Public debt lessons from Pakistan and Sri Lanka

October 21, 2024

KATHMANDU – Is Nepal on the verge of becoming another Sri Lanka? Questions of these motifs were common in Nepal’s public debate sphere after Sri Lanka defaulted on its sovereign debt in April 2022. Around the same period, another South Asian nation—Pakistan—had difficulty servicing its foreign debt.

While the doomsday predictions of Nepal becoming another Sri Lanka turned out far-fetched, can the debt distress experienced by Sri Lanka and Pakistan offer lessons for Nepal’s public finances? A closer investigation of public debt in three countries—Nepal, Pakistan and Sri Lanka—offers some answers.

First, these three South Asian nations differ markedly in their public debt levels and other public finance characteristics. While assessed as having a low risk of debt distress, Nepal has witnessed a surge in its public debt holding, from about 25 percent of GDP in the fiscal year 2014-15 to 42.7 percent in 2023-24. However, despite the peculiarities of every nation, some common patterns let us draw a few lessons.

Fiscal profligacy to serve short-term political gains is at the heart of the public debt woes. For instance, Sri Lanka aggressively used foreign loans obtained at a high cost to finance development projects and social welfare to fulfil election pledges and appease the voters. Even when the debt accumulation was spiralling out of control, the government failed to make timely adjustments and instead opted for counter-intuitive tax cuts in 2019. Covid-19 halted Pakistan’s tourism, a critical foreign reserve source. Moreover, policies such as a ban on imports of chemical fertilisers caused a decline in agricultural production and exports, hastening the debt crisis. However, the crucial factor was a long