Thursday, December 14, 2017

Uneconomical and populist recurrent spending commitments need to be scaled down

This interview was published on The Himalayan Times, 11 December 2017, p.11

The country has fully embarked towards a federal structure of governance, along with the completion of the elections for the three layers of government — parliamentary, provincial and local levels — as per the provisions of the new constitution. After the elections a new government with a new political mandate will be formed and it is expected to set up and implement long-term plans to take the country towards economic prosperity, as announced by the political parties in their election manifestos. However, the country still faces a lot of challenges associated with generation of resources to bridge the fiscal gap, along with increased need of recurrent and development expenditure in the changed context. Pushpa Raj Acharya of The Himalayan Times spoke to Chandan Sapkota, a young economist, on the prospects and challenges of federal Nepal. Excerpts:

The country just concluded elections in three layers of administration-- parliamentary, provincial and local assembly. There are critical to implement the new constitution and some believe that it will bring stability and stimulate growth and development. What is your view on this and what are the push factors for development? 

The local elections after two decades and the historic federal and provincial elections close one chapter of the prolonged and tumultuous transition period after 2006. Although the economic performance during this period was slightly better than during the decade-long Maoist insurgency, it was still below public’s expectation and economic potential. For instance, average economic growth during the Maoist insurgency was 4.1 percent, but during the transition period it was 4.4 percent and the economy is dependent on remittances more than ever. The core growth boosters, especially industrial sector, continues to be affected by a lack of adequate supply of infrastructure (electricity and transport), unfavorable industrial relations, political instability, and policy implementation paralysis. Consequently, not only private investment but also public budget execution capacity and public service delivery are dismal.

The recently concluded elections have elected people’s representatives at the three layers of government, which will help to decentralize decision-making and development planning. These will ideally remove the obstacles to project planning and execution, ensure better utilization of taxpayers’ money and institutionalize sound governance of public assets. Furthermore, the constitutional provision on at least two years of government stability is different from the transitional period, which was beset by frequent change of government and alliances. These are improvements compared to the past political system and may be a harbinger of some level of political stability, which should then lead to policy certainty, increase in private investment and enhanced budget execution. However, major downside risks are the deficient capacity of provincial and local bodies to manage human resources, coherent regional and local development planning, public finances and relation among the three tiers of government especially with regard to revenue sharing and control of resources.

Although we have three layers of administration, capacity constraint in handling development projects is a perennial problem. How we can cope with this problem? 

Technically, the three layers of government would mean delegation of development planning, revenue mobilization authority and expenditure priorities. Local ownership and accountability of development projects will be much better than before. However, it does not solve the core issues leading to under-execution of capital budget. There are structural weaknesses in project preparation, resulting in allocative inefficiencies during the inclusion of projects and programs in budget; low project readiness; bureaucratic hassles during project and budget approvals; high fiduciary risks in suburban and rural areas where there is limited human resources and administrative capacity; weak project management including lengthy procurement processes and subpar capacity of contractors; and political interference at planning and operational levels. Tackling these issues requires capacity building as well as rules-based fiscal prudence at all tiers of government. Ministry of Finance and National Planning Commission have important roles to play in this regard.

During the parliamentary and provincial polls political parties competed elections under the umbrella of leftist versus democratic alliance. Will this create ground for competitive politics? 

It all depends on how the political parties align their constituents and their priorities. Large electoral alliances would ideally lead to stable government as coalition parties have less incentive to defect and topple the government— a glaring feature of the political ecosystem in the past. However, we need to note that there are different factions within each party and their conduct with respect to government’s and alliance’s policies will matter as well. Given the past record, leftist government tends to be fiscally imprudent as they tend to favor incoherent, populist and piecemeal projects, leading to recurrent spending growth overshooting tax revenue growth. Hopefully, the alliances will result in renewed focus on inclusive economic development and prosperity instead of protection of party’s political and commercial interests. 

Political parties have raised aspiration of people that the country will move towards rapid economic development. What is your expectation regarding rapid economic development as mentioned by political parties in their election manifestos?

It depends on how they choose to govern and implement policies and programs. If their intention is to hold on to power and protect political and commercial interests, then we should not expect much in terms of growth-enhancing, employment-generating policy and governance regime. However, if they are determined to achieve the grand promises committed in their manifestos then they need to change the way they govern their parties, key institutions and bureaucracy. The priority should be to reverse the trend of deindustrialization and raise productivity across all sectors by focusing on hydroelectricity, transportation network, light manufacturing goods, high value agricultural products, tourism, and information technology development. Growing domestic and regional markets as well as a competitive federal system will likely create sustained demand for us to tap into.

Leaders and policy makers have not paid much attention to fiscal federalism. Political parties have committed to raise grant to lower level of administration to over 50 per cent of total budget. Is it feasible? How can the country address widening vertical and horizontal fiscal gaps?

Revenue-expenditure asymmetry at federal, provincial and local levels is going to be a major issue in the coming days. Fiscal transfer and grants to local bodies constitutes about 50 percent of planned recurrent spending, which already is so high that even tax revenue is insufficient to cover it. Natural Resource and Fiscal Commission, which is yet to be formed, will decide on the distribution of revenue and royalties among the three layers of government. However, these fiscal transfers and revenue distribution will not cover expenditure needs. All tiers of government must be fiscally prudent and stick to feasible medium term budget framework. Uneconomical and populist recurrent spending commitments need to be scaled down and revenue administration strengthened. That said, recurrent spending in the first few years will be high due to the need to cover initial adjustment related infrastructure and administrative costs. 

It seems that the country will have to be more reliant in foreign aid for development work as we have limited space to increase revenue and domestic debt. What prospects do you see regarding mobilisation of foreign aid?

Yes, foreign grants and loans will be a key factor in bridging fiscal gap owing to the insufficiency of revenue and domestic borrowing. However, major donors anchor their lending in budget execution, especially project implementation and subsequent disbursement. So the level of foreign aid will depend on expenditure absorption capacity, which is low and receding. For instance, actual capital spending in the last six years averaged just 72 percent of planned capital spending. Additionally, note that major multilateral donors will provide concessional loans only given that debt sustainability is deemed to be less risky. Similar is the case with major bilateral donors, who will increasingly provide project-based line of credit. It will increase outstanding public debt and dependency on foreign aid. Overall, the better the absorptive capacity, and governance and accountability regimes, the higher will be foreign aid. Meanwhile, large domestic borrowing to finance deficit will crowd out private sector as it tends to increase interest rates and worsen liquidity shortages.

Mobilisation of natural resources is another critical issue, mainly water resources for developing hydropower projects and river diversion based irrigation projects. Do you think local disputes will create disturbances in development activities? What can be done to prevent such an undesirable local hassle?

Ownership of projects and revenue based on natural resources will be a major contentious issue among all tiers of government in the next few years. This will be more so between local and provincial authorities as this institutional arrangement remains untested so far. Each tier of government will try to claim a fair share of project and benefit based on their perception of fairness. The constitutionally mandated commissions on natural resources and revenue sharing will have to work out details that are acceptable to a majority of stakeholders. Given that spending needs during the first few years will be high amidst limited revenue sources, including conditional and unconditional transfers, vigorous debate on benefit sharing is likely. This may also lead to disruption or delay in project finalization and implementation. 

To avoid any confusion on fiscal prudence and benefit sharing, local government operation guidelines, fiscal management principles, inter-governmental transfer modality, and natural resource and fiscal commission’s decision need to be timely, broad-based and transparent. Intensive knowledge sharing and training on fiscal management at local and provincial levels should be an urgent priority because next fiscal year’s budget is going to be messy and demanding. Local and provincial assemblies will have to align their budgets with federal budget, but they don’t have experience in this regard. Furthermore, there should be clarity on tax revenue mobilization authority between local and provincial bodies as the constitution allows for both tiers of government to collect taxes under similar headings.