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%.

Key highlights of Nepal's 15th five-year plan (FY2020-FY2024)

National Planning Commission recently published the 15th five-year plan (FY2020-FY2024) taking also into account the effect of COVID-19 pandemic on the government’s priorities and the economy. This plan is considered as a first phase of a 25-year long-term economic vision that aims to position Nepal as a high-income country with per capita income of USD 12,100 by FY2044.  Its theme is 'generating prosperity and happiness' and aims to create the foundation of prosperity and happiness through economic, social and physical infrastructures to accelerate economic growth. 

The government is expecting Nepal to graduate from LDC category to a developing country status within this plan (by 2022 with per capita income of USD 1,400). This plan is expected to contribute to efforts to ensure that Nepal reaches a middle-income country status by FY2030 (with per capita income of USD 2,900) and achieve the SDGs as well. By the end of FY2024, per capita income is estimated to reach USD 1,595.

The plan emphasizes boosting investment in the sectors or thematic issues that are considered as drivers of economic transformation. These include transport, ICT, energy, education and healthcare, tourism, commercialization of agriculture and forest products, urbanization, social protection, subnational economy, and good governance, among others.

 By FY2024, the government wants to achieve a double-digit growth rate, increase per capita income of USD 1,595, reduce population under absolute poverty line to 9.5%, and increase share of formal sector employment to 50%. 

Some of the major national targets for 15th five-year plan (FY2020-FY2024) are as follows:

• Average GDP growth (at basic prices): 9.6%
• Average GDP growth (at producers' prices): 10.1%
• Per capita income: USD 1,595
• Export of goods and services: 15.7%
• Share of essential goods (agri, livestock, food items) in total imports: 5%
• Population under the absolute poverty line: 9.5%
• Population with multidimensional poverty: 11.5%
• Share of formal sector employment: 50%
• Unregistered (formal) establishment: 10% of total establishment
• Literacy rate (15+ years): 95%
• Road density: 0.74 km of road per sq km of land
• Households with access to electricity: 95%
• Population with access to internet: 80%
• Electricity generation (installed capacity): 5,820 MW
• Renewable energy: 12% of total energy consumption
• Per capita electricity consumption: 700 kwh
• Agricultural productivity (major crops): 4 MT per hectare
• Irrigable land with year-round access to irrigation: 50%
• Per capita tourist spending: USD 100 per day
• Human development index: 0.624
• Gender development index: 0.963
• Population covered by basic social security: 60%
• Social security expenditure: 13.7% of budget
• Global competitiveness index: 60
• Ease of doing business index: 68
• Travel and tourism competitiveness index: 3.8
• Corruption perception index: 98
• Nepali citizens with national ID card: 100%
• Population affected by disaster incidents: 9.8%

The NPC estimated average growth in agriculture, industry, and services sectors to be 5.4%, 14.6%, and 9.9%, respectively. By the end of the 15th plan, the government is targeting to increase the share of industry and services sectors to 18.8% and 58.9%, respectively, while the share of agriculture sector is to decrease to 22.3%. To achieve the stated average growth rate, the NPC estimated that NRs 9.229 trillion (at FY2019 constant prices and based on ICOR of 4.9:1; FYI, a lower ICOR indicates efficient production process) investment will be required over the plan period. Public, private and cooperative sectors are expected to contribute 39%, 55.6%, and 5.4%, respectively of this required investment.  

[The government is considering FY2019 as a base year for the long-term economic vision. So, the data is presented in FY2019 constant prices. However, this is not much helpful in doing comparative analysis including that of long-term plans and targets. National account estimates, public finance, and periodic surveys - based on which the numbers are estimated eventually- are either presented with different year as base year (FY2011 for NEA for now) or are in current prices (fiscal, monetary, external sectors, and household surveys.]

As a share of GDP by FY2024, the expected impact on macroeconomic indicators are as follows:

National accounts (focused on increasing investment through savings mobilization)

• Average GDP growth (at producers' prices): 10.1%
• Per capita income: USD 1,595
• Export of goods and services: 15%
• Gross domestic savings: 22%
• Gross national savings: 47.5%
• Gross fixed capital formation: 41.6%

Fiscal sector (focused on allocation and implementation efficiency, and fiscal discipline for expenditure management; maximize revenue mobilization and taxpayer-friendly tax administration)

• Total budget: 43.3%
• Recurrent expenditure: 17.9%
• Capital expenditure: 18.6%
• Financial management: 6.8%
• Revenue: 30%
• Income tax: 10%
• Foreign debt: 5.7%
• Domestic borrowing: 4.3%

Monetary and external sector (focused on controlling inflation, balance of payments stability, and financial stability)

• Average annual Inflation: 6%
• Export of goods and services: 15%
• Import of goods and services: 49%
• Remittances: 22.1%
• Foreign investment: 3%

Meanwhile, the average financing gap to achieve the SDGs is estimated to be NRs 585 billion per year for the entire period of 2016 to 2030 (SDG period). It is on average 8.8% of GDP for 2016-19, 12.3% of GDP for 2020-22, 13% of GDP for 2023-25, and 16.4% of GDP for 2026-30. The overall annual financing gap is estimated at 12.8% of GDP throughout the period of 2016 to 2030.

Nepal's FY2021 budget at a critical juncture

It was published in The Kathmandu Post, 03 June 2020. An earlier blog post is here (in Nepali language here).

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The budget has failed to take advantage of a critical juncture

The government has, once again, not been able to enact structural change when afforded an opportunity by the extraordinary circumstances.

The federal government’s budget for the fiscal year 2020-21, presented by Finance Minister Yubaraj Khatiwada, prioritises short-term measures to respond to health, economic and employment crises caused by the novel coronavirus disease, Covid-19. The unique nature of concurrent health, demand and supply shocks due to the pandemic and the consequent lockdowns to contain its spread, meant that the government had no option but to increase spending in healthcare and social protection, even if it increased fiscal deficit sharply.

That said, this critical juncture is also an opportune moment to not only craft a short-term response to deal with the effect of Covid-19 on lives, livelihoods and the economy, but also to overhaul the existing inefficient systems and rectify long-running economic ills that are holding back inclusive economic growth and prosperity. Unfortunately, the budget loses sight of this opportunity at this critical juncture. Similarly, the budget is not clear about the medium-term strategy for economic recovery, growth-enhancing revenue policy and a consolidation plan to narrow the widening fiscal deficit.

The federal government’s total budget for the next fiscal year is Rs1.47 trillion, which is lower than the Rs1.53 trillion budget estimate for 2019-20, but 37.4 percent higher than the revised estimate. It comprises Rs948.9 billion as recurrent expenditures (64.4 percent of the total outlay), Rs352.9 billion as capital expenditures, and Rs172.8 billion as a financial provision. Note that fiscal transfers and conditional grants to subnational governments are also included in recurrent spending of the federal government. So, the capital spending allocation of all tiers of government is a bit higher than the one indicated in the centre’s budget.

Total central receipts (revenue and foreign grants) are expected to cover 65 percent of the budget. The government is planning to cover the budget gap by borrowing internally and externally. The fiscal deficit is expected to increase to about 8 percent of the gross domestic product.

Underwhelming response

The budget also includes a Covid-19 economic recovery package, but it is not really an additional fiscal package that is going to prop up subdued demand and business activities. Nor is it likely to restore the severely disrupted supply networks and output. Most of the already announced incentives and initiatives are subsumed in the budget, including a Rs100 billion refinancing facility by the central bank. The government is planning to set up a separate Rs50 billion fund to provide subsidised loans, at 5 percent interest, to sectors badly affected by the Covid-19. The government has not committed a full amount to the fund as it expects contributions from public enterprises and development partners. The operationalisation and effectiveness of this fund is uncertain, as there is no standard operating procedure that outlines eligibility and bureaucratic prerequisites.

Furthermore, the government argues that there is about NRs 60 billion worth of interest and utility subsidies, and tax concessions. There is also a plan to employ 700,000 people through direct employment, and provide training related to skills upgradation and technical education.

Besides these mundane, halfhearted measures to deal with the immediate effect of the crisis, the government had an opportunity to overhaul long-running economic ills and rigid systems that have fostered extractive economic and political institutions. It is easier to do when an economy reaches a critical juncture, which according to economists Daron Acemoglu and James Robinson are ‘major events that disrupt the existing political and economic balance’. In their book Why Nations Fail, they argue that at critical junctures a country can transform its extractive political and economic institutions into inclusive ones, resulting in meaningful socioeconomic changes and acceleration on the path to prosperity. Nepal reached this kind of critical juncture in the 1950s (end of Rana rule), 1990s (restoration of democracy), 2006 (end of Maoist insurgency and monarchy) and 2015 (catastrophic earthquakes). Unfortunately, we have missed opportunities to reorient economic and political institutions during these times for greater good. Instead, we have let the prevailing political-business nexus to capture land, labour, capital and product markets.

At the critical juncture created by the pandemic, we are once again missing a chance to roll out transformative reforms to create inclusive political and economic institutions. These include agricultural transformation; consolidation of social protection schemes with a unified digital registry of all beneficiaries (including the Prime Minister Employment Programme and cash allowances); rationalisation of ballooning recurrent spending; freeing markets from the clutches of cartels; changing revenue policy to support growth and innovation; nixing politically-oriented distributive spending; harmonising planning and financial reporting standards across all tiers of governments; prioritising projects strictly based on implementation readiness; sound governance framework to curb misappropriation of public funds, and, lastly, changes to legal, policy and institutional frameworks to increase private sector participation.

Most of these are transformative in nature and growth-enhancing structural changes that are relatively easy to roll out during critical junctures. They set in motion a process of creative destruction and creative creation processes, which are vital for enhancing private investment, innovation, and public services delivery. They also boost the entrepreneurial spirit and incentivise saving, investment and innovation.

Budget takeaways

Besides this missed opportunity, there are three particular macroeconomic takeaways. First, there is no medium-term recovery plan for a sustained recovery. The focus is on immediate-term only with increased funding for the healthcare sector and state-led employment creation. Propping up demand (through additional cash transfers, subsidy and income tax concessions) and maintaining supplies of essential goods and services (including through graded easing of the lockdown), even during the immediate-term, are pretty much ignored. A medium-term recovery strategy could at least include assistance for preventing layoffs in both organised and unorganised sectors, and saving struggling micro, small and medium enterprises from collapsing. The private sector has been largely left to fend the crisis for themselves.

Second, with declining revenue and increasing spending needs, the fiscal deficit is expected to be around 8 percent of GDP. Besides some discretionary spending—such as insurance cover for frontline staff and social security fund payments—other increased recurrent spending may not be easy to rollback. It will keep recurrent spending at a high level even after the crisis subsides. With consistently lower than expected revenue mobilisation since 2017-18 and an increase in recurrent spending, narrowing down the widening fiscal deficit will require a credible medium-term fiscal consolidation plan. A drastic increase in domestic borrowing to fund the deficit will likely squeeze liquidity and raise interest rates, thus crowding-out private investment.

Third, revenue and foreign aid budget estimates and growth targets are too ambitious. For instance, given the past trend, tinkering import duties alone will not be helpful to achieve revenue mobilisation target of 22 percent. Likewise, foreign grant and loans targets are 89 percent and 147 percent respectively—higher than the revised estimate for 2019-20. Note that even after the 2015 earthquakes, the government was able to mobilise less than 50 percent of foreign grants and loans estimated during the budget speech. Similarly, even with a favourable base effect, a GDP growth target of 7 percent is unrealistic, particularly given the prospect of a continued slowdown in agriculture (thanks to a shortage of chemical fertilisers and workers), subdued industrial activities (especially manufacturing and construction), and uncertainty over the recovery of services—especially in travel and tourism, wholesale and retail trade, transportation, real estate, and education.

Budhi Gandaki project re-awarded to Chinese firm, MPs to execute 20 projects, and more

PM asks ministry to rehire Chinese firm

From The Kathmandu Post: Budhi Gandaki Hydropower Project, once again, has fallen into politicking. The KP Sharma Oli administration last week decided to rope in China Gezhouba Group Corporation (CGGC), reverting the erstwhile Sher Bahadur Deuba government’s decision to develop the 1200MW project with internal resources. The Cabinet meeting on Friday directed the Energy Ministry to initiate the process to award the project to the Chinese developer. As per the Cabinet decision, the ministry has been asked to hold talks with the Gezhouba, prepare a proposal, and strike a deal to execute the $2.5 billion reservoir project.

Following the government decision, the Energy Ministry will now invite the Chinese company for talks and prepare a draft of the memorandum of understanding (MoU) before signing it, according to multiple sources at the ministry. “The understanding will be signed to execute the project under the engineering, procurement, construction and financing (EPCF) model,” said one senior official.

Multiple sources at the Energy Ministry said the proposal was taken to the Cabinet directly by the Prime Minister’s Office (PMO) without involving Energy Ministry officials. “We came to know that the Chinese developer had filed an application at the prime minister’s office, expressing interest in executing the project under the EPCF model,” said another official who spoke on condition of anonymity because he wasn’t allowed to discuss details of the proposal. Energy Secretary Anup Kumar Upadhyay, however, said he was unaware of the recent development and has yet to receive instructions from the PMO.

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Local Infrastructure Development Partnership Programme: Guideline allows MPs to execute 20 projects in single constituency

From The Kathmandu Post: Going against the budgetary provision, the government on Friday endorsed the working procedure of Local Infrastructure Development Partnership Programme, which not only increased the number of projects, but also allowed lawmakers to have their say in project selection. Government officials said the working procedure has effectively ended the efforts to make the programme less distributive, as it has allowed federal lawmakers to execute as many as 20 projects in a single constituency.

The programme is modified version of controversial Constituency Infrastructure Special Programme (CISP) and the Constituency Development Programme (CDP) implemented through lawmakers. According to officials at the Federal Affairs Ministry, the option of selecting as many as 20 projects goes against the current fiscal year budget that states maximum of five projects related to road, drinking water, irrigation and river control could be carried out in one constituency. While drafting the working procedure, the ministry had proposed for selecting maximum 10 projects within five areas. However, after a strong pressure from the lawmakers, the number was doubled to 20.

After a strong lobby from lawmakers, it has given sole authority to select the projects to a committee headed by directly elected lawmaker and represented by parliamentarians from proportional representation and the lawmaker in the National Assembly. This goes against the provision of the current budget which had envisioned forming a committee co-ordinated by directly elected representative from particular constituency and represented by members of federal parliament, provincial parliaments and heads of the local governments.

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Cabinet approves splitting of CAAN

From The Himalayan Times: The Cabinet meeting on Friday gave permission to the Ministry of Culture, Tourism and Civil Aviation (MoCTCA) to split the Civil Aviation Authority of Nepal (CAAN) into two different entities — regulatory body and air navigation services provider.

“Since the Cabinet has given permission to split CAAN into two entities, MoCTCA and CAAN will frame a new act to implement the decision,” said Sanjeev Gautam, director general at CAAN. He further mentioned that after the formulation of the new act, MoCTCA will first forward it to the Parliament for approval. “After it is endorsed by the Parliament it will come into implementation.” In 2012, the government had formally announced that CAAN would be divided into two separate autonomous bodies. The government had said it would create two entities by dividing CAAN so as to improve the regulatory mechanism and also to develop civil aviation infrastructure.

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Government goes hard on transport syndicates

From The Kathmandu Post: The Department of Transport Management on Friday directed all its offices to open route permits on all the roads for competitive distribution. The DoTM recently amended the Transport Management Directives- 2004, which allows for any company to get route permits in any parts of the country in a hassle-free manner.

Following the disruption caused by a group of 11 passenger transport committees operating on the route east of Koteshwor, the transport department amended the directives to allow more carriers to openly compete in the sector. The DoTM has done away with recommendation from such committees, a hurdle for new entrants in seeking route permits.“Syndicate in public transport has persisted because the existing committees do not accept new entrants. Now, new companies won’t need such reference from these committees, meaning anyone interested in the market for healthy services can apply for road permit in any part of the country after registering with the DoTM,” said Aryal. Earlier, only those receiving approval from such committees would get the licence to operate. 

Syndicates, which exist in different parts of the country, block entry of interested companies, who provide better facilities to passengers often at cheaper rates, to curb competition.

From Setopati/Nagarik: Meanwhile, bus fares has come down following the entry of new companies. Kavre Bus Association has asked all its members to put up a notice in their public buses outlining fares for designated routes. This has come after Sajha Yatayat and Mayur Yatayat, both much organized companies and offering better services, started charging NRs35 for travel from Banepa to Kathmandu. Earlier, the local bus syndicate was charging NRs40 for the same distance. 

The present government has gone pretty hard on the syndicates. This is quite unusual and unheard of in the previous years (even when the same party was leading the government). A comfortable majority at federal and provincial and at a majority of local bodies has led to a strong government that can stand up to organized syndicates. Now, the government needs to be similarly tough on other syndicates as well. Syndicates are illegal by law (Transport Act 2049) and the Supreme Court had issued several orders asking the government to implement the law. A deep connection between quasi-political businessmen and politicians meant that the syndicates were politically protected. Furthermore, clamping down on syndicates may help to widen the tax base as syndicates because since syndicates are established under Organizations Act 2034, they do not pay taxes and operate like an NGO. Now, the government wants such syndicates to register as a company following Companies Act 2007. 

Priorities of PM Oli-led government and more

Priorities of PM Oli-led government (from his address to diplomatic community on 27 March 28, 2018):

1. Nationalism: “protection of our sovereignty, territorial integrity, national independence, and fulfilment of our national interest”
2. Democracy and fundamental freedoms: “We believe that democracy is irreversible and no one can snatch it now from us.”
3. Social justice based on equality: “We stand firm on achieving social justice that ensures equitable opportunities and equal protection to all sections of our society.”
4. Stability, progress and development: “Any attempt to undermine peace and stability will not be tolerated at any cost and will be dealt with firmly and resolutely. There is no space for violence in our society.”
5. Good governance: “We will also pursue a policy of zero-tolerance against corruption. Our aim is to ensure corruption-free governance. We will adopt an efficient and smart mode of service delivery so that people can feel the change.”
6. Broad-based, inclusive and sustainable development: “We have a strong resolve to attain rapid economic growth to underpin political transformation.”

Here is an outline of the previous version of the priorities of left alliance. We need to see further specifics on this government's economic vision, and strategy to achieve them within a given time frame. 

• Replace gas and petroleum fuel with electricity use within five years
• One industrial area in each province
• Establish waste processing and disposal center and generate electricity out of it
• Establish polytechnique institute in each local body
• Upgrade zonal hospitals to medical college
• Government to establish medical college
• Retain National Planning Commission
• Revive National Trading Limited
• Widen tax net
• Reduce government expenditure

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Bad loan ‘evergreening’ in Nepal

From The Kathmandu Post: Haphazard credit disbursement that created irreparable holes in the balance sheet of erstwhile Apex Development Bank has exposed long-suspected counterintuitive practice of ‘evergreening’ of bad loans in the banking sector, which could contaminate and even bring down the entire financial sector. A loan restructuring directive approved by the board of directors of the development bank on September 13, 2015 had included a provision that enabled the management to disburse fresh loans to settle the outstanding credit, says an on-site inspection report prepared by the Nepal Rastra Bank (NRB), the banking sector regulator, a copy of which has been obtained by the Post. This implies the bank’s board, whose job is to ensure good governance, had officially allowed the management to evergreen the loan book.

Evergreening takes place when banks provide additional loans to borrowers who are unable to service their debt on time. The additional loan is then used to repay the instalments of the outstanding loan. This is a counterintuitive practice because it prevents banks from issuing good loans, as available fund is diverted to borrowers holding low-quality loans. This creates a vicious circle and the financial institution ultimately finds itself in a position where it can no longer issue good loans, thus exerting pressure on capital adequacy ratio, an indicator to gauge the credit disbursement capacity of banking institutions.

Apex Development Bank was engaged in this malpractice for quite some time. This is evident from the practice of issuing loans to the same group of borrowers and diverting credit to the same group via other borrowers, according to the report, which was submitted to the NRB on January 12, 2017, or a month after the extension of final approval for merger between NCC Bank and Apex Development Bank.

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Direct contribution of tourism is estimated at 4% of GDP in 2017

From The Kathmandu Post: Nepal’s travel and tourism sector injected Rs195 billion into the economy and supported more than 1.02 million jobs directly and indirectly last year, according to the latest report of the World Travel and Tourism Council (WTTC). The report said that 497,500 jobs were generated directly out of the total jobs supported by the industry last year.

According to the report, the direct contribution of tourism to the GDP was Rs99.8 billion in 2017, which is 4 percent of the total GDP. This is forecast to rise by 4.9 percent in 2018 and then by 3.8 percent annually to Rs152.4 billion in 2028. The total contribution of the travel and tourism industry to the GDP was Rs195 billion, 7.8 percent of the GDP in 2017. This is projected to rise by 3.9 percent annually to Rs299.5 billion, or 8.2 percent of the GDP, in 2028. This primarily reflects the economic activity generated by industries such as hotels, travel agencies, airlines and other passenger transportation services, excluding commuter services. It also includes, for example, the activities of the restaurant and leisure industries directly supported by tourists.

The country received Rs72.5 billion in foreign exchange earnings from tourists last year. More than 940,000 tourists visited Nepal in 2017, up 24.86 percent from 2016. 

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Bharatpur metropolitan city passes a local law to hike taxes

From myRepublica: Office of the Municipal Executive, Bharatpur Metropolitan Office, has increased registration fee for applications from Rs 10 to Rs 25, while fee for getting relationship certificate has been increased to Rs 100 from existing Rs 25. Similarly, fee for registration of gold and silver shops has been increased to Rs 25,000 (for A category) and Rs 15,000 (for B category) from the Rs 1,008. The business tax for running a restaurant and hotel has been increased from Rs 1,500 to Rs 125,000. Earlier, such rates were in range of Rs 500 to Rs 12,000 only.

Likewise, the metropolis has also hiked the fees for services like getting certificates of family details, certifying birth dates, issuing character certificates, fee for connection of drinking water lines, and ownership transfer. Fee for all of these services has been increased to Rs 575 from Rs 190. 

Bharatpur Metropolitan City introduced the new tax rates by endorsing the Financial Act from the Municipal Executive meeting in January. Tax rates have been hiked by up to 20 times. Bharatpur Metropolitan City has defended the decision to hike tax rates, stating that the metropolis needs for resources to 'strengthen its financial status'. Chitwan Chamber of Commerce and Industry (CCCI), on Tuesday, submitted a memorandum to the Office of the Municipal Executive, Bharatpur Metropolitan Office, drawing the attention of the municipal officials toward tax rate hike. CCCI have also said that the Act has no clarity on segregating villages and towns in respect to levying taxes. 

Slow capital spending this year as well and more

14% of budgeted capital spending used by H1 FY2018

The government’s capital spending hovered around Rs47 billion in the first six months of the fiscal year, which is only 14 percent of total capital budget of Rs335.2 billion allocated for 2017-18. Three main reasons for underutilisation of the capital budget: (i) flooding in Terai in August delayed progress in implementing infrastructure projects; (ii) state and federal elections meant that government staff were deputed to conduct and monitor elections, and workers returned back to their hometown to cast vote; and (iii) confusion over transfer of projects to local bodies and implementation agency. Other reasons include delay in preparation of detailed project design, land acquisition, establishment of project management offices and preparation of procurement plans.

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Five key economic challenges for the next government

1. Increase investment in physical and social infrastructures
2. Sound fiscal management and governance regimes
3. Coherent planning and policies among the three tiers of government
4. Bureaucratic reform for better budget execution and public service delivery
5. Accelerated post-earthquake reconstruction

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Contractor-politician nexus in Nepal

In Nepal, half a dozen contractors exercise monopoly over construction contracts. The cartel holds sway over entire construction administration and political sector. They huddle together before bidding for large infrastructure projects. […]After the deal, the contractors divide civil works among themselves. The contractor who is receiving the contract proposes a cost one percent less than the estimated cost. In order to show it was a competitive bidding, another contractor of the group proposes a slightly higher cost. As a result, one of the group members wins the contract.

In the last few years, against the fundamental principles of law, procurement policies have been modified so that only certain companies can bid for tender without any competition or by limiting competition. The report details how collusion affected more than Rs 25 billion worth of road projects.

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Local bodies lack planning and budgeting expertise

Local bodies in Gulmi have been approving short-term populist programs instead of medium-term projects that help to raise local productive capacity. They don’t have the capacity to do planning, select projects and approve budget. 

Resunga municipality approved 648 project, of which 103 are of NRs10,000-NRs50,000. There are 211 projects with a budget of just NRs100,000. Similarly, they have allocated NRs30.6 million to upgrade 150 local roads. Isma village council (gaupalika) has approved 42 drinking water projects, of which 10 have allocations below NRs300,000. 

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Govt to break up Air India into four parts to speed up privatisation process

The proposed privatisation of Air India Ltd has gained momentum, with the government deciding to break the airline into four units and offer to sell at least 51% in each of them besides transferring most of the non-core debt owed by the carrier to its own balance sheet. The core airline business comprising Air India and Air India Express—the low-cost overseas arm—will be offered as one company, and the process will be completed by the end of 2018, minister of state for aviation Jayant Sinha said in an interview with Bloomberg on Monday. Its regional arm, ground handling and engineering operations will also be sold separately in the same process.

The government has also eased rules allowing foreign airlines to buy a stake of up to 49% in Air India with prior government approval but with the caveat that substantial ownership and effective control of Air India will remain with Indian nationals as is the case with all domestic airlines. The airline has a fleet of about 140 planes, with a 17% share of traffic on routes linking India to international destinations and about 13% share of the domestic market.