Sunday, December 28, 2014

Does low public debt signal prudent fiscal management in Nepal?

A latest FCGO report shows that cumulative public debt is consistently decreasing in Nepal, reaching an estimated 28.7% of GDP in FY2014 (down from about 52% of GDP in FY2005). Total external and domestic debt stood at 18.0% and 10.7% of GDP in FY2014, respectively.

Generally, a declining public debt is a good sign of a sound/prudent macroeconomic situation in an economy. Recall how high level of debt in the EU and the US after the financial crisis (post-2007) resulted in harsh fiscal measures, including austerity measures, to bring down spending. Quite contrary to that Nepal’s public debt is declining rapidly.

If Nepal cannot mobilize enough revenue to finance its expenditure (both recurrent and capital), then the gap is bridged by domestic as well as external borrowing. Each year the country borrows money equivalent to about 2.0% of GDP from the domestic market. External borrowing is limited to long-term loans at concessional rates from multilateral and some bilateral donors. Overall, total stock of public debt is influenced by economic growth, which then affects revenue mobilization (positively) and jobs creation (positively).

Consider the following trends in recent years:

  • GDP has been growing at below 5.0% (above 5.0% just twice in the last decade).
  • Tax revenue averaged 20.9% in the last decade, reaching an estimated 16.2% of GDP in FY2014.
  • Actual capital expenditure averaged just 71.3% of planned capital expenditure in the last decade. Actual  expenditure averaged about 92% of planned recurrent expenditure in the same time period.
  • Fiscal balance (expenditure and net lending minus revenue and grants) averaged just minus 1.6% of GDP in the last decade. In FY2013, the country ran a fiscal surplus equivalent to 0.7% of GDP.

It is fair to deduce the following from the above four points:

  • GDP growth is largely supported by monsoon-fed agricultural growth and remittance-backed services growth (mainly wholesale and retail trade, which is sustained by imported goods). Industrial sector growth has been chronically sluggish. There is hardly any discernible impact on employment generation (about 1,500 workers leave each day to work overseas). So, the prudent/sound macroeconomic situation/fiscal management as indicated by low and declining public debt (also low fiscal deficit) has little to do with economic growth and jobs creation. Structural transformation is unusual and labor productivity growth is dismal (more here and here).
  • Revenue growth is largely dependent on taxes on imported goods, which are financed by remittances (reached about 28.2% of GDP in FY2014— also, merchandise trade deficit reached 30.9% of GDP in FY2014). Tax revenue on consumption and imported goods account for about 70% of total tax revenue mobilization.
  • Low capital expenditure and high revenue mobilization have resulted in a large treasury surplus and the need to borrow less from domestic and external sources (grants are always welcome!). For a country like Nepal with a tremendous financing needs to plug the severe infrastructure deficit, running such a low fiscal deficit is not an optimum fiscal policy stance. Annual  infrastructure financing requirement over 2011-2020 is estimated between 8% and 12% of GDP. The country could afford to easily borrow more to finance higher capital expenditure in critical infrastructure projects. However, this option is constrained by the low and receding expenditure absorption capacity. (Lets not even touch on the quality of such spending in this blog post).

It is leading to two unreasonable developments on public debt front (based on the level of income per capita of Nepal):

  1. The low fiscal deficit means less borrowing, and hence accumulation of low outstanding debt. External borrowing is declining even when generous concessional terms are being offered. Lately domestic borrowing is mainly used for managing liquidity in the economy (this should not be treated as a monetary instrument to manage liquidity!)
  2. The high revenue growth and low expenditure have also resulted in substantial government savings, which are being used to service debt payments. Total debt service payments averaged 17.9% of total revenue over FY2007-FY2014. Not only interest payments, the country is rapidly repaying principal amount as well. Over the same period, principal and interest payments averaged 12.4% and 5.5% of total revenue, respectively. External debt service payments averaged 10.3% of total exports of goods and non-factor services in the last decade.

Note that low fiscal deficit means slowdown in the accumulation of public debt, and high principal and interest repayment means fast offloading of debt payment obligations. Consequently, this leads to lower stock of outstanding public debt, which in turn is interpreted as a sign of sound/prudent macroeconomic situation/management (despite sluggish GDP and income growth rate, and high unemployment).

The low public debt also affects the debt sustainability analysis, which showed Nepal faced a low risk of debt distress in 2014. In 2012 DSA, Nepal was categorized as facing moderate risk of debt distress. 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 are more inclined to providing concessional/soft loans only (and the allocations/commitments may increase depending on the public expenditure performance of the country).

So, there is no point boasting about sound/prudent macroeconomic situation and at the same time whining about losing grants by multilateral development banks. Nepal has to efficiently and optimally manage fiscal and macroeconomic situation.