Finance Minister Prakash Sharan Mahat presented the budget for the next fiscal year 2023-24 against the backdrop of weak aggregate demand, slowdown in revenue mobilisation, high inflation, low demand for credit, stabilising external sector, and low confidence in the private sector. Political constraints in expenditure allocation for certain schemes aside, the budget has tried to address the core economic issues while maintaining fiscal discipline. It also attempts to reorient economic reforms to finetune public service delivery and to enhance private sector confidence.

As with previous budgets, the main hurdle will be on the implementation of the promises as they are easier to make than deliver on time with the current state of bureaucracy and politics. This will be particularly true for higher capital budget execution and meeting the revenue target.

Balancing act

A few weeks before the finance minister delivered his budget speech, the National Statistics Office released national accounts estimates that detailed a surprisingly unexpected level of economic slowdown. It estimated that the real gross domestic product (GDP) will grow by just 1.9 percent in 2022-23, much lower than the 5.6 percent in 2021-22 and the government’s initial target of 8 percent. This was mostly due to tight fiscal and monetary policies that slowed public spending and credit disbursement.

Accordingly, both public and private demand fell. The private sector complained of factory closures, issues in cash flow management, and decreased capacity utilisation. The slowdown was stark in the first two quarters of 2022-23, as seasonally adjusted quarterly GDP data pointed to two consecutive quarters of economic contraction. The lower growth projection was attributed to a contraction in manufacturing, construction, and retail and wholesale trade activities, which together account for about 28 percent of GDP.

Given the dilemma of boosting aggregate demand amidst the limited fiscal space and spending capacity, the finance minister took a balanced approach. The expenditure outlay is Rs1751.3 billion, which is 16.4 percent higher than the revised estimate but 2.4 percent lower than the budget estimate for 2022-23. Of the total expenditure outlay, 65.2 percent is for recurrent expenses, 17.3 percent for capital expenditure, and 17.5 percent for financing provision. As a share of GDP, recurrent expenditure allocation is lower than the 2022-23 revised estimate, but capital budget allocation is slightly higher. Overall, fiscal deficit will likely fall from the estimated 3 percent of GDP this year.

The government plans to meet 71.3 percent of the expenditure needs by increasing domestic revenue, 2.9 percent from foreign grants, 12.1 percent from foreign loans, and 13.7 percent from domestic borrowing. The general direction is on expenditure rationalisation where possible, but there are deviations as well. For instance, the government has decided to either close or merge 20 offices and boards that are not relevant or have identical roles and functions. It has committed to not purchasing new vehicles, curbing the construction of new buildings and foreign trips, and providing cash to entitled officials instead of fuel allowance.

The finance minister has committed to overhauling contract management to boost capital spending, reviewing the viability of public enterprises to save resources, lowering fiscal risk, and promoting fiscal federalism, including restructuring Town Development Fund. However, succumbing to political pressure, he has revived the controversial constituency development fund, which was rife with governance issues.

Four issues

The expenditure plan and reform agenda of the government are broadly in line with the evolving macroeconomic situation and the direction of reforms needed to address them. However, this was also generally true of most previous budgets. They simply could not deliver as promised, owing to implementation shortfalls. Four issues will be particularly important for improved budget execution and the realisation of committed reforms.

First, achieving revenue target to meet expenditure needs will continue to be challenging. The budget targets revenue growth of around 20 percent over the revised estimate for 2022-23, which looks ambitious given that economic activities have still not picked up pace and private sector confidence continues to be weak. The last time revenue growth was this high was in 2016-17. The focus on marginal increases in most tax rates is in most categories but not on improving tax administration with concrete measures to boost efficiency gains may require reconsideration if monthly targets are not as per expectation.

The budget estimates tax changes and administrative reforms to contribute just 6.4 percent of the total estimated revenue, implying that most of the expected increase in revenue will be through existing measures and sources. Revenue buoyancy, which refers to revenue growth relative to nominal GDP growth, of about 2 percent is also not realistic. In fact, the upward revision of tax rates may discourage private sector investment and dampen consumer demand. It will also put upward pressure on inflation.

Second, enhancing capital budget execution is going to be the key in boosting aggregate demand. Public capital spending affects construction, mining and quarrying, and manufacturing sectors, which are currently performing poorly. It also indirectly affects a few key activities in the services sector.

While higher capital spending allocation compared to the revised estimates is encouraging, the government should come up with a concrete, enforceable implementation plan that decisively tackles three key issues that are contributing to a chronically low capital budget absorption rate: Bureaucratic delays (project approval delays and weak inter- and intra-ministry coordination), structural weaknesses (limited planning and implementation capacity, weak contract management, and delayed procurement), and allocative inefficiency (lack of project readiness and the lack of a strong pipeline of bankable projects). The capital budget absorption rate was just 57.2 percent last fiscal and is estimated to be about 68 percent this fiscal.

Third, the allocation for financing provision (5.2 percent of GDP) has drastically increased in 2023-24, and is also slightly higher than the capital budget. To make room for more capital spending, it needs to be decreased gradually. Increasing government share and loan investment in public enterprises and amortisation of external and internal borrowings are driving expenses in this category. A judicious fiscal and debt management and cash flow strategy is required to control the rising public borrowing. Note that outstanding public debt is over 42 percent of GDP, up from just 23.8 percent in 2016-17.

Finally, constant engagement with the private sector to enhance their confidence is vital. While the budget commits to introducing several private sector-friendly reforms—lower export requirements for firms operating inside special economic zones, lower cost of company registration and simple entry and exit rules, removal of foreign investment threshold in the IT sector, and promotion of micro, small and medium enterprises—the private sector itself is not fully convinced.