VZCZCXRO5818
PP RUEHCI
DE RUEHKT #1110/01 2770931
ZNR UUUUU ZZH
P 030931Z OCT 08
FM AMEMBASSY KATHMANDU
TO RUEHC/SECSTATE WASHDC PRIORITY 9298
INFO RUEHBJ/AMEMBASSY BEIJING PRIORITY 6682
RUEHLM/AMEMBASSY COLOMBO PRIORITY 6975
RUEHKA/AMEMBASSY DHAKA PRIORITY 2283
RUEHIL/AMEMBASSY ISLAMABAD PRIORITY 5021
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RUEHNE/AMEMBASSY NEW DELHI PRIORITY 2677
RUEHSA/AMEMBASSY PRETORIA PRIORITY 0213
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RUEAUSA/DEPT OF EDUCATION WASHINGTON DC PRIORITY
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RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 04 KATHMANDU 001110 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EAID PGOV KDEM PREL IN NP
SUBJECT: NEPAL: NEW GOVERNMENT UNVEILS AMBITIOUS BUDGET 
 
REF: KATHMANDU 807 
 
KATHMANDU 00001110  001.3 OF 004 
 
 
Summary 
------- 
 
¶1. (U) On September 19, Nepal's new Finance Minister, Dr. 
Baburam Bhattarai, presented an ambitious budget of NRs 236 
billion (USD 3.2 billion) -- 40 percent higher than last 
year's budget.  Bhattarai stated that the policy priorities 
for the budget were completion of the peace process and 
immediate relief for those affected by the conflict, followed 
by accelerated economic growth, social security and 
inclusion.  The budget includes a revenue forecast that is 32 
percent higher than last year's revised estimate.  Increases 
are expected to come through improved tax collection.  The 
budget contains a number of ambitious populist programs with 
a 60 percent increase in the estimated capital expenditures. 
Foreign grants are forecast to increase by over 100 percent 
to be over NRs 47 billion (USD 644 million).  In his budget 
speech Bhattarai explained that the private sector and the 
cooperative sector are the "two legs" of the transitional 
economy and a policy of "balanced walking with these two legs 
will be actively pursued."  Many of the proposed programs are 
loosely defined and raise concerns over moneys being misused, 
misdirected and manipulated.  It will be important to monitor 
how programs are implemented to determine their true purpose. 
 The proposed creation of an Economic Council, a Cooperative 
Board and the revival of defunct state owned enterprises 
signals that the new Government of Nepal (GON) intends to 
take a controlling role in the economy.  It also creates a 
new level of uncertainty in the private sector. 
 
Bhattarai Presents 236 Billion Budget 
------------------------------------- 
 
¶2. (U) On September 19, Nepal's new Maoist Finance Minister, 
Dr. Baburam Bhattarai, presented the first budget of the 
Federal Democratic Republic of Nepal.  Bhattarai defended the 
whopping NRs 236 billion budget (USD 3.2 billion), which is 
40 percent higher than last year's budget, by explaining that 
"some risks must be taken when you want to take a leap 
forward."  Bhattarai stated that the policy priorities for 
the budget were completion of the peace process and immediate 
relief for those affected by the conflict, followed by 
accelerated economic growth, social security and inclusion. 
Sectoral priorities were listed as the transformation of the 
agriculture sector, development of water resources, wider 
expansion of tourism, expansion of physical infrastructure, 
human resource development and national industrialization. 
Bhattarai emphasized that the 65 percent increase in capital 
expenditure is proof that the budget is focused on 
development.  The Finance Minister defended the huge size of 
the budget claiming that the budget's parameters were within 
international macroeconomic norms and would push the growth 
rate to over 7 percent this year. 
 
--(Note: The Nepali fiscal year runs from July 15 to July 14. 
 On July 15, 2008, due to the delay in the formation of a new 
government, the Constituent Assembly passed a temporary bill 
allowing routine government operations until a complete 
fiscal year budget could be presented.  Nepal's growth rate 
last fiscal year was 5.6 percent -- the highest growth rate 
in last seven years. Reftel) 
 
Revenue Projected to Grow by 32 Percent 
--------------------------------------- 
 
¶3. (U) The budget includes a revenue forecast of nearly NRs 
142 billion (USD 1.9 billion), a 32 percent increase over 
last year's revised estimate.  Increases are expected to come 
through improved tax collection.  Value-added tax (VAT) is 
projected to increase by 10 percent.  With new duties on 
cigarettes, beer and liquor, excise duties are expected to 
rise by 19 percent.  A new education service tax which levies 
a 5 percent tax on fees collected by private schools is 
 
KATHMANDU 00001110  002 OF 004 
 
 
forecast to bring in an additional NRs 100 million (USD 1.3 
million) and a similar tax on fees collected by private 
health care providers is projected to bring in NRs 11.3 
million (USD .15 million).  Both income tax and property tax 
are forecast to grow by over 13 percent.  In order to realize 
the expected improvements in tax collection, the budget 
contains special provisions to "encourage" tax compliance.  A 
provision for "Voluntary Disclosure of Income" allows any 
person to disclose taxable assets or income on which they 
have not paid tax in the past to avoid future penalties. 
Other provisions to increase revenue include mandatory income 
disclosures when purchasing houses, land and vehicles with 
values above certain limits, modifications to the existing 
property tax act, a revised valuation system at customs and 
strengthening the revenue investigation system. 
 
40 Percent Increase in Expenditures 
----------------------------------- 
 
¶4. (U) Total expenditures are projected to increase by over 
40 percent.  Of the total estimated budget, approximately 54 
percent has been allocated for recurrent expenditure (NRs 129 
billion or USD 1.8 billion), 39 percent for capital 
expenditures (NRs 91 billion or USD 1.25 billion) and the 
remaining 7 percent for loan and interest payments (NRs 16 
billion or USD 219 million).  The estimated capital 
expenditures reflect a increase of over 60 percent.  Budget 
allocations for all major sectors increased:  education up 37 
percent, health up 28 percent, agriculture up 1.5 percent, 
hydropower up 66 percent, roads up 49 percent, irrigation up 
45 percent, drinking water up 49 percent and security (police 
and military) up 12 percent.  The budget contains a number of 
ambitious populist programs, including an increase in the 
monthly allowance for elderly, widows, and disabled people. 
It also introduces new programs with slogans like "Our 
Village, Beautiful Village," "New Nepal, Healthy Nepal." 
Millions have been set aside for relief to conflict victims 
and families of "martyrs."  Bhattarai stated that an 
"agriculture revolution should be the basis of building a new 
Nepal.  Through the slogan "Cooperatives in Every Village, 
Food Storage in Every  House," cooperatives be will 
established in each village and small farmers will be 
eligible for special loan and interest waivers.  The budget 
also calls for the formation of a High-Level Scientific Land 
Reform Commission to abolish feudal land ownership and 
production relations.  Block grants to all the Village 
Development Committees (VDCs) will be increased by 100 
percent.  The budget also includes education programs to 
ensure free education up to grade 8 and a literacy campaign 
that will employ 35,000 youth across the country.  There are 
also youth programs to promote self-employment and support 
vocational training. 
 
The Deficit 
----------- 
 
¶5. (U) The projected deficit before foreign grants is over 
NRs 94 billion (USD 1.29 billion).  Foreign grants are 
forecast to be over NRs 47 billion (USD 644 million).  This 
is more than a 100 percent increase (last year foreign grants 
totaled NR 22.8 billion or USD 312 million).  The deficit 
after foreign grants is still over NRs 47 billion (USD 644 
million).  Foreign loans are estimated at NRs 18.7 billion 
(USD 256 million) and domestic borrowing remains at NRs 25 
billion (USD 342 million), the same rate as last year.  There 
is a small amount of additional borrowing against the cash 
balance, but the total projected borrowing is 28.5 percent of 
GDP, which the International Monetary Fund considers within 
reasonable limits.  (Note: The projected amount of foreign 
grants appears foolishly high.  However, in reality the 
government will only be able to spend the funds it actually 
receives.  It is likely that many of the budget's ambitious 
programs which are tied to donor funding will fail for lack 
of funds.) 
 
 
KATHMANDU 00001110  003.2 OF 004 
 
 
The Private Sector & Cooperative Sector: 
Two Legs of the Transitional Economy 
------------------------------------ 
 
¶6. (U) In his budget speech, Bhattarai explained that in the 
transitional economy the private sector, cooperative sector 
and public sector would all play a "coordinating role 
together."  He stated that the "private sector and 
cooperative sector will be the two legs of this transitional 
economy and a policy of balanced walking with these two legs 
will be actively pursued."  To further rapid economic growth 
the budget speech calls for the establishment of a high-level 
"Economic Council" under the chairmanship of the Prime 
Minister.  Both an "Investment Board" and a "Cooperative 
Board" will work under the Economic Council.  A 
public-private partnership approach will be utilized to 
"motivate domestic and foreign investors to invest in the 
priority sectors."  More than 60 projects and programs are 
proposed under the campaign "Building New Nepal."  A "Holding 
Company" will be created to revive state-run industries, 
including the Biratnagar Jute Mill, Birgunj Sugar Mill, 
Hetauda Textile and Gorakhkali Rubber Limited.  Bhattarai 
also proposes to create a conducive and business-friendly 
environment.  Amendments to the existing labor policy, 
industrial policy, foreign investment policy and trade policy 
are promised, as well as an act to establish special economic 
zones.  The budget also calls for the creation of an 
industrial security force.  The budget gives special emphasis 
to infrastructure development projects, including rural 
reconstruction and rehabilitation, hydropower projects, 
roads, railways and airports, and calls for the formation of 
an infrastructure development bank that will be a joint 
public-private venture.  Domestic resources for small and 
medium-scale and foreign investment for large-scale 
hydropower projects will be mobilized.  A high-level power 
sector development committee under the chairmanship of the 
Prime Minister will be established to ensure that 10,000 MW 
of hydropower will come on line in the next 10 years. 
 
Comment 
------- 
 
¶7. (SBU) The Maoist-led government's new 2008/2009 budget is 
highly ambitious in its projection of expenditure and 
resources.  The affect on Nepal's macroeconomy could be 
negative if the revenues cannot be increased to keep pace 
with the proposed social-welfare programs and debt relief. 
Local experts considered the projected revenue figures 
largely inflated - with a 15 to 20 percent increase in 
revenue a more reasonable estimate.  Higher salaries and 
increased government spending could also create inflationary 
pressures.  However, much of the proposed spending will be 
tied to the availability of donor funds and the government's 
ability to implement the projects.  The larger concern may be 
the uncertainty the budget has created and the murky policies 
it promotes.  There are numerous areas where funds could 
easily be misused, misdirected and manipulated.  One example, 
is the proposed 100 percent increase in block grants to the 
VDCs.  Although these grants are likely to be 
under-dispersed, the existing political vacuum and complete 
absence of accountability in the VDCs leaves the door open 
for misuse.  There is considerable speculation that the 
programs in a number of areas are designed to employee 
members of the Maoist Young Communist League (YCL).  It will 
be important to monitor how programs are implemented to 
determine the Maoists' true intentions.  The level of 
coercion the GON is willing to use to meet revenue targets 
will be another important indicator. 
 
¶8. (SBU) Understandably, private sector confidence is 
faltering.  By placing both the Cooperative Board and the 
Investment Board under the Economic Council, the GON is 
clearly indicating that it intends to take a controlling role 
in the economy.  The interests of these two boards are sure 
to collide and there is the real possibility of private 
 
KATHMANDU 00001110  004 OF 004 
 
 
sector investment being crowded out.  The promise to inject 
money into defunct state enterprises completely comprises 
efficiency and productivity in favor of a populist political 
agenda of creating employment.  Although Bhattarai defends 
the inflated budget by preaching that the government must be 
ambitious to succeed, many of the policies promoted in the 
budget are simply not in line with proven economics and 
Nepal's realities.  History has shown that state-run 
economies eventually fail.  Moreover for the private sector 
"leg" to succeed in Nepal, there must first be reform in the 
existing institutions which are marred by inefficiency -- 
such as the customs department, taxation system, judiciary, 
education, financial sector and government bureaucracy. 
Until reforms in these sectors are supported, Nepal is 
unlikely to see any private sector led economic growth or 
anywhere near the double digit growth the Maoist are 
advertising. 
BERRY