Moving Forward with Fiscal Federalism in Nepal

• Much of the legal framework to move to federalism has been or is about to be completed. It includes an Intergovernmental Fiscal Arrangement Act, a Local Government Operations Act, a National Natural Resources and Fiscal Commission Act, an Audit Act, and a Financial Procedures and Fiscal Responsibility Bill.
• All provinces and local governments have established a consolidated treasury single account, as required by the Constitution, and have received federal grants based on published formulas. Nearly all local authorities have submitted their accounts to the Auditor General. Two-thirds of them have passed a law regulating their budget process, and almost all have voted a budget on time.
• Financial reporting by subnational governments is still an area of weakness but the federal Treasury published in February the budget execution report for FY 17/18 which included for the first time detailed revenue and expenditure data at subnational level.
• Important regulations and guidelines relating to PFM were issued in 2019, including Internal Control Guidelines and Gender Responsive Budgeting Guidelines for Provinces.

Critical weaknesses remain. Capacity at the subnational level is still very thin. The general quality of reporting by subnational governments remains poor and ongoing work to improve accounting and IT systems will take time to yield significant results. The Auditor General noted in his April 2019 report that financial irregularities at local level were slightly lower than at federal level, but this result may mainly signal his lack of capacity to audit local governments. Besides, decision makers at the provincial and local level lack the tools to ensure that their priorities are reflected in the budget and that value for money is obtained from public expenditures. For key public services such as health, education, and water, services are delivered at the subnational level, but priorities, strategies and financing envelopes are mainly defined at the federal level. This creates a disconnect that is detrimental to service delivery and creates uncertainty about political roles and responsibilities at the various levels of government.

The journey will be long and bumpy, but the following suggestions, while clearly not exhaustive, could be considered by reformers who want to make federalization a success.

First, the many laws, regulations, frameworks and guidelines that have been issued recently need to be implemented. This will require a vast effort in terms of awareness raising of local politicians and decision makers, as well as training of the administrative cadre at local and provincial level. So far, the training efforts have been piecemeal at best. In PFM, a training needs assessment is being conducted and the establishment of a PFM Academy is being considered. Progress is nevertheless slow and may be hampered by the lack of trust between the federal government and some local governments.

Second, responsibilities for service delivery should be clarified and match responsibilities for financial management. A performance-based approach for service delivery funding could be considered but should go hand in hand with increased responsibilities for local decision makers in defining their strategic priorities and resource requirements and in managing their budgets.

Third, subnational governments should be allocated enough resources to fill existing gaps in human capacity and IT systems. This might require provincial civil service commissions to be established. In addition, subnational governments will need the fiscal space to recruit staff and pay salaries and benefits that are sufficiently attractive to lure federal employees to the provinces. For this, the current arrangements for sharing taxes among the provinces and municipalities would have to be reexamined.

Finally, the new Constitution has given the Auditor General responsibility for auditing subnational governments and to be the cornerstone of the public sector’s accountability framework. To fulfill this enlarged mandate, the auditor will have to use his resources with imagination and creativity. For example, the financial statements of subnational governments could be audited over a 3- or 4-year cycle. This would allow the auditor to visit individual municipalities less frequently, while engaging in a deeper analysis of the accounts during these visits, focusing on specific areas of risk such as multiyear investment projects or recurring patterns of suspicious transactions.