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Views on the NFC Award

Since its finalization in 2010, the seventh NFC Award has faced considerable criticism for allegedly causing financial strain on the central government. Recently, calls for a review of the award have intensified, especially after reports emerged that the IMF has raised the issue for discussion.

At first glance, attributing the financial challenges to the seventh NFC Award seems justified. Pakistan’s public finances have been under strain for years, with a significant portion of the federal divisible pool being allocated to provinces since 2011.

Consequently, the central government’s share of retained revenue has dwindled compared to its escalating expenses, leading to substantial borrowing. With concessional external financing options drying up, the government has resorted to high-cost domestic borrowing with shorter tenors. This borrowing pattern has contributed to an unsustainable debt dynamic, where debt servicing now exceeds 100 per cent of net federal revenue.

Given the fiscal trajectory since the implementation of the seventh NFC Award, it’s understandable that it receives widespread blame.

However, such criticism often lacks proper context and may mislead in crucial aspects. As someone who served as the principal economic adviser at the Ministry of Finance during that period, I can offer a more comprehensive and balanced perspective on the rationale behind the seventh NFC Award. (While there have been commendable analyses in the media lately, they tend to adopt either a center-centric or provinces-centric viewpoint).

To start, it’s important to clarify the purpose behind the NFC Award. It’s not merely a constitutional obligation but also crucial for fostering the participatory federalism that Pakistan aims for. With most social spending and public service delivery responsibilities, like education and health, falling under provincial jurisdiction, the NFC Award plays a vital role in achieving fiscal equalization. Its aim is to ensure that provinces have the fiscal resources necessary to fulfill their expenditure responsibilities.

A more cautious and nuanced approach needs to be taken with regards to the NFC Award.

The conceptualization behind the seventh NFC Award aimed at transferring more fiscal resources from the center to provinces, aligning with the soon-to-follow 18th Amendment which transferred expenditures incurred by the center on behalf of provinces.

Provinces were informed that the sustainability of the award depended on not raising tax revenue by an additional 3% of GDP within three years and achieving an ambitious 5% increase in tax-GDP ratio over five to seven years. There were expectations for provinces to enhance their tax efforts, especially tapping into urban property and agricultural income bases, and adopting a modern value-added tax system.

However, challenges arose due to the rejection of certain tax reforms and the lack of binding commitments from provinces to increase tax efforts. Despite efforts to safeguard against pitfalls, loose ends remained in both conceptualization and execution, particularly in monitoring fiscal resource usage and overseeing fiscal decentralization progress. Concerns were raised about the incentive structure created by the award, as provinces’ own-source revenue mobilization remained low despite claims of success, with provinces financing only a small fraction of their expenditure through own revenue.

The center’s own lackluster performance in tax collection since 2010 adds complexity to the explanation, suggesting additional factors beyond the NFC Award.

Improving the existing NFC Award involves implementing safeguards, addressing perverse incentives, tying the award to revenue and expenditure outcomes, and exploring provincial contributions to debt servicing and electricity circular debt. Recommendations include returning collection charges to the FBR and enhancing the oversight role of the Council of Common Interests.

Revisiting the seventh NFC Award is crucial for stabilizing Pakistan’s fiscal framework, but it should be approached cautiously and collaboratively with full provincial involvement, rather than being solely driven by the center.

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