Fiscal commission warns against misuse of domestic borrowing as Nepal’s debt efficiency comes under scrutiny

KATHMANDU: Nepal’s fiscal framework is facing renewed scrutiny after the National Natural Resources and Fiscal Commission issued a strong recommendation to prohibit the use of domestic borrowing for recurrent and administrative expenditure, highlighting deep structural inefficiencies in public debt utilization.

In its recommendations for the upcoming fiscal year 2083/84 (2026/27 AD), the Commission has not only capped domestic borrowing limits across all tiers of government but also raised serious concerns about how such borrowing is being deployed—warning that current practices are undermining capital formation and long-term economic growth.

Strict Cap, Stronger Warning

The Commission has maintained its annual ceiling, allowing the federal government to mobilize domestic debt up to 5.5 percent of GDP. For provincial and local governments, the borrowing limit has been set at a maximum of 12 percent of the sum of revenue sharing and internally generated revenue, subject to federal approval.

However, the more critical message lies in how these funds should be used.

The Commission has explicitly stated that domestic borrowing must be strictly prohibited for financing recurrent or administrative costs. Instead, it should be directed toward projects that generate employment, contribute to capital formation, and deliver long-term economic returns.

Debt Recycling, Not Development

The recommendation comes at a time when Nepal’s domestic borrowing appears increasingly trapped in a cycle of debt servicing rather than productive investment.

Data from the Ministry of Finance Nepal shows that a large portion of domestic debt mobilization is being used to repay principal and interest on existing loans. In fiscal year 2081/82, net domestic borrowing stood at just 1.41 percent of GDP—indicating that most new borrowing is effectively offset by repayments.

This trend raises a fundamental concern: domestic debt is not expanding fiscal space but merely sustaining past liabilities.

The Commission warns that such a pattern limits the economy’s ability to generate productive assets, ultimately weakening growth potential and reducing the multiplier effect of public spending.

Transparency Deficit Raises Accountability Issues

A key structural weakness identified is the lack of transparency in domestic debt utilization. Unlike foreign loans—which are typically tied to specific projects—domestic borrowing lacks clear disclosure on where and how funds are spent.

This opacity has led to persistent questions about the effectiveness of debt mobilization. The Commission itself acknowledges that it has been unable to conduct a proper evaluation of debt utilization and implementation of past recommendations due to insufficient data disclosure.

This signals a governance gap in fiscal management, where borrowing decisions are not matched by robust accountability mechanisms.

Government Internal Borrowing and GDP Ratio

Note: Values for Debt and GDP are in Kharb (100 Billion NPR)

Investment Quality Over Quantity

The Commission has stressed the need to shift from volume-driven borrowing to efficiency-driven investment.

It recommends that domestic debt be channeled into projects that pass rigorous financial and economic viability tests, including cost-benefit analysis, net present value (NPV), and internal rate of return (IRR). Only projects with returns exceeding the cost of capital should qualify for debt financing.

Even in the social sector, borrowing should be limited to programs that demonstrate high economic or social returns.

Moreover, the Commission has emphasized that any project financed through debt must ensure repayment capacity—meaning future cash flows or economic benefits should be sufficient to cover both principal and interest obligations.

Structural Reform Imperative

The report also highlights a concerning trend among subnational governments, particularly provinces, which tend to inflate budget sizes by including domestic borrowing without adequate planning or approval.

To address this, the Commission has recommended that provincial and local governments include domestic borrowing in their budgets only after obtaining formal approval from the federal government, in line with the Intergovernmental Fiscal Arrangement Act, 2017.

Additionally, all three tiers of government have been urged to clearly disclose domestic borrowing under the source-wise breakdown in budget documents, enhancing fiscal transparency.

Toward Integrated Debt Management

In a significant structural recommendation, the Commission has called for the establishment of a unified electronic system to track, manage, and report public debt across all levels of government through the Public Debt Management Office.

Such a system would enable real-time monitoring, improve coordination, and allow institutions—including the Commission—to access data for analysis and oversight.

Bigger Economic Implications

At a broader level, the Commission’s warning underscores a critical macroeconomic reality: domestic borrowing is essentially a mechanism of advancing future revenue into present expenditure.

If not invested in productive sectors, it risks creating a debt burden without corresponding economic returns.

With rising debt servicing costs and limited revenue growth, Nepal faces a narrowing fiscal space. Without reforms in how domestic debt is utilized, the country risks entering a low-efficiency debt cycle—where borrowing sustains government operations but fails to drive economic expansion.

The Commission’s recommendations, therefore, go beyond technical guidelines—they represent a call for a fundamental shift in Nepal’s fiscal discipline, investment prioritization, and public financial governance.