WB backs cuts in provincial NFC

Allocations by provinces fall short by Rs229b; bank for bridging imbalances

ISLAMABAD:

The World Bank said on Wednesday that only the two largest provinces allocated Rs806 billion in grants for the Centre, recommending that Pakistan review the National Finance Commission (NFC) formula to permanently address fiscal imbalances, including backing deductions from provincial shares for seven national public goods services.

The Rs806 billion grant is Rs229 billion, or 22%, less than what the federal government showed in the budget, as Khyber-Pakhtunkhwa (K-P) did not allocate any money in its budget.

The Washington-based lender released a comprehensive report on the implementation of the seventh NFC Award and found the federal government at fault for spending in areas that, under the constitution, were not its responsibility and caused fiscal stress. It also wrote that the provincial governments, too, did not spend wisely, and major spending was incurred on creating more government jobs, increasing salaries and pensions after 2010.

The Strengthening of Fiscal Federalism in Pakistan report was launched days after the provinces agreed to give up Rs1.035 trillion in grants to fund national security, large dams, and stabilise future fuel prices in times of crisis.

"The reverse grants are an attempt to address vertical imbalances and provide a short-term financing solution, but broader efforts will be required to sustainably resolve fiscal federalism challenges within the constitutional framework," said Tobias Haque, Lead Country Economist at the World Bank.

According to Tobias's presentation, Punjab has allocated Rs546 billion and Sindh Rs260 billion in their budgets to fund the federal expenses. This is 22% short of what the federal government was expecting from the federating units.

"Khyber-Pakhtunkhwa and Balochistan did not allocate any money in their budgets," said Jaffer Askari, an economist working with the World Bank, while responding to a question.

The World Bank urged the federal government to reduce wasteful spending that overlaps with provincial mandates. It said that once the achievable savings are realised, a federal revenue potential assessment should determine whether further vertical rebalancing is needed and to what degree. It said that after making these assessments, the remaining gaps could be addressed through several mechanisms within the existing constitutional restrictions.

The "function-specific deductions from the divisible pool could share the burden of continued federal expenditure on national public goods such as national transport infrastructure, certain security expenditures, debt servicing, social protection, environmental programmes, strategic interprovincial water infrastructure, and national policy coordination," according to the lender.

It added that, in addition, changes to the composition of the revenue divisible pool or temporary reductions in the provincial revenue share agreed by all parties could be progressed to address urgent fiscal needs, such as reduction in the outstanding debt stock.

The report states that the 18th Constitutional Amendment devolved responsibility for social services and economic functions to provinces. However, the federal government continues to operate in constitutionally devolved areas, causing waste and blurring accountability. Total federal expenditure increased from an average of 11.2% of GDP during FY02-09 to 13% during FY10-24. Federal spending on devolved topics increased from 0.5% to 0.7% of GDP over FY08-24, including 0.5% of GDP on BISP by FY24.

The report revealed that despite devolution, there was continued growth in the number of civil servants. The number of civil servants engaged in devolved functions has remained unchanged through FY24. Furthermore, federal employment in non-devolved sectors increased by 85% between 2009 and 2024.

The federal employment in non-devolved sectors recorded a net rise of 191,004 employees, or 85%, between FY09 and FY24, according to the lender. The increase is largely attributed to the expansion of non-military security personnel. Relevant units, originally designed for border security, now perform domestic policing roles – a function constitutionally devolved to provinces, it added.

Although these forces operate at the provincial level, their salaries are 70% federally funded, with provinces contributing only 30% as a special allowance, according to the report.

A weak overall revenue and macroeconomic performance and the misalignment between federal financing and functional needs has been a material contributor to Pakistan's fiscal deficit and to the accumulation of public debt, said the lender in a statement. It said that the current NFC framework reduced federal resources without a commensurate adjustment in expenditure responsibilities, driving a structural federal fiscal deficit.

Bolormaa Amgaabazar, Country Director of World Bank, said that some adjustments can be made in the NFC formula without politicising it. The biggest disappointment is that the first phase of devolution did not achieve the intended objective of improving social services, she said.

The report noted that while provinces have increased spending on basic services since the 18th Constitutional Amendment, the largest single increase has been made in administrative expenses. Around 80% of consolidated provincial expenditure continues to be absorbed by recurrent costs, with the largest share of incremental spending absorbed by general public services and administrative costs rather than education or health, it added.

Current expenditures absorbed approximately 82% of the incremental resources transferred to provinces over FY09-23. This growth was driven primarily by increased spending on salaries and pensions as provincial bureaucracies expanded. During FY09-23, real provincial spending on salaries and pensions increased by 250% and 330%, respectively, it added. Additional salary expenditure on education and health accounted for 36% and 18% of the incremental wage bill during this period, respectively, beyond these sectors.

The World Bank recommended that a transparent fiscal gap approach – replacing the current complex multi-factor formula – would allocate divisible pool resources based on standardised assessments of expenditure needs versus own-source revenue capacity, eliminating disincentives to revenue effort and avoiding penalties on provinces for fiscal efficiency.

This equalisation framework could be complemented by conditional transfers tied to measurable service delivery outcomes in devolved sectors such as education and health, with disbursements verified by an independent third party and supported by strengthened federal and provincial statistical systems, said Tobias Haque.