Fiscal Deficit and Deficit Financing

2.29 A situation of fiscal deficit or deficit financing refers to a state wherein revenue
collection of government including tax and foreign grants together with other
receipts is less than government expenditure. As expenditure of Nepal government
is higher than its income, it has been facing the situation of budget deficit or deficit
financing for quite a long time. In such a situation, the government manages funds
to meet its expenditure either through the change in cash reserves or through
domestic borrowings or loans from foreign countries and donor
agencies, or any of these measures. Due to inability of Nepal
Government to meet its expenditure from receipts of taxes, grants and
principal repayment receipt, necessary amount for expenditure is
garnered by using various instruments of financing including external
and domestic borrowings. The detail of Nepal governments fiscal
deficit and its sources of financing from fiscal year 2010/11 to 2014/15
are presented in Table 2(g).

In fiscal year 2011/12, government budget deficit reached the figure of

Rs. 51.18 billion with an increase of 3.2 percent. However, such deficit
dropped by 51.7 percent to Rs. 24.71 billion in fiscal year 2012/13. As
compared to its preceding fiscal year, such deficit in fiscal year 2013/14
totaled Rs. 38.15 billion with a growth of 54.39 percent. Fiscal deficit is
anticipated to soar up by 170.7 percent reaching Rs. 103.28 billion if all
budgetary allocation estimated for the current fiscal year gets spent.
The share of fiscal deficit to GDP, which stood at 3.4 percent in fiscal
year 2011/12 had dropped to 1.5 percent in fiscal year 2012/13 and
stood at 2.0 percent 2013/14, whereas this is expected to rise thereby
reaching 4.86 percent in the current fiscal 2014/15.

2.31 Government of Nepal has been financing its budget deficit through
domestic and external debt mobilization. In a situation where
expenditure could not be met by raising debts, shortfall amount is
32
funded through change in cash reserve. The net budget deficit which
stood at Rs. 51.18 billion in fiscal year 2011/12 was borne through
foreign debt of Rs. 11.08 billion, domestic borrowings of Rs. 36.41
billion and rest Rs. 3.68 billion through change in cash reserve. Though
the budget deficit in fiscal year 2012/13 was Rs. 24.71 billion,
government mobilized Rs. 31.01 billion through foreign and domestic
borrowings. In fiscal year 2013/14, a sum of Rs. 41.11 billion was
mobilized through foreign and domestic borrowings. Despite
mobilization of foreign and domestic borrowings in fiscal year 2011/12
decreased by 8.2 and 14.3 percent respectively as compared to
preceding fiscal year, foreign debt mobilization rose by 8 percent while
domestic borrowings mobilization rose by 76.7 percent and 4.94
percent in fiscal year 2012/13. To meet the budget deficit of current
fiscal year, government has aimed at raising Rs. 49.52 billion of foreign
debt and Rs. 52.75 billion from domestic borrowing. This amount is
higher by 148.5 percent than total debt raised in fiscal year 2013/14,
134.35 percent higher than foreign debt and 164 percent more than
domestic borrowings.
2.32 In recent years, volume of foreign loan receipt of the government has
not increased though the volume of domestic borrowing is on the rise.
The government was mobilizing about 25 percent foreign resource
towards meeting its financing resource gap until fiscal year 2011/12,
which it went up to 38.6 percent in FY 2012/13. Foreign loan receipt in
first eight months of current fiscal year stood at Rs. 14.21 billion as
compared to the receipt of Rs. 13.45 billion in the corresponding period
of the previous fiscal year. Contribution of foreign debt for financing
the budget deficit in current fiscal year is expected to rise further
reaching nearly 50 percent.
Total Public Debt and Repayment
2.33 Outstanding debt of Nepal in the form of foreign and domestic debts
that stood at Rs. 545.31 billion by fiscal year 2012/13 had increased by
1.5 percent to Rs. 553.50 billion in fiscal year 2013/14. Total
outstanding debt liability had grown by 4.2 percent in fiscal year
2012/13 as compared to its preceding fiscal year. The share of foreign
loan in total outstanding debt which stood at 61.1 percent in fiscal year
2012/13 has reached to 62.7 percent in fiscal year 2013/14. The
outstanding public debt has reached Rs. 519.50 billion by the end of
first eight months of the current fiscal year 2014/15, which is lower by
6.1 percent as compared to that of Mid-July 2014. The share of foreign
33

debt to total outstanding debt has remained at 63 percent during this

period.
2.34 The outstanding foreign debt had grown by 7.8 percent reaching Rs.
333.44 billion by the end of fiscal year 2012/13. Such outstanding debt
totaled Rs. 346.81 billion in fiscal year 2013/14 with an increase of 4.1
percent. The outstanding foreign debt of government has remained Rs.
327.11 billion by the end of first eight months of current fiscal year
2013/14 which is lower by 5.7 percent than that of Mid-July 2014.

Outstanding domestic borrowings that stood at Rs. 213.99 billion in

fiscal year 2011/12 amounted to 211.87 billion with 2.9 percent fall by
the end of fiscal year 2012/13. In fiscal year 2012/13, outstanding
domestic borrowings of government had grown by 2.4 percent as
compared to its preceding fiscal year reaching 206.68 billion. Such

borrowing has not collected in first eight months of current fiscal year.
2.36 Treasury bill has been as one of the major sources of Nepal
governments domestic borrowing. Of the total domestic borrowings
as of Mid-July 2013, share of Treasury bill stood at 64 percent,
Development Bonds at 24 percent, National Saving Certificates at 8
percent, Citizen Saving Certificates at 2 percent and IMF Valuation
adjustment bonds at 2 percent. Minor change was witnessed in the
structure of loan outstanding by the end of Mid-July 2014. The share of
Treasury bills to domestic borrowing by the end of Mid-July 2014 stood
at 66 percent, Development Bonds at 23.0 percent, National Saving
Certificates at 8 percent, Citizen Saving Certificates at 1.0 percent and
IMF Valuation adjustment bond at 2 percent. The higher share of
Treasury bills to domestic borrowing denotes higher short-term (one
year or less) liability of the government. Availability of the amount for
development and construction works shrinks if the gap between the
governments income and its short-term liability narrows down within
a fiscal year. In addition, the government either will not be able to
renew such loan or interest rate is likely to go higher even if renewed if
the volume of short term liability remains high. Hence, it is imperative
to make timely efforts so as to avoid such risk.
2.37 Of the governments total outstanding domestic borrowing, share of
Nepal Rastra Bank has been declining, while that of commercial banks
and other private institutions has continued to rise in recent years. The
share of Nepal Rastra Bank to its total outstanding domestic borrowing
stood at 7.6 percent and that of commercial banks at 71.1 percent and
other institutions and private sector at 21.3 percent until mid-July 2013
against the respective figures of 11.6 percent, 67.6 percent, and 20.8
percent by mid-July of fiscal year 2014. The declining trend in the
share of Nepal Rastra Bank to domestic borrowing and increasing
trend in commercial banks and private sector have indicated that the
government is committed towards complying with financial discipline.
35
Government reliance on domestic capital market to cope with budget
deficit will ensure security of the government bond market, minimize
risk of foreign exchange loss by reducing share of external debt in
public debt and also help in the development of overall capital market
of the country. The government relying more on capital market than on
Nepal Rastra Bank while financing its fiscal deficit can be regarded as
the strength of public financial management.
2.38 Public debt is decreasing mainly due to principal repayment of
domestic borrowings without accepting additional domestic
borrowings and falls in exchange rate as it occupies majority share in
foreign borrowings. Exchange rate of S.D.R. that stood Rs. 148.299 in
mid-July 2014 has dropped to Rs. 137.104 by mid-March 2015. As a

result of falls in exchange rate, foreign loan liability which was nearly
Rs. 2 billion in SDR denomination has decreased by more than Rs. 20
billion.
2.39 In fiscal year 2012/13, expenditure on repayment of principle and
interest had increased by 38.3 percent as compared to preceding fiscal
year reaching Rs. 48.87 billion, while such expenditure had declined by
7.6 percent totaling Rs. 45.11 billion in fiscal year 2013/14. The
repayment of principle and interest on public debt that accounted for
approximately 10 percent of total government expenditure in last two
fiscal years has reached to 9.45 percent in fiscal year 2013/14.
Expenditure on repayment of principle against foreign debt and
domestic borrowing had stood at Rs. 35.32 billion in fiscal year 2012/13
with rise of 17.93 percent as compared to that of its preceding fiscal
year. However, expenditure against interest on foreign debt and
domestic borrowing that had stood at Rs. 13.73 billion in preceding
year dropped by 12.37 percent in fiscal year 2013/14. Of the total
expenditure made towards repayment of principle in fiscal year
2012/13, foreign debt shared 40.4 percent of total expenditure while
such expenditure remained at 39.9 percent in fiscal year 2013/14.
Likewise, interest expenditure on domestic borrowings shared 78.1
percent and 72.02 percent of total expenditure on interest payment
made in fiscal year 2012/13 and 2013/14 respectively.
2.40 The share of public debt to GDP seemed to have declined in recent
years. It had remained at 40.7 percent in fiscal year 2008/09 which
36
continued to fall in its succeeding years and arrived at 32.5 percent in
fiscal year 2010/11. Such share that had marginally increased to 34.3
percent in fiscal year 2011/12 came down to 28.7 percent in fiscal year
2013/14. The ratios of net outstanding foreign debt and domestic
borrowing to GDP that stood at 19.7 percent and 12.5 percent
respectively in fiscal year 2012/13, has dropped to 18.0 percent and
10.7 percent respectively in fiscal year 2013/14. The ratio of net
outstanding foreign debt to GDP remained at 19 percent by the end of
fiscal year 2010/11. The share of outstanding public debt to GDP
seemed to have remained away from worrying state as per
international standard.
2.41 The role of public debt is not only limited to financing fiscal deficit of
the government. It has also played vital role in the construction of
physical infrastructures and in public service delivery required for
overall economic development of the country. Nonetheless, foreign
and domestic debts that are accepted every year to finance fiscal deficit
have further increased countrys liability of outstanding domestic as
well as foreign debt principal and interest payable thereon. There are
several examples that most of the countries in the world have been

facing a number of predicaments due to their inability to payback their

loans on time. In this context, it is necessary to think for Nepal
towards assessing risks inherent in public debts and managing them
accordingly thereby assessing and containing the costs within a
desirable limit.

3. Price and Supply

Inflation Structure and Trend
3.1 Inflation rate is the prime indicator of macroeconomic stability.
Inflationary fluctuations adversely affect savings, investment, and
economic growth. Therefore, price stability is a pre condition for
achieving higher and stable of economic growth rate. Hence,
macroeconomic policy tends to focus on maintaining price stability.
3.2 Nepals inflation rate for past 10 years has averaged 8.4 percent.
During this period, average inflation rate of food and beverage group
stood at 10.4 percent, while that of non-food and services group
remained at 6.7 percent. Likewise, average inflation rate of last five
years stood at 9.3 percent. During this period, average inflation rate of
food and beverage group stood at 11.8 percent and that of non-food
and services group was 7.2 percent. Food and beverage group has
contributed more to higher inflation rate than non-food in past few
years. Historical observation also reveals that price of food and
beverage group has remained higher and volatile as compared to nonfood and
services group.
3.3 Inflation is generated from demand and supply side. Monetary policy
mainly focuses on containing inflation that is generated through
aggregate demand side. For this, containing money supply within the
desired level becomes necessary. However, price stability could not be
maintained just by containing money supply as inflation rate tend to be
higher even when Nepal is successful in maintaining monetary
expansion at the desired level.
3.4 Supply and structural factors are more responsible than demand side
for Nepal's higher inflation rate since past few years. Inflation is the
product of low supply in comparison to demand due to market
imperfections and structural rigidness. Effect on agricultural
production due to adverse climatic condition; frequent closures,
strikes, load-shedding and political instability negatively affecting
production oriented activities, and supply situation; rise in costs of
goods and services due to persistent transporters' cartels; steady rise in
laborers' wage rate; volatility in prices of petroleum products;

Nepalese currency depreciating against US Dollar; increasing trend of

hoarding due to inadequate market monitoring; increase in price of
agricultural produces due to middlemens growing influence; and
emergence of uneasy situation in the distribution system are among the
major reasons for higher inflation. Likewise, Nepals open border with
44
India, pegging of Nepalese currency with Indian currency, and trade
with India occupying two third of Nepals total trade volume have
been the factors that have direct influence of inflation in India over
inflation in Nepal.
Overall Consumer Price Situation
3.5 Consumer Price Index (CPI) based annual inflation rate that stood at
8.9 percent in the first eight months of FY 2013/14 slid a little resting at
7.0 percent in corresponding period of the current fiscal year. During
the review period, price index of food and beverage group on annual
point-to-point basis stood at 9.5 percent while such price index of nonfood and
services group remained at 4.9 percent. The price indices of
these groups were 10.8 percent and 7.1 percent respectively in the same
period of the previous fiscal year.

Average consumer inflation rate in first eight months of the current

fiscal year has been 7.2 percent. It was 9.0 percent in the corresponding

period of the previous fiscal year. The average consumer inflation rate
of the first eight month of current fiscal year has been lower than 8.0
percent as targeted by the monetary policy made public by Nepal
Rastra Bank and by its mid-term review. CPI based inflation rate in the
45
review period stood lower than the set target owing to reduction in the
price of petroleum products in international market, stability observed
in foreign exchange rate, attempt to contain monetary aggregates
within the desired limit, steps taken for managing liquidity, and
decline in consumer inflation rate in India.

By geographical regions, price indices of Kathmandu valley and hills

recorded an increase of 7.1 percent during review period of current
fiscal year. Likewise, consumer price index of Terai has increased by
6.9 percent during the same period. These figures were 8.7 percent, 7.9
percent and 9.5 percent during the same period of previous fiscal year.
3.8 Group-wise analysis of CPI shows that price of food and beverage
group, which carries 46.8 percent weight in CPI, increased by 9.5
percent by mid-March 2015 on annual point-to-point basis. Such
growth rate had remained at 10.8 percent in the same period of the
previous fiscal year. Increase in the price index of tobacco products,
liquors, dairy products and eggs and pulses (lentils) played major role
for the increment in the price of food and beverage group. As a result,
price indices of goods by sub-group namely, tobacco products rose by
26.6 percent, liquors by 21.1 percent, dairy products and egg by 16.8
percent and pulses by 16.7 percent.
3.9 The price of non-food and services group that carries 53.2 percent
weight in CPI has increased by 4.9 percent in mid-March 2015. This
index had increased by 7.1 percent during the same period of the

previous fiscal year. Due to the lower growth rate of price indices of all
sub-groups except that of communication sub-group under this group,
the growth rate of price index of this group has been low as compared
to that of previous fiscal year. Price index of clothing and foot-wears
46
sub-group among non-food and services group recorded the highest
growth of 10.0 percent while price index of communication sub-group
has registered the least growth of 0.3 percent.