Macroeconomic and Distributional Impacts of Downsizing Fiscal Deficits

This paper analyzes the price, growth, and distributional changes in a developing economy under domestic fiscal reform to narrow a fiscal deficit. We take the case of the South Asian developing economy of Nepal, which has been less covered in policy studies. Our approach is the Computable General Equilibrium (CGE) method applied to the Social Accounting Matrix (SAM) data. We conducted a simulation analysis with an approximately 10 percent reduction in the fiscal deficit of the government from domestic measures. This simulation exempted the agricultural sector from imposition of the additional tax, as an effort to protect the welfare of the poor. Our results show that under this policy the industrial and agricultural sectors expand, whereas the services sectors contract. However, basic macroeconomic fundamentals hardly change. Households that basically draw their livelihood from the industrial and agricultural sectors are benefited, whereas those that draw basically from the service sectors lose. Therefore, the study warrants the policy implication that the potential expansions and contractions of different activities must be envisaged beforehand when implementing this type of policy reform. Otherwise, poor who are working in the potential contractionary sectors may become even poorer after the implementation of this policy.