akistan’s journey towards fiscal devolution has been marked by both progress and challenges. Pakistan stands at a critical juncture in its economic journey, where the balance between federal and provincial resource allocation mechanisms is under intense scrutiny.

Central to this equilibrium is the National Finance Commission award, a cornerstone of Pakistan’s fiscal governance designed to ensure fair and transparent distribution of financial resources across various tiers of governance. This mechanism aims to correct both vertical fiscal imbalances (between the federal and provincial levels) and horizontal imbalances (among the four provinces). However, amidst strides forward, Pakistan confronts formidable challenges, including mounting public debt and low human development indices that necessitate comprehensive reforms.

Understanding Pakistan’s fiscal evolution requires tracing its roots back to the pre-independence era. The foundation was laid with the Government of India Act, 1935, which established the framework for revenue allocation. Post-independence, Pakistan embarked on initiatives such as the Raisman Award of 1951, a precursor to the formal establishment of the National Finance Commission in 1971 in response to the separation of East Pakistan.

Article 160 of the constitution establishes the NFC’s mandate. It requires the president to convene the commission every five years. The commission includes key stakeholders from federal and provincial levels to ensure representation and transparency. The president’s authority under Article 160(6) allows for necessary adjustments to revenue distribution laws, highlighting the importance of flexibility. Pakistan’s fiscal governance is deeply rooted in its constitutional framework. Articles 160 to 164, alongside Articles 37 and 38, provide guidance for equitable resource distribution.

An NFC award is a pivotal element in Pakistan’s fiscal framework, embodying core values of equity, decentralisation and transparency. However, its effectiveness relies on navigating a complex landscape characterised by political consensus, fiscal prudence and adaptability to evolving economic dynamics to foster sustainable nationwide development.

Despite the evolution of the NFC formula over time, with population as its primary criterion, concerns persist regarding its potential to perpetuate economic disparities among provinces. The emphasis on population could disadvantage smaller provinces. This runs counter to the overarching goal of fostering equitable growth and comprehensive development nationwide. Horizontal allocations are now based on population (82 percent), backwardness (10.3 percent), revenue collection (5 percent) and inverse population density (2.7 percent).

Amidst fiscal constraints, adept negotiation of federal-provincial agreements is paramount, requiring a delicate balance between cooperation and contention. This challenge is particularly pronounced in the post-18th Amendment era as Pakistan aims to institutionalise devolution. Achieving this balance necessitates a fusion of fairness and fiscal prudence, guided by objective metrics such as SDG-aligned equalization allocations.

To address these challenges effectively, a nuanced approach is essential — one that ensures every province’s equitable participation in the country’s economic trajectory. Only through such inclusive measures can Pakistan fulfill its vision of fostering growth and prosperity for all its citizens.

After the 7th NFC award

The aftermath of the 7th NFC Award presents a myriad challenges, including integrating the erstwhile FATA into Khyber Pakhtunkhwa; incorporating new census data; deteriorating economic and fiscal position of the country; and poverty alleviation. Addressing these challenges requires a concerted effort to revitalise fiscal mechanisms and adapt to evolving socio-economic realities.

The integration of tribal districts into Khyber Pakhtunkhwa is a significant milestone in Pakistan’s quest for territorial integrity and governance reform. However, the transition poses complex administrative, economic and security challenges, requiring careful planning and coordination. Moreover, the incorporation of new census data is essential for ensuring accurate representation and resource allocation. Delays and discrepancies in the census process have hindered this work. Additionally, poverty alleviation efforts must be prioritised to address entrenched poverty and inequality, particularly in marginalised regions.

Stalled consensus

Pakistan’s journey towards fiscal devolution has been fraught with challenges. The Raisman programme, initiated during the 1950s One Unit scheme, aimed to distribute awards evenly between West Pakistan and East Pakistan. However, only three awards were made under this programme.

Following the separation of East Pakistan, the first NFC award was enacted in 1974. It laid the groundwork for subsequent awards. The NFC’s trajectory has been marked by hurdles. Deliberations of the second, third and sixth NFCs remained inconclusive.

Empowering provincial governments is crucial for decentralising decision making and catering to local needs. This includes granting greater autonomy in financial and administrative matters.

Public debt

Pakistan currently faces a significant challenge as its public debt and liabilities have increased exponentially, growing by a staggering 659 percent following the 7th NFC award period (from Rs 10.703 trillion in 2010 to Rs 81.194 trillion in December 2023). The escalation in debt can be attributed to a combination of factors, including inefficient expenditure, revenue shortfalls and overreliance on external borrowing.

Large-scale infrastructure projects, subsidies and recurrent expenditures have also contributed to the ballooning debt burden exacerbated by a lack of fiscal discipline and accountability. The consequences of mounting public debt are far-reaching, impacting macroeconomic stability, investor confidence and social welfare. High debt servicing costs divert resources away from critical sectors such as education, healthcare and infrastructure, hindering long-term development efforts. Moreover, excessive debt levels constrain fiscal policy flexibility, limiting the government’s ability to respond effectively to economic shocks and crises.

Human development

Pakistan’s low human development index (a global ranking of 164 out of 193 countries) underscores the urgent need for socio-economic reform. Regional disparities, particularly pronounced in areas like Balochistan and the tribal districts, highlight the imperative of equitable resource distribution to foster inclusive development and address systemic inequalities. The low human development indicators reflect systemic challenges in healthcare, education and socio-economic empowerment. Persistent poverty, unemployment and social exclusion further exacerbate the situation.

Interest on provincial borrowing

Provincial governments struggle with high interest rates (significantly exceeding market rates) on borrowings from the federal government. This undermines fiscal autonomy, exacerbating their financial burdens and impeding effective resource utilisation at the provincial level. The high interest rates reflect systemic inefficiencies in fiscal management and debt servicing.

Faced with limited revenue sources and escalating expenditures, provincial governments resort to borrowing to finance budget deficits and development projects. However, the reliance on expensive debt instruments and unfavourable borrowing terms exacerbates their fiscal vulnerabilities and limits investment in critical sectors.

Devolution to local governments

Incomplete devolution to local governments undermines the fundamental principle of decentralisation. This gap underscores the need to bridge the divide between policy intent (empowering grassroots governance structures for effective service delivery) and implementation. The incomplete devolution of financial and administrative powers to local governments hampers efforts to promote inclusive and participatory governance. Weak accountability mechanisms, bureaucratic inertia and political interference further undermine the effectiveness of local governance structures.

Sales tax

An essential aspect of the revenue-sharing framework was the management of sales tax, initially handled at the provincial level. On April 1, 1952, sales tax authority was temporarily shifted from the provinces to the federal government. It was then stipulated that 50 percent of the proceeds would be allocated to the provinces. Ever since, sales tax on commodities has remained in federal jurisdiction.

Oil resource allocation

The fourth NFC award recognised provincial entitlement to natural resources. This gave provinces royalties and gas development surcharge on oil and gas, a crucial step towards decentralisation and bolstering provincial governance. However, the assurance of regular provincial share disbursements has remained elusive.

Provinces thus continue to struggle with persistent challenges in accessing these allocations. This hinders their capacity to effectively manage and leverage resources. This failure to consistently uphold commitments undermines fiscal decentralisation.

Global insights

To ensure economic prosperity and stability, it’s crucial to leverage insights from resource sharing models around the world particularly those of Canada, India and Germany.

Canada’s Equalisation Programme is meant to ensure that all provinces can provide similar levels of public services despite economic differences. It embodies equity principles and minimises regional financial imbalances through structured approaches. Canada’s fiscal need is estimated at 5 percent, with specific equalisation not specified. Performance metrics include population, forest cover and various HDI indicators, along with tax effort.

India’s Finance Commission mechanism plays a pivotal role in promoting equitable growth and development. The commission allocates central tax revenues to central and state governments. It employs a multi-dimensional approach, considering factors like population, income disparity and fiscal responsibility to ensure a balanced distribution of funds. Using various criteria, the commission aims to promote fairness and inclusivity while addressing regional disparities and fostering balanced development. Transparent engagement with states and stakeholders ensures participatory decision-making, while periodic reviews keep the mechanism responsive to changing socio-economic realities, enhancing long-term sustainability and resilience in fiscal federalism.

Germany’s Fiscal Federalism Model combines vertical and horizontal fiscal equalisation mechanisms. Wealthier states contribute to a fund redistributed to less affluent ones, promoting solidarity and fiscal autonomy.

Recommendations

There is a need to enhance transparency in decision-making processes, empowering provincial governments, diversifying revenue streams, and strengthening local governance structures.

Providing stakeholders access to information and including them in policy formulation can facilitate efficient resource allocation and utilisation.

Empowering provincial governments is crucial. This can take various forms, including greater autonomy in financial and administrative matters, allowing provinces to tailor policies and initiatives to their specific contexts.

Diversifying revenue streams beyond conventional taxes, such as exploring property taxes and natural resource royalties, is vital to reduce reliance on federal transfers. By tapping into alternative revenue sources, provinces can enhance fiscal resilience and mitigate risks associated with excessive dependence on central funding.

Equalisation transfers have a critical role in redistributing resources to underserved areas. Their effectiveness hinges on the efficiency, transparency and accountability of management systems.

NFC awards should prioritise empowering historically disadvantaged regions by directing resources towards essential services, thereby improving living standards and fostering economic viability. A targeting approach is crucial for addressing historic inequalities and promoting balanced regional development.

Fiscal responsibility at the provincial level is paramount to prevent excessive borrowing and mitigate the risk of debt accumulation. Adhering to prudent fiscal management practices can contribute to the sustainability of the national debt and ensure long-term financial stability.

Incorporating social development indicators into the NFC formula and strengthening equalisation transfers are essential steps towards promoting inclusivity and resilience. By considering metrics such as education, healthcare and poverty the NFC can ensure that resource allocation aligns with the diverse needs of the citizens.

The writer is a public financial management expert. He can be reached at waqas_paracha@hotmail.com