Nepal’s patronage economy

Bishal Thapa

Bishal Thapa

Nepal’s patronage economy

Government-led capital expenditure projects are overwhelmingly selected by patronage and corruption

The blind push for government-led capital expenditures without adequate concern over the quality of those investments is limiting Nepal’s growth and could derail the economy. Development partners, who in effect finance the capital expenditures, must demonstrate greater honesty in the due diligence of their investments.

Despite the projected decline in economic growth, Nepal’s broader economic indicators remain robust. Foreign exchange reserves are now bordering on the excess, having surged to be sufficient for 12 months of imports. Budget deficits, external current account, inflation, and other key markers remain stable.

A recent analysis by the International Monetary Fund (IMF) concluded that Nepal has strong borrowing capacity. The current public debt to GDP ratio, at approximately 30 percent, is less than half of what IMF estimated as the benchmark debt carrying capacity. There is similar space in debt servicing capacity. These ratios are projected to remain comfortably below the benchmarks in the future.

There are growing calls for Nepal to accelerate public capital expenditures. The Asian Development Bank (ADB), for example, believes Nepal must significantly increase infrastructure investments. It calls for tripling the public capital spending to GDP ratio from current 3.5 percent to between 8-12 percent.

This is the simple narrative in Nepal: investments are needed for growth, and there is ample room to borrow. So, hurry up government!

This, however, fails to examine the quality of public capital expenditures—how the projects were chosen, their broader economic returns, and who really benefits from these investments.

Public capital expenditures failing

While Nepal does have adequate space for borrowing to finance capital investments, it also has an almost infinite need for infrastructure. From that perspective, public capital investments are zero sum. An investment on a project erodes the equivalent debt space. Government-led capital investments, therefore, must be viewed through the lens of budgetary constraints.

In Nepal, every capital investment—whether a simple community tap or a magnificent new airport—is needed. But in the context of budgetary constraints and the many competing projects, how are public capital expenditure projects prioritized and rationalized?

Government-led capital expenditure projects are overwhelmingly selected by patronage and corruption, and based on who will execute them, rather than on their broader economic returns. This is the reason public capital expenditure programs disproportionately favor projects with frequent procurements.

The failure of government-led capital expenditures in Nepal is already visible. These projects are not providing economic returns fast enough: their impact on broader economic growth is negligible, and they have failed to improve domestic capacity or enhance investor confidence.

Consumption based taxes (value-added, customs, and excise duty) currently account for approximately 60 percent government revenues. When public capital expenditures fail to produce growth, government revenue base will remain limited. Consumption-based taxes will need to continue to finance these expenditures. This means higher taxes on consumption products.    

Government capital expenditures aren’t enhancing the confidence of international investors. In project selection, design, and execution, investors see a messy network of intertwined short-term interests. These projects are also not increasing the technical, financial, or managerial capacity of domestic firms at the rate public capital expenditures suggests they should.

Absence of institutional filters

Nepal lacks the institutional filters to screen government prioritization and rationalizing of public capital expenditures. The National Planning Commission (NPC), and the civil service in the ministries, should be playing that role. Unfortunately, they have folded into the patronage economy.

Business associations are too vested in the patronage economy to serve as meaningful filters. Civil society lacks the organization and resources.

This where Nepal’s donors could do more to plug the gap for an honest filter of government prioritization and rationalization of public capital expenditures. Donors must employ more comprehensive due diligence on their proposed investments—listen carefully to stakeholders, and critically examine the process for rationalizing and prioritizing projects. They must partner with, and help empower, independent civil society organizations in this process.

Financing a poor public capital expenditure project does more to relegate Nepalis to a future of poverty and debt servitude, than not financing it at all.   

An alternative narrative

The continued emphasis on accelerating public capital expenditures for growth is overshadowing the underutilized productive capacity and pent-up growth potential bottled within the economy. Unlocking this potential requires interventions not with public capital expenditures but painful reforms.

For the patronage economy, that’s simply not profitable enough.

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