Legal frameworks essential to remove operational barriers to fiscal federalism

  • Interview Shankar Prasad Adhikari

Jan 8, 2018-

Nepal has officially embarked on the road to realising a fully federal system of governance. With the change in state structure, there is also a need to bring fiscal federalism into operation. But a number of laws, guidelines and bodies are yet to be put in place to fully empower subnational governments, heralding a slow start. Rupak D Sharma talked with Finance Secretary Shankar Prasad Adhikari about the challenges in store for financially sustaining a federal Nepal, the increased responsibility of local bodies in revenue generation, and past difficulties with capital expenditure.

Will the government have difficulties in sustaining the federal structure financially?

The current structure of government will have to be rearranged under the federal system, and if this is managed rationally, there will be no difficulties. Under the old administrative structure, the central government had to bear all the costs. We had almost 4,000 cost centres at zones, districts and the Village Development Committees. However, with the implementation of federalism, the number of local bodies have come down to 753 from around 3,500 in the past. At the centre, the government is planning to limit the number of ministries to 15 to 18 from the existing 31. And at the state level, we are planning to establish around seven ministries. With this decrease in the number of centres, the central government’s expenses will fall. So financially, there will be no difficulty in implementing fiscal federalism as long as the budget is managed rationally. 

There may be 15-18 ministries at the centre, but there is also talk of establishing more than seven ministries in the provinces. And 753 local bodies will also have to oversee over 6,900 wards.

If states have a robust mechanism to generate revenue, the hike in the number of ministries may not create problems. That being said, the number of ministries in the 

provinces must also be kept in check. We must not increase the size of the state government beyond necessity; doing so will only increase costs. The government should be of a size whereby it can address the needs of the people and the society adequately, but no larger. 

We may have an additional 6,900 wards to contend with, but they will have to execute tasks as per the budget allocated by municipalities and rural municipalities.

People at the local level have great aspirations that under the federal structure, development works will gather pace. Will their hopes be realised?

Under the federal structure, people have a greater hand in the completion of development projects. Now, instead of ministries, local bodies will have to carry out developmental work. So, they have greater responsibilities. They have to understand that they must mobilise resources on their own as well if any progress is to be achieved. Hope alone cannot fuel development. 

But many local bodies do not know how to mobilise resources, as there is limited understanding of how the federal structure operates amongst government officials and elected local representatives.

The centre has to educate the people in this regard. Training in budgeting, auditing and assessment of expenditure needs (among other things) will have to be given to elected representatives, and government officials. We have included this in our agenda, however, we still have to prepare legal framework. We are also in the process of preparing templates of procurement laws and budgetary regulations for the local bodies. If appropriate legal and institutional frameworks are put in place, many operational barriers can be removed.

Local bodies are not accustomed to mobilising resources on their own. Many hold the view that the centre will provide them funds to execute projects. Will a legal framework alone be enough to make them financially independent?

This sense of autonomy will be difficult to realise at the outset. The country has never functioned under a federal structure before, so it will take time for subnational governments to identify new revenue sources. But already, we are hearing news that some of the local bodies have increased fees for services rendered to the public. It seems that local bodies are already trying to function independently. 

But many local bodies are only focusing on increasing tax rates, which will add burden on people.

The local level representatives are elected by the constituents, and if they raise tax rates exponentially, their chances of being re-elected will drop. So tax rates have to be affordable. That being said, I do believe that increasing rates in a cost effective manner is not remiss, as long as it does not impact the public excessively.

And what if the local bodies go on another tangent altogether and pursue a more populist line of governance. What if there is negligence in collection of taxes and fees? This could be a possibility given that tax compliance of local bodies was between 30 to 40 percent in the past.

Local level bodies will have to function rationally. If the rates are too high, people will not be able to afford them. If they are too low, local bodies may not be able to provide public goods and services effectively. So cost effectiveness is key and rates have to pegged accordingly. This will be difficult to achieve, and mistakes will be made, but people will learn from experience and from the success of others. 

With the federal structure in place, what should be the tentative budget for the next fiscal year (FY) 2018/19?

Nepal experienced a revenue growth of 25 percent between the FY 2015/16 and 2016/17. If there is political commitment, revenue growth rate can go up to 30 percent. With this resource, we can launch a budget of around Rs1,600 billion for the FY 2018/19. 

Do you think the centre can afford such a big budget, as it will have to share certain portion of value added tax (VAT) and excise duties with local bodies and provinces from next fiscal year?

The funds that will be made available to provinces and local bodies under the revenue sharing mechanism will be factored in while allocating grants to them. Also, revenue generating capacity of every local body and province will be taken into account at the time of allotting grants. So, the shortfall in the government’s income due to the provision in revenue sharing will be partially offset by lower allocation of grants to local bodies and provinces.

The government always introduces a big budget, but fails to fully utilise it because of problems in capital spending. Will this problem of low capital spending be seen at the local level as well? And will the funds be spent appropriately?

There has always been a problem with capital expenditure at the central level. But I believe this will change under the new federal structure. People will be able to keep an eye on how much progress has been made and can hold their local representatives accountable if work is slow. And there will be public audits and hearings on whether or not funds are being spent wisely and appropriately at the local level. 

What about the difficulties with capital expenditure at the central level?

Capital expenditure at the central level depends on government stability, good governance, and project specific planning and budgeting. We lack discipline in these areas. A number of rules and regulations are required for progress in this regard. Two of them are Project Implementation Act, and Fiscal Responsibility and Budget Management Act. There is also need for project-specific sunset laws. For example, mega projects such as a Kathmandu-Tarai expressway may require a specific set of rules that will only be in effect until the project’s completion.

Furthermore, in the past, a budget used to be allocated for a project before ascertaining its readiness. Now, we have introduced a project readiness filter, under which a detailed project report must be prepared, environmental impact assessments must be conducted, resettlement requirements must be fulfilled and social impact assessments must be carried out before a budget is allocated to projects.

Another problem has to do with the nexus of suppliers and contractors. Strong political will is required to deal with this problem. Neither suppliers nor contractors can be brought to book right now for failure to deliver because of political protection. 

And has this inability to spend capital affected the banking sector in terms of liquidity?

Yes. As the government has failed to spend capital budget on time, the money is stored in the central bank. Had public spending gone up, the money would have departed the state coffers and transferred into the hands of the contractors or suppliers, following which it would have been deposited in commercial banks. Since this cycle is not working properly, banks are facing a shortage of cash. 

POST PHOTO: Shaligram Tiwari

Published: 08-01-2018 08:16

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