Post NFC-award, fiscal management
and socio-economic development

Not surprisingly, less financial resources provided an opportunity to the provincial govts of not committing themselves fully to improve the social sector and develop infrastructure of their respective provinces with the result that critical issues related to social sector development, poverty alleviation and growth of provincial economies were not addressed satisfactorilyx

By M. Sharif

The win-win resolution of the NFC (Non Finance Commission) award with maximum participation for consensus building by the four provinces and federal government on 11 December, 09 was to the satisfaction of smaller federating units about vertical and horizontal distribution. An increase of 8.5 per cent in the share of provinces from the federal divisible pool (FDP) during the first year of the award and a further increase of 1.5 per cent in the remaining four years of the award is a positive achievement for all stakeholders. The award seems to gain success as the federal government has met its obligations towards provinces and socio-economic development for the provinces has been ensured by the provincial governments. This should be possible for them with more funds coming from FDP and VAT on services that they are empowered to collect from next financial year. This is a challenging task and people are eagerly waiting for a quantum change in their lives. How far this can be facilitated by the award needs to be seen.

The award has a long history of denying a justified distribution of financial resources under the cover of two- point formula that doled more resources to the federal government. These currently stand at 56.0 per cent of FDP for the federal government and 44.0 per cent for the four federating units. The formula makes horizontal distribution on a single criterion of a province’s population. This flawed formula kept only the federal and the Punjab government satisfied while the other three smaller provinces kept grudging. Not surprisingly, less financial resources provided an opportunity to the provincial governments of not committing themselves fully to improve the social sector and develop infrastructure of their respective provinces with the result that critical issues related to social sector development, poverty alleviation and growth of provincial economies were not addressed satisfactorily.

The NFC award effective from next financial year has made a radical shift from above stated two-point formula to making vertical distribution provinces-friendly and adopting multiple criteria for horizontal distribution of financial resources from FDP among the provinces. The federal government has reduced its share from 56.0 per cent at present to 44.0 per cent for FY 2010-2011 and a further reduction to 42.5 per cent from FY 2011-15. The share of provinces is to increase correspondingly from 44.0 per cent at present to 56.0 per cent for FY 2010-2011 and a further increase to 57.5 per cent from FY 2011-2015.

The award is to increase cash inflows to provinces substantially. According to the federal finance minister, the provinces will have Rs174 billion more than they get presently and this amount is to increase further to Rs217 billion on account of net hydel profit, gas development surcharge and sales tax on services. NFC has also resolved non-NFC issues particularly NWFP’s hydel profits and Balochistan’s gas development surcharge. The two provinces will receive Rs100 billion each on account of resolution of these issues. The federal government has responded to fiscal needs of the provinces by boosting their share and reducing its own share that will affect its fiscal management. It has also conceded collection of VAT on services by the provincial governments according to the Constitution from next financial year. These two measures are a step towards federal fiscal system, however, there is still much to be done in this direction.

The federal government is conscious of fiscal constraints that it is likely to encounter because of decrease in its share from the FDP. The federal finance minister is reported to have said, “The government will need an additional Rs217 billion to fulfill the undertaking. The foremost task is to increase tax-to-GDP ratio from 8.9 to 13.9 per cent within six years and between 15.0 and 20.0 per cent in the long run. This is a major challenge and will have to be achieved.” How the government is going to enhance the tax to GDP ratio is still not clear. The government is depending on imposition of VAT from next financial year because of the IMF and WB. Implementation of NFC award by the federal government without compromising on PSDP (Public Sector Development Programme) is one of the sensitive areas of fiscal management that needs to be viewed carefully because the federal government has a history of reducing PSDP to overcome its fiscal constraints.

Vertical distribution relies on multiple criteria based on population, backwardness/poverty, inverse population density and generation/collection of revenue. It could generate sufficient heat for safeguarding interests of individual provinces. Secondly, even if the provinces agreed to a multiple criteria, weightage to be accorded to each criterion could create problems to arrive at a consensus. Despite such apprehensions, the federating units ultimately succeeded in coming to an agreement on a multiple criteria and give weightage to each criterion to the satisfaction of three smaller provinces, as well as the largest province. In fact, the latter made tangible sacrifice in its existing share to accommodate the most affected province, Balochistan.  

New formula of horizontal distribution has reduced the existing shares of Punjab, Sindh and NWFP provinces from 53.1 to 51.74 per cent, 24.94 to 24.55 per cent and 14.88 to 14.62 per cent respectively. Reduction in the shares of three provinces has helped to increase the share of Balochistan from 7.17 to 9.09 per cent. In addition to this, the federal and provincial governments of Punjab and Sindh have shown a spirit of fairness while addressing the problems faced by two smaller provinces, NWFP and Balochistan. NWFP being the front line province in the war against militants is to bear the main brunt. The award makes a special financial assistance of one per cent of undivided FDP to the province. It would amount to 1.83 per cent of provincial pool meant for horizontal distribution. Likewise, Balochistan has been promised a minimum of Rs83.0 billion in case its share from the FDP fell short of this minimum amount during any one of the five years of the award. It should help the province to overcome critical issues related to fiscal management.

The issue of allocating weightage to four indicators for horizontal distribution was also resolved after making detailed analysis. The allocation is as follows: population 82.0 per cent against 100.0 per cent in existing award; poverty/backwardness 10.3 per cent; revenue collection/generation 5.0 per cent and inverse population density 2.7 per cent. Giving the award on multiple criteria is the first attempt after a long denial and there could be reservations about allocating right weightage to each indicator.

The optimistic point in this respect is that a beginning has been made and with the passage of time, refinement could be made in the larger public interest. One example would be sufficient to highlight subtleness of the weightage. Backwardness/poverty carries a weightage of 10.3 per cent. Share of provinces of Punjab, Sindh, NWFP and Balochistan under this criterion stands at 23.16, 23.41, 27.82 and 25.61 per cent respectively. NWFP emerges as the most backward unit contrary to the general understanding that Balochistan is the most backward federating unit of the country. NFC arrived at this conclusion after taking the average of three reports, that is, PRSP report 1999-2000, HDI reports of 2003-04 and 2007-08.

With the resolution of NFC award, the issues related to decentralising the existing fiscal system, bridging inter-provinces and intra-provinces development gap do not come to an end. This is the first step towards resolving these tricky issues that would materialise from the beginning of next fiscal year. A lot of practical difficulties would be faced by the federal and provincial governments. The federal government is to ensure that it has sufficient fiscal space to fulfill its commitments under the award, without reducing PSDP or shifting its burden partially to the provinces. The federal finance minister was upbeat in highlighting the need to generate additional resources of Rs217 billion and increasing tax-to-GDP ratio.

The provinces are likely to face three problems. They may have to build the capacity to levy VAT on services and make sure they do not act the same way as they did with levying agriculture tax. Also, with more funds at their disposal they have to ensure that the money is spent judiciously through good governance. The people of each province must witness a change in the development of social sector and poverty alleviation. The issues of poverty alleviation and inter-province economic disparity and development can be best addressed at the grass roots level through good governance by the provinces.

The 7th award decided through mutual accommodation and consensus should be a key factor in resolving socio-economic problems faced by the common people in each province. The experience that the provincial governments will gain in this respect should give them a deeper insight about future challenges. This could be the key factor to improve fiscal management at the provincial and federal levels of governance by further improving the award according to the needs of the people and provinces.