After a 75-day lockdown, Nepal is slowly emerging out of a nationwide shutdown and extended travel restrictions. Like many countries facing the global COVID-19 pandemic, policymakers in the Government of Nepal (GoN)had a stark choice to make - public safety vs economic vitality. Despite measures to curb the spread of the pandemic, the past month saw an exponential rise in COVID-19 transmissions with official estimates from the Ministry of Health and Population exceeding 14,500 as of July 2, 2020. The government has finally considered a phased re-opening of the country, a substantial lightening of the lockdown, growing anger and frustration both from the public and private sectors prior to the June 15, 2020end date.

Economic Ramifications

Although the pandemic has not yet taken the form it has in many other countries, key statistics have begun to emerge on the immediate and longer-term impacts and effects of the lockdown that has adversely affected the Nepali economy. Just during the first month of the lockdown, economic loss was approximated at USD 2 billion. In May, the Central Bureau of Statistics (CBS) decreased Nepal’s growth estimates from 6.7% to 2.2%; actual numbers may go further down- the World Bank’s most recent(June) projection stands at 2.1%.A sector-wise examination reveals dire circumstances for several of them, particularly tourism, manufacturing, certain sub-sectors in agriculture, Small and Medium Enterprises (SMEs), and banking. Manufacturers in Nepal face further challenges across sectors of having to import the necessary raw materials as well.

The year 2020, heralded as Visit Nepal Year, ushered the country into the new year with significant investments into the hospitality industry with over 10,000 rooms added, construction of 5-star hotels and plans for a second international airport. Given the scale of investments in the tourism sector and at least a 2-year rebound delay, the credit risk exposure at upwards of NPR 1.5 billion is a serious concern for the financial sector. The banking sector, whose survival is vital for a healthy financial system was already suffering from liquidity issues prior to Covid-19. It will now face further challenges ranging from principal payments, finding the flexibility to refinance and restructure, and increasing access to finance for bailouts. Given the interconnectivity of the sectors, the fall in remittance, the loss of income, declining purchasing power and collapsing demand, restarting the economy will be an uphill task.

With less than two weeks remaining in this fiscal year, the purpose of the relief packages introduced earlier in April and May has not only fallen short for big and small businesses but has had no economic impact to provide some respite until the next fiscal year. At face value, the two relief packages introduced by prior to the annual Budget Speech on May 28 appeared as immediate introductory response measures. Among these provisions, salient features included a decision by the Central Reserve Bank- Nepal Rastra Bank (NRB) - to bring down interest rates on loans, GoN’s commitment to increase its refinancing fund to NPR 100 billion and to defer the interest payment period for one quarter. Yet, reduced earnings and decreased consumer spending due to stay at home orders have resulted in a severe market liquidity crunch as the sale of goods and services has come to a grinding halt. The lockdown has pushed numerous businesses to the brink of collapse, forcing closures, resulting in substantial wage reductions, if not full termination and unemployment. The World Bank has projected Nepal’s economic growth to decelerate to 1.8% with a couple of weeks remaining in the fiscal year, and even with the recent relaxation and incremental-opening, it is difficult to imagine the economy functioning at full capacity any time soon; especially considering the real possibility of a second wave and lockdowns being re-imposed. Hence, the private sector’s request across all sectors for a stimulus of NPR 200 billion which is around 5.5% of the GDP.

Fiscal Firepower Falling Short

While the private sector expected a fiscal stimulus package, GoN only tweaked the monetary policy in its next year’s budget. The relief packages provided subsidies on interest rates to Small and Medium Enterprises (SMEs), but not at the required levels.SMEs will require a strong stimulus package to boost productivity as they are the largest employment generator in the private sector. They were provided minimal relief in the form of lowered interest rates. Given the economic fall-out, it is difficult to envisage SMEs even meeting the minimum threshold of NPR 2 million in annual transactions to qualify for a 75% exemption; a tax-specific measure providing an exemption on income tax for SMEs in the annual budget. The lockdown has wiped out what little revenues and savings SMEs might have had, and the harsh reality is that many businesses and companies will not come back from this crisis. Many of them might not apply or have access to intermediaries’ like Nepal Agribusiness Innovation Center (NABIC)to provide support to the small businesses to navigate the requirements in accessing credit and financial resources they would have been eligible for prior to the lockdown. While big businesses might secure funds, smaller ones will find this profoundly problematic as younger firms always find it harder to survive during economic slumps.

The relief packages mostly centered on easing upcoming interest obligations and offered a few provisions on refinancing while completely ignoring larger alarming issues like disruptions in supply chains. The GoN had the opportunity to rectify this while announcing the annual budget but still seem to have missed the implications of global supply chain disruptions and bottlenecks in the aftermath of the lockdown placing further complications in the Nepali market and impeding the revival of the economy. In this regard, the government has only mustered a bleak provision allocating NPR 1 billion for local governments to build 200 cold stores, missing the opportunity to re-think strategies for import, export, production, storage and distribution; even this could be better executed if GoN would outsource such jobs to the private sector. The GoN owned Food Management and Trading Company’s recent decision to outsource home delivery service of the essentials in their warehouse to Sastodeal, an online shopping store in Kathmandu, indicates progress in regard to GON's willingness to utilized private sector expertise and optimize efficiency. Sastodeal’s offer to provide supply chain assistance to the GoN’s otherwise unheard-of warehouse also reveals the private sector’s appetite to work with the government. Even though with few progressive collaboration between the GON and the private sector, the budget falls short on having the vision to tap into the potential of the private sector in terms of guaranteeing strengthened supply chains.

The budget has also failed to deliberate on making supply chains more resilient by diversifying the sources, in turn, deconcentrating risks and achieving enhanced economies of scale. Further, it has missed the chance to break the dependency on imports from select countries, especially given the worldwide panic in terms of impending food shortages prompting major suppliers like India to impose export restrictions. It wasn’t so long ago that the neighbor to the south went through an onion shortage and therefore banned the export on it; yet again demonstrating how foreign policy can be centered around ‘food supply’ as well. Going further, consideration should be given to assess the feasibility of replicating the thought process of numerous governments as they strive to draw manufacturers currently operating in China but looking to relocate.

A couple of weeks leading up to the announcement of the budget also saw criticism on the lack of deliberations on priorities. There was a growing call to re-allocate unspent money from the parliamentarian’s development fund, which claims roughly NPR 20 billion per year from the annual budget, towards COVID-19 response; coupled with calls to completely stop allocating funds through this channel going forward. While it was hard to envision funds being diverted away from parliamentarians as the incumbent government continues to scrap to find solid ground, the budget announcement was indeed an opportunity for the government to demonstrate an intention to mitigate further deterioration of the economy and commit to its rehabilitation. The budget only showed a reduction in such pork-barrel funding with provisions continuing its promotion in the next fiscal year, along with increased health budget, subsidies in loans for new businesses, and ambitious plans for infrastructure development among others. However, the GoN’spast performance in collecting revenue and ensuring expenditure raises questions on the viability of these plans.

Revenue Collection and Expenditure

GoN’s historical reliance on revenue collection through taxation to meet its fiscal expenditure obligations over the years now presents a looming crisis. Last year, the country’s revenue to GDP ratio stood at 22%, national income collected through taxes, of which almost 90% was made up of tax revenue[1] More . Direct taxes (collected from payroll) and indirect taxes (collected from consumers pending) both have been affected and therefore has lowered revenue collected from taxation. Both public and private sector confidence are at record lows. COVID-19 has exposed serious fault lines in the current fiscal budget and the next upcoming one as well, given the dependency on taxable revenues.

It is not only the reliance on revenue from taxes but also GoN’s track record itself on collecting taxes that has been poor; the Financial Comptroller General’s Office April Report documented only 53.46% of targeted total revenue from taxes was collected in the first three-quarters of the fiscal calendar. Now with less than a month left in the fiscal calendar, theMinistry of Finance has voiced further challenges in revenue collection due to the lockdown crippling government’s ability to sustain daily expenditures like salaries. Moreover, the Supreme Court has ordered taxpayers to be given another month after the lockdown is ‘completely’ lifted to pay their dues which means the government will not be collecting any more taxes this fiscal year.

With reduced levels of consumption worldwide, experts envision governments to become the only engine of consumption for the foreseeable future. As of today, most of the final quarter has passed by in lockdown. Most infrastructure and capital expenditure are incurred towards the end of the fourth quarter and that too inadequately as manifested by GoN spending only 38% of capital expenditure allocation in FY 2018 – 2019 and only spending around 26% of the budget allocated for this fiscal year at the end of the third quarter. Hence, at a time when public spending is needed the most, the re-allocation of budget and the lockdown poses to further cripple the economy. The GoN’s imposition of a nation-wide lockdown coupled with the practice of aversion behavior by citizens with social distancing has no doubt yielded reduced incomes from both the supply and demand sides. Therefore, government spending designed to stimulate the economy first demands a serious reduction of costs and a commitment to getting leaner; given that government’s revenue will seriously collapse due to several factors including contracting revenues from direct taxation, reduced revenues from import duties with the drop in imports of luxury vehicles, and falling revenues from excise duty which have always served as robust and constant streams of revenue.

The Longer Road to Prosperity

The next six months will be critical in evaluating the GoN’s forecast of a V-shaped economic recovery and its own projection of a 7% economic growth rate in next year’s budget. The government needs to go beyond a few guidelines hastily put together with minor tweaks in monetary policy to ride out the current crisis and kickstart production. The growing need for a stimulus package will only increase in the days to come, with additional policies that support an expansionary fiscal policy along with coherent provisions for debt-financing

The Current Macroeconomic and Financial Situation Report released by NRBshows the Balance of Payment (BoP) at a surplus of NPR. 120.9 billion. This comes as a result of increased Foreign Direct Investment in the past year, along with decreased import expenses as a result of distressed demand and lowered consumer spending. However, the continued rise in cases and the potential second wave as observed across many countries that have been able to flatten the curve, pose significant hurdles in meeting ambitious growth targets to maintain foreign currency inflows as BoP surplus diminishes. Furthermore, declining remittances (though currently less than was feared) also hint at current accounts remaining at a deficit going forward.

The impact of the lockdown is still unfolding with the financial sector looking towards the end of year fiscal reporting and closing of balance sheets. Given the uncertainty and economic ramifications still being observed, the true picture of the damage will only be clear in the next quarter of the new fiscal year. However, if the backlog of interest payments and deferral continues, coupled with a delayed monetary policy, the first quarter of the fiscal cycle 2020-2021 is something to watch out for the Nepali economy.

An approach to policymaking that takes all these above factors into account might involve a reduction of taxes complemented by increased government spending. Where will the government find this money? It could very well explore the idea of increasing its internal borrowing through the public – some pockets of the population may now have increased savings - or from private businesses who are now putting all private investment plans on hold and are practicing austerity measures. There is a need to address the shrinking private sector in an economy which was already contracting before the lockdown. Further, the decline in aggregate demand leading to increased levels of unemployment will also mandate increased government spending along with the need to inject capital into the private sector. However, if this is not a possibility for our economy, then it at least re-enforces the argument to re-visit current operational costs.

The incumbent government’s rise to power was paved by dreams for a “Prosperous Nepal, Happy Nepali”, a highly touted slogan with self-reliance as its centerpiece. While ‘self-reliance’ and deglobalization may become the word covering the populist agenda across countries, the institutional void and delayed regulatory measures to manage the crisis is further proliferating and derailing public and private confidence. TheGoN’s failure to adequately respond may very well catapult the looming economic crisis which started as a health crisis further into a political crisis, ultimately leading to a crisis of an existential nature for the state.

Ashray Bikram Pande is a Senior Program Officer at The Asia Foundation, Samarjeet Singh Thapa is a Program Associate at The Asia Foundation