Nepal has adequate resources and avenues to spend its budget. Yet, why do government units fail to spend? Why is there a rush during the year-end to execute the budget? The answer lies in the institutional, operational and management frameworks in which budget allocation and execution operate. This article breaks down these components and discusses what drives this dynamic.

The government spends money under three headings—capital expenditure, recurrent expenditure and financial management. The under-execution of the capital budget is the primary reason for aggregate underspending, with around one-third of the budget remaining unspent. Recurrent spending reflects mandatory expenditures on wages and administration, and expenditures in this area are generally sound. While numerous reasons drive underspending, the four reasons listed below largely explain it.

Flawed project selection and management

Capital budget underspending is explained by the problematic way the government selects projects for funding. Capital project selection in Nepal lacks transparency, with project appraisals often bypassing the Public Investment Management Framework. Project prioritisation is based on political considerations, resulting in a supply-driven project selection rather than a demand-driven approach. Projects are often announced without clear funding plans, and the budget is allocated to projects like the Nijgadh International Airport Project, which could go unspent.

Additionally, frequent staff changes delay the timely completion of projects. The lack of a community engagement strategy among staff leads to land acquisition problems and conflicts with the local population. Local communities often increase land prices once megaprojects are announced, resulting in disputes regarding compensation amounts. These practices create budget implementation problems or push budget spending to the next fiscal year.

Procurement issues

Well-functioning procurement systems scrutinise contractors extensively, ensuring that when the project begins, it is completed on time and without hiccups. In Nepal, however, the situation is quite the opposite.

According to the World Bank, around 60 percent of Nepal’s budget is executed through contracts. The country’s procurement system heavily focuses on choosing the lowest bidders, who often possess limited expertise. Contracts are usually awarded without a thorough assessment of the contractor's capacity. The procurement system systematically deprioritises qualified bidders by following a “cheap over competent” approach. Contracts are hurriedly awarded at the tail-end of the fiscal year, resulting in subpar quality of development work. Additionally, authorities raise valid concerns that the quality of contractors in Nepal is poor, and even after competitive selection, contractors fail to perform. Poor contractor performance thus amplifies the problem.

Approval and processing of payments further delay budget execution. Financial Comptroller General Office (FCGO) officials report that it takes around two months to clear payments exceeding Rs2 million. Many small and mid-sized projects cost Rs2 million or more, causing delays in payment disbursements to suppliers. The year-end spending rush triggers the awarding of multiple contracts, straining the FCGO’s capacity to clear payments all at once.

Sub-national governments’ underspending

Sub-national governments, too, experience capital underspending, which drives aggregate budget underspending. These governments face similar issues relating to project preparation and contractor management, which are compounded by challenges such as inadequate staffing and limited available staff capacity. As of 2022, over 30 percent of provincial positions were vacant. This limits the capacity of sub-national governments to manage their finances and achieve expenditure targets.

Ineffective procurement planning adds to the woes of sub-national governments. Procurements start late in the year and are characterised by a leisurely pace. In the first quarter of the fiscal year, sub-national governments are busy preparing procurement plans, resulting in only a small expenditure in the initial months. The transfer of government officials typically takes place during this time, delaying the preparation of procurement plans, which further slows spending. Given that the start of the fiscal year corresponds with the onset of monsoon, government entities wait for the rains to subside to begin capital spending.

With a few months already lost, SNGs scramble to execute the budget in the remaining time. The spending rush peaks at year-end to avoid the lapsing of unspent budget (mainly conditional grants) back to the federal government. This causes a surge in spending during the last quarter, especially in the final month of the fiscal year. In 2022, the situation was so dire that the FCGO had written to provincial and local governments, allowing them to settle bills even on the weekend.

Additionally, mid-year reduction of intergovernmental grants made by the federal government reduce the spending capacity of sub-national governments, affecting their ability to meet budgeted expenditure amounts. In the ongoing fiscal year, the Ministry of Finance reduced the aggregate Fiscal Equalisation Grant earmarked for sub-national governments by 26 percent. Similar grant cuts have occurred before, with local government chiefs expressing strong objections to this practice.

Corruption

Bureaucrats often seek commissions when awarding contracts. Research shows that about 51 percent of firms in Nepal give gifts to secure government contracts, more than twice the regional average. Awarding contracts based on personal interests affects capital spending as

contractors show negligence and are safe under the protection of powerful officials and political backing.

In capital projects, the transfer of staff is often influenced by political motives to secure undue benefits, particularly in large projects that present opportunities for substantial commissions. Technical staff sees transfer with a change in government as officials close to party leaders get appointments in well-funded projects. All of this adds to the woes of timely budget execution.

A few practical measures to address the systemic underspending include fully implementing the National Project Bank, reducing the project staff turnover rate, reforming the country’s procurement system, and devolving personnel from overstaffed federal ministries to sub-national governments. Supporting sub-national governments in building capacity, expanding usage of IT systems, and preparing realistic budget targets can also help improve spending capacity and ensure fuller utilisation of our endowment.