Budget Cycle: Critical Examination and Budgeting Reforms

Concept

The budget cycle is the sequence of recurring stages through which a government's annual budget is prepared, approved, executed and audited. It makes public finance a continuous, accountable process rather than a one-off statement of spending.

Stages of the cycle (Nepal)

1. Preparation / formulation – The National Planning Commission fixes resource ceilings and the Medium Term Expenditure Framework (MTEF); the Ministry of Finance issues budget guidelines; ministries and agencies submit proposals, which are reviewed in budget discussions.
2. Legislative approval – The Finance Minister presents the budget to the Federal Parliament on Jestha 15 (late May/early June). It is debated, the Appropriation Bill and Finance Bill are passed, and the Appropriation Act is enacted before the fiscal year begins on Shrawan 1.
3. Execution – Ministries spend through the Financial Comptroller General Office (FCGO) and the Treasury Single Account, following authorisations, procurement rules and quarterly spending plans.
4. Accounting, reporting and audit – The FCGO consolidates accounts, and the Office of the Auditor General audits them. Reports go to the Public Accounts Committee of Parliament, which closes the cycle and informs the next budget.

Critical examination

Strengths

• Gives a legal, predictable framework linking policy, resources and accountability.
• Provides parliamentary control over taxation and spending.
• Annual audit feedback can improve later budgets.

Weaknesses

• Incrementalism: budgets are based on the previous year's allocations, so priorities rarely change.
• Weak execution: capital spending is bunched in the last quarter and especially in Ashadh (the "June rush"). Capital budget utilisation in Nepal has often been well below target, so planned projects are delayed and quality suffers.
• Political capture: many small, scattered projects are inserted to please constituencies, rather than being chosen on economic returns.
• Weak link between planning and budgeting: periodic plans and the MTEF are not strictly followed.
• Overlapping calendars: federal, provincial and 753 local governments run the cycle simultaneously with unequal capacity and late transfers.
• Audit follow-up is slow: arrears of audit irregularities pile up and sanctions are rare.

Budgeting reforms with examples

Conclusion

The budget cycle is a necessary discipline for public finance, but in practice incrementalism, late and bunched spending and political interference limit its value. Reforms such as MTEF, performance and gender-responsive budgeting and better treasury systems have improved transparency, yet their benefit depends on timely execution, realistic project selection and strict audit follow-up.

Role of Deficit Financing in Economic Development of Developing Countries like Nepal

1. Concept of Deficit Financing

Deficit financing refers to the practice of financing government expenditure in excess of its current revenue receipts. It is the gap between total government expenditure and total government revenue (excluding borrowing), which is met through borrowing from internal and external sources, and in many developing countries, through the creation of new money by the central bank (printing of currency or direct central bank credit to the government).

In the context of developing countries like Nepal, deficit financing is not merely a fiscal tool but a deliberate policy instrument used to mobilize resources for economic development. Since the domestic savings rate is low and the tax base is narrow, governments often rely on deficit financing to bridge the resource gap between planned investment and available domestic resources.

2. Rationale for Deficit Financing in Developing Countries

The case for deficit financing in developing countries rests on several grounds:

(a) Low Domestic Savings and Narrow Tax Base: Developing countries like Nepal have low per capita income, low marginal propensity to save, and a narrow tax base. The government cannot raise sufficient revenue through taxation alone to finance development projects. Deficit financing fills this resource gap.

(b) Need for Rapid Capital Formation: Economic development requires heavy investment in infrastructure—roads, bridges, hydropower, irrigation, education, and health. These projects have long gestation periods and cannot be financed solely by private sector or current revenue. Deficit financing provides the necessary capital.

(c) Breaking the Vicious Circle of Poverty: Developing countries are trapped in a vicious circle of low income → low savings → low investment → low income. Deficit financing injects purchasing power and investment funds to break this cycle.

(d) Mobilization of Idle Resources: In developing economies, there are often unutilized or underutilized resources—labor, land, and capital. Deficit financing can mobilize these idle resources into productive use, increasing national output.

(e) Financing of Development Plans: Nepal's periodic plans (from the First Five-Year Plan to the current Sixteenth Plan) have consistently relied on deficit financing to meet planned expenditure targets. Foreign aid and internal borrowing are major sources of development finance.

3. Role of Deficit Financing in Nepal's Economic Development

(a) Financing of Development Expenditure

Nepal's development expenditure has consistently exceeded its revenue collection. The government has used deficit financing to finance development projects. For instance, in recent fiscal years, the budget deficit has been financed through foreign grants, foreign loans, and internal borrowing. This has enabled the construction of roads, hydropower projects, and social infrastructure.

(b) Bridging the Resource Gap

Nepal faces a chronic resource gap—the difference between planned investment and domestic savings. Deficit financing, particularly through foreign loans and grants, has helped bridge this gap. The resource gap is estimated to be significant in the current plan period.

(c) Mobilization of Domestic Resources

Internal borrowing through treasury bills, development bonds, and citizen savings certificates has mobilized idle domestic savings for development purposes. This has helped channel household savings into productive investment.

(d) Control of Inflationary Pressures

In developing countries, deficit financing is sometimes used to stimulate demand when there is deflationary pressure. However, in Nepal's case, excessive deficit financing has often contributed to inflationary pressures, especially when financed through money creation.

(e) Promotion of Infrastructure Development

Major infrastructure projects like hydropower (Upper Tamakoshi, Budhi Gandaki), roads (Kathmandu-Terai Fast Track), and airports (Pokhara International Airport, Gautam Buddha International Airport) have been financed partly through deficit financing. These projects are expected to generate long-term growth.

(f) Human Capital Formation

Deficit financing has also been used to finance education, health, and social security programs. Investment in human capital is essential for long-term economic development.

3. Limitations and Risks of Deficit Financing

Despite its role, deficit financing in developing countries like Nepal faces several limitations:

(a) Inflationary Pressure: When deficit financing is done through money creation (printing currency), it increases money supply without a corresponding increase in goods and services, leading to inflation. Nepal has experienced high inflation in periods of excessive deficit financing.

(b) Crowding Out Effect: Heavy government borrowing from the domestic market can crowd out private investment by raising interest rates and reducing credit availability for the private sector.

(c) Debt Burden: Foreign loans create future repayment obligations. Nepal's external debt has been increasing, creating a burden on future generations.

(d) Misuse of Funds: In developing countries, deficit financing often leads to wasteful expenditure, corruption, and unproductive projects, reducing its effectiveness.

(e) Balance of Payments Problems: Foreign borrowing can lead to balance of payments difficulties when loans have to be repaid in foreign currency.

(f) Dependence on Foreign Aid: Excessive reliance on foreign aid and loans can reduce policy autonomy and create dependency.

4. Deficit Financing in Nepal: Empirical Evidence

Nepal's fiscal deficit has been persistent. According to the Ministry of Finance, the budget deficit in recent years has been financed through:

• Foreign grants (about 20-25% of deficit)
• Foreign loans (about 50-60% of deficit)
• Internal borrowing (about 20-30% of deficit)

The deficit has been used primarily for development expenditure, but a significant portion also goes to recurrent expenditure. The effectiveness of deficit financing in Nepal depends on the quality of expenditure and the absorptive capacity of the economy.

5. Conditions for Effective Deficit Financing

For deficit financing to promote economic development in Nepal, the following conditions are necessary:

1. Productive Use of Funds: Deficit financing should be used for productive investment, not for consumption or unproductive expenditure.
2. Absorptive Capacity: The economy must have the capacity to absorb funds efficiently—adequate infrastructure, skilled labor, and institutional framework.
3. Control of Inflation: Deficit financing should be within safe limits to avoid inflationary pressures.
4. Debt Sustainability: Borrowing should be kept within sustainable limits to avoid debt crisis.
5. Fiscal Discipline: Government should control unnecessary expenditure and improve revenue collection.
6. Complementary Policies: Deficit financing should be supported by appropriate monetary, trade, and industrial policies.

6. Conclusion

Deficit financing plays a crucial role in the economic development of developing countries like Nepal. It provides the necessary resources to finance development projects, bridge the resource gap, and mobilize idle resources. However, it is a double-edged sword—if used excessively or unproductively, it can lead to inflation, debt burden, and balance of payments problems. Therefore, Nepal should use deficit financing judiciously, ensuring that funds are directed towards productive investment, and should simultaneously strengthen domestic resource mobilization to reduce dependence on deficit financing in the long run. The effectiveness of deficit financing ultimately depends on the quality of governance, the efficiency of expenditure, and the overall macroeconomic environment.

Intergenerational Equity in Public Debt

Intergenerational equity refers to the fairness of distributing the costs and benefits of public debt across different generations. It asks a simple but profound question: when a government borrows today to finance expenditure, who bears the burden — the generation that receives the benefit, or the generation that must repay the debt?

The Core Issue

When a government issues debt, it borrows from someone. Two distinct cases arise:

1. Internal debt (borrowed from domestic citizens): The government borrows from its own citizens and later repays them (with interest) through taxation. Here, the resources remain within the same economy. The bondholders (usually the wealthier, older generation) receive interest payments financed by taxes paid by the working population. This is essentially a transfer within the same generation rather than a burden shifted to future generations — though it may have distributional consequences between rich and poor.

2. External debt (borrowed from abroad): The country borrows foreign exchange from foreign lenders. Future generations must export goods and services to earn foreign exchange to service this debt. In this case, there is a genuine intergenerational burden shift — future generations consume less because resources are transferred abroad.

The Traditional (Lerner) View

Abba Lerner argued that internal debt does not burden future generations. His reasoning: "We owe it to ourselves." The repayment is a transfer from taxpayers to bondholders within the same country. No real resources leave the economy; only claims are redistributed. Therefore, the "burden" is not a net loss to the nation but a redistribution among its citizens.

The Modern (Modigliani–Musgrave) View

Franco Modigliani and Richard Musgrave challenged this. They argued that even internal debt can burden future generations if the debt-financed expenditure is consumed rather than invested:

• If the government borrows to finance current consumption (e.g., salaries, subsidies), the present generation enjoys the benefit while future generations inherit the obligation to pay taxes — a clear inequity.
• If the government borrows to finance productive investment (e.g., infrastructure, education), future generations inherit both the debt and the productive assets. If the return on investment exceeds the interest cost, future generations may actually be better off — no net burden.

Thus, the burden depends on what the debt finances, not merely on whether the debt is internal or external.

The Golden Rule of Public Finance

This leads to the golden rule: governments should borrow only to finance capital expenditure, not current consumption. This ensures that future generations, who benefit from the assets, also bear the debt cost — achieving intergenerational equity. Borrowing for consumption violates equity because it shifts the cost of today's enjoyment onto tomorrow's taxpayers.

Mechanisms of Burden Shifting

Intergenerational inequity arises through several channels:

1. Debt illusion — Current voters underestimate future tax burdens and support debt-financed spending, leading to excessive borrowing.
2. Fiscal imbalance — Persistent deficits accumulate into a debt overhang that constrains future fiscal space.
3. Crowding out — Heavy borrowing raises interest rates, reducing private investment and slowing future growth.
4. Inflation tax — If debt is monetized, inflation erodes real incomes of future generations.
5. Demographic asymmetry — An aging population means fewer future taxpayers to service debt incurred today.

Implications for Fiscal Policy

For intergenerational equity, policymakers should:

• Distinguish between capital and current expenditure — borrow only for the former.
• Assess debt sustainability — ensure debt-to-GDP ratio remains stable.
• Use generational accounting — measure the net tax burden on each cohort.
• Maintain transparency — reduce debt illusion through clear fiscal reporting.
• Invest in human capital — education and health spending today raises future productivity and repayment capacity.

Conclusion

Intergenerational equity in public debt is not simply about whether debt exists, but about who benefits and who pays. Internal debt is largely a within-generation transfer, while external debt and consumption-financed borrowing shift real burdens to the future. The principle of intergenerational equity therefore demands that public borrowing be guided by the golden rule — financing investment, not consumption — so that each generation bears the cost of the benefits it receives.

Budgetary Process: Concept and Operation

Concept

The budgetary process refers to the entire cycle of activities through which a government prepares, approves, executes, and audits its annual budget. It is the mechanism that translates fiscal policy into concrete revenue and expenditure decisions. In the Nepali context, the budget is the annual statement of estimated receipts and expenditures of the government, presented before the legislature as required by Article 119 of the Constitution of Nepal. The process is continuous and cyclical, covering four major stages: formulation, approval (legislation), execution, and auditing (control).

Operation

1. Budget Formulation (Preparation)

• The Ministry of Finance (MoF) issues a budget calendar and circular to all ministries, departments and provinces, setting ceilings and guidelines.
• Spending ministries prepare and submit their estimates to the MoF through the National Planning Commission (NPC) for consistency with the periodic plan.
• The MoF consolidates these into a draft budget, holds pre-budget consultations with stakeholders, and finalizes it.
• In Nepal, the budget is normally presented on 15 Jestha (end of May) for the fiscal year beginning 1 Shrawan (mid-July).

2. Budget Approval (Legislation)

• The Finance Minister presents the budget speech in the joint session of the federal parliament, along with the Finance Bill and Appropriation Bill.
• Parliament debates the principles, priorities and expenditure of the budget; subject committees scrutinize ministry-wise allocations.
• The budget is passed by majority vote; the President authenticates it. Until passage, a vote-on-account (advance release) may be used to meet essential expenses.

3. Budget Execution

• The MoF releases funds to spending agencies through the Financial Comptroller General Office (FCGO) in quarterly instalments, based on progress.
• Ministries and departments spend according to the approved heads and use the Treasury Single Account system.
• Revenue is collected through the Inland Revenue Department and customs; expenditure is monitored against targets.
• Supplementary budgets or transfers may be introduced if circumstances change.

4. Auditing and Control

• Internal control is exercised by the FCGO and line ministries; external audit is conducted by the Office of the Auditor General (OAG).
• The OAG submits its report to the President, who lays it before parliament; the Public Accounts Committee (PAC) examines it.
• Findings feed back into the next cycle, closing the loop of accountability.

Conclusion

Thus, the budgetary process is a cyclical, multi-stage mechanism—formulation, approval, execution and audit—that ensures planned, authorized, accountable and transparent use of public resources in line with the country's fiscal and development objectives.

Gender Responsive Budgeting (GRB)

Gender Responsive Budgeting (GRB) is a planning and budgeting approach that integrates a gender perspective into the entire budget cycle — formulation, approval, execution, monitoring and audit — so that public resources are allocated and spent in ways that address the different needs, roles and constraints of women, men, girls and boys. It is not a separate budget for women, nor simply an increase in spending on women's programmes; rather, it is a mainstreaming tool that examines how existing revenue and expenditure policies affect the two sexes differently and restructures them to promote gender equality.

Key features:

• Gender-aware analysis: Every budget line is assessed for its differential impact on women and men, using sex-disaggregated data and gender indicators.
• Beneficiary incidence: Tracks who actually receives public services and transfers, revealing gaps between stated policy and actual delivery.
• Budget cycle coverage: Applies at all stages — gender budget statements, gender-sensitive allocations, gender audits and outcome evaluation.
• Institutional mechanism: Requires gender focal points in line ministries, capacity building of officials, and civil society participation.
• Accountability: Links budget outcomes to national and international commitments such as CEDAW, the Beijing Platform for Action and the SDGs (especially Goal 5).

Relevance to Nepal: Nepal is a pioneer in South Asia. The Ministry of Finance has, since FY 2007/08, classified the national budget through a Gender Responsive Budgeting system, scoring ministries and their programmes as directly gender responsive (Category A), indirectly responsive (Category B) or gender neutral (Category C). Local governments are now required to prepare gender-responsive plans and budgets under the federal structure. GRB has helped expand allocations for girls' education, safe motherhood, women's health, skill development and women's participation in decision-making.

Limitations: Weak sex-disaggregated databases, inadequate technical capacity of planners, ritualistic compliance without real reallocation, and weak monitoring of actual outcomes often reduce GRB to a reporting exercise rather than a transformative fiscal tool.

In short, GRB is an instrument of fiscal policy for gender equality — it makes the budget a mirror of a government's true priorities regarding women and men.

Conditional and Unconditional Grants

A grant is a transfer of money from a higher-level government (or donor) to a lower-level government or institution, made without any direct return of goods or services. Grants are classified by the degree of discretion the recipient has over their use.

1. Unconditional Grant (Non-matching / Block Grant)

• Also called a general-purpose grant or revenue-sharing grant.
• The recipient is free to spend the funds on any item in its own budget, according to its own priorities.
• No matching contribution is required, and no specific conditions are attached to its use.
• Purpose: to correct vertical fiscal imbalance (fiscal gap) and horizontal imbalance (equalization) between rich and poor regions.
• Example: In Nepal, the Local Government Operation Act 2074 provides an unconditional grant to local levels as "samanya anudan" (general grant) under the Fourteenth Finance Commission's recommendations; the local body may allocate it to any sector it chooses. Similarly, India's Finance Commission tax devolution to states is essentially unconditional.

2. Conditional Grant (Matching / Specific-Purpose Grant)

• Funds are given for a specified purpose or programme, and the recipient must use them only for that purpose.
• Conditions may include: matching contribution from the recipient (e.g., 50:50 cost-sharing), maintenance of a minimum standard, reporting and audit requirements, or achievement of performance targets.
• Purpose: to finance merit goods and services with positive externalities (education, health, drinking water), to ensure minimum national standards, and to direct spending to national priorities.
• Example: Nepal's "sasharta anudan" (conditional grant) given to local levels for basic and secondary education, health, and agriculture; the federal government's "vishesh anudan" (special grant) for roads, irrigation and rural electrification. In India, centrally sponsored schemes such as MGNREGA and Sarva Shiksha Abhiyan are conditional grants. Foreign aid tied to a project (e.g., a World Bank loan for a hydropower project) is also conditional.

Comparison

Conclusion: Unconditional grants promote local autonomy and equalization, while conditional grants ensure minimum standards and national objectives. A balanced mix of both is essential for fiscal federalism.

Revenue Assignment vs Expenditure Assignment

Revenue assignment and expenditure assignment are two components of fiscal federalism that determine how powers and responsibilities are divided among different tiers of government.

Revenue assignment refers to the allocation of taxing powers and revenue sources among different levels of government. It deals with the question of who collects which taxes. Under this, taxes with high mobility and uneven distribution, such as income tax and corporate tax, are assigned to the central government, while less mobile and locally concentrated taxes, such as property tax and land tax, are assigned to sub-national governments. It determines the revenue-raising capacity of each level of government.

Expenditure assignment refers to the allocation of expenditure responsibilities and public service delivery functions among different levels of government. It deals with the question of who spends on what. Under this, functions with nationwide benefits, such as defense, foreign affairs, and monetary policy, are assigned to the central government, while functions with local benefits, such as local roads, sanitation, and primary education, are assigned to sub-national governments. It determines the spending obligations of each level of government.

Key differences:

In short, revenue assignment concerns the income side of the budget, while expenditure assignment concerns the outlay side. For fiscal federalism to work smoothly, the two must be balanced so that the expenditure responsibilities assigned to a level of government match its revenue-raising capacity.

Intergovernmental Fiscal Transfer (IGFT) refers to the transfer of funds from one level of government (usually the central/federal government) to another level (usually sub-national governments — provinces and local governments). It is a key instrument of fiscal federalism.

Importance of IGFT:

1. Correcting vertical fiscal imbalance: In most federations, the central government collects a larger share of revenue than its expenditure needs, while sub-national governments have larger expenditure responsibilities than their own revenue capacity. IGFT bridges this gap so that sub-national governments can meet their expenditure obligations.

2. Correcting horizontal fiscal imbalance: Different provinces and local units have unequal revenue capacity and different expenditure needs. IGFT (especially equalization grants) reduces regional disparities by transferring more resources to poorer regions, promoting balanced regional development.

3. Financing local public goods and services: Sub-national governments are responsible for health, education, local roads, water supply, sanitation, etc. IGFT provides the necessary funds to deliver these services to citizens.

4. Promoting national minimum standards: Conditional or matching grants ensure that all citizens enjoy a minimum level of essential services (e.g., basic education, primary health care) regardless of where they live.

5. Maintaining macroeconomic stability and fiscal discipline: A well-designed transfer system with rules and conditions prevents excessive borrowing by sub-national governments and keeps overall public finances stable.

6. Strengthening accountability and autonomy: IGFT allows local governments to exercise fiscal autonomy and respond to local preferences, while central oversight through conditional transfers maintains accountability.

7. Promoting unity and national cohesion: By sharing national revenue with all units, IGFT gives every region a stake in the federation and strengthens national unity.

In the Nepali context, the Constitution of Nepal (2015) and the Local Government Operation Act provide for fiscal transfers through the National Natural Resources and Fiscal Commission, including fiscal equalization grants, conditional grants, special grants, and complementary grants to provinces and local levels.

Conclusion: IGFT is essential for fiscal balance, equitable regional development, effective service delivery, and the stability of a federal system.

Fiscal decentralization is the transfer of fiscal powers, responsibilities, and resources from the central government to sub-national governments (provinces and local levels) so that they can raise revenue, decide expenditure, and manage their own budgets. It is the fiscal dimension of decentralization, complementing political and administrative decentralization.

It has three main components:

1. Expenditure decentralization — assigning spending responsibilities (e.g., local infrastructure, basic health, primary education) to lower levels of government.
2. Revenue decentralization — giving sub-national governments their own revenue sources or tax powers (e.g., property tax, local fees) and/or intergovernmental transfers.
3. Intergovernmental fiscal transfers — grants from the centre to correct vertical and horizontal imbalances between revenue-raising capacity and expenditure needs.

In Nepal, the Constitution of 2015 (Articles 57, 59 and Schedules 5–9) assigns exclusive and concurrent fiscal powers to the federation, provinces, and local levels, and provides for the National Natural Resources and Fiscal Commission to recommend revenue sharing and equalization grants. The objectives are to bring government closer to the people, improve allocative efficiency, promote local accountability, and ensure balanced regional development. Its main risks are fiscal indiscipline, weak local capacity, and unfunded mandates.

Debt trap refers to a situation in which a country (or an individual) is compelled to borrow fresh loans merely to repay the interest and principal of existing loans, so that debt keeps accumulating without any corresponding improvement in the capacity to repay. The borrower falls into a self-reinforcing cycle: each new loan adds further interest liability, which necessitates yet another loan, and the debt burden grows faster than income or output. In development economics, the concept is closely associated with external debt of low-income countries (the "debt overhang" problem) and with the vicious circle of poverty.

Mechanism of the debt trap

1. A country borrows to finance investment or to cover a balance-of-payments gap.
2. If the returns from the borrowed funds are low (poor project selection, corruption, capital flight) or if export earnings fall (terms-of-trade shock, global recession), the country cannot generate enough foreign exchange to service the debt.
3. It therefore reschedules or borrows again — often on harder terms — to meet interest and amortisation payments.
4. Interest compounds, the debt-service ratio rises, and an increasing share of national income and export earnings is transferred abroad.
5. Resources available for domestic investment and social spending shrink, growth slows further, and the capacity to repay declines — completing the trap.

Key indicators: rising debt-to-GDP ratio, debt-service ratio, and the share of external debt in total public debt. A common rule of thumb is that a debt-service ratio persistently above 20–25 per cent of export earnings signals debt distress.

Consequences: reduced fiscal space, cutbacks in health and education spending, dependence on IMF/World Bank conditional lending and structural adjustment, exchange-rate and inflation pressures, and intergenerational transfer of the burden. For Nepal, remittance-financed imports and concessional borrowing have so far kept external debt sustainable, but rising debt-service obligations remain a policy concern.

Remedies: productive use of borrowed funds, export diversification, debt restructuring or relief (HIPC/MDRI-type initiatives), concessional rather than commercial borrowing, and prudent fiscal discipline.

Management of Public Debt

Public debt management refers to the process by which a government plans, raises, services, and retires its debt in order to meet its financing needs at the lowest possible cost over the medium to long term, consistent with an acceptable degree of risk. In Nepal, this function is carried out mainly by the Public Debt Management Office (PDMO) under the Ministry of Finance, in coordination with the Nepal Rastra Bank as the debt manager and fiscal agent of the government.

Objectives of public debt management:

1. Meeting financing needs — raising adequate funds to cover budget deficits and development expenditure without disrupting the economy.
2. Minimising cost — obtaining debt at the lowest possible interest cost, both currently and over time.
3. Containing risk — managing refinancing risk, interest rate risk, and exchange rate risk so that debt remains sustainable.
4. Supporting monetary and fiscal stability — avoiding excessive borrowing from the central bank (which fuels inflation) and developing the domestic bond market.
5. Maintaining credibility — ensuring timely repayment so that the country retains access to credit at reasonable terms.

Instruments and techniques of management:

• Choice of instruments — treasury bills (short-term), development bonds and national savings bonds (long-term), and foreign loans/grants from multilateral and bilateral sources.
• Maturity structure management — balancing short-term and long-term debt to avoid bunching of repayments in any single year.
• Currency composition management — limiting the share of foreign-currency debt to control exchange rate risk.
• Debt ceiling and legal framework — in Nepal, the Public Debt Management Act, 2015 (2072 BS) fixes limits on internal and external borrowing and requires the government to publish a debt management strategy.
• Sinking fund and debt retirement — setting aside funds to repay debt systematically.
• Debt restructuring and rescheduling — renegotiating terms when debt servicing becomes burdensome.
• Debt sustainability analysis — assessing the ratio of debt to GDP and debt service to revenue to judge whether debt is sustainable.

Institutional framework in Nepal:

• The Ministry of Finance formulates debt policy and approves borrowing.
• The Public Debt Management Office handles day-to-day debt operations, auctions, and record-keeping.
• The Nepal Rastra Bank acts as the government's banker, issues treasury bills, and manages the domestic debt market.
• External debt is governed by agreements with the World Bank, ADB, IMF, and bilateral donors, often on concessional terms.

Conclusion: Effective public debt management balances the need for resources against the cost and risk of borrowing. For a developing country like Nepal, prudent management — favouring concessional external loans and developing the domestic bond market — is essential to keep debt sustainable while financing growth.

Black economy (also called the shadow, underground, hidden, or parallel economy) refers to those economic activities that are deliberately concealed from the government so as to evade taxes, escape regulation, or hide illegal transactions. Such activities produce income and employment but are not recorded in the national income accounts. In Nepal, informal estimates suggest the black economy may be of the order of 20–30 per cent of GDP.

Causes of the black economy:

1. High tax rates and tax evasion — Heavy direct and indirect taxes, along with weak enforcement, encourage people to hide income and transactions.
2. Excessive government regulation and controls — Licensing, quotas, price controls and bureaucratic red tape push activities outside the legal framework.
3. Weak and corrupt administration — Bureaucratic corruption, poor monitoring, and ineffective penalties reduce the risk of being caught.
4. Inflation — Rising prices erode real incomes and induce people to earn extra income through unrecorded channels.
5. Unemployment and underemployment — Lack of adequate formal-sector jobs forces workers into informal and illegal activities for survival.
6. Low levels of education and awareness — Illiteracy and ignorance of tax laws make evasion easier and more acceptable.
7. Desire for high profits and conspicuous consumption — The greed for quick, untaxed profits and a showy lifestyle motivates concealed dealings.
8. Political instability and weak institutions — Frequent political transitions, poor law enforcement, and impunity encourage smuggling, hoarding, and illegal trade.
9. Growth of illegal activities — Smuggling, drug trafficking, black marketing, counterfeit goods, and unregistered foreign employment/trade add to the black economy.
10. Inadequate legal and administrative machinery — Insufficient tax administration, poor record-keeping, and a large unorganized sector make concealment easy.

Short Notes (any two)

a) Money laundering

Money laundering is the process of concealing the true source, ownership, or destination of money obtained from illegal activities so that the funds appear to have come from a legitimate source. It allows criminals to enjoy the proceeds of crimes such as drug trafficking, corruption, smuggling, tax evasion, fraud and organised crime without attracting the attention of law enforcement agencies.

The process generally passes through three stages:

1. Placement – illegal cash is introduced into the financial system, for example through deposits, buying assets or remitting funds abroad.
2. Layering – a series of complex transactions (transfers between accounts, companies and countries) is carried out to break the link between the money and its criminal origin.
3. Integration – the laundered money is returned to the economy as apparently legal income, used for investment, property purchase or business financing.

Money laundering harms the economy by distorting investment, reducing tax revenue, weakening the integrity of financial institutions, encouraging corruption and undermining monetary and fiscal stability. It is therefore controlled through anti-money laundering laws, "know your customer" rules, reporting of suspicious transactions and international cooperation. In Nepal, the Asset (Money) Laundering Prevention Act, 2008 (2064 BS), the Financial Information Unit (FIU) of Nepal Rastra Bank and the Department of Money Laundering Investigation are the main instruments for its control.

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b) Expenditure assignment

Expenditure assignment refers to the division of public expenditure responsibilities among different levels of government in a federal fiscal system. It answers the question of which level of government should provide which public good or service, and it is one of the core elements of fiscal federalism, along with revenue assignment and intergovernmental transfers.

The general principles of expenditure assignment are:

• National public goods such as defence, foreign affairs, currency and monetary policy, and national highways are assigned to the central government, because their benefits extend over the whole country and they cannot be provided efficiently by smaller units.
• Local public goods such as local roads, drinking water, sanitation, primary education and local health services are assigned to local governments, because local bodies know local preferences and needs better and can be held accountable.
• State/provincial governments handle intermediate functions such as secondary education, provincial roads, hospitals and provincial-level infrastructure.
• Functions with spillover effects or economies of scale are assigned to a higher level, while functions where local preferences differ widely are assigned to a lower level.

In Nepal, the Constitution of 2015 (Schedule 5 to 9) assigns exclusive and concurrent powers to the federal, provincial and local governments. Proper expenditure assignment reduces duplication, improves accountability and increases the efficiency of public spending. However, when expenditure responsibilities are assigned without matching revenue sources, a vertical fiscal imbalance arises, which must be corrected through fiscal transfers.

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c) Loan and taxes

Loan and taxes are the two major sources of public revenue through which the government finances its expenditure. They differ in nature, obligation and economic effect.

Taxes are compulsory payments made by individuals and firms to the government without any direct or specific benefit in return. They are imposed under legal authority and are not repayable. Taxes may be direct (income tax, property tax, profit tax) or indirect (VAT, customs duty, excise duty). They are the main source of regular government revenue and are used for public goods and services. Taxes reduce the disposable income of the payer and involve no repayment obligation, but they may affect incentives to work, save and invest.

Loans are funds borrowed by the government from domestic or foreign sources, such as banks, the central bank, international financial institutions and foreign governments. They must be repaid with interest after a fixed period. Loans may be internal (borrowed within the country) or external (borrowed from abroad). They are used mainly to finance capital expenditure and to cover budget deficits. Unlike taxes, loans create a liability for the government and impose a burden on future generations through debt servicing.

In short, taxes are compulsory, non-repayable and regular sources of revenue, whereas loans are voluntary, repayable and temporary sources. A sound fiscal policy uses taxes for routine expenditure and loans mainly for productive capital investment.