Nischal Dhungel on Nepal's Sovereign Credit Rating and its Potential Implications

[00:00:10] - [Speaker 0]
Namaste and welcome to Pods by PEI, a policy discussion series brought to you by Policy Entrepreneurs Inc. My name is Kushi Hang and in today's episode, PEI colleague, Ostli Sreshta, is in conversation with economist Nischal Dungal on understanding Nepal's first sovereign credit rating. Nistal Dungyal is a consultant for the World Bank Group and the Independent Evaluation Office at the Global Environment Facility in Washington DC. He's also a non resident fellow at the Nepal Institute for Policy Research and holds a M. In Economic Theory and Policy from Bart College, New York.

[00:00:47] - [Speaker 0]
Osslesh and Nistal dive into Nepal's first ever sovereign credit rating and what it means for the nation's bold economic future as it gears up to graduate from LDC status. They break down its implications on foreign investments, business opportunities, and more. From hydropower to tourism, they explore the sectors ready to thrive and the reforms needed to keep the momentum going. Disclaimer. The views expressed in this podcast are Nistral's personal views and do not reflect the views of the organizations he works for or represents.

[00:01:23] - [Speaker 0]
Like listening to Pods? Would love to hear your thoughts. So please comment on Spotify, Apple Podcasts, YouTube or wherever you listen to the show. You can also follow us on Twitter tweet2pei and on Facebook and Instagram policy entrepreneurs inc for updates on the latest episodes. We hope you enjoy the conversation.

[00:01:48] - [Speaker 1]
Glad to welcome you here at Pods by PEI, Nishu. How are things going in Washington?

[00:01:54] - [Speaker 2]
Everything is good just busy with work and you know following Nepal economy closely.

[00:01:59] - [Speaker 1]
So we'll get right into the topic of sovereign credit rating then. Before getting into the discussion I'd like to bring in certain things into context. Nepal recently in November 21 received the first sovereign credit rating of BB- and this process has been going on for quite some time right from 2019 I think there was a discussion on before the investment summit in 2019 there was calls of getting this rating done but due to certain reasons and after that Covid and certain economic imbalances This process only started in April 2024 right before the investment summit in 2024 and now that the ratings has been done there is some optimism regarding this milestone event that it is going to bring some boost to the Nepali economy. So before discussing the implications for the Nepali economy of this sovereign credit rating, could you briefly explain to the listeners what a sovereign credit rating is and which agencies are responsible for providing these kind of ratings?

[00:03:13] - [Speaker 2]
Yeah I'll just break it down the concept of sovereign credit rating with one simple example so that everyone can understand. So let's say you want to borrow money from a bank right so basically the bank will look at your credit history which tells whether you have paid your previous loans on time or not. This is very important Similarly if you take the case of US there are credit score which basically reflects the credit history of customers and it usually ranges from 300 to 850 and higher score means that it would be easier to get a loan and if you have a low score it would be very hard to get a loan. So what's the catch here actually is bank looks at your credit history right? So credit history is the catch and based on credit history bank makes the decision whether to lend you money or not so similarly sovereign credit rating they're more applied to entire nations rather than individuals and these ratings are usually assigned by big international credit rating agencies there are three which are S and P is called Standards and Poor's and next is Fitch Rating and the other is Moody's These they have their own rating scores and these major agencies usually use various factors or considers various factors including economic data, government debt levels and political stability to measure whether the country can pay back its debt or not so in simple language it's the measure where ratings are the measures whether the country can pay back its loan or not and these credit agencies usually have their own scoring system for example Fitch Rating has its criteria from triple A to down to D A) it represents high credit quality and B) it represents good credit quality and with regards to C) it considers as substantial credit risk criteria.

[00:05:21] - [Speaker 2]
So now what does this triple A mean? For example this is a top notch rating which signifies that the country is financially good and it's very reliable and it has a great chance of paying back its debts so these countries usually like who have this rating for example Switzerland is considered as a safe investment destination greatly because it has a good ability to attract international investors So on the other hand if I had to talk about B ratings basically they range from these B ratings or below B ratings this makes investors very very cautious you know why cautious because it's relatively riskier in investing in these countries compared to the countries that have A ratings so investors definitely look at higher returns so since there is a high risk it falls under the speculative grade which I'll explain later and lastly if a country has a degrading then it indicates that a country is in whether in default or they fail to meet its financial obligations so in a nutshell yeah these ratings help investors decide whether to invest in that respective country or not and it looks at whether the country can pay back its debt on time or not.

[00:06:48] - [Speaker 1]
Alright thanks for the brief introduction on ratings similarly you talked about the big three that gives which are internationally popular but there are other kind of ratings like the DBRS Morningstar or the SCOOPS ratings or like the Japan graded ratings which are also kind of popularly used right apart from the big three. So how do these ratings differ from the big three? Are there any technicalities on which they differ?

[00:07:19] - [Speaker 2]
So yeah these rating agencies they have their own assessment criteria and these rating criteria are based on the economic, political, mostly economic and political factors also institutional factors so there is no like hard and fast rule on determining the assessment for example if you take case of fees rating it provides a structured and very data driven assessment focusing mostly on quantitative metrics like GDP growth, debt levels and fiscal health and yeah indeed there are other rating agencies but the one that I know is Fitch Rating and that's how they conduct the assessment and which provides us baseline of a country's credit worthiness through a very structured and updated credit analysis and there is also called Euromoney RICS survey that at least what this offers this takes into account more current mode of the markets and it takes suggestions from economists and experts around the world and they don't heavily rely on hard data they mostly rely on the opinions since it's a survey right so it will be a opinion based so

[00:08:36] - [Speaker 1]
okay then yeah So you just mentioned that the Fitch ratings takes into consideration certain macroeconomic indicators while assessing any country's credit potential or credit worthiness, let's say. But what are the major macroeconomic indicators that are considered specifically in the Fitch Ratings because we would want to kind of highlight the current scenario or the current situation of these indicators in the Nepali context So can you briefly tell us, what kind of indicators have been, basically monitored in this ratings?

[00:09:16] - [Speaker 2]
So yeah. Yeah. Fitch ratings, they considered various factors, especially macroeconomic factors and these factors provide a detailed picture of country's economic health and its ability to meet financial obligations right and some of the major ones are one is gross domestic product GDP growth and next is debt to GDP ratio and also they look at fiscal balance and next is foreign exchange reserve and then they also take political stability into consideration So just to go through quickly how Fitch Rating has seen Nepal's economy is that it has predicted that especially World Bank it has predicted that country is expected to grow at around 5% in 2025 right this means that the economy is thriving or it's growing and this indicates a very healthy economic activity going on especially driven by hydropower and agriculture as well as recovery in tourism and with regards to debt to GDP ratio this ratio generally indicates how much debt a country holds relative to its GDP or economic output and then if the lower ratios are generally seen as positive and as per fees Nepal's debt seen is quite manageable at this moment which is around 44% of GDP and next is fiscal balance with regards to fiscal balance it looks at the country's revenue and expenditure and the Nepal's federal government deficit is expected to narrow down mainly because of I think fiscal consolidation efforts and similarly foreign exchange reserve I think this plays one of the key roles it is very important while paying the debt we have to look at whether the country can pay back the money or not right because this directly shows how much reserve the country has for example if you take the case of Nepal receive remittance and we also have income from tourism sectors and but if we look at the outflow of money it's mostly through imports right because we import heavily from India and mostly from India and I think these are the major ones besides this they also look at the inflation rate and current account balance and then there is also factor called environment social and governance indicators and they place a huge importance on ESG indicators as well for example as I said earlier political stability and if you see the case of Nepal's ranking it is below the fiftieth percentile in global indices and this negatively impacts Nepal credit profile similarly I'll not go into detail but there are other factors such as rule of law and governance human rights creditor rights which they take into consideration.

[00:12:15] - [Speaker 1]
Alright. The creditor rights maybe we'll come into that later because that that would be a important part on whether or not investors are willing to invest in Nepal. But let's get into the main part of the topic which would be Nepal getting the BB- rating and obviously there is optimism in Nepal that we've got a certain rating which even though is in the speculative risk zone but still a good rating in terms of how the economy has performed in the past few years. Right? So in your article specifically you've mentioned the term junk status related to this category b b minus category so could you explain like what relevance does the b b minus category provide to the Nepali economy and what junk status mean to the listeners because that is very interesting why the term junk has been used here.

[00:13:16] - [Speaker 2]
Yeah I think you have rightly pointed out that Nepal received its first ever sovereign credit rating from FIT and I think Nepal should definitely celebrate this milestone because it's the first time we have received it and with regards to BB- rating which is given to Nepal it's also called junk status or it's under speculative status right so this basically means that investing in this country is risky like it's not about being bad it's about the higher chance of running into trouble compared to investing in more stable countries let's say India because of this risk investors they expect higher returns to make their investment worth it. So it's just the risk components because of that it is called junk status. So there are uncertainties surrounding like business, financials or economic conditions right and it can be any one of those and it is the reason why it's kept on the respective or given a junkie status. I think how FIT sees our economy or the way they have rated our economy is even though Nepal is not buried in debt or you know it's not the debt situation is not that risky it is open to various shocks like natural disasters and or big global economic shifts that affects this rating for example imagine if our remittance or tourism income decreases right then that will have a big blow off on the economy so these geopolitical or global economic shift might impact it so there are some uncertainties that makes investment very risky in the countries and also as I discussed there are governance and political stability factors and maybe because of this reason also it's riskier to invest in Nepal you can see the case of frequent government change and that hugely impacts because investors they want stability especially policy stability whenever investing in this country so I think that is what the status means but although in future they also highlight that there is need for structural change, improved governance and enhanced economic activity to elevate Nepal's creditworthiness.

[00:15:46] - [Speaker 1]
So compared to Nepal scenario or economic situation before Nepal received the credit rating is the risk premium for investors going to reduce now or Nepal's cost of borrowing also will reduce due to the status is that a possibility or there is not going to be much change regarding those contexts?

[00:16:09] - [Speaker 2]
I mean I think that will mostly change once we graduate from LDC status since we are enjoying concessional loans right now but what it gives is before this sovereign credit rating there was no rating that investors could rely on so what it does is that it puts Nepal into the picture among other countries that has been rated so it's a positive sign. For example many investors those who don't know about Nepal or what's its like economic status or what's its rating then it it gives a very good idea about okay there is some potential in this country maybe hydropower or energy sector or ICT right so with regards to risk premium I think that will only change once we graduate because we'll get less exposure to concessional loans so yeah that's what I think.

[00:17:09] - [Speaker 1]
Since you also mentioned India is a favorable destination compared to Nepal and in the ratings also we can see that India has a BBB- rating. Can we actually compare countries using only these ratings like generally we compare countries with GDP per capita or some human development index indicator right so is this indicator just the two letters or the three letters we use to signify certain credit worthiness of a country can we compare countries by this metric like for example let's say India has a BBB- Nepal has BB- and Bangladesh currently has a B plus which would signify a higher risk than Nepal right But generally consider Bangladesh's economic growth and economic activity it would be considered more favorable investor friendly country. Other examples like the developing nations like South Africa, Turkey, Jamaica, Ivory Coast, they also have a b b minus rating. So how are these countries comparable or or actually we can't compare them, you know, just on this basis?

[00:18:26] - [Speaker 2]
Yeah I think that's a very very intuitive question and given Nepal's BB- rating yeah it puts in same board like several other countries that you have mentioned and moving on to India's part if we see India's economy it's a huge economy and it has a BBB BBB- rating and it's more larger and diversified economy and if you look at the track history it has more robust global financial system and they are already exposed to global financial economic system. If you see their manufacturing and sector growth it's growing right and I think this builds confidence among many investors and why would someone invest in country like Nepal or Bangladesh if you are seeing the growth of six-seven percent in emerging economy like India right so that's why it is under the investment grade rating BBB-. So now if we see the case of Bangladesh and to see whether Nepal is more favorable investment destination than Bangladesh or any other similarly rated country then I think this is not very straightforward answer in my opinion because sovereign credit rating is just one of the metrics where investors they look at whether it's good to invest in that country or not and I do agree that though these ratings like provide important insights into the economic mostly from economic stability and risk perspective they don't capture the entire picture So why is that?

[00:20:12] - [Speaker 2]
It's mainly because there are other factors such as market size and growth potential of that very country right If you have a larger more diversified economy then typically they offer more investment opportunities and they also in some cases look at sector specific opportunities. If you just read the feature rating that has been assigned to Nepal, they don't talk about sector specific opportunities in detail. They do highlight yes there are hydropower or tourism or you know ICT sector that's growing but they don't deep dive into sector specific opportunity and besides this also regulatory environment right they don't go into detail because they just look at what's the political situation right now is it good enough where economy can grow positively that's what they look at So these insights such as market size and growth sector specific opportunities and regular regulatory environment they don't go that much into detail. So that's why I said it's not a straightforward answer. Yes, it's one of the main tricks but it does not capture everything.

[00:21:23] - [Speaker 2]
Now I'll just give you a recent developments in Bangladesh as we all know like it's recent political turmoil and it's one of the reason why they downgraded this rating from b b minus to b plus. So what's the difference between b b minus and b plus is that b b minus is speculative, whereas b minus is highly speculative. Now you know the difference right? And it was mainly because of the political situation and this political situation hugely impacted Bangladesh rating. Although their economy is doing very fine it is growing in a good pace but yeah political situation led to the downgrade in rating from BB- to B plus and as I highlighted so these ratings mostly I think focus on the government's ability to pay back its debts and they don't cover the other important areas like business conditions or what's happening in specific industries.

[00:22:27] - [Speaker 1]
Sticking to the downgrading of ratings right these are considered very risky especially in the context of developing nations and also sometimes considered really biased towards developing nations on how their ratings are very easily downgraded and given Nepal's political instability there was an article on Le Monde French newspaper that Nepal is considered world champion of political instability having like 14 prime ministers change in fifteen years. So do you think in the just hypothesizing that the context like how risky is the political scenario or the political context in Nepal and how is it going to be impacting the ratings in the near future in possibility of downgrading and which is going to have further impact on reduced investments or reduced credit in Nepal?

[00:23:30] - [Speaker 2]
Yeah I think that's a very good question. The reason behind this as you have laid out is the champion in terms of like political instability right world champion. So it might impact but how I see is if you see this macroeconomic stability component in Nepal I think almost all the parties they have agreement on this respect because you only you don't see the drastic fiscal policy changes you only see whether they have increased the tax in certain let's say EV vehicles or you know but not the major major ones that directly impacts government tax revenue or taking a radical move like if you take the case of Sri Lankaar they took a radical move when it comes to agriculture sector so I think our political parties and finance ministers they do have a kind of same agreement when it comes to driving the economic forward and if you see the case of even debt right it's it's very manageable although it's growing but it is under the limit so political situation definitely matters a lot but unless there is a political conflict like Bangladesh where people come into the streets or there is some big uprisings then only I think it will impact otherwise if you just see one government coming in and handing over to other government I don't think it will impact much although it brings some policy instability for some time in terms of capital expenditure or any other government expenditure but in general I don't see that drastic changes even though like our government changes but yeah main catch is I think how big is the political turmoil in the country that's the most important in deciding or downgrading the ratings.

[00:25:21] - [Speaker 1]
Okay now that have an I think the listeners have a good idea on what sovereign credit rating is and also in the Nepali context what it means we'd like to go further into the implications of this rating on certain sectors in Nepal and I'd like to start with primarily the foreign direct investment or the investment sector right. I don't know if it's untimely or timely that the credit rating was actually announced so four or five months after the investment summit right after certain pledges were made during the investment summit now that the investors have a good idea of what the Nepali economy is like. So do you think this b b minus status would be a boost to the Nepali economy in terms of bringing in foreign direct investment?

[00:26:13] - [Speaker 2]
Yeah. So I think I kind of covered this in my Kathmandu post article as well. Getting assigned BB minus rating definitely I think gives a bit of spotlight in the world of global investment. Now the investors know that okay Nepal is relatively stable and it is worth considering for potential investment. That's the positive aspect but what we have to look at is it's not the overall picture right if you see the case of FDI in Nepal it's been I think quite a ride if you see the FDI numbers like in 2019 there was around 190,000,000 FDI inflow and the following year during the pandemic it significantly impacted and then it dipped after that things picked up and then FDI suit up and again in like if you see the case of 2022 and it again dipped down if you see the trend it's not stable it's always up and down and if you just see the case of this fiscal year we have seen like there is a big gap between commitments and disbursement and this is the main issue in Nepal's FDI landscape and that is I think I read an article where it says that yes Nepal will have a huge commitment at first but it will take time to roll out these projects because investment does not come all in one go it slowly comes up I think that's also one of the reasons there is a big gap so going beyond the ratings I think we have to take a deep dive how the FTI inflow has been in the economy so far because that's one of my main takeaways from the article because if we don't look at this closely then how would investors know what is the FTI landscape in the country because FITS rating they only look at the surface level whether it's increasing or decreasing but there are many hindering factors in Nepal's fti landscape I'm sure we'll discuss later on that that is important to consider and yeah this BBB rating will hopefully will be a very good give a good message to international investors.

[00:28:30] - [Speaker 1]
Like you mentioned there are certain structural issues in Nepal in relation to bringing in FDI right so going into certain statistics or certain rankings we'll say that Nepal is in terms of ease of doing business ranked ninety fourth in the world in terms of index of economic freedom it's ranked 130 in the world considered mostly on free which is below both regional and world average and then if you look further into the ratings Nepal scores only 10 when it comes to investment freedom right As you rightly mentioned last fiscal year's realization FDI was only N8.5 billion Nepali rupees in terms of the pledge N61.9 billion which is around somewhat 15% and given the last decade's record it's around almost 38% realization of FDI. And even in the Fitch ratings I've quoted it says that burdensome procedures on profit repartation and other regulations on external transactions have historically constrained FDI inflow significantly but authorities are addressing this. So what kind of policy changes or regulatory reforms are the concerned authorities bringing in to attract FDI at the moment apart from obviously bringing this credit rating?

[00:29:58] - [Speaker 2]
So I think that's a very good question and it usually comes up whenever we discuss hurdles that is hindering a path's growth. It's often said that problems can be the solutions so we have to look at the problems and see how can we solve that problems. For that I think one of the main lessons we should learn from recent investment trend is that let's take an example of Pokhara And Gautam Buddha International Airport I think we should take a big lesson from these investment projects because if your investment decision is not right at the first place if you know that if that investment is not going to give you good return why invest in such projects at first place. Although we know there are other bureaucratic hurdles or profit repartation or Ftia friendly policies and so forth Those are also important component of it but the major investment decisions it should be very serious. Government should strictly think on what big ticket projects we should invest.

[00:31:05] - [Speaker 2]
If you see the positioning of these airports these new airports are expected to boost like tourism significantly. Right Pokhara if you see it's a high spending tourist destination and while Gautam Buddha it's very famous from the Buddhist dream age point of view and especially Gautam Budha Airport it's close to the proximity of Indian border like it can invite large now. Yes, positioning was right but we didn't do I think enough homework in terms of how much return these investment like investing in these big projects would invite because we completely failed on that respect. Next is when it comes to fti friendly policies yes I think government has taken very good steps for example for an investment and technology transfer act which aims to simplify the investment processes and try to offer some incentives and the one stop center had been set up to streamline approvals and reduce bureaucratic hurdles and also they introduced the automatic route which invited some good amount of investment but as I mentioned before there is a huge investment and commitment and disbursement gap that tell there is some issues to be solved especially from the government side and next thing I want to highlight here is if you see the power hydropower sector right most power generation companies in Nepal have built only one project and if any new investors they want to invest in Nepal then once they invest after thirty five years then they have to hand it over to government Which foreign investor will have to invest in a country where their investment will be overtaken by government and after let's say thirty five years what would be the share price of the investors?

[00:33:07] - [Speaker 2]
It's zero so they do not get the investment we should definitely change this these are the things that are happening and that's hindering investors right so yeah I think these are some of the key issues that maybe government should consider.

[00:33:24] - [Speaker 1]
So given that we've discussed like how investments can come in generally the other sector that is primarily impacted by certain amount of investments would be the banking and financial institutions right Given that certain banks have already have access to the IFC fund or funds from FMO in The Netherlands or various examples can be given from international investors how banking and financial institutions have managed to bring in funds but given that the sovereign rating has been received how is this going to impact the liquidity channel of banks and given that certain government guarantees provided to banks or maybe let's just say the spillover effect of this rating towards the banking sector as well. What kind of impact do you think it is going to bring in the VFI sector?

[00:34:19] - [Speaker 2]
What it does is I think first of all this rating it provides more credibility I think it will be easier for our banks to get foreign loans and investment because these ratings reassures everyone that Nepal's financial ground is solid right and next is it also offers better loan rates with higher credibility our banks might get loans at lower interest rate internationally this means that they lend more money to local business in Nepal and helping them grow and I think next thing is it might invite new players in town such as like it could attract new foreign banks and they might bring new practices and competition right now we only have standard chartered I guess so I think it gives exposure to other international banks to invest in our country and with regards to Ripple effects for example if the country's rating is solid right it helps improve their ratings of individual banks too because this means lower cost when our banks need to borrow money and more trust from the international investors and customers and I think with regards to government safety or safety net if you see the case of Nepal's banking sector non performing loans have been one of the big talents and even IMF is proposing solutions to Nepal Rastra Bank to work on this and I think they are conducting this audit on major commercial banks doing a study with regards to non performing loans where our banks missing out and why the loans are going bad so I think these studies are undergoing but the sovereign credit rating definitely gives a good image about Nepal and I think the next thing is this is not an instant magic right because the benefits of this rating won't show up overnight or it won't show up tomorrow so our banks they need to keep proving that they are on solid financial footing and keep innovating or come up with better products.

[00:36:37] - [Speaker 1]
Going into a more broader economic sector which would be the sovereign debt. In the last three-four years we've had various conversations regarding Nepal's rising debt accumulation and then obviously rising debt servicing costs as well and like you mentioned Nepal is as 44% debt to GDP ratio which is still as per the IMF's report which shows low debt distress right but there are still various conversations that have been going on in Nepal that that we are accumulating debt very rapidly. One of the reports in NRB's report recently said that Nepal's ideal GDP debt to GDP ratio would be somewhere around 35 to 36%. So we're already above that mark by maybe 8%. So given that we're going to get this rating that gives us that increases the probability of getting more loans more favorable loans but that would lead to certain accumulation of debt and given the pace that we which we're accumulating debt do you think it is going to be unsustainable for us?

[00:37:51] - [Speaker 2]
Yeah I think that's a very good question because as you rightly pointed out Nepal's public debt is currently manageable right as of 2024 it stands at around 40 two-forty 3% of GDP lower than the 55% median for similarly rated countries so it's very good signs but there are two very concerning trends on this one is debt servicing cost and next is with regards to the type of debt that we have with regards to debt servicing costs if you see it has reached record levels with debt repayment we call it amortization accounting for around 3.9% of GDP and interest payments of at around 1.44%. So in simple terms what it means is Nepal is spending more on paying back debt than on investing on infrastructure or on developing projects so that's why the desk servicing cost is increasing recently and next is Nepal's debt is split almost evenly between domestic and external debt which is around 4951% and this is the trend even in other South Asian countries although external loans have been favored or because it comes with lower interest rate and long repayment periods but more reliance on domestic borrowing especially through treasury bills and bonds it could also increase the interest cost because it might be more expensive than borrowing from the international multilateral institutions.

[00:39:29] - [Speaker 2]
So with this I think there are many risks first is I think crowding out risks because high debt servicing cost it means that the government has less money to invest in important projects especially on health education and this might have an impact on economic growth and there is one thing I think in this piece I did not cover my article that I did not cover with regards to climate vulnerability and debt dynamics like IMF and World Bank they have this debt sustainability framework for low income countries. It is very manageable and now what they are trying to do is they are trying to integrate climate risks in this debt sustainability framework as well and that's very important because if you see many studies it has highlighted that a rise in climate vulnerability directly correlates with significant increase in public debt up to like 13% of GDP similar to countries like Nepal and this is a very important factor for Nepal and I recently read a paper by the Nepal economist who is working at climate analytics based in USA and what his findings tells us is that nations that have high vulnerability but also have higher resilience to climate related disasters are likely to maintain the sustainable public debt but if you see the case of Nepal Nepal stands more on debt repayment front because its capacity to fund climate resilience and adaptation may be constrained because of this and high vulnerability to climate impacts could increase the borrowing to fund recovery and adaptation efforts for Nepal and this might further increase the debt levels for this country I think it would be very good to highlight this climate aspect and I think FIT's rating also misses on this aspect Climate risk has been incorporated in many banks.

[00:41:28] - [Speaker 2]
Many banks have tried to consider Climatrix but it's a very evolving topic and even IMF and World Bank are working on this. Next thing is revenue constraints. Nepal has always struggled to meet its revenue collection targets. This I think if you see over the years we have fallen by 25% short and if this trend continues right it could lead to a greater borrowing just to cover the recurrent expenditure and will not have enough money to support the capital expenditure and as you have mentioned like we are dependent on concessional funding mostly overseas development assistance till 2026 we had this privilege but after this we might lose this privilege as well so I think these are the few things I think that's hindering Nepal's growth. Next important question is will this sovereign rating help or hurt Nepal right?

[00:42:25] - [Speaker 2]
It's very important to consider this as well because it has impact on the conditionalities as well. There are both positive and negative effects of this. The positive aspect is that stable BB minus rating it gives a good signal to lenders that Nepal has a low risk of default and Nepal has been paying its debt on time which could help the government negotiate better loan terms in future and next is if our rating is downgraded then rating could it could increase the borrowing cost and both for government and private sector and it would signal the higher default risk to lenders.

[00:43:06] - [Speaker 1]
Like you pointed out regarding Nepal's graduation from the LEC status Obviously the focus is going to be on the private sector. Private sector bringing growth to the economy but in context of Nepal the lack of capital has always been a significant obstacle for businesses apart from other structural issues that we discussed lack of capital has been significant hindrance as you mentioned in your article there's a financing gap of around $3,560,000,000 in Nepal specifically for businesses how do you think the small and medium enterprises or maybe even the bigger enterprises can leverage this credit rating to address the limitations of capital within the Nepali economy and do you think the small and medium enterprises that are functioning in Nepal are attractive enough for potential investors?

[00:44:08] - [Speaker 2]
That's an interesting question because credit rating will definitely play a very important role in especially boosting the growth prospect of local business particularly micro small and medium sized enterprises right but what is important here is whenever we see the reports coming out from policy think tanks or big international organization we say that okay there is a huge financing gap in the country and this is mostly the case of all the developing countries financing is always major problem but with the credit guarantee schemes the point that me and my co author Nidhan Srestha we were trying to make on this is that we should also leverage the amount of capital that the country has because there is a huge potential on this respect that we have to in many countries credit guarantee schemes had been have been utilized to counter the risks that is inherent in the undeserved sectors so this becomes very important and this credit guarantee schemes will help especially SMEs to get the capital and at the same time grow their business. While SMEs Nepal face challenges it might become attractive to investors especially those prioritizing ESGs there have been cases where Nepal private equity and venture capital have been able to bring those green funds from international market like from Netherlands and next is I think it is very important to meet the investor expectation because investors are looking for business that align with ESG principle right and with ESG principle they can it's a very tricky part for Nepal's business as well because not every SMEs take ESGs into consideration and this might restrict our SMEs to access such ESG related investment.

[00:46:18] - [Speaker 2]
I think SMEs need to effectively communicate their ESG initiatives to investors and this can be done mostly through sustainability reports impact assessment and the participating in ESG ratings and that is something international investors might look so working on this would be one step next is I think there is a role for innovative financial instruments as I laid out credit guarantee schemes while these schemes.

[00:46:54] - [Speaker 1]
You give one example regarding the credit guarantee scheme maybe it could help the listeners understand the concept better?

[00:47:02] - [Speaker 2]
Yes sure so in the context of like I can give you the case of Nigeria where they have this development bank of Nigeria and they have this subsidiary form called Impact Credit Guarantee Limited so the main role of DVNs is mainly to like alleviate the financing constraints based by MS semi by providing partial credit guarantees to financial institutions and they have this subsidiary agency called ICGL and this ICGL specialises mostly on credit guarantee schemes and they have a strong focus mainly on undeserved markets or undeserved sectors such as women women or SMEs or young entrepreneurs So if you see the case of Development Bank of Nigeria, it has like dispersed almost 1,600,000,000 in last year I think or few years back and these are mostly targeted to MSMEs. And next one I think I can think of is India's credit guarantee fund trust for MSMEs this is also very popular because the beauty of this credit guarantee fund is they offer collateral free credit to MSMEs mainly to strengthen the credit delivery through various institutions financial institution without having them to provide a collateral so it has significantly enhanced access to credit for small businesses and I think the one that I covered in the article was Indonesia Sarula power project so it is one of the largest thermal power projects in the world and they leveraged substantial financial guarantees to secure the investment mostly from Japan bank for international cooperation and this has a twenty year business viability guarantee from the Indonesian government so this is the case of big guarantee schemes and definitely this guarantee play a very important role in securing funding for the projects and this will have a big impact in the economy itself.

[00:49:20] - [Speaker 1]
Very interesting examples you've provided of various countries. So overall as we're coming to the close of the conversation you've painted a slightly favorable picture for the Nepali economy given that this rating is going to have certain positive impacts if we are to address certain structural issues in Nepal and would eventually spur long term growth in Nepal. So but like I mentioned regarding the LDC graduation, Nepal is going to lose out on certain privileges regarding trade tariffs and obviously the interest rates on certain concessional loans are going to change and certain trade benefits are going to be lost. Eventually how is Nepal going to cope up with this so that Nepal doesn't downgrade after losing the LDC status? What can Nepal do in the longer run by using this credit rating to spur economic growth?

[00:50:28] - [Speaker 1]
I would like you to frame your answer and also provide the concluding thoughts on how Nepal can maybe sustain the ranking or maybe even upgrade the ranking to a higher level to maybe investment status like India.

[00:50:44] - [Speaker 2]
So I think Nepal should definitely celebrate this historic milestone right because it's the first time that we got this rating. While we are celebrating this rating I think we should keep in mind that it can increase or decrease. We cannot just be happy and say oh Nepal got BB minus rating and I painted a picture of how's the inflow of FDI has been in the country right although it had seen some volatility in recent years but there are lots of things to be done to bridge the commitment and disbursement gap so I think this is the first thing that maybe government can focus on to attract the foreign investors so if we don't work on the key problems or issues that we are facing with regards to FTI although government has come up with good plans for the policies but it still needs to be fast enough like automatic road it has to work efficiently to bring the new investment in the country and I think this will soon this will definitely encourage should encourage government to create a favorable investment climate and improve on governance and institutional quality and also regulatory efficiency and ease of business.

[00:52:03] - [Speaker 2]
Now if I have to be more specific with regards to economic aspects I think they have to strengthen the revenue collection because if you see the revenue collection they have resort on terms of tax revenue so I think they have to work on this maybe implement realistic revenue forecast and put on the tax base and next thing is we have to capitalize on concessional funding that we are getting it's only a year left right although even after 2026 we might have those access but still we should prioritize the sectors as we talked about investing in right projects at the right time and when we are investing in big ticket projects it should not be like the one we have seen with Pokhara and Vedawai International and next is yeah spending if you see the spending pattern of government we should avoid the end of year spending spree that waste resources only at the end of the year that's the very common trend that we see in Nepal and so we have to allocate and spend budget efficiently throughout the year to ensure that the infrastructure development projects are completed on time and I can go on about like diversifying the economy like reducing dependence on imports and remittance right but it requires a long term planning it does not happen overnight and I think government needs to look for ways to encourage FDI in priority sectors rather than being dependent only on imports and remittance and also maintaining external liquidity is very important our foreign exchange reserve currently covers I think thirteen months of import which is well above the median for similarly rated countries so and this I think cushion should be maintained to protect from external shocks and next is maybe we have to keep our debt control I see that fees rating they provide a huge importance on debt condition of the country we have to strictly enforce borrowing caps maybe like I don't know no more than 30% of GDP and this will prevent reckless borrowing and it can ensure that debt remains within the manageable levels and we have been doing fine but as I mentioned before the debt servicing cost is increasing we have to look into this and work on this to better manage our debt situation.

[00:54:40] - [Speaker 2]
Overall I think these are the few that are important areas where government can work on and I think my last thought is I should encourage everyone not only government but also private sector to utilize this rating in a positive manner so that our economy can grow because we have big challenges coming ahead of us after LAC graduation so keeping that in mind we should better utilize this and yes bring more investment and try to grow our economy.

[00:55:16] - [Speaker 1]
Thank you, thank you Nishu for a very interesting conversation. On behalf of PEI, I would like to thank you for being part of Pods by PEI.

[00:55:33] - [Speaker 0]
Thanks for listening to Pods by PEI. I hope you enjoyed Auslatious conversation with Nistal on understanding Nepal's first sovereign credit rating. Today's episode was produced by me, Kushi Hang, with support from Nirjan Rai and Bhivuti Bharta. The episode was recorded and edited at the PEI studio and our theme music is courtesy of Rohit Shakya from Zindabad. If you liked today's episode please subscribe to our podcast.

[00:55:58] - [Speaker 0]
Also, please do us a favor by sharing us on social media and leaving a review on Spotify, Apple Podcasts, YouTube or wherever you listen to the show. For PEI's video related content, please search for policy entrepreneurs on YouTube. To catch the latest from us on Nepal's policy and politics, please follow us on Twitter tweet2pei. That's T W E E T followed by the number two and PEI. And on Facebook at Policy Entrepreneurs Inc.

[00:56:27] - [Speaker 0]
You can also visit pei.center to learn more about us. Thanks again from me Kushi. We will see you soon in our next episode.