Friday, July 17, 2015

Nepal’s budget after the earthquake and its effective implementation

Finance Minister Dr. Ram Sharan Mahat presented budget for FY2016 (ends 15 July 2016) to the Constituent Assembly on 14 July. This is the first budget after the catastrophic 7.8 magnitude earthquake on 25 April and the subsequent aftershocks, and the reconstruction conference on 25 June.

The budget was highly anticipated by the public because it was supposed supposed to focus squarely on rehabilitation and reconstruction. And it did meet that expectation in terms of numbers and direction of spending allocation. However, it fell short of outlining an implementation arrangement to accelerate capital spending, of which almost half would be set aside for reconstruction over the next five years.

First, the budget outlay:  

The total expenditure outlay for FY2016 is NRs819 billion (an estimated 33.8% of GDP), which is 56.7% higher than the revised total expenditure in FY2015. The FY2016 outlay comprises NRs484 billion for recurrent expenditures (59.1% of the total outlay), NRs208.9 billion for capital expenditures (25.5%), and NRs126.3 billion for financial provision (15.4%).

The substantially larger size of the budget is due the 141% increase in planned capital spending (compared to the FY2015 revised estimate), which will primarily be used for post-earthquake reconstruction of physical and social infrastructure.

The outlay for recurrent expenditure (equivalent to 20.0% of GDP) is 42.8% higher than the revised estimated expenditure in FY2015. The planned capital spending has been increased by a whopping 141.2% over the FY2015 revised estimate (equivalent to 8.6% of GDP compared with 4.1% of GDP in FY2015). About NRs91 billion is set aside for reconstruction activities.

FY2016 budget overview
GDP growth target (%) 6  
Inflation target (%) ---  
Budget allocation for FY2016 FY2016BE  
Rs billion %
Budget allocation 819.0 100
Recurrent  484.3 59.1
Capital 208.9 25.5
Financial provision 126.3 15.4
Projected total revenue 587.9 100
Revenue 475.0 80.8
Foreign grants 110.9 18.9
Principal repayment 2.0 0.3
Projected budget surplus (+)/deficit (-) -231.1
Projected deficit financing 231.5 100
Foreign loans 95.0 41.0
Domestic borrowing 88.0 38.0
FY2014 cash balance 48.6 21.0

Second, revenue mobilization:

A total revenue target of NRs587.9 billion (24.3% of GDP) has been set for FY2016, including projected foreign grants of NRs110.9 billion (4.6% of GDP) and principal repayment of NRs2.0 billion. The revised estimate for revenue mobilization (including grants) in FY2015 was 20.3% of GDP.

This government has increased the business transaction threshold for value added tax (VAT) to NRs5 million from NRs2 million and has also given tax concessions on import of construction materials (zinc sheet and pre-fabricated home), and agricultural machinery. The rates of excise duty on cigarette, beer and alcohol, and vehicle tax have been revised upward. Besides these, there isn’t significant change in revenue policy.

Third, deficit financing:

The budget deficit is to be financed by foreign loans amounting to NRs95.0 billion, domestic borrowing of NRs88.0 billion, and FY2015 cash balance of NRs48.6 billion.

Net foreign loans and net domestic borrowings are projected to be 3.0% and 1.9% of GDP, respectively

Overall, fiscal deficit (expenditure including net lending – revenue including grants and carry over) is projected to be about 5.0% of GDP. Large internal borrowing could exert upward pressure on interest rate.

Fourth, the focus on reconstruction:

The budget aims to complete all reconstruction work within the next five years. A total of NRs91 billion ($910 million) has been earmarked for reconstruction work, including $740 million for National Reconstruction Fund, which will initially prioritize reconstruction of housing, public buildings, archeological structures, physical infrastructure and enhancement of productive capacity. About $170 million is earmarked for sector ministries and agencies to carry out reconstruction works till the reconstruction authority is operational.

Fifth, where is the recurrent budget going?

Almost 43% of planned recurrent expenditure of NRs484.3 billion is going to local bodies as grants (or transfers) to enable them to launch local level development works on their own. The other big ticket item is compensation of employees, which takes up about 22% of total recurrent budget. These amount to an estimated 8.5% and 4.3% of GDP respectively.

Sixth, where is the capital budget going?

Almost 65% of the planned capital budget of NRs208.9 billion) is going for civil works— a 113.5% increase over FY2015’s revised estimate. About 18% is allocated for building work— a 286.8% increase over FY2015’s revised estimate. These amount to an estimated 5.6% and 1.5% of GDP, respectively.

Seventh, the two main takeaways from FY2016 budget are:

  1. The drastic increase in capital budget for reconstruction is in the right direction.
  2. Unfortunately, the expectation of a robust, credible and a time-bound implementation plan to spend the allocated money is missing. This is disappointing because the next three priorities should have been implementation, implementation and implementation. This issue should have been kept above mundane political tussle.

Related to #2 is #1 as the inability of the government to spend the money on time and higher revenues will eventually likely lower the projected fiscal deficit to about 2-3% of GDP (as has been happening in the past). So, the perceived large increase in fiscal deficit in FY2016 (it was just 1.3% of GDP in FY2015 and fiscal surplus in FY2013 and FY2014) may not be realized and would likely end up with a lower deficit. This should be manageable for now.

Before going into more detail on that, lets give credit where its due. FY2016 is touted as ‘Budget Implementation Year’. Accordingly, line ministries administering large projects now have the authority to spend the allocated budget without getting prior approval from National Planning Commission and Ministry of Finance. Furthermore, project directors, account chiefs and key staff won’t be transferred until the project period if they achieve more than 80% of the targeted spending. Also, progress against the target will see their budget surrendered to MOF for reallocation to performing projects. Now, these partly address four issues related to weak budget execution: delays in approval after introducing the budget, high staff turnover, delays in awarding contract, and inadequate allocation for performing projects.

Now, the main point: the above four measures address only a part of the problem related to persistently weak budget execution. The capital budget absorption rate averaged just 72% in the last ten years. It was 74.2% in FY2015. The gap between actual and planned capital budget is persistent. Capital budget was just 4.1% of GDP in FY2015 against a target of 5.5% of GDP. Higher quantum and quality of capital spending (productivity-enhancing) is needed for an high and inclusive growth. Furthermore, when private sector investment is suppressed, public investment plays a crucial role in stimulating aggregate demand quickly, accelerating recovery and establishing more sustainable growth patterns, encouraging technological innovation, and spurring private sector investment by increasing returns.

However, this is not the case as there are many pending issues that need to be resolved before capital budget is fully spent. Some of these include following:

  1. Bureaucratic hassles
    • Project approval hassles
      • The budget addresses delays caused at NPC and MOF. Now, the secretaries at sector ministries need to give faster spending authority to local level bodies within their jurisdiction.
    • Weak inter and intra ministry coordination
  2. Structural issues
    • Limited capacity of sector ministries (planning & implementation)
    • Lack of strong pipeline of projects ready for implementation
    • Legislation hurdles (procurement & maze of processes dictated by various Acts and policies)
  3. Low project readiness/allocative inefficiency
    • Lack of ready detailed design
      • Important for building a strong pipeline of key national infrastructure projects (sort of a Project Bank)
    • Hassles in land acquisition
    • Frequent staff turnover
      • The budget addresses part of this problem by anchoring performance to time-bound spending target
    • Lack of feasible procurement plans
    • Weak capacity of contractors
    • Weak contract management
    • Efficiency of budget approval and execution processes

Now, despite these long-running issues, why were most folks expecting accelerated capital sending going forward? Well, the reason was the decision to establish National Reconstruction Authority by giving it sweeping powers to do away with the above hassles in one go. On this regard, the lack of a clear institutional set up, competent human resources and a time-bound action plan missing in the budget is a disappointment.

About $740 million is deposited in the National Reconstruction Fund, which will be used when the authority comes up in shape. About $170 million is allocated to sector ministries to initiate reconstruction work as an interim arrangement. Here lies the challenge. The sector ministries won’t be able to get past the maze of issues raised above in a short period of time as they themselves are not able to spend even the regular capital budget allocated to them. The same process, mindset and governing laws and policies won’t cut it in terms of accelerated capital spending.

The delayed implementation will also mean lower foreign aid as disbursement will be lower. The total foreign aid (grant and loan) expected in FY2016 is $2.059 billion (8.5% of GDP). It was just $632 million (3% of GDP) in FY2015. Most of the foreign aid committed for reconstruction are included in the National Reconstruction Fund heading in the Red Book. It means that unless the authority is up and running, the money from the fund may not be utilized as expected.

Had the authority been given full shape right now, then it would have been able to take fast-track decision on most of the issues raised above and handover shovel-ready projects to sector ministries for implementation. Unfortunately, this is missing and hence reconstruction will be delayed, hitting the expected growth target of 6% and dampening the affected people’s hope of an early recovery of livelihood and restoration of basic infrastructure and public services.

  NRs billion Share of GDP
FY2015 budget details FY2015RE FY2016BE FY2015RE FY2016BE
GDP growth target (%) 3 6    
Inflation target (%) below 8% --    
Details of Income and Expenditure
Projected total expenditure 425.8 693.1 20.0 28.6
Recurrent  339.2 484.3 16.0 20.0
Capital 86.6 208.9 4.1 8.6
Projected total revenue 431.2 585.9 20.3 24.2
Revenue 393.5 475.0 18.5 19.6
Tax revenue 353.5 427.0 16.6 17.6
Foreign grants 37.7 110.9 1.8 4.6
Projected surplus (-)/deficit (+) -5.5 107.2 -0.26 4.4
Projected financing 27.5 -58.4 1.3 -2.4
Net loan investment 20.2 48.9 1.0 2.0
Net share investment 10.2 11.9 0.5 0.5
Net foreign loans -8.0 -72.6 -0.4 -3.0
Net domestic borrowing 5.0 -46.7 0.2 -1.9
Projected overall surplus (-)/deficit(+) 22.0 48.8 1.0 2.0