Government Borrows at Cheaper Rates Amid Excess Liquidity in Banking System

The Government of Nepal is currently raising internal debt at one of the cheapest rates in recent years due to the presence of excess liquidity in the banking system. In fiscal year 2079/80 (2022/23), the interest rate on development bonds went as high as 11%. In sharp contrast, bonds issued at the start of the current fiscal year have carried rates as low as 3–4%, according to data from the Public Debt Management Office (PDMO).

As of Bhadra 10 (August 26, 2025), the government has already raised NPR 50 billion through development bonds. These include five separate issuances worth NPR 10 billion each, with maturities of three years and eleven years. The average rate for these bonds stands at just 3.74%. Investor demand has been exceptionally strong, with some auctions oversubscribed up to seven times the issued amount.

Continuing with this borrowing drive, the PDMO has announced the issuance of an 11-year development bond titled “Development Bond 2085 ‘Dha’” worth NPR 10 billion. The auction is scheduled for Bhadra 11 (August 27, 2025). Investors ranging from banks, financial institutions, insurance companies, and organized institutions to individual citizens are eligible to participate. Of the total, 85% of the issue is reserved for competitive bids, while 15% is for non-competitive bids, with proportional allocation if oversubscribed.

The movement of interest rates on government bonds in recent years reflects Nepal’s liquidity cycles. In FY 2076/77 (2019/20), the average rate stood at 6.77%. It dropped to 4.33% during FY 2077/78 due to the COVID-19 slowdown. The rates then climbed to 7.74% in FY 2078/79 and further to 8.64% in FY 2079/80, with one auction in Poush 2079 recording nearly 11%. In contrast, the most recent fiscal year saw the average rate fall back to 4.73%, with a range of 3.85% to 5.30%.

The current year has now seen bond yields fall even below the Nepal Rastra Bank’s (NRB) policy rates. NRB recently reduced the benchmark rates, cutting the bank rate to 6%, the policy rate to 4.5%, and the Standing Deposit Facility (SDF) to 2.75%. Despite these reductions, government bonds are still pricing at an average of 3.74%, highlighting the extent of oversupplied liquidity in the financial system.

This situation offers the government a clear advantage. Borrowing costs are significantly lower, reducing fiscal pressure, especially at a time when the budget has set a plan to raise NPR 362 billion in internal loans. The first quarter target alone stands at NPR 113 billion, followed by NPR 85 billion in the second quarter, NPR 109 billion in the third, and NPR 55 billion in the fourth quarter.

For banks, however, the picture is mixed. As of now, deposits total NPR 7.23 trillion while loans stand at NPR 5.59 trillion, leaving a liquidity surplus of more than NPR 600 billion. The average Credit-to-Deposit Ratio (CD Ratio) is only 76.33%, well below the 90% limit, showing that banks have the capacity to lend nearly NPR 900 billion more. But due to weak loan demand, they are instead channeling surplus funds into government securities, even at low yields.

In broader economic terms, the government benefits in the short run from reduced debt-servicing costs. However, persistently low yields on government bonds indicate deeper structural issues—private sector credit demand remains subdued, investment appetite is weak, and economic expansion is sluggish. Unless loan demand recovers, excess liquidity may continue to distort interest rates, keeping deposit rates suppressed and squeezing bank profitability.