Domestic vs External Debt: Which Burden Is Heavier for Nepal?

Nepal’s public debt has been steadily rising, split between domestic debt and external debt, each carrying its own challenges. As of FY 2024/25, domestic debt stood at Rs. 1.27 trillion (20.8% of GDP), while external debt reached Rs. 1.40 trillion (22.9% of GDP). Together, total public debt now exceeds 43% of GDP, which is manageable by global standards but worrying given Nepal’s weak revenue mobilization and low capital expenditure efficiency.

Domestic debt is generally considered less risky because it is raised in local currency and serviced from internal revenues. Nepal relies heavily on treasury bills and bonds, which are absorbed by banks and financial institutions. However, the rapid buildup of domestic debt creates crowding-out effects: banks prefer lending to the government over riskier private borrowers, limiting credit growth for businesses. With private sector credit growth already modest (7.7% in mid-August 2082/83), rising domestic borrowing may further suppress investment. Moreover, servicing domestic debt takes up a growing share of government revenue, squeezing fiscal space for development.

External debt, by contrast, poses currency and repayment risks. Although Nepal’s foreign loans are mostly concessional (from the World Bank, ADB, and bilateral partners), they are denominated in foreign currencies. This creates vulnerabilities if remittance inflows or foreign exchange reserves falter. Currently, reserves are strong at over USD 20 billion, providing a buffer, but Nepal’s heavy reliance on remittances (Rs. 1.7 trillion inflows in FY 2024/25) means its debt sustainability is tied to external labor markets and global economic conditions. Furthermore, Nepal’s low capital expenditure efficiency means borrowed funds often fail to generate the returns needed for repayment, raising the risk of debt dependency.

When comparing burdens, external debt carries greater long-term risks, as it is vulnerable to exchange rate fluctuations, global interest rate changes, and declining remittance inflows. Domestic debt, though easier to manage, directly impacts liquidity, investment, and fiscal flexibility. In essence, Nepal faces a dual challenge: managing domestic borrowing without crowding out private sector growth, while ensuring external debt is channeled into high-return projects that enhance foreign exchange earnings.