Monday, September 16, 2013

Nepalese economy in FY2013: Fiscal sector

[This blog post is adapted from Nepal’s Macroeconomic Update, August 2013, published by the ADB. Here is a previous blog post on real sector.]


Expenditure Performance

The expenditure performance in FY2013 was adversely affected by the disruption in budget preparation as a result of the political uncertainties following the dissolution of the Constituent Assembly in May 2012.[1] Growth of both recurrent and capital expenditures (revised estimates in nominal terms) slowed in FY2013, resulting in a mere 3% growth in total expenditure, compared to over 15% in the previous years (Figure 1). Also, the FY2013 budget was underspent, more significantly in the case of capital expenditure, reflecting the impact of the delayed budget as well the weak project implementation capacity. Actual expenditures in FY2013 were 90.5% of the total budget allocation, 92.5% of the total recurrent budget, and 81% of the total capital budget. Expenditure performance was also dismal in terms of GDP. As a share of GDP, total expenditures (including net lending) were 19.4% in FY2013, down from an average of 19.7% in the previous five years. The FY2013 budget was not the first casualty of the political impasse. The issuance of FY2009, FY2010 and FY2011 budgets were also delayed by several months, adversely affecting the expenditure, especially capital expenditure, performance during these years.

Figure 1: Total, recurrent and capital expenditures growth (% change)

Note: Total expenditure excludes net lending

Source: Budget Speech various years; NRM staff estimates.

Figure 2: Total, recurrent and capital expenditures (% of GDP)

Note: Total expenditure excludes net lending.

Source: Budget Speech various years; NRM staff estimates.

Within recurrent expenditures, transfer (grants) to local bodies and for social work grew by 1.4% in FY2013, down from 14.5% growth in FY2012. Recurrent expenditures related to social security and use of goods and services[2] increased by 24.2% and 16.9%, respectively. A substantial portion of recurrent expenditures is spent as grants/transfer to local bodes and social work (42%) and compensation of employees (25%).

Figure 3: Recurrent expenditures (% of GDP)

Source: Budget Speech FY2014.

While both recurrent and capital expenditures have slowed in FY2013, capital expenditure has consistently been dismal since FY2009, reflecting the impact of political instability on development activities. Capital spending actually experienced a negative growth in FY2011. As a percentage of GDP, it halved from 6.6% in FY2009 to 3.1% in FY2013.[3] The key factors impeding capital expenditure are: (i) lack of project readiness, in terms of timely preparatory activities such as land acquisition, establishment of project management offices, and preparation of procurement plans; (ii) delays in the budget release processes at various stages (iii) delays in procurement process; and (iv) overall weak project planning and implementation capacity. A higher quantum as well as quality of capital spending is essential to address the country’s severe infrastructure bottlenecks, to achieve other social development objectives, and to lay the foundation for higher and inclusive growth.

Within capital expenditures, while land purchase and building construction registered negative growth rates, vehicle purchase and expenditure for plant and machinery grew by 50.4% and 18.8%, respectively. The expenditure for civil works increased just by 3%, reflecting the delayed full budget and the procedural hassles in approval of and procurement for projects. Except for civil works— which was 2.1% of GDP in FY2013, down from 2.3% of GDP in FY2012 and 2.5% of GDP in FY2011— none of the eight sub-headings within capital expenditures was above 1% of GDP (Figure 4).

Figure 4: Capital expenditures (% of GDP)

Source: Budget Speech FY2014.

5. As in the previous years, FY2013 also saw a bunching of spending, especially capital spending, towards the last few months. Almost one-fourth of total expenditure was done in the last month and 48% in the last three months. Of the total capital spending, 43% was spent in the last month and 64% in the last three months (Figure 5). It raises concerns about not only the absorptive capacity, but also the procedural and procurement delays along with unrealistic expenditure planning of the capital budget.

Figure 5: Monthly spending (cash basis) in FY2013, NRs billion

Source: Nepal Rastra Bank.

Revenue Performance

Unlike expenditures, revenue performance has been resilient to the political disruptions. Revenue collection has been sustained with a 21.2% growth, reaching NRs 296 billion (17.4% of GDP) in FY2013. This is higher than the budget target of NRs 289.6 billion. Tax revenue increased by 22.6%, reaching NRs 259.6 billion. As a share of GDP, tax revenue mobilization jumped remarkably from 13.8% in FY2012 to 15.3% in FY2013 (Figure 6). Several factors have contributed to this, including the ongoing reforms to modernize and strengthen revenue administration, efforts to broaden the tax base and the rising import bill due to the depreciation of the Nepali rupee and growing remittance income. Some of the important reforms undertaken in recent years include: (i) information and communication technology based tax returns filing and payment systems; (ii) establishment of a data link with Company Registrar’s Office to enhance tax compliance; (iii) measures to reduce tax compliance cost[4]; (iv) strengthening of the tax monitoring and audit system; (v) measures to widen the tax net for various tax categories; and (vi) implementation of the Any Branch Banking System (ABBS) for large tax payers.

Figure 6: Tax revenue (% of GDP)

Source: Ministry of Finance; NRM staff estimates.

While value added tax (VAT) and vehicle tax collections decreased in FY2013, collections from all others sources grew by at least 20% (Figure 7). Customs, income tax and excise duty collections increased by 31%, 28% and 21%, respectively. They had grown by 21.7%, 25.5% and 15.2%, respectively, in FY2012. The deceleration in VAT collections is attributed to the lower growth of VAT on production; goods, sales and distribution; and service and contracts—all of which registered growth slowdown by over 15 percentage points. Overall, the largest contribution to total revenue came from VAT (28.2%), followed by income tax (22.6%), customs (19.2%), and excise duty (12.4%) (Figure 8). Taxes on remittances-induced imports and consumption constitute around 70% of the total tax revenue mobilization. Specifically, import and non-import related indirect revenue account for about 50% and 20%, respectively, of total tax revenue. It suggests a tax structure disproportionally tilted towards import-based revenues.[5] Accordingly, the political instability, and to some extent economic growth, seems to have an insignificant impact on revenue generation.

Figure 7: Revenue growth (% change)

Source: Nepal Rastra Bank.

Figure 8: Composition of total revenue in FY2013

Source: Nepal Rastra Bank.

The ongoing tax reforms need to be continued to sustain the current revenue growth rate in order to finance the rising recurrent expenditures, and more importantly to scale up the sluggish capital expenditure. The effective implementation of the Inland Revenue Department (IRD) Strategic Plan 2012/13-2016/17 along with the subsequent IRD Reform Plan 2012/2014/2015 is essential to boost revenue mobilization and efficaciously enhance the capacities of the various agencies involved in revenue collection. This is particularly important if IRD’s revenue targets –tax revenue equivalent to 18% of GDP, income tax 5.5% of GDP, VAT 5.6% of GDP, and excise duty 3.2% of GDP—are to be achieved by 2017.

Budget Balance

Due to the issuance of partial budgets in FY2013, its restraining impact on spending and the then caretaker government’s lack of authority to raise domestic debt (until after the full budget was approved on 9 April 2013), the year ended with an unusual budget surplus equivalent to 0.4% of GDP, compared to a deficit of 2.2% in FY2012 and 2.4% in FY2011 (Figure 9).[6] Total net domestic borrowing amounted to a surplus of NRs 2 billion as domestic amortization far surpassed domestic borrowing. Meanwhile, net foreign loans amounted to only NRs 0.7 billion.[7] While the budget surplus and low levels of borrowing are desirable from macroeconomic stability standpoint, this is not optimal for the country given the need for increased capital investment to support higher growth. While maintaining net domestic borrowing at around 2% of GDP (as generally recommended by the International Monetary Fund), Nepal could still run a moderate budget deficit, without compromising macroeconomic stability, to finance the huge investment needs, estimated at about 8.5% of GDP over 2010-2020.[8]

Figure 9: Budget balance (% of GDP)

Note: Budget balance = Expenditure (including net lending) – Revenue (including grants). Net lending is equal to internal loans and domestic share investment minus internal loan refund.

Source: Ministry of Finance; NRM staff estimates.

Public Debt

Nepal’s overall public debt (domestic and external) has been consistently declining, reaching 31.7% of GDP in FY2013. Total external debt decreased to 19.6% of GDP in FY2013 from 20.1% of GDP in FY2012. Similarly, total domestic debt declined to 12.2% of GDP in FY2013 from 13.9% of GDP in FY2012, reflecting low domestic borrowing as a result of the delayed full budget. In FY2012, both external and domestic debts were higher than in FY2011 (Figure 10). Total debt service payments have increased to 16.5% of revenue in FY2013 from 14.5% in FY2012. However, external debt service payments have declined to 9.8% of exports of goods and non-factor services in FY2013 from 10.6% in FY2012. The rise in domestic debt service payments corresponds to the increased domestic borrowing. Overall, the declining stock of public debt and debt service payments indicate prudent fiscal and public debt management.

Figure 10: Public debt (% of GDP)

Source: Financial Comptroller General Office, Ministry of Finance.

Public Enterprises

The overall performance of the public enterprises (PEs) remained weak in FY2012. Of the 37 PEs, 21 made losses and one did not make any transaction. 8 PEs that earned profit in FY2011 made losses in FY2012. Compared to a net profit of NRs 6.7 billion in FY2011 (0.5% of GDP), FY2012 saw a loss of NRs 3.5 billion (0.2% of GDP), with a majority of it being incurred by Nepal Oil Corporation (NRs 9.5 billion) and Nepal Electricity Authority (NRs 9.9 billion). The combined losses of Nepal Oil Corporation and Nepal Electricity Authority amounted to 1.3% of GDP in FY2012. The Government’s pension related obligations (basically unfunded liabilities) increased by 25.9% to NRs 21.2 billion. Nepal Telecom’s (NT) profit of NRs 12.1 billion in FY2012 (0.9% of GDP) compensated most of the losses incurred by PEs.

Figure 11: Profit and loss of select PEs (% of GDP)

Source: Ministry of Finance; NRM staff estimates.

The cumulative liabilities of PEs have been around 1.8% of GDP, with unfunded liabilities of 1.4% of GDP and contingent liabilities of 0.4% of GDP. The unfunded liabilities (salary, pension, social security contribution, health care, and recurrent costs, among others, that the PEs cannot finance themselves) have increased steadily from 1% of GDP in FY2009 to 1.4% of GDP in FY2012. However, the contingent liabilities (state guarantees of loans, defaults of PEs, and clean-up liabilities of privatized PEs, among others) have decreased from 1.7% of GDP in FY2009 to 0.4% of GDP in FY2012. This has contributed to the overall decline in liabilities relative to FY2009 (Figure 12). The increase in unfunded liabilities reflects the occasional salary and allowance hikes in the public sector.

Figure 12: Unfunded and contingent liabilities (% of GDP)

Source: Ministry of Finance; NRM staff estimates.

Either privatization or liquidation of loss making PEs needs to be accelerated to reduce the budget drain. The weak financial position of PEs has led to large unfunded liabilities, especially for pension and other related retirement benefits, which could ultimately become government liabilities. It may be noted that due to the lack of accurate and updated data, the contingent liability of PEs presented here are conservative estimates. It is possible that the government will be exposed to much higher levels of liabilities. In this regard, fiscal and macroeconomic stability could potentially be subject to significant risks.



[1] Due to the caretaker status of the then government and the lack of broader political consensus, a timely and full budget could not be introduced for FY2013. Instead, the budget was introduced on a piecemeal basis on 15 July 2012 (one-third of the actual expenditure in FY2012); 20 November 2012 (two-thirds of actual expenditure in FY2012); and 9 April 2013 (a full budget consolidating the previous two partial budgets). The size of the full budget was NRs 404.8 billion, with an outlay of NRs 279.1 billion (78.9%) for recurrent expenditures, NRs 66.1 billion (16.3%) for capital expenditures, and NRs 59.7 billion (14.7%) for financing (loan and share investments, and debt servicing).

[2] Use of goods and services consists of (i) rent & services; (ii) operation and maintenance of capital assets; (iii) office materials and services; (iv) consultancy and other services fee; (v) program expenses; (vi) monitoring, evaluation and travel expenses; (vii) recurrent contingencies; and (viii) miscellaneous.

[3] Prior to FY2012, ADB adjusted capital expenditure by deducting internal loans and domestic share investment to be consistent with GFS 2001

[4] The cost of collection per NRs 1000 has decreased from NRs 16.4 in FY2007 to NRs 12.7 in FY2011.

[5] For more on the tax revenue structure in Nepal, see: IMF. 2011. Selected Issues: Nepal’s Tax Regime. Washington, DC: International Monetary Fund.

[6] Budget balance is computed as expenditures (including net lending) minus revenue (including grants).

[7] As a share of GDP, net foreign loans and net domestic borrowing were negative 0.04% and surplus 0.12%, respectively in FY2013. In FY2012, they were negative 1.4% and 1% of GDP, respectively.

[8] Bhattacharyay, B. 2010. Estimating Demand for Infrastructure in Energy, Transport, Telecommunications, Water and Sanitation in Asia and the Pacific: 2010-2020. ADBI Working Paper 248. Tokyo: Asian Development Bank Institute. Available: