Nepal’s federal budget 2024-25: An analysis of expenditures and revenues

The federal budget of Nepal proposes Rs 1,860bn as total annual expenditures for the fiscal year 2024-25. Of this total, Rs 1,141bn (61.3 percent) is allocated for recurrent expenditures, and Rs 352bn (18.9 percent) for capital expenditures. Of the remaining Rs 68bn (3.6 percent) is allocated for domestic and foreign loan and share investments, and Rs 300bn (16.1 percent) is for the principal payment of current domestic and foreign loans. 

Of the total recurrent expenditures, Rs 96bn is allocated for transfers to the seven provincial governments and Rs 312bn for the 753 local governments. The total expenditure requirement is proposed to be met by Rs 1,260bn (67.7 percent) raised in revenues, arrears, and cash reserves, and Rs 52bn (2.8 percent) received as foreign grants. The resultant financial deficit of Rs 548bn is proposed to be met by Rs 218bn in foreign loans and Rs 330bn in domestic borrowings.

Budget increase and revenue projections

The proposed total budget is 6.2 percent above last year’s proposed budget and 21.6 percent above last year’s revised budget. The proposed recurrent expenditures are 6.9 percent above the current year’s revised estimate, while capital expenditures are proposed at an exaggeratedly high 63.7 percent above the corresponding estimate. Leaving aside the fiscal years 2019/20 when the Covid-19 pandemic and 2022-23 when import restrictions adversely impacted revenue generations, the overall revenue has increased by an annual average of 18.4 percent since 2015-16. 

The budget estimates an economic growth of 6.0 percent and a price inflation of 5.5 percent. Even if these estimates turn out to be true the other way around, the overall revenue GDP ratio is likely to be only slightly above 22 percent, a level that is not much higher than the current one. Hence, we can assume that the federal revenue estimate of Rs 1,419bn is achievable.

Resource shortfall and capital expenditure

With the dwindling capacity of the government to attract foreign grants since 2015-16, it is less likely that the next year’s foreign grants will increase over the current year’s estimates of Rs 34bn. Given the trend in the capacity to attract foreign loans over the last 8 to 10 years, it is not likely to go over Rs 150bn in the next year, an amount much lower than the budgetary estimate of Rs 217bn. Likewise, a more realistic domestic borrowing will be around Rs 25bn less than that proposed in the budget.

With these estimates, the federal government’s sources of funds are likely to face a shortfall of about Rs 100bn. Most of the impact of this shortfall will have to be borne by reduced capital expenditures. In other words, the resources most likely available for capital expenditures will be around Rs 250bn, which is significantly lower at 71 percent of the proposed Rs 352bn. It should be noted, however, that it has been customary to propose overly inflated or optimistic capital expenditure estimates. 

Excluding 2019-20, the year with exceptionally adverse Covid-19 impacts, the ratio of actual to budgeted capital expenditures has varied from a low of 57.8 percent in 2021-22 to a high of 80.8 percent in 2017-18, with a median of 66.9 percent since 2015. The government has, as usual, proposed higher capital expenditures without conducting any serious homework on how to increase project implementation effectiveness or adequately developing game-changing projects within the framework of its three-year rolling inventory of projects included in the Medium-Term Expenditure Framework (MTEF). 

Provincial and local government capital expenditure

On the other hand, the ratio of actual to budgeted capital expenditures in the case of the seven provincial governments has been better and more consistent, varying from 68.2 percent to 70.6 percent in the last five years since 2018-19 when provincial and local governments were elected and came into full-fledged operation. Unfortunately, the provincial capital budget is around half of the federal capital budget. 

Hence, there is much room for improving the provincial project implementation capacity as these units are new and still need to be fully institutionalized with clear and adequate legal instruments. Reviewing the capital expenditures by the 753 local governments over the three years immediately preceding 2023 reveals that the local governments spent slightly above 40 percent less than that by the federal government and a little above 40 percent more than that by the provincial governments together.

Effectiveness of federal capital expenditures

Comparing capital expenditures before and after the implementation of federalism reveals that we have failed to utilize federalism to improve capital expenditure effectiveness. Capital expenditures for the federal government and provincial governments (for the initial few years when provincial governments were being formed as federalism was being implemented) for 2017-18 were Rs 270.7bn and Rs 1bn, respectively. 

In other words, the initial capital expenditures before provincial governments came into being, the benchmark total federal and provincial expenditures was Rs 271.7bn. Taking inflation into account, this outlay of Rs 272bn would translate to Rs 284bn in 2018-19, Rs 294bn in 2019-20, Rs 313bn in 2020-21, Rs 339bn in 2021-22, Rs 358bn in 2022-23, Rs 367bn in 2023-24, and Rs 407bn in 2024-25. Comparing these with actual federal and provincial capital expenditures: Rs 303bn in 2018-19, Rs 278bn in 2019-20, Rs 341bn in 2020-21, Rs 325bn in 2021-22, and Rs 359bn in 2022-23. On average, they are roughly equal, with annual positive/negative percentage variations within a single-digit range. This is further evidence that, contrary to usual expectations, we have failed to utilize federalism to improve capital expenditure effectiveness. 

Moreover, 2023-24 has been even worse as the revised capital expenditures for this year have been less than 90 percent of what would have been normative based on the price level. Additionally, the proposed capital expenditures outlay for 2024-25 is 126 percent of what would have been normative (coincidentally, it was 126 percent in 2023-24 too). This clearly evidences our customary practice of inflating budgeted capital expenditures.

Now let us review the effectiveness of the federal government in spending capital expenditures. Before doing so, it is important to note that financing expenditures include domestic loan investments, both domestic and foreign share investments, and principal payments of domestic and foreign borrowings. These expenditures are used either to create assets or reduce liabilities. The asset creation part of such expenditures is the subject of discussion in the proposed budget. In contrast, the liability reduction part of financing expenditures is not, as it is incurred due to past expenditures, regardless of whether they were justifiable at the time. 

Similarly, financial transfers to provincial and local governments are expenditures of those levels of government, not the federal government. Therefore, we exclude such financial transfers and financing expenditures in our calculation of the ratio of federal capital expenditures to recurrent and capital expenditures. This ratio has gradually deteriorated from 37.9 percent in 2018-19 to 28.3 percent in 2022-23, confirming the gradual erosion of the effectiveness of capital expenditures. Even worse, it suggests that the seriousness and quality of budgeting have suffered due to the realpolitik approach that has increasingly permeated the highest echelons of decision-making in the country over the last five to seven years.

Project implementation capacity and national pride projects

To get a sense of our project implementation capacity, let us now briefly discuss the projects of national pride. These projects were expected to make the overall economy dynamic and constitute the backbone of the national economy. They were anticipated to create a multifaceted impact for socio-political transformation through economic and employment generation. 

Originally, 17 projects were identified, classified, and initiated in 2011-12, with another four added later, giving the government a portfolio of 21 such projects. The committee for national development problems, known as the National Development Action Committee, is chaired by the prime minister and is responsible for directly overseeing these projects of national pride. This was done to give them high visibility and ensure attention at the highest level for problem-solving and effective implementation. 

In the 13 years since the start, only two airport projects have been completed (though they have not been put into operation yet), and another three projects, namely the Melamchi drinking water project (almost complete) and Sunkoshi Marine diversion multi-purpose project and Chure preservation project (close to completion), have achieved above 93 percent physical progress. The rest of the projects are at different stages of completion, even after such a long time, despite the hype we created for them in our regular development dialogue.

Additionally, in the year 2022-23, a sum of Rs 166bn was allocated for these projects, but the actual outlay was Rs 92bn, resulting in only 55.5 percent financial progress. Regarding the annual progress of these projects, five out of 21 projects had 15.6 percent to less than one-third physical progress, three irrigation projects and four road/bridge construction projects had around 50 percent to 57 percent physical progress, six projects had around two-thirds physical progress, and only three projects were on track with around 80 percent to 90 percent progress. These projects received a relatively high proportion (22.1 percent in 2022-23) of our capital expenditures. 

Despite the allocation, the physical and financial progress of these projects has been considerably below the target and unsatisfactory. A quick assessment suggests a relatively weak institutional capacity or issues related to inter-agency coordination, financing, and overall project management were the major hindrances to the success of other projects.

Fiscal and monetary policy coordination

Another issue that needs the attention of the government’s fiscal policy, complemented by the Nepal Rastra Bank (NRB)’s monetary policy, is the problem of excess liquidity/idle money and the slowly but steadily increasing non-performing loans in the banking and financial sector. These issues have marred our development endeavors in general and the banking and financial system in particular. In the past 10 months of 2023-24, banks and financial institutions increased their deposits by
Rs 443bn (7.8 percent) while their credit increased by Rs 225bn (4.7 percent), adding further to their idle deposits. As a result, the credit-deposit ratio of banks is 79.9 percent. 

Likewise, the share of non-performing banking loans is 3.7 percent. According to the NRB, there is currently an excess liquidity of a little less than Rs 70bn. This further underscores that, particularly now when the private sector has remained hesitant, there is a serious need for the government to lead with a more effective capital expenditures plan to stimulate economic growth.

Before closing the discussion on capital expenditures, let us point out that we do in fact need to drastically increase the share of capital expenditures in the budget. However, the practice of inflating its estimation in the budget does not achieve this goal. To address this, we need to improve the entire process of budget preparation, starting with how the periodic five-year plan is formulated, how the MTEF is developed based on it, and how a portfolio of new and ongoing projects is developed and proposed for inclusion in the budget.

Revenue structure and its challenges

Now we turn to a brief discussion on some important issues regarding the revenue structure. Except in 2019-20 and 2022-23, when the tax collected at customs points averaged around 41 percent (due to the impact of the Covid-19 pandemic in the former and import restrictions implemented to address the deteriorating foreign exchange reserve position in the latter), the total tax collected at customs points averaged around 46 percent over this period. 

Of the total tax collected at the customs point, customs on imports accounted for 41 percent, value-added tax on imports another 43 percent, and excise tax on imports 14 percent on average over this period. In other words, tax on imports, on average, accounted for 98 percent of all tax collected at the customs point and thus, on average, constituted 45 percent of all taxes collected over this period. Simply put, our tax system is overly dependent on imports. Also note that our total imports over this period averaged 33 percent of GDP. 

A significant portion of our appetite for consuming imports is fueled by remittance income sent home by Nepalis working abroad, as this income added a portion as large as 23 percent of GDP to gross national disposable income on average over this period. Remittance income has significantly contributed to our gross national income, reduced the incidence of poverty, and improved household consumption, imports, and revenue. As a result, we have become a nation that significantly depends on private remittances for both household and government incomes.

Forex reserves and import restrictions

In the year 2021-22, our foreign exchange (forex) reserves depleted by Rs 83bn to Rs 1,216bn, which was sufficient to finance merchandise and service imports for only 7.8 months. This depletion was due to a sharp increase in imports by Rs 381bn and largely stagnant remittance income, contributing to a deficit of Rs 252bn in the balance of payments that year. To prevent the forex reserve situation from deteriorating further, the government imposed restrictions on imports of non-essential goods. This should be viewed as a one-time measure to mitigate the adverse impact of substantial price inflation resulting from the international supply shock in petroleum products. 

Not only has the international oil supply improved, but our forex reserve position has also recovered to Rs 1,873bn as of mid-May 2024. This recovery resulted from a reduction in the total import bill and a fairly quick rebound in remittance incomes. The forex reserve in 2022-23 was sufficient to finance 10 months of merchandise and services imports. In four years (2009-10, 2010-11, 2018-19, and 2022-23), our forex reserves were sufficient to finance only a little over seven months of merchandise and services imports. Despite these periods, we have maintained healthy forex reserves over the last two decades. 

Therefore, producing merchandise, especially agricultural commodities, domestically to substitute imports, and pooling and channeling remittances for domestic investment must become important budgetary priorities.

Raising resources for increased expenditures

When we talk about increasing capital expenditures, we naturally need to consider how we raise resources for it. Some have argued that our current revenue-to-GDP ratio is already higher compared to other South Asian and low-income countries. International Monetary Fund (IMF) estimates that the current revenue-to-GDP ratio in Nepal is 19.6 percent, which is clearly less than its estimates of 20.1 percent for India and 23.8 percent for Bhutan, but certainly higher compared to Bangladesh (8.8 percent), Pakistan (12.5 percent), Sri Lanka (13.7 percent), and the low-income developing countries (15.3 percent). Some have cited statistics for India while excluding its provincial revenue collection, which is significantly broader and higher than that in Nepal. 

Furthermore, it goes without saying that such an argument undermines the reform measures Nepal has rightfully undertaken since the early 1990s to improve and expand its revenue base, reduce external dependency, and avoid constraining the scope and ability of the private sector to borrow in the domestic market.

Debt sustainability and social welfare expenditures

Additionally, there is an argument that increasing capital expenditures faces a serious limit due to the continual rise in the debt-to-GDP ratio. Starting from 23 percent in 2016-17, this ratio has now reached 43 percent. While it is true our indebtedness has grown, IMF data shows our ratio remains significantly lower compared to other low-income developing countries: Bangladesh (41.4 percent), Pakistan (71.8 percent), India (82.5 percent), Sri Lanka (107.3 percent), and Bhutan (111.4 percent). 

Therefore, the concern is not about the sustainability of our debt level but rather ensuring that projects funded with borrowed funds yield higher financial and social returns, are timed appropriately, and have justifiable grounds for utilizing public finances.

Another issue that is often discussed is the capacity to sustain the ever-increasing level of social welfare expenses. These expenditures were Rs 38bn in 2013-14 and grew to Rs 219bn in 2022-23, registering annual growth rates of 22.5 percent in nominal terms and 14.8 percent in real terms. Moreover, social security assistance, which constitutes more than half of the total, has been growing much faster than the rest of the programs, with annual increases of 30.1 percent in nominal terms and 22.9 percent in real terms. Social welfare expenses constituted 8.7 percent of total expenditures in 2013-14 and increased to 15.4 percent in 2022-23. These expenses were already as large as the total capital expenditures and represented 4.3 percent of GDP in 2022-23. 

Of the total social welfare expenses in 2022-23, social security assistance constituted 53.3 percent, social insurance (largely pensions and gratuities) constituted 44.1 percent, and the remaining 2.6 percent went to social assistance programs, including scholarships and mid-day meals for school children. Since a substantial part of the social security assistance goes to senior citizens and the proportion of seniors above 68 years in the national population is 5.2 percent and growing annually at 4.1 percent (four times faster than the overall population), this component will grow at a much faster pace than the rest of the total budget. 

Additionally, these programs are quite popular, and the constitution mandates some social programs, so a serious discussion on how the overall social welfare programs can be redesigned and capped warrants consideration across political party lines.

Conclusion

A capital expenditure-led economic policy is necessary to spur economic growth. However, the likely shortfall of around Rs 100bn in resources will predominantly impact capital expenditures, reducing them to an estimated Rs 250bn, about 71 percent of the proposed amount. Additionally, the persistent practice of inflating capital expenditure estimates without a corresponding increase in project implementation capacity, exacerbated by the realpolitik influencing budget allocations, continues to undermine capital expenditure effectiveness.

Federalism has not yet yielded the expected improvements in capital expenditure effectiveness. However, provincial and local governments have shown better consistency in capital expenditure utilization compared to the federal level. Nonetheless, significant room for improvement exists, especially in institutionalizing project implementation frameworks.

Projects of national pride, intended to drive economic transformation, have seen mixed progress. It is essential to align the budget with the MTEF, ensuring that large-scale projects are planned and executed with a strategic vision. Institutional weaknesses, inter-agency coordination issues, and project management challenges persist as major hindrances.

The revenue structure’s heavy dependence on import taxes, fueled by remittance income, highlights the need for diversifying revenue sources and fostering domestic production. The fluctuations in foreign exchange reserves underscore the importance of strategic import substitution and the effective utilization of remittances for domestic investment.

Raising resources for increased capital expenditures requires a balanced approach, considering Nepal’s debt sustainability and the need for high-return investments. Despite a rising debt-to-GDP ratio, Nepal’s debt level remains manageable compared to regional counterparts. Ensuring the efficient utilization of borrowed funds for productive projects is essential.

The growing social welfare expenditures, particularly social security assistance, necessitate a serious dialogue on redesigning and capping these programs. With a gradually aging population and constitutional mandates, the sustainability of social welfare expenses must be addressed to ensure fiscal stability and equitable resource allocation.

Prioritizing capital expenditure, improving budgetary processes, and coordinating fiscal and monetary policies are crucial to ensure that the budget is not just a financial statement but also a tool for sustainable growth and socio-economic transformation. In summary, Nepal’s federal budget for the fiscal year 2024-25 reflects both aspirations and challenges.