Economic Environment Analysis

Submitted to Mr. Satyendra Timilsina

June 10, 2017
By Ashish Singh

Sources of Deficit financing in Nepal

Introduction
Government budget is a powerful tool of macroeconomic management, control, and
regulation of the economy. The use of government revenue and expenditure as weapon to solve
macroeconomic problems of the country and to control and regulate the economy is called fiscal
policy. Fiscal policy is used to accelerate the process of economic growth, to stabilize the
economy, to reduce income inequalities, to promote employment opportunities, and so on. With
the increase in government's economic role and other functions, the size of the government
budget has increased and so have the magnitude of the budget related problems. Post World War
II the most important budget related problems are managing budgetary deficits mainly due to
ever increasing government expenditures.
The government budget balance is the overall difference between government revenues
and spending. While a positive balance is called a government budget surplus, a negative balance
is called a government budget deficit. In Nepal, the share of fiscal deficit to Gross Domestic
Product (GDP) ratios was about 3.3 per cent in Fiscal Year (FY) 2015/16. This ratio has
increased in recent year as the deficit has increased substantially. According to the revised figure
of FY 2016/17, the deficit has increase by 260 per cent while the GDP growth rate is likely to be
6.94 per cent. Some school of thoughts, a budget deficit can actually be a positive factor in
reinvigorating a stalled economy if constructively incurred. For example reducing spending and
increasing taxes to fill the deficit gap could actually have negative repercussions for the
economic well-being especially during recessions.

Fiscal 2017-18 Budget is defined as a statement of the

Budgeted Expenditure - Rs. 1279 bn financial position of government during its
amount in billions
fiscal year based on estimates of anticipated
Principal
Investment tax revenues and expenditures. A fiscal
Rs. 90 budget is the source of fiscal policy. A
Repayment
Rs. 50 government budget is the financial statement
presenting the government's proposed
revenues and spending for a financial year
which is reflective of the government's
Re-Current
Capital Expenditure existing policies and plans. On May 29, 2017,
Expenditure Rs. 803 Finance Minister Krishna Bahadur Mahara
Rs. 335
announced the budget for the FY 2017/18
with the objective of implementing the constitution, Fiscal 2017-18
achieving high and inclusive growth, maintaining Resources - Rs. 817 bn
economics stability and increasing the reach of people amount in billions
to government services. The announced budget of total Principal
Rs. 1279 billion is an increase of about 37 per cent Refund
from current fiscal. As usual majority of the budget is Rs. 15
Grants
allocated to re-current expenditure followed by capital Rs. 72
expenditure. Similarly, government expects to
recuperate Rs. 817 billion in resources with Rs. 730
billion from tax and other revenues and the rest from Revenue
Rs. 730
grants and principal refund. This leaves the fiscal
deficit at Rs. 462 billion. Compared to last year, this an
increase of about 71 per cent. Nepal has been incurring
fiscal deficits from its very beginning. In the first budget of the country, i.e. of 2008 B.S. revenue
was estimated at Rs. 30.5 million and total expenditure at Rs. 52.5 million incurring this the
fiscal deficit of Rs. 22 million (Thapa, 2005).
The trend of incurring fiscal deficits has sustained to date. Historically, the deficit to GDP
ratio of Nepal has stayed at middle to lower single digit. According to the data provided by the
Ministry of Finance (MoF), the ratio peaked at 10 per cent for the FY 1988/89 and since has
remained around 6 per cent in average up until early 2000. As we can see from the chart below,
the deficit-GDP ratio starting second decade of the 21st century remained relatively low, with
lowest in the FY 2013/14 where the ratio was a mere1.2 per cent. However, as of recent, we have
started to see unprecedented level of deficit ratio. According to the revised figure for the FY
2016/17, the deficit-GDP stood at an astounding 11.22 per cent which is expected to grow to
18.03 per cent for the
Budgetary Deficits of Nepal next fiscal.
% of GDP
Under liberal
3000
economic policy
2500
in billion Rs.

2000 economic growth does

1500 not take place in instable
1000 macroeconomic situation
500 resulting from the large
0
fiscal deficits. Also
private sector is crowded
out and investment
Deficit squeezed if government
uses internal borrowing
for fiscal deficit financing. This directly hampers economic growth. This is what the IMF, World
Bank, Asian Development Bank and others have been emphasizing over these years. Nepal also
has been pursuing the similar policy since the beginning of the 1990s (Thapa, 2005). However,
this should not deter the government from incurring any deficit, but only incur within the means.
Thus it has become paramount for Government of Nepal to effectively manage the deficit
financing more now than ever.

Sources of Deficit Financing

Fiscal deficit can be financed by the following four different means with each mode
having a different impact on the economy.
1. Borrowings from the central bank
2. Borrowings from the financial system
3. Borrowings from abroad
4. Using the reserves
Each of these modes of deficit financing have a different impact on the economy.
Domestic Borrowing One of the measure of financing governments budgetary deficit is
through borrowing from the central bank, borrowing from the commercial banks or through bond
financing of budget deficits. Government can borrow money in domestically by selling
government
securities, including Sources of Deficit Financing
national savings 500
certificates. If such
securities are only 400

sold to non-bank 300

in billion Rs.

private sector and

200
general public, the
rise in liquid assets 100
is counteracted by
0
the fall in savings
as the money is -100
withdrawn.
However if the Foreign Borrowing Domestic Borrowing Cash Surplus
government
borrows from the central bank, the total money supply will increase as new money comes into
circulation. Such borrowing has economic effects such as inflation. It is even being said that
deficit financing is inherently inflationary. However if the borrowing is used for development
purpose, the multiplier effect might neutralize the inflation.
In Nepal, internal borrowing is done through the issuance of four types of government
securities:
i. Treasury Bills
ii. National/Citizen Savings Certificates
iii. Development Bonds
iv. Special Bonds
 Fiscal 2017-18 For majority of the time, domestic borrowing has
Sources of Deficit Financing been the dominant share of deficit financing.
amount in billions According to the revised number of FY 2016/17,
Cash Surplus, domestic borrowing accounted for about 33.5 per cent
Rs. 102.74, 22% of the total financing. During the FY 2015/16,
domestic borrowing was at 117 per cent of the total
budgetary deficit.
Foreign Borrowing Developing countries like Nepal
use external borrowing as a mechanism to address the
Foreign gap between the government revenue and its
Domestics
Borowing, Rs.
Borrowing, investment and the export and import. Such borrowing
Rs. 214.04, 46%
Rs. 145, 32%
adds to the resources available to the country and if
properly utilized can contribute to the economic growth and poverty reduction. However, foreign
borrowing can adversely contribute to macroeconomic management problems in the form of high
or even unsustainable levels of external debt-servicing obligations (Thapa, 2005). The risk is
further escalated due to exchange rate uncertainty. Foreign borrowing can be made from the
following sources:
i. Bilateral Bilateral borrowing generally involves a single borrower and a single lender.
The lenders are usually foreign countries. According to a report of International
Monetary Fund (IMF), Nepals bilateral creditor includes Japan, South Korea, India and
China.
ii. Multilateral In multilateral borrowing is an institutional loan where a country borrows
from international financial institutions (IFI) such as IMF and World Bank. For most of
the worlds poorest countries, multilateral borrowing looms larger than other borrowings
due to the IFIs status as preferred creditors. According to a World Bank data, between
1980 and 1997, the multilateral debt increased by some 544 per cent. As of FY 2015/16,
87 per cent of the external debt of Nepal was concessional borrowing mainly from the
World Bank and the Asian Development Bank (ADB).
Nepal has aggressively used foreign borrowing as a key source for financing fiscal deficit. This
trend has been more evident as of recent. According to the revised figure of the FY 2016/17,
government borrowed almost Rs. 148 billion from external sources which covered more than
half of the total deficit. The trend seems to confer in the next fiscal as well where the expected
foreign borrowing stands at Rs. 214 billion out of total expected fiscal deficit of Rs. 462 billion.
Cash Surplus Usually government choose to use the cash surplus as a source for deficit
financing if there is a positive balance leftover from past accumulation. In other words, positive
fiscal balance, i.e. the difference between revenue and expenditure, contributes to national
savings. This can be used to finance future deficit. So, government can also finance consumption
from its own reserve. The source of cash surplus can be any including borrowing.
In Nepal, the contribution of cash surplus towards fiscal deficits is marginal compared to
other sources. Matter of fact, contribution has been negative for the most part in the last decade.
For example in the FY 1025/16, the contribution of Cash Surplus towards deficit financing was
Rs. 47 billion. This can be attributed to excessive domestic borrowing which stood at Rs. 88
billion, a 117 per cent of the total deficit incurred during that fiscal. According to the revised
figure, Cash Surplus has contributed to 11.73 per cent of the deficit for the current fiscal.

Regional Perspective (FY 2016/17) (Beyer, 2017)

Bangladesh Budget deficit stood at 3.1 per cent of GDP. Financing relied heavily on domestic
non-bank sources, constituting 2.2 per cent of GDP. Overall balance of payments surplus stood
at USD 5 billion.
Bhutan The fiscal deficit is projected to be at 2.5 per cent of GDP largely due to increase in
capital expenditure. The country relies heavily on external debt which is due to hydropower
project loans from India. The debt stood at 102 per cent of GDP.
India Indias fiscal deficit in the year ending in March 2017 came in at 3.5 per cent of GDP.
The government primarily resorts to market linked domestic borrowing for financing its fiscal
deficit.
Maldives The fiscal deficit in 2016 has widened slightly to an estimated 8.6 per cent of GDP.
Most of the debt financing is done with concessional external borrowing and domestic debt.
Pakistan The fiscal deficit stood at 2.4 per cent in the first half of this fiscal, 0.7 per cent
higher than the same period of last year. Non-bank financing accounts for about 46 per cent of
the deficit financing followed closely by bank financing. Net external financing stands at about
18 per cent of the total deficit.
Sri Lanka The revised fiscal deficit for 2016 has decline to 5.4 per cent of GDP from 7.4 per
cent in 2015, due both to increased revenue collection, less capital expenditure, and control of
current expenditure. According to 2016 estimates non-bank domestic borrowing accounts for 37
per cent with total domestic borrowing standing at 63 per cent of total financing. External
borrowing accounts for about 39 per cent of Sri Lankas deficit financing.

Conclusion
Incurring fiscal deficit for capital formation in the economy is an unavoidable
phenomenon for developing countries Deficit financing can be used as an effective fiscal mean
to mobilize additional resources for economic development ensuring higher level of
employment. However there are negative connotations associated as well. For example, deficit
financing by printing of new currency increases money supply and leads to inflationary impact
on the economy. When government borrows funds, it inadvertently causes crowding out effect as
private sector investment is depressed. Also, while external borrowing increase resources
available in the disbursement period, in the long term is relies on future productive resources in
form of debt servicing.
 According to government of Nepal, one of its strategic goal it looks to achieve through
budget implementation is to help maintain macroeconomic stability by limiting domestic
borrowing and regular expenditure. However, according to Tula Raj Basyal, Former Executive
Director, Nepal Rastra Bank, the budget is likely to destabilize the macro economy of Nepal due
to unrealistic assumptions regarding power to obtain foreign assistance and borrow loans. In
recent budget, Nepal has placed increased reliance on debt sources as well as external aid. High
budget deficit of FY 2016/17 is mostly financed by debt, primarily foreign borrowing.
Productive capital expenditure and efficient debt management including ability to service past
debts is essential while deciding the sources of deficit financing in order to maintain
macroeconomic stability.
References
Thapa, Dr. G. B (2005). Deficit Financing: Implications and Management. Nepal Rastra Bank
Economic Review. Volume 17, Article 2.
Beyer, R. (April 13, 2017). South Asia Economic Focus Spring 2017 Globalization Backlash.
International Bank for Reconstruction and Development / The World Bank. Retrieved
from
https://openknowledge.worldbank.org/bitstream/handle/10986/26373/9781464810954.pd
f?sequence=5
 Annex

Table A. Nepals Economic Indicator FY 2010 2018

2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18
A A A A A A R E
GDP 1367.0 1527.3 1695.0 1964.5 2120.5 2248.7 2404.76 2561.07
Total
295.36 339.17 358.64 435.05 531.34 601.03 935.88 1278.99
Expenditure
Resources 245.74 285.37 333.93 411.43 452.10 526.15 666.16 817.22
Deficit/
-49.62 -53.80 -24.71 -23.62 -79.24 -74.88 -269.72 -461.77
Surplus
Deficit
49.62 53.80 24.71 23.62 79.24 74.88 269.72 461.77
Financing
Foreign
12.08 11.08 11.97 18.00 25.53 34.46 147.81 214.04
Borrowing
Domestic
42.52 36.42 19.04 19.98 42.37 87.77 90.26 145.00
Borrowing
Cash
-4.97 6.29 -6.30 -14.36 11.34 -47.35 31.65 102.74
Surplus
Source: CBS - National Accounts 2016, Budget Summary - MoF, Government of Nepal
A Actual
R - Revised
E - Expected