Nepali economy has entered 2018 in better health. Nepal’s economic growth rate topped a 23-year high of 6.9 percent in the fiscal year 2017, inflation stood at 3.9 percent in November (the latest data available), and foreign exchange reserves have adequate funds to finance merchandise imports of up to 13.5 months.

The challenge now is to build on these achievements. This can, however, be difficult in 2018 as the country has just started experimenting with fiscal federalism.

With the implementation of fiscal federalism, the central government must share a certain portion of income generated from value added tax (VAT), excise duty levied on domestic products and royalties generated from the use of natural resources with the newly-formed provinces, and local bodies. In the federal set-up, the central government will also be barred from collecting land registration and vehicle taxes.

The reduction in revenue source, coupled with sharing of income generated from VAT, excise duties and royalties, is likely to reduce the central government’s revenue growth rate to 3.7 percent in the next fiscal year from annual average growth rate of 22 percent in the last one decade. This is expected to create a shortage of funds for the central government, hitting the construction of big-ticket infrastructure 

projects, the higher education sector and the delivery of other services.

This calls for the need to: expand the tax net, especially that of VAT, which has not been implemented properly; curb smuggling and under-invoicing so as to maximise revenue collection; and find alternative income sources. In other words, the government must focus on increasing revenue collection to sustain fiscal federalism, under which the central government will not only be obliged to share its income with sub-national governments but extend grants to them as well.

One precondition to high public revenue is high economic growth. Once growth picks up revenue generation will automatically go up in Nepal because tax buoyancy in the country is quite high. The buoyancy of taxes collected by the central government jumped from 1.3 in fiscal year 2013-14 to around 2.2 in 2016-17. This means 1 percent nominal GDP growth led to 1.3 percent hike in revenue collection in 2013-14 and 2.2 percent hike in revenue collection in 2017-18.

To grease the wheels of economic development, the government, in the initial phase, must focus on completing all national pride projects—an inventory of 21 projects, which includes mega schemes on highway, railway, irrigation, hydroelectricity, airport and drinking water. Completion of these projects would narrow down the infrastructure gap, which is one of the biggest binding constraints for Nepal’s rapid growth. Also, introduction of Foreign Investment and Technology Transfer Bill, Commercial Agriculture Bill and Public Private Partnership Bill—drafts of which have been prepared—can help a lot in making structural reforms. If the new government focuses on these areas in 2018, a solid groundwork can be laid for rapid economic growth in the coming years.