Suppose you’ve taken a loan. You could either use this money to pay your rent, buy your groceries, go on a vacation, or buy a car. Or, you could use this money to buy an apartment that earns you a rental income, or fund your child’s education. The latter of these two broad alternatives gives you some return in the future which you can use to pay the loan back. On the other hand, if you’re doing the former, then you’re going to need another loan to pay back the old loan. Doing so would indeed be an unwise financial decision, and observers would agree that you have been living beyond your means, and should cut down your non-essential expenses.
The same principle applies when thinking of governments as well. In this article, we will see that the federal government of Nepal has been living beyond its means, too. In this sense, the government is too big at its current state, and should explore ways to cut down expenses where it can. To understand this, let’s start by unpacking the concept of budget briefly.
Building blocks
At its core, a budget is a government’s promise to its citizens on the approach and the actions it is going to take in the upcoming fiscal year in pursuit of the development plans that the voters have entrusted the political leaders with. Executing these development plans – be it building roads, bridges, hospitals, schools – or running the necessary agencies to deliver public services requires resources. As governments do not inherently produce these necessary resources, the people forgo some portion of their income or assets in the form of taxes or service fees, and empower their agents (in this case, the government) to carry out the will of the people (the principal). Budgets can thus be divided into two parts – expenditure allocation and the resource pool to fund those expenditures. Now, if budgets were to be balanced, i.e., government’s revenues from taxes, fees and grants were to equal expenditures, then this division would suffice. However, with limited internal capacity to generate resources and greater development needs, Nepal’s federal budgets have been deficit budgets, i.e., expenditures have overshot revenues. This thus requires one more component to complete the budget – deficit financing.
Recurrent expenditures are ongoing operational expenditures, and go towards employee salaries and benefits, social security, procurement of goods and services, interest on borrowings, grants and subsidies, to name some. Capital expenditures are spending on long-term assets and infrastructure, aimed at economic development and capacity building. And financial provisions cover expenses such as loan repayments, contingent liabilities (which could include financial obligations that arise from government’s past commitments to public enterprises, or legal claims, or loan guarantees), or even financial support to public enterprises in the form of loan and share investments. Likewise, domestic revenues include tax and non-tax receipts generated locally, including royalties. Grants signify the non-repayable development assistance provided by foreign governments, international organizations or development partners to support the government’s budgetary needs. And as the names suggest, domestic and foreign borrowings are loans secured from domestic or foreign sources, respectively.
Spending and funding
Now, if we consider the period from 2018 and 2025, recurrent expenditures have been the largest allocations on the expenditure allocation side, representing 63.88% of the total budget allocation on average, followed by capital expenditures (22.6 %) and financial provisions (13.52%). On the revenue estimate side, which has represented 68.35% of the total expenditure allocation on average over the same period, domestic revenues have made up the largest portion (94.11%) of the estimated revenues, with the remainder coming from grants. Finally, on the deficit financing side, which has represented about 30.64% of the total budget on average, we’ve estimated to secure about 53.5% of this pool from foreign loans and 46.5% from domestic borrowing.
The reality check
As discussed in an earlier article though, our federal budgets are not credible. There is quite some discrepancy between these expenditure allocations and resource estimates, and their actual performance. For example, between 2018 and 2023, in terms of actual expenditure, we were able to spend 86% of our budgeted recurrent expenditure on an average. Notice how this is better than our actual overall spending rate (i.e. 80.04%). This means that we’ve been doing fairly well in terms of employee salaries, benefits, pensions, interests, etc. This spending represents 69% of actual expenditure (again, higher than 63.88% of budgeted recurrent expenditure to total budget outlay). This is followed by financial provision (at 77.05% average annual realization rate), and then capital expenditure (64.71%).
If we turn to our revenues and deficit financing targets, on average, we’ve been able to achieve 85.31% of estimated total revenues and 65.80% of deficit financing over the period 2018 – 2023. Our actual domestic borrowing realization rate is particularly high, at 90.84%, compared to 46.51% in case of foreign loans. Our grant conversion rate is pretty low too, at 46.69%. That leaves us with actual domestic revenue to cover our expenses. Given our performance across most other categories, this category is particularly noteworthy as it stands at an average annual realization rate of 88.27%. Interestingly, actual domestic revenue (taxes, fees, and royalties) also represents ~69% (68.68%) of total budget absorption. This means that there is a one-is-to-one relationship between actual domestic revenues and actual recurrent expenditure. In other words, every bit of the taxes and fees that Nepalis pay, goes towards recurrent expenditure.
Where does the money go?
Now, is the fact that every Rupee that Nepalis pay in taxes and fees goes to recurrent expenditure and not towards capital expenditure inherently bad? Not necessarily. Like we’ve discussed above, when spending needs overshoot internal revenue capacities, governments may, and do usually go for deficit financing. But there are at least two areas worth probing further when we are talking about the federal government of Nepal: where is the deficit financing going, and how has it been contributing to the economy, or improving the lives of the people?
Ideally, deficit financing under situations like ours should go towards capital expenditures. Capital expenditures represent spending on building long-term assets and infrastructures, which, in return, contribute positively to the economy. Simply put, debt financing should cause the Gross Domestic Product to grow, such that the government is able to raise higher internal revenues from the growth in economic activities, and that higher internal revenue enables the government to pay back the loan in the future. However, that has not been happening in Nepal. A study conducted by Samriddhi Foundation in 2020 showed that there is no significant relationship between Nepal’s public debt and GDP.
This raises an obvious follow-up question: how then are we paying back the debt? At this point, the only packet left in the federal government’s resource pool to pay back these loans is the deficit financing packet. This means that we have been paying back out old loans with new loans. Some other places where these debts are going, besides those capital expenditures and loan paybacks, are towards fulfilling the government’s contingent liabilities, or supporting public enterprises when they face some financial hardships. Public enterprises again, have historically not been able to generate a satisfactory level of economic returns for the state.
And finally, what about the recurrent expenditure itself? Ideally (again), one would expect that the recurrent expenditure has been going towards ensuring a decent level of public service. Given the state of the republic at the moment, different people have different opinions regarding the state of public services. One of the objective measures then could be to compare the level and quality of public services with other countries. According to ‘TheGlobalEconomy.com’ that compiles data from national central banks, statistics offices and multiple international organizations, Nepal ranks 113 (out of 175 countries) in terms of the presence of basic state functions that serve the people. This shows that there is a massive room for improvement in terms of public service delivery.
While it is said that citizens pay their fair share of taxes so that the government can do its job to improve the lives of the people, as things stand at the moment, Nepalis can only claim that their taxes keep the state machinery running. Many of the agencies are indeed providing a number of important public services, and the quality of those services has indeed been improving over the years. That said, the gap in services (as shown by the distance between Nepal and good public service providers), and the gap between spending and development (as shown by the disconnect between public debt and economic growth), is being closely watched by the citizens in recent times. And people see that the federal government is disproportionately big, relative to its capacities.
As the nation gears up for a series of budget announcements in a couple of months, the numbers we have explored in this article suggest that it is time to reconsider whether or not all of the government agencies, public corporations, and even programmes that the federal government has been running are indeed needed. The public should be a part of that scrutiny, and the federal government should make sure that budget priorities reflect public needs through a participatory process.
[Notes: This is the second article in the federal budget analysis series. The first article on weak credibility of the federal budgets can be read here. This series refers to FY 2017/18 as 2018, 2018/19 as 2019, and so on. The series covers the period 2018 – 2025 in terms of budget allocations and resource estimates, and the period 2018 – 2023 in terms of actual budget performance.]
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