NEPALFISCAL

FEDERALISMUPDATE

May2024

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NEPALFISCAL

FEDERALISMUPDATE

May2024

WORLDBANKGROUP

Contents

Figuresiv

Tablesiv

Acronymsvi

Boxesv

AcknowledgmentsviiExecutiveSummaryviii

Chapter1:Macro-fiscalUpdateonProvincialandLocalGovernments1

1.1Economicgrowthslowedinallprovinces,withthelargestprovincialeconomy,Bagmati,experiencing

thelowestgrowthrate,mainlyduetothecontractionofwholesaleandretailtrade

2

1.2MostlocalgovernmentsalsoexperiencedadeclineineconomicactivityinFY23

5

1.3FiscalbalancesofprovincialandlocalgovernmentsfellintodeficitinFY23forthefirsttimesincethe

implementationoffiscalfederalism

5

1.4Consolidatedrevenueandgrantsofprovincialandlocalgovernmentsdeclinedtoarecordlowin

FY23duetoadecreaseinintergovernmentalgrantsandrevenuesharing

7

1.5ProvincialandlocalgovernmentspendingedgedupmarginallyinFY23

9

1.6Alargegapremainsbetweensub-nationalgovernments’ownexpenditureandownrevenue

11

1.7Budgetcredibilityisunderminedbylackofalignmentbetweenperiodicdevelopmentplans,

medium-termexpenditureframeworks(MTEF),andbudgets,aswellassignificantallocationto

thecategoryof‘EconomicMiscellaneous’spending

12

Chapter2:EnablingLegal,Policy,andInstitutionalFrameworks,withEmphasisonProvincialGovernments15

2.1Legalandinstitutionalsetupforfiscalfederalismintheprovinceshasevolved

17

2.2Own-sourcerevenuecollectionhasstagnated,reflectingmoderateimprovementinpolicyonrevenue

assignmentandweaknessinrevenueadministration

19

2.3Expenditureassignmentisadvancing,butisnotsupportedbyeffectiveprocurementmanagement

20

2.4TheInter-GovernmentalFiscalTransfersSystemrequiresupgradedinstitutionalarrangementsfor

effectivemanagement

22

2.5Theregulatoryframeworkonborrowingandcapitalfinanceisevolving

26

2.6Therehasbeenlimitedprogressmadeinthesustainableandequitablemobilizationand

distributionofnaturalresourcesrevenue

26

Chapter3:ProgressonPublicFinancialManagementbyProvincialandLocalGovernments29

3.1Whilemostlocalgovernmentsadheredtolegalrequirementsforannualbudgetsandbudgetspending

delegation,progressinpreparingperiodicdevelopmentplansandMTEFsremainslimited30

3.2Althoughlocalgovernmentsseemtobecompliantwithlegalprovisionsonmaintainingaccounts

accordingtonationalaccountingstandards,thebudgettransparencyoflocalgovernmentsremainslow32

3.3Althoughtherehasbeenanimprovementinthenumberoflocalgovernmentspreparing

procurementplans,closetohalfoflocalgovernmentshavestillnotpreparedthem

34

3.4InternalcontrolsystemsareimprovinginPLGs,butthecoverageofthiskeyoversight

mechanismremainslimited

35

3.5Auditirregularitiesatbothprovincialandlocallevelsdecreased

36

3.6Compliancewithpreparingandpublishingtheannualbudgetexecutionreportdeterioratedforlocal

governments,whilepublichearingsimproved

37

Chapter4:KeyRecommendationsfromtheNFFU2024

39

References

45

ActsandGuidelines46

Annex1.ListofKeyStakeholdersConsulted48

Annex2a.Listof115MunicipalitiesSampledinOAGAnalysis49

Annex2b.Listof444MunicipalitiesSampledinLISAAnalysis50

Annex3a.Macro-FiscalStatisticsforProvinces(FiguresA1–A7)52

Annex3b.FiscalStatisticsforFourTypesofMunicipalities(FiguresA8–A11)66

Annex4.ComplementaryStudiesonFiscalFederalisminNepal70

NepalFiscalFederalismUpdate,May2024|iii

iv

Tables

Table2.1.SnapshotofthefivekeypillarsoffiscalfederalisminNepal16

Table2.2.Keyprovincial-levelinstitutionsfortheimplementationoffiscalfederalismandPFM17

Table2.3.StatusofenactmentofProvincialCivilServiceActsandcivilservicerecruitment18

Table2.4.Scheduleforallocationgrants25

Table2.5.Keyrolesofthefourinstitutionsonborrowingandcapitalfinancing26

Table2.6.NaturalresourceroyaltydistributiontoPLGsbysourceFY2127

Table4.1.ProgressonimplementationofrecommendationsinNFFU2023,andsummaryof

keyrecommendationsinNFFU202440

Figures

Figure1.1.AllNepal’sprovincialeconomiesgrewataslowerpaceinFY23 2

Figure1.2. drivenprimarilybytheservicessector…2

Figure1.3. particularlywholesaleandretailtrade3

Figure1.4.Manufacturingsub-sectorinallsevenprovincescontractedinFY233

Figure1.5.Bagmaticontributedmorethanone-thirdofnationaleconomicgrowthinFY234

Figure1.6.FiscalbalanceofallprovincesmovedintodeficitinFY23,thefirsttimesinceFY196

Figure1.7.FiscalbalanceoflocalgovernmentsalsofellintodeficitinFY23,thefirsttimesinceFY196

Figure1.8.ProvincialgovernmentrevenueandgrantsplummetedinFY238

Figure1.9.LocalgovernmentrevenueandgrantsalsoplummetedinFY238

Figure1.10.ProvincialgovernmentspendingincreasedmarginallyinFY239

Figure1.11.LocalgovernmentspendingdecreasedmarginallyinFY2310

Figure1.12.VerticalfiscalgapremainedhigherforlocalgovernmentsthanprovincialgovernmentsinFY2311

Figure1.13.ProvincialgovernmentunderspendingincreasedinFY2312

Figure1.14.LocalgovernmentunderspendingdecreasedmarginallyinFY2312

Figure1.15a.Recurrentspendingallocationunderbudgets,MTEFs,andperiodicplans13

Figure1.15b.Capitalspendingallocationunderbudgets,MTEFs,andperiodicplans13

Figure2.1.BudgetallocationsforthefourtypesofgrantsfromthefederalgovernmenttoPLGs22

Figure3.1.Percentageoflocalgovernmentspreparingperiodicdevelopmentplans30

Figure3.2.Percentageoflocalgovernmentspreparingonlyspatial-baseddevelopmentplans30

Figure3.3.PercentageoflocalgovernmentspreparingandimplementingMTEFs,andannualdevelopment

programsbasedonthespatial-baseddevelopmentplans31

Figure3.4.Percentageoflocalgovernmentspreparingannualbudgetandprogrambasedon

recommendationsofthethreecommittees31

Figure3.5.Percentageoflocalgovernmentssubmittingannualbudgettotheirlocalassembly32

Figure3.6.Percentageoflocalgovernmentswiththeirlocalassemblyendorsingsubmittedbudget

withinthelegallystipulatedtimeline32

Figure3.7.Percentageoflocalgovernmentscomplyingwithlegalprovisionsonbudgetspendingdelegation32

Figure3.8.Percentageoflocalgovernmentscomplyingwithlegalprovisionsonmaintaining

accountsinlinewithnationalaccountingstandards33

Figure3.9a.Percentageoflocalgovernmentsmakingbudgetspeechpubliclyavailable33

Figure3.9b.Percentageoflocalgovernmentswiththreesetsoffiguresavailableinbudgetspeech33

Figure3.9c.Percentageoflocalgovernmentswithrevenueestimateavailableforbudgetyear34

Figure3.9d.Percentageoflocalgovernmentswithspendingestimatebasedoneconomicclassification

availableforbudgetyear34

Figure3.9e.Percentageoflocalgovernmentswithspendingestimatebasedonfunctionalclassification

availableforbudgetyear34

Figure3.10.Percentageoflocalgovernmentspreparingandfullyimplementingmasterandannualprocurementplans35

Figure3.11.Percentageoflocalgovernmentspreparingandfullyimplementinginternalcontrolsystems35

Figure3.12.Percentageoflocalgovernmentsperformingandnot-performinginternalaudit35

Figure3.13.Auditirregularitiesasshareofauditedamountforprovinces37

Figure3.14.Auditirregularitiesasshareofauditedamountforalllocalgovernmentsbymunicipalitytype37

Figure3.15.Percentageoflocalgovernmentspreparingandmakingtheannualbudgetexecution

reportpublicwithinthelegallystipulatedtimeline37

Figure3.16a.Percentageoflocalgovernmentsconductingatleastonepublichearingeveryfourmonths38

Figure3.16b.Percentageoflocalgovernmentswithtwopublichearingsduringtheevaluationperiod38

FigureA1.Macro-fiscalstatisticsforKoshi52

FigureA2.Macro-fiscalstatisticsforMadhesh54

FigureA3.Macro-fiscalstatisticsforBagmati56

FigureA4.Macro-fiscalstatisticsforGandaki58

FigureA5.Macro-fiscalstatisticsforLumbini60

FigureA6.Macro-fiscalstatisticsforKarnali62

FigureA7.Macro-fiscalstatisticsforSudurpashchim64

FigureA8.Fiscalstatisticsformetropolitancities66

FigureA9.Fiscalstatisticsforsub-metropolitancities67

FigureA10.Fiscalstatisticsforurbanmunicipalities68

FigureA11.Fiscalstatisticsforruralmunicipalities69

Boxes

Box1.1.Povertyratesacrossprovinces4

Box1.2.Backgroundonnighttimelightsdata5

Box2.1.Doesthefederalcivilservicebillreinforcefiscalfederalism?19

Box2.2.ExpenditureassignmentimplicationsoftheWaterSupplyandSanitationAct(2022)

anddraftRegulations(asofMarch2024)21

Box2.3.GuidancecriteriatoincorporateperformanceelementsinIGFTsinNepal23

NepalFiscalFederalismUpdate,May2024|v

vi

Acronyms

CAO

ChiefAdministrativeOfficer

CG

ConditionalGrant

FCGO

FinancialComptrollerGeneralOffice

FEG

FiscalEqualizationGrant

FFCD

FiscalFederalismCoordinationDivision

FY

FiscalYear

GDP

GrossDomesticProduct

IGFAAct

IntergovernmentalFiscalArrangementAct

IGFT

Inter-GovernmentalFiscalTransfer

LISA

LocalGovernmentInstitutionalCapacitySelf-Assessment

MAPS

MethodologyforAssessingProcurementSystems

MoF

MinistryofFinance

MoFAGA

MinistryofFederalAffairsandGeneralAdministration

MoFE

MinistryofForestsandEnvironment

MTEF

Medium-TermExpenditureFramework

NARMIN

NationalAssociationofRuralMunicipalitiesinNepal

NASC

NepalAdministrativeStaffCollege

NFFU

NepalFiscalFederalismUpdate

NNRFC

NationalNaturalResourcesandFiscalCommission

NPC

NationalPlanningCommission

NPRNepaliRupee

NRBNepalRastraBank

OAGOfficeoftheAuditorGeneral

OPMCMOfficeofthePrimeMinisterandCouncilofMinisters

PAC

PublicAccountsCommittee

PCGG

ProvincialCenterforGoodGovernance

PDMO

PublicDebtManagementOffice

PFM

PublicFinancialManagement

PLG

ProvincialandLocalGovernment

PMoFEA

ProvincialMinistriesofFinanceandEconomicAffairs

PPC

ProvincialPlanningCommission

PPMO

PublicProcurementManagementOffice

PSC

PublicServiceCommission

PTCO

ProvincialTreasuryControllerOffice

SuTRA

Sub-NationalTreasuryRegulatoryApplication

TDF

TownDevelopmentFund

VFGVerticalFiscalGap

Acknowledgements

ThissecondeditionoftheNepalFiscalFederalismUpdatewasproducedbytheWorldBankMacroeconomics,PublicSector,Trade,andInvestmentteamforNepalandwasledbyYoshihiroSaito(PublicSectorSpecialist,ESAC1),NayanKrishnaJoshi(CountryEconomist,ESAC1),andMarcelaRozo(SeniorPublicSectorSpecialist,ESAC1),andconsistingofSyedWaseemAbbasKazmi(SeniorFinancialManagementSpecialist,ESAG1),AbdoulGaniouMijiyawa(SeniorEconomist,ESAC1),OjesweePande(ExtendedTermConsultant,ESAC1),DurgeshKumarPradhan(Consultant,ESAC1),PrabinDongol(Consultant,ESAC1),andShreeramGhimire(TeamAssociate,SACNP).InputswerereceivedfromArvindNair(SeniorEconomist,ESAC1),BishwaRajBasaula(FinancialManagementSpecialist,ESAG1),LokendraPhadera(Economist,ESAPV),HaiderRaza(SeniorProcurementSpecialist,ESARU),SoyeshLakhey(Consultant,ESAC1)andRameshoreKhanal(Consultant).

TheteamwishestothankpeerreviewersZubairKhurshidBhatti(LeadPublicSectorSpecialist,EAEG2),RamaKrishnanVenkateswaran(LeadPublicSectorSpecialist,EEAG1),AnwarShah(FiscalFederalismExpert),andKrishnaPathak(TeamLeaderforADBNepal,PublicSectorManagementteam)forprovidingqualityassurance.Theteamalsowantstoexpressitsappreciationtotheparticipantsinthevariousconsultationmeetingsfortheirinputsandfeedbackonthedocument.

ThereportwasproducedundertheguidanceofMathewVerghis(RegionalDirector,EquitableGrowth,FinanceandInstitutions[EFI],SouthAsiaRegion),FarisHadad-Zervos(CountryDirectorforMaldives,Nepal,andSriLanka),LadaStrelkova(Manager,OperationsforMaldives,Nepal,andSriLanka),andShabihAliMohib(PracticeManager,ESAC1).AkashShrestha(ExternalAffairsOfficer,ECRSA)andAvinashiPaudel(ExternalAffairsAssociate,ECRSA)managedmediarelationsandoutreach.

NepalFiscalFederalismUpdate,May2024|vii

viii

ExecutiveSummary

TheWorldBank’sNepalFiscalFederalismUpdate(NFFU)aimstoreportannuallyontheprogressoffiscalfederalisminNepalandidentifyimplementationgaps.Thissecondupdatereviewstheprogressonfiscalfederalismsincethepublicationofthefirstreportandprovidesanupdateoneconomicconditionsacrossprovincesandlocalgovernments.Consideringtheirimportantroleinfiscalfederalismandtherecentgrowthofpublicdebateontheroleofprovincialgovernments,thiseditionplacesspecialemphasisontheprovinciallevelofgovernment.

Growthhasbeenslowanddeficitshavemanifestedacrossprovincesandmostlocalgovernments.

Infiscalyear(FY)23,Nepal’sprovincessawtheirslowestgrowthsinceFY20,rangingfrom1.4percentinBagmatito3.3percentinGandaki,drivenbyadeclineinwholesaleandretailtradeandmanufacturing.ImportrestrictionsimplementedbythefederalgovernmentinthefirsthalfofFY23tomanageexternalpressuresresultedinasignificantdeclineinthewholesaleandtradesub-sectoracrossallprovinces,whilemanufacturingandconstructionsub-sectorsalsocontracted,inpartduetotheelevatedpricesofmanufacturedgoodsandconstructionmaterials.Bagmati,whichhasthelargestservicessector,contributedtotheslowdowninnationalgrowth.

Theslowdowningrowthalongwithimportrestrictionsledtoadeclineinfederalrevenuefrom23.1percentofgrossdomesticproduct(GDP)inFY22to19.2percentofGDPinFY23.This,inturn,causedadecreaseof1.3percentagepointsofGDPinfiscaltransfers(includingrevenuesharing)tosub-nationalgovernments.Consequently,inFY23,provincialrevenueandgrantsplungedby0.9percentagepointsofGDPtoarecordlowof3.5percent,andlocalgovernmentrevenueandgrantsfellby1percentagepointto8percentofGDP.Whileallprovincesandmunicipalitytypesexperiencedthisdecline,Sudurpashchimandurbanmunicipalitiessawthelargestdecrease.

Withspendingremainingrelativelyunchangedat

around12percentofGDP,lowerrevenueandgrants

inFY23ledtoadeficitforbothprovincialandlocal

governments,thefirsttimesinceFY19.Provincial

deficitsreached0.3percentofGDPinFY23,while

localgovernmentdeficitsstoodat0.4percentofGDP.

Thesedeficitswerefinancedusingtheopeningcash

andbankbalances,reflectingunspentunconditional

fiscalequalizationgrants(FEGs)andrevenuesharing

frompreviousfiscalyears.Theseverityofthedeficit

variessignificantlyacrossprovincesandmunicipality

types,withSudurpashchimandurbanmunicipalities

experiencingthelargestdeficits.

ProvincialandlocalgovernmentsinNepal

underspenttheirbudgetsinFY23.Provincial

governmentsunderspentatarateof34percent,while

localgovernmentsunderspentatarateof24.4percent.

Programexpenses(recurrentexpenditure),public

construction(capitalexpenditure)andcontingencies

(recurrentandcapitalcomponents)werethecommon

driversofunderspendingforsub-nationalgovernments.

Underspendingattheprovinciallevelcontinuesto

beexplainedbyalackofalignmentbetweenperiodic

developmentplans,themedium-termexpenditure

framework(MTEF),andthebudget,aswellasthe

allocationofasignificantportionofthebudgettothe

categoryof‘EconomicMiscellaneous.’

Progressontheregulatoryframework

forfiscalfederalismandinstitutional

developmenthasbeenslow,and

urgentactionisneededonreinforcing

expenditureandrevenueassignments,

aswellasupgradingtheInter-

GovernmentalFiscalTransfersSystem.

Nepal’slegalandinstitutionalreformunderfiscal

federalismhasbeenprogressingmoderately.Atthe

institutionalandstrategiclevels,theFiscalFederalism

CoordinationDivision(FFCD)attheMinistryofFinance

(MoF)hasthemandatetocoordinatetheimplementationoffiscalfederalism,includingforthedevelopmentoffiscalfederalismstrategies.Inaddition,sinceNovember2023,FFCDhasbeendesignatedastheunitresponsibleforcoordinatingpublicfinancialmanagement(PFM)strategies.Proactivereviewsonregulatoryframeworks,suchastheLocalGovernmentOperationsAct(2017)andInter-GovernmentalFiscalArrangementAct(2017),togetherwiththereviewoftheUnbundlingReport1ledbytheOfficeofthePrimeMinisterandCouncilofMinisters(OPMCM),areunderwaytofurtherclarifythedivisionofresponsibilitiesamongthethreetiersofgovernment.

TheenablingenvironmentforfiscalfederalismandPFMattheprovinciallevelisslowlyadvancing.

Followingfederal-levelinstitutionaldevelopments,provincial-levelinstitutionsresponsibleforfiscalfederalismandPFMareintheprocessofdevelopingtheircorebuildingblocks.ByDecember2023,allsevenprovinceshadenactedtheirProvincialCivilServiceActs(PSCA),pavingthewayfortherecruitmentofsub-nationalcivilservants.Thedependenceofprovincialgovernmentsonconditionalgrants(CG)asashareoftheirtotalrevenuedecreasedfrom19.6percentinFY22to17.3percentinFY23,whichindicatesamarginalincreaseinthefiscalautonomyofprovincialgovernments.Enhancingthecapacityforrevenueadministrationattheprovincialleveloughttobeencouragedtofurtherempowerprovincialfiscalautonomy.

Moreprogressneedstobemadeonrevenueandexpenditureassignmentsacrossthethreelevelsofgovernment.Forinstance,someofthesectorallegalandregulatoryframeworks,suchastheWaterSupplyandSanitationRegulationsandtheEducationBill(currentlyunderreviewbyParliament),shouldprovidefurtherclarityonexpenditureassignmentinthesectors,determiningwhichtierofgovernmen