Nepal needs to use its money better

Nepal’s September protests and regime change created two major unexpected costs that Prime Minister Sushila Karki’s interim government is scrambling to deal with: reconstruction of destroyed government buildings, and holding elections on 5 March.

The buck stops at the desk of economist and former bureaucrat Minister of Finance Rameshore Khanal about where and how to spend limited resources.

“Rameshore-ji is a fresh face and the right person for the role. He is capable and interested, and he knows the system,” says Kalpana Khanal of the Policy Research Institute (PRI).

But Minister Khanal has to grapple not just with the immediate budgeting needs for elections and reconstruction, but also initiate longer term measures to restore investor confidence badly dented by arson and vandalism of 9 September, and mend the economy.

Immediately after taking office, he had set up a three-member task force to cut programs and free up budget to meet immediate expenses.

“We have to hold elections and we have to reconstruct. Both need money, and they are equal priorities for us,” said Ministry of Finance spokesperson Tanka Prasad Pandey. “It is important to find these funds internally, and not look to aid from abroad.”

But Minister Khanal flew into heavy flak last week for his decision to restore investor confidence by giving a strategic capital gains tax break to Nepal’s only foreign private equity fund.

The Mauritius-based Dolma Impact Fund has invested venture capital into Nepal’s hydropower, construction and biotech sectors as well as solar farms and hospitals. It said in a statement that its capital gains are only taxable in Mauritius as per its double-taxation avoidance agreement with Nepal, which predates and overrides the Income Tax Act of 2002 subsequent to the Treaty Act 1990.

Leaks to the media possibly by bureaucrats fearful of being hauled over the coals by the CIAA has set financial circles abuzz for the past week. The Internal Revenue Office refused to grant the exemption, citing the 2002 Act.

Prime Minister Sushila Karki asked Chief Secretary Eaknarayan Aryal for clarification, and learnt that the Cabinet’s decision was not official since it was not recorded in the minutes.

Some experts worry that gifting the fund such perks can set a dangerous precedent and a loss in tax revenue. Professor and economist Pushkar Bajracharya says: “The most important thing is to have a consistent policy about tax cuts and not do it piece-by-piece. Besides, the evidence just isn’t strong that tax cuts lead to higher investment, or more jobs.”

Others hark back to the capital gains dispute of the sale of Ncell ownership, which went to the Supreme Court and all the way to the international tribunal in The Hague.

Khanal has said privately that he is responding to the damage to Nepal’s investment climate from the dramatic visuals beamed worldwide of an international hotel chain and government buildings set ablaze in September. Western embassies are also said to be lobbying to allow Dolma tax exemption and smooth profit repatriation.

There are tradeoffs. Private equity funds like Dolma could funnel foreign funds more efficiently towards successful Nepali companies than the government, which is slowed down by many layers of bureaucracy. The downstream multiplier effect of such investments would outweigh taxes to the government since much of it is misused and wasted.

For example, the government is not taxing income in FY 25/26 generated by the US-funded $697 million Millennium Challenge Corporation (MCC) projects to build transmission lines and upgrade highways.

Strategic tax exemptions do provide incentives to investors, to make sure these projects are carried out effectively, which in turn helps Nepal’s development which has been affected by corruption and mismanagement.

The main demand of the GenZ protests that led to the downfall of the government coalition two months ago was to control corruption and make government more efficient so there is investment and job creation. The interim government seems to be responding to that sentiment.

The Dolma issue has distracted from the larger and longer-term need to reform the country’s financial systems and streamline public expenditure. How to reduce corruption and spur development is going to be the main agenda for elections, and the criteria by which voters will select candidates and parties.

TASKED FORCE

Shortly after Rameshore Khanal was appointed he set up a three member task force made up of the heads of Budget and Program, Foreign Aid, and Revenue Management Divisions. The team sent through the budget culling items DOGE-style — projects deemed ‘inadequately prepared,’ ‘fragmented,’ or ‘included through political pressure.’

Khanal hoped to save up to Rs100 billion by cutting all projects less than Rs30 million. However, such a slash and burn method would hurt rural and remote area projects for health and education more, and much bigger corruption-ridden infrastructure projects would be unscathed. 

Says Bajracharya, “There are thousands, maybe hundreds of thousands of low-return programs in the budget that are there because of political or personal influence. But the criteria for cutting them needs to be properly defined. Doing it arbitrarily is unacceptable.” 

Kalpana Khanal of the Policy Research Institute was involved in the taskforce, and explains: “The decision to mobilise internal funds is a pragmatic move to fund elections and reconstruction.”

However, she also singles out the massively-funded Ministry of Physical Infrastructure and Transport as being particularly problematic: “Time and cost overruns are historically the norm, and many are ‘vote bank’ projects that are politically motivated rather than done for return on investment.”

For example, politicians use their influence to build roads to their home districts to secure popularity even if the funds would have been better spent elsewhere.

“Another problem is the amount of funds that are transferred randomly for things that outside the budget,” continues Khanal.

Bajracharya adds, “While reconstruction and elections are big financial commitments, Nepal could easily find the funds. Cancelling low impact programs is a good move by the ministry of finance, and another option could have been to raise customs or taxes by a few percent. The main problem is that a huge amount of funds are lost to corruption.”

Kalpana Khanal and Dilli Raj Khanal co-authored a technical report last year titled Improving Public Expenditure System in Nepal: Critical Areas of Reform which did a forensic examination of such wasteful projects.

The conclusion: recommendation to have stricter accountability measures in place to check the actual use of funds and merit-based appointments in the National Planning Commission, Ministry of Finance, and the CIAA.

The technocrats in Prime Minister Karki’s cabinet resonate with the latter point. Nepal is so entrenched in the ‘afno manche’ culture of nepotism and connections that it has become the norm.

The report also refers to the well-known off-budget ‘re-allocations’ of big outlays during the seventh and first months of the fiscal year that undermine in-built check and balance. Almost a quarter of the budget is spent in the last month, which results in low quality and low impact work.

The authors call for reward and punishment systems to prevent these practices. The CIAA could also be supercharged to build transparency into the digital Line Ministry Budget Information System, instead of being an agency for political vendetta.