The latest IMF-IDA debt sustainability analysis (DSA) shows that Nepal faces a low risk of debt distress. In 2012 DSA, Nepal was categorized as facing moderate risk of debt distress. At the outset, the DSA is used mainly by multilateral development banks to determine if a low income country needs either concessional/soft loans only or grants only or a combination of both. They conduct country economic, social, policy and institutional reform and capacity assessments independently and the resulting composite score (threshold) is ultimately evaluated against the various debt scenarios/simulations and the corresponding debt distress classification. Now that Nepal has been categorized as facing low risk of debt distress, multilateral development banks might move to providing concessional/soft loans only (and the allocations/commitments may increase depending on the public expenditure performance of the country).
Nepal’s public debt is about 30% of GDP, almost half of the level held a decade ago. The low risk of debt distress is attributed mainly to the reduced estimates of the cost of a potential financial sector shock and the increase in the discount rate used (5% for all LIC DSAs). This was underpinned by prudent fiscal policy and low execution of capital expenditure budgets. The low debt distress also means that Nepal has plenty of room to boost capital expenditure (or fiscal space) despite running a modest fiscal deficit.
Highlights from the DSA July 2014:
- Under the baseline scenario, Nepal’s external debt indicators remain well below indicative sustainability thresholds. Under the baseline, the ratio of public debt to GDP rises modestly by the end of the projection period.
- Debt dynamics remain resilient to standard shocks. These stress tests include shocks to GDP growth, exports, non-debt creating flows, and a combination of these shocks, as well as a onetime 30% nominal depreciation shock in 2015 (the most extreme shock).
- Under the most severe shock (to non-debt creating flows, capturing a remittance shock), the PV of debt to exports + remittances rises rapidly over the next 2 years but stays below the threshold, and thereafter declines again, while all other indicators remain well below the thresholds.
- In the context of the PV of public debt-to-GDP ratio, the most extreme shock is a 30 percent one-time depreciation in 2015, which does not lead to a breach of the threshold.
- The 10 percent of GDP increase in debt creating flows shock mimics a financial sector shock leading to domestic debt-financed bank recapitalization needs. The recapitalization needs for the entire banking sector (public and private) from a financial sector shock in which nonperforming assets increase by 2 percentage points (implying a 50 percent increase) could amount to 4¾ percent of GDP.
- Contingent liabilities arise mainly from the operations of state owned enterprises (SOEs), and rising pension costs need to be addressed to head off future risks.