The current coalition government, led by Prime Minister Sher Bahadur Deuba, has inherited a difficult economic situation that continues to be affected by the Covid-19 pandemic and related lockdowns. Finance Minister Janardan Sharma faces the difficult task of reviving economic activity, which remains subdued after contraction in fiscal 2019-20, with the likelihood of a convincing rebound beyond the base effect is slim. Specifically, a short-term economic recovery strategy for the harvest of “low hanging fruits” must be rolled out and implemented in such a way that it does not deviate much from the budget regulation 2021-22 and the 15th five-year plan.
The biggest constraint here is the availability of resources amid unprecedented spending pressures as the country stares at a third wave of the pandemic. The government cannot dramatically increase spending, both actual and budgetary allocations, due to its implementation capacity and funding constraints. The latest data shows that the government has missed target on pretty much all fiscal indicators. In the 2020-21 period, recurring spending was about 90 percent of target, while capital spending was only 65 percent. Tax revenue mobilization was about 95 percent of the target, but foreign grants was only 34 percent. A relatively slower pace of spending compared to revenue mobilization meant that the budget deficit fell from 5.5 percent in 2019-20 to 4.8 percent of gross domestic product (GDP). In the 2021-22 budget, a sharp increase in expenditure compared to revenue is expected to temporarily widen the budget deficit to around 6 percent of GDP.
Against the backdrop of slow economic activity, tight fiscal space, inflationary pressures and the deteriorating external sector, the new finance minister is faced with the challenging task of stimulating broad and inclusive economic activity. Perhaps, given the funding and implementation constraints, he would like to deliver visible results in a short period of time. Unfortunately, the options are limited.
First, ensuring the availability of resources when needed for an effective response to the health crisis should be a top priority. The most visible result for the government right now is an orderly process of testing, tracking, and treatment; Availability of vital drugs to treat coronavirus; and widespread vaccination in no time.
Second, the industrial and service sectors affected by the pandemic need continuous support – be it in the form of tax breaks or concessions or direct wage subsidies or social security contributions – until the situation stabilizes. A third wave of infections and the associated restrictions on mobility will further impair cash flows. It can even cut off the ailing small and medium-sized enterprise permanently from production networks. This will have long-term economic consequences as gaps in supply chains cannot be closed immediately. Not only could the government support aggregate demand by increasing public spending, but it could also help the private sector wade through the crisis so that it can at least reach pre-pandemic capacity utilization levels.
Third, a supplementary budget or a major amendment to the Financial Regulation is not ideal for financial and time reasons. The focus should now be on the execution of the budget and, if possible, on cutting down on some of the wasteful spending and ad hoc projects and programs contained in the budget. With serious efforts, Sharma could make a difference by prioritizing the operation and maintenance of ailing roads and bridges, water supply and drainage systems, power distribution lines, school and hospital buildings, and other public infrastructure. These initiatives produce quick, visible results and help increase the productive efficiency of public spending. Funding of additional operating and maintenance expenses could be arranged by realigning and reallocating existing budget allocations.
The finance minister could also prioritize public investment management by introducing a mechanism whereby only well-reviewed and prioritized projects are included in the budget and medium-term planning. This means a revision of the existing National Project Bank, which contains guidelines for the identification, evaluation, selection and prioritization of projects, which, however, are hardly adhered to during implementation. This will support the allocation efficiency of public spending.
In mobilizing domestic resources, most of the work needs to be on improving revenue management so that spills are closed. Note that new revenue-related policies are only expected to contribute 7 percent of total estimated revenue for this fiscal year. The remaining 93 percent are to be generated from existing measures, which means an increase in the taxpayer base and an improvement in compliance. Harmonizing the IT systems of different tax wings, active risk-based auditing to ensure taxpayer compliance and a monetization strategy for unused public sector assets will help. In addition, assisting sub-national governments in managing revenues as well as managing public investments will also be important. Since, in deficit financing, the cost of external borrowing is lower than that of internal borrowing, the former can be given priority for the transition period. However, this requires sector-political and institutional reform commitments or an improved budget implementation capacity.
Fourth, fiscal and monetary policy must be coordinated with the aim of ensuring a stabilization of demand and supply as well as a possible economic recovery. Moderate inflationary pressures are fine in the meantime, but a medium-term plan to tame inflation expectations, which are trending upward, shouldn’t be overlooked. There could also be cooperation to ensure that the existing support measures relating to refinancing programs, subsidized loans and regulatory deferrals are not prematurely terminated. However, the authorities need to cautiously curb excessive credit growth that is inconsistent with indicators such as GDP growth and deposit growth. An unjustifiably bullish stock market and rising real estate and residential property prices are currently not good signs of the healthy health of the financial system.
Minimal physical interface
Fifth, the external sector needs careful monitoring, particularly the direction of remittance inflows, given the decline in the number of outgoing migrant workers and the weak demand for them in destination countries. This, together with growing trade and current account deficits, could jeopardize the stability of the external sector. Adjusting import tariffs and tightening bank funding to reduce demand for expensive overseas vehicles and gold could be considered.
Finally, the finance minister can push for new measures that have a direct impact on troubled households and businesses and could support the recovery process. For example, a partial loan guarantee system with an umbrella framework that covers all guarantees, including loan subsidies for various sectors, is helpful. Similarly, digitizing public services so that there is minimal physical interface between the public and businesses and bureaucrats is another promising area for quick results. Fighting youth unemployment through retraining, vocational training and temporary employment guarantees will also pay off.