Kathmandu, April 18

The World Bank Group has warned that widening fiscal and current account deficit has intertwined risk in the financial sector.

The Nepal Development Update of the World Bank Group unveiled today has said that due to the deficit, the country’s financial sector has started witnessing an adverse impact in credit expansion, collection of deposits and stability in interest rates.

The cost of setting up sub-national governments under the federal system and the transfer of funds to the local levels for decentralised service delivery, coupled with reconstruction related to the earthquakes and floods, not to mention the bigger social assistance programmes have widened the fiscal deficit.

The World Bank has said that revenue collection is expected to grow but at a slower rate, while the spending needs are high. It has estimated that public expenditure will rise by 32.4 per cent in the current fiscal, and by 33.8 per cent, 34.6 per cent and 34.3 per cent in the subsequent three fiscals. However, revenue is expected to grow by 26.5 per cent in this fiscal compared to last fiscal and 27.6 per cent, 28.4 per cent and 28.9 per cent, respectively, in the three fiscals from 2018-19, as per the Bank’s estimation.

Debt-to-GDP (gross domestic product) ratio is expected to increase by 10 percentage points to 37.6 per cent by 2020 from 27 per cent of last fiscal. The pace of increase in debt-to-GDP ratio has been high in recent years. According to the World Bank’s estimation, the debt-to-GDP ratio will hover around 30.7 per cent in this fiscal, 34.4 per cent in fiscal 2018-19 and 37.6 per cent in fiscal 2019-20.

The World Bank has suggested for realistic budget to minimise the fiscal deficit. “Budget deviation has risen sharply in last two years due to unrealistic budget estimates, which has continued in ongoing fiscal as well,” said Damir Cosic, senior country economist of World Bank Nepal.

Transfer of funds to the sub-national governments for the decentralised service delivery has not propelled higher spending of the government. Out of the Rs 150 billion transferred in the first half to the local bodies, around Rs 93 billion remained unspent. The government transferred entire grant amount of Rs 225 billion by mid-March of this fiscal in three different tranches. However, unfinished fiscal architecture in the federal setup has caused difficulties in realising the expenditure.

The federal government has been raising debt at high interest rate to transfer the funds and manage the expenses at the federal level, but the fund has remained unspent in the coffers of the local level governments. Increase in internal debt, slowdown in remittances and sluggish exports resulted in lack of fresh deposits in banking system. Some anti-competitive practices have been witnessed in banking sector as banks have curtailed interest rate after they failed to track fresh deposits to prevent reshuffling of funds among banks.

Lending growth has also slowed down due to lack of funds in the banks. Banks have floated more loans for the import of capital goods than for the import of consumable goods. The widening trade deficit and declining growth of remittances are pushing the current account deeper into deficit in recent months, as per the World Bank.

The World Bank has projected that the growth and inflation will drop below that of current fiscal till fiscal 2019-20. However, the current account deficit will widen considerably in coming fiscals. Current account deficit widened to Rs 153.96 billion in first eight months of this fiscal from a deficit of Rs 6.31 billion in the same period of the previous year.

“The decline in outflow of migrant workers has continued and the growth of remittances has significantly slowed over the last two years. Further slowdown could result in sharper deterioration in the balance of payments,” said Sudyumna Dahal, an economist and co-author of the update. “Slower growth of remittances could further slow accumulation of deposits in the financial sector.”

Slowdown in remittance growth, sluggish export performance and skyrocketing imports have caused depletion in foreign exchange reserves as well.

The World Bank has recommended the government to adopt the transitional plan citing the problems are caused by the lack of a unified transition management plan. As per World Bank, among the three areas — fiscal, administrative and functional restructuring under the federal setup — fiscal restructuring has made some progress, but the other twoareas are witnessing slow progress. The new government has yet to take formal decisions on the recommendations made under the administrative and functional restructuring.

“Thus, institutional responsibility for the management of the transition remains scattered across the different agencies. Consequently, greater clarity on the overall transition is needed through development, adoption and execution of an adequately sequenced and time-bound plan,” says the World Bank’s update.