According to the World Bank’s “Nepal Fiscal Federalism Update”, the intergovernmental fiscal transfer (IGFT) mechanisms need to be revised to make the systems more effective
Fiscal federalism, which began in Nepal in the fiscal year 2018/19, has entered the sixth year with the provincial governments presenting their sixth budget in the second week of June. When Nepal formally started exercising federalism following the general election in 2017, there were doubts about whether sub-national governments (provincial and local governments) would be able to deliver services to the people effectively. Five years down the line, the country has made significant progress on fiscal federalism with functioning sub-national governments and periodic budgets.
A new report by the World Bank acknowledged the progress made by Nepal in fiscal federalism so far. “Since 2019, Nepal’s fiscal federalism institutions have continued to take root,” states the World Bank in its first annual “Nepal Fiscal Federalism Update.” According to the report, the regulatory framework has been further developed with four new key acts adopted at the federal level, which lay out public financial management (PFM) rules, including audit and public debt management, and inter-governmental coordination mechanisms and procedures for the three tiers of government.
The World Bank says considerable progress has been made on sub-national PFM performance. “Provincial and local governments have been building the basic core elements of their financial management frameworks related to planning, budgeting, accounting, treasury, and expenditure management,” reads the report. According to the report, all provinces have established planning commissions and prepared periodic development plans and medium-term expenditure frameworks (MTEF), and have prepared their first provincial development plans.
Following the federal FPFA Act, 2019, three out of the seven provinces have updated their own PFM laws aligned with the federal legislation, and the rest are in the process of passing their new acts. In addition, almost all local governments have adopted the Sub-national Treasury Regulatory Application (SuTRA), which is a web-based system for planning, budgeting, and accounting. “This enabled more than 90 percent of the 753 local governments to submit their budgets within the legally stipulated time,” states the report.
While the journey to fiscal federalism so far, has been satisfactory, more needs to be done to strengthen the regulatory framework, institutional setup, human resource capacity, and public financial management (PFM) systems at the provincial and local levels.
Federalism and local governance experts say the weakness seen in fiscal federalism can be attributed to the ineffectiveness of the federal government itself. “Despite the Constitution clearly defining the working areas for the three tiers of government, the lack of coordination undermines effective governance and weakens federalism. To address these challenges, a comprehensive restructuring is necessary,” said Krishna Prasad Sapkota, a local governance expert.
Even after five years, all the provinces and local governments rely heavily on federal grants and revenue to run the government. “Own-source and miscellaneous revenues accounted for only a small share of the overall revenue of sub-national governments,” says the World Bank report. All seven provinces’ budget for FY 2023/24 clearly illustrates this fact. The total internal revenue source of the provinces is only 10.7 percent of the total allocated budget. Similarly, 28.6 percent of their income is received in the form of revenue-sharing from the federal government.
While provincial governments have been presenting their annual budget on a stipulated date, the same has not happened in the case of local governments. Of the 753 local governments, only 520 have presented their annual budget for FY 2023/24 till the third week of July. The World Bank report says about 90 percent of Nepal’s local governments submitted their budgets within the established process in FY 2022/23. According to the Ministry of Federal Affairs and General Administration, in FY 2022/23, 682 of the 753 local governments submitted their budget to the local assembly within the legally stipulated timeframe, more than the 656 local governments in FY 2021/22.
Despite improved budget execution, provincial and local governments’ budget credibility remained low as there continued to be a high level of underspending, which may have affected the delivery of public services. The under-execution rate was 28.8 percent for provinces and 26.5 percent for local governments in FY 2021/22, mainly in recurrent budgets for provincial governments and capital budgets for local governments. “The extent of underspending was larger for recurrent budgets, with provinces spending only 61 percent of these budgets versus 80.3 percent of their capital budgets,” says the report. The key drivers of provincial government underspending included substantial lump-sum allocations under the ‘Economic Miscellaneous’ budget sub-heading, and the lack of alignment between annual budgets, MTEFs, and periodic development plans.
Most local government spending, particularly capital spending, takes place in the last four months of the fiscal year. The World Bank says 547 of the 753 local governments spent 68.8 percent of their capital spending in the last four months of FY 2020/21 and 44.9 percent in the last month of FY2020/21.
Federalism expert Rudra Sharma says Nepal’s provincial and local governments currently lack the knowledge and understanding necessary for effective spending. “This inability to spend effectively can be attributed to the reluctance of both bureaucrats and politicians to undertake innovative projects that could drive economic change. Implementing such projects requires thorough research and studies, even for policymakers and lawmakers,” said Sharma.
The World Bank underscores that moving into the next phase of fiscal federalism requires further legal and institutional reforms. “The existing structure of concurrent responsibilities on expenditure and service delivery among the three tiers of government provides overlapping mandates to different tiers of government and hinders responsiveness to citizens’ demands,” states the report. “Adjusting the regulatory framework to give clarity on these aspects would reduce duplication in spending and enable better service delivery.”
The unclear division of tax responsibilities undermines the materialization of provincial and local governments’ own-source revenue potential. There is a need to strengthen the institutional capacity and the coordination arrangements between the key federal institutions responsible for fiscal federalism; and of them with the provinces and local governments, according to the report.
The intergovernmental fiscal transfer (IGFT) mechanisms need to be revised to make them more effective and introduce more flexibility. While provincial and local governments received nearly 36.7 percent of the federal money through intergovernmental fiscal transfers which amounted to 64.8 percent of their revenue in the fiscal year 2021. The largest and proportionally growing fund transfers to subnational governments, in the past five years, have been through conditional grants. “Since conditional grants are heavily earmarked, they limit provincial and local governments’ spending autonomy and maintain undue control from the federal government on their spending,” states the report.
The share of conditional grants needs to be gradually lowered and other grants including equalization grants be increased following the expenditure capacity of the provincial and local government increases, according to the report
“There is room to improve the current IGFT system to make the transfers more flexible, clear, and timely, as well as increasingly performance-based, to enable PLGs to better align their available resources with planning processes and investment priorities and facilitate better outcomes of PLG service delivery,” reads the report.
The ‘Nepal Fiscal Federalism Update’ identifies key reforms to help Nepal improve fiscal federalism outcomes. It recommends developing a fiscal federalism roadmap to guide and monitor the reforms in this area, reinforcing the IGFT system, and establishing a consolidated PFM performance database at the subnational level. It also recommends amending the legal framework to clarify the concurrent and shared responsibilities among the three tiers of government, strengthening the capacity of provincial and local government staff to carry out PFM-related functions, and reinforcing systems to improve the budget credibility and delivery of services by subnational governments.
“Central government has struggled to manage federalism properly”
Krishna Prasad Sapkota, Local Governance Expert
The weakness seen in fiscal federalism can be attributed to the incompetence of the federal government, which unfortunately has been emulated by provincial governments. Timely programs are lacking at the provincial level, and budgets are often spent hastily towards the end of the fiscal year, copying the practices of the central government.
At the local government level, the issue lies with staff management, as 200 local units are currently without chief administrative officers. This scarcity hampers the effective functioning of local government bodies, which have essentially become centers for managing cadres of mayors and deputy mayors.
The central government has struggled to manage federalism properly, often transferring budgets to provincial and local governments late and leading to duplication of work. Despite the Constitution clearly defining the working areas for the three tiers of government, the lack of coordination undermines effective governance and weakens federalism. To address these challenges, a comprehensive restructuring is necessary.
Capacity-building initiatives, clear guidelines and timelines, and a focus on strengthening local government institutions are key. Improved coordination, timely budget transfers, and the establishment of a robust monitoring and evaluation system will contribute to a stronger federalism that enhances governance and service delivery.
“The system has not improved in the past 6 years”
Rudra Sharma, Federalism Expert
Nepal’s provincial and local governments currently lack the knowledge and understanding necessary for effective spending. Despite the adoption of a federal structure, the system has not improved in the past six years, resulting in a lack of spending culture across all three tiers of government. This inability to spend effectively can be attributed to the reluctance of both bureaucrats and politicians to undertake innovative projects that could drive economic change. Implementing such projects requires thorough research and studies, even for policymakers and lawmakers.
To address this issue, the central government must take a more proactive role. If the provincial and local governments fail to deliver effective results, they should be held accountable, and the central government should empower them by granting the rights clearly stated in the constitution.