The macroeconomic situation has improved as of the first half of the fiscal year 2022-23, but the economy is not out of the woods yet as the underlying vulnerabilities remain unaddressed. Due to interventions by the government and the central bank, economic activities have recovered from the pandemic slump, bank interest volatility is stabilising and external sector balance is gradually improving. However, the fiscal situation remains dire with lower than anticipated revenue mobilisation against high expenditure commitments and the rising cost of borrowing. The next two quarters will be crucial in terms of judicious fiscal and macroeconomic management and policy coherence.

The unrealistic budget projections are now gradually unravelling. As of the first half of the fiscal year, the government was able to mobilise just 35 percent of the annual revenue target and 74.2 percent of the half-yearly target. Revenue decreased owing to a slowdown in imports and slower than expected economic recovery. A slowdown in construction and real estate and share transactions also affected revenue mobilisation.

Faced with the reality of a revenue shortfall, the Finance Ministry proposed a cut in expenses, especially recurrent spending, by 20 percent in all tiers of government. It also plans to tighten approval of projects that were included in the budget but whose procurement process has not started.

Note that the cut in spending is not only due to lower revenue mobilisation but also less foreign aid and a dismal capital budget absorption rate, which was just 14 percent as of the first half of this fiscal year.

As per the Appropriation Act 2022, the federal government needs to make fiscal transfers in four instalments—on August 18, 2022; October 19, 2022; January 16, 2023 and April 15, 2023—to sub-national governments. These fiscal equalisation, conditional, complementary and special grants should have amounted to Rs129.46 billion for the seven provincial governments and Rs300.37 billion for the local governments. The provincial and local governments are supposed to get an additional Rs163 billion through a revenue-sharing mechanism. It will be challenging for the federal government to honour these commitments, undermining the agenda of cooperative and competitive fiscal federalism.

Fiscal management

Fiscal management is becoming challenging due to internal and external factors. First, sound fiscal discipline, accountability and transparency will be critical to ensure that fiscal deficit and public debt are at manageable levels. Recurrent expenses must be rationalised, and capital projects must be prioritised and well vetted before including them in the budget. For instance, the Ministry of Finance was forced to increase allocations for social security, subsidies, national priority projects and debt payments. It is high time that these were targeted and rationalised because they together account for about 35 percent of the recurrent budget.

Similarly, debt payment has become costlier in recent years as the government attempts to borrow more domestically despite a tight liquidity situation. The depreciation of the Nepali rupee, which makes foreign loan repayments expensive, is also contributing to high fiscal costs. Note that public debt increased by about 19 percentage points in the last five years, reaching 41.5 percent of the gross domestic product (GDP). Interest payments alone account for about 1 percent of the GDP. Coherent fiscal and debt policies anchored to sound medium-term rules-based frameworks are long overdue.

Second, although Nepal’s revenue as a share of the GDP is higher than the average of middle-income countries, greater efforts are needed to boost revenue collection given the high expenditure commitments and fiscal liabilities. Efforts could focus on broadening the tax base, closing loopholes, reducing tax expenditures such as multiple layers of concessions that are not growth-enhancing, employing a sound compliance risk management framework and reducing compliance costs, maintaining accurate and reliable taxpayer registry, boosting uptake of e-payment options, and reducing high and growing level of arrears, among others. For instance, the Finance Ministry has been providing tax concessions to projects that are initiated by government-owned or non-profit organisations, and projects funded by foreign loans or grants. In the first half of the fiscal year, these concessions amounted to Rs3.1 billion. Similarly, additional tax concessions of Rs24.5 billion were given through the Inland Revenue Department during the same period.

Third, to relieve pressure on internal borrowing, the government could focus on increasing foreign grants and loans in the immediate term. Note that the government is borrowing at around 11 percent for 91-day and 364-day treasury bills compared to less than 1 percent in January 2021. Almost all foreign loans are concessional in nature with an interest rate of less than 2 percent and longer grace and maturity periods. However, to boost foreign borrowing, the government will have to accelerate project implementation as project loans are reimbursed based on physical progress, that is, the capital budget absorption rate.

No coordinated effort

During the first half of fiscal 2022-23, the government was able to realise just 11.6 percent of the targeted foreign loans and grants for the year. It could also opt for more budgetary support to relieve interim fiscal pressures, but this kind of lending is contingent upon fulfilling legal, regulatory, policy and institutional conditions that aim for structural reforms over the medium term. However, budget support loans should be discouraged over time so that the focus is on project loans as necessary.

Finally, the government should make an all-out effort to increase domestic and foreign investment. Nepal occasionally tinkers with investment laws, regulations and policies in response to long-running concerns raised by the private sector. However, there has been no proactive and coordinated effort to review and resolve the entire gamut of issues affecting private sector activities, ranging from crippling laws and policies to infrastructure supply and human resources availability. An approach that involves the whole government is required instead of the marginal and siloed focus by the Ministry of Industry, Commerce and Supplies and Investment Board Nepal. Higher private investment, exports and competitiveness will boost growth, revenue and employment. It will make fiscal management a bit less challenging.