ISLAMABAD: The Internat­ional Monetary Fund (IMF) has asked Pakistan to consider drastic changes to the next National Finance Commission (NFC) award due to the serious pressure it is placing on the federal government finances, as well as the macroeconomic imbalances that are arising from its implementation.

In 2009, the PPP government passed the 7th NFC award that devolved the highest ever proportion of the funds in the federal divisible pool to the provinces. Ever since, the centre has struggled to keep the fiscal deficit within established bounds.

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In a comprehensive set of proposals, the IMF has now advised the government to set up a technocratic fiscal council under the aegis of the Council of Common Interests (CCI), creation of a contingency fund under a joint supervision of the federal and provincial governments and a permanent national tax commission for widening the tax net in areas of joint jurisdictions with checks and balances.

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The advice is part of the final report of the IMF under Article-IV review of Pakistan’s economy, expected to be approved by the IMF executive board next week, and exclusively shown to Dawn. The IMF has been critical of the 7th NFC in the past as well, but this is the first time it has advanced formal proposals for a change of course.

The report, which will be released shortly after the board’s approval, describes the 7th NFC award for being “unbalanced and less flexible”, and constrained the government’s ability to address macroeconomic imbalances and vulnerabilities, leaving important revenue sources underexploited, and stripping the government off any room to tackle possible economic shocks in the near-term.

“In more turbulent times, these vulnerabilities could undermine macroeconomic stability”, the IMF warns. It advises changing design aspects of the fiscal framework in the next NFC award.

“The next NFC award should aim to strengthen macroeconomic stability and increase efficiency, flexibility, and responsiveness of the fiscal framework,” the report says, noting that although “constitutional parameters” limit the options for change, “improvements can be considered within the current legal framework.”

These improvements, the report continues, must “better account for the anticipated consequences of the next award on public debt, the effectiveness of fiscal policy, nation-wide efficiency of public expenditure across all levels of government in light of the uneven quality of public finance management frameworks as well as strategies to cope with unanticipated shocks.”

It proposes the creation of a technocratic fiscal council under the CCI to develop and agree on broad fiscal rules for all levels of governments, with explicit links to a realistic macroeconomic framework, as well as transparent enforcement procedures.

Alongside this, the report asserts that a uniform framework for transparency, reporting, and accounting of quasi-fiscal liabilities including public enterprises, public-private partnerships, liabilities from wheat purchases, and special purpose vehicles at all levels of government, would be critical to fiscal discipline.

On top of this, the IMF report proposes a contingency fund to be financed jointly by the centre and provinces to absorb large and unexpected shocks to expenditure of national importance, subject to its use through mutual consent of both federal and provincial authorities or sanctioned by the CCI.

Highlighting the fact that 7th NFC award is continuing for the 9th year instead of five as it was supposed to, did not provide incentives to the centre or the provinces to expand the tax net, the report says. Therefore, a stronger incentive-based national framework for tax revenue mobilisation is needed to avoid over-taxation of compliant taxpayers and facilitate a coordinated expansion of the fiscal space for much-needed development and social spending.

This should be done, the report advises, through a national consensus with specific revenue targets to be set by the CCI and mechanisms to overcome coordination and political economy issues in sensitive areas like agriculture and real estate.

In this regard, it says a national tax commission should be established under the CCI for improved coordination, both vertically in common initiatives to widen the tax net in areas of joint tax jurisdiction and horizontally in harmonizing regulations or implementation of GST on services to balance the need for increased fiscal revenue and business promotion.

The next NFC award should minimize federal borrowing needs, the report emphasises, by reducing the vertical imbalance (eg through assumption of additional expenditure responsibilities by the provinces) or consider a burden-sharing arrangement for the impact of its design on public debt, especially given the fiscal surpluses at the provincial level. Similarly, it calls for participation of the provinces in reforming the power distribution sector as well as sharing the burden of liabilities arising from delays.

The reports calls for further devolution of expenditure and revenue to local governments over the medium term for achieving substantial improvement in the provision of basic services in view of large size of most of the provinces.

This should be done through a clear time-bound framework for improving administrative capacity and public finance systems in local administrations, and transferring basic service delivery functions and the needed resources from provincial to local governments for delivering on the socio-economic promise of decentralisation.

Saying that existing framework was not sufficiently flexible and could have serious implications for overall socio-economic outcomes in the long term, the IMF said the changes it proposed were possible within the existing legal framework although initial feedback from provinces indicated a potentially challenging road ahead.

“Achieving a broad consensus on the specific improvements and modalities of strengthening the fiscal framework will require extensive dialogue to balance the provinces’ concerns about preserving their autonomy on one hand, and the need for more coordination and flexibility to improve overall economic outcomes”, the report concludes.

Published in Dawn, January 31st, 2018