Fitch affirms Nepal’s ‘BB-’ rating, flags political risk as fiscal pressures rise

KATHMANDU: Global rating agency Fitch Ratings has affirmed Nepal’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BB-’ with a Stable Outlook, citing the country’s low external debt burden, strong foreign exchange reserves, and medium-term hydropower-driven growth prospects. The affirmation comes despite heightened political uncertainty and widening fiscal deficits triggered by the September youth-led unrest.

The rating action, published on Tuesday from Hong Kong, underscores Nepal’s resilience in macroeconomic stability but warns that prolonged political instability could weaken governance standards, slow reforms, and pressure the country’s sovereign credit profile.

Political Instability Emerges as Key Risk

Fitch said Nepal’s political environment remains fragile even after the rapid de-escalation of the September 2025 protests that erupted following the social media ban. The interim government formed on 12 September has scheduled elections for 5 March 2026, but any delay or fragmented outcome could hamper policy execution.

The rating agency noted that while Nepal has shown resilience under the IMF-supported reform programme, lingering political uncertainty poses increasing risks to growth, fiscal discipline, and external financing stability.

Fiscal Deficit to Widen on Reconstruction and Weak Revenues

Fitch projects the federal government deficit to widen to 3.5% of GDP in FY26, higher than both the FY25 estimate (1.7%) and the BB-rated peer median (3%). The deficit is expected to remain elevated at 3.4% of GDP in FY27, as revenue recovery is partially offset by rising capital expenditure.

The interim government has estimated economic damage from the unrest at NPR 80 billion, equivalent to 1.2% of projected FY26 GDP.

Debt to Remain Manageable

Government debt is forecast to rise moderately to 46.1% of GDP in FY26, up from 43.8% in FY25, but still below the BB-median of 54.4%. Fitch expects debt levels to stabilise around 46% of GDP by FY29, assuming the post-election government maintains the current fiscal framework and reforms.

Nepal’s debt structure remains favourable, with highly concessional external loans enjoying an average maturity of 13 years and interest rates near 1%. Local and provincial governments carry no debt, while government-guaranteed debt remains minimal at around 1% of GDP.

External Liquidity Strong but Current Account to Weaken

Foreign exchange reserves remain a key strength. Nepal’s reserve coverage reached 13.5 months of imports in FY25, far above the BB peer median of 4.8 months.

However, Fitch expects the strong 6.7% current account surplus in FY25 to narrow sharply to 2.4% in FY26, before slipping into a 1.2% deficit in FY27 as reconstruction-related imports rise and tourism receipts soften following the unrest.

Remittances, equivalent to 28% of GDP, are expected to remain robust and continue supporting liquidity.

Growth to Slow in FY26

Fitch forecasts GDP growth to fall to 2.5% in FY26, down from 4.6% in FY25, citing disruptions to economic activity, reduced private investment, lower tourist inflows, and climate-related agricultural setbacks.

However, major hydropower and transmission projects remain on track, anchoring Nepal’s medium-term growth potential at around 5%.

Financial Sector Stress Continues

Nepal’s banking sector continues to face stress from the post-2021 credit boom. Non-performing loans rose to 5.2% of gross loans in FY25, up from 3.7% in FY24, and may be revised further after the IMF-backed asset quality review of the 10 largest banks is completed by December 2025.

Domestic reinsurers are also exposed to significant losses due to insurance claims from the September unrest.

Governance Concerns Remain the Weakest Link

Fitch assigned Nepal an ESG Relevance Score of ‘5’ for Political Stability and Rights, and ‘5’ for Rule of Law, Institutional Quality and Control of Corruption, reflecting Nepal’s low ranking in the World Bank Governance Indicators (34th percentile). These governance weaknesses remain a major constraint on Nepal’s credit rating.

Rating Sensitivities

Fitch said Nepal’s rating could be downgraded if: