All eyes will be fixed at the new budget to be presented by Finance Minister Shankar Prasad Koirala in the first week of July, which has been the practice since 1952 when the formal budget-making began. The important exception was last year’s budget that was delayed because of the expiry of CA’s tenure that created a legislative vacuum.
The full 2012/13 Budget (mid-July 2012 to mid-July 2013) was presented on April 9 this year, eight months into the new fiscal year. Predictably, the new and revised budget was as traditional as prior ones, if measured in terms of revenue, expenditures, and the size of deficit. [break]
There were no new tax and expenditure initiatives but the principles of sound budgeting were maintained—no high deficits and no significant debt accumulation. Domestic revenue and expenditure growth reflected past patterns (both growing at about 15 percent annual rates), which also meant a nearly balanced budget and no major policy change.
Now what to expect of the new budget for 2013/14, in terms of budget numbers and programs? We can be almost certain that past patterns of budgeting will be repeated, implying an unchanged revenue and expenditure structure and few significant policy initiatives. What has been noticeable over the past few years of budget presentation is the focus on revenue generation, which has been remarkably successful, despite an uncertain politics and wobbly tax regime. The success of tax effort, in large part, has followed from the reduction in tax-fraud and a better compliance with tax-filing regulations.
Government’s relentless effort to increase tax has allowed the growth in tax revenue be a bit higher than growth of GDP, which means a rising level of tax buoyancy, a rare feat for developing countries. Tax and nontax collection of above 15 percent of GDP isn’t common for countries at Nepal’s level of development.
In terms of expenditure patterns, the government usually commits a significant portion of revenue to meet operational costs. During recent years, current spending has comprised upward of 80 percent of total budget spending, implying that only a very small part of total budget has been allocated for development programs. More significantly, current budget spending has almost matched revenue collection, which means development spending being financed almost entirely out of foreign resources.
Weaknesses
Despite the outward appearance of sound budgeting—no large deficits, low and stable debt-GDP ratio—the underlying budget profile cannot be termed healthy. There are a number of areas of concern. First, there are huge chunks of financial obligations that remain off-budget. Two of such off-budget items carry what we can term an outsized risk for the budget as well as for the larger economy—high deficits incurred by Nepal Electricity Corporation (NEA) and Nepal Oil Corporation (NOC) that totaled Rs. 20 billion in the past year alone. Their total debt of Rs. 88 billion comprised 6 percent of GDP.
Second, despite the low deficit, government borrowings from private creditors remain high—Rs. 36 billion in 2011/12 was about equal to revenue from nontax sources. Much of the borrowed funds are re-lent to public enterprises to cover their losses and used for loan amortization. However, the government’s financing needs tend to crowd out private sector borrowers, reduce loan availability, and push up the interest rate. The high cost of borrowing adds to business cost and lowers competitiveness.
Third, current spending is heavily loaded with discretionary items, such as subsidies and grants which, among other things, put a heavy squeeze on more essential and desirable uses of government money, including for government salaries. Normally, civil service remunerations make up about half of current spending in most developing countries, compared to just about a fourth in Nepal. Keeping a lid on wage spending does help lower government cost and restrain wage demand in the private sector but its adverse side-effects are an incentive for corruption and lower quality government workforce.
Fourth and finally, government share of capital formation at less than 3 percent of GDP (excluding asset purchases) remains extremely low. Generally, a low level of government investment limits the utilization of foreign aid and works as a disincentive for private investment. Adequacy and good quality of public capital—roads, utilities, sanitation—tends to boost private sector investments more than does interest subsidy and tax exemption.
A visionary budget
As the budget date approaches, Ministry of Finance officials must be under pressures from all types of interest groups seeking special favors for expenditure allocations, tax breaks, grants, and subsidies. The balancing of often conflicting demands is hard and contentious but, in the aggregate, the final shape of the budget remains quite predictable. Revenues, expenditures, and budget deficit all will show no significant departures from their past patterns of a stable relationship to GDP.
A profile of the traditional budget for fiscal 2013/14 is presented in the table alongside showing main revenue and expenditure categories that keep the overall structure of the budget basically unchanged. Changes in individual categories are in line with growth in nominal GDP that ensures their real levels go up with economic growth. Budget deficit at about 1 percent of GDP indicates continued commitment to financial stability although, as indicated above, the underlying deficit remains much larger if we include off-budget items.
An “activist” or visionary budget would, on the other hand, focus on improving the economy’s overall performance and, specifically, would deal with the country’s low-growth scenario that has persisted for years. It will comprise policies that are designed to stabilize the economy as well as help accelerate economic growth. Budget speeches in the past did make references to budget’s impact on the macroeconomy but provided no clue as to how the new policies are linked to desirable changes in the larger economy.
The sketch of such a “visionary” budget with explicit linkages to the macroeconomy has been presented in the last column of the table. It provides for a significant reduction in tax burden and, overall, a preference for incentive-based taxation. It includes a substantial boost in civil service remuneration, much above the past levels. At the opposite end, grants and subsidy payments are reduced to their bare bones, boosting spending in more productive areas. Overall, although the budget deficit rises to more than the past levels, its financing from domestic sources is minimized and more reliance is placed on tapping external sources.
Together, these new initiatives will lead to a significant reduction in the size of the government measured in terms of GDP, making room for private sector expansion. Also, the change in revenue collection and expenditure allocation strategies will reduce the need for domestic financing of the budget, allowing the government to become a net lender to the private sector.
Finally, for maximizing the positive impact of government operations on rest of the economy, tax reduction will initially be focused on the corporate sector which is currently exposed to high tax rates and bureaucratic red-tapes associated with discretionary tax collection. It may be worthwhile doing away completely with corporate taxation to attract foreign investment and provide incentives for the conversion of family-owned businesses into corporate enterprises.
We can be almost certain that the economy will respond positively to such favorable change of policies that will mean, on the aggregate, higher economic growth, gains in real income, and expanding job opportunities. We can look forward to a near doubling of growth rate from the traditional 3-4 percent—a rate appropriately labeled as the ‘Hindu rate of growth,’ in reference to poor performance of the Indian economy prior to reforms launched in 1992.
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