Paired with an already low spending capital expenditure budget, the shortage of government revenue required to fund development projects has delayed several important projects, with the contractors not being paid on time which will lead to delays in project completion.
Amidst increasing inflation and declining economic growth, the Government of Nepal presented a bloated budget for the fiscal year (FY) 2022/23, which is 8.8% bigger than the previous fiscal year. Being an election year, the budget of 2022/23 includes several populist provisions intended to influence voters to favour the then-ruling coalition. These include lowering the age limit for elderly allowance, widening the income tax ceiling, and increasing government employee salaries. The government had introduced an import ban on luxury goods, which extended until December of the current fiscal year, and was expected to affect government revenue collection. Given these circumstances, it comes as no surprise that the government is facing a resource gap in the current fiscal year.
The total expenditure estimate stipulated by the budget stands at NPR 1,790 billion, of which, the recurrent expense is NPR 1,180 billion and capital expense is NPR 380 billion. As of 8 January 2023, NPR 422.96 billion has been spent as recurrent expenditure, a figure much higher than the current revenue collection of NPR 291.97 billion. As of 8 January 2023, NPR 46.4 billion has been spent as capital expenditure in FY 2022/23. This represents a mere 12.21% of the capital expenditure budget. The underutilization of capital expenditure has been a common phenomenon in Nepal, with 40% of capital expenditure being spent on average in the last month of the previous five fiscal years. Public capital expenditure is necessary for developing economies like Nepal, where infrastructure gaps remain a significant bottleneck for both the public and private sectors. Capital expenditure by the government can also act as a catalyst for private-sector investment in the country.
Paired with an already low spending capital expenditure budget, the shortage of government revenue required to fund development projects has delayed several important projects, with the contractors not being paid on time which will lead to delays in project completion. The liquidity crunch prevalent in the banking sector of Nepal has affected credit disbursement to productive sectors of the economy. Because of this, government contractors who have faced delays in receiving payments are unable to finance their operations via loans.
To fund FY 2022/23’s budget, 69.15% of expenses are planned to be financed through government revenue, 3.06% from foreign grants, 13.5% from external debt, and 14.3% from internal debt. The current state of the three main sources of government funds is examined further in this article.
Government revenue collection
The government had targeted a total revenue collection of NPR 1.4 trillion in the FY 2022/23, of which NPR 1.29 trillion was expected solely from taxes. However, the government revenue collection as of the four months of the current FY 2022/23 was NPR 291.97 billion, of which NPR 245.28 billion are from taxes. Despite the elapse of four months of the current fiscal year, the total revenue collection in this period only represents 20.85% of the targeted total revenue collection for the year. This figure is even lower for revenue from taxes, which is only 19.01% of the target for the year.
The main reason for an underperforming revenue collection during the current FY is the import restriction imposed on luxury goods such as automobiles, liquor, and mobile phone. Owing to the dwindling foreign exchange reserves of the country, the restrictions on imports started in April 2022 and got harsher over time. Even though the ban has been lifted as of December 2022, it had a significant impact on revenue collection for the first four months of FY 2022/23. Custom duty and excise duty, which represented 36.6% of total government revenue in FY 2021/22, have fallen by 34.07% and 16.61% in the first four months of the current FY, compared to the same period last year. Value Added Tax (VAT), which forms the largest part of government revenue collection, is also levied on imports and has fallen by 15.48% partly as a result of the import ban.
Internal debt
The budget for FY 2022/23 has estimated an internal debt of NPR 256 billion, a slight increase from the internal debt figure of last fiscal year. The uptake of internal debt will affect the liquidity crunch in the banking sector. Nepal Rastra Bank (NRB) has recently issued treasury bills worth NPR 38.5 billion, after issuing NPR 190 billion worth of treasury bills until November of the current fiscal year. NRB has also recently auctioned a development bond worth NPR 5 billion with a maturity period of four years. Commercial banks are the largest buyers of treasury bills and development bonds in Nepal, and these instruments form a part of the Statutory Liquidity Ratio required to be maintained by the commercial banks. Due to the liquidity crunch in the banking sector of Nepal and the lower money supply target by the NRB, the government may find it difficult to raise funds from the banking sector. It might lead to the under-subscription of government-issued securities, thereby leading to insufficient funds in the government’s treasury to fund its increasing expenses.
External debt
The budget for FY 2022/23 estimates an external debt of NPR 242 billion. Until the first four months of the current fiscal year, the government has taken foreign loans of NPR 24.34 billion, an increase of 65% from the same period last fiscal year. External debts may prove difficult to service as they are denominated in USD and possesses a lot of foreign currency risk. A significant portion of external borrowing by the government is in the form of concessional loans provided by bilateral and multilateral agencies. In the fiscal year 2020/21, 10.35% of the total foreign loan was received from bilateral agencies whereas 89.64% was received from multilateral agencies. While concessional loans are cheaper to service, they come with their conditions attached. A prime example of this is the recent lifting of the import ban on luxury goods to meet the condition of the International Monetary Fund (IMF)’s USD 400 million loan funding.
As Nepal graduates from its least developed countries (LDC) status in 2026, the concessionary loans provided by these development finance institutions will decrease substantially. Nepal can raise debt in the external markets to reduce its reliance on concessionary finance provided by these institutions. However, access to foreign debt in the external market might be limited due to the lack of a sovereign credit rating. Since foreign debt providers cannot assess the credit risk of Nepal without a sovereign credit rating, issuing bonds in the international market will be more expensive and will attract a higher interest rate. Further, the use of foreign borrowings has been mostly to fund the recurrent expense, rather than investing in capital expenditure. This can lead to increasing debt without increasing the means to service those debts in the future, increasing the risk of Nepal falling into a debt trap.
Way forward
While the government revenue collection has been abysmal until the first four months of the current fiscal year, the revenue can be expected to pick up the pace later in the year. The import ban had been subsequently lifted in December 2022, and as transport equipment and vehicles represented 4.4% of total imports to Nepal, the custom duty and excise duty levied on automobiles can be expected to increase government revenue. Further, as the deadline for income tax filing by individuals and corporations is approaching, tax revenue collection can be expected to pick up the pace. It is also highly likely that the budget for this fiscal year 2022/23 will be revised downwards, as this has been an ongoing pattern in Nepal such as last fiscal year when the budget was decreased by 11.65%.
However, Nepal’s fiscal issues are largely structural and can only be solved through a long-term approach. To address the frequent issue of an underspent capital budget, the root causes such as the allocation of budgets without considering the ministry’s capacity, lack of financial discipline, and lack of coordination between government departments need to be addressed. Similarly, the over-reliance on import taxes for government revenue needs to be decreased by promoting productive sectors within the economy. Further, the formalization of our largely informal economy needs to be incentivized so that the tax base for government revenue can be increased.
Sneha Shrestha is an ACCA affiliate with interests in business valuation, financial planning, mergers and acquisition, and strategy consulting. She has previously worked in audit and accounting for few years before joining Beed. She is currently working as a beed fellow at beed management.