Why are Nepal's domestic borrowing costs cheap? And, Who owns Nepal's government bonds and why they are not traded? An easy-to-understand summary.

Let us look at the recent long-term bonds issued by the Government of Nepal in the fiscal 2017/18.

Observation 1: The bonds were oversubscribed when issued.

Observation 2: Bond yields average close to 5%.

Let me put that into context below:

Nepal's government domestic borrowing costs are lower than that of India, Russia, Brazil and Sri Lanka. The government is enjoying cheap funds. You definitely want to know why and how. We'll explore that below by first understanding what is the bond market like here in Nepal.

Nepal has a small bond market.

While the bond market in many developed economies is many times the equity market, the bond market here is quite small and almost entirely dominated by government bonds. The domestic of the government is 340 Bio and except for 128 Bio in Treasury Bills, the remaining are long-term funds. The market capitalization of NEPSE, the country's only stock exchange, is NPR 1,753 Bio. The few corporate bonds that do exist (less than 5 Bio) are all issued by banks as the stock market (as well as formal economy) is primarily dominated by the financial sector. It's doubtful if bonds issued by other corporates would sell or even get approval from the Securities Exchange Board of Nepal (SEBON).

The corporate bond market, however, is set to grow because of new regulations by the Central Bank that allow banks to lend money borrowed through bonds. Earlier, such funds only helped towards Capital Adequacy purposes.

The corporate bond market, however, is set to grow because of new regulations by the Central Bank that allow banks to lend money borrowed through bonds. Earlier, bonds only helped banks towards Capital Adequacy purposes.

Nepal's bonds are not traded.

The bonds are tradable, of course. But, they aren't. Perhaps it's the size. However, it's quite strange that the bonds issued by the Government aren't actually liquid because there are absolutely no bond-related transactions in the stock market. Maybe, people and companies also like to hold-till-maturity. Yields used above are therefore yields at issue.

0% of bonds issued by government this year were purchased by individuals

Because all bonds were (and are almost always) bought by banks. The government issues bid-bonds where buyers compete on price. Bidders are allotted based on the average bid-price of the lowest bidders till the threshold amount. Price is determined by the market. Individuals wouldn't find this attractive as these bond yields are lower than half of fixed deposit rates offered by commercial banks. Individuals also are usually not aware of such bonds. Banks here usually sit on high liquidity (I'll share why later) and therefore these bonds are always oversubscribed.

There are separate bonds for individuals

I don't think any other country has such an arrangement where there is no single rate for a government bond. While 'development bonds issued by the government can be purchased by anyone - corporates and individuals - there are 'citizen savings bonds' and 'foreign employment bonds' that can be purchased only by Nepali citizens and Nepali citizens working abroad respectively. These bonds are minimal in volume (10 Bio) and were last issued last year at 8.5%. This is primarily meant to safeguard individual participation in domestic debt. Price of these bonds are pre-determined and allotment is only based on amount, first come first serve. Also, these bonds are not traded in the stock market but sold and purchased through banks that are market-makers for the Central Bank.

Banks hold almost the entirety of government debt

Banks can lend only 80% of deposits because of the CCD Ratio. Out of the remaining 20%, Statutory Liquidity Ratio (SLR) requirements are 12% (which includes 6% CRR). Bonds and Treasury bills count towards the SLR requirement. Also, the remaining (100% - 80% - 12%) is usually invested in form of secure government bonds for lack of investment avenue. Few banks invest in the stock market. So, it is banks that help the government borrow funds cheaply for lack of opportunities for banks.

Therefore, it is the Central Bank's regulations regarding CCD Ratio, liquidity ratios and the lack of investment avenues for banks that have resulted in (usually) high liquidity for banks and, therefore, high appetites for investment in bonds.

However, as Nepal is essentially out of touch with global financial markets, bond yields do not make much sense for comparability purposes as it is hard to fathom Nepal's bonds being sought out Internationally in the near future. Another problem for another time. Right now, these cheap funds are only lying in government coffers as the government continues to under-spend.

The author is a financial sector professional and a Chartered Accountant.