Wednesday, November 24, 2010

Nepal’s budget 2010-11: Big budget, big incentives

My latest piece is about a review of Nepal’s fiscal budget 2010-2011 published yesterday’s edition of Republica daily. Due to space constraint, I have focused on export and production incentives, infrastructure, employment generation and economic growth. If time permits, I will write blog posts about the potential impact of the expansionary budget on the already high inflation rate, economic growth and development outcomes. For starters, here is a rundown on Nepal’s fiscal budget 2010-2011. Here is a review of FY 2009-2010 and FY 2008-2009 budgets.

Big budget, big incentives

Unlike previous budgets filled with turgid slogans and riddled with pet projects, Finance Minister Surendra Pandey presented a simple one, which gives continuity to ongoing projects and adds a few new ones. Overall, the budget is progressive, private sector-friendly, and focused on infrastructure, employment and exports promotion. Pandey’s hands were tightly tied— thanks to the incessant, inconclusive, futile political marathon—to effectively allocate funds and prioritize projects. Against such a backdrop, the fact that he was able to present a budget itself is a success story.

Make no mistake, the budget’s size of Rs 337.9 billion, up by 30.4 percent from last year’s expenditure, is not warranted by the incapacity of existing bureaucracy and local administrations, and fluid political economy, to effectively execute proposed projects. The size of our budget is ever-increasing, irrespective of the country being in civil war or peace period.

The government is planning to spend Rs 190.32 billion and Rs 129.54 billion as recurrent and capital expenditures, respectively. It represents 56.3 percent and 38.3 percent of total expenditure, and 25.8 percent and 44.8 percent increase over last year’s expenditure, respectively. Principal repayment is estimated to be Rs 18.42 billion, which is 5.4 percent of total expenditure. One good aspect of this year’s budget is that expenditure allocation for development programs have been jacked up substantially to Rs 178.61 billion, which represents 52.9 percent of total budget. Development programs have been in the backburner for more than two years due to never-ending political wrangling and the parties’ inability to forge a consensus on key development agendas. The other 47.1 percent of the budget is allocated to cover general administration expenses.

A country needs to match up its expenditure with revenue and deficit financing. Accordingly, the government is planning to collect Rs 281.99 billion (83.45 percent of total expenditure) revenue. Specifically, it aims to collect 63.92 percent and 19.33 percent of total expenditure from tax and non-tax revenue, and foreign grants, respectively. This still leaves the government with Rs 55.91 billion (16.54 percent of total expenditure) short of meeting the total expenditure target. It plans to cover this by deficit financing, consisting of foreign loans of Rs 22.23 billion and domestic borrowing of Rs 33.68 billion, representing 6.58 percent and 9.97 percent, respectively, of total expenditure.

Budget for FY 2010-1011 
Rs, billion Percent of total budget Percent increase from last FY
Total expenditure 337.9 100 30.4
Recurrent  190.32 56.3 25.8
Capital 129.54 38.3 44.8
Principal repayment 18.42 5.4
Development programs 178.61 52.9
General administration 159.29 47.1
Projected total revenue 281.99
Revenue 216.64
Foreign grants 65.34
Deficit 55.91
Deficit financing 55.91
Foreign loans 22.23
Domestic borrowing 33.68

 FY 2010-11 full annex

There are plenty of customary allocations and projects. The things that should matter the most are projects and policies that will aid economic growth, employment generation, and development. Overall, the budget focuses on three aspects that should, in principle, meet these objectives: Infrastructure, exports promotion and private sector development.

It has given priority to develop infrastructure such as road transport, hydropower, and irrigation, which are critically needed to spur growth in the sluggish economy. Apart from funds for construction of four six-lane highways along major trading routes, there are also funds for regular and periodic repair and maintenance of potholed and dilapidated roads. Along with additional bridges and irrigation projects in villages, including rural Karnali zone, four hydropower projects with a combined capacity of 134 MW are planned. Moreover, it aims to develop at least one large- and medium-sized reservoir hydro projects in each development region. The government aims to establish Infrastructure Development Bank by inviting private sector’s participation as well.

These projects and goals are in the right direction. But, since infrastructure is the most binding constraint to growth (see What’s holding back growth?, Republica, May 14, 2009), the funds allocated to this sector are insufficient to not only meet demand for adequate infrastructure, but also to effectively generate multiplier effects large enough to push growth rate higher than the existing one.

The government has been very generous in providing enough incentives to the private sector. It will only be realized if they stop whining for even more and start utilizing them by being innovative investors, and by exhibiting competitive entrepreneurship instead of adhering to old school business models that survive on government concessions.

The government has promised blacktopped roads reaching premises of manufacturing firms employing more than 100 Nepali workers; sub-health posts staffed with health workers and a police post to any firm or industry employing over 500 Nepali workers; and 3 percent and 4 percent tax incentive, along with 25 percent income tax exemption, if value addition in exported commodities exceed 50 percent and 80 percent respectively. These initiatives will reduce transportation as well as transaction costs. Furthermore, there is 50 percent tax rebate on earnings from exports of goods produced using local raw materials. This is one of the import substituting policies.

One good incentive but will basically remain ineffective is the 2 percent rebate, in Nepali rupees, to exporters if they submit bank document explaining receipt of convertible currencies earned from exports. It will remain largely ineffective because this provision will cover about 20 percent of the exporters only. There should be easier ways other than showing bank document of earned convertible currencies.

These are some of the sweet deals in the budget, which apparently does not have hooks on incentives and policies. This might render the whole initiative futile.

First, the allocated sum for infrastructure development is insufficient. Funds should have been allocated to projects that are shovel-ready and have high marginal returns to investment in the short term. Instead, money is being allocated to study construction of railway, metro cable cars and waterways. They are fine projects for the future. But, as of now, we are a resource-strapped economy and have to manage resources judiciously and efficiently. It would have been better to focus on building more roads, connecting more villages with markets, and linking villages with each other, rather than conducting feasibility study of projects that we are dead sure will take decades to complete. It would be better to have modest aims and invest in sectors that have the highest marginal rate of return on public investment.

Second, there should have been a catch in the plan to constructing road up to premises of firms employing over 100 Nepali workers. What if a firm employing 100 workers fires 50 percent of workforce after the government builds road up to its premises? If this happens immediately, then the cost of government incentive offered to firms will be higher than the return it would generate. Also, the incentives package should have been product-specific as the socioeconomic impact of production of different products is different. The ones that generate the highest positive socioeconomic impact should get the highest incentives.

Third, the incentives package and exports promotion strategies are not fully compatible with the recently updated Industrial Policy 2010, Trade Policy 2009, and Nepal Trade Integration Strategy (NTIS) 2010. The industrial policy has already specified tax holidays and income rebate to firms investing in underdeveloped, undeveloped, and less developed areas, and also outlined plans for promoting Special Economic Zones (SEZs). The incentives offered in the budget should have been compatible with these or have built on the already prevailing ones. Same goes for the incentives outlined in trade policy and promotion of 19 products identified in NTIS 2010. This policy incoherence will flare up confusion and bureaucratic hurdles. This is a mistake of the Ministry of Finance. It should rectify this, if it wants to see the industrial and export sectors rebound with positive impact on growth, employment, trade deficit, and balance of payments.

The budget is also not in line with Three Year Investment Plan 2010-2013 published by National Planning Commission (NPC) last April. With this kind of incoherent and loosely assorted projects, the aim to achieve 5-6 percent growth rate, lower absolute poverty to below 20 percent, generate 20,000 jobs, and encourage private sector to invest 64 percent of the needed investment will remain a distant dream.

That said, the fact that we have a budget is itself good news. Now, we can only hope that it will be implemented as promised.

[Published in Republica, November 23, 2010, p.7]