Sri Lanka’s public debt to GDP ratio has skyrocketed over the past few years with the IMF projecting its public debt to GDP to reach 119.9 percent in 2022. Nepal, on the other hand, is operating at a public debt to GDP ratio of 37.3 percent. Sri Lanka’s public debt to GDP ratio is very concerning. Studies highlight that a public debt to GDP ratio above 64 percent among emerging markets amounts for a loss of real GDP growth by 0.02 percent points with each additional percentage points increase in public debt. While the number might seem small, however, with cumulative effect with each percentage points increase can be devastating. Sri Lanka is operating at an almost double the public debt to GDP threshold. Countries with excessively high levels of public debt are more likely to lose their output during crisis and are more prone to spillover effects. That’s exactly what happened in Sri Lanka’s case as well. During the pre-COVID era in 2019, Sri Lanka’s public debt was already very high at 93.6 percent. As the COVID pandemic surfaced the economy in 2020, its ability to cope with the crisis worsened. It became even worse when the spillover effects of Russia-Ukraine war hit the economy with massive inflation, food shortages and weak exchange rates. Not to forget, the 2019 tax cut and its impact on revenue, with estimated revenue loss crossing 2 percent of GDP. With rising expenditures and low revenue, fiscal deficits widened by 12.8 percent of GDP in 2020 and 11.4 percent in 2021. Owing to increasing fiscal deficits inter alia, public debt was pushed up massively. By 2020 Q3, public debt was 114 percent. Compared to Sri Lanka, Nepal is doing fairly well in this regard.
Infact, Sri Lanka’s debt distress started taking an upward shift ever since a decade back. Given that Sri Lanka was upgraded to a middle-income country in the early 2000s, Sri Lanka’s access to concessional loan with low interest and high repayment periods from multilateral and bilateral organizations declined which pushed Sri Lanka to pursue commercial loans. Back in 2007, Sri Lanka issued its first International Sovereign Bond (ISB) of $500 million. In 2009, Sri Lanka’s commercial loans consisted of only 2.5 percent of external debt. By 2019, commercial borrowings consisted of 56 percent of total external debt and most of it were ISBs. Unlike the concessional loans, ISBs have higher interest rates and shorter repayment periods.
Nepal hasn’t taken a commercial foreign loan yet although the International Development Cooperation Policy 2019 allows it. While Nepal’s debt to GDP ratio is gradually increasing, Nepal is still at a safe debt to GDP position. However, jumping to take heavy commercial loans or getting comfortable with taking any loans with high interest can easily shift the tide towards debt distress. Hence, such acts should not be initiated unless absolutely necessary. Unlike Sri Lanka, Nepal’s bilateral and multilateral deals largely pushes for grants and if it must be a loan, then it should be concessional loans or loans as similar as multilateral donor agencies which are less than 2 percent with high re-payment period. Having said that, it’s pertinent to understand that Nepal is also not in a comfortable position to take the whole debt distress scenario lightly especially given that the outstanding debt has shown a consistent increasing pattern over the past few years.
It is evident that Sri Lanka’s public debt is unsustainable.
Foreign exchange reserves of both countries are critically low. As mentioned earlier as well, Sri Lanka’s reserve is at a stage where they are already unable to pay for their imports largely reflecting pre-existing debt vulnerabilities, policy failures and the effects of exogenous shocks like pandemic and the ongoing war. Nepal Rastra Bank (NRB) aims to maintain foreign exchange reserves at a level that can sustain imports for at least 7 months. However, that target is compromised lately, for the first time in the last six years, which proposes a loud alarm to the economy. Between mid-July 2021 to mid-May 2022, Nepal’s gross exchange reserves tumbled down by 21.1 percent. Likewise, Sri Lanka’s foreign reserves tumbled down by 44.58 percent from 2020 to 2021 and has only seen a consistent downfall each month. Between May 2021 to May 2022, reserves went down by 53.21 percent. IMF estimates that Sri Lanka’s gross reserves over 2022-26 will remain extremely low at around 1 month of imports. Sri Lanka’s catastrophic state of currency reserves can be a wake-up call for Nepal given that Nepal still has time to boost its reserves.
Likewise, Inflation has gone rampant all over the world, but tends to be much better when compared to Sri Lanka. Sri Lanka’s inflation rate has shown a consistent increase every month over the past year. Nepal and Sri Lanka were standing at a fairly good inflation position during August 2021. However, post 8 months by April 2022, Nepal and Sri Lanka had a difference in Inflation of 22.52 percent approximately. By July 2022, Sri Lanka was operating at an Inflation rate of 60.8 percent and given the consistent economic debacle, it is not expected to improve anytime soon.
Food and Non-Alcoholic Beverages in Sri Lanka saw its Consumers Price Index (CPI) reach 90.9 percent on June 2022. Transport sector crossed the century mark with a whopping 143.6 percent. Largely, due to fuel shortages and inability of purchasing fuel with its worsening foreign exchange reserves, Sri Lanka was forced to call for a fuel lockdown. Nepal, on the other hand, is operating at a fairly comfortable position when compared to Sri Lanka in this regard. Although, the situation in Nepal also needs a dire attention when it comes to inflation of daily necessities. Mid May/June comparison shows a 7.43 percent CPI on food and Beverage. Like in Sri Lanka, Nepal is also embracing the impacts of war with the rising fuel prices creating the largest inflationary pressure on transportation sector with about 25.79 percent.
Policy Recommendation
Matters went multifold worse due to back-to-back exogenous shocks. Nepal’s high imports over the last couple of months is largely accommodated by inflated fuel prices subsequently hampering the country’s reserves. Nepalese government has taken steps to ban a few products considered as luxurious goods on a temporary basis in order to avoid an outsource of dollars from the country. However, moves as such, hardly brings sustainable solution. Instead of focusing on restricting imports, focusing on encouraging exports would be a welcome move for the medium or long-term recovery. In fact, for the short term, Nepal can try increasing taxes on luxurious goods or goods that are imported in heavy amounts instead of initiating an import ban, like the austerity policy initiated by Bangladesh.
Nepal’s export scenario is considerably vulnerable given that a significant chunk of our export is largely boosted by soybean oil and palm oil imported from third countries which are exported to India with a minor value addition. Between 2075-76 to 2077-78, approximately 29% of Nepal’s total export was covered by Soybean oil and Palm oil accounting for NRS 97.34 billion worth out of the total export of NRS 335.94 billion. The fear factor here is that the strength of Nepal’s export of palm oil and soybean oil is largely in the hands of India. If India applies quota or issues import ban of these products like they did earlier in a temporary manner, Nepal’s export scenario will get worse, and it will hit harder than before with the current reserves in a very fickle state. Hence, there is a strong need for Nepal to avoid heavy dependence on few products that aren’t even produced in the country. A concrete pathway to pursue a sustainable and long-term export ease should be of utmost priority.
Likewise, Nepalese government needs to refrain from making a mockery out of themselves by coming into attention with consistent political fiasco and multiple controversies. The case of Finance Ministry and Nepal Rastra Bank (NRB) is a fresh example. Finance Ministry is the fiscal body and NRB is the monetary body of the nation. Fighting with each other like a cat and dog is not something that any economy would expect from the two most important body of the nation. Friendly and effective collaboration is a must between these two departments, especially, in a time like today, whereby the macroeconomic crisis is consistently looming around the corner.
