NEPAL'S ANNUAL BUDGET HEAVY ON FOREIGN ASSISTANCE

C O N F I D E N T I A L KATHMANDU 001920 SIPDIS SIPDIS MANILA FOR PSPELTZ E.O. 12958: DECL: 07/18/2016 TAGS: ECON EAID EFIN NP SUBJECT: NEPAL'S ANNUAL BUDGET HEAVY ON FOREIGN ASSISTANCE REF: A. KATHMANDU 1688 ¶B. KATHMANDU 1906 Classified By: Charge d'Affaires Nicholas Dean. Reasons 1.4 (b/d). SUMMARY -------------- ¶1. (C) On July 12, Finance Minister Ram Sharan Mahat presented to Parliament the Government of Nepal's (GON) USD 1.97 billion annual budget for FY 2006/07, which was 28 percent higher than in FY 2005/06 (Note: Nepal's fiscal year runs from July 15, 2006 - July 14, 2007. End Note). Mahat said the budget was aimed at institutionalizing the democratic system and establishing peace through constituent assembly elections. The budget included an ambitious 72 percent increase in the amount of revenue collected from foreign grants. Representatives from the International Monetary Fund (IMF) and Asian Development Bank (ADB) told us the budgeted revenue from foreign grants was too high. Foreign Grants will depend on the outcome of the peace process and whether donors give final commitments to tentative commitments already given. The ADB and IMF both discussed with the GON ways to speed up its allocation process so that foreign assistance could be spent properly within the fiscal year. The Maoists were not happy with the budget, because, among other things, it failed to address land redistribution. End Summary. FINANCE MINISTER ANNOUNCES AMBITIOUS BUDGET TO PARLIAMENT -------------- -------------- ¶2. (U) On July 12, Finance Minister Mahat presented to Parliament the GON's FY 2006/07 USD 1.97 billion annual budget, which was 28 percent higher than in FY 2005/06. Mahat said the budget was aimed at institutionalizing the democratic system and establishing peace through constituent assembly elections. The budget allocated USD 1.15 billion for recurrent expenditures, USD 616 million for development (capital) expenditures, and USD 207.8 million for principal payments of domestic and foreign loans. In order to meet government expenditures, the GON's budget called for the GON to collect USD 1.73 billion from internal revenue and USD 325 million in foreign grants (a 72 percent increase over FY 2005/06). Of the remaining USD 476.8 million budget deficit (40 percent increase over FY 2005/06),USD 231.6 million is budgeted to be met by foreign loans, the rest by domestic borrowing. ¶3. (U) Key FY 2006/07 budget expenditures included: 
 --USD 13,700 to each of Nepal's 75 Village Development Committees (VDC) (100 percent increase over last fiscal year), --USD 311 million for education. --USD 127.4 million for health. --USD 109.6 million for road construction, --USD 54.2 million for agricultural development, --USD 17.1 million for constituent assembly elections, --USD 139.4 million for defense (decrease of 17 percent),and --USD 3 million for the royal palace (decrease of 45 percent compared to last year's budget, a 70 percent decrease compared to actual expenditures). The first five items are part of the GON's efforts to restore government institutions and services to the Nepali people. "SENSIBLE" BUDGET, BUT DOUBTS OVER REVENUE COLLECTION -------------- -------------- ¶4. (C) IMF Resident Representative Sukwinder Singh told Emboff that the macro-economic framework of the budget was "broadly sensible" and very much in line with what the IMF had previously discussed with the GON. He added that this budget did not accelerate domestic borrowing and was "fairly responsible." ADB Country Director Sultan Hafeez Rahman commented that it was an expansionary budget, with a 28 percent increase in total expenditures while the average increase for the last four years was 10 percent. He said the 16 percent increase in revenue collection was "super ambitious." Businessman Rajendra Khetan felt the revenue projection was "too optimistic." Bishwambher Pyakuryal, President of the Nepal Economic Association and Professor of Economics, commented that the GON implementation mechanism remained weak. He worried that if the all the budgeted money could not be spent inflation might increase. Former Finance Minister Prakash Chandra Lohani wrote in an op-ed that the GON had made an ambitious budget without considering whether or not it could attain the specified results. FOREIGN ASSISTANCE FIGURES ARE HIGH -------------- ¶5. (C) Many of our interlocutors felt the anticipated revenue from foreign grants was too high. Rahman commented that the 72 percent increase in foreign grants was "not realistic." However, he added that if the peace process went well and the international community accepted the outcome, Nepal could get significant commitments as "there is a lot of sympathy for Nepal" among donors. Rahman noted that British Department for International Development (DFID),the European Union (EU) and some of its constituent countries were planning to raise their funding levels. Singh noted that most of the USD 325 million in foreign grants had been accounted for, but lacked final commitments from donors. Former Finance Minister Lohani said the ambitious estimates of foreign grant assistance were based on commitments by foreign donors, but noted that it takes a lot of time for foreign aid to be processed and allocated. To put the 72 percent increase in context, observers note that foreign assistance was significantly cut last year as donors reacted to the royal coup of February 2005 and a deteriorating security environment. As a result, the 72 percent increase is based on a relatively low level from last fiscal year. DEVELOPMENT SPENDING NEEDS TO BE ACCELERATED -------------- ¶6. (C) IMF Resident Representative Singh said the GON needed to accelerate development spending. He noted that, based on IMF discussions with the GON, the GON had agreed to find ways to get money allocated earlier in the fiscal year. However, he cautioned that implementation was largely dependent on the pace of political progress. Lohani stated that, in years past, by the time the GON processed donor money there was little time to spend it and that was the reason more than 50 percent of foreign assistance went unspent in FY 2005/06 (ref A). ¶7. (C) ADB Country Director Rahman opined that it would be challenging for the GON to spend all of its development expenditures in FY 2006/07 as the allocation process was very political and there were many internal tensions in the GON. He explained that he had advised Finance Minister Mahat to develop a coordination committee for government allocations. Rahman said he had suggested to Mahat that the coordination committee meet at least twice a month. As an economist, Rahman acknowledged that the country needed fiscal stimulus. He said much would hinge on the implementation of development expenditures, noting that it was easier to make politically popular recurring expenditures like salaries. EXTRA MONEY TO VDCS WILL BE DIFFICULT TO SPEND -------------- - ¶8. (C) The GON doubled the amount of funds given to VDCs in an effort to restore government services to all Nepalis. Singh noted it was "hard to understand" how VDCs would be able to spend a 100 percent increase in funds when the national government framework was still in flux. He opined that it would likely be a long time before VDCs would be fully operational. Rahman questioned the increase in funds to VDCs, noting that very few were functioning and many were influenced by Maoists. Lohani questioned how the GON could implement any programs at the VDC levelQhen there were no elected representatives in the VDCs. Not withstanding these objections, the pro-poor budget does represent a commendable attempt by the GON to fund development activity throughout rural Nepal and to empower locaQcommunities. MAOISTS UNHAPPY WITH BUDGET -------------- ¶9. (C) Several economists and businessmen noted that the budget was not prepared in coordination with the Maoists and failed to address the goal of Maoist land redistribution. Although Finance Minister Mahat had consulted with many different groups, he had told us earlier that the GON did not intend to consult with the Maoists to seek their approval. He told the media "there is nothing which should be unacceptable to the Maoists," Maoist leader Dev Gurung complained the budget was regressive and that his party "cannot endorse what the government has presented today." He added that the GON had not announced programs that could increase investment in productive sectors and redistribute land in a fair manner. Rahman thought it was smart of the GON to not address the Maoists' desire to redistribute land in the budget. He said he had advised the GON to engage the Maoists on the issue and to stress that there were market principles that could be used to address land issues and therefore no need to buy and redistribute land. MORE MONEY FOR MARTYRS FAMILIES, LESS FOR THE PALACE -------------- -------------- ¶10. (U) On July 16 Parliament passed an interim spending measure until the House of Representatives approves the budget. Based on Parliamentary discussion, Mahat announced that the GON had decided to increase the monthly allowance to families of pro-democracy movement Martyrs from USD 41 to USD ¶68. Mahat also stated that the budget of the royal palace would likely be gradually decreased. COMMENT -------------- ¶11. (C) Implementation of the GON budget lies largely with how the peace process unfolds. The GON will have to reach an internationally accepted peace to receive final donor commitments for most of the foreign funds. The GON also needs to adopt measures to quickly allocate funds if it hopes to spend all its foreign assistance money within the fiscal year. In the meantime, however, the GON demonstrated it was working for the benefit of the Nepali people, despite displeasing the Maoists. The Maoists' criticism of the budget -- as well as that of others -- is as much about process as substance. Players and would-be players continue to jockey for position to enhance their political clout. DEAN