Nepal in the red

Nepal’s Finance Minister Bishnu Poudel is a Red. And as Finance Minister in a coalition led by his Communist Party of Nepal (Unified Marxist-Leninist) he has the unenviable job of saving a country deep in the red.

Despite its impressive name, there is nothing even remotely ‘communist’ about his party as Poudel works on the upcoming budget. He has warned repeatedly about a massive revenue shortfall with Nepal’s expenditure now 25% higher than its income.

The government has already reduced subsidies to local governments due to lack of money, and plans to cut small-scale programs entirely in the budget. But such rollbacks do not even make a dent in reducing the deficit gap.

Revenue has been falling since Covid-19, and never really recovered — even though in 2023/2024 revenue was a record high compared to the previous year. The fiscal year 2022/23 marked the first time in the last five decades that Nepal experienced a negative growth rate in revenue.

This year, collections rose to Rs919 billion by mid-May, a 11.5% increase over the previous year, but with only two months to go before the end of this fiscal year, the government has only collected 65% of the expected revenue.

Revenue mainly comes through VAT, customs, excise and income tax. A slowdown in imports and domestic economic activity has led to a fall in collection. Domestic consumption has slowed as young Nepalis migrate overseas. There is also concern about smuggling across the border.

“Our revenue is not rising in proportion to our imports,” says Kewal Prasad Bhandari, former Secretary to the Government of Nepal. “This points to significant leakage at border checkpoints.”

Customs evasion has been rising since Covid-19, and non-compliance with custom duty regulations worsened during the 2022 elections. This prompted lawmakers to approve an amendment to Nepal’s Revenue Leakage Act 1995 that proposes the formation of a Central Revenue Leakage Control Committee under the coordination of the Finance Minister.

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“Customs evasion has been out of control since 2022, with people blatantly flouting the laws,” says a former secretary who wished not to be named. “Customs fraud is widespread because there is little political will to hold those who break the law to account because of their political connections.”

The Finance Ministry is currently staffed by officials who have no experience and expertise in the sector. “It used to be called a ‘Super Ministry’ with capable financial administrators, but that is no longer the case,” adds the former secretary.

VAT fraud is also rampant with almost 28% of registered taxpayers failing to file annual turnover details to revenue offices. Another 24% of VAT-registered taxpayers who do file documents show zero VAT on transactions.

“We can generate up to Rs2 trillion in revenue if we make active efforts to monitor tax, VAT, and customs fraud,” says Min Bahadur Shrestha, former Vice President of the National Planning Commission.

With the implementation of the federal system, government expenditure has increased exceptionally in the form of grants administered by the central government for provinces and municipalities. Such grants are a significant part of current expenditure, which also includes social security and administrative spending.

Even as the number of development and infrastructure projects goes down, the size of the budget has increased every year, primarily due to the debt burden. Unable to raise enough revenue to cover expenditure, the government has borrowed extensively from within and outside the country, quadrupling its public debt over the last decade.

Nepal has now reached a point where it is borrowing more money to pay back what it has borrowed.

Current expenditure and debt servicing make up much of government spending, leaving little money for essential development. In the previous fiscal year, 67.6% of Nepal’s spending was current expenditure and 18.% on debt servicing, leaving only 13.6% for development projects.

Nepal’s public debt has exceeded Rs2.67 trillion as of mid-April, and forms 46.75 % of its GDP in comparison to 22.3% ten years ago. Officials have attributed Nepal's debt load to post-earthquake reconstruction, a bloated federal machinery, and the pandemic.

Nepal has to either significantly cut spending, or scale up revenue generation. Min Bahadur Shrestha, says reducing expenditure is not the right policy for a country like Nepal, the focus should be on income generation.

Last year’s High-Level Tax Reform Advisory Committee led by former Finance Secretary Bidyadhar Mallik projected a revenue increase of up to Rs300 billion annually through reforms like tax hikes and reducing VAT exemptions.

The Economic Reform Commission under former Finance Secretary Rameshore Khanal this month was recommended new revenue-raising ideas, including a controversial inheritance tax on property and real estate transactions, which it suggested would also discourage people from accumulating large amounts of wealth. Critics say this will discourage saving and disrupt Nepal’s business environment.

And then there is the corruption. Instead of holding those flouting tax laws to account, politicians pander to lobbyists and special interest groups. Defaulters and tax evaders get away, and cronies are appointed to leadership positions in regulatory bodies whose job it is to monitor tax evasion.

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“The government’s credibility comes into question when it allows itself to be bribed into handing over leadership of regulatory bodies to middlemen,” says Shrestha. “A lot of money goes not towards our national coffers, but to line the pockets of a select few individuals.

Various committees have recommended economic austerity in order to minimise wasteful spending, including banning unnecessary travel, cutting down on the purchase of vehicles, furniture, and IT infrastructure, as well as closing and downsizing offices. None of this has been followed through.

Says former secretary Kewal Prasad Bhandari: “There is no other country in the world with such large-scale waste of government resources like ours, that is why we need stronger policies that make appropriate use of taxpayer money. Otherwise we will just go deeper into the red.”