The major political parties unveiled a long wish list of distributional and aspirational programmes in their election manifestos. Irrespective of the lofty promises, which were also announced five years ago but remain unfulfilled, and their viability due to resource and administrative constraints, the next government will have to steer an economy that is facing substantial internal and external headwinds. Weak economic growth, limited fiscal space amidst rising public borrowing, escalating inflation and financial sector vulnerabilities, and threats to external sector stability are some of the macroeconomic challenges that the next administration will have to confront head on. Unfortunately, there are no easy fixes.

The political parties have aimed for high and sustained growth rates as in the previous manifestos. The Nepali Congress wants to achieve real gross domestic product (GDP) growth of over 7 percent, and the CPN-UML promises a double-digit growth rate. The Nepali Congress and the CPN-UML each have pledged 2 million and 2.5 million annual tourist arrivals, respectively. Additionally, they have vowed to create 250,000 and 400,000 jobs annually. There are equally grand promises on governance, prosperity, inclusivity and sectoral reforms. There is competition among the parties to increase unfunded and unconditional social security handouts outright or lower eligibility requirements. Note that social security expenses nearly doubled as a share of GDP since 2016-17 and are higher than the money the government invests in civil works.

Dream merchants

None of the political parties’ manifestos explains how to mobilise resources and enhance administrative capabilities to achieve the intended goals. In fact, none has costed their proposed projects and programmes. They read like a stripped-down version of the medium-term plan published by the National Planning Commission but without the details on costed programmes, intended resources mobilisation, fiscal deficit, and governance and accountability mechanisms. They also don’t honestly discuss the achievements against the promises in their previous manifestos. There are hardly any substantial changes in the way public finance is governed, development plans are made, and projects and public services are delivered.

The manufacturing sector is still performing poorly due to an unfavourable environment for private sector development. Its growth rate over the last five years averaged just 3.4 percent. Budget execution, particularly the capital spending absorption capacity, has eroded. It averaged 65.2 percent between 2017-18 and 2021-22, lower than 76.2 percent in the preceding five years. Cooperative and competitive federalism remains an unfinished and neglected agenda. Banking sector liquidity problems have become endemic and financial sector vulnerabilities are building up to a level that threatens to unravel economic stability.

Despite overall tight liquidity for an extended period, there was a generous flow of credit to a few sectors, such as real estate and housing, whose prices have skyrocketed throughout the country. The fact that it is happening despite a sharp rise in interest rates points to unresolved structural weaknesses, including asset liability mismatches and evergreening or whitewashing of portfolios. Inflationary pressures have generally been elevated. External sector imbalances loom large, although much of it is masked by the decline in imports due to increased prices, tight bank financing and quantitative restrictions.

Challenges persist

The economy is in this state owing to external factors beyond the government's control, such as the pandemic’s effect on economic activities and the increase in fuel and commodities prices because of the Russian invasion of Ukraine. However, it also reflects the shortcomings of the last and current administrations in decisively tackling the binding constraints to growth, good governance and effective public service delivery.

Going forward, three main macroeconomic challenges confront the next administration. First, the government will be pressed to accelerate growth while taming elevated price pressures. Supporting industrial sector growth, particularly the manufacturing sector, by overhauling legal and regulatory hurdles to ease the process of doing business so that output is cost competitive globally will be the key to sustained growth and employment generation. A cheaper supply of electricity (but not below cost recovery rate) to domestic firms rather than the export of allegedly surplus electricity will be important. A full recovery of the tourism sector with higher per-tourist spending could also provide some momentum. Promotion of agro-processing activities and value chain, year-round irrigation in agricultural belts, and digitisation to improve service delivery and streamline subsidies and targeting will be helpful. However, this must be synced with the need to rein in inflationary pressures, which are partly imported as high energy and commodity prices pass through, and partly exacerbated by domestic supply-side constraints such as lack of adequate infrastructure, black marketeering and sectoral cartels. A tighter monetary policy aimed at unproductive and speculative sectors to reduce vulnerabilities while facilitating a sustainable level of credit to productive sectors may be helpful. A coordinated fiscal and monetary policy response can support growth-enhancing measures without jeopardising price and external sector stability.

Second, effective fiscal management and discipline will be challenging, given the lofty promises. The large fiscal deficit since 2016-17 means that there is limited fiscal space to launch new initiatives as promised by the political parties. Revenue growth is stagnating, but expenditure growth remains high. Tax revenue may not fully cover recurrent expenses. Hence, efforts to rationalise recurrent expenses, especially unfunded handouts and the public wage bill; boost chronically low capital spending and its quality; broaden the tax net and the tax base through effective monitoring and digitisation; and increase concessional external financing will be important in the medium term. Furthermore, judicious cash flow, debt operations and management to reduce the cost of debt servicing and plugging fiscal leakages through digitisation and accountability are vital.

Third, the government will have limited options to manage external sector imbalances. A high cost of production that is eroding comparative and competitive advantages and an adverse external environment due to economic slowdown in major export destinations are affecting exports. The increasing import bill, partly due to high energy and commodity prices globally and a depreciation of the Nepali rupee against convertible currencies, combined with low exports and moderation in remittances growth have widened the current account deficit, which reached 12.8 percent of GDP in 2021-22. Efforts to discourage imports through outright quantitative restrictions and credit tightening have led to a lower current account deficit lately and a slight improvement in import cover by foreign exchange reserves. However, it is not a sustainable approach because the slowdown in essential imports also hampers overall economic activities. Tariffs should be adjusted without breaching multilateral and bilateral trade agreements. Ideally, the adequacy of foreign exchange reserves should not fall below 5.5 months of prospective imports of goods and services.