The royalty sharing framework provided in Schedule 4 of the Intergovernmental Fiscal Arrangement Act 2017 shows how the fees charged on the generation of hydroelectricity is divided among the three levels of government. The framework indiscriminately allows the rule of 50/25/25 for sharing royalties collected by the Department of Electricity Development from all forms of electricity production—half goes into the federal consolidated fund, and the rest is divided equally between the provincial and local governments.

But assigning a common sharing formula for natural resource operations—ranging from the exploitation of river resources for hydroelectricity generation to the exploration of extractive resources like mines and minerals—is inappropriate because the factors and priorities governing such resource operations vary significantly. To begin with, renewable natural resources are perpetual in supply in contrast to extractive natural resources that are exhaustive in nature.

Local communities

Also, the exploitation of river water for hydroelectricity generation often specifically poses intense externality implications for local communities affected by the exploitation work, along with widespread implications in the province where a particular project is sanctioned. Hence, a major portion of the royalties emanating from hydroelectricity projects is expected to be utilised in compensating the affected local entities and other provinces. Hydro projects are often viewed by local communities as an avenue for local development. As such, numerous non-monetary benefits, such as local infrastructure development, is expected by them as compensation for allowing the exploitation of local river networks.

This is undoubtedly a hefty challenge for the compensating parties despite mediation by local jurisdictions. The justification for demanding such compensation arises from the fact that hydroelectricity projects are likely to substantially disturb the systemic socio-cultural and economic integration of local communities, often demanding lifestyle changes if not painful resettlement. So, instead of assigning a common formula for sharing royalties emanating from hydroelectricity generation, an astute derivation-based sharing mechanism that addresses the specific concerns of the affected communities and jurisdictions is required.

A major portion (more than 50 percent) of the royalties should be shared among the sub-national entities to justify the pledged sharing regime and address local and inter-regional externalities, if they are to be resolved by the sub-national governments themselves. In a derivation-based sharing regime, the royalty is shared among the affected jurisdictions, as opposed to an indicator-based sharing regime where the royalty is shared across the country to create inter-regional fiscal equality.

A derivation-based sharing regime recognises the need for the concerned sub-national authorities to at least administer the royalties (that is raise and share royalties) concerning hydroelectricity projects. Provincial governments can be recognised as the most suitable level of government to undertake the responsibility of administering the royalty obtained from hydroelectricity projects. The administration of royalties obtained from projects at least above the capacity authorised for local governments by the upcoming electricity bill (more than 3 megawatts) can be devolved to provincial governments.

A derivation-based sharing regime is often observed by pieces of literature to be discriminative against other jurisdictions with no concern or provision in the royalty sharing scheme. The sharing regime is popularly labelled as being unrepresentative of inter-regional fiscal equality demanded by most federal constitutions including the Constitution of Nepal. While river networks or potential hydroelectricity projects and royalties exist in most political regions of the country, Province 2 in the southern plains lacks hydroelectric potentialities or mineral resources. In this situation, the chances of fiscally discriminating against Province 2 through the adoption of a derivation-based sharing regime, for royalties obtained from hydroelectricity or other natural resource operations, are likely.

Moreover, communities representing Province 2 already bear resentment against the state for observed ethnic marginalisation, and a royalty sharing provision that excludes them from the right to receive benefits from river resources could intensify this feeling. Hence, a separate 'royalty equalisation fund' under the custody of the federal government can be set up where the other six provincial governments may chip in a specific proportion of their royalties to be shared with the government of Province 2. This way, the royalty received by Province 2 at least comes close to the average royalty obtained by the other provinces from the hydroelectricity sector.

Fiscal equality

Such a provision shall allow the royalty sharing mechanism to incorporate the idea of inter-regional fiscal equality while addressing the larger context of compensating the affected jurisdictions and communities. Lastly, the remaining royalty, after provisioning for the concerned sub-national jurisdictions and the equalisation fund, should be shared with the federal entity, mainly as compensation for its role in the mediation of inter-provincial conflicts that may arise from the exploitation of an inter-jurisdictional river basin.

The geological characteristics of Nepal are awash with running water resources preceded by the immense potentiality for hydroelectricity generation. But lack of a sufficient or astute legal framework has prevented the optimum realisation of this potential. In this context, Nepal has adopted federalism and the ensuing fiscal federalism to benefit from the precious natural resources within the country. However, an all-encompassing resource revenue or royalty sharing framework with a significant emphasis on devolution is undoubtedly necessary to yield favourable gains from such resources. The federal fiscal commission needs to acknowledge this idea when it sits down to review and improve the current royalty sharing framework every half a decade.