Kathmandu-Since the implementation of federalism, the Government of Nepal has often faced allegations that it has taken foreign loans to sustain the federal system. Groups that oppose federalism frequently raise this issue.

The government, however, has not taken loans specifically to implement federalism. It has signed loan agreements to strengthen decentralisation and improve federal governance. These loans are development policy credits.

Under policy support loans, the government does not need to spend funds on a specific project or sector. It receives funds after committing to policy reforms or proving that reforms have been implemented. There is no fixed limit on how the funds must be used. The government can allocate the money where it is most needed. For example, it can use the funds for projects such as expressways if required. This gives the government flexibility, including in projects planned to be financed through domestic resources.

The government signs loan agreements under titles such as Finance for Growth, Fiscal Recovery, and Financial Sector Development. These loans are also called policy credit or budget support. Their main advantage is spending flexibility.

Over the past five years, policy credit has accounted for more than 20 per cent of total loan agreements. Development partners have recently shown greater interest in this type of lending.

Loans tied to physical infrastructure projects often face delays due to procedural obstacles. These delays create challenges for donors. As such obstacles increase, donors have become more open to policy credit, according to Ministry of Finance officials.

Nepal’s record in projects implemented through donor agreements remains weak. The government has also struggled to strictly follow procurement standards. Repeated delays caused by minor procedural issues have pushed donors towards more flexible lending.

Officials say donors became more supportive after Nepal worked to strengthen institutions and improve policy transparency.

Former Chief Secretary Baikuntha Aryal says such loans give the government greater autonomy. He says policy credit allows the government more space to manage spending standards and implementation in its own way.

Another advantage is lower administrative and structural costs. Project financing often requires separate institutional arrangements and increases costs. Policy support loans allow the government to use existing structures.

The main risk is misuse of funds. Nepal’s budget system often favours political and vested interests. If such borrowing increases and funds are poorly managed, the country could face serious consequences.

There is also a risk that such loans could be used for allowances, social security payments, or other distribution programmes instead of development projects. The government can show donors that it has invested in certain sectors during the year. This creates a high risk of misuse.