or increase domestic borrowing to facilitate that spending. Nepal’s inflation rate in 2023 was around 7.11 per cent on account of rising global fuel and other imported prices. However, it was reduced to 3.85% in September 2024. Nevertheless, currency depreciation raises the price of imports, and reduces the capacity to purchase goods and services.
4. Strategies for Managing Public Debt and Reducing the Fiscal Deficit
a. Expanding the Tax Base
One effective approach to address the deficit is by enhancing government revenue. Tax collection methods in Nepal could broaden its tax base by legitimising the significant informal economy sector and enhancing adherence to tax laws while introducing progressive income tax adjustments. Also, instituting a just and effective property tax system might offer the government a consistent source of income since there’s potential for significant and consistent tax revenue from properties.
b. Promoting Domestic Industry and Reducing Imports
Government should boost industries and reduce reliance on imports which could ease the trade shortfall. Also, we should decrease the necessity for borrowing from abroad through investments in agriculture, small and medium enterprises (SMEs) and sustainable energy sources such as hydropower. This can bolster self-reliance, promote employment opportunities and curtail currency outflows.
c. Enhancing Debt Transparency and Accountability
In order to handle debt better the government needs to be transparent and accountable in how they borrow money. Creating rules for managing debt, performing audits and guaranteeing general public access to information can establish trust and avoid misusing borrowed funds.
d. Encouraging Foreign Direct Investment (FDI)
Attracting investments from overseas can help lessen the reliance on government loans by introducing funds for development initiatives in Nepal. The country could boost its appeal to investors by enacting policies that're favourable to them and streamlining bureaucratic processes while also focusing on enhancing infrastructure and ensuring political stability.This surge in investment would not just spur development but also lead to a gradual alleviation of the nation's debt burden.
e. Debt Restructuring and Seeking Concessional Loans
When there's already debt in place, restructuring the debt might be needed to ease the burden of repayments. The government could discuss extending repayment timelines or look into getting loans from financial institutions that usually offer lower interest rates and better conditions. These tactics could give Nepal some space to concentrate on boosting its economy of repaying debts.
f. Efficient Use of Borrowed Funds
It's essential for the government to make sure that borrowed funds are used effectively and channelled into investments that generate returns. Establishing a monitoring and evaluation framework for projects financed with borrowed funds can mitigate corruption risk. State agencies must minimise wastage while ensuring that investments support sustainable economic development in the long-run.
5. The Role of International Assistance and Multilateral Support
Nepal faces challenges, with its debt and fiscal deficit situation; therefore international support could greatly help ease the country's economic struggles. Organisations such as the International Monetary Fund (IMF) and the World Bank are actively offering low interest loans and expert guidance to assist with restructuring and enhancing capabilities. As an example of this partnership in action, in 2023, the IMF granted Nepal a $52 million loan to aid in pandemic recovery efforts and fiscal improvements.
Moreover international assistance from countries can be targeted towards sectors like healthcare, education and infrastructure to lessen the reliance on both local and international borrowing. Nevertheless it is crucial to guarantee that foreign aid supports Nepal's development objectives without imposing terms that could result in weaknesses or lead to debt traps as seen in Sri Lanka’s Hambantota Port or Pakistan’s Gwadar Port.
Conclusion
The growing public debt and ongoing fiscal deficit in Nepal pose hurdles to the country’s stability and development prospects. Meeting these challenges demands a strategy that involves broadening the tax base to support businesses, fostering transparency in debt management, promoting foreign direct investment and ensuring prudent utilisation of borrowed resources. Although these measures can contribute to addressing Nepal's debt and deficit issues over time the importance of stability and consistent policy execution cannot be overstated.
As Nepal progresses on its path towards advancement, finding the right equilibrium between required borrowing and financial prudency is crucial. By implementing strategies for managing debt and introducing changes Nepal can establish a groundwork for long term economic progress, enhance public services and lessen its reliance on external borrowing. Eventually, Nepal can effectively end up accomplishing a sturdier and self-sufficient economy.