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OP-EDs and Columns

Public debt paradox


The opinion piece originally appeared in The Kathmandu Post on 2 February 2023. Please read the original article here.

The modern globalised ecosystem has increased public debt due to changing economic and political circumstances. Handling public debt goes hand in hand with an effort to balance those circumstances. Public debt is a domestic or foreign loan issued by a government, which remains a viable option to support government spending, and development initiatives, for which the government lacks funding. Owing to economic complexity and the Covid-19 pandemic, government spending has recently increased more quickly than its capacity to generate revenue. With interest rates skyrocketing, the rising debt severely impacts the budgets of developing countries that must invest in their economies.

Nepal started budgeting in 1951, taking debt 11 years after the budgetary practice began. The history of our public debt is not very old. The government started taking domestic loans in 1962, while foreign loans were only accepted beginning in 1963. Post-earthquake and transition to federalism, Nepal’s public debt has increased over the past several years, reaching 42.2 percent of GDP in fiscal 2019-20 from a progressive reduction of 25 percent of GDP in fiscal 2016-17. The impact of Covid-19 and responses to it are responsible for the significant increase in fiscal 2019-20. The debt-to-GDP ratio for Nepal stood at 39 percent in fiscal 2020-21. Due to Nepal’s access to concessional funding (grants or loans less than 2 percent with long repayment periods) from multilateral institutions and foreign countries, its foreign debt servicing needs are low. As per the World Bank, Nepal’s debt distress risk is rated low for both external and total debt. The International Development Cooperation Policy (2019) allows Nepal to obtain a foreign commercial loan, but Nepal has yet to utilise this opportunity. The country needs to be careful while borrowing large commercial foreign loans with highinterest rates.

The impact of public debt on Nepal’s economic growth, examined by the journal Public Debt and Economic Growth of Nepal utilising data from 1978 to 2020, indicates no clear link between public debt levels and economic expansion. The limited revenue sources have resulted in a rise in government spending more quickly than government revenue. The government has borrowed money primarily for weak areas, leaving it cash-strapped and forcing it to take out another loan to repay the previous ones. Some of the current capital loan money is in the stock market and land. Due to insufficient domestic resource mobilisation, excessive fiscal deficit, export-import imbalance, and gaps in revenue and spending, the external debt has worsened. Thus, some authors argue that deficit financing should not be considered as long as there is sustained economic growth and the possibility of encouraging investment rather than discouraging it. Furthermore, there has been no improvement in the country’s capability to repay debt; there has only been an increase in overall public debt and interest.

It is also crucial to analyse the country’s debt condition in light of its foreign exchange reserves. The depreciation of the Nepali rupee against the US dollar has increased Nepal’s debt liability in local currency terms. Foreign currency debt payments may become more challenging at a time of shrinking foreign currency reserves and rising government borrowing from foreign creditors. Nepal’s foreign direct investment (FDI) is the lowest in the region at 0.5 percent of GDP. The impact of lowering the FDI threshold to Rs20 million will further decrease the inflow of FDI. Further, capital flow restrictions may have negative effects on GDP, but FDI offers the extra benefit of not increasing the nation’s debt and relieving strain on foreign exchange reserves. The government should put in place long-delayed FDI reforms, such as simplifying regulatory approval processes, which would lead to foreign currency inflows and spur the transfer of capital and technology to boost growth.

Lesson from Bangladesh

Thanks to a robust economy and a stable government, Bangladesh has avoided relying on foreign forces for domestic survival. Three factors—exports (second largest clothing exporter), remittances (one of the biggest recipients), and fuel prices (relies on imported fuels)—together account for the majority of the economic health of the country. But these factors are in jeopardy due to a global economic slowdown that is particularly destructive in developing nations. Bangladesh has less money to import fuel as exports fall and prices rise simultaneously. It has decided to postpone non-urgent projects and expressed concerns about a growing trade deficit and a decline in remittances.

However, Nepal’s exports are not as strong as Bangladesh’s, and will be less affected by the global slowdown. The government of Nepal is making several efforts to boost foreign reserve exchange. To stop the mounting debt, the newly passed Public Debt Management Act set a limit on external debt at one-third of the GDP. This measure is intended to prevent the government from borrowing carelessly and motivate it to pay down its debts on schedule so it can borrow more money in the future. Nepal also came up with a slew of measures to ban imports of luxury goods to prevent the depletion of its foreign exchange reserves and ended the ban as foreign reserves rose. These underlying traits will continue to shape how Nepal and Bangladesh react to the current global upheavals, including growing prices, impact on remittances, and widened trade imbalance.

State institutions in Nepal are fragile and continue to have problems with checks and balances. The government will struggle in 2023 to stop tax evasion and broaden its revenue base, increasing its need for public borrowing. With a new government in place, synchronising fiscal and monetary policy should ease liquidity shortage to fuel investment in productive sectors. A significant issue with the democratic history of Bangladesh is the absence of robust and viable opposition. Despite political hiccups and mounting public debt, Bangladesh has made commendable economic progress. Nepal and Bangladesh are unlikely to have the same situation as Sri Lanka if their policy measures successfully utilise public debt, and balance national goals and domestic capabilities.

Addressing structural barriers

Building on prior accomplishments and addressing structural barriers will help to accelerate growth, attract private investment, boost productivity, and develop climate resilience to successfully graduate from the least developed country’s (LDC) status and achieve lower middle-income status by 2026. Nepal’s plan for economic growth and how trade, infrastructure, exchange rates, and other economic policies can help with economic development is still unclear. The growth potential will be increased by fostering an environment, encouraging trade and foreign direct investment, growing the financial sector, building human capital, and enhancing good governance. The country must spend the borrowed funds wisely and enact programmes to reduce debt. As Nepal plans to leave the LDC status in 2026, it is crucial to leverage the advantage of a lower interest rate with a long repayment period of borrowed funds. It should then work towards building a sustainable economy by investing in productive sectors with high-efficiency levels to repay the loans over time.

Research Commentaries

NRC0008 – Understanding and Correcting Nepal’s Widening Trade Deficit

Understanding and Correcting Nepal’s Widening Trade Deficit

Prashanta Pradhan


While trade deficit is not necessarily viewed as a problem, they tend to raise serious concerns when trade deficit persistently widens for almost two decades as in Nepal. Nepal’s trade deficit emerging from persistent growth in imports that largely cater to consumption accompanied by budget deficit cannot be ignored. The Trade Policy 2015 specifies one of the objectives as reducing trade deficit by enhancing supply side capacity. Nepal’s Monetary Policy 2019 as well as the Budget Speech of Fiscal Year 2019/2020 underscore the need to correct the trade deficit.

Nepal’s trade deficit in numbers

International Trade Centre (ITC)’s statistics indicate that trade deficit peaked in 2018 at USD 9.5 billion which is 8 times or 725 per cent higher than in 2003 when it was USD 1.15 billion. Since then, the number has only widened. The recent macroeconomic situation report published by the Nepal Rastra Bank (central bank of Nepal) indicated that in the first eleven months of the last fiscal year from mid-July 2018 to mid-June 2019, trade deficit widened by 17.2% as compared to the previous year.

Nepal’s imports have grown consistently except for a minor slump in 2015. There has been nearly six-fold increase in imports from USD 1.8 billion in 2003 to 10.2 billion in 2018 whereas while exports have increased but only marginally at 13%. In 2003, Nepal exported USD 652 million compared to USD 732 million in 2018.

Causes of trade deficit in Nepal
  • Firstly, the surge in imports have been driven by strong domestic demand for private consumption fueled by remittances from overseas and expansionary monetary policy coupled with weak manufacturing base. The share of remittances to GDP was 28% in 2018. The current monetary policy tends to be expansionary with the limit for growth of broad money (M2) set at 18% and domestic and private sector credit growth rates projected at 24% and 21% respectively. Large pool of inward remittances and increase in money supply in the context of weak manufacturing base have led to an increase in imports of inputs and capital goods driven by construction and consumer goods to meet domestic demand for private consumption. Moreover, Nepal suffers from a weak manufacturing base. As per the World Bank, the value added of services is 50% of GDP, the share of manufacturing was only 5% and including construction was 13% of GDP which added extra demand for imports of capital as well as consumer goods.
  • Secondly, poor export competitiveness along with non-tariff barriers to trade have led to poor export development. Nepal Trade Integration Strategy (NTIS) 2016 identified 12 priority goods and services for export promotion based on criteria of export performance as well as inclusive and sustainable development. The export basket is concentrated in terms of products as well as markets. While the volume of exports has been increasing, the share of markets other than India is relatively low. Nepal enjoys preferential tariffs in major international markets through multilateral, regional and bilateral agreements to which Nepal is a party including India-Nepal Treaty of Trade, South Asian Free Trade Agreement, Generalised System of Preferences, Everything But Arms etc. Most of the export products including priority products in NTIS, face non-tariff barriers. For example, sanitary and phyto-sanitary (SPS) related barriers on agricultural products, technical barriers to trade (TBTs) in manufactured goods and regulatory requirements on services. Hence, the competitiveness of Nepalese exports is hindered leading to low volume of exports. Nepal’s export development is also hindered by higher costs of moving goods across borders. Nepal scored 77.17 in Trading Across the Border by the World Bank which is higher than the South Asian average of 62.57 but lower than Bhutan (94.25) and India (77.46).
  • Thirdly, lack of adequate financial inflows have contributed to trade deficit. Although remittances account for a major share of GDP and help fund the trade deficit, with only marginal increase in exports, remittances cannot cope up with the immense volume of rising imports. Moreover, uncertainty of inflows of remittances due to changing regional and global economic dynamics poses concerns over the volume and sustainability of trade deficit.
Impact of Trade Deficit on Foreign Exchange Reserves

Increasing trade deficit has caused loss of foreign exchange reserves. As per the available data, as of mid-June 2019, gross official foreign exchange reserves held by the central bank was USD 9.25 billion whereas a year back, it was USD 10.08 billion. On the basis of the first eleven months of imports of 2018/19, existing foreign exchange reserve is sufficient to cover merchandise imports of only 8.8 months and merchandise and services imports of 7.7 months as compared to 16.8 and 14.3 months respectively in 2015/16.

Correcting Nepal’s trade deficit
  • Export Diversification: One of the objectives of Nepal’s Trade Policy 2015 is to reduce trade deficit by enhancing supply side capacity. Export diversification shall play a major role in expanding export opportunities of Nepal and reducing trade deficit. Earlier in the week, The Kathmandu Post reported that as an effort to trim the trade deficit, the Ministry of Industry, Commerce and Supplies has identified 28 goods for export promotion which is broader than the list identified in NTIS 2016. The updated list includes medicinal and aromatic plants, black cardamom, ginger and tea, leather products, footwear, readymade garments, pashmina and hand knotted carpet under items with a high comparative advantage. The International Trade Centre’s Export Potential Map shows Nepal’s export potential markets with USD 221.9 million untapped potential with India, USD 45.5 million with China, USD 30.6 million untapped potential with the United States, USD 17.2 million with Germany, for example. Moreover, diversification and development of services sectors could be an important opportunity for Nepal to increase exports. Being a landlocked mountainous country, the geographic obstacles of trading across border shall be easier in services. On the other hand, services sector contributes directly to respective sectoral GDP and employment as well as inputs to other sectors while some services like health and education have a direct impact on sustainable development.
  • Trade Facilitation to reduce Trade Costs: Nepal ratified the World Trade Organisation’s Agreement on Trade Facilitation (TFA) in 2017. The TFA includes provisions for expediting the movement, release and clearance of goods, including goods in transit involving cooperation between authorities on customs and other areas of trade facilitation. Full implementation of TFA in Nepal could reduce trade costs by 13.9-15.8%. Nepal is implementing the Customs Reform and Modernisation Strategies and Action Plans 2017-2021 aiming to reduce compliance costs and time, helping risk management and export promotion, among others. Additionally, Nepal is also part of the South Asia Subregional Economic Cooperation programme for Customs Reform and Modernisation for Trade Facilitation Programme 2017-2021. Timely and effective implementation of trade facilitation measures shall reduce the non-tariff costs of trade and promote exports.
  • Increasing foreign inflows: Remittances have been largely offsetting trade deficits. However, remittances also bear the risk associated with global economic volatilities. Hence, Nepal should enable a favourable environment to attract more foreign investments along with remittances to ensure there are adequate inflows to finance productive activities as well as support trade balance. To the extent possible, care should be taken to ensure that such foreign investments also bring transfer of technology and knowledge while building responsible business models.
  1. International Trade Centre. (2019). Trade Map – International Trade Statistics.
  2. Khanal, R. (2019, August 21). Ministry moves to expand the export basket to trim trade deficit. The Kathmandu Post. Retrieved from https://kathmandupost.com/money/2019/08/21/ministry-moves-to-expand-the-export-basket-to-trim-trade-deficit
  3. Ministry of Commerce, Nepal Government. (2016). Nepal Trade Integration Strategy. Retrieved from http://www.fncci.org/uploads/publication/file/NTIS_2016_20161004020748.pdf
  4. Nepal Rastra Bank. (2016). Monetary Policy for 2016/17. Retrieved from https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)–2016-17_(Full_Text).pdf
  5. Nepal Rastra Bank. (2019). Current Macroeconomic and Financial Situation of Nepal. Retrieved from https://www.nrb.org.np/ofg/current_macroeconomic/CMEs%20Eleven%20Months%20English%202075-76-Final.pdf
  6. Nepal Rastra Bank. (2019). Current Macroeconomic and Financial Situation of Nepal (Based on eleven months’ data of 2018/19). Retrieved from https://www.nrb.org.np/ofg/current_macroeconomic/CMEs%20Eleven%20Months%20English%202075-76-Final.pdf
  7. Nepal Rastra Bank. (2019). Monetary Policy for 2019/2020. Retrieved from https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)–2019-20_(Full_Text)-new.pdf
  8. World Bank. (2019). Doing Business 2019: Nepal. Retrieved from https://www.doingbusiness.org/content/dam/doingBusiness/country/n/nepal/NPL.pdf
  9. World Bank. (2019). World Bank Data. Retrieved from https://data.worldbank.org/indicator/BX.TRF.PWKR.DT.GD.ZS
  10. World Trade Organization. (2017). TFA Factsheet. Retrieved from https://www.wto.org/english/tratop_e/tradfa_e/tfa_factsheet2017_e.pdf