Finance Minister Bishnu Prasad Poudel presented the 2021-22 budget on May 29 through an ordinance, owing to the dissolution of the federal Parliament and the announcement of fresh elections scheduled for November. The bloated budget includes big promises on expenditure, revenue mobilisation and deficit financing that are challenging to implement if elections are held—that too without fully vaccinating a sizable share of the population.

Nevertheless, the finance minister has rightly prioritised the most pressing challenge right now, i.e., testing, tracing, treatment, vaccination and upgrading healthcare infrastructure. The strategy seems to be the stabilisation and recovery of economic activities by addressing healthcare challenges, continuation of existing projects and relief measures for individuals and businesses, and propping up aggregate demand as well as the voter base by increasing allowances.

Large outlay, large deficit

The total expenditure outlay for 2021-22 is Rs1.65 trillion, which is 30.1 percent higher than 2020-21 revised estimate. Recurrent and capital spending allocations constitute 61 percent and 26 percent of the budget. Notably, the government started reporting recurrent and capital grants to subnational governments (SNGs) separately from the next fiscal. This gives a better picture of actual capital spending, because earlier the government used to argue that reported capital spending underestimates the actual figure as some fiscal transfers recorded under recurrent spending are used for financing capital projects by SNGs.

Total federal receipts (federal government’s share of revenue plus foreign grants) are estimated to be Rs1.09 billion. The revenue mobilisation growth target is set at 20 percent. Considering the federal government’s expenditure and its share of revenue in total revenue mobilisation, the budget deficit turns out to be Rs559.3 billion, which is to be financed by foreign loans and domestic borrowing. The government expects foreign aid (grants and loans) to cover about a quarter of its expenditure needs. Overall, the fiscal deficit is projected to increase to about 7 percent of the GDP in 2021-22, up from about 5 percent in 2020-21.

About 45.1 percent of the planned recurrent budget is earmarked for SNGs in the form of recurrent fiscal transfer 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 assistance); and social benefit of employees (pension and disability allowances, retirees related gratuity and medical assistance). The increase in allowances by 33 percent, including for 70 years and above elderly people, has drastically increased allocation under this heading by 50 percent. Meanwhile, about 58 percent of the planned capital budget is going for civil works and 14 percent as capital grants to SNGs.

Major takeaways

The budget has been rolled out when the country is at a critical juncture. In fact, economic activities are estimated to have contracted by 2.1 percent in 2019-20 and will likely grow at around 2 percent in 2020-21, most of which will be due to a base effect anyway. Increase in social security allowances, the allocation for free vaccination, the continuation of refinancing facility and business continuity funding, and income tax relief for individuals and businesses are some of the notable features of the budget.

Without ascertaining resources, it is also redistributive in nature, particularly aimed at influencing the voter base ahead of the planned federal parliamentary elections. A larger increase in federal expenditure (30.1 percent) than an increase in federal receipts (14.5 percent) points to a challenging fiscal management task going forward. Against this backdrop, there six specific macroeconomic takeaways.

First, since the budget deficit is widening, and outstanding public debt and interest payments are increasing, it would have been good to anchor expenditure and revenue on medium-term expenditure and revenue frameworks. Outstanding public debt is also rising fast, particularly after 2014-15, reaching about 37 percent of GDP in 2019-20 from 22 percent barely five years ago. One also needs to tally how this budget falls in line with the 15th five-year plan and to what extent it includes projects listed in the National Project Bank.

Second, the revenue mobilisation growth target of 20 percent compared to the 2020-21 revised estimate is a bit ambitious at the moment. In fact, revenue growth has been consistently below 20 percent since 2016. Increasing excise duties on ‘sin’ goods and tinkering with administration reforms may not yield many benefits without an increase in the taxpayer base and better compliance. Large-scale, ad hoc tax exemptions are not helpful.

Third, most of the projected foreign loans may not be realised if project implementation is not drastically overhauled. Compared to the revised estimate for 2020-21, foreign loans are projected to increase by 87 percent, which is not realistic given the poor budget execution capacity and the fact that if elections happen in November, it will disrupt development activities. Meanwhile, domestic borrowing is projected to cross 5 percent of the GDP. Large domestic borrowing may sound okay, given the ample liquidity in the banking system and lack of investment opportunities for pension funds and institutional investors. However, as the situation normalises and capacity utilisation of firms improve along with demand for credit by individuals and businesses, there may be pressure on liquidity, leading to a rise in the inter-bank rate and then retail interest rates.

Fourth, the projection of foreign grants seems ambitious as sources of grants are drying up. For example, Asian Development Bank and World Bank now provide loans only, although technical assistance is principally a grant. And that most bilateral donors may not increase aid allocations given their priority to boost domestic economies ravaged by the pandemic. The government is projecting to receive a 134 percent growth in foreign grants over the 2020-21 revised estimate, which is unrealistic.

Fifth, the non-contributory allowance for the elderly, a sort of a guaranteed universal basic income, hopes to support individual or household consumption demand. 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 populist schemes. Increasing social protection liability by borrowing or by cutting down capital spending is not a good policy.

Finally, the real GDP growth target of 6.5 percent 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 2020-21 with a forecast for a normal monsoon and the availability of inputs such as chemical fertilisers. Industrial output may not fully recover because capacity utilisation will not drastically increase amidst subdued demand and investment. Travel and tourism activities are unlikely to recover anytime soon without adequate healthcare measures and mass vaccination. Elections-related spending, if it happens, will add to consumption demand. Overall, GDP growth may hover around 4 to 5 percent in 2021-22.