Nepal's economy and federalismConfronting the policy blunders of the past is a must for the renewal of the faltering federal republic.
Nepal has faced immense economic challenges since transitioning to a federal democratic republic over 16 years ago. Key economic indicators such as gross domestic product, trade deficit, tax revenue, national debt and manufacturing have declined rapidly, indicating a tipping point in the economy.
According to the latest World Bank data, Nepal's irregular GDP growth averaged about 4.2 percent after transitioning into the federal system. The same report indicates that this growth rate falls short of the 7 percent required for the much-hoped development transformation to qualify for an emerging economy. Moreover, this modest growth rate relies heavily on remittances instead of competitively advantaged sectors such as tourism or other export-oriented industrialisation. The lacklustre growth rate (excluding remittances) has caused the average income level to remain barely above $1400, severely limiting job creation, even with marginal pay. This and the never-ending political mesh have resulted in a staggering 600,000 working-age citizens leaving Nepal annually for overseas opportunities.
According to the Ministry of Finance economic survey data, the trade deficit has increased from 14 percent to over 50 percent of GDP since 2008. In the same period, the size of national debts almost quadrupled from $3 billion to $14 billion. This has pushed total repayment obligations to nearly 50 percent of GDP, breaking global risk thresholds. The government's debt service now consumes over one-third of tax revenues, reflecting a perilous trap that new borrowings are needed to finance past interest payments. Furthermore, the survey data also shows that the ratio of tax revenue to GDP has rapidly declined in recent years due to the increasing bureaucracy in the federal system plagued by corruption. Additionally, the manufacturing sector's GDP share has decreased by almost 50 percent (from 10.5 percent in 2008 to just 5.5 percent in 2022), indicating a shocking deindustrialisation trend.
There have been systemic failures across all major economic parameters in the past decade: Fiscal discipline, trade balances, revenue collection, industrial policies and exploiting synergies in federal oversight. The litany of problems mentioned reflects a severe governance decay and highlights the structural weakness within the new federal structure.
Given the aforementioned facts, it is imperative to ask what has caused all these economic troubles within the federal republic. Political cronyism, nepotism, rampant corruption, inept political leaders and the deep politicisation of public institutions, including the supposedly independent judiciary, are collectively responsible. If the messy over-politicisation currently rampant in the federal system were the solution, institutions like Tribhuvan University, where political chaos is considered a virtue, would be among the best in the world. However, too much politics harms public organisations.
Appointing unqualified political allies instead of competent technocrats to constitutional positions is damaging the ability of these bodies to achieve their national goals. This has resulted in widespread corruption, rent-seeking and the formation of cartels in governance processes, where political loyalty is prioritised over merit. As a result, corruption has been practically institutionalised and decentralised in the federal system.
Unfortunately, the economy is showing little sign of breaking free from the grip of entrenched special interests. In totality, Nepal’s political transformation stumbled at delivering on most economic parameters, whether it be income and job growth, external balance, debt sustainability, industrialisation, or governance integrity. Development outcomes lag almost all optimistic projections made in 2008 across fundamentals.
The proposed reforms
There is an urgent need for meaningful reforms to reduce the excessive control of politics. Nepal’s bleak economic potential can only improve through decisive course correction with constitutional and policy changes. Two significant changes are vital to minimising the political landscape that has an immediate positive impact on the economy. First, eliminating the provinces that are too expensive to maintain is crucial. An alternative approach could be to reduce the number of provinces to three or four and cut the number of local bodies in half. This could address prevalent political grievances while controlling the federal system’s maintenance costs.
Second, a constitutional law requiring a minimum 10 percent vote threshold for qualification for a national party should be introduced. These significant reforms can save billions of rupees, which can be redirected towards development. Moreover, there will be reduced political noise, which helps public institutions function effectively. The third necessary reform is introducing strong laws to improve the dysfunctional electoral system. This can be achieved by promoting inclusivity in elected positions and eliminating proportional representation.
Fourth, all executive posts, including the prime minister (and chief ministers), should be directly elected to promote a true mass-based democracy. The law should mandate free and fair competitions to fill vacancies across all public posts, including judges, ambassadors, university appointees and other constitutional appointments. Additionally, party-based politics should be prohibited in all public institutions with zero tolerance. Nepal can follow the model adopted by the United States, where political parties' involvement is limited only to governance and parliamentary affairs. All other public institutions, such as universities, the judiciary, constitutional bodies and the bureaucracy, must remain free from political influence.
Finally, it is imperative to have enforceable laws to keep politics out of public projects. The unhealthy relationship between politicians and project contractors is responsible for delaying, devastating and destroying development projects once launched. This must be addressed at the legal and policy levels.
The proposed reforms will radically minimise the rampant politics engulfing the Nepali economy, help reduce corruption and divert public attention to economically productive areas. It will also create a pleasant business and commerce environment in Nepal that can positively change its macroeconomics. “Limited politics with unlimited business” should be the driving mantra of all reforms. Thus, confronting the policy blunders of the past is a must for the renewal of the faltering federal republic. Political players and the public must realise that amid the bleak economic realities, the federal structure cannot advance in its present form.