Nepal has pursued the course of federalism with three tiers of government, resulting in horizontal and vertical expansion of 5,758 spending units across the country. With the distribution of power of the purse, the incidences of fiduciary risks have also increased, which are manifested in the growing size of arrears recorded by the Office of Audit General each year and the number of corruption cases filed by the Commission for the Investigation of Abuse of Authority. The country is facing shortages of resources for public investment to generate growth and employment. Widening fiscal space and erecting the architect of sound fiscal governance by controlling the fiduciary risks is necessary for our prosperity.

The fundamental limitation of public finance is that the money does not belong to those who spend it. It is about spending others people’s money. The public agents—the bureaucrats and the politicians, spend scarce public resources on behalf of their principals—the people. Without proper sanctioning and a robust accountability system, there are possibilities for misuse and mismanagement of public funds. Since the principals are invisible directly, the self-interested public agents may not work in the best interests of the people. Instead, they may be involved in extracting rents from these resources.

Fiduciary risk is about the possibility of misuse, mismanagement, inefficiency, and ineffectiveness of public funds to deliver results due to insufficient capacity, weak or non-compliance with due process of law, and corruption in public sectors. Inefficiency occurs in public finance when spending agents use more resources than necessary due to a lack of ability or skills. Ineffectiveness occurs when spending agents cannot produce the intended results. When the public funds are not used for an intended purpose, are not properly accounted for, and do not achieve value for money, the incidence of fiduciary risks occurs. Corruption risks, result risks and process risks are the main components of fiduciary risks.

Corruption, the misuse of public funds for private gains, is the main source of fiduciary risks. We can notice the corruption in revenue collection, public expenditures, public service delivery, and in the structure of public policies. The biggest threat is policy corruption, which occurs when the policymakers draft public policies that bring sub-optimal benefits to the people, if not harm them, and benefit certain individuals and/or interest groups. Some examples of policy corruption are frequent changes of laws in favour of interest groups, a continuation of bad provisions of laws, and enacting unnecessary laws for the benefit of certain groups. However, we lack a proper legal system to combat corruption in policy-making.

The failure of the public purse to bring about beneficial changes to societies is related to result risks. According to the Economic Survey of Nepal, for the fiscal year 2020-2021, the share of capital expenditure in the annual budget is 23.9 percent for the federal government, 53 percent for provinces, and 45.8 percent for local governments. The consumption of public funds in current expenditure limits the resources for productive sectors. Inefficiency and capacity constraints may also invite result risks. The Office of Auditor General has been raising concerns over low- and poor-quality public spending. The International Monetary Fund has pointed out that the average inefficiency in public investment processes is about 30 percent around the world. Rationalisation of expenditure, use of technology, capacity building of public officials, sound procurement and project management system and a culture of accountability politics can contribute to reducing such inefficiencies.

One of the main risks associated with public management is that there are many instances where public officials circumvent the due process of law. Compliance with due process of law is essential not only for ensuring conformity with legal provisions but also for institutionalising justice and fairness. Due process of law is also equally important for maintaining the quality of public expenditures. Weak public financial capacity, lack of training, shortages of trained manpower, and politicisation of civil servants are some of the causes of process risks. Process risks in public finance could be reduced by improving the public financial management system in planning, budgeting, revenue management, and programme management.

One of the key causes of fiduciary risks is the intense level of the common pool problem, where powerful politicians divert substantial amounts of the budget to their own constituencies to please their voters. As a result, the average benefit received by their voters far exceeds the average benefit received by ordinary citizens of the country. The burden is borne by the whole country, but the benefits get accrued to only certain groups of people. For instance, hundreds of thousands of people have suffered from low levels of development in upper Karnali due to lack of road infrastructure, whereas there are many projects in some parts of Nepal. Anyone travelling from the powerful constituencies to weaker ones can easily notice the prevalence of the common pool problem in the country.

Controlling fiduciary risks involves a range of reforms in the system of public financial management. There is an opposite relationship between perceived risks and fiduciary risks—the more the level of perceived risks, the lower the level of fiduciary risks. Strengthening the capacity of the Office of Auditor General, widening the scope of the Commission of Investigation of Abuse of Authority with the power to investigate policy corruption, empowering the parliamentary committees such as public account committees, partnership with free and fair media, and promoting civic education are some of the measures that can increase the level of perceived risks among the public officials. Enforcement of social accountability measures such as public audits, social audits, and public hearings are also instrumental in increasing the perceived risks among public officials.

The Ministry of Federal Affairs and General Administration assesses the level of fiduciary risks of the local government. The Office of Auditor General often carries out risk-based auditing. The Financial Comptroller General has devised some systems like Sub-national Treasury Regulatory Application (SuTRA), Line Ministry Budget Information System (LMBIS), Provincial and Line Ministries Budget Information System (PLMBIS), Public Expenditures Tracking System and the Medium-term Expenditure Framework. Despite all these systems, fiduciary risk has been the main obstacle in our public finance. Strengthening the public financial capacity of all levels of government and controlling the leviathan behaviours—increasing the burden on the public purse by expanding the unnecessary, politically motivated organisations—are the starting points to reduce fiduciary risks. Controlling fiduciary risks is imperative for Nepal not only for meeting development expenditures but also for the legitimacy of the federal system.