This paper develops a macroeconomic forecasting model focusing on fiscal policy and
economic growth in Nepal. The structure of the model, which comprises a total of 14
equations, allows alternative policy options for maintaining fiscal stability and promoting
economic growth as well as switching deficit financing between domestic and foreign
loans. We use annual data from 1992/93 to 2009/10 to estimate the model and provide
out-sample forecasts for 2010/11 to 2012/13, consistent with the current Three Year Plan
period, in order to evaluate the plan performance. The empirical evidence suggests that
fiscal policy, particularly governments' capital expenditure affects economic growth
positively and also crowds-in private investment. However, there exists a trade-off
between fiscal stability and high level of economic growth as the policy goal of achieving
both objectives seems to be unattainable. Finally, the out-sample forecast suggests that it
is unlikely to attain the targeted economic growth in the Three Year Plan period from the
planned fiscal outlay even if it is realized.