Nepal’s move from unitary to federal government system has enabled local bodies and provinces to design policies, make decisions, introduce budget and deliver public goods and services on their own. This has laid the groundwork for bottom-up development. But many local bodies do not have the capacity to generate financial resources on their own to pursue development works. The revenue generated by local bodies in the past accounted for less than 2 percent of the central government’s tax income. This is unlikely to change drastically in the federal setup because local bodies have not been assigned vibrant revenue sources. This will be the same for provinces. This is expected to exert pressure on the central government, as many local bodies and provinces will completely rely on central government’s grants to meet expenditure needs. Rupak D Sharma of The Kathmandu Post caught up with Annette Dixon, the World Bank vice president for South Asia, to discuss the problem facing the government in institutionalising fiscal federalism and ways to overcome the barriers. Excerpts: 

Fiscal federalism has finally come into operation in Nepal. What do you think of the progress that has been made so far?

The constitutional reform process, which has led to creation of a new federal structure, provides a huge opportunity for Nepal to focus on effective and efficient delivery of public goods and services, promote inclusive economic development and respond to needs of different communities. Currently, people’s expectations are very high. And it will be important but difficult to manage these expectations, because everything will not happen overnight. International experience shows countries going through successive iteration to get things right. So, it will take a number of years for Nepal to develop capacity of different levels of government and align resources with responsibilities. The law that has been put in place envisages the Fiscal Commission looking at both expenditure and revenue sides. That is a positive aspect because it provides an opportunity to look at total resources that each level of government needs in line with its functions. The World Bank is committed to supporting the decentralisation process and providing technical support to make sure expenditure and revenue collection plans are aligned. We will also help develop capacity of different levels of government and help the country to address other policy issues. 

Many local bodies and provinces here do not have the capacity to generate their own revenue. This means they will completely rely on the central government for resources. What international practices can Nepal emulate to strengthen revenue generating capacity of lower tiers of government?

It’s a virtuous circle. If governments provide quality services people will be willing to pay taxes. Tax mobilisation rate in South Asia is low. As a consequence, they are failing to meet expectations of citizens. So, it’s very important to improve service delivery and meet expectations and needs of societies. 

But how can resources be generated to meet these expectations?

It’s a tax policy and tax administration challenge. The policy should figure out right type and right level of taxes. On the other hand, tax systems should be kept very simple and avoid too many exemptions because that gives a sense of unfairness. So the virtuous circle is very important.

Can Nepal, at this stage, produce the virtuous circle to deliver quality public goods and services?

I think the challenge facing Nepal is less on the tax mobilisation side—although that is also an issue—and more on ensuring that different levels of government absorb the budget and deliver services. Nepal’s central government has traditionally struggled to spend all the resources made available through the budget. So, I would encourage people to initially focus on strengthening the capacity, especially that of civil service. This will be important to ensure delivery of quality service. 

Over time, the government can focus on the revenue mobilisation side as well. 

Until the capacity of the lower tiers of the government is strengthened, the central government will have to fund them. But the central government has limited resources.

Don’t you think this will create a hurdle in institutionalising fiscal federalism?

Until the capacity of lower levels of government improves, the central government will have to allocate funds for provinces and local bodies. So, it is important to keep the budget allocation model simple for the time being. A sophisticated budget allocation model should be created once more data points are available. Over time, challenges related to revenue collection also need to be addressed. This is not something that will start from Day 1.

The central government is currently worried about not having enough resources to meet expenditure needs of lower tiers of government. In this regard, the government has sought budgetary support from the World Bank to avoid glitches in operation of fiscal federalism. Did you have a discussion in this regard with the government? 

We have been providing budgetary support to the government for quite some time. We call that development policy credit, which is used by the government to develop policies in certain areas. One area that is using this support is the financial sector. Using that support, policies are being developed to enable financial institutions to support private sector-led growth. The second area where we are going to support is the fiscal policy, under which assistance will be provided to smoothen decentralisation process. 

You just mentioned about World Bank’s interest to extend credit line to support decentralisation. This is a new credit line, isn’t it?

This is a new development policy area of support. This is important because constitutional reform is part of the political reform process, which includes setting up of different levels of government and ensuring each level of government is responsive to needs of different communities in different constituencies. The fiscal decentralisation process, on the other hand, ensures that different levels of government have the resources to deliver services. So, one process goes with the other. It’s a case where fiscal reform process will be important to achieve changes envisaged by the political reform process.

What will be the size of this credit line?

We’re still finalising the amount. But it will be $200 million for this fiscal year. 

What are the conditions placed by the World Bank to tap this fund?

There will be two main areas. One is related to rules and policies on fiscal transfer from the central government to provincial and local governments. The second is about improving the efficiency and transparency of public financial management system of all three tiers of the government. These will be the key policy areas which are going to be critical for the implementation of fiscal federalism.

So the focus would be on enhancing fund absorptive capacity of all tiers of 

government, so that resources allocated through the budget do not remain unutilised or underutilised?

In the short term it’s going to be important that the new tiers of government absorb the budget. As the capacity develops, more resources can be transferred from the centre or they can generate their own revenue as well. But there is something else that is really powerful in federalised countries. That is the opportunity which comes from development taking place at different paces in local or provincial governments. This is called the competitive federalism model, under which provinces or local bodies that achieve results faster get more budget. In other words, finances are made available by the central government on the basis of results and not just parameters such as population. This encourages governments to deliver results rather than just absorb money.

Won’t that widen inequality because weaker local bodies or provinces will continue to be left behind?

This may not necessarily widen inequality if you have the capacity and are accountable to people. The central theme of decentralisation is to achieve more equal outcomes. That’s what people want from this process. That is why provincial and local governments should be responsive to needs of local communities. This is the real prize that comes from the decentralisation process. So, local and provincial governments need to be competitive in delivery of quality service.

Before wrapping up this interview, would you like to provide some highlights of the World Bank’s new four-year country partnership strategy for Nepal?

We’ve started working on the new country partnership framework. We will finalise our consultations once the new government is established. One of the areas which the framework will focus on is ensuring a better environment for private sector development, including infrastructure. This will help in connecting the country and bringing in more investment. The new country partnership framework will also focus on human development, which includes support in early childhood development, education sector and vocational skills development. Another big area of support in the coming four years would be decentralisation. We also want to make sure public services are well governed and that there are transparent and well-performing institutions. 

How much is the World Bank providing to roll out the new four-year country partnership strategy?

We provide funds in three-year cycles. In the current three-year period [which began last July], we expect to contribute about $1.4 billion, which is 50 percent more than in the previous three-year period. We can bring in more funds if there is need.