KATHMANDU: The Nepalese government has achieved the lowest interest rates on domestic debt in the past four years due to an overflow of liquidity within the banking system. In the fiscal year 2079/80 (2022/23), development bonds were auctioned at rates as high as 11 percent, whereas this fiscal year has seen rates dip below 4 percent, as per data from the Public Debt Management Office. This shift signals a marked reduction in interest rates due to excess liquidity in Nepal’s banking system, where Nepal Rastra Bank (NRB) continues to absorb excess liquidity through permanent deposit facilities and deposit collection tools.
Despite the lowered interest rates, the government has maintained a steady pace in mobilizing internal loans since the fiscal year began. Amrit Lamsal, head of the Public Debt Management Office, shared that the Ministry of Finance approved the schedule for internal debt mobilization in the month of Shrawan (mid-July to mid-August), aligning with the government’s annual target to issue NPR 330 billion in internal debt. Data reveals that NPR 100 billion has already been mobilized by November 8, 2024, marking the disbursement of over one-third of the government’s annual target for internal debt.
The government utilizes various instruments for internal debt mobilization, referred to as government bonds. These marketable securities allow investors to receive fixed interest returns, enabling the government to fund essential national development initiatives. Historically, Nepal Rastra Bank managed public debt as the government’s bank, but now, the Ministry of Finance has established a separate Public Debt Management Office to oversee this critical function.
Four primary types of government bonds are issued to meet the government’s internal borrowing requirements: Treasury Bills, Development Bonds, Citizen Savings Bonds, and Foreign Employment Bonds. Treasury Bills, designed for short-term borrowing under one year, come in four types: 28-day, 91-day, 182-day, and 364-day bills, depending on duration. Development Bonds, however, serve as medium- to long-term borrowing instruments with maturities over two years, offering stability to investors seeking reliable returns.
While Citizen Savings Bonds and Foreign Employment Bonds contribute to internal borrowing, they represent a minor share of overall internal debt. Notably, Foreign Employment Bonds were first issued in FY 2066/67 (2009/10) to attract foreign capital and increase overall liquidity within the national economy, driven by the need to channel remittances back into the formal banking system.
Citizen Savings Bonds, issued annually, aim to foster a culture of savings and investment among citizens. However, with limited public interest, commercial banks and financial institutions increasingly invest in Treasury Bills and Development Bonds, making these instruments the primary sources of internal debt for the government.
To meet its target, the government relies on Treasury Bills for short-term debt mobilization and Development Bonds for long-term financing. For this fiscal year, the target of NPR 330 billion includes NPR 209 billion through Development Bonds, NPR 115 billion through Treasury Bills, and a smaller share of NPR 5 billion through Citizen Savings Bonds and NPR 1 billion through Foreign Employment Bonds.
Treasury Bills, typically renewed as per financial needs, are subject to interest rate fluctuations based on prevailing liquidity levels in the banking system, given their short duration. Development Bonds, due to their longer terms, generally bear higher interest rates, raising the long-term cost of public debt. In normal conditions, the average interest rate on government bonds ranges between 5 and 6 percent, but the volatile liquidity and interest rate conditions in Nepal’s banking sector continue to impact the cost of internal debt.
The COVID-19 pandemic initially triggered a dip in deposit interest rates as loan demand dwindled, which brought Development Bond yields down to as low as 3.88 percent on January 30, 2021. Since then, liquidity shortages in fiscal years 2078/79 (2021/22) and 2079/80 (2022/23) drove Development Bond interest rates higher, peaking at an average of 8.64 percent last year. In a specific auction held on December 21, 2022, Development Bonds reached a high of 10.93 percent.
In the current fiscal year, as liquidity eases in the banking system, Development Bond rates have reduced to 6.54 percent, well below the NRB’s policy rate of 5 percent. Notably, on September 10, 2024, Development Bonds were auctioned at an interest rate as low as 3.95 percent, followed by a recent auction on October 24, 2024, where the interest rate was maintained at 4.27 percent. According to Lamsal, the government issued NPR 115 billion in internal debt in the first quarter of the fiscal year alone, strategically capitalizing on surplus liquidity.
The reduction in interest rates is expected to decrease the government’s budget for interest payments on public debt. Although favorable foreign exchange rates provided some cost savings on foreign debt last fiscal year, this year’s decrease in domestic interest rates will similarly reduce the cost of internal debt.
For fiscal year 2080/81 (2023/24), the government has allocated NPR 402 billion for the repayment of principal and interest on both internal and external debt. This includes NPR 275.79 billion allocated specifically for internal debt servicing, with principal repayments amounting to NPR 182.55 billion. Of this, NPR 594 million was already disbursed by mid-October 2024, according to official records.
An additional NPR 93.23 billion has been earmarked for interest payments, of which NPR 118.5 million was disbursed by mid-October 2024. Lamsal explained that the reduced interest rates this fiscal year may result in unutilized budget for interest payments on internal debt.
Looking ahead, Lamsal foresees stable or declining interest rates through mid-December 2024, with liquidity levels expected to rise due to deposit growth, potentially leading to further rate reductions by fiscal year-end. While foreign exchange rate fluctuations could increase the cost of foreign debt, the cost of internal debt is likely to decline.
Even as the government issues over NPR 125 billion in internal debt, the banking system still reports excess liquidity of nearly NPR 300 billion. According to NRB data from November 8, 2024, banks have placed NPR 285.15 billion in liquidity facilities with the central bank, despite rates as low as 3 percent or below.
Given the restrained loan demand and the continued inflow of remittances, deposit growth has remained robust, reducing the immediate likelihood of interest rate hikes. In this scenario, the government can expect to maintain a low cost for internal debt in the short term.
As the government continues to manage fiscal pressures and ensure adequate funding for development projects, the favorable interest rate environment provides a significant advantage for public debt management, easing the burden of debt servicing while encouraging sustained economic investment.