A STUDY ON PUBLIC DEBT IN NEPAL

A Proposal Submitted to

Central Department of Department of Economics,

Tribhuwan University, Kirtipur, Kathmandu,
In Partial fulfillment of the Requirements

For the degree of

MASTER OF ARTS
In
ECONOMICS

Submitted by
Usha
Roll no:
TU Regd. No:

TABLE OF CONTENTS

CHAPTER I

INTRODUCTION

1.1 Background of the study

1.2 Statement of the problem
1.3 Objectives of the study
1.4 Significance of the study

CHAPTER II

LITERATURE REVIEW

2.1 Review of theoretical concepts

2.2 Review of International Empirical Studies

2.3 Review of National Empirical Studies

CHAPTER III METHODOLOGY

REFERENCES

CHAPTER I
INTRODUCTION

1.1 Background of the study

Public debt is the accumulated loan taken by the government either from domestic sources or
external sources or both. In other words, public debt refers to loans raised by a government
within or outside the country. Almost all governments face budget deficit due to high
expenditure and fewer revenues. Borrowings for the government may become necessary in
terms of budgetary deficit, economic crisis and emergency. This may be the case of
developed, underdeveloped and developing economies. Governments can get revenue by
increasing taxes, printing money, domestic or external borrowing and using previous budget
surplus. When the government decides to borrow instead of introducing additional tax
measures, to finance the budget deficit, it creates a liability on itself known as public debt.
Government follows debt financing because it provides a relief to the current taxpayers and
shift the burden of present tax to future generation reducing further the political costs of the
government.
The public debt or public borrowing in Nepal is considered to be an important source of
income to the government. In Nepal's government finance, the public debt is of different types
and kinds. The public debt may be raised both internally and externally. The internal debt, also
named as national or domestic loan, refers to the public debts floated within the country, while
external debt, also named as foreign or international loan, refers to the public debts floated
outside the country. Thus the domestic debt, that is, owed to bondholders and banks within the
country, or external, that is, owed to foreign governments, multilateral or bilateral institutions,
and/or individuals.
Public debt has played an important role in financing overall budget deficit and public
development expenditures. Public debt has been used in Nepal as a regular mechanism of
deficit financing since last few decades. Growing public debt is a worldwide phenomenon. It
has become a common feature of the fiscal sectors of most of the economies. Almost all
developing countries are under minor or high public debt situation. Economists do not

consider public debt a major problem; rather problem is the mismanagement and unsustainability of the public debt.
Therefore, debt sustainability is primary requisite for macroeconomic stability and persistent
growth of an economy. Usually, high stock of public debt create funds outflow which could
crowd out highly required public expenditure. Public debt becomes unsustainable, if it rises
persistently as percentage of GDP or if debt servicing starts absorbing the resources of
economy. An assessment of public debt sustainability depends upon trend in interest rate,
growth rate of economy, revenue and expenditure of government and etc. Sustainability of
public debt becomes more important when debt servicing reaches to the level of government
revenues.
The public debt management of any country is an important task for the overall economic
management. Public debt management is the process of establishing and executing a strategy
for managing the governments debt in order to raise the required amount of funding, achieve
its risk and cost objectives, and to meet any other sovereign debt management goals the
government may have set, such as developing and maintaining an efficient market for
government securities (IMF and World Bank, 2003).
Ministry of Finance (MOF) is responsible for the management of countrys overall public debt
management in Nepal. The domestic debt management of Nepal is done by Nepal Rastra Bank
through various debt management instruments. The public debt of any country can be
managed through use of external as well as domestically available funds. The domestic debt
management is usually done by the government through assistance of central banks. Various
government securities are issued and managed in order to assist the government to raise debt
useful for short, medium and long term.
Financial Comptroller General Office (FCGO) under the Ministry of Finance (MOF) is the
main government agency responsible for treasury management of the Government of Nepal.
FCGO is mandated in undertaking several functions in the areas of public financial
management. Of which, public debt management is one of the core function of FCGO. The
structure of the government finance in Nepal clearly indicates the important role of public
debt, both internal and external, in meeting the resource gap. Public debt has been used in
Nepal as a regular mechanism of deficit financing since last five decades. Public debt
management comprises of projection for debt requirements, receipt of debts, utilization of
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debts, repayment of debts (principal plus interest) and maintaining of records of the receipt,
repayments and liabilities thereof.
Whether the domestic public debt is sustainable for absorbing the risks over long term is a
complex issue for any country. For country like Nepal, the budget is structured in such a way
that all the requirements cannot be fulfilled through revenues alone. The deficit is fulfilled
through means of foreign debts, domestic debts, money printing, etc.
Nepalese economy relies heavily on short-term domestic debt and concessional foreign loans,
particularly multi-lateral agencies like The World Bank, ADB, IFAD, etc., of long maturity.
More than 65% of domestic debt has maturities of one year or shorter, and less than 9% of
domestic debt has maturities of 10 years or longer. The bulk of the cheap foreign loans have
maturities of longer than 30 years and account for more than 57% of the financing of the
budget deficits in Nepal. Concessional foreign loans have been the best source of financing,
which will not be available forever. The high stock of debt, slow growth rate of economy and
outflow of considerable amount of resources in the form of debt servicing cause an adverse
effect in the economy.
In the developed countries, public borrowing is preferred for creating employment
opportunities and maintaining economic stability but in the developing countries like Nepal,
growth in productivity is basically a great need from the use of government borrowing.
Mobilization of resources through the collection of revenue and foreign aid may not be
sufficient to cover the total expenditure. As a consequence, internal borrowing may be taken
as the other practicable way of meeting the resource gap.
Macroeconomic stability of Nepalese economy is determined by a couple of factors.
Macroeconomic variables such as inflation, GDP growth rate, constraints or limitations on
issuance of debt implied by persistent creditworthiness and solvency, all impose restrictions.
Not only by the macroeconomic variables, the composition of debt and the provision of debt
relief over time also influence a countrys public debt.
Factors contributing to the threat to the macroeconomic stability come through many sourcesboth internal and external and are causes and results of both internal and external shocks.
Pervasive Poverty, low economic growth rate, growing unemployment and underemployment,

inequality in the distribution of income and consumption and political instability are the main
internal reasons.
The Government expenditure in FY (2012/13) remained low mainly due to the political crisis,
which emerged after the dissolution of the Constituent Assembly, failure of political parties to
forge consensus to bring full budget. The estimated government expenditure for the FY
(2013/14) is higher by 44.2 percent as compared to the actual expenditure of FY (2012/13).
The sluggish investment, pervasive weaknesses in the fiscal and financial sectors and high rate
of inflation add further problem to the economy of Nepal.

1.2 Statement of the Problem

Nepal's fiscal sector is structurally weak and vulnerable owing to low level of revenue
mobilization for financing government activities, high dependence on foreign financing of
capital budget and continued deficit in the budget. Nepalese economy has been growing at a
steady pace and the securities markets are less developed. Apart from measures like printing
money and taking external debts, the factors influencing the public debt need to be considered.
The fiscal deficits over the years lead the government to issue various government securities
for short as well as long term. But even the government securities are not encouraging enough
to convince the investors for investment. The fiscal situation continues to remain weak,
largely caused by the widening gap between the growth of the total expenditure and public
revenue and as a percent of GDP; the gap between the revenue and expenditure continues to
remain a critical problem of public finance in the country.
Not only resource availability but also resource utilization capacity is a major problem in the
public sector. The major source of foreign capital inflow in Nepal is foreign aid. As a least
developed country, Nepal has been receiving loans in a large scale, particularly from
multilateral institutions like the World Bank, ADB and the IMF. Besides, bilateral assistance
has also been the source of financing developing activities in Nepal both at the government
and non-government level. This has developed dependency syndrome in the development
process and eroded policy autonomy of the government.
Public debt itself is not a challenge, but the problem is the mismanagement which brings
sustainability problem for the public debt. If the debt un-sustainability increases, the
credibility of the country for both internal and external lenders will decline. This will further
4

add to government consumption beyond the projections which can be fulfilled only through
further borrowing from external sources.
Resource gap in Nepalese economy has always been a common phenomenon since the starting
of the systematic budgeting system in Nepal. The annual growth rate of total expenditures and
the collected revenues are not increasing in the same pace. As a result, revenue expenditure
gap is growing in every fiscal year. One of the major macroeconomic policy objectives of
government of Nepal is to maintain low and stable rate of inflation. The appropriate rate of
inflation is necessary to ensure the competitiveness of domestic goods and services as well as
to improve the living standard of people. Public debt may have some influence on the rate of
inflation. So, through this study, the major determinants that influence public debt both in
short run and long run are examined.
Further, issues to be addressed for the proper management and sustainability as well as the
strategies for the implementation of the plans are also studied. The major issues or the
problems will be explored in the study are:
i.

What is the trend and structure of public debt in Nepal?

ii.

What are the existing policies and the institutional set up related to the public debt?

1.3 Objectives of the study

The general objective of the study will be to study the major determinants of public debt in
Nepal. However, the project has been carried with some specific objectives:
i.

To study the trend and structure of public debt in Nepal.

ii.

To review the policies related to public debt and to find the policy gaps.

1.4 Significance of the study

In the developing countries like Nepal, where the size of saving is small, scattered and where
very few investment opportunities exist, the government has a significant role to perform in
the overall socio-economic development of a nation. In this context, the government raise
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fund through internal and external borrowing. Internal borrowing mobilizes the available
savings even though they are scattered and of small size which further increase the saving
habit in people and creates opportunities to the general public to participate in nation building
process.
On the other, external borrowing solves the problem of capital deficiency, corrects the BOP
problems, and combats inflation, finance public enterprises, and fights depression. This results
in favorable impact on growth of incomes and output. Public debt acts as a compensatory
fiscal device to bring economic stability when the country suffers from unemployment.
This study will be helpful to the policy makers, academicians, researchers and students in
order to study about the factors that directly or indirectly influence the public debt of Nepal.

CHAPTER II
LITERATURE REVIEW

This chapter reviews the relevant literature which consists of review of theoretical concepts
and context, review of empirical works at global and national level.

2.1 Review of theoretical concepts

Historically, there is great debate among the economists about the role of public debt. The
major theories on public debt are:
I.

Classical Theory of Public Debt:

The classical economists of 18th and 19th century who believed in Laissez Faire
policy were generally against the idea of public borrowings. These economists had the
view that the government had to maintain only law and order, defence from external
aggression and look after some public works. They believed that there is existence of
full employment in the economy and there is a perfect competition and mobility of
factors for production in the market. They had more belief in individualism and felt
that self-interest leads to national interest. There is no need of government intervention
in the smooth going economic activities and if any calamity befalls, it will bring to
equilibrium point automatically. When the government is performing minimum
functions then there arises no question of huge public expenditure and for that, there is
no need of large public revenue. In addition to this, they expressed, the State
Government expenditure is wasteful and unproductive.
The classical economists believed pubic borrowing may create economic instability
through inflationary pressure. Further, they assumed that in the long-run, actual GDP
automatically adjusts to the potential GDP. So, due to this reason, classical economists
were not in favor of counter-cyclical fiscal policy. They further assumed that private
sector can employ resources more efficiently than the public sector. They were,
generally, in the favor of balanced budget.
The classical theory is criticized mainly on two grounds. Firstly, every government
expenditure is not always unproductive, hence public borrowing may not be always
burden upon the economy and secondly, the traditional view regarding the shifting of
debt, is not correct. The real burden must be borne in the period in which public
7

expenditure has been incurred through government borrowing program because

resources are not withdrawn from private use and put into public projects only in this
period. There is no burden of the basic burden to the future generation. Future
generation not only inherits liabilities of the payment of interest and principal from the
present generation but also inherits assets in the form of the right of receiving the
interest and principal on the payment side along with interest and principal on the
receipts side belong to the same generation; there is no inter-generation transfer but a
transfer within the same generation.
II.

Keynesian Theory of Public Debt:

Keynes was against the view of classical economists. He highlighted the possibility of
less than full employment equilibrium. He argued that resources in the private sector
may remain unemployed or underemployed for long period, if corrective or
compensatory action is not employed by the government. So, in such situation, when
government borrows the idle resources from the private sector, it would not be
unproductive but rather would have positive effects on the income of the country.
The Economic crisis created by the great depression of 1930s was partly responsible
for the development for modern theory of public debt. The traditional view that
constant unbalanced budgets and rapidly rising public debt imperial the financial
stability of the nations, gradually gave way to the conception which states that a huge
public debt is a national asset rather than a liability and that continuous deficit
spending is essential to the economic property of the nations (of public debt assumed
full employment). The Keynesian attack on the classical principles of budgeting and
public finance was logical extension of the Keynesian attack on the view that economy
tends to equilibrium at full employment. Keynes assumed that if there were
unemployed resources which the private sector could not employ, these resources can
be put to use by the by unbalancing the budget. Keynes held the views that increase in
public debt through the multiple effects would raise the national income. He linked
public borrowing with deficit financing and authorized government to borrow for all
purposes so that effective demand in the economy is increased resulting in increased
employment and output. He did not draw any demarcation between productive and
unproductive expenditure as the classical. Keynes borrowing for consumption was as
desirable as borrowing for investment in productive goods because consumption
expenditure induced investment to rise. Keynesian analysis reached its culmination in
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A. P. Lerners Functional Finance. This viewed government revenue and expenditure

and government debt solely as instruments for the control of community expenditure.
These were merely the tools to achieve the goal of stable employment. Taxes and
expenditure were to be increased or decreased safely to affect the nations rate of
spending; debt instrument were to be sold to the public to absorb their idle balances
and redeemed to increase liquidity in times of depression.
III.

Modern Theory of Public Debt:

The economic philosophy of public debt in modern finance shows a radical departure
from the Laissez Faire notions. This situation changed after the Great Depression of
1930s to a great extent. The classical theory of public debt had absolutely collapsed
which had taken for granted full employment and unproductiveness of public
expenditure. The classical antagonism towards public borrowing was based on these
assumptions.
The modern economists believe that public debt is not necessarily inflationary; it may
become inflationary only during full employment. In fact, whether public borrowing is
inflationary or not depends on specific circumstances of the nation. Similarly, public
debt becomes burdensome for the future generation if it is not used productively. But
profitable and productive use of public debt will facilitate national investment and
growth.

2.2 Review of International Empirical Studies

Shobana (2012) studied an economic analysis of the external debt burden of South
Asian Countries by using line chart and regression model after the year 2000. The
paper identified different economic and non- economic variables such as population,
international reserves, GDP per capita, etc. affecting external borrowings of South
Asian counties negatively and thus concludes borrowing can be a boon or bane for the
countrys growth and welfare depending upon how the country uses such factors for
better debt performance.
Ribeiro and et al (2012) explored the effect of public debt and other determinants of
the economic growth of selected European countries by using multiple linear
regression models over the year 2000 first quarter till year 2011 third quarter. The
research found that there is no relation between the debt crisis, level of government
debt and its effect on GDP whereas private borrowing showed a positive effect on the
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economy for every country, suggesting that private borrowing is more efficient than
public borrowing.
Tantos (2012) examined public debt sustainability of Greece by developing a debt
sustainability model and carrying out an empirical investigation based on a system of
four equations for the period of 1980-2009, using Autoregressive Distributed Lag
Model (ARDL) with the variables: growth rate, public debt to GDP, primary deficit to
GDP and real interest rate. The study checked whether the Greek public debt will be
sustainable up to 2020 or not. By conducting a number of simulations, the study found
that the change of public debt to GDP ratio decreases when the primary deficit
decreases or the growth rate increases, while this ratio rises when the real interest rate
increases. The study concluded that the debt can be sustainable in the case of high
primary surpluses or high growth rates; however, surpluses and growth rates may be
lower if the revenues from privatization programs and additional measures are
introduced into the analysis.
Egert (2012) studied public debt, economic growth and its nonlinear effects. This
paper endorsed the existence of a strongly negative nonlinear effect of public debt on
economic growth based on bi-variate regressions on secular time series for the period
of 1960-2010. This paper seeks to contribute to the literature by Reinhart and Rogoff
(2010) A public debt-to-GDP ratio higher than 90% of GDP is associated with
considerably lower economic performance in advanced and emerging economies alike.
The negative nonlinear effect kicks in at much lower levels of public debt (between
20% and 60% of GDP) is detected using non-linearity. Using nonlinear threshold
models, it is found that there is some evidence in favor of a negative nonlinear
relationship between debt and growth.
Sichula (2012) examined the paradox of debt overhang in the Heavily Indebted Poor
Countries (HIPC) of the Southern African Development Community (SADC) by using
a combination of models for the period of 1970-2011. A linear relationship was
measured of debt indicators on economic output by using financial modeling. A typical
debt overhang model was adapted and was modified to show the effect of debt relief
effects on the economic output and private capital, eventually a causality test is done
on economic output, private capital and debt service obligations using the Granger
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Causality Test (GAT). The study demonstrated that a significant relationship does exist
between external debt and GDP. As external debt decreases, it shows an increase in
GDP. Also as countries in the region attain HIPC completion it greatly increases GDP,
assumed to be due to a decrease in debt service obligations. As government capital
expenditure decreases it shows an increase in private capital that can be used in
investment and economic development within these countries. The study further
concluded debt service does not have any direct effect on GDP or private capital unless
via forms of macroeconomic variables like debt and debt overhang is still a paradox
that may exist but debt relief plays a major role in GDP growth for these countries.

2.3 Review of National Empirical Studies

Bhatta (2003) studied an assessment of the impact of External debt on economic
growth of Nepal by using ordinary least square (OLS) regression equation with the
data of 1979/80-2000/01. The study found that the flow of external debt has positive
impact, the debt accumulation has no impact and the debt servicing has a negative
impact on GDP growth. It further concludes that the continuous dependence on
external financing may not be productive and sustainable in the long run and may not
necessarily spur the growth of the economy.
Rhee (2005) studied debt management analysis of Nepal estimating an optimal target
portfolio of sovereign debt that minimizes long term financing cost for Nepal using the
traditional mean variance efficient frontier approach and relatively new concept of
cost-at-risk (CAR) . The study showed that the Nepalese economy needs to increase
longer term domestic borrowing instruments and the maturity structure of domestic
bonds should be simplified.
Center for Empowerment Innovation and Development (CEMID-Nepal) (2012)
studied overall situation of public debt in Nepal. The research finds out issues in the
policy and laws regarding public debt management, institutional issues, resource
utilization issues, management issues, development of markets, etc. that can affect the
long term public debt sustainability of Nepal. The study suggests that there needs to be
clear legal provisions and institutional arrangements for the domestic as well as
external public debt management. Also, the activities of various public debt managing
institutions need to be well coordinated.

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Bhattarai (2013) studied an assessment of public debt in Nepal for the period 1975/76
to 2010/11 using descriptive analysis. The study found out the problem of low rate of
economic growth and high rate of inflation are the major problems in Nepalese
economy and concludes that efforts should be employed which increase the level of
aggregate supply and maintain the price stability.
Sharma (2014) explored the trend and impact of public debt in Nepalese economy. The
research found that the borrowing money is unlikely financed on the non-monetized
and unproductive sectors of the economy which in turn has proved to be a burden for
the nation. It further highlighted that the degree of indebtedness of the external debt
has increased due to the poor mobilization of internal resources, widening investment
saving gap, export import gap, revenue expenditure and large amount of fiscal deficit.
Pokharel and Shrestha (2014) studied domestic public debt management in Nepal
through multiple regression analysis for the period (1997-2011). The study indicated
the debt sustainability of Nepal has improved than before. The study showed that the
factors such as fiscal deficit, inflation, etc. do not influence the domestic borrowings
whereas the growth rate of GDP has negative impact over it. Likewise, the
determinants of external borrowing showed significant impact of population and
exports over the amount of external debt. The statistical figures showed a decreasing
trend of public debt in terms of GDP for both internal as well as external debt. Also, in
terms of debt sustainability indicators, the figures provided a positive situation for
sustainability. The study concluded that the amount of outstanding foreign debt are
higher than outstanding domestic debts, but the annual borrowing to fulfill deficits are
gradually inclined more towards domestic debt.
Upreti (2015) aimed to identify the factors affecting economic growth in developing
countries using cross country data for seventy-six countries from 2010, 2005, 2000 and
1995. Using multiple Ordinary Least Square (OLS) Regressions, the relationship
between economic growth and other variables were identified. The study concluded
that higher investment rates, high volume of exports, plentiful natural resources, and
longer life expectancy have positive impacts on the growth of per capita GDP in
developing countries.

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CHAPTER III
METHODOLOGY

III.1

Research Design

Quantitative analysis will be used in this study. This research work will be mostly
descriptive and analytical one where the trend and pattern of public debt and review of
the foreign policy of Nepal.
III.2
Nature and Sources of Data:
This study will use only the secondary data. The sources of the data will be the
Economic Survey of the Ministry of the Finance, Government of Nepal, and
Quarterly Bulletin of the Nepal Rastra Bank. The policy document ts related to
foreign aid will be collected from the ministry of finance, National Planning
Comission, Nepal.
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III.3
Data Analysis and Interpretation
The simple statistical tools will be used to study the trend, structure and pattern of the
public debt. The ratio analysis, percentages, trend lines, bar graphs, pie chart will be
used to analyze and interpret the public debt related data. The policy document will be
reviewed and the policy gaps will be identified.

References:
Bhatta, G. (2003).

An Assessment of the Impact of External Debt on Economic

Growth of Nepal.
Bhattarai, K. (2013). An Assessment- Public debt in Nepal.
Cecchetti, S.G., Mohanty, M.S., and Zampolli, F. (2011). Achieving Growth Amid
Fiscal Imbalances: The Real Effects.
CEMID- Nepal. (July 12, 2012). Report on the study of Overall Situation of
Public Debt in Nepal, Center for Empowerment Innovation and Development,
Ekantakuna, Lalitpur, Nepal: Financial Comptroller General Office.
Pokharel and Shrestha (2014). Developing Domestic Public debt Management in
Nepal.
Sharma, Y.R (2014). Trend and Impact of Public Debt in Nepalese Economy. A
Multidisciplinary Journal, Volume 4.

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Shobana, N. (November, 2012). An Economic analysis on the External Debt Burden of

South Asian Countries. Department of Economics, Bharathidasan University, Trichy,
620 023, TN India.
Tantos, S. (2012). Public Debt Sustainability: The Case of Greece, Department of
Economics, University of Athens, Journal of Reviews on Global Economics, 27-40.
Upreti, P. (2015). Factors Affecting Economic Growth in Developing Countries

15