In-Depth Analysis: Rate Nepal Sovereign Risk

Posted: August 25th, 2021

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In-Depth Analysis: Rate Nepal Sovereign Risk

Sovereign risk refers to a given country’s possibility to default on its debt obligations. The economic and political developments within Nepal in recent years have made the country’s international lenders such as the World Bank Group (WBG), The International Monetary Fund (IMF), and the International Finance Corporation (IFC) to carefully scrutinize its sovereign risk. In conducting this analysis, the main points of focus for these bodies have been Nepal’s credit strengths and weaknesses (Jansen, Lara, and Siebrits 7). From the findings and implementation of the suggested recommendations, Nepal is showing slow but steady improvements in its credit quality, at least in comparison to Cambodia – a country that had similar credit quality as Nepal less than a decade ago. With improved safeguards on local shares, Nepal’s credit quality is bound to improve even more.

Nepal’s Credit Strengths and Weaknesses

Even though Nepal climbed the most out of 186 countries, inclusive of Cambodia within the first half of 2019, investors and international lenders still treat this country with utmost caution. This mixture of fortune and anguish is a pointer to Nepal’s equally strong but opposing credit strengths and weaknesses. On the credit strengths front, Nepal’s macroeconomy has remained on a sound footing since the April 2015 earthquake, enabled by predictable and trustworthy political regimes that enforce credible and competitive policies (Cerutti, Claessens and Laeven 210). With such a stable credit quality, Nepal stands to access funding from the aforementioned international capital markets for purposes of financing its development spending. It is worthwhile to note that as of 4^th November 2019, Nepal was yet to be rated. So, the country is currently inhibited from issuing bonds in the international markets. To secure a sovereign credit rating, Nepal will have to request one of the three large rating agencies – Standard & Poor’s, Moody’s, or Fitch – to evaluate its internal economic and political conditions (Guerguil, Mandon and Tapsoba 193). According to a World Bank’s 2014 paper on sovereign shadow rating of unrated nations, Nepal scores a Moody’s equivalent rating of Caa1, which loosely places the country in the high default risk category. The main factors contributing to Nepal’s credit weaknesses include low public debt and poor governance (Kaufmann, Kraay, and Mastruzzi 235). As such, Nepal still has some relatively weak economic shock absorbers.

Nepal’s Debt Profile and Sustainability Assessment

As of 2018, Nepal’s public debt was 8,766 million dollars, an improvement of 2,195 million dollars from the country’s 2017 national debt, according to IMF figures. As such, its 2018 debt was 30.2% of the national GDP, a 4.11 percent improvement from 2017 when the debt value represented 26.1 percent of the GDP. On the contrary, Cambodia’s 2017 debt to GDP ratio stood at 30.4%. Comparing the two countries’ 2017 Revenue to GDP ratio, Cambodia’s value stood at 22.1%, whereas Nepal’s value stood at 25.5%. IMF statistics also show that Cambodia’s general government debt to revenue ratio stood at 107.3%, whereas Nepal’s corresponding figure was 105.6% as of 2017. Therefore, Nepal has generally higher volatility in Real GDP growth as compared to Cambodia.

Taking into account the paramount role of remittances, Nepal’s risk of debt distress has remained low for quite a while now. Over the past four years, subdued capital spending and a strong revenue growth have kept Nepal’s budget in surplus. Thus, the country’s public debt has been on a downtrend. Upon close scrutiny, all the indicators of public external debt stock and public debt service ratios seem to stay within policy dependent thresholds. This feat is largely attributed to Nepal’s projected high level of concessionality of official domestic and foreign borrowing. The country has within the past four years been exposed to several risks and vulnerabilities which have in major ways affected its debt profile(Kaufmann, Kraay, and Mastruzzi 232). For example, the 2015 earthquake which led to trade disruption at Nepal’s southern border resulting in a sharp economic decline but kept at a low the country’s risk of debt distress.

The higher public investment expenditures and financing requirements driven majorly by the post-earthquake reconstruction are met through grants and external borrowings. It is worth noting that the low starting level of external loans and high concessionality of new loans has managed to reduce Nepal’s risk of debt distress. Working towards the attainment of such debt profile factors in such macroeconomic assumptions like Nepal’s political uncertainty and frequent changes of government which have the potential to inhibit medium growth prospects, the need for higher government capital spending, and slower growth of remittances due to the observed reduced outflows of migrant workers (Adhikari 43). As such, the deciding factor in rating Nepal’s credit profile in comparison to Cambodia was its vulnerability index which wholesomely takes into account the aforementioned macroeconomic assumptions.

With a prudent fiscal policy already in place and real GDP growth projected to recover fully from the effects of the 2015 earthquake, the World Bank’s shadow rating for Nepal’s debt quality at a considerably lower value than Cambodia’s B2 was highly misplaced. This is in light of the fact that Nepal has over the past four years made genuine efforts towards strengthening its capital budget implementation and has also been keen to mobilize more foreign financing with the aim of speeding up the country’s recovery process from earthquake and the associated trade disruption at its border. Even with scaled up public investments, Nepal’s risk of debt distress is projected to remain in comparison to Cambodia, thus, no logical reason under any standards can justify Nepal’s lower credit rating. 

The Key Factors Supporting Nepal’s Current Credit Quality and its Future Trajectory Drivers

Four main factors are boosting Nepal’s current credit quality. First, relative to Cambodia, the country has sustained economic growth through the recent 50 percent increase in its WEF Global competitiveness index, a 25 percent increase in the nominal GDP, and GDP per capita. Secondly, Nepal’s policy credibility and effectiveness and institutional framework ad effectiveness have been on a constant rise averaging at 75 percent higher than Cambodia. Thirdly, the country’s debt affordability has kept increasing in recent years (Adhikari 44). Fourthly, the size and strength of the banking system within Nepal have kept growing in recent years, signaling the country’s better susceptibility to geopolitical risks.

In summary,Nepal is in a state of reconstruction following the 2015 earthquake. As such, the country is still trying to win back the full confidence of foreign investors who are usually skeptical about investing in natural disaster-prone regions. Also, the country’s poor governance, oftencharacterized by much political infighting, has derailed its development progress. Amidst all of these unfavorable political conditions, the country’s policy credibility and effectiveness, and institutional framework and effectiveness have been on a constant rise, thus, against all expectations, painting Nepal with a relatively stronger credit quality when compared to Cambodia.

Nepal Vs. Cambodia Rating Factor Framework

Figure 1:Nepal Vs. Cambodia Rating Factor Framework

Works Cited

Adhikari, Ratnakar. “Foreign Direct Investment in Nepal.” (2013).

Cerutti, Eugenio, Stijn Claessens, and Luc Laeven. “The use and effectiveness of macroprudential policies: New evidence.” Journal of Financial Stability 28 (2017): 203-224.

Guerguil, Martine, Pierre Mandon, and René Tapsoba. “Flexible fiscal rules and countercyclical fiscal policy.” Journal of Macroeconomics 52 (2017): 189-220.

Jansen, Ada, Lara Marais, and Krige Siebrits. “Strategies for Fiscal Consolidation after the International Financial Crisis.”

Kaufmann, Daniel, Aart Kraay, and Massimo Mastruzzi. “The worldwide governance indicators: methodology and analytical issues.” Hague Journal on the Rule of Law 3.2 (2011): 220-246.