Macroeconomic Implication of Fiscal Deficit and Public Debt in Nepal

Fiscal deficit is a gap between government receipts and government expenditure and public debt is an accumulation of yearly deficits. Nepal has been adopting budget deficit since 1952 when first formal budget was announced. The fiscal deficit/GDP is 4.48 percent and public debt/GDP is 35.60 percent in 2011 in Nepal. This study is focused to investigate the various macroeconomic implications of fiscal deficit and public debt in Nepal by analyzing the annual time series data from 1975 to 2011. The econometric instruments used to analyze the empirical results are unit root test, ARDL approach to cointegration, Granger causality test and other OLS diagnostic tests. The empirical results of the study show that there is positive and significant impact of fiscal deficit and public debt on economic growth, investment, government expenditure and government revenue in long run and short run. But, there is negative relationship between consumption and fiscal deficit and consumption expenditure is also negatively associated with economic growth rate. There is significant positive relationship between debt finance and unproductive expenses like government regular expenditure. It is also found that there is crowding-in effect rather than crowding-out effect of domestic borrowing in Nepal. The positive effect of foreign borrowing is higher than the effect of domestic borrowing on economic growth. There is small inflationary effect of fiscal deficit and Indian inflation is more responsible than the fiscal deficit to increase inflation in Nepal. Money supply has no significant impact on inflation of Nepal. Finally, the public debt is found strongly sustainable in Nepal. Policy implications of the study suggest that Nepal can further adopt the expansionary fiscal policy utilizing more foreign loan than domestic loan for economic development. The government recourses financed through deficit are found to be used for unproductive expenses as well which should be channelized into productive sectors by improving fiscal policies. Nepal should diversify the international trade with other countries to reduce the over dependency on India for independent implementation of fiscal and monetary policies to control inflation in Nepal.