It will take time to manage federalism

 Baikuntha Aryal

Acting Secretary, National Natural Resources and Fiscal Commission (NNRFC)

Along with the completion of the final phase of the federal elections in October, the Parliament ratified the Inter-governmental Fiscal Management Act, which envisioned four grants – fiscal equalisation, conditional, matching and special - for the subnational governments.

From the coming fiscal year 2018/19, the federal government needs to provide 15 per cent each of the collected VAT and excise duty to the local bodies and 15 per cent to the provinces. To recommend the bases of grant mobilisation to the local bodies and to create a formula and methodology to distribute VAT and excise duty as well as to share the revenue generated from the use of natural resources, a constitutional body - National Natural Resources and Fiscal Commission (NNRFC) – has been constituted. 

As the NNRFC has been formed recently and all the local governments have started the budgeting process, the commission has a challenge to fulfill its duties to offer formulae and methodologies and recommendations to the national as well as the subnational governments. Against this backdrop, Modnath Dhakal of The Rising Nepal talked to Acting Secretary of the Commission Baikuntha Aryal, Ph.D. He said that the commission had already begun work and consultations and would be able to develop a methodology and furnish recommendations to the government in time. Excerpts:  

What is the National Natural Resources and Fiscal Commission (NNRFC) doing now? 

According to the National Natural Resources and Fiscal Commission Act, the federal government will send the ceiling of the fiscal equalisation grant and revenue distribution to the provincial and local governments by March 14, in consultation with the NNRFC. The commission is currently preparing the framework for this and will submit the formula to the Ministry of Finance (MoF) within the stipulated timeframe. Then the MoF will send the ceiling of the budget to the local governments as per the formula recommended by the commission. 

What will be the role of the National Planning Commission (NPC) in this? 

The NPC is the central level planning body. It sets the overall budget ceiling of the central budget, earmarking the budget size for the provinces and local bodies. It doesn’t look into the budget of the provinces and local bodies. The fiscal equalisation grant will be provided as per the Inter-governmental Fiscal Management Act and National Natural Resources and Fiscal Commission Act. These legal instruments have said that grant and revenue distribution will be on the basis of the Human Development Index, development and infrastructure status, condition of revenue, population and the like. It’s the duty of this commission to develop a composite formula for grant and revenue distribution within the ceiling set by the central planning body.

When will the commission take its complete shape? 

As it’s a constitutional commission, certain provisions are required for it to take complete shape. There will be recommendations for the chairperson and members of the commission, there will be a hearing in the Constitutional Council – which is yet to take full shape - after the formation of the new government. Only after completing these processes, the commission will come into full shape. So, it may take some time. 

The commission will not take full shape soon while the local bodies have started the budgeting process for the upcoming fiscal year 2018/19. What will be your role in such a situation? 

The commission is not working in a void as it has legal instruments, as I said before. In order to send the budget ceiling to the MoF, we are devising a preliminary formula. By the time of budget allocation, the commission will also take full shape, and it may endorse this formula or enrich it. However, a shortage of sufficient data is creating challenges to us. 

According to the constitutional provisions, the federal government must announce the budget on May 29, the provinces on June 15, and the local bodies on June 24. Are we to believe that the commission can offer the necessary recommendations to all the governments in such a short span of time? 

It’s not a question of whether the commission can do so. As I said, the commission will create the base for grant distribution by March 14 so that the MoF can send the budget ceiling to the provinces and local bodies. The commission has conducted interactions in five of the seven provinces, except in Provinces 1 and 4. This exercise will continue even after sending the budget ceiling to the local bodies. There are other duties to perform as well, such as creating the base for the fiscal equalisation grant, and base and framework for the use and distribution of the revenue generated from the natural resources. In addition, the commission will also set the ceiling for domestic borrowing on the basis of the macroeconomic fundamentals for the national as well as sub-national governments. However, there are no legal instruments to facilitate the local governments’ domestic borrowing, so this provision might not be included in the budget of the next fiscal. We are committed to fulfilling all these constitutional provisions within the pressed period.   

Much of the deliberation on federalism in Nepal is largely focused on the political and geographical aspects while little attention has been paid to the fiscal characteristics of the provinces and local governments. How do you see federalism from the fiscal perspective? 

I think we are gradually moving to fiscal federalism. The first phase was the existence of the federal structure itself, mostly on the basis of geography and population. Now we need the resources to run the governments. So the issues of fiscal federalism will come to the surface now. The states and local bodies will not only analyse their fiscal strengths and weaknesses but also compare their situation with other states and local bodies regarding their demand for resources from the central government. The local governments have to find resources to implement infrastructure development, social welfare and many other programmes that they announced in their election manifesto, which may motivate them to be more innovative in terms of identifying resources and mobilising them. The provinces and local bodies now have their own treasuries, and when they learn all these things, fiscal federalism will be in practice. However, it is also a truth that it will take quite some time to manage federalism, but it will be fully functional from the next fiscal year. 

Some people say that the huge structure of the governments might cost a dear sum of money, but it’s not the truth. Managing federalism is about how we manage the resources and consolidate them. If the government were to prioritise the issues and focus on the results, the situation will improve much earlier. 

What are the major elements of fiscal federalism in Nepal? 

I think it’s about generating and mobilising resources by the various levels of the government, it’s about the source of funding. Local and provincial governments get four types of grants – fiscal equalisation, conditional, matching and special. The matching grant will be provided to them for projects, such as hospitals that provide services to more than one local body, but have a funding gap. They can directly approach the federal government for the matching grant. 

A special grant is not for all, but for special purposes such as natural disasters and poverty alleviation. Revenue sharing will provide another major chunk of resources to the local bodies as they will get 15 per cent of the VAT and excise duty. Another source is royalty sharing of the natural resources, which does not go to all the provinces or local bodies but is shared among those where the royalty is collected. The Constitution has already set the criteria of taxes and royalties for all the three levels of government. Proper utilisation and sufficient investment can generate a huge sum of money as well as create employment and development opportunities in the respective local units, but they must ensure sustainable exploitation of the available resources. In addition to it, they will have facilities of internal borrowing and borrowing from the federal government. Therefore, the provinces and local bodies have enough fiscal options.  

Will the commission provide any recommendations to the local governments regarding resource generation? 

Yes, the commission can provide recommendation in terms of utilising the natural resources and mobilising the resources. It can suggest in creating and amending certain laws and policies. Most of the local bodies have given high priority to revenue generation, but they must consider increasing economic activities, productivity and employment in their respective units at the same time.

And, what about the MTEF? Do the local bodies have the capacity to develop it? 

All the governments must create a Mid-Term Expenditure Framework (MTEF) – an annual, rolling three-year expenditure planning. It includes budget priorities, sectoral focus, areas that need refining and outcome criteria with performance monitoring. Without creating it, they can’t develop and announce the budget. The MTEF should include infrastructure development projects, economic activities that generate revenue and employment and other development works. The local bodies should prepare an inventory of resources in their respective area to develop the MTEF. Many local bodies do not have enough capacity to develop the MTEF. Therefore, the commission has urged the NPC and MoF to conduct training on it.

Have you observed any international modality of the commission that Nepal has now in order to recommend resource sharing among the three tiers of governments? 

On the domestic front, we are coordinating with the NPC and MoF while the Constitution has guided us in the whole process. We have analysed the status of other countries in terms of fiscal transfer and resource mobilisation. The modalities are not the same, many countries do not have three tiers of governments. For example, the Indian federalism model has powerful central and federal governments, while the villages are under the provinces. But in Nepal, resources move from the federal to the provincial and then to local level as well as from the federal to the local at the same time. We have 760 government units. 

Published in The Rising Nepal on 12 March 2018.