Quick thoughts on Nepal’s FY2022 budget

On 29 May 2021, Finance Minister Bishnu Prasad Paudel presented FY2022 budget (mid-July 2021 to mid-July 2022). The FY2022 budget is introduced through an ordinance since the parliament was dissolved and fresh federal elections were announced for November 2021. The budget focuses on addressing healthcare challenges due to the Covid-19 pandemic— particularly testing, vaccination, and healthcare infrastructure—, social security, elections, infrastructure investment, and pandemic-related relief measures for individuals and businesses. The priority is stabilization and recovery of economic activities by addressing the immediate healthcare challenges, continuation of existing projects, and tax relief for individuals and businesses.

The budget is rolled out when the country at a critical juncture that has widely disrupted lives, livelihoods, and economic activities. In fact, economic activities are estimated to have contracted by 2.1% in FY2020 and will likely grow at around 2% (lower than 4% CBS’s provisional estimate) in FY2021, most of which will be base effect anyway. 

Much of the focus is on stabilization measures, especially for households and businesses. Increase in allowance by 33% including those for 70 and plus years old, allocation for free vaccination, continuation of refinancing facility and business continuity fund for businesses, scrapping of constituency development fund (or local infrastructure partnership program) and poverty alleviation fund, income tax relief for individuals and businesses, and promotion of electrical vehicles are some of the notable features of the budget. Some of these measures are continuation of last year’s budget. However, there are also signs of redistributive nature of the budget, without ascertaining resources, with a view of influencing voter base ahead of the federal parliamentary elections. Resources have also been allocated for preparation of detailed project reviews or feasibility studies of prospective projects such as hydropower projects and river diversion projects. That said, larger increase in federal budget (30.1%) than the increase in federal receipts (14.5%) point to a challenging fiscal management task going forward, especially fiscal consolidation and higher revenue mobilization to lower widening fiscal deficit. 

More on these later. But, let us first look at the macro-fiscal specifics:

Expenditure outlay

The total expenditure outlay for FY2022 is NRs 1647.6 billion, which is 30.1% higher than FY2021 revised estimate and 11.7% higher than FY2021 budget estimate. The government expects to spend 85.9% of NRs 1474.6 billion allocated in FY2021. However, given the expenditure trend so far, it is highly unlikely as public works have also been affected by the pandemic, especially in the last quarter of FY2021—the time when most of the work accelerates. 

FY2022 expenditure outlay comprises of NRs 1004.4 billion as recurrent expenditures (61% of the total outlay), NRs435.2 billion as capital expenditures (26.4%), and NRs208 billion as financial provision. From this year’s budget the government started reporting recurrent and capital grants to subnational governments (SNGs) separately. The earmarked recurrent and capital transfers to SNGs are NRs325.7 billion and NRs 60.9 billion, respectively. If the previous accounting was followed, i.e. all transfers in recurrent heading, then recurrent and capital expenditure in FY2021 are estimated at NRs 867.5 billion and NRs 251.2 billion, respectively. It means recurrent budget is up by 15.8% and capital budget by 73.1% over the revised estimate for FY2021. Without previous accounting (capital transfers being a part of recurrent spending), then recurrent and capital expenditures are estimated to increase by 17.1% and 48.8%, respectively. In any case, there is a large increase in capital budget. However, without a viable implementation plan and the effect of lockdowns on labor mobility and availability of supplies, it is most likely to be underspent as before.

As a share of GDP, total budget amounts to 35.1%, including 21.4% of GDP as recurrent spending and 9.3% of GDP as capital spending. As per FY2020 revised estimates, the government now expects to spend just 81.9% of planned recurrent budget and 71.3% of planned capital budget. 

FY2022 budget overview
GDP growth target (%)				6.5
Inflation target (%)
Budget allocation for FY2022				Rs billion	%
Projected total expenditure	1647.6
Recurrent	1004.4				61.0
Capital	435.2				26.4
Financial provision	208.0				12.6
Projected total receipts		1088.3
Revenue		1024.9			94.2
Foreign grants		63.4			5.8
Projected budget surplus (+)/deficit (-)		-559.3
Projected deficit financing			559.3
Foreign loans			309.3		55.3
Domestic borrowing			250.0		44.7

Receipts

A total revenue target of NRs 1025 billion (21.8% of GDP) has been set for FY2022 (or NRs 1151 billion if revenue sharing with subnational governments is included—24.5% of GDP). Foreign grants are expected to be NRs 63.4 billion (1.4% of GDP). Total federal receipts (total revenue plus foreign grants less sharing of revenue with subnational governments) turns out to be NRs 1088 billion (23.2% of GDP). The central government shares, based on monthly collections, 30% of VAT and internal excise duty, and 50% of royalties from natural resources with subnational governments. The revised estimate for federal revenue mobilization (including grants) in FY2021 is 22.3% of GDP. 

Compared to the revised estimate, revenue growth target for FY2022 is about 20%, which is ambitious in the first place due to the expected low nominal GDP growth. The government missed revenue target in FY2018, FY2019 and FY2020. In FY2021, it is expecting revenue growth of 20.9% as economic activities partially normalized and imports recovered. With an assumption of 10% nominal GDP growth for FY2022, revenue buoyancy comes to be about 2.

Given that the GDP growth target itself is a bit optimistic, and revenue administration reforms along with tinkering of excise duty on tobacco, alcohol, beer, and petroleum fuel has its own limits, it needs to be seen how this government plans to achieve the revenue target. 

Nepal’s revenue mobilization is already one of the highest among low-income countries and about 45% of it comes from taxes on international trade (primarily imports). Tax revenue is projected to be around 22.1% of GDP in FY2022, up from an estimated 20.4% of GDP in FY2021. Non-tax revenue is projected to be 2.4% of GDP. The government expects to mobilize 95% of tax revenue target for FY2021. In FY2020 it was just 75.5%.

Deficit financing

Considering the federal government’s expenditure and its share of revenue in total revenue mobilization, budget deficit turns out to be NRs 559.3 billion, which is to be financed by foreign loans equivalent to NRs 309.3 billion and domestic borrowing of NRs 250 billion. So, government’s projected revenue is able to fund only 66% of its projected expenditure for FY2022. The government expects foreign aid (grants and loans) to cover about a quarter of its expenditure needs. Domestic borrowing will cover 15% of its financing needs. 

Large domestic borrowing tends to affect market liquidity and interest rates if the government borrows aggressively to fund expenditure commitments just when economic activities start to normalize after the ebbing of infections from the second wave. The government had a plan to raise NRs 225 billion internally and NRs 299.5 billion externally in FY2021. The latest estimates show that while the goal of domestic borrowing will be met, only 55.1% of the external borrowing target will likely be realized. 

Compared to the revised estimate for FY2021, the government is planning to double net foreign borrowing (5.8% of GDP) and net domestic borrowing by 27% (4.3% of GDP). Again, without substantial improvement in budget execution capacity, it is unlikely that the government will be able to borrow the targeted amount. 

Overall, fiscal deficit (revenue incl grants minus expenditure incl net lending) is projected to increase to about 7% of GDP in FY2022, up from about 5% in FY2021. Primary deficit (fiscal deficit before interest payments) is projected to about 4% of GDP. The FY2021 budget estimate put fiscal deficit at around 7% of GDP in FY2021, but lower budget execution (both recurrent and capital spending) and near-target revenue mobilization resulted in lower deficit. When actual numbers are reported, it will probably be revised down further.

Where is recurrent budget going?

About 45.1% of planned recurrent budget of NRs 1004.4 billion is going to subnational governments (SNGs) in the form of recurrent fiscal transfer (fiscal equalization, conditional, complementary and special grants) and unconditional recurrent grants. The other big-ticket item is social security, which takes up about a quarter of the recurrent budget. Social security includes allowances, social assistance (scholarship; rescue, relief and rehabilitation, medical); social benefit of employees (pension and disability allowances, retirees related gratuity and medical assistance). The increase in allowances for 70 years and above elderly people by NRs 1000 to NRs 4000 has drastically increased allocation under this heading. Allocations for social security has been increased by 50%. About 15% of recurrent spending is earmarked for compensation of employees. Interest payments on foreign and domestic debt has drastically increased in recent years as borrowings increase to plug in widening fiscal deficit. Allocations for it increased by 27% and is estimated to be about 1% of GDP. Given the high fiscal deficit and accumulation of outstanding public debt due to the 2015 earthquake and fiscal profligacy during elections time, interest payments have been rising fast. Interest payments have more than tripled since FY2015.

The government has earmarked NRs 64.8 billion (1.4% of GDP) for use of goods and services, which also includes some of the pet projects of politicians and government. 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. 

Where is capital budget going?

Almost 58% of the planned capital budget of NRs 435.2 billion is going for civil works, 14% as capital grants to SNGs, 13.4% for construction or purchase of buildings, and 4.1% for land acquisition. Compared to the FY2020 revised estimate, capital budget has been increased by 48% (including capital grants, it will be about 67%). 

Major takeaways from FY2022 budget

First, the budget has been designed keeping in mind two objectives: (i) addressing the immediate health crisis, particularly testing, treatment and vaccination, and (ii) upcoming parliamentary elections. The validity of the budget itself is contested by other political parties and constitutional experts as it a full-fledged budget was unveiled through an ordinance. If the Supreme Court reinstates the house of representatives again, then the fate of this budget is undecided. The new government could either adopt it or bring out a new budget. But for now, since the budget was announced just before the elections, it includes several pork-and-barrel type projects and programs to woe voters including elderly vote through increase in allowance without ascertaining resources. The budget also has allocation for projects that probably won’t be completed till the medium-term. These include Lumbini development masterplan, industrial zones, smart and mega cities, etc. So, it has both populist as well as distributive flavor. It does not spell out overall governing macroeconomic framework.

Second, since budget deficit is widening, and outstanding public debt and interest payments are increasing, it would have been good to anchor expenditure and revenue to medium-term expenditure and revenue frameworks. It is missing in the budget. Note that outstanding public debt is rising fast in Nepal, especially after FY2015. It reached 37% of GDP in FY2020, up from 23.9% of GDP in FY2015. External debt comprises of 58% of outstanding public debt. Both internal and external debt have been rising rapidly. One also needs to tally how this budget falls in line with the 15th five-year plan and to what extent projects includes in National Project Bank are incorporated. Some projects such as tunnels in highways and industrial parks have been included without much due diligence. There has to be a fiscal consolidation strategy as a part of a medium-term budget framework. 

Third, the plan of large domestic borrowing will have implications in the financial market, and most of the foreign loans may not be realized if project implementation is not drastically overhauled (well, except for policy-based lending, whose disbursement is conditional on fulfilling pre-agreed policy and institutional reforms). Budget execution has to be improved, with limited time and cost overruns, to ensure timely disbursement by multilateral donors. Compared to revised estimate for FY2021, foreign loans are expected to rise by 87% (net foreign loans by almost 100%), which is not realistic given the budget execution capacity and the fact that if elections do happen in November, it will disrupt development activities as most of the resources will be diverted to hold elections. Meanwhile, domestic borrowing is projected to cross 5% of GDP (net domestic borrowing of above 4% of GDP). Large domestic borrowing may sound okay as of now given the ample liquidity in the banking system and lack of investment opportunities for pension funds and institutional investors. However, as situation normalizes and capacity utilization of firms improves along with demand for credit by individuals and businesses, there may be a pressure on the financial market, leading to rise in inter-bank rate and then retail interest rates. 

Fourth, revenue mobilization growth target of 20% compared to FY2021 revised estimate is a bit ambitious at the moment. In fact, revenue growth has been consistently below 20% after FY2016. In FY2021, the revenue target was 22% over FY2020 revised estimate. The government has increased excise duty on sugar-based goods, tobacco, cigarettes, alcohol, beer, and petroleum fuel, among others. Just increasing rates on some non-essential goods without much efforts to reform tax administration for better services delivery and to increase tax base is not going to yield substantive results. The authorities should be thinking of new strategies to boost domestic resources mobilization: simplification of tax code, e-filing of taxes and digitization of services, improved taxpayer compliance to control leakages, proper enforcement of property tax, etc. 

To be fair, there is a sort of growth-enhancing tax policy as the budget commits to tax imported industrial inputs lower than imported final goods. Similarly, customs duty on equipment used by tea, jute, pashmina, and agricultural firms has been waived off. There are income tax exemptions of varying degree for new businesses established after the pandemic, startups, firms operating in special and industrial zones, etc. Similar exemption commitment was made in the past budgets as well, but they hardly get implemented. There are other tax rebates and concessions such as abolition of excise duty on import of electric vehicles and substantial reduction of customs duty (to encourage domestic consumption of electricity and to ensure environment-friendly transport network). Excise duty on electric vehicles ranged from 60% to 120%. 

Fifth, projection of foreign grants seem ambitious as sources of grants are drying up (ADB and WB now provide loans only although TA is principally a grant) and that most bilateral donors may not increase aid allocations given their country’s priority to boost their economies ravaged by the pandemic. The government is projecting to receive foreign grants of about NRs 63.4 billion in FY2022—a growth of 134% over FY2021 revised estimate— which has not happened in the last decade. The largest foreign grant it received was NRs 43 billion in FY2016 after the earthquakes. In FY2021, the government expected to received NRs 60.5 billion but has revised it down to NRs 27 billion. 

Sixth, cash allowance/pension (non-contributory) for 70 years and above and other allowances have been increased by 33%. Allowance to elderly is a part of social protection scheme to support individual or household consumption demand. This is like a guaranteed universal basic income for elderly people. However, it directly increases the government’s liability as well because it needs to be continued for years to come. Normally, such schemes are reasonable when the economic pie is growing and there are enough resources to fund such populist schemes. However, increasing social protection liability by borrowing loans or by cutting down capital spending is not a good policy. Against this backdrop, this tranche of increase in elderly allowance is probably aimed at influencing the voter base for the upcoming elections. In its political manifesto ahead of 2017 elections, the CPN(UML) party committed NRs5000 per month elderly allowance.

Seventh, grants or transfers to local bodies are reported under recurrent and capital grants. Earlier, grants were clubbed under recurrent expenditure only and the government used to argue that real capital spending is much higher than just capital spending because grants or transfers to local bodies under recurrent spending included conditional and unconditional capital grants as well. That said, there are still conditional and unconditional grants to government agencies, committees and boards under recurrent spending, but these are not that large (about 5% of recurrent expenditure). 

Eighth, revised budget estimate for FY2021 is optimistic given the setback in project implementation due to COVID-19 pandemic related restriction on mobility and economic activities after April 2021 (second wave) and in the first quarter of FY2021 (tail end of first wave). So, most of the numbers will be revised downward when the government presents actual numbers in the next budget.  

Ninth, real GDP growth target of 6.5% of GDP may a bit optimistic given that the pandemic will continue to affect lives, livelihoods and economic activities well into the next year. There is no likelihood of sharp V-shaped recovery. Agricultural output growth might be higher than in FY2021 given the forecast of a favorable monsoon and likely availability of inputs such as chemical fertilizers. Industrial output may not fully recover and capacity utilization may also not be drastically higher as both consumption demand and investment remain subdued. Mining and quarrying activities and construction will be slow to pick up, and manufacturing activities will also likely be at a modest pace. New addition of hydroelectricity to the national grid will jack up its growth rate. In the services sectors, travel and tourism activities are unlikely to recover anytime soon as both domestic and foreign visitors remain cautious of travel without adequate vaccination. International travel may continue to get disrupted in countries with less vaccination rates and rising covid-19 infections. Elections-related spending, if it happens, will add to consumption demand. Overall, GDP growth may hover around 4-5% in FY2022.  

Tenth, as in the previous years, the main challenge is budget execution. This will be a bit challenging during an election year, the risk of another wave of infections disrupting labor and capital mobility, slow vacation drive, and the apparent disconnect between MOF’s budget implementation directives to lines ministries and the latter’s pace and nature of work. For instance, several promises made in the previous budget were never realized. One such case is that the government promised a separate 300 bed infectious diseases hospital in Kathmandu, additional 250 intensive care unit beds at government hospitals in Kathmandu and provincial capitals, and separate infectious disease hospital in the provincial capitals. These were promised even before the deadly second wave hit the country. They remained unfulfilled. High staff turnover, political interference at management and operational levels, lack of consultant and contractor management capability, hurdles in inter-ministry and intra-ministry coordination, governance shortcomings, and a lack of project readiness will continue to impact capital spending.

So, a likely scenario at the end of the year will be that recurrent budget will be almost spent (over 90%), and capital budget will be under-spent. The government will try to borrow the full amount domestically. But, both foreign grant and loan will fall short of the target. Revenue mobilization growth will be short of target but still high enough. Eventually, fiscal deficit will be lower than projected and that the government will have treasury savings at the NRB. 

FYI, I have assumed FY2022 nominal GDP growth to be 10% and inflation to remain at around 5-6%.