Nepal’s public financial management (PFM) is currently suffering from what we call institutional isomorphism. We have adopted the forms of modern budgeting without substance. According to the mid-term review report of the Financial Comptroller General Office, in the first half of the fiscal year, the government spent Rs153.64 billion on debt servicing, the amount the government pays for its borrowing. This amount is three times the amount it managed to invest in capital assets, which is Rs50 billion. This 3:1 ratio suggests systemic erosion: The government is not borrowing to build; it is borrowing to pay for inefficiency.

The half-yearly report also shows that capital expenditure is only 12.12 percent of its annual target, while recurrent costs and debt payments consume over 40 percent of respective allocations. This creates a negative net transfer, in which the government takes liquidity from the market to fund its consumption, effectively crowding out private and government consumption and ensuring that the real interest rate on our debt outpaces the very GDP growth meant to sustain it. While this year’s government performance can be attributed to the recent political turmoil, the pattern in our public finance management is similar regardless of the nature of the government.

The myth of alignment

Nepal’s PFM system appears to be a seamless chain. There is a periodic development plan. This outlines the goals for growth and structural transformation, but without binding budgetary force. The Medium-Term Expenditure Framework is designed to fill this gap, projecting multiyear spending needs and connecting them to the strategic priorities, and the annual fiscal budget funds the immediate needs.

But in Nepal, this chain is broken at every link. Our PFM system has reached a death cross, a structural tipping point where the cost of the past now dwarfs investment in the future. Despite having adequate planning instruments such as the Five-Year Plan, the medium-term expenditure framework (MTEF) and the recent PFM Reform Strategy, these frameworks remain largely disconnected from annual budget decisions.

The lack of coherence across planning and budgeting has important fiscal consequences. If PFM tools were integrated and valued, they could anchor aggregate fiscal discipline, direct resources to priority outcomes and improve predictability in budget execution.

Nepal’s PFM system today suffers from multiple divergent processes. Development plans fail to translate into binding resource allocations, leaving ministries to pursue priorities incrementally; the MTEF framework often fails to constrain expenditure decisions meaningfully, and macroeconomic and revenue forecasts tend to be optimistic, leading to revenue shortfalls and larger fiscal gaps.

According to the World Bank’s 2025 Development Update, capital expenditure execution remains low at 63.2 percent. The reason is not just slow procurement; it is allocative inefficiency. MTEF projections are often ignored during the budget ‘horse-trading’ phase.

The subnational paralysis

The fiscal disconnect is equally acute at the provincial and local levels, where federalism was meant to bring development closer to the people but has instead decentralised our inefficiencies. A substantial 16.66 percent of provincial budgets for FY 2025/26 now consists of cash balances—essentially unspent funds rolled over from previous years.

Under the federal architecture, our constitution has devolved the authority to spend, but the Financial Comptroller General Office’s mid-term report proves we have not yet devolved the capacity to manage. While the federal treasury is forced into expensive domestic borrowing to cover a revenue shortfall, billions of rupees sit idle in subnational accounts due to project unreadiness and technical paralysis. Without a unified, integrated financial management information system that links all three tiers of government, these cash balances represent a massive opportunity cost for us.

The debt dilemma

Nepal’s internal debt is a real concern. Domestic debt accounts for nearly 47 percent of total debt stock, but it consumes a disproportionate share of the budget. Till mid-December, the government spent Rs137 billion on domestic debt servicing, of which Rs114 billion was for principal repayment. We are spending 83 percent of debt servicing expenditure not for growth but simply to keep us afloat as we pay back the principal on maturing domestic bonds and external loans. We are effectively caught in a vicious debt servicing cycle. This institutional dysfunction will eventually lead us to a domestic debt trap.

This debt profile reflects not only a growing stock but also a deteriorating structure. The fiscal system is primarily reliant on short-term domestic borrowing, which is costlier and compresses fiscal space. Domestic bonds are maturing faster than the economy can expand, forcing the government to roll over debt at higher interest rates. This is happening at a time when revenue buoyancy is weakening and growth has slowed, worsening the interest-to-revenue ratio. Debt stress is therefore not about size but composition and its direct link to PFM inefficiencies.

Capital formation crisis

The most damning evidence of PFM failure is the trend in capital expenditure versus financial management. Nepal’s spending on debt servicing is consistently rivalling or exceeding its actual capital spending. Data from the Financial Comptroller General Office shows that while we plan for massive infrastructure shifts, the financing head in the budget intended for debt repayment and equity is growing at a CAGR of 18.2 percent, far outstripping the 8.7 percent growth in actual capital investment. We are building a transfer economy rather than a production economy.

As financial management shifts heavily towards debt repayment and recurrent liabilities, capital formation is being displaced by consumption financing. This undermines productivity, slows job creation and reduces the long-term growth rate of the economy. The disconnect between planning, budgeting, procurement and treasury functions results in capital expenditure becoming more ceremonial than transformative.

The fiscal path Nepal is currently treading is unsustainable. An imbalance between debt servicing and capital formation signals a fiscal regime drifting towards stagnation. The PFM system prioritises procedural compliance over economic outcomes. Fiscal rigidity needs to be addressed by right-sizing the bureaucracy and curbing the exponential rise in unconditional transfers that lack performance benchmarks. We need to address the gaps in budget reliability and asset management as highlighted by the PEFA assessment.

Federalism was meant to bring development closer to the people, but without fiscal discipline at all three tiers, we are decentralising inefficiency. To grow out of this trap, the PFM system needs to be reoriented towards fiscal discipline and productive investment. Political ambitions should be matched by PFM integrity. Doing this will transform public finance from a source of vulnerability into an engine of national prosperity.​