It was published in The Kathmandu Post, 17 June 2016. An earlier blog post on FY2017 budget is here.
Drastically increasing the budget without improving absorption capacity is reckless and shows a lack of accountability
The Oli government’s first budget, presented by the Finance Minister Bishnu Prasad Poudel, has triggered debate over its focus, impact and intention. While the supporters argue that the budget is balanced and reflects the aspirations enshrined in the constitution, the dissenters charge that the budget is old wine in a new bottle, with enhanced distributive features designed to placate the voters. However, an informed yet dispassionate discussion on its macroeconomic implications has largely been missing.
Overall, the budget is characterised by two main features: Sharp increase in planned spending owing to the inclusion of additional pet programmes and projects that will have macroeconomic consequences in the future; and an absence of noteworthy plans to implement the budget, especially capital spending.
That the budget 2016-2017 was unveiled one and a half month before the start of the fiscal year is a positive development. The additional time will provide the bureaucracy with a cushion to initiate preparatory work for the timely implementation of the projects from mid-July. Hopefully, the Nepali people will not have to wait till the end of the festival season to see development activities initiated in their communities. This should ideally enhance the quantity and quality of spending.
The budget is of an unprecedented amount, topping Rs1,049 billion, out of which 58.8 percent is earmarked for recurrent spending, 29.7 percent for capital spending and 11.4 percent for financial provision. The budget includes pork-barrel projects and programmes that are distributive in nature, post-earthquake reconstruction, and funds to initiate preparatory work for critical, long-term infrastructure projects.
The government intends to cover about 65 percent of the budget from tax and non-tax revenues, foreign grants and principal repayment. To finance the deficit, it is planning to borrow about 29 percent of the budget from domestic and foreign sources, and utilise about Rs60 billion of the money saved from last year’s budget.
The expansionary budget is a mess in terms of macroeconomics, primarily due to the uncertainty over the resources to finance such a large spike in expenditure.
First, most likely the ambitious revenue target will not be met—a 20 percent increase in revenue is unrealistic given that it averaged only 17 percent in the last five years. This will result in budgetary complication, especially in honouring the large distributive commitments. Some economists are justifying the high revenue target based on the expected growth target of 6.5 percent, which itself is highly optimistic. Note that import-based revenue accounts for about 45 percent of total revenue and except for income tax (22 percent), the rest depends on indirect taxes on the consumption of goods and services that are largely financed by remittance income.
Without widening the tax base significantly, increasing the share of direct tax (which means more individuals paying income tax), higher remittance inflows and revenue administration reforms (enhancing work efficiency and plugging leakages), it would be difficult to meet a high revenue target year after year. The existing mechanism is reaching its limit to increase revenue higher than the prevailing growth rate.
Second, the deficit financing plan is unrealistically optimistic. The planned domestic borrowing is 26 percent higher than last year’s budget estimate. The government is hoping that excess liquidity will persist in the market and there will be enthusiastic support for its bills and bonds. However, as businesses get back to normal after a lull triggered by the earthquake and the trade blockade, excess liquidity will also start to dry up. Demand for loans will pick up and so the interest rate will rise accordingly. High domestic borrowing will further raise interest rates, which will be an extra burden to the public and business enterprises. Similarly, the planned foreign loan is 106 percent higher. It is foolhardy to expect such a drastic increase in foreign loans given that the disbursement rate is hardly 25 percent. Finally, the intention to use the cash balance of last year’s budget for a mix of recurrent and capital spending can set a bad precedent. The unspent budget should ideally be used exclusively for designated infrastructure projects by creating an independent fund.
Third, the budget is so high that even tax revenue will not be able to cover it. There is no dispute that public sector salary needs to be adjusted to inflation. However, it is also true that the number of public employees is too high compared to their productivity (their salary is about 66 percent of capital spending). The government should lay off some public employees and use the resulting ‘potential savings’ to increase the salary of the remaining employees so that they are incentivised to be more productive. Furthermore, grant to local bodies, which contains some capital spending component, is also drastically increased without paying much attention to their absorptive capacities and the governance structure.
Lastly, the growth target of 6.5 percent is ambitious and the inflation target of 7.5 percent is conservative. GDP growth rate of 4.5 percent to 5.5 percent is attainable with a favourable monsoon, revival of the service sector and accelerated reconstruction activities. But inflation is bound to go beyond the target as a result of the inflationary expectations arising from an increase in public sector wages and the large planned spending, which will create demand pressure amidst supply capacity constraint.
The nature of spending on certain programmes and projects and the envisaged pattern of financing for them will have long term consequences. The massive increase in net domestic borrowing (3.5 percent of GDP, up from about two percent of GDP in 2015-2016) and net foreign loans (6.4 percent of GDP, up from about 1.5 percent of GDP in 2015-2016) without heeding market conditions and absorption capacity is bound to create budgetary pressures. Importantly, it will be challenging to reconcile such spending with projected revenue in the 2017-2018 budget. Moreover, there is no contingency plan to plug the deficit if the revenue mobilisation and borrowing targets are not met. This is budgetary dishonesty and a burden to the future generation.
An appropriate way would be to freeze the budget in real terms and focus all energy on fully spending the funds intended for infrastructure projects. Additional funds for critical projects could be arranged by rationalising unproductive recurrent spending. Drastically increasing the budget without improving absorption capacity is reckless and shows a lack of accountability.