Fitch Ratings has assigned Nepal a Long-Term Foreign-Currency Issuer Default Rating (IDR) of ‘BB-’ with a stable outlook.

This reflects no material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments, it said in a statement on Thursday, November 21. 

Earlier this year, the government had handed over the responsibility of the sovereign credit rating of Nepal to American credit company Fitch Ratings.

It is a huge achievement for Nepal, benefiting both the government and the private sector in the coming days, Former Finance Secretary Rameshore Khanal told NBA. 

“This rating, mainly, has two advantages,” said Khanal. “First, it will now be easier for us to borrow from the international financial market; and for the government to issue sovereign bonds.”

While the Government of Nepal itself does not borrow from the international financial market currently since the agencies such as World Bank and ADB have fulfilled such a need so far, it will help the government to make the borrowing, if needed, in the coming years.

“The second advantage is in the foreign direct investment sector,” Khanal added. “Foreign direct investors would be assured that there won’t be, at least, foreign exchange reserves-related hurdles during repatriation. It will thus boost investors’ confidence.”

The report says that strong and stable economic growth enabling substantial increases in GDP per capita, potentially supported by improved governance standards and regulations conducive to private and foreign investment; and, a material reduction in government debt could individually or collectively, lead to an upgrade on rating.

Read: Fitch Ratings to undertake Sovereign Credit Rating of Nepal

On the contrary, the statement mentions that factors such as substantial increase in the government debt/GDP ratio, weakening of bilateral and multilateral creditor support that strains external financing and pressures foreign-exchange reserves, and weakening of medium-term growth prospects could, individually or collectively, lead to downgrade of the rating. 

Fitch’s credit rating scale for issuers and issues is expressed using the categories ‘AAA’ to ‘BBB’ (investment grade) and ‘BB’ to ‘D’ (speculative grade) with an additional +/- for AA through CCC levels indicating relative differences of probability of default or recovery for issues. 

The terms “investment grade” and “speculative grade” are market conventions and do not imply any recommendation or endorsement of a specific security for investment purposes, according to Fitch Ratings.

Investment grade categories indicate relatively low to moderate credit risk, while ratings in the speculative categories signal either a higher level of credit risk or that a default has already occurred.

Here are the findings of the Fitch Ratings for Nepal:

Low Debt; Weak Structural Factors: 

The ratings reflect Nepal's low and highly concessional government and external debt burdens, strong external liquidity and solid growth prospects underpinned by the hydropower sector, reads the statement.

“This is balanced against an underdeveloped economy that is vulnerable to external shocks and natural disasters,” it says. “GDP per capita and governance metrics are well below the 'BB' median, but have been improving since the end of armed conflict in 2006 and the subsequent political transition.”

Stable Debt:

Fitch Ratings said that it estimated federal government debt surpassed 44% of GDP in the fiscal year ending 15 July 2024, below the forecast 'BB' median of 55%. 

“We expect debt to remain around these levels in the coming years amid a pick-up in growth and fiscal consolidation under Nepal's IMF-supported programme,” it said. “Non-financial contingent liabilities appear limited, although monitoring and oversight is still not comprehensive.”

Strong Debt Affordability: 

We estimate federal government interest payments peaked at about 8% of revenue in FY24 (2023/24), just below the forecast 'BB' median, although debt/revenue, at 230%, was above the median, the company said.

“More than 40% of government debt is external and highly concessional, with an average maturity of nearly 13 years and an average interest rate of about 1%,” reads the statement. “Real interest rates are also low on domestic debt, which has maturity of less than three years.”

It reflects, according to Fitch, a liquid banking sector that is funded by large remittance inflows and low policy rates that are accompanied by capital controls. It expects Nepal to enjoy strong availability of concessional funding after graduating from Least Developed Country Status in 2026.

Large Deficits; Consolidation: 

The company also forecasts the federal government deficit to narrow to 4% of GDP by FY26, from our estimate of 5% in FY24 and nearly 6% in FY23 ('BB' median: 3%).

“The consolidated general government position is better. State and local governments, mostly funded via federal transfers, struggle with spending execution and posted nearly 1% of GDP surplus in FY22,” reads the statement. “Consolidation efforts are focused on raising revenue/GDP from the low level of 19% FY24, in particular through more direct taxation, as part of the government's domestic revenue mobilisation strategy.”

Revenue Shock: 

The fiscal deficit nearly doubled in FY23 on a sharp decline in imports and import-related taxes.  

“This was the result of policies aimed at curtailing the current account deficit, which widened as tourism revenue dropped, while Covid-19 pandemic-related stimulus measures overheated the economy,” it said.  “These policies included government spending cuts, higher interest rates and import controls, and resulted in an economic slowdown.”

Basic Fiscal Framework:

The government tends to have optimistic revenue growth forecasts, but regularly adjusts spending plans mid-year to comply with a rule limiting annual domestic gross borrowing to 5% of GDP. 

Government external debt is limited to 30% of the preceding year's GDP. However, the government ran up a negative treasury single account balance at the central bank of about 3% of GDP at FYE23, although it still has general government deposits.

Temporary External Surplus; Strong Reserves: 

We expect stronger domestic demand to widen the current account deficit to 4% of GDP by FY26 and narrow reserve coverage to about nine months of current external payments.

“This will exceed the 'BB' median of five months and should comfortably support the long-standing Indian rupee peg,” the statement said. “Nepal posted a current account surplus of nearly 4% of GDP in FY24, a stark turnaround from a deficit of 13% in FY22 on import compression, tourism recovery and continued growth in remittances, which reached about 70% of external receipts and 25% of GDP.”

Net External Creditor:

There is little external borrowing outside the public sector, reflecting Nepal's minimal amount of foreign direct investment and limited integration into the global financial system. 

This saw Nepal post a net external creditor position of 10% of GDP in FY24 ('BB' median: debtor position of about 15% of GDP) and a net international investment position of 5% of GDP, according to the statement. “Burdensome procedures on profit repatriation and other regulations on external transactions have historically constrained foreign direct investment inflows significantly, but the authorities are addressing this.”

Growth Recovering: 

Fitch forecasts growth to pick up to about 5% over the medium term, from the policy-induced slowdown to 2% in FY23 and an estimated 3% in FY24. 

“Nepal's growth is traditionally driven by consumption and investment. The development of hydropower, backed by an export agreement with India, supports medium-term growth,” the statement reads. “Over the past 30 years, despite significant political turmoil and a devastating earthquake in 2015, growth has averaged at over 4% a year (over 3% per capita). Nevertheless, GDP per head, at about USD1,400, remains a fraction of the 'BB' median.”

Large Banking Sector; Manageable Risks: 

Bank credit to the private sector reached nearly 86% of GDP in FY24, down from a peak of 94% in FY22, the statement mentions. 

“This is high for Nepal's level of development, but is backed by a large remittance-funded deposit base of 106% of GDP,” it says. “Enhancements to the regulatory toolkit are a core focus of IMF engagement. Financial soundness indicators are deteriorating, but remain adequate.” 

Underregulated non-bank financial institutions represent another 10% of GDP in credit, but new licences have been frozen and linkages with the broader financial system are limited, the statement added.

Frequent Leadership Changes:

The report stresses that frequent changes in government, fueled by continuous power struggles and shifting political alliances, have undermined long-term policymaking and development planning. Nevertheless, there appears to be broad consensus around economic and fiscal management as the political instability has had little effect on the operation of the central bank, the statement said.

ESG - Governance: 

Nepal has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. 

“These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model,” the statement says. “Nepal has a medium WBGI ranking at the 34th percentile.”

The government had mentioned in the budget announcement before the Covid pandemic that it will opt for the country’s sovereign credit rating. It took almost a year to find the donor for the rating. The government handed over the responsibility to Fitch Ratings. However, it was halted due to the onset of the pandemic the same year as the government was apprehensive that the credit rating outcome would not be as expected due to the impact of the pandemic.

The government had included the topic of credit rating in the budget for the last fiscal year.