Fiscal Risks of Sovereign Guarantees

Posted by Parajuli Sushil 1 week Ago Add Comment 11 Min Read

Introduction

In Nepal’s fiscal landscape, the public debt-to-GDP ratio of 43.79% (as of mid 2024) often gets the most attention. However, this visible metric tells only part of the story. The true vulnerability may lie in the government’s contingent liabilities – specifically, sovereign guarantees. These are promises by the Government of Nepal (GoN) to repay the debts of other entities (especially state-owned enterprises SOEs) if they fail. While instrumental for funding public projects, these guarantees can swiftly transform from silent backstops into massive public debt during economic downturns or institutional failures.

This analysis, grounded exclusively in official PDMO’s reports up to mid-July 2024, moves beyond the surface to quantify the explicit, implicit, and often overlooked risks embedded within Nepal’s sovereign guarantee framework.

The Legal Framework

Nepal’s constitution and laws establish a clear framework for fiscal responsibility.

  • Constitution of Nepal (2015), Article 115: Mandates that no government loan or guarantee can be issued without federal legislation.
  • Public Debt Management Act, 2079: Section 14 explicitly allows for GoN to provide guarantees on commitments of the State Owned Enterprises.

Despite this robust legal footing, the Public Debt Management Office (PDMO) itself acknowledges a critical flaw: “The record of guarantees provided by the government and the potential liabilities arising from them is not systematically maintained.” This admission is the first clue that the official numbers don’t tell the whole story.

Explicit Guarantees: Tip of the Iceberg

The official data on explicit guarantees appears deceptively small.

  • As of Mid-July 2024, the GoN’s explicit guarantees total NPR 34 billion, a modest 0.59% of GDP.

The Concentrated Risk: The Nepal Airlines Corporation (NAC) Case

This entire explicit guarantee amount is overwhelmingly concentrated in one entity: Nepal Airlines Corporation (NAC). The guarantees, provided for wide-body and narrow-body aircraft purchases from domestic institutions like the Employees Provident Fund (EPF) and Citizens Investment Trust (CIT), have soured dramatically.

  • Due to NAC’s non-performance, the guaranteed amount has ballooned with unpaid interest. The outstanding principal and capitalized interest now stand at a staggering NPR 52.46 billion.
  • This liability is broken down into specific loans from EPF and CIT for each aircraft type, illustrating a precise and concentrated exposure.
  • With NAC recording a cumulative loss of NPR 15.62 billion, the activation of this guarantee – transferring NPR 52.46 billion in debt to the public – is a near-certainty.

Implicit Guarantees: Hidden Iceberg

The most significant fiscal risk is not explicit, but implicit, arising from the GoN’s role as a primary lender to SOEs.

  • The GoN has invested a total of NPR 82,751 crore in 150 public institutions. A critical 52% (NPR 43,233 crore) of this is debt investment (loans).
  • 64% (NPR 27,595 crore) of these loans are financed by the GoN through foreign borrowing, creating a massive implicit guarantee. If the SOE defaults, the GoN remains liable for the original foreign debt.

The Depth of the Problem: Scale and Non-Performance

The scale of this implicit guarantee exposure is vast. The top recipients of GoN loans are major utilities like the Nepal Electricity Authority (NEA) and the Kathmandu Upatyaka Khanepani Sanchaya Kosh Board, with investments reaching into the trillions of rupees. This concentration in a few entities mirrors the risk seen in the explicit NAC guarantee.

Alarmingly, many of these SOEs are already failing to service their debts. The total principal and interest overdue to the GoN is a massive NPR 181.15 crore (0.42% of total GoN’s lending to SoE), with NEA and the Water Board alone accounting for over NPR 134 crore. This non-performance is a clear indicator that the implicit guarantees are already under stress.

Calculating the True Fiscal Exposure

When we combine all layers of guarantee exposure, the picture becomes alarming:

  1. Explicit Guarantees (NAC): NPR 5,246.10 crore
  2. Implicit Guarantees (Foreign Loan Relending): NPR 27,595 crore
  3. Implicit Guarantees (Domestic Loan Relending): NPR 15,638 crore

Total Exposure = NPR 48,479 crore
(These figures are translated at NRS as of Mid 2024 – for accurate FCY liabilites, refer annual report from the source link below)

This total exposure equates to approximately 8.49% of GDP – a figure fourteen times larger than the official “explicit guarantee” number.

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Strictly speaking: A guarantee is a contingent obligation: the guarantor (here, GoN) promises to pay if the primary borrower (SOE) defaults. A loan from GoN to SOEs is not a formal guarantee because the money is directly lent. It appears on the GoN balance sheet as an asset (loan receivable). The GoN is already the creditor; it doesn’t “promise to pay someone else” if the SOE fails. So, in technical accounting terms, the loan itself is not a guarantee. Despite not being a formal guarantee, there is a strong theoretical and practical rationale for calling it an implicit guarantee: a) Contingent risk through GoN’s ultimate responsibility: SOEs in Nepal are largely state-owned, politically significant, and strategically important (e.g., NEA, Water Board, NAC). Even if the SOE borrows directly from the GoN (via relending), the GoN may still be politically or economically compelled to cover losses if the SOE cannot repay. In other words, the GoN is ultimately responsible for ensuring SOEs are viable, because their failure can have systemic implications (power outages, water shortages, airline collapse). b) Funding chain and foreign debt exposure: GoN often borrows from external sources to relend to SOEs. If the SOE defaults, the GoN still has to service the original foreign loan. This is a real contingent liability: the foreign lender expects repayment regardless of the SOE’s performance. Therefore there is a mixed element to it, but if it were to be accounted as GoN's gurantee, in that case it makes sense to not account such relending to SoEs as debt of GoN. In other case, they should not be accounted as gurantee. But in any case, So “implicit guarantee” is a risk classification, not a legal term. It captures the probable exposure of the sovereign to potential SOE defaults.

Are GoN loans to SOEs really guarantees?

Key Alarming Indicators

  1. Foreign Exchange Vulnerability: The GoN’s external debt, which funds the implicit guarantees, is highly vulnerable. A projected exchange rate loss of NPR 6,554.79 crore of the total stock of FCY debt 125,760.23 (~ 5.21%) is expected in one year. This is a direct, costly hit to public finances on top of interest payments.
  2. Costly FCY Interest Costs when compared to LCY Interest Costs: The average interest rate on the foreign currency debt portfolio for the FY 2023/24 has stood at NPR 1,016.95 crore of the total stock of FCY debt 125,760.23 (~ 0.81%) bringing the total cost including the cost of debt to ~ 6.01% on the outstanding foreign currency loan. This is higher than the the average cost of local current borrowing which comes to 6,027.87 crore of the total stock of the LCY debt 117,698.64 brings to average rate of LCY borrowing to ~ 5.12%. 
  3. Systemic Risk to Domestic Finance: The explicit NAC guarantees are held by critical domestic institutions like the EPF and CIT. A default would directly impact the retirement savings and investments of millions of citizens, posing a severe systemic risk.
  4. The Precedent of Non-Performance: The NPR 181.15 crore in overdue SOE payments to the GoN proves that the system is already failing. It demonstrates a pattern of financial mismanagement that makes the calling of guarantees not a theoretical risk, but a probable event.

Conclusion

Nepal’s sovereign guarantee market reveals a hidden fiscal risk. The concentrated failure of NAC and accumulating non performing lending in other SoE are clear and present dangers, but the diffuse, implicit guarantees across the SOE sector – especially in large utilities – represent a far larger, systemic vulnerability.

The data reveals a chain of risk: foreign borrowing leads to implicit guarantees to SOEs, which are then jeopardized by exchange rate fluctuations and chronic non-performance. To safeguard fiscal stability, policymakers must move with urgency to:

  • Formalize and Disclose all implicit liabilities.
  • Enforce SOE Accountability and restructuring.
  • Stress-Test the entire guarantee portfolio against economic shocks.

Transparency and proactive management are no longer optional; they are essential to preventing these contingent liabilities from becoming Nepal’s next fiscal crisis.

Sources:

  1. Public Debt Management Office (PDMO), Annual Report 2080/81 (2023/24): Link to Loan Report
  2. Public Debt Management Office (PDMO), Investment Report 2080/81: Link to Investment Report
  3. Public Debt Management Act, 2079: Link to Gazette