NFC: Restoring the fiscal balance

Updated May 18, 2020

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The latest notification requires the NFC to allocate resources for meeting growing expenditures on national security. — AFP/File
The latest notification requires the NFC to allocate resources for meeting growing expenditures on national security. — AFP/File

THE centre has set the ball rolling to restore the federal-provincial fiscal balance after years of its unease over the 7th National Finance Commission (NFC) Award that shifted a major chunk of the common revenue stream to the federating units in 2010.

In a notification issued last week, President Arif Alvi constituted the 10th NFC to formulate a new award for the sharing of federal divisible resources among the centre and the provinces. Under Article 160 of the Constitution, the NFC has a four-pronged mandate on the distribution of about seven major taxes and duties, allocation of grants in aid by the centre to the provinces, borrowing powers of the federal and provincial governments and any other matter referred by the president.

The fourth item — any financial matter referred to the commission by the president — has expanded this time quite significantly. And that is where the federation wants to retrieve a lot from the provinces that secured more than 60 per cent resources, including 57.7pc of the divisible-pool taxes and some other transfers, under the 7th NFC Award.

Roughly, the centre wants to regain at least 1pc of GDP (about Rs450 billion based on the current year’s budget estimates) from the provinces that it surrendered voluntarily in 2009 along with a reduction in collection charges from 5pc to 1pc. As a result, the centre’s total share out of the divisible-pool taxes should go up to about 50pc from 42.5pc fixed under the 7th NFC Award finalised in 2009 under the PPP government. The PPP, now ruling Sindh, appears to be the only stumbling block that some commentators suggest will be overcome through political and institutional manoeuvres.

This comes following multiple calls from various quarters, including the Ministry of Finance, armed forces and International Monetary Fund (IMF), to rebalance the fiscal arrangement. The federal government is making a case for setting aside about 10pc gross proceeds of the federal divisible pool to meet the growing federal needs and then negotiate the sharing of net proceeds (about 90pc of the gross amount) with the provinces.

The latest notification requires the NFC to allocate resources for meeting growing expenditures on national security and natural disasters

The debate did not progress in 2016 when the centre first put on the table a formal proposal for the allocation of 7pc of gross divisible-pool taxes for the National Security Fund (NSF) and the development of special areas — erstwhile Fata, Azad Jammu and Kashmir and Gilgit-Baltistan — before distributing the remaining proceeds among the centre and the four provinces.

Under the terms of reference, the 10th NFC is required to make grants-in-aid by the federal government to provincial governments and set powers and conditions for these governments to borrow besides the assessment and allocation of resources to meet expenditures related to Azad Jammu and Kashmir, Gilgit-Baltistan and the merged districts of Khyber Pakhtunkhwa.

The influential quarters in the centre argue that security dynamics have gone beyond the traditional defence budget mandatory for national security. As an example, they refer to the security of the China-Pakistan Economic Corridor and other internal security areas for which around 100 divisions are required. In fact, a national security committee had formally taken a decision about five years ago for such a dispensation with the provision that the Council of Common Interests (CCI) should monitor and oversee the disbursement and utilisation of the NSF. This did not progress though.

Hence, the proposal for at least 3pc of gross divisible-pool taxes for the NSF, followed by another 3pc for mainstreaming the tribal region now merged with Khyber Pakhtunkhwa and 1pc for the additional development needs of Azad Jammu and Kashmir and Gilgit-Baltistan.

The list this time has been expanded by the president to include debt servicing and losses of public-sector entities as well. The centre now wants the provinces to bear some additional fiscal responsibilities. This pertains to “exploring ways to reduce the losses of state-owned enterprises (SOEs) and agreeing on a mechanism for sharing these losses between the federal and provincial governments”.

This is based on the argument that some SOEs were in the red primarily because of provincial interference and non-payments, particularly in the case of electricity and gas distribution companies. Therefore, the centre is building the case to assess how much losses to these SOEs occur because of provincial reasons. The centre wants to assign their costs where they belong and, if a provincial government wants to subsidise a service to its citizens, it should also pick up that bill.

The notification also requires the NFC to allocate resources to meet expenditures made on security and natural disasters/calamities and assess the total public debt and allocate resources for its repayment.

The 10th NFC will also be expected to rationalise subsidies given by the federal and provincial governments in their budgets and formulate a mechanism to finance them. As part of the budget for 2020-21, the federal government is also working on delivering a targeted subsidy to poor consumers on electricity through BISP instead of the power tariff to limit it below Rs200bn – less than 0.5pc of GDP – instead of Rs250bn targeted in the 2019-20 budget, which appears to have been missed by a wide margin.

Interestingly, the provinces volunteered cash balance of close to 1pc of GDP every year over the past 10 years to the centre on the premise of containing the fiscal deficit. Practically, they have justified the critics’ claim that the provinces did not have the capacity to absorb additional fiscal space they had long been fighting for or lacked the will to spend on improving the living standards of their people.

Two things are critical. Any fresh NFC has to come through a complete consensus – one stakeholder can veto a majority decision. Secondly, the same Article 160 of the Constitution promises that “the share of the provinces in each award of the NFC shall not be less than the share given to the provinces in the previous award”. This is subject to interpretation. The new NFC also faces a major legal challenge as the results of the national population census conducted in 2017 have yet to be notified.

Published in Dawn, The Business and Finance Weekly, May 18th , 2020