We need to be fiscally prudent to sustain federal system

Recently, the incumbent government decided to reduce the age for social security allowance for senior citizens from 70 to 65 years. It also raised the grant for quake victims by Rs 1 lakh and decided to provide monthly allowance to those battling with renal diseases, spinal injury and diabetes. Many believe that the Nepali Congress-led government has launched such populist programmes to woo voters in the next election after the electoral debacle in the recent parliamentary and provincial polls. This move has created liability of around Rs 100 billion on the state. Ram Sharan Mahat, former finance minister and Nepali Congress leader, spoke to Pushpa Raj Acharya of The Himalayan Times about how the country could suffer from such decisions. Excerpts:

Political parties are competing to distribute funds from the state coffer through populist programmes. What could be the impact of such distributive programmes on the economy?

I term such practices as fiscal populism that has been in trend for some time. Political parties are competing with each other for the sake of short-term partisan interest at the cost of the public exchequer or taxpayers’ money and also at the cost of future growth. One cannot rule out populist policies in politics, but going beyond financial limits will be counterproductive. Naturally, excessive populism and also distribution of public money to serve partisan interests and please groups with vested interests for short-term political gain is fiscal mismanagement, which will harm the economy. This phenomenon has been more pronounced under recent governments. Such decisions will reduce state resources for long-term investment and could widen fiscal deficit that will destabilise the fiscal regime. When the government spends more money on consumption then less will be available for investment. When the government starts spending more on unproductive distributive sectors, then investment in infrastructure, capacity building, productive sectors, rural development and social sector, which should be national priorities, could suffer. Budget deficit and borrowing will add more burden on future tax payers. Also reckless spending violating due process of law could create fiscal anarchy.

Nepali Congress has always been considered ‘fiscally prudent’. However, the incumbent government seems to have gone against that trend. 

Recent decisions by the Sher Bahadur Deuba-led government are part of a populist competition with the Left alliance, which did similar things in the past and is promising more in future. This is obviously a deviation from our past policies, which emphasised on rule of law, fiscal discipline, long-term sustainability and sound macro management. But our party workers have been saying we are not taking enough populist measures for political advantage despite impressive growth in internal revenue generated from various policy measures introduced by our government in the past. When the Leftist government starts distributive programmes from the revenue generated by our policy, our party workers start questioning our priority that only emphasises on long-term interest with little concern for immediate political gain. Therefore, it is natural that our party workers also expect Nepali Congress government to resort to populist measures like the Left parties that will help expand our vote bank. Having said that, I do not mean we did not bring social security measures. We have introduced many measures in the past targeting the poorest of the poor, the vulnerable and marginalised groups. Like, we introduced the widow pension and mass stipend programme for primary school education of Dalit children and districts with low literacy/female literacy to name a few. But such measures were introduced in a sustainable manner.

However, this time there is no specific target group for the programmes that have been introduced. What do you have to say on it?

I am for social security for vulnerable groups, poorest of the poor and the disabled. It is the state’s responsibility to take care of such groups. It is a general practice that social security schemes for those who are already well off are contributory in nature. Even in developed countries, there is a practice of contributory social security schemes. A poor country like Nepal will have difficulty in sustaining non-contributory social protection programmes solely from state coffers for all citizens irrespective of their economic status. The country is already the biggest social security spender in terms of gross domestic product (GDP) in the SAARC region.

The government could expand tax rates/net to cover the expenditure as there is scarcity of funds in the market. If the government does raise domestic debt, will it immediately affect the private sector as the interest rate will rise and it is not the priority of development partners from where the government can generate resources?

Economic reforms including tax reforms by the Congress-led government in the past have already made the country’s tax to GDP ratio the highest in South Asia. Potential for raising tax further is therefore limited. The emphasis should be more on enforcement and tax compliance rather than raising rates. Unbridled public spending is bound to widen fiscal deficit and disturb the macro balance. It is true that raising domestic public debt will reduce liquidity in the market and it will drive up interest rate raising cost of fund for private investment which is not good for the economy. We were appreciated by the donor community in the past for sound fiscal management and discipline with good revenue growth, deficit control and low debt to GDP ratio. But the recent trend for populist and reckless spending, coupled with large multi-layered political and administrative infrastructure under the new political setup is bound to destabilise fiscal balance and prudent macro management built in the past.

You played a crucial role to host the International Conference on Nepal’s Reconstruction after the devastating earthquakes of 2015. Then the government had announced Rs two lakh for reconstruction of individual houses, which has doubled by now. How have the governments formed later found the space to raise the grant and why was your government a bit rigid on the amount being provided?

We introduced the scheme to provide cash benefit for reconstruction of homes to earthquake victims. For this, we mobilised resources internally and externally by holding the international conference. We arranged to provide cash subsidy and low-interest loan. Later governments announced additional cash subsidy without managing matching finance. Some adjustments were necessary due to inflation. The construction cost has gone up tremendously in last three years, hence the need for additional grant. But there must also be simultaneous mobilisation of resources to finance that. Making additional commitment without funding source means nothing but empty promises.

Initially, the government had announced it would conclude post-quake reconstruction in five years and individual houses in three years. But it seems to be a never ending process. What is your take on this?

The country has been suffering from poor governance caused by unstable politics that has repercussions on civil service and on the National Reconstruction Authority too. I feel sad about it because initial works started by us in the immediate aftermath of the quakes had generated high hopes. By persuading and convincing the international community we were able to get pledges of more than $4 billion within 60 days of the earthquakes. We organised the conference against all odds. There was scepticism about its outcome. But I was confident about its success, and as we know it was a hugely successful event. But we had to leave the government immediately and the subsequent government was not very serious in expediting the work. Excessive politicisation in appointments of high positions has been hurting our administration and overall governance and reconstruction has also suffered from this phenomenon.

As finance minister, you started the process to amend many laws to create a conducive investment climate and introduced administrative reforms. However, subsequent governments do not seem serious on these reforms. What do you have to say on this?

Governance is the key issue. Poor governance is the main reason behind why we are not progressing fast and next generation reforms that we started are yet to fully materialise. I have to admit that some of the Bills that our government prepared like the SEZ Act, Labour Act, BAFIA and Central Bank Act have been enacted. However, their implementation and other reforms slowed down because of unstable politics and bureaucracy, poor accountability, excessive politicisation, and lack of right man in the right place, which is the main problem in Nepal today.

Nepal has embarked on a journey towards a federal structure. As an economist, how would you like to explain the prospects and challenges of a federal Nepal?

I had cautioned about federal structure even in the past when people started proposing federalism as a panacea for all evils. I had said it is a difficult and expensive system and it could hurt us if we do not manage it properly. Once we were committed to federalism I urged for making it manageable and sustainable. We need to be fiscally prudent and austere at the same time, maintaining financial discipline to sustain this system. We have to reduce consumptive and unproductive expenditure, focusing on efficiency, capital formation and investment, but this is not happening. The leadership does not seem to be concerned about it. We are in a very difficult federal journey for which we need a mature and far-sighted leadership.

The Left alliance, which will most probably form next government, spoke about raising grant to lower layers of administration to about 50 per cent of total budget and raise social security allowance for elderly people to Rs 5,000 in their election manifesto. In this scenario, do you expect a mature and responsible leadership?

Everything that political parties mention in their election manifesto is not always translated into action. The tendency is to promise many things to the electorate to attract votes, but when one understands the fiscal reality, they have to become more reasonable. I hope the new government considering the current financial reality will better utilise the available fiscal space in the best interest of the country to raise productive capacity for long-term development and prosperity without succumbing to pressure for narrow political advantage.

Recently, KP Sharma Oli, who could be the next prime minister, opposed the anti-money laundering laws and spoke about providing a chance for underground money to surface for investment in the real sector. What is your perception on his remarks?

I was surprised when I read those remarks. How can a person who has been prime minister before and is a prime minister in waiting speak like that? Prevailing laws on money laundering were enacted as per our international commitment. There is a Financial Action Task Force globally as well as for the region, on whose advice we passed our anti-money laundering legislation compatible with international norms. Purpose of that is to combat terrorism financing, drug money and money from other unlawful activities. Nepal is also part of the Asia Pacific Group on money laundering, which periodically reviews compliance of legal provisions. We are under constant watch and surveillance of the international community on our activities regarding money laundering through such unlawful activities. Therefore, if we do not respect our own laws, we run the risk of being treated as a non-cooperative country and the integrity of our financial sector will be suspect. As a result of which letters of credit issued by our commercial banks may not be accepted by other international banks and will negatively impact foreign investment and trade.