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Public Expenditure Review 2000 - An Executive Summary of the Main Report
- Nepal, with a per-capita income of only $210 p.a., is the ninth poorest country in the world. Nearly half of its population is below the poverty line; and her social indicators, though improving over time, are comparable to those of poorer African countries. Much of this backwardness is attributable to centuries of political and economic isolation, a land-locked mountainous terrain, and a late start in development -- Nepal embarked on economic development very late, only in the nineteen fifties. Since then, considerable public resources, supported by external aid of the order of 6% of GDP p.a., have been spent on promoting development, with noteworthy progress in many areas. Government spending, on average, has been nearly one fifth of overall GDP; and its share of monetized GDP has been significantly higher. Nevertheless, there is considerable evidence that a large share of these resources have been misspent. With the incidence of poverty around 42%, unchanged over the last 25 years, particularly in rural areas where 90% of the population live and work, the country can ill-afford waste of its scarce resources. The main objective of this report is to identify the incentives and institutional factors that lead to this waste and propose remedies.
- Nepal's macroeconomy is reasonably sound, with an improving balance of payments, adequate foreign exchange reserves (equivalent to about nine months' imports), relatively modest inflation, fiscal deficits financed largely by external aid and relatively low levels of domestic borrowing. However, it is stuck in a low level equilibrium, with declining investment, modest economic growth, high population growth (2.5% annual rate) and, as noted, widespread poverty. In addition to poor use of public resources, Nepal has also been unable to establish a policy framework conducive to high levels of economic growth. Although a brief period economic reforms led to a significant acceleration of economic growth (from an average of 4.6% p.a. in the second half the eighties) to about 5.6% p.a. in the early nineties, since then the growth rate has decelerated to 3.9% p.a. in the mid-to-late nineties and to only 2.8% p.a. in the last two years. Moreover, even the faster growth in the early nineties largely benefited the urban areas, and the rural economy has seen little improvement. Fiscal management has been particularly weak; and fiscal stability is being maintained largely at the expense of development activity. Although public spending continues at a rate which should be sufficient to provide a reasonable level of basic public services in most countries, in Nepal there is little to show for it, particularly in rural areas, reinforcing the widespread perceptions of misuse and waste of scarce public resources.
- There are no simple explanations for the apparent ineffectiveness of public spending in Nepal. A complex web of systemic factors, which cut across virtually all sectors and projects/programs, has consistently contributed to poor implementation and development results. Among these, deficiencies in the budget planning, resource allocation and expenditure management process have been a major factor contributing to low productivity. These are evident at many points in the budget cycle: (i) Budget preparation is bifurcated, with the Ministry of Finance (MOF) preparing the "regular budget" and the National Planning Commission (NPC) preparing the "development budget." These two budgets are not well integrated; and resources are often allocated on an incremental basis (based on previous year's utilization and negotiating strengths of implementing agencies) rather than on resource needs of projects/programs and well-considered priorities. (ii) The budget (particularly its development component) is heavily over-programmed. Because of political pressures to accommodate new projects, resource estimates (for both revenues and external aid) have been consistently over-optimistic, permitting the size of the budget to be set at levels which are not consistent with the actual availability of resources and institutional capacity. The consequences of this approach have been predictable: too many projects chasing too little resources, and limited resources spread too thinly among too many projects. Thus, the number of projects/programs have risen from around 400 in FY94 to over 700 in FY98; and budget allocations per project have fallen to about half the level in the mid nineties, in real terms. (iii) There is little prioritization of the budget. Although there are ambitious five year plans, the link between these plans and the annual budgets is weak. Nepal still does not have a rolling three year public expenditure program which can serve as a bridge between its five year plans and annual budgets, or clearly defined sector strategies which can help define project/program priorities and guide budget allocations. (iv) Despite several years of technical assistance, institutional mechanisms for project screening and expenditure management are still weak. A rigorous process for screening new projects (particularly for fully government financed projects) or a tightly defined core program which can be used as a guide for fund release decisions has not been operative in many years. Similarly, mechanisms for monitoring actual implementation and physical progress of projects remain unsatisfactory. Although there has been considerable improvement over time in financial reporting by implementing agencies due to stronger financial monitoring by the Financial Comptroller General's Office (FCGO), this alone is not sufficient to ensure that funds have been effectively utilized to achieve expected outputs and outcomes. (v) The fund release process favors quick spenders rather than priority projects/programs, as funds are released largely on the basis of whether previous releases have been spent and accounted for by implementing agencies. However, there are instances, for example in the case of local development programs, where the FCGO cannot withhold fund releases to projects/programs even if expenditure reporting is poor or not made on a timely basis, because of political pressures.
- The lack of ownership of projects and programs by key stakeholders, notably the government and local communities, is another important factor contributing to poor performance. This is evident at several levels. At one level, many donor-financed projects which constitute about 70% of the development budget are perceived to be "donor-driven", (i.e. initiated and prepared by donors, with little involvement of and consultation with local stakeholders, and implemented sometimes directly by donors or under special implementation arrangements), rather than owned and implemented by the government. At another level, fully government financed projects also suffer from similar weaknesses. The government budget preparation process is widely perceived as a top-down process, which is unresponsive to local needs and initiatives. Moreover, many HMG projects are centrally administered and managed through line ministries and departments and their district offices, with little involvement of local beneficiary/community groups. An inevitable corollary of weak ownership is a lack of commitment to such projects, manifested in insufficient budget allocations and fund releases, long delays in fulfilling agreed effectiveness conditions and long completion delays, inadequate beneficiary involvement and poor maintenance.
- Institutional weaknesses remain probably the most critical set of factors affecting project implementation and the effectiveness of public spending across sectors in Nepal. Institutions at all levels -- NPC, line ministries, local governments, village committees etc -- are weak. The requisite technical skills are lacking at many points, while motivation is a systemic issue. An important reason for these deficiencies is the weaknesses in the public administration system itself: over-staffing, low salaries, low compression ratios, political interference in appointments and transfers, inadequate recognition of efficiency and performance etc. These in turn affect public resource management directly. As noted, the capacity to monitor the implementation of the public expenditure program is weak at all levels. Inadequate supervision, poor financial management, dilatory government procedures and lack of co-ordination among government entities, are some other indicators, all of which lead to poor development results. The recent experience of local development programs provides a good example of how these institutional weakness affect the quality and effectiveness of public spending. Although successive governments have strongly emphasized decentralization and channeled considerable funds to district and village councils/committees, the experience so far has been mixed. In a majority of cases, technical capacity to prepare and manage projects is low; financial reporting and accountability is poor; and irregularities and misuse of funds have been numerous. However, there are also many examples where, with appropriate technical assistance for building capacity and promoting beneficiary involvement and transparency at the local level, there have been encouraging results in terms of better allocation and use of resources and greater accountability.
- Governance issues have been a major factor undermining the effectiveness of public spending, increasingly so in the last 4 - 5 years. These have taken many forms, notably (i) excessive political interference at key points in the project cycle and (ii) increasing corruption. As noted, short-lived governments have been more concerned with starting new projects and securing access to resources rather than with effective implementation of projects/programs and development results. The most common examples have included excessive political interference in the appointments and (frequent) transfers of civil servants and project officials, political involvement even in simple procurement decisions, misuse/diversion of public funds (and project vehicles) for unauthorized purposes, and cabinet decisions serving parochial interests. This has undermined the effectiveness of public resource management in several ways. As noted, (iii) such interference has led to increased politicization of the civil service and insecurity among public officials who, to protect themselves in a uncertain political environment, pass on even routine matters to higher levels. (iv) It has also created an environment which is conducive to leakages and lack of accountability. For example, on the revenue side, it has encouraged gold smuggling as well as collusion between tax officials and tax payers in regard to customs valuation, tax assessment etc; and on the expenditure side, increased incidence of financial irregularities at various levels. (v) However, the mechanisms/legal safeguards for addressing these deficiencies remain weak. For example, although the Auditor General's recent reports have reported numerous financial irregularities, there are no effective legal or institutional arrangements to follow up on these reports and check such abuses. Similarly, although the Commission for Investigation of Abuse of Authority (CIAA) has filed several cases against various individuals in recent years, there has not been even a single case of conviction so far.
- Apart from the systemic factors discussed above, the pattern of resource allocation and use has also contributed to poor performance: (i) As noted, development budget resources have been scattered thinly among too many projects, with the result that in several cases, allocations are not sufficient to undertake any meaningful development work, in turn leading to completion delays and poor results. (ii) Government-financed projects account for only about one-third of the development budget allocations, but in practice receive the larger share of scarce local currency resources. However, given inadequate screening, monitoring and accountability of such projects, they tend to be even less productive than aided projects. A good example is local development, which receives the largest share of local currency resources, but its performance has been mixed so far. (iii) There is also considerable disconnect between the government's development objectives as articulated in Five Year Plans and annual budget allocations. In recent years, the favored sectors in terms of increased budget allocations have been power, local development and health. The combined share of these three sectors in development budget allocations has risen from 22% in FY94 to 41% in FY99. This has been largely at the expense of agriculture, irrigation and forestry. Despite their critical importance for agricultural/rural development and poverty reduction, and the government's declared commitment to the Agricultural Perspective Plan, resource allocations for these three sectors combined has fallen from 27% of the development budget in FY94 to 17% in FY99. This disconnect has been even more pronounced with regard to actual expenditures, since the combined share of power, local development and health rose from 18% of development spending in FY94 to nearly 42% in FY99, while that of agriculture, irrigation and forestry fell from 31% to 17% over the same period. In this context, it is worth noting that the relative stagnation of the rural economy has been probably the most important factor contribution to the lack of progress in poverty reduction during the past decade; and a direct link can be made between poor agricultural performance and the neglect of the agricultural sector in terms of budget allocations and their poor utilization (see below). On the other hand, power, though very important for non-agricultural sector growth, directly benefits only about 15% of the population mainly in urban areas; expenditures on local development, though having considerable potential for transforming the rural economy, have not been effectively utilized, as noted above; and increased expenditures on health have been largely channeled to support urban hospitals and construction activities without leading to any tangible improvement in rural health care delivery so far.
- The reasons for poor performance/development results however go beyond sectoral allocation and expenditure patterns. Even where resources are allocated and provided, there are considerable intra-sectoral misallocations and inefficiencies in the use of resources. Some notable examples include: agriculture, where a large part of the development budget has been used until recently to subsidize inefficient operations of the Agricultural Inputs Corporation, and where a re-vamped extension service has failed to delivery relevant crop research and improved cultural practices to rural farmers; transport, where a significant proportion of resources has been channeled to unplanned construction of uneconomic (political) road projects; primary education where, despite substantially increased funding, the drop-out rates are high and quality of education remains low; and health, where construction of rural health centers is not supported by adequate trained staff and basic drugs, medicines and equipment. Also, across sectors, funding for operations and maintenance activities has been inadequate, contributing directly to the poor quality of outputs and services, as well as to increased rehabilitation/reinvestment needs which cost several times more than the foregone maintenance expenditures. These inefficiencies are reflected across sectors, sometimes in increased unit costs, but primarily through failure to deliver public services of acceptable quality and regularity. Thus, although budgeted funds are spent, service delivery particularly to rural communities remains poor.
- In addition, in a number of instances, the benefits of public spending accrue largely to the relatively better-off segments of the community and cannot be defended on equity grounds. For example, a significant proportion of increased spending on health has largely benefited the relatively well-off urban population; and in education, a substantial part of the sectoral budget goes for higher education which has primarily benefited the upper income groups. Similarly in power, as discussed above, the benefits accrue largely to urban communities; and the rural areas where the majority of the population live are badly under-served.
- Finally, the public enterprise sector has been a major user of public resources; but its performance both in terms of financial results and efficient delivery of goods and services has been poor. Many public enterprises (PEs) are poorly managed. A recent analysis of public enterprises carried out by the Ministry of Finance shows that: (i) 28 out of 43 PEs incurred operating losses during FY98 -- the latest year for which full year data are available. (ii) The total operating profits of the entire PE sector (including operating subsidies provided by HMG to PEs) was only Rs. 1.3 billion in FY98, equivalent to 1.6% of net capital employed (i.e. share capital, government loans plus other long term borrowing). Since 4 PEs -- namely Nepal Telecommunications Corporation (NTC), Nepal Electricity Authority (NEA), National Insurance Corporation (NIC) and the Rastriya Banijya Bank (RBB) -- reported a combined operating profit of Rs. 3.4 billion (some of which may be open to question too, if proper accounting and auditing standards were applied), the other 39 PEs together made a net loss of Rs. 2.1 billion, equivalent to 10.7% of their net capital employed in FY98. (iv) Government subsidies and transfers to these PEs as equity and long term loans for financing capital investment have averaged around Rs. 2-3 billion a year in the past few years, and nearly Rs. 60 billion on a cumulative basis. However, the dividends paid by the PEs to the government in FY98 was a paltry Rs. 24 million in FY98. Moreover, most of the public enterprises (apart from NTC and NEA) have not been paying their debt service obligations to the government, which has to take over itself the responsibility of paying external lenders. Although the government does not directly guarantee the financial commitments of most public enterprises, nevertheless, the government may be exposed to substantial contingent liabilities, particularly in the case of the two largest (government-dominated) banks.
- Nepal is at a major cross roads in its economic and political development. As noted, widespread poverty and pervasive public perceptions of "failed development" have led to considerable disenchantment among the public, particularly among the rural communities, with development policies, politicians and the Kathmandu/urban elites. There are also new demands from rural communities for greater involvement and participation in decision-making and access to public resources. These pressures are to some extent an inevitable corollary of a social awakening unleashed by the democratization process; unless effectively addressed, they constitute a potential threat to the political, social and economic fabric and even to the democratic process itself.
- The government's development strategy, as broadly articulated in its Ninth Plan, emphasizes that poverty eradication is its primary development objective. It recognizes as key elements of this strategy, the need to accelerate economic growth (to 6.0% p.a. over the Plan period and to over 7% in the following decade and a half) and slow down population growth, increase employment opportunities, promote social development with fewer regional, gender and ethnic disparities and improve access to basic infrastructure. The Plan's emphasis on harnessing the growth potential in agriculture, forestry, hydropower and tourism; undertaking much-needed investments in infrastructure and human resource development; enlisting the private sector as the key agent in development, supported by complementary role for the public sector and market-oriented economic policies, are highly appropriate. The Plan however suffers from a number of weaknesses: (i) Its key targets are ambitious; (ii) It tries to do too many things in many sectors without recognizing resource limitations and priorities; and (iii) It is also doubtful whether the Plan can be effectively implemented without a significant improvement in the political environment. Indeed, in the first two years of the Plan period, the Plan's implementation performance and sectoral achievements have fallen significantly below the targets.
- Alternative scenarios show that under more realistic assumptions, resource availabilities and sustainable levels of public investment would be significantly less than anticipated in The Ninth Plan. Nevertheless, by adopting appropriate public resource management policies and economic reforms, it would still be possible for Nepal to achieve economic growth rates of the order of around 5.0 % p.a. and improve the pattern of its economic growth so as to benefit the largely rural poor, while making modest improvements in national savings and the balance of payments. Given the past record of public resource management, this however will be a major challenge.
- This report takes the view that traditional budget reforms, as important as they are, alone will not be sufficient to improve the effectiveness of public resource management in Nepal at this time. To make such reforms work, several important changes, in the political environment, behavior and attitudes and institutional capacity, will be needed.
- Efforts to improve public resource management in Nepal must begin with a re-examination of the role of the public sector in the economy. (i) Even under optimistic assumptions regarding revenue mobilization, the government's resource position will improve only modestly over the next few years; and this will severely limit what the state can do in terms of public spending. (ii) Second, given the poor record of the public sector in terms of delivering outputs and services to the public efficiently, there is little assurance that more public spending will lead to better performance. (iii) Third, the experience of many countries, including those in South Asia, clearly demonstrates that less direct government involvement, rather than more, is compatible with and conducive to faster economic growth and better provision of goods and services to consumers. Countries which rely on market forces and effectively harness the creative energies of their private sectors and civil society through liberal economic policies have a much stronger record of performance than those who do not.
- This report takes the view that, given its serious fiscal constraints, the government will need to focus its limited resources on key priority areas where such resources can be put to most effective use. (i) Wherever the private sector can undertake economic activities and/or deliver goods and services competitively, there is little justification for public involvement in such areas. (ii) Public involvement should be limited to those areas and activities which the private sector will not find attractive, i.e. where social benefits exceed private costs, but are not adequately factored in by private providers. (iii) In terms of resource allocation, on a broad sectoral basis, public resources should be channeled to such areas as agriculture and irrigation, human resource development (education, health, drinking water), rural infrastructure, poverty alleviation programs, and backward area development, among others. Additional resources are also needed for O & M activities virtually across the board. But areas such as telecommunications, power generation and tourism should be left to the private sector. (iv) Even within the priority areas identified above for public investment, there is considerable scope for private involvement within specific sub-sectors. Some notable examples include: fertilizer and seed supply and distribution, higher education, urban hospitals and air transport. (v) There is also little justification for continued government involvement in many public enterprises, particularly where these involve commercial activities. Where there might be justifiable social reasons for public involvement in some enterprises, the social costs of such involvement should be quantified and separated from enterprises' losses; (vi) Finally, even where the government needs to remain involved, alternative ways of carrying out these responsibilities and delivering outputs and services more efficiently to the public need to be examined.
- Ensuring good governance and transparency is the most critical factor which can have a relatively quick and decisive impact on improving the effectiveness of public spending over the short to medium term. For this purpose, the governance issue needs to be interpreted broadly. (i) While controlling corruption and misuse of public resources is very important, good governance also needs to include broader and more effective political commitment to development by the government, major political parties and civil society at large. For any technical solutions to work effectively, the behavior of political leadership and political parties needs to change significantly. The key challenge in this regard is how to redirect the involvement and energies of the political leaders and political parties in a more constructive way to facilitate the development process and public resource management: (ii) There is an urgent need for a national consensus among major political parties on key development issues and solutions and how to go about implementing them. For example, with regard to key economic reforms, such as VAT, privatization, price adjustments etc., such a consensus is lacking. Political parties which support reforms when they are in power routinely oppose them when they are in the opposition. Where genuine differences of views exist on such issues, it is essential to let the majority governments to take necessary decisions and bear the responsibility for them. (iii) Engaging political leadership and political parties early on in the budget preparation process is essential in order to make them understand the realities of the resource situation and the trade-offs that have to be made. (iii) It is also necessary to minimize political interference in the public resource management process, for example, in staff transfers and procurement decisions; and to (iv) Re-channel the energies of politicians from advocacy for new projects to greater involvement in monitoring and implementation of projects in their particular constituencies.
- Similarly, decisive action to formulate an anti-corruption agenda, for example, to reduce revenue leakages and the misuse and waste of public resources, and to strengthen legal and institutional mechanisms to ensure greater accountability can have an important impact in terms of improving the effectiveness of resource use even in the short term. In addressing this issue, the government undoubtedly needs to take the lead; but it is ultimately the responsibility of Nepalese civil society, including major political parties, authorities at different levels, the private sector and NGOs. It is also important to recognize that whether the governance situation in Nepal is better or worse than in other developing countries is a moot point. As one of the poorest countries in the world, Nepal can least afford the misuse and waste of its limited development resources through continued governance problems; and it needs to address these issues quickly without further semantic debate.
- To improve the effectiveness of public spending, it is necessary to promote greater local ownership of the public expenditure program. This will require actions both from the government and external donors. For example, the government will need to take the lead in designing, financing, and implementing the development program and, even more importantly aid co-ordination itself. It will need to decide what its own development priorities and programs are, and ask the donors to support such programs. Where donor aid does not fit its priorities and program objectives, the Government will need to reject such "donor-driven" aid. This will of course require building up its institutional capacity and a greater degree of self-financing/self-reliance through stronger efforts to mobilize revenues, which may take considerable time. External donors will need to support this process, as discussed in para 28 below. Clearly such a strategy will entail risks for both donors and the government. But, if it works, it may help ensure greater sustainability and effectiveness of Nepal's development efforts.
- Similar efforts are needed in the case of fully government-financed programs also. To improve effectiveness, it is necessary to create greater synergies between institutions at the center and those at local levels and to build partnerships involving the private sector, NGOs and other stakeholders. This can take place at many levels, for example through: (i) greater devolution of responsibilities by NPC to line ministries for program formulation (within sectoral guidelines and policies agreed with the National Planning Commission), monitoring and supervision; (ii) increased involvement of local bodies and beneficiary groups in determining priorities and designing projects to better reflect local needs and implementing such projects; (iii) developing alternative approaches to (currently centrally managed) project implementation and service delivery, for example, involving the private sector as an alternative to traditional government mechanisms, contracting out to NGOs specific tasks such as supervision, technical services or program implementation on behalf of community groups; and (iv) strengthening the decentralization process (see below).
- Another element which is vital for improving public resource management is strengthening the institutional capacity for carrying out development activities. Despite considerable technical assistance, institutional capacity remains weak at virtually all levels; but improvements in two areas are particularly important: (i) civil service reform and (ii) decentralization.
- Civil Service Reform needs to be geared to the type of development administration that is needed to deliver public services more effectively in the future and to the severe local resource limitations hampering Nepal. First, with increased emphasis on transferring responsibility for development activities to local levels through decentralization, the role of the center, line ministries and supervisory agencies will need to change over time. For example, the NPC may need to transform itself into a planning agency responsible for setting overall development goals and priorities as well as sector strategies, while the MOF takes the lead in formulating and managing well integrated annual budgets consistent with these priorities. Similarly, the line ministries themselves will need to change from actual implementers of programs to facilitators, while taking on broader responsibilities for sectoral program formulation, provision of technical support to local bodies, and supervising and monitoring project/program implementation. Such a transition will obviously take considerable time, but will have important implications for skill needs, staffing levels and personnel management. Second, to provide adequate incentives, the overall compensation levels may need to increase significantly, together with a widening of salary differentials between lower and higher grades (i.e. decompressing the salary structure) and the introduction of a merit- based, performance-oriented reward/promotion system. How to pay for civil service reforms thus will be a major issue. Third, different alternatives therefore will have to be considered. Enhancing government revenue through tax reforms is one such option. This will however present its own challenges. Moreover, additional revenues are also needed for increased O & M and other development activities. Other alternatives therefore will also have to be looked at, including downsizing, as well as donor funding for civil service reforms on a relatively short term basis. External assistance however is likely to be forthcoming only if a credible reform program is developed and initiated.
- Decentralization is an important alternative to the presently highly centralized system for improving service delivery to local communities and for enhancing effectiveness of public spending. It is however not a complete substitute for the role of the central government. Even as more functions and responsibilities are transferred to local levels, the line ministries and government departments will have an important role to play in facilitating, providing technical support to, and supervising and monitoring the activities of, local bodies. It is also important to note that decentralization is not an easy solution; and several things need to be done to develop an efficient management and delivery system at the local levels: (i) First, it is necessary to remove the political and bureaucratic impediments which currently hamper the decentralization initiative. (ii) Second, it is necessary to improve the technical capacity of local bodies (DDCs and VDCs) for identifying their needs and priorities; resource mapping and planning; project design, preparation and implementation; accounting, record-keeping and expenditure reporting; etc. Although some efforts have already been made by the government and external donors to build capacity at district and village levels, much more remains to be done. (iii) Providing more budgetary resources to the local levels is not an issue at present, since substantial resources are already allocated to local bodies, in addition to several parallel programs implemented by central government ministries and departments, (for example in health, education, drinking water, rural roads etc., among others). What is needed is to streamline these centrally managed programs to ensure that they do not overlap with those that are locally managed, so as to avoid duplication and waste of resources, together with clearer definition of responsibilities of both local bodies and line ministries for these programs. (iv) The most effective way of promoting better management and accountability at local levels is by enhancing the participation of beneficiary groups in the decision-making and implementation process. Greater transparency (for example, through an "open-book system") in regard to the availability of budget funds, the nature of projects being financed and public access to financial records have permitted greater accountability and better use of resources. This would call for greater efforts to promote community mobilization and empowerment, particularly of the poorer and under-privileged groups in the communities.
- These behavioral and institutional changes need to be complemented by technical reforms to improve fiscal management. To improve expenditure management, (i) It is necessary to integrate the regular and development budgets. Instead of the current practice of allocating resources on an incremental basis, it is necessary to look at the resource needs for O & M, other recurrent activities and for ongoing development projects/programs in an integrated manner, and to provide the necessary resources for them in terms of priorities for growth, poverty reduction and service delivery objectives. (ii) To control the development budget and minimize the waste of resources associated with over-programming, it is essential to ensure greater realism in resource forecasting. Projections of revenue, aid inflows and the size of the development budget would need to be in line with recent performance and reasonable expectations. (iii) Such estimates, prepared for three years at a time, should provide a medium term framework for the development budget. Such a framework in turn would help bring out the key trade-offs that would have to be made, including the need for prioritization and the (limited) scope for new project starts, and help persuade the political leadership about the need to rationalize or downsize projects/programs which are not working well in order to bring the development program to a more manageable level. (iv) This needs to be combined with strengthening project screening and appraisal capacity in the National Planning Commission and the line ministries (by providing adequate staff and budgetary resources) so that greater discipline could be exercised over the process of initiating new projects into the development budget. (v) The budget process also needs to be made more responsive -- less "top-down" and more "bottom-up" -- in terms of accommodating programs (so long as they are consistent with sectoral strategies and priorities) proposed by local level constituents and line ministries.
- Once formulated, the expenditure program would need to be better managed, without resorting to ad-hoc expenditure cuts which disrupt project implementation. To strengthen expenditure management and control, a number of steps can be taken: (i) The mid year budget review process could be used to reassess resource outlook during the year to make expenditure adjustments in a more systematic manner. (ii) To protect priority projects from any resource shortfalls, a core program of priority projects would need to be formulated and fund releases to projects/programs based on the core program. (iii) Expenditure reporting by spending units need to be improved, both in terms of timeliness and quality of reporting. (iv) The capacity for monitoring expenditures as well as physical progress of projects/programs needs to be strengthened at various levels of the government, particularly the NPC and line ministries. For this purpose, the practice of holding periodic progress/implementation reviews by the Prime Minister and the Cabinet need to be re-instituted, with active involvement of parliamentarians in this process, so as to send out strong signals regarding the importance of speedier implementation.
- Recent experience of major donors suggests that the key to improving project implementation is to clean up the portfolio, focus attention and resources on a smaller number of projects/programs and to monitor their implementation closely. In addition to measures outlined above, other steps can be taken to address problems which currently hamper project implementation: (i) To reduce procurement delays, standard bidding documents have been recently adopted by the Government. This system needs to be made effective by familiarizing government staff with the new procedures through training. (ii) Even more importantly, political interference in procurement decisions need to be eliminated. Clearly defining the approval limits for procurement decisions that can be taken at various administrative levels, together with clarification of procedures to be followed and mandatory punishments for transgressions (through an anti-corruption program) may be needed for this purpose. (iii) To encourage project managers to make project-related decisions and to hold them accountable, an atmosphere conducive to such decision-making needs to be created by reducing insecurities associated with frequent political changes. Strict implementation of the recently amended civil service rules regarding staff transfers would help reduce such insecurities.
- If such actions are taken to improve the effectiveness of public spending, then additional revenue mobilization by the government would be warranted. Increased revenues could help finance anticipated increases in current expenditures (including those for civil service reforms), provide for much needed O & M expenditures and counterpart funding for development projects, and help promote greater self-reliance for and ownership of the development program. Without making the improvements on the expenditure side, however, it will be difficult to justify tax increases, since there would be little assurance that increased resources will not be misused or wasted.
- The longer term solution to Nepal's complex fiscal management problems would be for the government to take charge of its overall expenditure program, integrate the regular and development budgets and prioritize it to truly reflect its development/poverty reduction needs and priorities; and for the donors to support such a program with the additional resources that are needed without imposing their own project and technical assistance priorities. While this is a desirable longer term objective, the transition to it is likely to require a more gradual process. To support such a transition, important behavioral changes will be required from external donors as well as the government. While the government takes the lead in, and ownership for, introducing critical fiscal reforms, donors' role also will need to change from providers of "supply-driven" aid, implementers of projects, and purveyors of expensive technical assistance to facilitators who will provide financial and technical support that fit the country's needs and priorities in a way that fosters local ownership, institution-building, and longer term sustainability. Towards this end, donors could support the government's fiscal reform process in several ways: (i) The government's technical capacity to undertake budget reforms is limited at present; and donor assistance will be needed to help carry out this work (for example, to help the government to formulate a prioritized three year expenditure program, and sectoral strategies and investment programs consistent with those priorities), in the short term, as well as for strengthening institutional capacity at various levels over the longer term. (ii) Donors will need to accept the consequences of expenditure rationalization (for example, downsizing/canceling poor projects, limiting new project starts for some time etc.); and adjust their own aid programs to support only those projects/programs which fit the country's needs. (iii) It will also require stronger efforts among the donors themselves, within the context of agreed sectoral investment programs, to co-ordinate their support without competing with each other. (iv) It may also call for changes in the way donors prepare and manage projects in order to promote greater local ownership of project preparation, implementation and management. For example, in regard to technical assistance, instead of extensive reliance on external consultants, they need to look at alternative more cost-effective ways of providing technical support, (for example, using teams of local consultants under the direction and supervision of expatriate advisors who could be hired for short periods of time). Also, technical assistance needs to be carefully tailored to the country's needs, rather than being a mechanism for developing new follow-up projects, as too often is the case now. (v) Similarly, donors need to examine whether quick disbursing cash support is warranted under present circumstances, given the fungibility of such assistance. Such assistance can be potentially useful, but only when it does not substitute for revenue generation by the government and where the public expenditure program is reasonably well prioritized, so that it actually supports such priorities and sound sectoral expenditure programs. Such an approach will entail risks for both the government and the donors, since project preparation could take more time, projects may have to be smaller and more simple, and aid utilization and commitments may decline initially. Even so, such risks are worth taking if they lead to greater ownership, better development results and increased sustainability over the longer term.
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