Thursday, February 8, 2018

Competitive populism in Nepal

It was published in The Kathmandu Post, 07 February 2018, p.6

Non-budgetary, ad hoc, populist decisions will exert additional pressure on the already stressed fiscal situation

On January 24, a cabinet meeting chaired by Prime Minister Sher Bahadur Deuba approved a proposal to lower the age of eligibility for receiving social security allowance from the existing 70 years to 65 years. The government also decided to increase household grants by Rs100,000 for the reconstruction of earthquake and flood damaged houses.

At a time when the country is struggling to find adequate resources to cover the initial costs associated with setting up offices for the local bodies and provincial assemblies, this irresponsible decision by a caretaker government is going to have long term fiscal consequences. The cabinet decision is going to increase spending by at least Rs110 billion, which is equivalent to about 3.8 percent of GDP.

These non-budgetary, ad hoc, populist distributive decisions will exert additional pressure on the already stressed budgetary situation. Worse, the next government will find it incredibly hard to undo the populist decisions made by this government. It is unusual for a caretaker government led by a prime minister whose party has suffered one of the most humiliating electoral defeats to take such fiscally irresponsible decision that will have long-term implications on the economy and handicap the next government in terms of managing the budget for their signature electoral commitments.

Can’t sustain

The Deuba-led government has been just as fiscally irresponsible as the communist-led governments in the past. Doling out populist social security allowances has been a major selling point to secure elderly votes during elections. In 1994, the then Prime Minister Manmohan Adhikari-led government decided to hand out Rs300 monthly to those who were 70 years and above. This amount was later increased to Rs1000 and then in fiscal year (FY) 2017, the then Finance Minister Bishnu Prasad Poudel doubled the amount to Rs2000. Consequently, the government spent around Rs24 billion last year on old age allowance. The FY2018 budget has earmarked Rs36 billion for allowances to senior citizens, single women, Dalits, endangered indigenous people or ethnic groups, and physically challenged people. Overall, the government spent Rs88.6 billion in social security (allowances, scholarship and retirement benefits) in FY2017 and has allocated Rs102.6 billion for this purpose in FY2018, which is equivalent to about 8 percent of the entire budget and one-third of capital spending.

Granted that it is the state’s responsibility to look after those who are unable to take care of themselves for various reasons including financial constraints. However, the state’s generosity should be in line with available resources. Else, more money meant for building hydropower, roads, airports, schools and hospitals will have to be diverted to fulfil social security commitments which are used for consumption purposes. Furthermore, the government will have to borrow more to fulfil its recurrent spending commitments. This is not good for the economy as it increases the fiscal deficit (revenue minus expenditure) and eventually hurts the private sector through an increase of interest rates and relative appreciation of currency. For an economy with a low per capita income like ours, it is okay to have a modest level of fiscal deficit as long as internally and externally borrowed money is used to build capital assets. However, if it is used to cover recurrent spending, then the economy heads toward a fiscal slippery slope.

This is exactly where the caretaker government is taking the economy, making it harder for the upcoming left government to fulfil their own election commitments. By lowering the age for receiving senior citizen allowance to 65, the government instantly added around 0.65 million additional recipients. This means an additional Rs15.5 billion on top of the Rs25.2 billion paid to the one million citizens who are of 70 years and above. Cumulatively, this comprises around 1.4 percent of the GDP. Considering the population growth of the cohort aged 65 and above in the next five years, we are looking at an annual average additional cost of Rs16 billion in elderly allowance (or cumulatively, Rs80 billion by 2022). If we consider the additional cost of revising eligibility to 55 years for those residing in the Karnali region, Dalits and single mothers then the liability of the state will be even higher. Since growth of recurrent spending is surpassing growth of tax revenue, it will be difficult for the state to fulfil its spending commitments. Add the fact that more than Rs200 billion is needed to cover initial administrative costs to make local and provincial bodies functional in the next few years, and the budgetary situation looks frightening. 

Cabinet also decided to increase the grant given to each eligible household for reconstruction of earthquake, flood and fire damaged buildings by NRs100,000. This instantly widened the spending envelope by Rs96 billion (about 3.3 percent of GDP) in the middle of the fiscal year. Note that less than 15 percent of the 767,705 households eligible for housing grants have completed construction of houses so far and the reconstruction authority is struggling to disburse the second tranche of housing grants. Such grant distribution for flood and fire victims is almost negligible even months after the devastating disasters.

Competitive populism

Instead of resolving the administrative and policy bottlenecks related to infrastructure and reconstruction projects, the caretaker government is intent on splurging state resources wilfully on commitments for which it won’t be held accountable for. Proposals having far reaching consequences for the economy have been tabled in the cabinet meeting without adequate discussion with government agencies, particularly the Ministry of Finance and National Planning Commission. Although the next government will find it very hard to undo some of these populist measures, it should convene a committee to review fiscally fatal decisions taken by the caretaker government in the last few months.

However, if it engages in competitive populism by increasing elderly allowance to Rs5,000 as per its election manifesto, then the fiscal situation would further worsen. The elderly allowance itself will be around Rs101 billion (Rs 63 billion for those 70 and above years old, and an additional Rs38 billion for those in 65-69 age cohort), equivalent to about 3.4 percent of GDP. Increasing the treasury’s burden on unproductive spending without having the means to sufficiently cover them will erode whatever sound fiscal position we had in the past. Balance between populism and fiscal prudence should be of utmost priority now.

Correction: The then PM Adhikari-led government decided to give NRs100 to those 75 and more years old.