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NEPAL FISCAL FEDERALISM UPDATE June 2023 Contents Tables iii Figures iii Abbreviation iv Acknowledgements v Executive Summary vi Background ix 1 Macro-fiscal Update on Provincial and Local Governments 1 1.1 Economic activities expanded in all provinces and most of local levels 2 1.2 In the context of increased spending, there is ample room for the improved fiscal performance of provincial and local governments 6 1.3 Policy Recommendations to improve the budget credibility of PLGs 15 2 Legal, Policy, and Institutional Frameworks on Fiscal Federalism 17 2.1 There has been good progress on establishing the regulatory framework, but more work is needed to clarify the responsibilities of the different tiers of government 18 2.2 The next stage of fiscal federalism requires stronger and better coordinated institutions to lead the implementation of the reform agenda 21 2.3 The methods to determine intergovernmental fiscal transfers, revenue sharing and the sharing of natural resources royalties need revising 24 3 Progress on Public Financial Management in Provincial and Local Governments 27 3.1 Planning and budget preparation and execution processes are more advanced in provincial than local governments 28 3.2 Expenditure reporting at local level is not timely or in line with national accounting standards 30 3.3 Internal control and treasury management systems are improving in PLGs 31 3.4 PLGs’ audits, oversight and transparency and accountability measures are in place, but implementation is challenging 32 3.5 Policy Recommendations 35 References 37 Annex 1: Stakeholder Organizations whose Representatives were Consulted to Produce this Update 42 Annex 2: The Legal Framework Underpinning Fiscal Federalism in Nepal 43 Annex 3: Local Government Budgeting Committees 45 Annex 4: Overview of Nepal’s Intergovernmental Grants 46 Annex 5: Public Financial Management Related IT Systems in the Government of Nepal 47 Annex 6: Disbursement Calendar for Intergovernmental Fiscal Transfer for FY23 48 Annex 7: Complementary studies on different aspects of Fiscal Federalism in Nepal 50 Tables Table E 1.1: Key recommendations of Nepal Fiscal Federalism Update viii Table 2.1: Exclusive powers of federal, provincial, and local governments 18 Table 2.2: Revenue rights of federal, province, and local governments (schedules of the Constitution) 19 Table 2.3: Main PFM related institutions across the three tiers of government 22 Table 2.4: Revenue sharing of federal taxes among the three levels of government (in percent) 25 Table 2.5: The administration and revenue sharing of PLG taxes 25 Table 2.6: Recommended, budgeted, and disbursed fiscal equalization grants, FY19 to FY23 (NPR billion) 26 Table 3.1: Legal provisions on transparency and citizen engagement measures across PLG public financial management 33 Figures Figure 1.1: All Nepal’s provincial economies grew at a faster pace in FY22… 2 Figure 1.2: …driven primarily by the services sector… 3 Figure 1.3: … and particularly the wholesale and retail trade 3 Figure 1.4: Growth in electricity and construction sub-sectors boosted industry sector GDP 4 Figure 1.5: Bagmati contributed more than one-third of national economic growth in FY22 4 Figure 1.6: Most local governments experienced increased economic activities in FY22, as indicated by nighttime lights data 5 Figure 1.7: The fiscal surpluses of most provinces narrowed in FY21… 6 Figure 1.8: …due to improved budgets in most provinces 7 Figure 1.9: The consolidated fiscal surplus of local governments narrowed in FY21 7 Figure 1.10: Intergovernmental revenues accounted for the highest proportion of provincial revenues in FY21… 8 Figure 1.11: ..and of local economies 8 Figure 1.12: Local governments’ intergovernmental revenue varied by types of local government… 8 Figure 1.13: … and which provinces local governments are located in 9 Figure 1.14: Spending increased in most provinces in FY21 10 Figure 1.15: Local government spending also increased in FY21 10 Figure 1.16: The share of capital spending in total spending varied across provinces… 11 Figure 1.17: …and local governments 11 Figure 1.18: All provinces underspent their budgets in FY21 12 Figure 1.19: Underspending was driven primarily by contingencies and goods and services on the economic classification basis 12 Figure 1.20: In FY21, local governments underspent their budgets with metropolitan cities underspending the most 13 Figure 1.21: In FY21 the local governments in Bagmati underspent the most 13 Figure 1.22: The underspending of capital budgets drove the local government underspending in FY21 14 Figure 2.1: Budget allocations of the four types of grants from the Federal Government to PLGs 24 Figure 3.1: An example of a provincial government’s budget formulation process (Gandaki) 29 Figure 3.2: The local government budget formulation process 29 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | iii Abbreviations CAO Chief Administrative Officer COVID-19 Coronavirus Disease 2019 DTCO District Treasury Controller Office e-GP Electronic Government Procurement System FCGO Financial Comptroller General Office FFCD Fiscal Federalism Coordination Division FPFA Act Federal Fiscal Procedures and Financial Accountability Act FY Fiscal Year GDP Gross Domestic Product IGFA Act Intergovernmental Fiscal Arrangement Act IGFT Intergovernmental Fiscal Transfer IPFMRP Integrated Public Financial Management Reform Project IT Information Technology LG Local Government LGO Act Local Government Operation Act LISA Local Government Institutional Capacity Self-Assessment LMBIS Line Ministry Budget Information System MDTF Multi-Donor Trust Fund MoF Ministry of Finance MoFAGA Ministry of Federal Affairs and General Administration MTEF Medium-term Expenditure Framework NARMIN National Association of Rural Municipalities in Nepal NNRFC National Natural Resources and Fiscal Commission NPC National Planning Commission NPR Nepali Rupees NUGIP Nepal Urban Government and Infrastructure Project OAG Office of the Auditor General OPMCM Office of the Prime Minister and Council of Ministers PFM Public Financial Management PG Provincial Government PLGs Provincial and Local Governments PTCO Provincial Treasury Controller Office SuTRA Sub-National Treasury Regulatory Application VAT Value-added Tax iv Acknowledgements The Nepal Fiscal Federalism Update will be produced annually to report on the progress of fiscal federalism in Nepal and identify gaps between the vision of fiscal federalism laid out in the 2015 Constitution and the current state of play. The Update is intended for a wide audience, including policy makers in all three tiers of government, business leaders, the community of analysts and professionals engaged in the fiscal federalism debate, and the general public. This first edition of the Nepal Fiscal Federalism Update was produced by the World Bank Macroeconomics, Public Sector, Trade, and Investment (MPSTI) team for Nepal led by Yoshihiro Saito (Public Sector Specialist, MPSTI) and Nayan Krishna Joshi (Economist, MPSTI) and consisting of Marcela Rozo (Senior Public Sector, MPSTI), Alice J. Brooks (Senior Economist, MPSTI), Ojeswee Pande (Consultant, MPSTI), and Anima Maharjan (Team Assistant, SACNP). Inputs were received from Bishwa Raj Basaula (Financial Management Specialist, ESAG1), Prakash Jung Thapa (Consultant, ESAG1), Durgesh Kumar Pradhan (Consultant, ESAG1), Timila Shrestha (Senior Financial Management Specialist, ESAG1), Syed Waseem Abbas Kazmi (Senior Financial Management Specialist, ESAG1), Anwar Shah (Consultant), and Rameshwor Khanal (Consultant). The team wishes to thank peer reviewers Serdar Yilmaz (Lead Public Sector Specialist, EEAG1), Arvind Nair (Senior Economist, EECM1) and Maxwell Bruku Dapaah (Senior Financial Management Specialist, EEAG2) for providing guidance throughout the process. The team also wants to express its appreciation to the participants in the various consultation meetings for their inputs and feedback on the document. The report was produced under the guidance of Mathew Verghis (Regional Director, Equitable Growth, Finance and Institutions [EFI], South Asia Region), Faris Hadad-Zervos (Country Director for Maldives, Nepal, and Sri Lanka), Lada Strelkova (Manager, Operations), Shabih Ali Mohib (Practice Manager, ESAC1), and Tae Hyun Lee (Practice Leader for EFI, Maldives, Nepal and Sri Lanka). Akash Shrestha (External Affairs Officer) and Avinashi Paudel (External Affairs Associate) managed media relations and dissemination. The cutoff date for data included in this report was March 15, 2023. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | v Executive Summary The World Bank Nepal Fiscal Federalism Update aims However, moving into the next phase of fiscal to report annually on the progress of fiscal federalism federalism requires further legal and institutional in Nepal and identify implementation gaps. This first reforms. The existing structure of concurrent such update reviews the progress on fiscal federalism responsibilities on expenditure and service delivery since the publication of the Federalism Capacity Needs among the three tiers of government provides Assessment (FCNA)1 in 2019. overlapping mandates to different tiers of government and hinders responsiveness to citizens’ demands. Since 2019, Nepal’s fiscal federalism institutions Adjusting the regulatory framework to give clarity on have continued to take root. The regulatory framework these aspects would reduce duplication in spending has been further developed with four new key acts and enable better service delivery. Specifically, the adopted at the federal level,2 which lay out public unclear division of tax responsibilities undermines the financial management (PFM) rules, including audit and materialization of PLGs’ own-source revenue potential. public debt management, and inter-governmental Simplifying the division of tax responsibilities among coordination mechanisms and procedures for the the three tiers of government would help increase the three tiers of government. These new laws are vital for effectiveness of tax administration. In the same direction, the effective implementation of fiscal federalism. This there is a need to strengthen the institutional capacity federal-level legal framework has been complemented and the coordination arrangements between the key by multiple pieces of provincial and local governments federal institutions responsible for fiscal federalism; and (PLGs) legislation, including the updated provincial of them with the provinces and local governments. It is financial procedures and fiscal accountability acts in also important that PLGs adopt a more proactive role some provinces for better alignment with the PFM rules in accelerating the enactment of their own laws and that are stipulated in the Federal Financial Procedures regulations to improve the delivery of services. and Fiscal Accountability Act (FPFA Act, 2019). The intergovernmental fiscal transfer (IGFT) Complementary policies and guidelines have also mechanisms need to be revised to make them more been promulgated to reinforce the outcomes of effective and introduce more flexibility. Four types of fiscal federalism. This includes the National Planning such mechanisms have been established to distribute Commission’s (NPC’s) medium-term expenditure funds from the Federal Government to PLGs and from framework (MTEF) guidelines (2021) and Unified National provincial to local governments.4 PLGs received nearly 36.7 Project Bank guidelines (2020), Project Preparation, percent of the federal money through intergovernmental Selection and Prioritization Unified Standards fiscal transfers, which amounted to 64.8 percent of PLG’s (2023), the Ministry of Finance’s (MoF’s) guidelines for revenue in FY215. However, in the last five years, the intergovernmental fiscal transfers3 and various PFM largest and proportionally growing fund transfers to PLGs related model laws issued by the Ministry of Federal have been through conditional grants, which are heavily Affairs and General Administration (MoFAGA). earmarked, thus limiting PLGs’ spending autonomy and 1 The FCNA was jointly led by the Government of Nepal, the World Bank, UNDP and other development partners. The assessment survey was conducted by Nepal Administrative Staff College, Georgia State University, World Bank, and UNDP in 2019. 2 Financial Procedure and Fiscal Accountability Act (FPPAA, 2019), Audit Act (2019), Inter-Governmental Coordination Act (2020) and Public Debt Management Act (2022) 3 These guidelines are published after the budget every year. 4 Equalization, conditional, special, and complementary grants. 5 Nepal’s fiscal year runs from mid-July to mid-July of the following year. I.e. FY21 goes from July 2020 to July 2021. vi maintaining undue control from the Federal Government preventative action by provincial and local authorities. on PLG spending. There is room to improve the current In addition, effective citizen engagement mechanisms IGFT system to make the transfers more flexible, clear, on planning and budget preparation are lacking in and timely, as well as increasingly performance-based, most local governments, as well as in the monitoring to enable PLGs to better align their available resources and oversight of governments’ performance. And the with planning processes and investment priorities and performance monitoring of PLGs needs improving to facilitate better outcomes of PLG service delivery. offer consolidated data to facilitate evidence-based policy making by all tiers of government. Considerable progress has been made on sub-national PFM performance. PLGs have been The consolidated fiscal surplus of provincial and building the basic core elements of their financial local governments narrowed in FY21 as higher management frameworks related to planning, budgeting, expenditure outpaced revenue expansion. accounting, treasury and expenditure management. Expenditure rose due to the less stringent social For example, all provinces have established planning distancing measures in FY21 compared to the national commissions and prepared periodic development lockdown in the latter part of FY20. There were substantial plans and medium-term expenditure frameworks variations in provincial and local governments’ (MTEF). Following the federal FPFA Act, 2019, three out fiscal balances in FY21. More than 13 percent of local of the seven provinces have updated their own PFM laws governments recorded fiscal deficits. These deficits aligned with the federal legislation, and the rest are in the were financed by cash and bank balances, which reflect process of passing their new acts. In addition, almost unspent equalization intergovernmental fiscal grants and all local governments have adopted the Sub-national shared revenues. PLGs’ own source resources continued Treasury Regulatory Application (SuTRA), which is a web- to account for only a small share of their overall revenues based system for planning, budgeting, and accounting. in FY21, at 3.5 percent for provinces and 6.2 percent for This enabled more than 90 percent of the 753 local local governments. governments to submit their budgets within the legally Despite improved PLG budget execution in FY21, stipulated time in FY23. Moreover, two thirds of local there continued to be a high level of underspending, governments have carried out their FY21 internal audits, which may have affected the delivery of public and the external audit reports of most local governments services. The under-execution rate was 28.8 percent have been made publicly available by the Office of the for provinces and 26.5 percent for local governments Auditor General. in FY21, mainly in recurrent budgets for provincial Nevertheless, challenges remain in terms of the governments and capital budgets for local governments. effectiveness of certain processes and compliance The key drivers of provincial government underspending with the applicable policies of sub-national public included substantial lump-sum allocations under the financial management. This is mainly due to the ‘Economic Miscellaneous’ budget sub-heading, and the lack of technical and human resource capacity. Local lack of alignment between annual budgets, MTEFs, and governments have made only very limited progress on periodic development plans. maintaining accounting records and making public their The following table summarizes the key financial reports. Most of them have not prepared and recommendations of this report along with a disclosed periodic development plans and MTEFs despite proposed level of priority (short and medium-term) being required to do so by the regulatory framework. based on their feasibility, impact and sequencing. It There is a need to accelerate the establishment of also suggests responsible agencies who should or can internal control systems by sub-national governments execute the actions. All the actions that are proposed to address the rising number of irregularities reported under the leadership of federal agencies should be for PLGs through the audit process. Effective public undertaken in close consultation with PLGs to uphold accounts committees need to be in place to improve the the 3Cs principles of the Constitution of co-existence, oversight of PLGs’ audit irregularities and to promote co-operation, and coordination. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | vii n  EXECUTIVE SUMMARY Table E 1.1. Key recommendations of Nepal Fiscal Federalism Update Recommendations Responsible institutions Short-term 1. Develop a fiscal federalism roadmap based on relevant NNRFC, MoF and NPC government strategies such as the Public Financial Management Strategy (2017) and the Capacity Development Action Plan on Fiscal Federalism (2022). 2. Reinforce the Inter-Governmental Fiscal Transfer system to make the transfers more flexible, clear, and timely, as well as increasingly performance based. More specifically, do the following: a) NNRFC a) Update the methodology for calculating fiscal equalization b) MoF, NPC, NNRFC and line grants. ministries b) Transition conditional grants towards sectoral block grants c) MoF, NNRFC and NPC with limited earmarking. c) strengthen the inter-governmental coordination mechanism among the key fiscal institutions of the MoF, the NNRFC and the NPC. 3. Establish a consolidated PFM performance database at the MoF and MoFAGA federal level to enhance the monitoring and evaluation of the overall performance of PLGs’ public financial management. Medium-term 4. Amend the legal framework to clarify the concurrent and Office of the Prime Minister and shared responsibilities among the three tiers of government. Council of Ministers (OPMCM) 5. Strengthen the capacity of PFM human resource to carry out MoFAGA, MoF and PLGs PFM-related functions. 6. Reinforce systems to improve the budget credibility and MoF and PLGs delivery of services by PLGs by strengthening: a) the alignment of periodic development plans, MTEFs, and annual budgets; b) cash management systems; and c) provincial appropriation acts by setting amount limits to the budget sub-heading ‘Economic Miscellaneous’. viii Background Objectives and The key elements of methodology federalism and fiscal This first Nepal Fiscal Federalism Update mainly federalism in Nepal focuses on the developments in fiscal federalism One of the most widely used ways of framing federalism since 2019, building on the extensive review of the is to view it as comprising the three components of Federalism Capacity Needs Assessment (2019). The political, administrative, and fiscal federalism. This report assessment covered Nepal’s achievements in federalism mainly focuses on fiscal federalism, which concerns the implementation over the first five years since the provisions and practical elements of the benefits and adoption of the new Constitution. costs of fiscal decentralization, fiscal competition, the The data for this update was collected through a division of taxing, spending, borrowing, and regulatory desk review and consultations with the three tiers powers, and the exercise of such powers by multiple of government, development partners, civil society orders of government in federations (Shah 2023, p.91). In organizations, and other stakeholders (see Annex 1). The defining the breadth of this first fiscal federalism update, desk review examined the regulatory framework; related consideration was given to the current level of progress in World Bank, government, academic, and development Nepal, with the focus being on the following three areas: partner reports; and other publicly available data such as 1. Macro-fiscal update on provincial and local media reports. Due to the non-existence of a federal level governments (Chapter 1) consolidated PFM database on the performance of PLGs, the analysis of progress on public financial management 2. Legal, policy, and institutional frameworks on fiscal in provincial and local governments (Chapter 3) faced federalism (Chapter 2) serious constraints. 3. Progress on public financial management in provincial and local governments (Chapter 3) This report builds on and complements several studies on Nepal’s fiscal federalism, which are listed in Annex 7. They cover different aspects highlighted in this update and can be consulted for more in-depth insights. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | ix x CHAPTER 1 Macro-fiscal Update on Provincial and Local Governments NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 1 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS This chapter examines the economic performance of provinces and local governments and undertakes an in-depth analysis of their fiscal position by focusing on the spending execution and the possible drivers of underspending. As Nepal’s economy emerged strongly from the pandemic, provincial and most local economies also experienced increased economic activity. The vertical fiscal imbalance, defined as the difference between own-source spending and own-source revenues of provincial and local governments, is a fundamental feature of Nepal’s intergovernmental fiscal design and is addressed through the intergovernmental fiscal transfer system. The imbalance increased in FY21 because of reduced own-source revenues. In FY21, PLGs’ own spending accounted for 13.1 percent of general government spending, while their collected own-source revenues amounted to 3.1 percent of general government revenue. This large vertical fiscal imbalance is primarily covered by intergovernmental revenues, which include intergovernmental grants and revenue sharing. 1.1 Economic activities expanded in all provinces and most of local levels Provincial economies grew at a higher pace in FY22 compared to FY21. The country’s biggest provincial economy, Bagmati, outperformed all other provinces with a growth rate of 6.7 percent (Figure 1.1). Gandaki was the second province to surpass the national growth rate of 5.8 percent. All other five provinces had growth rates lower than the national rate. The pace of growth was the lowest at 4.8 percent for the most populous province, Madhesh. Figure 1.1. All Nepal’s provincial economies grew at a faster pace in FY22… (real GDP growth rate, percent) FY20 FY21 FY22 8.0 6.7 6.2 5.8 6.0 5.4 5.4 5.5 4.9 4.3 4.8 4.6 4.3 4.2 4.2 3.8 3.7 4.1 4.0 2.0 1.4 2.0 0.0 -2.0 -0.7 -0.8 -1.4 -2.0 -2.4 -4.0 -6.0 -5.7 -8.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim National Fig1.1 Sources: National Statistics Office and World Bank staff calculations (contribution to real GDP growth rate, percentage points ) Agriculture Industry Services Real GDP 7.0 6.0 5.0 4.0 3.0 2 2.0 1.0 (real GDP growth rate, percent) FY20 FY21 FY22 8.0 6.7 The services 6.0 sector5.4 primarily4.8 drove the growth in 6.2 and accommodation 5.4 and food services by at 5.5 least 11 5.8 4.3 4.6 4.3 4.9 all provinces, in part due to a stronger recovery 3.8 3.7 4.2 4.1 supported by the relaxation of COVID-19 related percent, 4.2 4.0 in wholesale 2.0 and retail trade. For five of the seven social distancing (Figure 1.3). The importance 1.4 measures2.0 0.0 (excluding Bagmati and Madhesh), the provinces of different service sub-sectors to the economy varied -2.0 sector services explained 45.4 to 52.6 percent of their -0.7 -0.8 the provinces. For example, wholesale and retail across -1.4 overall -2.0 growth. In Bagmati and Madhesh, services trade and real estate activities accounted for more than a -2.4 -4.0 contributed -6.0 to more than 60 percent of overall growth half of services-related GDP for Bagmati, with education (Figure 1.2). Every province saw the economic-5.7 growth of and public administration accounting for more than 50 -8.0 wholesale and Koshiretail trades least 8.5 percent jump by at Bagmati Madhesh Gandaki percent of services Lumbini GDP for Karnali Karnali. Sudurpashchim National Figure 1.2. …driven primarily by the services sector… Fig1.1 (contribution to real GDP growth rate, percentage points ) Agriculture Industry Services Real GDP 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim fig1.2 Sources: National Statistics Office and World Bank staff calculations Figure 1.3. … and particularly the wholesale and retail trade (contribution to provincial services GDP growth rate, percentage points) Wholesale and retail trade Transportation and storage Accommodation and food services Financial and insurance activities Real estate activities Public administration and defence Education Other services Services 6.0 4.0 2.0 0.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim fig1.3 Sources: National Statistics Office and World Bank staff calculations (contribution to provincial industrial GDP growth rate, percentage points ) Construction Water supply; sewerage, waste management and remediation activities Electricity, gas, steam and air conditioning supply Manufacturing Mining and quarrying 3.0 Industry NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 3 2.0 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS The industry sector was the second largest slowed in FY22 in the five provinces6 that were hit hard contributor to economic growth in all provinces by the unseasonal rainfall in October 2021. However, (contribution to provincial services GDP growth rate, percentage points) except Karnali. This was boosted by the double-digit agricultural growth in FY22 remained similar to that in Wholesale and retail trade Transportation and storage growth in the electricity sub-sector and Accommodation and close food to services FY21 in Bagmati and Financial Gandaki. and insurance activities double-digit growth in Real construction theestate activities sub-sector Public administration and defence (Figure 1.4). The industry sector accounted for as high Education Bagmati was the main catalyst to national growth in Other services (contribution to provincial services GDP growth rate, percentage points) FY22. Bagmati accounted for 36.9 percent of national as 40 percent Services of overall growth in Gandaki, making it the 6.0 Wholesale and retail trade Transportation and storage province where the industry sector had the largest share GDP and contributed to 41.4 percent of national growth Accommodation and food services (Figure Financial 1.5). This and insurance province’s activities services sector, with a share of GDP.4.0 Real estate activities Public administration and defence of 24 percent, and its industrial sector, with a share of Education Other services Agricultural 2.0 growth slowed Servicesor remained close to 3.8 percent, contributed 24.2 percent and 9.1 percent, that of6.0 the previous year in all provinces. This growth respectively, to the whole of national growth. 0.0 4.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim Figure 1.4. Growth in electricity and construction sub-sectors boosted industry sector GDP fig1.3 2.0 (contribution to provincial industrial GDP growth rate, percentage points ) 0.0 Koshi Construction Bagmati Madhesh Gandaki Lumbini Karnali Sudurpashchim Water supply; sewerage, waste management and remediation activities fig1.3 Electricity, gas, steam and air conditioning supply Manufacturing Mining (contribution to provincial and quarrying industrial GDP growth rate, percentage points ) 3.0 Industry Construction Water supply; sewerage, waste management and remediation activities Electricity, gas, steam and air conditioning supply 2.0 Manufacturing Mining and quarrying 1.0 3.0 Industry 0.0 2.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim 1.0 fig1.4 Sources: National Statistics Office and World Bank staff calculations 0.0 (contribution to national real GDP growth rate, percentage points) Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim Agriculture Industry Services Net taxes Real GDP Figure 1.5. 3.0 Bagmati contributed more than one-third of national economic growth in FY22 fig1.4 2.5 (contribution to national real GDP growth rate, percentage points) 2.0 Agriculture Industry Services Net taxes Real GDP 3.0 1.5 2.5 1.0 2.0 0.5 1.5 0.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim 1.0 0.5 0.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim Sources: National Statistics Office and World Bank staff calculations 6 These five provinces had the agricultural to GDP share of more than 30 percent. 4 Most local governments saw a pick- was a substantial variation in growth rates ranging from minus 24.7 percent for Bishnu Rural Municipality in Sarlahi up in economic activities district to 19.2 percent for Bangad Kupinde Municipality in Salyan district. But note that nighttime light data for Metropolitan cities and rural municipalities had the rural municipalities should be interpreted with caution highest average growth rate, relative to the other as studies such as Gibson and Boe-Gibson (2021) suggest types of local governments − urban municipalities that this data is not a good proxy for economic activity in and sub-metropolitan cities. Nighttime lights data areas with a large share of agriculture in local economies, (see Box 1.1) shows that around 60 percent of Nepal’s as value can be added to the agriculture sector without 753 local governments experienced an expansion in an increase in nighttime lights. This is much less true for economic activities in FY22 (Figure 1.6), although there value addition in the services and industry sectors. Box 1.1 Background on nighttime lights data Nighttime lights data, as detected by satellites, are increasingly used as a proxy to indicate economic activity (Martinez 2022; Gibson and Boe-Gibson 2021; Gibson and Boe-Gibson 2020). There are four potential advantages of using this data compared to the traditional GDP measure: n They are available in real time and at a higher frequency (daily). n They are less prone to manipulation. n They are freely available and comparable between countries irrespective of the quality of statistical systems. n They are available at the local level and are useful for developing countries like Nepal where local level GDP data is not available. The nighttime lights data used in this study is Visible Infrared Imaging Radiometer Suite Day/Night Band (VIIRS DNB) (Román et al 2020). Figure 1.6. Most local governments experienced increased economic activities in FY22, as indicated by nighttime fig1.5 lights data Number of local governments 250 202 194 200 150 132 100 71 63 39 46 50 4 0 <-15 -15 to -10 -10 to -5 -5 to 0 0 to 5 5 to 10 10 to 15 >15 Growth of NTL (in percent) Fig 1.6 Sources: LAADS DAAC (2023) and World Bank staff calculations (as a share of provincial GDP, percent) FY19 FY20 FY21 10.0 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 5 8.6 8.0 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS 1.2 In the context of increased spending, there is ample room for the improved fiscal performance of provincial and local governments The consolidated fiscal balance of Federal Government if unspent. In FY21, the provincial government’s cash and bank balances as share of its provincial and local governments GDP ranged from 0.1 percent for Koshi to 6.2 percent for deteriorated Karnali. The fiscal surplus of provincial governments In FY23, provinces have budgeted a higher narrowed from 0.5 percent of national GDP in FY20 consolidated fiscal deficit of 0.9 percent of national to 0.3 percent of national GDP in FY21, as increased GDP. This is expected to be financed by cash and bank expenditure outpaced revenue expansion (Figure 1.7). balances and domestic borrowings. However, there is a The fiscal surplus as a share of provincial GDP declined significant variation in the budgeted deficit as a share of fig1.5 in FY21 for all provinces but Koshi, resulting in deficits in provincial GDP, ranging from 0.4 percent for Koshi to 2 Gandaki, Lumbini, and Karnali. percent for Karnali. The decline in fiscal surpluses in FY21 was primarily Local governments’ fiscal surpluses also narrowed Number of local governments 250 due to improved spending budget execution rates in FY21. The consolidated fiscal surplus of local 202 governments share of national GDP stood at 0.5 as a 194 amidst the 200 relaxation of social distancing measures (Figure 1.8). The fiscal deficits were financed by cash and percent in FY21, lower than the 0.9 percent in FY20, 150 132 largely due to increasing expenditure (Figure 1.9). Among bank balances, reflecting unspent intergovernmental revenues from the 753 local governments, 101 experienced fiscal 100 the previous 71 fiscal year, which mainly 63 deficits in FY21. The local government’s deficits were also include unspent equalization 39 grants and revenue 46 50 financed by cash and bank balances, reflecting unspent sharing that remain with provincial governments. These 4 are different from equalization grants and shared revenue from federal and 0 other grants (conditional, special, and complementary grants) <-15 which need -15 toto -10 -10 to -5to the be returned -5 to 0provincial governments. 0 to 5 5 to 10 10 to 15 >15 Growth of NTL (in percent) Fig 1.6 Figure 1.7. The fiscal surpluses of most provinces narrowed in FY21… (as a share of provincial GDP, percent) FY19 FY20 FY21 10.0 8.6 8.0 6.0 4.0 1.6 1.4 1.9 2.0 2.0 1.1 1.2 1.5 0.4 0.7 0.8 0.7 0.6 0.4 0.4 0.7 0.3 0.5 0.3 0.2 0.0 -0.4 -0.5 -0.3 -0.4 -2.0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.7 Sources: Provincial ministries of finance, National Statistics Office, and World Bank staff calculations 6 Figure 1.8. …due to improved budgets in most provinces (budget execution, percent) FY19 FY20 FY21 100 88 90 (budget execution, percent) 80 71 68 75 71 68 FY19 66 FY20 70 FY21 69 70 64 65 63 63 100 59 58 59 58 61 59 60 88 57 90 47 49 50 80 75 71 68 68 70 35 69 71 40 70 66 64 65 63 63 59 58 59 58 61 59 30 60 57 20 47 49 50 10 40 35 0 30 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All 20 10 Fig 1.8 0 Sources: Provincial ministries of finance, National Statistics Office, and World Bank staff calculations Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig (as1.8 a share of GDP, percent) Figure 1.9. The consolidated fiscal surplus governments FY19of local FY20 narrowed in FY21 FY21 12.0 (as a share of GDP, percent) 9.1 9.2 9.6 10.0 9.1 8.0 8.2 FY19 FY20 FY21 8.0 12.0 6.0 9.1 9.2 9.6 10.0 9.1 8.0 8.2 4.0 8.0 1.3 1.8 2.0 1.3 0.9 6.0 0.5 0.7 0.4 0.6 0.1 0.0 4.0 Expenditure Revenue and grants Fiscal balance Cash and bank Unspent fiscal 1.3 0.9 1.3 1.8 2.0 0.5 0.7balance equalization grants 0.4 0.1 0.6 Fig0.0 1.9 Expenditure Revenue and grants Fiscal balance Cash and bank Unspent fiscal balance equalization grants Fig 1.9 Sources: FCGO, National Statistics Office, and World Bank staff calculations Intergovernmental revenues drove revenues (69.2 percent grants and 13.9 percent revenue sharing) from the Federal Government and 10.3 percent provincial and local governments’ (6.2 percent grants and 4.1 percent revenue sharing) from revenues their provinces in FY21. However, there were notable variations in the shares. The relative importance of Intergovernmental revenues constituted the largest part intergovernmental revenue as a source of local revenues of sub-national revenues, but with significant variation also varied significantly across local governments − across the different governments. Intergovernmental from 50.3 percent for Kathmandu Metropolitan City to revenues, which include grants and revenue sharing, 100 percent for 39 local governments. These variations accounted for more than 90 percent of provincial and reflect the substantial differences in population size, local government revenues in FY21 (Figures 1.10 and 1.11). level of development, and annual revenues of local Local governments received 83.1 percent of their total governments (Figures 1.12 and 1.13). NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 7 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS Figure 1.10. Intergovernmental revenues accounted for the highest proportion of provincial revenues in FY21… (as a share of provincial GDP, percent) Own source revenues - tax Own source revenues - non-tax Miscellaneous revenues Revenue sharing Intergovernmental grants Totals 14 (as a share of provincial GDP, percent) 12 Own source revenues - tax Own source revenues - non-tax 10 Miscellaneous revenues Revenue sharing 8 Intergovernmental grants Totals 6 14(as 4 a share of provincial GDP, percent) 12 10 2 Own source revenues - tax Own source revenues - non-tax 8 0 Miscellaneous revenues Revenue sharing 6 Koshi Intergovernmental Madhesh grants Bagmati Gandaki Totals Lumbini Karnali Sudurpashchim All 4 142 12Fig 1.10 0 10 Koshi Sources: Provincial ministries Madhesh Bagmati of finance, National Gandaki Statistics Office, Lumbini and World Karnali Sudurpashchim Bank staff calculations All 8 6 4 2 1(budget F ig .10 execution, percent) Figure01.11. ..and of local economies Total Recurrent Capital Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All 99 100 88 88 al governments 700 77 80 77 80 80 72 75 71 75 589 71 69 F i g 1 .10 600 68 64 68 66 65 63 61 56 54 56 58 60 500 40 400 ts 700 nc 300 lo 589 fe 20 600 m no 200 99 rr e 500 be 0100 36 ov 10 gm 5 400 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All lu 0 N Number of loca 300 50-60 60-70 70-80 80-90 90-100 Fig 1.18 200 Share of intergovernmental revenues (percent) 99 100 10 36 F i g 1 .11 5 0 World Bank staff calculations Sources: FCGO and 50-60 60-70 70-80 80-90 90-100 (as a share of totals, percent) Share of intergovernmental revenues (percent) Intergovernmental revenues Own source revenues Miscellaneous revenues F i g1.12. Figure 1 .11 Local governments’ intergovernmental revenue varied by types of local government… 100 90 (as 80a share of totals, percent) 70 60 Intergovernmental revenues Own source revenues Miscellaneous revenues 50 100 40 90 30 80 20 70 10 60 0 50 Metropolitan cities Sub-metropolitan cities Urban municipalities Rural municipalities All 40 30 20 F i g 1 .12 10 0 Metropolitan cities Sub-metropolitan cities Urban municipalities Rural municipalities All Sources: 1 .12 and World Bank staff calculations F i gFCGO 8 Figure 1.13. … and which provinces local governments are located in (as a share of totals, percent) Intergovernmental revenues Own source revenues Miscellaneous revenues 100 95 90 85 80 75 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.13 Sources: FCGO and World Bank staff calculations (as a share of provincial GDP, percent) FY19 FY20 FY21 Higher 14intergovernmental revenues contributed to revenue in FY21. The return of unspent amounts accounted 12.6 the increase 12 in provincial and local governments’ for a significant share of provinces’ miscellaneous revenues in FY21. The provinces’ revenues as a share revenues (88.8 10.5percent) and were mainly unspent 10 of national GDP grew from 4.4 percent in FY20 to 4.7 conditional, complementary, and 7 special .6 grants from the percent8 in FY21, while local governments’ revenues 6.7 previous fiscal year returned by 6.6 6.4 local governments. The 5.8 5.4 as a share 6 of national 4.9 GDP expanded from 9.1 percent share of 5 .3 own-source revenues to overall revenues was the 4.6 4.1 3.5 percent in FY21 3.9 4.1 3.9 4.4 in FY204to 9.6 3.0 2.6 (Figure 1.9). Across the lowest 3.2 in Sudurpashchim (0.9 percent) and 2.9 the highest in provinces, Madhesh, Bagmati, Lumbini, 2.2 2.0Karnali, and Bagmati (8.1 percent), reflecting the different provincial 2 1.4 Sudurpashchim experienced an increase in revenue as economic and tax bases. 0 a percentage of their GDP, Koshi while revenue Madhesh declined Bagmati or Gandaki Karnali Lumbinirevenues Sudurpashchim All source of remained the same in Koshi and Gandaki. There was Non-tax were the dominant also a variation in the magnitude of provincial revenues own-source revenues for provinces in FY21. These Fig 1.14 relative to the size of their economies, driven primarily by came mainly from driving license and registration fees (37 differences in provincial GDPs − ranging from 2.8 percent percent), business registration fees (12.9 percent), income in Bagmati to 12.2 percent in Karnali. from the transport sector (11.1 percent), and service fees and sales (23.6 percent). As a percentage of total revenues, the magnitude of non-tax revenues ranged from 0.9 percent in Karnali to 8.1 percent in Bagmati. Own-source and miscellaneous revenues remained insignificant for Property taxes and local government service fees were the main sources of own-source revenues for sub-national governments locals. Property taxes consist of integrated property tax, land tax, house rent tax, and bahal bitauri (rentals from Own-source and miscellaneous revenues accounted the use of public land and buildings for commercial for only a small share of the overall revenue of purposes) and accounted for 36.1 percent of local sub-national governments in FY21. The provincial governments’ own-source revenues in FY21. Local governments obtained only 3.5 percent of their revenues government service fees, which mainly comprise from own-source revenues (Figure 1.12), while local design permit/pass fees and recommendation charges, governments received 6.2 percent from own-source contributed 31.8 percent to local government revenues revenues. Miscellaneous revenues mainly include the in FY21. The share of own-source revenues in the total recovery of irregularities and the return of unspent revenues was insignificant (close to 0 percent) in 55 local amounts from the previous year’s fund release and governments and as high as 44.9 percent in Hanspur constituted 2.1 percent of provincial governments’ Municipality in Dhanusa district. revenue and less than 1 percent of local government NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 9 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS Recurrent and capital spending from 8.2 percent in FY20 to 9.1 percent in FY21 (Figure 1.15). The majority of local governments (612 of the 753) led to higher expenditure (as a share of totals, percent) for Intergovernmental revenues sub- spent Own source more as a share revenues of national Miscellaneous GDP in FY21 than in revenues national 100 governments FY20 (when compared with that of revenue). Sub-national 95 spending rose on the back of higher There was a significant variation in expenditure recurrent and capital spending in FY21. The across the seven provinces in FY21. The expenditure 90 expenditure of provinces as a share of national GDP stood as a share of provincial GDP varied from 2.2 percent in at 4.4 percent in FY21 up from 3.9 percent in FY20 (Figure Bagmati to 12.6 percent in Sudurpashchim (Figure 1.14). 85 The variation reflects differences in capital spending, 1.14). Across the provinces, all but Koshi experienced increased fiscal transfers to local governments, and the different 80 expenditure. Local government expenditure as a share of national GDP also increased in FY21 growing size of provincial economies (Figure 1.16). 75 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Figure 1.14. Spending increased in most provinces in FY21 Fig 1.13 (as a share of provincial GDP, percent) FY19 FY20 FY21 14 12.6 12 10.5 10 7.6 8 6.7 6.6 6.4 5.8 5.4 6 4.9 5.3 4.6 3.5 4.1 3.9 4.1 3.9 4.4 4 3.0 2.6 3.2 2.9 2.0 2.2 2 1.4 0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.14 Sources: Provincial ministries of finance and World Bank staff calculations Figure 1.15. Local government spending also increased in FY21 (as a share of GDP, percent) FY20 FY21 3 2.6 2.6 2.5 2.1 2 1.5 1.5 0.8 0.8 1.0 1.2 1.0 1.2 0.9 0.9 1 0.3 0.4 0.5 0.0 0.0 0 Goods and services Road and bridge compensation Intergovernmental Other expenditure construction construction Other capital Other public expenditure Wages and construction Building grants Recurrent Capital Fig 1.15 Sources: FCGO and World Bank staff calculations (as a share of provincial GDP, percent) Wages and compensation Goods and services Fiscal transfers 10 Other transfers Construction spending Other capital spending Totals 12 Other pub Wages an constructi constructi expenditu Other capi Goods and servi compensat constructio Other expendit Road and bri Buildin Intergovernme grants Recurrent Capital Fig 1.15 Figure 1.16. The share of capital spending in total spending varied across provinces… (as a share of provincial GDP, percent) Wages and compensation Goods and services Fiscal transfers Other transfers Construction spending Other capital spending Totals 12 10 8 6 4 2 0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.16 Sources: Provincial ministries of finance and World Bank staff calculations As a share of total spending, provincial governments Gandaki (Figure 1.16), and across local governments spent more on capital expenditures relative to (Figure 1.17) from close to 0 percent in Chhinnamasta local governments and the Federal Government Rural Municipality in Saptari district to 70.5 percent in FY21. Provinces’ capital spending accounted for in Kageshwori, Manohara Municipality in Kathmandu 59.8 percent of overall spending, higher than the 40 district. Fiscal transfers to local governments accounted percent for local governments and 20.3 percent for for more than a third of overall spending and a half of the Federal Government. Most of this capital outlay recurrent spending of provincial governments (Figure was on construction (building construction, road and 1.16), while employee salary and program expenses bridge construction, and other public construction). represented similar magnitudes for local governments The share of capital spending varied across provinces (Figure 1.15). from 54.9 percent in Sudurpashchim to 68.7 percent in Figure 1.17. …and local governments 200 180 180 Number of local governments 157 160 138 140 120 94 100 77 80 60 47 40 24 13 14 9 20 0 < 20 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 > 60 Share of capital spending (percent) Fig 1.17 Sources: FCGO and World Bank staff calculations Fig 1.18 (budget execution, percent) Total Recurrent Capital 99 100 NEPAL 88 FISCAL FEDERALISM UPDATE, JUNE 2023 | 11 88 80 77 80 75 71 80 75 77 69 68 72 71 64 68 66 65 63 160 138 Number of local govern 140 120 94 100 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS 77 80 60 47 40 24 20 13 0 Provincial and local governments’ n By administrative < 20 classification, 20-25 25-30 the 35-40 Ministry 30-35 of 45-50 40-45 Share of capital spending (percent) 50-55 Physical Infrastructure Development, Ministry of budget credibility remained low Fig 1.17 Social Development, and ‘Economic – Miscellaneous’ Fig 1.18 budget headings accounted for around two-thirds of The provincial governments under-executed their underspending by the seven provinces. FY21 budgets by a significant proportion (28.8 (budget execution, percent) percent). The extent of underspending was larger for Local government expenditureTotal would have expanded Recurrent Capital recurrent budgets, with provinces spending only 61 more had actual spending remained closer to budget 99 100 percent of these budgets versus 80.3 percent of their allocations. Only 73.5 percent of local88 government 88 77 80 75 80 75 77 69 capital budgets (Figure 1.18). There was considerable budgets were 68 72 spent in FY21. The underspending 68 66 was 65 71 64 63 58 variation in the execution rates of their overall budgets driven 60 by the capital budgets, 56 of54 which only 64 percent was 56 ranging from 65.5 percent in Karnali to 88.3 percent in spent 40 compared with 81.5 percent of recurrent budgets. Lumbini. 20 n On the economic classification basis, recurrent 0 Figure 1.19. Underspending was driven primarily and capital contingencies and goods and services i h i ki ni li im at sh a es a bi by contingencies and goods and services on the rn ch gm Ko nd dh m Ka h accounted for 70 percent of all underspending by Ga Ba Lu Ma as rp economic classification basis du provinces (Figure 1.19). Su n By functional classification, (as a share of provincial GDP,general public services percent) and economic affairs contributed to Own source revenues - tax than 80 more Own 10 source revenues - non-tax Goods and services 6 28 percent of provinces’ underspending; Miscellaneous while within revenues Revenue sharing Contingencies the economic affairs function, the agriculture Intergovernmental grants and 14Totals Construction spending 14 transport 12 sub-functions were the key drivers of Wages and compensation underspending. 10 Other 42 8 n Based on the source of financing, provincial internal 6 revenues were underspent more than the grants from 4 the Federal Government accounting for between 51.6 Sources: Fig 1.19 Provincial ministries of finance, and World Bank staff 2 calculations and 86.6 percent of total underspending across the 0 seven provinces. Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.10 Figure 1.18. All provinces underspent their budgets in FY21 (budget execution, percent) Total Recurrent Capital 99 100 88 88 77 80 77 80 80 72 75 71 75 71 68 68 66 65 69 64 63 61 56 54 56 58 60 40 20 0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.18 Sources: Provincial ministries of finance, and World Bank staff calculations 12 The budget execution rate of local governments varied spending accounted for 47.7 percent of local by type and location with the level of underspending government underspending, while the recurrent wages being more related to larger populations, larger income and compensation and goods and services accounted levels and more infrastructure. The underspending was for 27.1 percent of this underspending. Relatively the highest for the metropolitan cities, reflecting their stronger execution of recurrent spending reflects lower execution of their capital budgets (Figure 1.20). mandatory spending including on wages and employee Across the provinces, the local governments in Bagmati compensation. On a functional basis, economic affairs had the most underspending as it has more (three) (mainly transport and agriculture) and housing and metropolitan cities than other provinces (Figure 1.21). communities contributed to more than half of overall On the basis of economic classification, construction underspending. Figure 1.20. In FY21, local governments underspent their budgets with metropolitan cities underspending the most (budget execution, percent) Capital Recurrent Total 90 83 82 82 82 80 (budget execution, percent) 74 77 73 72 73 71 70 63 Capital Recurrent 64 Total 64 60 90 51 83 82 82 82 50 77 80 38 73 74 73 40 72 71 70 63 64 64 30 60 20 51 50 10 38 40 0 30 Metropolitan cities Sub-metropolitan cities Urban municipalities Rural municipalities All 20 10 0 Sources: FCGO and World Bank staff calculations Fig 1.20 Metropolitan cities Sub-metropolitan cities Urban municipalities Rural municipalities All (budget Fig 1.20 execution, percent) Figure 1.21. In FY21 the local governments Recurrent the most Total in Bagmati underspent Capital 100 86 87 90 81 83 82 82 82 (budget execution, 79 percent) 78 80 80 75 75 76 75 73 71 Capital Recurrent 68 70Total 70 66 66 64 64 100 62 60 57 86 87 90 81 83 82 82 82 79 78 80 50 80 75 75 76 75 73 71 68 70 40 70 66 66 64 64 62 30 60 57 20 50 10 40 0 30 20 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All 10 Fig 1.21 0 Koshi Madhesh Bagmati Gandaki Lumbini Karnali Sudurpashchim All Fig 1.21 Sources: FCGO and World Bank staff calculations NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 13 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS Most local government spending in FY21, particularly b) Revenue underperformance led to lower budget capital spending, was bunched in the last four months execution. PLGs need to scale back expenditure if they of the fiscal year.7 For example, 547 of the 753 local collect less revenue than budgeted while their domestic governments spent 68.8 percent of their capital spending borrowing is subject to the consent of the Federal in the last four months of FY21 and 44.9 percent in the Government and the ceilings recommended by NNRFC. last month of FY21 (OAG 2022) This bunching of spending towards the last month of the financial year is the usual c) Timing of revenue receipts. PLGs receive most of situation at the national and sub-national levels, which their shared intergovernmental grants by the end of likely reduces the quality of capital spending due to the third quarter of the fiscal year. In contrast, they receive adverse impact of weather with the usual onset of the more than a fifth of their shared revenues towards the annual monsoons in June and ineffective supervision last quarter of each fiscal year.8 The higher collection of due to the limited numbers of technical staff available to shared revenues towards the end of the fiscal year forces supervise the many capital projects at the same time. PLGs to delay budget execution or reduce expenditures mid-year, especially discretionary expenditure such as capital spending. Low budget execution is driven by d) The substantial lump-sum allocations for six main factors ‘Economic Miscellaneous’ expenditures. In FY21, 10.7 percent of the total budgets of all provinces was allocated a) Capital underspending was the main contributor to the ‘Economic Miscellaneous’ budget sub-heading. to local government underspending. Capital These allocations9 were either unspent or transferred to underspending accounted for 36.2 percent of provincial other sub-headings at the year-end on a piecemeal basis. governments and 62.2 percent of local governments’ Underspending on this budget sub-heading explained aggregate underspending in FY21 (Figure 1.22). 37.1 percent of all province’s underspending ranging from 13.1 percent in Karnali to 60.8 percent in Bagmati. Figure 1.22. The underspending of capital budgets drove the local government underspending in FY21 (percent) Provincial governments Local governments Federal government 70.0 59.8 62.2 60.0 54.7 50.0 40.0 40.0 36.2 30.0 21.3 20.0 10.0 0.0 Capital spending as a share of total spending Capital underspending as a share of total underspending Fig 1.22 Sources: Ministry of Finance, provincial ministries of finance, FCGO, and World Bank staff calculations 7 For example, 84.7 percent FY18 FY19 of Karnali and 71.8 percent of FY20 Sudurpashchim FY21 FY22 capital spending happened FY22sub FY23 in the last four months of FY21, which was higher than the recurrent spending for the same period of FY21 (71 percent and 63.8 percent). While data for other provinces were not available for the last four months of FY21, data 300 for the first half of FY21 for these provinces suggests that a significant share of spending, and particularly capital spending was spent in the second half of FY21 by 250 five provinces. the other 8 As explained 200 in Chapter 2, in addition, federal revenues from VAT and domestic excise duty for the last 10 days of each fiscal year and royalties for the full fiscal year are transferred to province and local governments only in the following fiscal year. 150 9 The OAG (OAG 2022) said that in FY21, 233 local governments approved budgets and programs by retaining NPR 4.7 billion as unallocated budgets, which is against 100 in the Local Government Operation Act. However, the contribution of this to the overall underspending could not be examined for local governments provisions 50 of the unavailability of data for all of them. because 0 mplementary mplementary mplementary Equalization Equalization Equalization Conditional Conditional Conditional Special Special Special 14 e) Lack of alignment between periodic development f) Weak technical capacity. Information gathered plans, MTEFs, and annual budgets affects allocations. through visits to provinces and local governments This misalignment contributed to the lower recurrent suggests that the under-execution of spending, and capital budget allocations in the annual budget especially capital spending, is at least partly due to for FY22 relative to the MTEFs and periodic plans that the lack of technical capacity in PLGs. As per the FY21 were prepared prior to the annual budget. Given that OAG’s Audit Report (OAG 2022), since 2018, only 62 provincial governments’ three-year MTEFs need to be percent of vacant positions in provincial governments in alignment with their five-year periodic development and 66 percent in local governments, had been filled by plan, with annual updates prior to annual budgets, there the end of FY21. In addition, according to the National should not be significant discrepancies between the Association of Rural Municipalities in Nepal (NARMIN), allocations under these documents. about 100 local governments do not have permanent chief administrative officers (CAOs) to lead and oversee their PFM functions. 1.3 Policy Recommendations to improve the budget credibility of PLGs Strengthen the alignment of periodic development received at least three months before the end of each plans, MTEFs, and annual budgets. The data available fiscal year; and ii) strengthening own-source revenues. for four provinces suggests that there was a weak alignment across these three kinds of documents Strengthen the provincial appropriation acts by regarding recurrent and capital allocations for FY22. The setting a limit on the large lump-sum allocations to timing of MTEF and budget preparation are also often the ‘Economic Miscellaneous’ budget sub-heading. misaligned as the budget is prepared in parallel with the Addressing the underspending by provincial governments MTEF, which is the basis for the preparation of budgets. requires the review of the provincial appropriations The existing legal requirement (Clause 22 of the IGFA Act acts and the amendment of their virement rule that 2017) says that MTEFs are to be submitted as a part of allow for extensive administrative reallocations. All budget documents to provincial assemblies to inform seven provinces have a cap of 10 percent on virements the annual budgets. for FY23. However, this ceiling does not apply to the budget sub-heading ‘Economic Miscellaneous’ under Strengthen cash management systems. The timing of the administrative classification. In addition, it does revenue receipts is critical for budget execution. PLG’s not go through the standard budgeting and planning receive their fiscal equalization grants in four installments process. The acts should be amended to specify the (Annex 6), although there is considerable variation as maximum amount that can be vired from the ‘Economic to when they are actually disbursed. The timing of the Miscellaneous’ budget sub-heading disbursement of the federal conditional grants also shows significant variation. Some provinces and local Build institutional capacity and invest in technical governments have also been proposing domestic skills. Nepal’s sub-national governments need borrowing in their budgets to finance their budget supporting to recruit technical staff for planning, deficits despite the absence of an institutional framework budgeting, and budget execution and to conduct regular on this. Moreover, the shortfalls in federal revenue trainings for them. Capacity gaps at the sub-national collection could also result in the downward revision level cannot be addressed by just issuing templates and of the fiscal transfers to sub-national governments. All guidelines such as planning and MTEF guidelines and the above will lead to mismatches between budgeted templates for accounting and reporting. These need to and actual revenues, thus leading to underspending. be complemented by creating technical departments, Cash management systems need to be strengthened divisions or units in PLGs, such as revenue divisions in to mitigate this by i) disbursing all revenues (including local governments to strengthen own-source revenue grants) into three installments so the last installment is generation. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 15 n C HAPTER 1  n   MACRO-FISCAL UPDATE ON PROVINCIAL AND LOCAL GOVERNMENTS 16 CHAPTER 2 Legal, Policy, and Institutional Frameworks on Fiscal Federalism NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 17 n CHAPTER 2  n  LEGAL, POLICY, AND INSTITUTIONAL FRAMEWORKS ON FISCAL FEDERALISM Fiscal federalism has been taking root in Nepal through the passing of new laws and regulations and the strengthening of institutional arrangements and intergovernmental fiscal coordination mechanisms. But important gaps remain. This chapter examines the progress of the regulatory framework, the institutional setup, and the intergovernmental fiscal coordination mechanisms that underpin Nepal’s fiscal federalism; and provides some policy recommendations. 2.1 There has been good progress on establishing the regulatory framework, but more work is needed to clarify the responsibilities of the different tiers of government Provincial and local governments have exclusive powers, with autonomy from those of the Federal Government − Nepal’s ongoing transition to federalism is underpinned by the devolution of functional responsibilities for the public sector to the 7 provinces and 753 local governments (see Table 2.1 for list of exclusive powers). This goes hand in hand with the devolution of the basic public financial management functions of budget planning, budget execution, the mobilization of revenues, internal borrowing, and the increased responsibilities for delivering education, healthcare, water, sanitation and other basic services, while the Federal Government retains responsibility for overall national policy making and oversight (see Schedules 5, 6 and 8 of the Constitution). Table 2.1. Exclusive powers of federal, provincial, and local governments Tier of govt Exclusive powers Federal 35 exclusive powers including defense, central planning, currency, foreign affairs, citizenship and passports (Schedule 5) Provincial 21 exclusive powers including provincial police administration, provincial civil service, higher education, and provincial-level development activities such as electricity, irrigation, roads and land management (Schedule 6) Local 22 exclusive powers including municipal police and the provision and management of local services, basic and secondary education, basic health, local roads and drinking water (Schedule 8) Source: Constitution of Nepal (2015) Concurrent powers – The concurrent powers among the three tiers of government for expenditure are the following: n between the federal and provincial governments: civil and criminal procedures, the supply and distribution of essential goods, population management, social security, casinos and other aspects (Schedule 7); and n among federal, provincial and local governments: cooperatives, education, health, agriculture, irrigation, mines, minerals, disaster management, the environment, forests, personal events, archaeology, and motor vehicle permits (Schedule 9). 18 Each of the three tiers of government have their n The Intergovernmental Coordination Act (2020) own rights and assignments for formulating specifies the means of and requirements for vertical budgets, expenditure and mobilizing certain taxes. and horizontal intergovernmental coordination.11 The Constitution and the Federal Fiscal Procedures n The Public Debt Management Act (2022) defines the and Financial Accountability Act (FPFAA) (2019) and rules of public debt management for the three tiers of applicable guidelines, determine the mandate of each government, including their domestic borrowing. tier of government regarding own revenue generation and expenditure responsibilities is mandated to PLGs have improved their fiscal regulatory formulate their budgets, raise revenue and spend their frameworks guided by the national framework and budgets (see Table 2.2). model laws. PLGs have been advancing their regulatory framework underpinned by new developments in the Regarding this distribution, Schedule 9 defines there national legal framework and other federal level policies is a concurrent revenue authority of all three levels of and model laws, including the National Planning government on tourism fee, service fee, charge, penalty Commissions’ (NPC’s) Medium-Term Expenditure (also included in table 2.2 above), as well as on royalty Framework (MTEF) guidelines (2021), Unified National from natural resources. Project Bank guidelines (2020), Project Preparation, Selection and Prioritization Unified Standards (2023), the The federal level regulatory framework on financial Ministry of Finance’s guidelines for Intergovernmental procedures and on the intergovernmental fiscal Financial Transfers, and various PFM-related model laws system has been evolving. Following the first batch of issued by the Ministry of Federal Affairs and General related laws, which were passed in 2017,10 the following Administration (MoFAGA) and other ministries. Even four new acts were enacted at the federal level between though provincial and local finance procedural acts 2019 and 2022 to reinforce the regulatory PFM framework have been in place in all seven provinces and many local and the basis of intergovernmental fiscal relations: governments since 2017,12 in 2022 the three provincial n The Financial Procedures and Fiscal Accountability governments of Koshi, Gandaki and Sudurpashchim Act (FPFAA, 2019) regulates the management of public passed updated financial procedures and fiscal financial procedures for the three tiers of government. accountability acts aligned with the equivalent federal level Fiscal Procedures and Financial Accountability n The Audit Act (2019) prescribes the audit rules, Act, (2019) to define provincial level PFM systems and procedures, and mandates of the three tiers of procedures more precisely. government for auditing expenditure. Table 2.2. Revenue rights of federal, province, and local governments (schedules of the Constitution) Federal taxes Provincial taxes Local level taxes (Schedule 5) (Schedule 6) (Schedule 8) Customs, excise-duty, House and land registration Wealth tax, property tax, house rent value-added tax, corporate fees, motor vehicle tax, land and building registration fee, income tax, individual income tax, tax, entertainment tax, motor vehicle tax, advertisement tax, remuneration tax, passport fees, advertisement tax, tourism fee, business tax, land tax (land revenue), visa fees, tourism fees, service agricultural income tax, service entertainment tax service charges, fees, charges and fees, penalties. charges, fees, penalties. tourism fees, penalties, entertainment tax Source: Constitution of Nepal (2015) The Local Government Operation Act, Inter-Governmental Fiscal Arrangement Act, National Natural Resources Fiscal Commission Act and Employment Adjustment 10 Act were all enacted in 2017. Further details can be found in Annex 2. The Intergovernmental Coordination Act describes the principle of inter-governmental coordination among the three tiers of government as cooperation, co- 11 existence and coordination, following the Constitution’s mandate in Article 232. These finance procedural acts specify arrangements for formulating budgets and programs, approval and implementation, fund release procedures and spending 12 methods, budgetary control and reporting, internal and external auditing, and spending authorities. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 19 n CHAPTER 2  n  LEGAL, POLICY, AND INSTITUTIONAL FRAMEWORKS ON FISCAL FEDERALISM Lack of clarity remains on some concurrent and collection has not been defined. Consulted provincial shared responsibilities and procedures. This is creating and local government officials recommended duplication of expenditure, and conflicts on service revising the legislation to better define the division of delivery and revenue administration responsibilities responsibilities.13 across the different tiers of government: n A defined legal procedure on the extraction of non-renewable natural resources would address n More precise expenditure assignment and service the ambivalence in the collection and distribution delivery responsibilities would reduce duplication of related royalties. Confusion persists among of spending. A high degree of concurrent provincial and local governments on who should fix responsibilities across the three tiers of government the overall rates of taxation on construction materials continues to create confusion over the mandate (e.g., stones, boulders and sand), which affects PLGs’ of each tier on managing service delivery and revenue generation. This issue was highlighted in a undertaking investments. This causes a bias toward study carried out by the Federalism Implementation the Federal Government’s dominance. As an example, and Monitoring Parliamentary Committee (FIMPC ‘basic health’ is on the list of exclusive functions of 2022) which recommended formulating a legal local governments, while ‘health’ is a concurrent procedure to define the roles of the three tiers of responsibility of all three tiers of government. Some government on the collection, distribution, and functions under ‘health’, including epidemiologic extraction of non-renewable natural resources. surveillance and primary care curative services, have yet to be allocated across the tiers of government. This n A regulatory framework should be established ambiguity has resulted in duplication of spending, on implementing business taxes. While Schedule with the procurement of health-related equipment 8 of the Constitution delineates business taxation and other services being undertaken at both the as the exclusive responsibility of local governments, federal level and by local governments, leading to there is no regulation on its definition, scope and missed savings from bulk orders and pressures on the administrative procedures to levy such taxes. procurement capacity (World Bank 2021a). The development of such a legal framework and appropriate implementation guidelines would n Expenditure and service delivery responsibilities help improve the revenue potential of local should be further delineated. This applies governments. especially to the ‘exclusive but concurrent’ mandates (in schedules 7 to 9 of the Constitution) which, if Despite the progress made on PLGs’ fiscal and better specified, would increase the autonomy of financial regulatory frameworks, the lack of a solid PLGs and clarify funding for service delivery at each legal framework on PLG human resources continues tier of government. to constrain the advancement of fiscal federalism. n Simplifying the division of tax responsibilities The Federal Civil Service bill14 remains unpassed after among the three tiers of government should more than three years of drafting, revising, and refining. increase the effectiveness of tax administration. The lack of this federal act has limited the ability of PLGs The ambiguous division of tax responsibilities to develop their own human resources regulations and undermines PLGs’ potential to raise their own recruit their civil servants, thus undermining their PFM revenues. While the Intergovernmental Fiscal and administrative capacity and, ultimately, affecting the Arrangement Act (IGFTA, 2017) and the Local provision of services. As a result, 38 percent of provincial Government Operation Act (LGO Act, 2017) aimed and 34 percent of local government staff positions were to demarcate the tax jurisdictions of the three levels vacant at the end of 2021 (OAG 2022). The adoption of of government, some issues remain unsettled. the Federal Civil Service Act by the Parliament of Nepal For instance, while the tax sharing formula of continues to be one of the most important actions advertisement and entertainment taxes exists, the required for better fiscal federalism outcomes and, in authority to fix tariffs and the responsibilities for tax turn, for federalism as a whole. From field visits conducted to Gandaki and Madhesh provinces in May and June 2022. 13 In the absence of a federal act, the provinces have started passing their own bills and to undertake recruitment, although hesitantly in view of the lack of the federal 14 umbrella legislation. 20 Nepal’s PLGs need to take a more proactive role governments to suit local circumstances. Such variations to accelerate the enactment of their own laws and are important to promote competition and innovation. regulations to improve service delivery. While PLGs However, in practice, most PLGs are not fully exercising have autonomy under the Constitution to enact laws their legal and regulatory autonomy. This also applies and regulations on their areas of exclusive responsibility, to sectoral laws that are pending, including the federal in the interests of harmonization they often restrain education act, causing similar constraints to PLG service themselves from adopting them until there is a Federal delivery. The enactment of their own laws would allow Government act in the area concerned. Governments PLGs to better exercise their service provision roles and at all three tiers do not need uniform rules and they responsibilities. can vary across tiers and between provincial and local 2.2 The next stage of fiscal federalism requires stronger and better coordinated institutions to lead the implementation of the reform agenda The institutional setup at federal level to support to fulfill these roles. The division should be strengthened fiscal federalism implementation has improved and mobilized to enhance the fiscal discipline of since 2019. The Fiscal Federalism Coordination provincial and local governments to better meet their Division (FFCD) was established in the Ministry of revenue raising and expenditure responsibilities. Finance in 2020 to strengthen vertical and horizontal intergovernmental fiscal coordination. The division is Institutional arrangements for PFM have been responsible for intergovernmental fiscal management established across the three tiers of government. In work related to policy and law; for coordination 2018 and 2019, all seven provinces established ‘provincial amongst federal, provincial, and local governments; planning commissions’ (PPCs),15 which have been and for strengthening PLGs’ fiscal management responsible for preparing provincial development plans capacity. It serves as the Ministry of Finance’s focal in alignment with the NPC’s national development plan. point for the National Natural Resources and Fiscal The establishment of various bodies in line with the PFM Commission (NNRFC) and provides administrative and framework has helped distinguish who carries out which other support to the commission. PFM functions across the three tiers of government. This includes provincial treasury comptroller offices, which are The Fiscal Federalism Coordination Division in place in all seven provinces, and three key committees needs to improve its capacity to execute its responsible for budget and planning, revenue, and roles and responsibilities. As the secretariat of the resource estimation at local government level. Most local Intergovernmental Fiscal Council, the division should governments have established these committees.16 Table follow up on the annual decisions of the council, hold 2.3 summarizes the main PFM-related institutions across regular council meetings and build trust between the the three tiers. Chapter 3 gives a more detailed update on council and PLGs; but it has limited capacity and resources the progress of the PFM system in PLGs. Koshi, Lumbini and Karnali call them provincial planning commissions (PPCs). Madhesh, Bagmati, Gandaki and Sudurpashchim call them provincial policy and 15 planning commissions (PPSCs). The term provincial planning commission is used hereafter for them. According to consultations with MoFAGA and National Association of Rural Municipalities in Nepal (NaRMIN) focal points in February and March 2023. 16 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 21 n CHAPTER 2  n  LEGAL, POLICY, AND INSTITUTIONAL FRAMEWORKS ON FISCAL FEDERALISM Table 2.3. Main PFM related institutions across the three tiers of government PFM functions Federal level Provincial level Local level Planning and Ministry of Finance Ministries of economic Chief administrative officers (CAOs), budgeting affairs and planning accounts officers and planning staff. The Resource Estimation (MoEAPs) and provincial Committee17 planning commissions Three committees are responsible for revenue, resource estimation, budget, Line ministries and and development planning18 agencies Budget Line ministries Provincial line ministries Divisions, sections, and wards are execution responsible for budget execution based on budgeted activities and programs authorized by their CAOs Accounting Line ministries, Financial Provincial line ministries Local government financial and reporting Comptroller General Office and provincial treasury management units under the (FCGO) and district treasury controller offices supervision of CAOs controller offices (DTCOs) (PTCOs) Internal FCGO’s Internal Audit PTCOs internal audit Local governments’ internal audit audits19 Division staff or its designated sections and personnel. Some local offices governments have requested DTCOs to conduct their internal audits Legislative Office of the Auditor General, public accounts committees at the three levels of government and oversight the Commission for the Investigation of the Abuse of Authority (CIAA) Source: World Bank staff There is an urgent need to strengthen NNRFC’s deputation and transfer of its employees. As the technical and institutional capacity as well as commission requires specific technical skillsets to its coordination with other key fiscal federalism deliver its constitutional mandates and is a relatively actors such as the Ministry of Finance and the NPC. young organization, it is very important that its staff NNRFC has nine constitutional mandates related to not only have the required technical expertise, but just and equitable resource distribution across the also that they remain in post for sufficient time to tiers of government, but its institutional capacity needs build a robust institutional capacity. Hence, it is strengthening to deliver on its key roles: recommended that NNRFC prepares the set of staff profiles required for its positions and then discusses n Competency-based staffing is needed to strengthen with MoFAGA the most effective ways to ensure that, NNRFC’s performance. The commission’s annual even when staff rotations occur, commission staff report for FY22 (NNFRC 2022) said that 25 percent have the skillsets described in these profiles. There of its staff positions were unfilled.20 Despite its also needs to be a capacity building strategy that is constitutional mandates and importance to the implemented to regularly train its technical staff on success of fiscal federalism, the NNRFC lacks practical the principles and practices of grant design and on or financial autonomy to select its employees based monitoring the fiscal health of provincial and local on the required skills. Following the common governments. practice in Nepal, the NNRFC is prone to the frequent 17 Chaired by the NPC vice chairman. 18 They are a) local government revenue advisory committees, b) resource estimation and budget ceiling committees, and c) budget and program committee. Further information on their roles is given in Annex 3 19 Note that external audits are supplemented by internal audits to strengthen the quality of audits. 20 12 of the 49 required staff positions had not been appointed and one member had been absent for the past five years. 22 Box 2.1 Constitutional mandates of the NNRFC a) Determine the detailed basis and modality for the distribution of revenues among the three tiers of governments. b) Make recommendation on equalization grants to be provided to provincial and local governments. c) Conduct study and research work and prepare parameters on conditional grants to be provided to PLGs. d) Determine the detailed basis and modality for distributing revenues between PLGs. e) Recommend measures to meet expenditure of the federal, provincial and local governments, and to reform revenue collection. f) Analyze macro-economic indicators and recommend the ceilings of internal loans that federal, state and local governments can borrow, g) Review the bases for the distribution between the federal and provincial governments of revenues and recommend revisions. h) Set bases to determine the shares of the Government of Nepal in investments and returns in the mobilization of natural resources. i) Study and research on possible disputes that may arise among the three tiers of governments and make suggestions for preventing such disputes. Source: Constitution of Nepal (2015) n The established presence of the NNRFC in the The host of parallel legal, policy and institutional Intergovernmental Fiscal Council (IGFC) would reforms demonstrates the strong need for enhance coordination amongst key fiscal developing a fiscal federalism roadmap to anchor federalism actors. The fiscal council has played the implementation of these reforms. The absence a key role in enhancing intergovernmental fiscal of a comprehensive government-designed fiscal coordination, including among PLG representatives. federalism roadmap to guide and enable the monitoring However, the NNRFC does not have a permanent of reforms in this area, constrains the opportunity member position on the council, although the for a smoother transition to a fully operational fiscal Intergovernmental Fiscal Arrangement Act, 2017 federalism system. Such a roadmap should include all (IGFA Act) says that the commission’s chairman or aspects of fiscal federalism, including public financial representative may be invited to council meetings. management and intergovernmental fiscal transfers. It The inclusion of an NNRFC representative as a could build on the progress made through the Public permanent council member should make the Financial Management Strategy (2017) and the Capacity commission more effective on advancing a regular Development Action Plan on Fiscal Federalism (2022).21 dialogue with other federal agencies and sub-national It should provide clear benchmarks and indicators of level representatives, and should allow it to build this progress, identify the drivers of change, and establish dialogue into its decision-making processes. NNRFC’s sequencing and responsibilities for actions. To ensure regular participation in the fiscal council could also ownership at all levels, its preparation requires strong help improve horizontal and vertical information horizontal and vertical inter-governmental coordination sharing, and improve coordination among the three and consultation amongst federal agencies and PLGs. It is levels of government on fiscal federalism policies and recommended that the key fiscal institutions, principally actions. the MoF, NNRFC and NPC, jointly lead the process to design this fiscal federalism roadmap. It was produced by Ministry of Finance based on the report: Nepal Knowledge Exchange Program on Fiscal Federalism: Lessons and Reforms in 2022. 21 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 23 n CHAPTER 2  n  LEGAL, POLICY, AND INSTITUTIONAL FRAMEWORKS ON FISCAL FEDERALISM 2.3 The methods to determine intergovernmental fiscal transfers, revenue sharing and the sharing of natural resources royalties need revising The institutional autonomy of PLGs is constrained of sub-national governments and transition conditional by the large volume of earmarked conditional grants towards sectoral block grants with limited grants. Besides assigning specific revenue sources earmarking. This would help sub-national governments to PLGs, the Constitution (Article 60) envisions that fully assume their service delivery responsibilities (World the Federal Government will “equitably distribute the Bank 2021b). revenue generated by it from its sources, between the federation, provinces and local level entities.” Four types The allocation mechanisms of natural resources of intergovernmental royalties and for revenue sharing are up for (percent) fiscal transfer mechanisms have been established to distribute funds from the Federal Local review in 2023. These provisions are specified in the Provincial governments governments Federal government Government 70.0 to PLGs (see Annex 4) and from provincial to Intergovernmental Fiscal Arrangement Act, 2017 and the 59.8 NNRFC Act, 2017. The IGFA Act specifies that 30 percent 62.2 local governments. 60.0 The trend from 2018 to 2023 (Figure 54.7 2.1) shows that of value-added tax (VAT) and internal excises are to be 50.0 the largest and proportionally growing transfer of funds to PLGs has been through 40.0conditional distributed to provincial and local governments (15 40.0 36.2 grants, which are, however, heavily earmarked and thus percent to each) (Table 2.4). The amounts are based on 30.0 21.3 the formula that was developed in FY19 This formula is, 22 limit PLGs’ spending autonomy and maintain undue 20.0 however, applicable for only five years and so is up for control from the Federal Government on PLG spending. 10.0 It is important to clarify the role of conditional and fiscal review in 2023. Similarly, the distribution mechanism of 0.0 equalization grants, highlighting that fiscal equalization the royalties from the extraction of natural resources23 is Capital spending as a share of total spending specifiedCapital underspending in schedule shareAct as aIGFA 4 of the of total and underspending is due to be grants should co-fund all the constitutional mandates revised in 2023. Fig 1.22 Figure 2.1. Budget allocations of the four types of grants from the Federal Government to PLGs FY18 FY19 FY20 FY21 FY22 FY22sub FY23 300 250 200 150 100 50 0 Complementary Complementary Complementary Equalization Equalization Equalization Conditional Conditional Conditional Special Special Special Total Province Local Fig 2.1 Sources: Ministry of Finance, Budget Speeches from FY18-23 The formula is computed as a weighted sum of the population (60 percent), area (15 percent), Human Development Index score (5 percent), expenditure needs (5 22 percent), revenue collection effort (3 percent), infrastructure development (10 percent), and special conditions (2 percent). It covers six categories: a) mountaineering, b) electricity, c) forest, d) mines, e) minerals and f) water and other natural resources. 23 24 Table 2.4. Revenue sharing of federal taxes among the three levels of government (in percent) Federal Taxes Federal Provincial Local Value-added tax (VAT) 70 15 15 Internal excise duties 70 15 15 Natural resources royalties 50 25 25 Source: IGFA Act (2017) The division of tax responsibilities between PLGs fixes the ratio of revenue sharing between provincial and should also be revised to address the existing local governments for these taxes (see Table 2.5). The challenges. The division of tax responsibilities is NNRFC provides the basis and framework for determining specified by the IGFA Act with the basis for allocation the share of vehicle taxes to be allocated to local determined by the NNRFC. The IGFA Act (2017) specifies governments. The operational difficulties emanating the division of responsibilities between PLGs regarding from the current split of tax roles and responsibilities tax administration. These include (a) vehicle tax, (b) between PLGs indicate the need for an amendment of small vehicle tax, (c) house and land registration fees, (d) the legal framework. More clarity in these arrangements entertainment tax and (e) advertisement tax. The act also should enable an important increase in PLGs’ resources. Table 2.5. The administration and revenue sharing of PLG taxes PLG taxes Levied by Collected Revenue shares of Revenue share of by provincial govts local govts (in percent) (in percent) Vehicle tax PGs PGs 60 40 Small vehicle (non-mechanized) tax LGs LGs 0 100 House and land registration fees PGs LGs 40 60 Entertainment tax PGs LGs 40 60 Advertisement tax LGs LGs 40 60 Source: IGFA Act (2017) The intergovernmental fiscal transfer (IGFT) system enhanced under the leadership of Fiscal Federalism could be further improved under the joint leadership Coordination Division (FFCD) at MoF, by creating a of the NNRFC, NPC and the Ministry of Finance. As platform to foster horizontal coordination. PLGs are mainly reliant on fiscal transfers from the n Improve the methodology to calculate the federal Government to meet the minimum standard of distribution of fiscal equalization grants using service provision, it is crucial for PLGs to have adequate a clear estimation of the expenditure needs while financial resources through the IGFT and revenue sharing considering the hard budget constraints imposed by mechanisms. The following are areas for improvement to fiscal situation of the country. make the IGFT system more flexible, clear and timely: n Enhance flexibility on the use of conditional grants n Improve coordination and information sharing by reducing earmarking to encourage PLGs to between NPC, the Ministry of Finance and NNRFC support national priorities while flexibly addressing for better-informed decision-making in the three local-specific needs (there are currently more than institutions on the distribution of the four types 90,000 individual earmarked grants24 ). of grants under the IGFT system. This could be Source: Ministry of Finance, FY23 Budget. Earmarked grants are grants given under the condition that they can only be used for a specific purpose. 24 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 25 n CHAPTER 2  n  LEGAL, POLICY, AND INSTITUTIONAL FRAMEWORKS ON FISCAL FEDERALISM n Expand use of performance and result-oriented considerably less than the amounts recommended grants, following sound and transparent by NNRFC. In addition, starting from FY21, the Federal methodologies for grant allocation and incentivizing Government added a clause in the Appropriation Act investment in national priority areas such as human that allows the Federal Government to disburse less development, which are currently underfunded by than budgeted fiscal equalization grants in the case PLGs. of revenue shortfalls and disasters. Six of the seven provincial government have added a similar clause to The federal and provincial governments should their appropriation acts from FY21, followed by Karnali enhance compliance with the NNRFC’s province in FY22. Since the constitution bestowed recommendations on the amounts of fiscal NNRFC the role of recommending the amounts of equalization grants. The amounts of the allocated fiscal equalization grants, its recommendations should fiscal equalization grants in FY19 and FY20 (Table 2.6) be followed and, as per the Appropriation Act, any was reasonably close to the NNRFC recommended deviations should be fully justified. amounts. However, in FY21, the amounts allocated was Table 2.6. Recommended, budgeted, and disbursed fiscal equalization grants, FY19 to FY23 (NPR billion)   FY19 FY20 FY21 FY22 FY23 Recommended by NNRFC Federal to provincial 50.3 55.3 57.6 58.0 61.4 Federal to local 85.2 89.9 93.7 94.6 100.2 Provincial to local 4.4 6.2 6.3 7.0 7.6 Budgeted Federal to provincial 50.3 55.3 55.2 58.0 61.4 Federal to local 85.2 89.9 90.1 94.6 100.2 Provincial to local 4.0 6.2 6.3 7.0 7.6 Disbursed Federal to provincial 50.3 55.2 55.2 57.9 N/A Federal to local 85.3 89.9 90.0 84.6 N/A Provincial to local 4.0 6.3 6.3 N/A N/A Source: NNRFC and Ministry of Finance The Federal Government should transfer sub-national provincial and local governments in the following fiscal governments’ shares of federal revenues on a periodic year. Moreover, the Office of the Auditor General’s (OAG) basis, and they should be fully disbursed by the end of report for FY21 reported that the Federal Government had each fiscal year. Note that in most countries with similar deposited 62 percent of mining and mineral, 81 percent systems, such installments are paid quarterly based on of mountaineering, and 100 percent of royalties from projected revenues with adjustments made for over or water and ‘other’ in the federal consolidated fund (OAG, underpayment based on actual revenues at the end of 2022), which is much more than the legally stipulated each year. Currently, the Federal Government deposits share of 50 percent thus depriving PLGs of their share sub-national governments’ shares of VAT and domestic of royalties. It is critical that provisions are established excise duty revenues each month to their consolidated so that full budgeted resources are transferred from the funds, except for the revenues from the last 10 days of federal level to PLGs during each fiscal year in a timely the fiscal year, which are only deposited in the following manner, so that PLGs can properly plan and deliver year. The royalties for the full fiscal year are transferred to services to their citizens. 26 CHAPTER 3 Progress on Public Financial Management in Provincial and Local Governments NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 27 n CHAPTER 3  n  PROGRESS ON PUBLIC FINANCIAL MANAGEMENT IN PROVINCIAL AND LOCAL GOVERNMENTS Nepal’s provincial and local governments are establishing the core building blocks of public financial management at the sub-national level. This chapter highlights the progress made by PLGs on establishing their PFM systems and related issues and recommendations. The across-the-board analysis of this progress was seriously constrained by the lack of aggregated data for all PLGs, which meant that, particularly for local governments, much of the analysis is based on studies of samples of local governments. 3.1 Planning and budget preparation and execution processes are more advanced in provincial than local governments Mid-term expenditure frameworks and budget preparation processes are in place at the provincial level All provincial governments have prepared their first provincial development plans. Led by their provincial planning commissions, six of them prepared their first five-year development plans in FY20, followed by Sudurpashchim that prepared it in FY22. However, these provincial plans and associated budgets lack specific and unique transformational policies and programs and are similar to the current national development plan – the Fifteenth Five Year Plan (FY19-FY24) (National Planning Commission, 2020). Provincial planning commissions are also responsible for preparing three-year rolling MTEFs in coordination with their provincial ministries of finance.25 Provincial resource estimation committees26 are tasked with appraising the availability of resources and determining expenditure ceilings for each budget year for submission to their provincial ministry of finance. Unlike the federal MTEF, provincial MTEFs have not prioritized programs by accounting for costs and time (OAG 2022), which risks to undermining consistency between programs and budget. Like the federal MTEF, provincial MTEFs are prepared parallel to the annual budget seeking to ensure that budgets align with provincial governments’ annual work plans. The budget formulation process is in place for all seven provinces, led by provincial ministries of finance. Figure 3.1 illustrates the steps adopted by Gandaki for the preparation of its annual budgets guided by the Gandaki Provincial Fiscal Responsibility and Financial Procedures Act (2022). Other provinces have adopted similar practices with some variations on the timeline. Note that Koshi, Bagmati, Lumbini, Karnali and Sudurpashchim actually have ‘ministries of economic affairs and planning’ which this report refers to as provincial 25 ministries of finance. The provincial financial procedure acts say that resource estimation committees should be established. These committees are to comprise economic affairs and 26 planning ministers, provincial planning commission vice-chairpersons, economic affairs and planning secretaries, provincial accounts officers, representative from the Nepal Rastra Bank, the budget chiefs at ministries of economic affairs and planning, and revenue chiefs of ministries of economic affairs and planning. 28 Figure 3.1. An example of a provincial government’s budget formulation process (Gandaki) Resource Estimation Communicate Present Budget to Budget and Expenditure Budget Ceiling Provincial Preparation Ceiling Determination to Line Ministries Assembly by Line (Mid February) (End February) Ministries (Mid June) Sources: Gandaki Fiscal Responsibility and Financial Procedures Act, 2022 While most local governments governments (World Bank 2022) found that MTEFs for FY21 had only been made publicly available by one of have prepared their budgets within them, while none of them had made available their the required timelines, there has five-year development plan. only been limited progress on About 90 percent of Nepal’s local governments their preparation of MTEFs and submitted their budgets within the established development plans process in FY23. According to MoFAGA, in FY23, 682 of the 753 local governments submitted their budget to the Most local governments’ periodic, medium-term, local assembly within the legally stipulated time – more and long-term plans are not publicly available. While than the 656 local governments in FY22. In most local Section 24 of the Local Government Operation Act (LGO governments, the three committees that are required to Act) requires local governments to prepare periodic, be established by the LGO Act27 are working closely on medium-term, and long-term development plans, and budget preparation.28 The Local-level Plan and Budget to engage citizens during their preparation, there is no Formulation Guidelines, (2017) stipulate the budget publicly available data on whether citizen consultations formulation processes for local governments. Figure 3.2 are taking place. An unpublished 2022 study of 115 local shows the timeline for these activities. Figure 3.2. The local government budget formulation process Receive Estimating Ward level Prioritization Integrated Budget Budget Budget Resources Program of Projects at Budget and Approval Presentation Ceiling (Late April) Discussion Ward Level Program by Executive to Assembly (Mid March (Mid May) (End May) Formulation Committees (June 25) to Mid April) (June 15) (June 15) Sources: Local-level Plan and Budget Formulation Guidelines (2017) Detailed descriptions of these revenue advisory committees, resource estimation and budget ceiling determination committees and budget and program 27 formulation committees are given in Annex 3. Information collected through consultations with MoFAGA and the National Association of Rural Municipalities in Nepal (NARMIN). 28 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 29 n CHAPTER 3  n  PROGRESS ON PUBLIC FINANCIAL MANAGEMENT IN PROVINCIAL AND LOCAL GOVERNMENTS About 60 percent of local governments have been of the provinces run their procurement system based able to follow the provisions of budget spending upon the Federal Government’s procurement law, the delegation as per the law. The Local Government Public Procurement Act, 2007. Some provinces have Operation Act (2017) and the Financial Procedures and executed provincial procurement regulations under Fiscal Responsibility Act (2019) describe PLGs’ budget the federal act. Koshi and Lumbini have come up with authorization and execution processes. However, only such provincial regulations while Bagmati and Karnali 60.6 percent of the 115 sampled local governments have issued guidelines for clarifications and specific in the World Bank study had complied with the arrangements as required by the federal law. All these budget-related legal provision on spending delegation. provincial regulations and guidelines are based upon This could imply a lack of local government staff’s the federal law on public procurement. World Bank awareness of these provisions and/or insufficient (2022) reports that only 12 of the sampled 115 local human resources to follow the rules. governments had their own specific procurement laws or regulations posted on their websites. The rest of them There has been limited progress on PLGs establishing either followed the federal act and regulations or had their own procurement rules and regulations. Most executive rules on the procurement process. 3.2 Expenditure reporting at local level is not timely or in line with national accounting standards Section 56 of the Financial Procedures and Fiscal There has been only limited progress by local Accountability Act (2019) requires PLGs to make governments on maintaining their accounting their financial reports public, but this has not records. The LGO Act (2017) stipulates that local happened.29 The expenditure reporting format governments should maintain their accounts of is specified in the FCGO’s Accounting Manual and transactions in the OAG-approved format and that local the Chart of Accounts. The Accounting Manual was governments and their ward offices should publish the developed for the federal level, but also applies details of income and expenditure by the seventh day to PLGs in many respects,30 while the federal level of each month. The World Bank’s study (World Bank chart of accounts is also applicable to all tiers of 2022) found that in FY20, 95.4 percent31 of 108 sampled government. The FCGO consolidates local and local governments had not properly and adequately provincial governments’ financial reports within six maintained accounting records, while 54.6 percent of months from the end of each fiscal year. While these the 108 had not maintained their accounts and prepared consolidated expenditure reports are legally required reports in line with the recently approved Nepal Public to be made public, they were published for FY21, but Sector Accounting Standards. The FCGO is currently not for FY22. In addition, not all local governments’ developing an accounting manual for the three tiers of individual financial reports have been made available the government in line with the Public Sector Accounting to the public. Standards based on the International Public Sector Accounting Standards, 2017. These consolidated reports are called Bhag 10 for provincial governments and Bhag 11 for local governments. 29 There is no specific PLG accounting manual. 30 Out of 108 of 115 sampled local governments, for which the audit data was not available. 31 30 3.3 Internal control and treasury management systems are improving in PLGs There has been some progress in the Treasury management systems have been established in all seven provinces. As mandated by the Constitution, establishment of internal control all seven provinces have established consolidated committees in PLGs treasury single accounts (TSAs) to receive and manage federal grants and revenue transfers. Provincial Up to February 2023, four provinces32 had established governments are not required to return unspent internal control committees to institutionalize balances of their fiscal equalization grants and revenue internal control systems. These committees are transfers to the Federal Government. These remain in responsible for maintaining operational effectiveness their consolidated funds as cash bank balances towards and efficiency, reliable financial reporting and their next years’ budgets. compliance by establishing sound internal control systems.33 Treasury management is one of the more advanced areas of implementation by local governments The strengthening of internal control systems at through local consolidated fund systems. Funds the local government level is underway based on a are transferred from the federal to the local level sample of urban municipalities. Underpinned by in tranches − in the case of conditional grants with the LGO Act (2017) and the model internal control earmarked conditions. In the same way, some funds are guidelines issued by MoFAGA in 2021, many local also transferred from provincial to the local level. The governments are establishing internal control timeliness of receipt and the reliability of funds transfers systems. All local governments in a sample of 29 urban at the sub-national level have somewhat improved with municipalities covered by the Nepal Urban Government the predetermined timeline for the release of tranches and Infrastructure Project (NUGIP)34 had put in place of fiscal transfers in line with the Financial Procedures a dedicated team to strengthen their internal control and Fiscal Accountability Act, (2019). However, the systems. timely release of conditional grants has sometimes been challenging because some local governments have been Substantial progress has been made unable to comply with the disbursement conditions tied to the grants. on setting up Treasury Management Systems at PLGs Koshi, Bagmati, Gandaki and Karnali. 32 33 Internal control guidelines need to be prepared and approved following the establishment of these committees. The provinces where the committees have been established have prepared and approved such guidelines. Sample data collected from municipalities covered by NUGIP. Further details on these municipalities is available at: https://projects.worldbank.org/en/projects- 34 operations/project-detail/P163418 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 31 n CHAPTER 3  n  PROGRESS ON PUBLIC FINANCIAL MANAGEMENT IN PROVINCIAL AND LOCAL GOVERNMENTS 3.4 PLGs’ audits, oversight and transparency and accountability measures are in place, but implementation is challenging Audit mechanisms are operational, The OAG’s external auditing of PLGs each year as per the Constitution and the Financial Procedures but there are capacity issues and the and Fiscal Accountability Act (2019) is resulting low public disclosure of data in an increasing number of audit irregularities. In July 2022, the OAG completed the external audit of All provincial treasury controller offices (PTCOs) NPR 299.6 billion of FY21 expenses incurred by are carrying out internal audits of their provincial 1,131 entities operating under the seven provinces. governments; but the independence, timeliness These audits identified a 13.6 percent increase in and quality of the reporting needs improving. The cumulative irregularities for provincial offices from the provincial governments’ financial procedures acts previous year. Also, in July 2022 the OAG completed say that internal audits should be carried out by PTCO the external audits of NPR 1,051 billion of FY21 staff who are not involved in the concerned offices’ expenses by 744 local governments (plus 55 local financial transactions for independent and impartial governments’ FY20 expenditure). The cumulative auditing.35 While all seven provinces are conducting irregularities for audited local governments increased internal audits, the internal audit reports were only by 12.2 percent in FY21 from the previous year. While publicly available for Koshi for FY19 and FY20 (World local government expenditure had increased and the Bank 2022). The timeliness and quality of internal coverage of FY21’s local government audits expanded,36 audit reports need further assessing to inform required this increase in irregularities is a concerning trend improvements. The World Bank study found that some pointing to the urgent need to establish adequate internal audit personnel were tagged as accountants internal control systems in all PLGs. in PTCOs’ organograms, which is however a totally different function and thus misleading, with a Public accounts committees have potential impact on their independence. been established in provinces, but About 33 percent of local governments did not carry out internal audits for FY21. The internal auditing of the situation is not known at the local governments is carried out by local governments’ local government level internal audit departments or district treasury In the last five-years, all seven provinces have controller offices (DTCOs) under the Financial established public accounts committees (PACs) to act Comptroller General Office (the latter based on as oversight agencies, as per provincial assembly.37 requests from local governments that lack internal The audit reports issued by the OAG are submitted to audit resources). As per the OAG’s 59th annual audit PLG legislatures (assemblies) and their public accounts report (OAG, 2022), not only had 33 percent of local committees. The committees discuss reported audit governments not carried out internal audits for FY21, findings and recommend resolution and settlement of but most of those conducted had not been done in audit issues. While some public accounts committees a timely way or as per the scope required by FCGO’s have terms of reference and guidelines, the functions and internal audit guidelines (FCGO 2017). The carrying out responsibilities of most of them need further clarifying for of robust and effective internal audits is fundamental to the improved oversight of agencies, specifically in terms good governance, safeguarding taxpayers’ money, and of regularly following up on outstanding audit issues. fostering public trust in PLGs. Internal audits should be carried out every trimester (four months) and within a month of the end of trimesters. Any shortcomings observed and reported in internal 35 audit reports need to be addressed and settled before external audits commence. The OAG had audited 694 local governments in FY20. 36 With new provincial elections that were held in November 2022, provinces are in the process of establishing the new membership of the Public Accounts 37 Committees 32 The LGO Act (2017) stipulates that local governments details for Madhesh. While the regulatory framework and may form accounts committees and prescribe systems are in place, there is a significant room to improve regulations to manage their work. These committees budget transparency to facilitate citizen engagement are responsible for overseeing and monitoring financial across the PLGs’ public financial management cycles. management, audit reports, and examining financial There has been considerable progress on irregularities. They should meet once or twice a establishing and strengthening PFM-related month. While the regulatory framework indicates local information technology (IT) systems across the governments can form their own accounts committee, three tiers of government, but limited access to there is no consolidated data available yet at the the data undermines evidence-based planning and federal or provincial level to assess the number of local accountability. The eleven financial management governments that have such oversight mechanism and systems that have been established under the on their effectiveness. Government of Nepal between 2018 and 2022 are listed in Annex 5. The establishment of the Sub-National Treasury Regulatory Application (SUTRA) for local governments; Measures to enhance transparency the Provincial Line Ministry Budget Information System and accountability are in place but (P-LMBIS), the Computerized Government Accounting implementation lags behind System, and Treasury Single Account for provincial governments; and the Public Asset Management System Measures are in place to increase transparency and in PLGs have enhanced efficiency and controls in PLGs’ accountability in PLG public financial management, management of public funds. However, the limited but there are significant implementation gaps. The access to these system’s data across agencies is impeding major provisions for PLG transparency and citizens’ its use for decision-making and monitoring purposes. engagement to increase accountability are described in For example, SuTRA data is not accessible to key federal Table 3.1. The federal Fiscal Procedures and Financial ministries, including the Fiscal Federalism Coordination Accountability Act, 2019 (FPFA) requires that PLGs’ Division at the Ministry of Finance. Also, SuTRA needs financial statements are posted on websites or published to be expanded to cover revenue administration, in other appropriate media within seven days from the grants, borrowings, accrued liabilities, and current and completion of the reports. In FY21, 57.4 percent of the non-current assets. Expanding data accessibility and 115 sampled local governments and 18.3 percent of the coverage will enable better evidence-based planning same sample had made their budgets and appropriation and monitoring by governments. Furthermore, these acts publicly available (World Bank 2022). Although systems’ data needs to be made publicly available to budget data is publicly available for FY23 for all seven enhance government accountability to citizens on how provinces, it does not include revenue and expenditure their taxes are being used. Making these data publicly Table 3.1. Legal provisions on transparency and citizen engagement measures across PLG public financial management PFM cycle Measures Legal framework Planning and Citizen consultation on budget planning LGO Act Section 24 budgeting Reporting Provincial and local governments to prepare consolidated financial FPFA Act Section 4 statement of income (grants, revenue sharing, own source revenue), borrowing and expenditure and submit it to PTCOs and DTCOs. Auditing Local governments should hold public audits, social audits, and public LGO Act Section 78 hearings as appropriate to make public service delivery transparent, accountable and responsive. Oversight Every citizen shall have access to the information held in the public Right to Information bodies Act 2007 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 33 n CHAPTER 3  n  PROGRESS ON PUBLIC FINANCIAL MANAGEMENT IN PROVINCIAL AND LOCAL GOVERNMENTS available would enhance citizens’ engagement in supposed to be held at ward and local government planning and budgeting stages which will help to ensure levels. However, as per sampled local governments resource allocation as per the service delivery needs. and consultations with civil society organizations38 only some wards appear to be holding public hearings and The Electronic Government Procurement system consultations and many of these merely undertake (e-GP) has been established in most PLGs, but is ‘tick box’ exercises to satisfy the requirements of the not being used comprehensively. Provincial entities regulatory framework. Citizen’s engagement in local are using the e-GP system for all types of competitive government needs to be reinforced to foster adequate procurement except for those that cost below discussion and citizen’s participation. NPR 500,000, which is the threshold for direct procurement. Unlike at the provincial level, procurement Twelve out of a sample of thirteen urban by local governments is often still managed through municipalities39 were found to have grievance user committees, which can, however, undermine redressal officers to collect and address citizen competitiveness and transparency. While there is complaints, including issues related to PFM. As a part currently no clear regulatory framework to enforce of baseline survey conducted in 2022, these 13 NUGIP the complete use of e-GP systems from planning to municipalities were consulted. While this indicates good contract completion, it should be made mandatory to progress on appointing grievance redressal officers, there foster transparent and competitive procurement. is a large need to improve grievances systems. For example, none of the 12 municipalities with grievance officers had Local government wards are required to conduct grievances registration and processing systems. Both PFM public hearings on their annual budgets and and citizens engagement systems need strengthening to investment planning, considering available budget enhance the public’s trust in local governments. ceilings and service delivery programs. Budget proposals are consolidated by wards’ budget and Many of these and other findings were confirmed program formulation committees and presented to their through recent visits to Gandaki and Madhesh executive boards for submission to ward assemblies. provinces. Effective subnational PFM systems need And policies and programs, including fiscal policies, are better regulations to improve planning, better discussed at ward assemblies with public participation. consultations on strategies that influence PFM Local governments are also required to conduct public performance at the subnational level, and the improved consultations while framing their budget proposals, capacity of staff across the board underpinned by including at the ward level, to receive and consider strengthened provincial level training centers. More inputs and suggestions from the general public. Similarly, details on these findings are included in Box 3.1. public consultations on service delivery programs are Consultations with local governments include Lalitpur, Golbazar, Laxminia, Phedikhola, Putalibazar local governments complemented with consultation with 38 National Association of Rural Municipalities in Nepal (NARMIN) which is the umbrella organization of 460 rural municipalities. Consulted civil society groups listed in Annex 1. Among Itahari, Tansen, Pokhara, Dhankuta, Birtamod, Suklagandaki, Tilottama, Vyas, Mechinagar, Putalibazar, Triyuga, Urlabari and Damak municipalities, all except 39 Birtamod had appointed grievance officers. 34 Box 3.1 Key findings from the visits by MDTF partners to the Gandaki and Madhesh in January and February 2023 The PFM Multi-Donor Trust Fund (MDTF) partners40 conducted field visits to Gandaki and Madhesh including municipalities within the provinces in January and February 2023, to understand the status of PLGs’ PFM implementation and assess the need for related future PFM reforms. The following key issues were highlighted by PLGs officials and other stakeholders, amongst many others: n Need of fit for purpose PFM regulations. Local governments are implementing many micro-size development projects with limited impact. Despite the size of the projects, documentation requirements are the same as for larger projects, overloading local governments with bureaucratic workload. It was recommended to simplify the regulations on documentation requirements for smaller projects. n Lack of inter-governmental coordination on PFM reforms between the Federal Government and PLGs undermines the ownership of PFM future reforms. PLGs officials repeatedly confirmed they were unaware of the PFM Strategy, the PFM Training Needs Assessment, the Integrated Financial Management Information System (IFMIS) Assessment, and the Citizen’s Engagement Strategy that the Federal Government has prepared. n Inadequate human resource competencies. The lack of adequate human resources and of technical expertise at provincial and local governments level means that their PFM functions are not fully operational. n Provincial centers for good governance (PCGGs) have good potential to build the capacity of PLGs on public financial management. Though these centers have differing capacities among different provinces, they have a good potential to foster PLGs PFM functions. They can learn from and reinforce each other to become key hubs for capacity building of PLG officials on PFM by further developing training of trainer’s strategies and standardized training modules. 3.5 Policy Recommendations Strengthen measures to help local governments to submit their budgets on time by suspending grants comply with timely budget submissions. In FY23, or limiting revenue sharing allocations. However, both 66 of the 753 local governments (9 percent) submitted approaches are likely to further weaken concerned local their budget after the legally stipulated date, down from governments and negatively impact service delivery if 93 in FY22 (12 percent). In addition, 4 local governments lack of coordination and capacity are the reasons for not in FY22 and 5 local governments in FY23 did not present submitting on time. The recommended approach is to their budgets at all. There are two suggested approaches create PFM support units or teams in provincial ministries to ensure the timeliness of budget presentation. The first of finance to provide PFM-related assistance to local approach is to incentivize local governments to timely governments. These would provide capacity building submit their budgets by linking timely submission to the support for compliance with standards, technical amount of grants. This is already in place. The second assistance where needed and requested by LGs, and approach is to reprimand local governments that fail could analyze data on local government performance to The PFM MDTF is a program to strengthen the performance, transparency and accountability of public financial management in Nepal. The MDTF partners are 40 USAID, Norwegian Embassy, Swiss Development Cooperation, the UK Foreign, Commonwealth and Development Office (FCDO), the Australian Department of Foreign Affairs and Trade (DFAT) and the European Union. The program is managed by the World Bank. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 35 n CHAPTER 3  n  PROGRESS ON PUBLIC FINANCIAL MANAGEMENT IN PROVINCIAL AND LOCAL GOVERNMENTS inform the design of strategies to boost local government Strengthen the capacity of local governments to capacity on budget formulation and submission. implement internal control systems to prevent audit irregularities. A number of local governments Improve the transparency of budgeting and execution are yet to establish internal control systems in spite of to enhance planning and accountability. PLGs should it being required by MoFAGA’s Internal Audit Procedures prepare all the legally mandated reports in a timely Guidelines for PLGs. This is a priority issue considering way in line with the Nepal Public Sector Accounting the large number of audit irregularities reported for Standards and prescribed Charts of Accounts to allow local governments. As per the Internal Audit Guideline, the comparison of data over time and across PLGs. local governments can form accounts committees The consolidated financial statement prepared by that report to local government councils, as well as the FCGO for local governments should capture all internal audit sections that directly report to chief available data in the SuTRA. This includes budgeted administrative officers. These are positive provisions and actual data for revenue classification and all three that appear to be pending from adoption in many local spending classifications (economic, functional, and governments. Accounts committees need to be active source-wise). Only the annual consolidated financial for the timely monitoring and follow up on outstanding statements for the three tiers of government are publicly audit irregularities. Because of the lack of systems that available for FY21 while other data and most financial can automatically prevent mistakes or wrongdoing or reports are not. This lack of transparency is impacting the generate right and timely information for action to be credibility of local government budgeting and execution. taken, it is recommended to develop and pilot internal control systems in a few local governments per province Establish a consolidated PFM performance database and, once tested and documented through an internal at the federal level to enhance monitoring and control manual based on learning from the pilots, evaluation. A consolidated PFM performance database design a strategy to roll out such systems to all local is needed. Such a database could benefit from data governments. gathered through the Local Government Institutional Capacity Self-Assessment (LISA)41, whose findings are not Prepare and implement action plans to resolve audit yet publicly available. The lack of regular updates on the observations. Local governments need to maintain overall performance of PLG public financial management updated records of audit observations and prepare with disaggregated indicators impacts the overall and implement audit observation records as required capacity to monitor, plan and design better informed by OAG Form No. 800.42 The content of these forms can PLG PFM reforms and capacity building. Establishing be transformed into action plans for resolving audit regular PFM performance assessment systems is highly observations by defining responsible agencies and recommended for the Federal Government. timelines to address irregularities. Local government accounts committees should be actively mobilized to Support PLGs with the required infrastructure to monitor the implementation of such action plans. enable their public disclosure of their financial reports. While public access to financial reports has The OAG to consider introducing concurrent audits. improved at the provincial government level, there are The government could recommend that the OAG still significant disclosure gaps. The integrated financial introduces concurrent audits of PLG accounts on a reports for FY19, FY20, and FY21 were not made available sample basis each year, based on sector wise audit in five, three and five provinces respectively, while the risk. Concurrent audits would identify irregularities and annual evaluation reports were not made available for non-compliance in a timely way and promote corrective the same fiscal years in seven, six and five provinces action to prevent the aggravation of financial irregularities respectively (World Bank 2022). The causes of this lack of and the materialization of associated consequences. public disclosure need to be identified following which tailored support should be provided to provinces to address the causes. MoFAGA’s Local Government Institutional Capacity Self-Assessment (LISA) assesses the capacity of local governments annually. Further details are available at: 41 https://lisa.mofaga.gov.np/local/status Form No. 800 is a tool to maintain updated records of audit observations at the local government level. 42 36 References NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 37 n REFERENCES Reports FCGO (2021). Consolidated Financial Statement for FY 2019/20. Kathmandu. Financial Comptroller General Office. https://fcgo.gov.np/storage/uploads/publications/20210523121905_CFS_2019_20%20final.pdf FCGO (2022). Consolidated Financial Statement for FY 2020/21. Kathmandu. Financial Comptroller General Office. https://fcgo.gov.np/storage/uploads/publications/20220705103141_For%20Website.pdf Georgia State University [GSU] (2019). Nepal: Capacity Needs Assessment for The Transition to Federalism. 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Accessed 10 December 2022 at: https://cbs.gov.np/national-accounts/ NNRFC (2017). National Natural Resources Fiscal Commission Act. Kathmandu: National Natural Resources Fiscal Commission. NPC (2020). The Fifteenth Plan (2019/20–2023/24). Kathmandu: National Planning Commission. NPC (2022). Medium Term Expenditure Framework and Annual Development Program (2079/2080). Kathmandu: National Planning Commission PDMO (2022). Public Debt Management Act. Kathmandu: Public Debt Management Office. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 39 n CHAPTER 3  n  PROGRESS ON PUBLIC FINANCIAL MANAGEMENT IN PROVINCIAL AND LOCAL GOVERNMENTS 40 Annexes NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 41 n ANNEXES Annex 1. Stakeholder Organizations whose Representatives were Consulted to Produce this Update Government Agencies 1. Ministry of Federal Affairs and General Administration (MoFAGA) 2. Office of the Auditor General 3. Lalitpur, Golbazar, Laxminia, Phedikhola and Putalibazar local governments 4. Bagmati, Gandaki and Madhesh provincial governments 5. National Association of Rural Municipalities in Nepal (NARMIN) 6. The National Natural Resources and Fiscal Commission (NNRFC) 7. Ministry of Finance 8. Financial Comptroller General Office CSO, Academia, and Think Tanks 9. Centre for Innovative Governance Practices 10. Freedom Forum 11. Forum of Federations 12. International Institute for Democracy and Electoral Assistance (IDEA) 13. Institute for Integrated Development Studies (IIDS) 14. National Democratic Institute 15. South Asia Watch on Trade, Economics and Environment (SAWTEE) 16. Transparency International 17. Tribhuvan University Development Partners 18. Foreign, Commonwealth and Development Office 19. United States Agency for International Development 20. Asian Development Bank 21. European Union 22. Norwegian Embassy 23. United Nations Capital Development Fund 24. United Nations Development Program 25. GIZ 42 Annex 2. The Legal Framework Underpinning Fiscal Federalism in Nepal Legal framework Brief description Intergovernmental n Provides the bases for the collection of tax, non-tax, and other revenues by each tier Fiscal Arrangement of government, as well as for the provision of grants (fiscal transfers) amongst federal Act (2017) units. n Provides for the formation of an Intergovernmental Fiscal Council (IGFC) responsible for consulting and coordinating intergovernmental fiscal management among the three tiers of government. n Permits PLGs to resort to domestic borrowing within the limit NNRFC sets with the approval of the Federal Government. n Federal and provincial governments are allowed to raise internal loans by issuing bonds. It also says that the power to obtain foreign grants and assistance rests only with the Federal Government regarding plans and programs to be implemented by the provincial and local governments. National Natural n Supplements the NNRFC’s nine basic roles and duties under the Constitution. Resources and Fiscal n Mandates the NNRFC to determine the criteria for distributing equalization grants, Commission Act the bases for sharing revenues and the recommended amounts of conditional grants (2017) amongst the PLGs Local Government n Lays down the structure, powers, functions, and procedures of the three main organs Operation Act (2017) of local governments – their executives, assemblies, and judicial committees. n Details the roles and responsibilities of local governments under schedules 8 and 9 of the Constitution according to the functional ‘Unbundling Report’ ).43 n Local governments may raise domestic loans for productive, employment promotion, internal income generation and capital works. The maturity period of loans should be no more than 25 years. Employee n Manages the adjustment and posting of civil servants in federal, provincial, and local Adjustment Act governments. (2017) n Outlines the steps and timelines to be taken and followed in carrying out adjustments, including conducting organization and management (O&M) surveys and establishing the basis for transfers and the adjustment of employees, and their career development opportunities and retirement. The unbundling report provides further clarifications on the mandates and responsibilities of each tier of government under the Constitution. It says that the Federal 43 Government has 606 functions, provincial governments 267 functions and local governments 302 functions. NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 43 n ANNEXES Legal framework Brief description Financial Procedures n Regularize and systemize financial procedures of the federal, provincial and local and Fiscal levels. Accountability Act n Details the management of consolidated and other government funds, budget (2019) formulation, budget release, accounting, reporting procedures, internal control, auditing and other financial administration activities for maintaining macroeconomic stability through transparent, result-oriented and accountable financial management. n Directs governments to formulate and execute financial procedures in line with the act, and requires the Financial Comptroller General Office (FCGO) to consolidate financial statements across all three tiers of government, and submits them to the Office of the Auditor General (OAG). Audit Act (2019) n Mandates the auditing of the three tiers of government by the Office of the Auditor General and bodies or institutions that are responsible for auditing as specified by relevant laws. n Outlines the roles of the Office of the Auditor General and it should carry out audits. Intergovernmental n Supplements Article 234 of the Constitution on the 3Cs of co-existence, co-operation, Coordination Act and coordination, and further clarifies the relationships between the three tiers of (2020) government and how intergovernmental coordination and consultation should happen. n Provides for establishing institutional mechanisms for intergovernmental coordination and dispute resolution including the National Coordination Council and provincial coordination councils. n Lays the foundations for PLGs to adopt strategies, plans and regulations to operationalize the law to promote intergovernmental relations within their jurisdictions and across the three tiers of government. Public Debt n Defines the rules of public debt management for the three tiers of government Management Act including foreign borrowings for the Federal Government and domestic borrowings by (2022) PLGs. n Specifies the roles of each tier of government and the NNRFC to recommend annual ceilings for domestic borrowing..44 n Allows PLGs to raise domestic loans by issuing bonds within limits prescribed by the NNRFC. The annual maximum amount of borrowing is normally fixed as a percentage of the year’s GDP for the Federal Government. The annual debt ceiling for PLGs is a 44 percentage of their total revenue, i.e. of their shared revenue amounts plus own sources revenues. 44 Annex 3. Local Government Budgeting Committees Types Membership Key responsibilities Revenue n Coordinator: deputy mayors (a) Formulate, reform and amend revenue-related policies advisory n Members: Chief and laws; and consult on adherence to them. committees administrative officers, (b) Estimate revenue collection for the upcoming year based two members from the on the analysis of sources of revenue, the revenue base executive (including one and the tariffs’ structure. woman), a representative of (c) Analyze and estimate internal revenues based on the a private sector organization prevailing revenue tariff and base. or small cottage industry (d) Advise on taxation policies to promote local industries organizations and businesses and generate employment. n Member secretary: Chief of (e) Advise on the rates of tax and non-tax revenues, service revenue division fees, charges, etc. (f) Provide other necessary advice for improved revenue administration. Resource n Coordinator: mayors (a) Manage project internal revenues, receipts from revenue estimation n Members: deputy mayor and sharing, fiscal transfers from federal and provincial and budget four members of executive governments, domestic borrowing and other income. ceiling committees (b) Prepare frameworks for the balanced distribution of determination projected resources considering national and provincial n Member secretary: chief committees priorities and local needs. administrative officers (c) Determine total budgets based on the estimation of resources for the coming fiscal year. (d) Determine sectoral budget ceilings. (e) Determine the basis for the prioritization of budgets and programs based on federal and provincial government guidelines, the local economic condition and the status of internal revenues. (f) Prepare guidelines for sectoral budget formulation. (g) Other activities related to resource estimation and budget ceilings as per local needs. Budget and n Coordinators: deputy (a) Prepare a proposal on programs for the budget year. program mayors (b) Prioritize budgets and programs within the budget formulation n Members: executive ceiling set by the resources estimation and budget ceiling committees committee members committees as per Clause 66 of the LGO Act. representing thematic areas, (c) Arrange thematic discussions on budget and program chief administrative officers, proposals and prepare the proposals and present them chiefs of planning divisions to the executive committee. (d) Avoid duplication in plans and programs and maintain mutual compatibility among them. Source: LGO Act, 2017 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 45 n ANNEXES Annex 4. Overview of Nepal’s Intergovernmental Grants Mechanism Current status Regulatory framework Conditional Although the NNRFC identifies the parameters of conditional grants, Constitution grants45 in practice, their horizontal allocation is determined by federal sector (Article 60), NNRFC ministries and the Ministry of Finance. During the first few years of the Act, (2017) and transition to federalism (in the absence of basic information), it was Intergovernmental not unusual for line ministries to budget equal amounts to each local Fiscal government, with sectoral salary resources distributed to pay the Arrangement Act salaries of sectoral staff posted in each local government. (2017). Equalization As determined by the NNRFC, fiscal equalization grants are distributed grants46 as the sum of three components: a minimum grant (25 percent), a formula-based grant (73.125 percent), and a small performance-based grant (1.875 percent). The formula-based component is calculated based on a fiscal gap index47 (70 percent), a disparity index (5 percent), an infrastructure index (15 percent), and a poverty index (10 percent). The formula-based allocations are then adjusted to ensure that each local government receives at least NPR 65 million. However, this methodology and the reliance on non-transparent indices, means that the current allocation approach does not adhere to the constitutional mandate to distribute fiscal equalization grants “on the basis of expenditure needs and revenue capacity”. Complementary These grants are meant to be used by PLGs to implement infrastructure (matching) development plans and projects on a cost-sharing and competitive grants48 basis. They are distributed based on criteria, including project feasibility, expected inputs and outputs as well as PLGs’ project implementation capabilities. NPC allocates these grants based on applications from PLGs. Special grants49 The distribution of special grants aims to enhance the delivery of basic services such as health, education and drinking water, and achieve balanced development or uplift marginalized communities at the PLG level. They are managed by NPC. Source: Constitution of Nepal (2015), NNRFC Act (2017) and Intergovernmental Fiscal Arrangement Act (2017) Conditional grants are earmarked for specific activities and complement untied resources to meet service delivery standards. NNRFC parameters differ regarding the 45 allocation of grants to be provided from the Federal Government to PLGs as compared to the allocation of grants from provincial to local governments. Equalization grants are untied to equalize the resources available across PLGs and to enable them to meet their core functions. The indicators are the same on 46 Federal Government allocations to PLGs and provincial government allocations to local governments. The fiscal gap is defined as expenditure needs minus the ability to raise revenue. 47 Complementary grants are for national priority infrastructure projects. 48 Special grants are intended to support regionally and sectoral-confined special projects. 49 46 Annex 5. Public Financial Management Related IT Systems in the Government of Nepal Names Short description Established 1 Provincial Revenue The Provincial RMIS is a web-based software that tracks provincial 2018 Management governments’ revenue collection. Information System 2 Line Ministry Budget The LMBIS is an online program and budget submission system 2019 Information System in the Government of Nepal’s budget that has direct links to line ministries, the Ministry of Finance and the National Planning Commission. 3 Sub-national Treasury The SuTRA is a planning, budgeting and accounting software 2019 Regulatory Application system. It has separate broader financial management applications for provincial and local governments. 4 Computerized Government spending offices use the CGAS for accounting and 2019 Government reporting budget expenditure, which is linked with the Treasury Accounting System Single Account and LMBIS. (including Electronic Fund Transfer) 5 Provincial Line Ministry The PLMBIS supports the major functions required for provincial 2020 Budget Information governments’ budget allocation and execution. It also provides System budget authorization. Once budgets are approved, programs are entered into the PLMBIS for authorization, including expenditure. 6 Public Assets The Public Assets Management System is used to record and 2020 Management System report public assets. It has been mandatory for provincial governments from FY21. 7 National Project The NPBMIS is a web-based platform that facilitates the 2020 Bank Management functioning of the National Project Bank (NPB) by assisting data Information System capture, validation, analysis, and interpretation and sharing project information to assist decision-making in the course of preparing and developing projects. 8 National Audit It is an electronic system that enables all public bodies, including 2021 Management System local governments to interface directly with the OAG. This system also keeps computerized records of audits and audit observations. 9 Provincial Treasury The Treasury Single Account (TSA) system is a unified structure of 2022 Single Account government treasury operations that gives a consolidated view of government cash resources. 10 Provincial Project The PPBMIS is a web-based platform that facilitates the 2022 Bank Management functioning of the National Project Bank (NPB) at the provincial Information System level by assisting data capture, validation, analysis, interpretation and sharing project information to assist decision-making while preparing and developing projects. 11 Financial Management The FMIS is a central level consolidation system that is supported 2022 Information System by the District Expenditure Control System NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 47 n ANNEXES Annex 6. Disbursement Calendar for Intergovernmental Fiscal Transfer for FY23 Federal/ Type of grant Number Instalment dates Refund deadline Provinces of instalments for unused grants 1. Federal to provincial and local governments Equalization Four Aug 22 Oct 22 Jan 22 April 22  NA Remaining disbursed based Conditional Three Aug 22 on submission of periodic Federal statements of expenditure End-July of next fiscal year Complementary Based on the procedure approved by NA  and special the Federal Government 2. Provincial to local governments Equalization Four Sep 17 Nov 17 Feb 17 May 17  NA Remaining disbursed based Conditional Three Sep 17 on submission of periodic Koshi statement of expenditure End-July of next fiscal year Complementary Based on the procedure approved by  NA and special the province Based on the submission of periodic Equalization Four  NA statement of expenditure Madhesh Conditional, End-July of next complementary, NA NA fiscal year and special Aug Jan April Equalization Four Oct end  NA end end end Bagmati Conditional, Aug Jan April Mid-Aug of next complementary, Four Oct end end end end fiscal year and special Equalization Four Sep 10 Nov 10 Feb 10 May 10  NA Remaining disbursed based Conditional Two Sep 15 on submission of periodic Gandaki statement of expenditure Mid-Aug of next Remaining disbursed based fiscal year Complementary Two Sep 15 on submission of periodic and special statement of expenditure Equalization Four Sep 15 Nov 15 Feb 15 May 15  NA Lumbini Conditional, As per the directives of Ministry of Mid-Aug of next complementary, Four Economic Affairs and Cooperatives fiscal year and special 48 Federal/ Type of grant Number Instalment dates Refund deadline Provinces of instalments for unused grants Equalization Four Aug 22 Oct 22 Jan 22 April 22  NA Remaining disbursed based Conditional Four Aug 22 on submission of periodic Karnali End-July of next statement of expenditure fiscal year Complementary Based on the procedure approved by the province and special Equalization Four Aug 25 Oct 25 Jan 25 April 25  NA Remaining disbursed based Conditional Three Aug 25 on submission of periodic Sudurpashchim Mid-Oct of next statement of expenditure fiscal year Complementary, Based on the procedure approved by the province and special NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 49 n ANNEXES Annex 7. Complementary studies on different aspects of Fiscal Federalism in Nepal Complementary studies Brief Description World Bank (2017). Nepal The Nepal Development Update is a semi-annual assessment of Development Update: Fiscal economic performance in Nepal. This edition of the update took a close Architecture for Federal Nepal. World look at the emerging issues and potential risks in the design of fiscal Bank: Washington DC architecture for the new federal Nepal. Georgia State University (2019). Nepal: This report, which is known as the Nepal Federalism Capacity Need Capacity Needs Assessment for the Assessment (FCNA), explored the capacity needs for the adoption of Transition to Federalism. Report federalism covering the Federal Government, the seven provinces and commissioned by the World Bank 115 local governments. The assessment focused on organizational, and the United Nations Development institutional and regulatory capacity, as well as physical infrastructure. Program (UNDP). World Bank (2019). Policy Note for the This policy note was prepared based on the findings, analyses and Federalism Transition in Nepal. World recommendations of the FCNA study. It provides a synthesis of the FCNA Bank: Kathmandu findings as well as its forward-looking recommendations in terms of the immediate, medium, and long-term actions that the government could take to fully realize the benefits of implementing federalism in Nepal. World Bank (2021). Federalism This report provides a comprehensive review of the challenges facing and Public Expenditure for Human Nepal’s human development sectors in the federal context. Development in Nepal. World Bank: Washington DC World Bank (2021). Nepal Public This review provides an analytical basis to inform reform efforts to Expenditure Review - Fiscal Policy strengthen federalism and create fiscal space to support the new focus for Sustainable Development. World on a green, resilient, and inclusive development (GRID) model for Nepal’s Bank: Washington DC development. Ministry of Finance (2022). Nepal This report was prepared based on the learnings from six country studies Knowledge Exchange Program on under the World Bank Knowledge Exchange Programme from 2019 to Fiscal Federalism: Lessons and 2022, which identified lessons from international experience and the early Reforms. Kathmandu: Ministry of experiences of implementing fiscal federalism in Nepal. The report covers Finance. the four topics of intergovernmental fiscal transfers, provincial and local government performance management and appraisal, public finance management and taxation. 50 NEPAL FISCAL FEDERALISM UPDATE, JUNE 2023 | 51 The World Bank Nepal Country Office, P.O. Box 798 Yak and Yeti Hotel Complex Durbar Marg, Kathmandu, Nepal Tel.: 4236000, Fax: 4225112 Email: infonepal@worldbank.org www.worldbank.org/np www.twitter.com/WorldBankNepal www.facebook.com/WorldBankNepal