Where Are The Resources To Execute The Federal Setup

Along with successful completion of the parliamentary and provincial polls, the country finally entered into the federal structure envisioned by the new Constitution. There will be three layers of the administration: federal (central), provincial (state) and local in future. The federal government will transfer grants to the provincial and local government and they are responsible for framing their own programmes and budgets. Since the establishment of 753 local units, the federal government has already started the practice of fiscal transfer (providing grant) to local bodies through the fiscal budget of 2017/18. In total of Rs 1,278 billion’s budget for this fiscal, Rs 225 billion is allocated as grant for local units.

Change: A Costly Affair

From the coming fiscal 2018/19, the federal government has to transfer grants to the provinces. The constitution has ensured the autonomy of the lower level of government and there will be no instruction and interference from the central government. There will be separate parliament, ministries, judiciary, security and other functions of the state in each of the seven provinces which is going to come into function. As the country has already embarked on the federal set up, the National Planning Commission (NPC) and the Ministry of Finance (MoF) have been framing the next fiscal year’s budget as per the new set up. The MoF had recently carried out a study, which shows the requirement of Rs 820 billion or 30% of the gross domestic product (GDP) in the next three years for the construction of buildings, purchase of vehicles and management of civil servants at state and local levels, and it is challenging for the federal government to find resources. According to Yubraj Khatiwada, former Vice President of the NPC, though the decade long political transition ends with the recently concluded three tiers of election to elect representatives at local, province and federal assemblies, however, the institutional and legal transition towards the federal structure is yet to begin. This transition should be shorter to deliver from these mechanisms as per the expectations of the people, according to Khatiwada.

Central Government To Be Leaner

To reduce administrative costs, the government is mulling over limiting the number of ministries to around 15 from the existing 31 at the centre and to 7 at the states. The size of Council of Ministers at the centre should not exceed 25 once the new government takes office, says the constitution. Also, efforts are being made to utilise available stock of government officials for recruitment at newly formed states and local bodies. These cost-saving measures will go a long way in institutionalising federalism and maintaining fiscal discipline. Yet certain costs must be borne by the central government every year to finance national pride projects, maintain peace and security, deepen relations with foreign countries, stimulate economic growth, bridge the physical infrastructure gap, enroll citizens in social security schemes, execute day-to-day works at the centre, and manage emergencies. The central government, in the current fiscal year, allocated around 59% of its annual budget for national security, management of judiciary and federal administrations, foreign affairs, domestic and foreign debt servicing, pension and gratuity, social security, share and loan investment in state-owned enterprises, higher education, reconstruction, implementation of national pride projects, election, and natural disaster and other emergency management. This spending, according to Shanta Raj Subedi, former Finance Secretary, cannot be reduced in the coming years. Shankar Prasad Adhikari, Finance Secretary also admits to the fact that the central government’s spending is expected to further go up, as the constitution has directed distribution of four types of grants - fiscal equalisation, conditional, matching and special - among states and local bodies. This is a clear indication that the central government will need huge financial resources in the coming days to implement federalism.

Resources: The Key Challenge

Though the expenses requirement of the government increased exponentially but the resources to finance these are limited. The government has targeted to achieve Rs 730 billion’s revenue target in this fiscal, which could be increased by up to 30% in the coming fiscal 2017/18. On other hand, the government can raise domestic debt up to 5% of the GDP; the government is going to raise fiscal worth to Rs 145 billion in this fiscal. Similarly, foreign debt is around 24% of the GDP. Contribution of the foreign debt and grant will increase from next fiscal as the government has no other option for budget financing. After transferring Rs 150 billion grant in two tranche (mid-July and mid-November) to local bodies, the central government is raising domestic debt at high interest rate, around 6% to manage the expenditure of the federal government. By mid-March the central government has to transfer grant amount worth Rs 75 billion to local bodies. As the government believes that there will be 30% growth in revenue in next fiscal, however, there is no ground that the government can achieve high revenue growth continuously. The government’s main sources of income are value added tax (VAT), income tax, and customs and excise duties. These taxes and duties account for over 90% of government revenue. The Intergovernmental Fiscal Management Act has clearly stated thatcentral government must distribute 15% of VAT and excise duty collected from domestic products among local bodies and another 15% among states from the next fiscal year. The central government also needs to distribute 25% of royalties generated from use of natural resources, namely mountaineering, electricity, forests, and mines and minerals, among local bodies and another 25% among states from the next fiscal year. These revenue sharing mechanisms is certain to put a dent in the central government’s coffers.

What Next

One of the ways to narrow the resource gap is through widening of the value added tax net. However, tax expert says that tax to GDP ratio is already high in Nepal and the government does not have much room to raise other tax rates. Hike in corporate income tax could erode confidence of investors and entrepreneurs, and rise in individual income tax is not a solution either. On the other hand, hike in customs duties and taxes imposed on imports will stoke inflation. The government cannot resort to raising domestic debt because there will be crowding out effect in the private sector if the government raises the domestic debt breaching the ideal slab of 5% of the GDP. Considering these impediments, the only way to widen the government’s income base is by reviving the industrialisation process, commercialising agriculture, developing sectors such as energy and raising exports. Also, innovation should be fostered, entrepreneurship skills must be developed, and impediments to doing business should be removed. This will enable the country to grow faster, share prosperity and provide social justice in an equitable manner, which the people are expecting from the political change.