For technocrats at the Finance Ministry, pencilling the next week's budget is turning out to be very different than all earlier experiences.

This time, they will have to bend over backwards to downplay or even conceal security expenses. The government wants a counter-insurgency operation budget. This means not just increased budget to be spent on security but also development expenditure that it uses as a hearts-and-minds operation.

"Expenditures on security are an investment for peace, better revenue generation, better development delivery," Finance Minister Madhukar Shamsher Rana told a pre-budget local donor's forum on 7 June in Kathmandu.

This level of clarity is keeping the budget's designers scratching their heads trying to balance various priorities. But because there isn't enough money to pay for development, let alone security, there is just no way Rana can balance this budget without camouflaging some security expenses.

The trouble with military budgets is that once you give in, it never goes down. The recently- dissolved High Level Public Expenditure Commission found that security expenses including defence and the police accounted for almost 17 percent of the total expenditure in the 2003-4 budget, up from barely nine percent in 1997-98.

"It is an alarming situation," says economist Bishwamber Pyakurel, who headed the commission, "such a rise in security expenses cannot be sustainable, especially when your income targets are not met." During the current fiscal year, the government's aim was to increase revenue growth by 18 percent. But latest figures show it has gone up by only 12 percent.

The Royal Nepali Army is all set to revive its Integrated Security Development Program (ISDP) which it did in a half-hearted way in 2001-2 in Gorkha and some other districts. The idea is to move in after clearing the Maoists with health, education, roads and schools to win over the locals.

"We are preparing the budget in such a way that we can take both ideas together as was conceptualised in the ISDP," said one Finance Ministry source.

But this costs money, and the question is where will it come from: from the military budget or the development budget? Since the development budget is 80 percent donor-driven, they are sure to take a dim view of such item transfers.

Juggling the two roles will not be easy. The Deuba government had brought in what it called the 'peace budget' under a scheme that went by the acronym PCBPP (Participatory Community Based People's Projects). The idea was to increase development spending by giving grants to village non-governmental bodies. Finance Minister Bharat Mohan Adhikari had then said, "We want to use this budget as a confidence building measure to build trust with the Maoists."

It didn't work. Even when community-based organisations well out of the government's network implemented the projects it was difficult to carry out project activities in Maoist areas. With the ISDP, the army thinks it will be the one to spearhead development into the countryside.

A recent publication by the Asian Development Bank (ADB) has expressed concern about the quality of spending. The Quarterly Economic Update of the bank states, "While the government spent more than Rs 6.3 billion for the education sector in the first half of 2005, many schools in rural Nepal remained closed for large parts of the year due to Maoist threats. Government investments in the sector are unlikely to yield optimal results." The report predicted that the investment rate would fall to about 18 percent due to sluggish public and private investment in the conflict situation.

"That is an interpretation of a high conflict scenario," said an economist on the ADB publication. "If that is true, the situation is really getting out of hand."

The real question for the royal regime is how far the donors will go along with Rana's idea of military spending as investment. Bilateral donors, especially the Europeans, don't like it one bit. Multilaterals whose loans are down by 84 percent will also be reluctant. A top Finance Ministry official admitted to us: "Certainly, the development budget depends on what the donors give us."

Some officials have claimed that they would mobilise 'internal resources'. But with the revenue targets unmet, exports, investment and tourism down, it is unclear where that will come from. In the last few years internal borrowing has grown in direct violation of the Nepal Rastra Bank Act which caps such borrowing to only five percent of the budget.