Review of 7th NFC Award

The 7th NFC Award was signed by its members on the 30th of December, 2009. It became effective in 2010-11 after the Presidential Order No. 5 of 2010, during the tenure of the last PPP government. Initially, the Award was valid for a period of five years up to 2014-15. It has since been extended on an ad hoc basis till the finalization of the next award by the 8th NFC, which has started meeting recently.

The 7th NFC Award came with a gap of thirteen years after the promulgation of the NFC Award in 1997. In the intervening period various Commissions were constituted but could not arrive at a consensus. Eventually, as an interim provision, the Presidential Order No 1 of 2006 was issued.

 The 7th NFC Award represents a major step forward in a number of important ways. First, it makes a big move in the process of fiscal decentralisation. The vertical share of the four Provinces combined has been raised to 56% in the first year to 57.5% thereafter. This represents a big increase in transfers in comparison with the maximum share of 50% in the Presidential Order of 2006.

 Second, a fundamental transition has been made in the horizontal sharing formula between Provinces. Historically, the distribution was based solely on the basis of population. The 7th NFC Award was able to move toward multiple criteria for sharing, with the prime objective of achieving a degree of fiscal equalisation, leading to higher per capita transfers to the more backward provinces.

 Special features: The special features of the 7th NFC Award are summarised below:

 (i) The divisible pool of taxes consists of all FBR taxes, excluding tax revenue from remuneration paid out of the Federal Consolidated Fund and the excise duty on natural gas. Prior to the distribution to the four Provinces, one percent of the pool has been assigned to the government of Khyber Pakhtunkhwa to meet the expenses on the war of terror.

 (ii) The indicators and weights for horizontal distribution from the divisible pool of taxes are as follows: population, 82.0%; poverty or backwardness, 10.3%; revenue collection or generation, 5.0% and inverse population density, 2.7%. This formula implies a share of 51.74% to Punjab, 24.55% to Sindh; 14.62% to Khyber-Pakhtunkhwa and 9.09% to Balochistan from the divisible pool.

 (iii) In addition to divisible pool transfers there are straight transfers, distributed solely on the basis of collection. These straight transfers include the net revenue from the royalty on oil and natural gas, excise duty and development surcharge on natural gas.

 (iv) A relatively small special grant-in-aid, equivalent to 0.66% of the revenues in the net proceeds of the divisible pool has been made to Sindh as a compensation for the losses on account of abolition of octroi and zila tax.

 (v) The federal government has guaranteed revenues each year to the Government of Balochistan, based on annual budgetary projections.

 (vi) The 7th NFC recognizes that the sales tax on services is a Provincial subject under the Constitution and may be collected by respective Provinces.

 (vii) The federal and provincial governments have jointly committed to the development and enforcement of mechanisms for maintaining fiscal discipline.

(viii) The federal government may assist the provinces through specific grants in time of unforeseen calamities.

Level of transfers: Given the abovementioned features of the 7th NFC Award, the first question is the magnitude of transfers. These include the share in the divisible pool and straight transfers to the four Provinces combined.

 The total transfers are estimated at Rs 999 billion in 2010-11, equivalent to 5.5% of the GDP. This represents a jump of Rs 336 billion or 34% over the transfers in 2009-10, the last year prior to the 7th NFC Award. Thereafter, the transfers have reached Rs 1862 billion by 2015-16, with a growth rate annually of 12.5%. Currently, the total transfers represent 6.3% of the GDP. In the absence of the Award, the overall growth in transfers in 2010-11 would have been below 16%. It needs to be recognised, however, that the level of grants has fallen in relation to those provided for in the Presidential Order 2006.

 What is the gain in transfers for individual provinces? Given the emphasis on fiscal equalisation, it is not surprising that the biggest jump in revenue transfers in 2010-11 was 152% in the case of Balochistan, followed by Khyber Pakhtunkhwa with a rise of 97%. The increases for Sindh and Punjab were 53% and 42% respectively. Clearly, the 7th NFC Award has succeeded in raising substantially the shares in transfers particularly of the two relatively backward provinces.

 The comparison between share in population and share in transfers reveals that in the 7th NFC Award the only Province that has lost out is the largest Province, Punjab. While its share in population according to the 1998 Census was 57.4%; the share in revenue transfers was 48.4% in 2015-16. However, the big increase in the vertical share has compensated Punjab for the reduction in its horizontal share. The positive difference between share in transfers and in population is 4% in the case of Balochistan, 2.4% in Khyber-Pakhtunkhwa and 2.5% in Sindh.

Sindh has done well because of the high share in FBR revenue collection and larger straight transfers. The big jump of Balochistan is due to lower population density, higher incidence of poverty and a relatively high share of straight transfers. Khyber-Pakhtunkhwa has got a bigger share because of relative backwardness.

The next set of issues relates to the impact of the 7th NFC Award on the overall extent of fiscal decentralisation to the Provinces, the impact of enhanced fiscal powers on resource mobilisation at the sub-national level, the behavioural response by Provincial Governments to larger transfers, allocation of the extra resources to the social sectors and so on.

The first question relates to the impact of higher transfers on the fiscal behaviour of provinces. Did they slacken their own fiscal effort in the face of larger transfers? There is strong evidence that the two relatively developed Provinces, Sindh and Punjab, actually engaged in somewhat more aggressive resource mobilisation. This happened following the enhancement of fiscal powers, with the transfer of the sales tax on services to the provinces in the 7th NFC Award.

 Sindh set up the Sindh Revenue Board and Punjab, the Punjab Revenue Authority, as specialised tax agencies to collect the tax on services. More recently, Khyber Pakhtunkhwa has also taken this step. By 2015-16, the total revenue nationally of the tax has reached Rs 130 billion, equivalent to 0.4% of the GDP. This has raised the Provincial tax-to-GDP ratio from 0.4% of the GDP in 2009-10 to almost 0.7% of the GDP in 2015-16. However, provincial direct taxes like the agricultural income tax and the urban immovable property tax remained underdeveloped. Also, there exists scope for generating even more revenues from the sales tax on services.

 The increase in transfers has generally translated into a corresponding rise in expenditure. The combined expenditure of the four Provinces has gone up from 6.2% of the GDP in 2009-10 to over 7.2% of the GDP in 2015-16. However, almost 74% of this jump is in current expenditure. Salaries and allowances, in particular, of government employees have risen by almost 40% in real terms during the tenure of the 7th NFC Award. For example, in the first year, 2010-11, after the Award a generous 50% allowance on basic pay was granted.

 There is need to recognise the fact that following the commencement of the IMF Programme in September 2013, the provincial governments have been compelled to generate large cash surpluses to facilitate achievement of the consolidated deficit target in the Programme. The cumulative cash surplus over the period, 2013-14 to 2015-16, is as much as Rs 492 billion. Consequently, the budgeted level of PSDP of the four provinces combined has been cut back by almost 27% over the last three years. During the current year, the provinces are expected to generate a massive surplus of Rs 337 billion as part of the hangover of commitments to the IMF.

 The next question is whether the provinces have increased their share in total national public expenditure following the NFC Award, despite the pressure to generate cash surpluses in recent years. The answer is yes. The combined share of the four provinces has gone up to 35% in 2015-16, as compared to 28% in 2009-10. Therefore, a degree of fiscal decentralisation has been achieved, despite the Fund Programme. However, this is significantly less than the target share of 45% set by the 7th NFC for 2014-15. Also, the states account for 55% of total public expenditure in India.

 One of the principal objectives behind the relatively liberal dispensation in favour of the provinces by the 7th NFC was to promote human development, especially since most of the social services are in the domain of provincial governments. Therefore, a relevant question is whether the share of education, health, water supply, etc., has increased in the total expenditure by provincial governments.

 The relevant data on expenditure is available up to 2014-15. In the case of all four provinces, the overall share in public expenditure of social services has, in fact, increased. The biggest increase is in Balochistan from 26% in 2009-10 to 37% in 2014-15. In the latter year, the largest share of social sectors was in Khyber Pakhtunkhwa at 47%.

 We come finally to the bottom line. Has the 7th NFC Award led to a faster rate of expansion in the coverage of social services, given the increase in expenditure? Unfortunately, the outcome here has been disappointing.

 A five-indicator index has been constructed to measure the combined coverage of different social services. It includes primary and secondary enrolment, literacy, immunisation and provision of tap water to households. There are two major findings as follows:

 (i) The rate of increase annually in absolute terms nationally of the index of coverage of social services is larger from 2004-05 to 2008-09, the pre-7th NFC period, than from 2008-09 to 2014-15.

 (ii) The highest index value of coverage of social services in 2014-15 is in Punjab. However, the biggest increase in the index value has been registered in Khyber-Pakhtunkhwa and smallest improvement in Sindh.

 The fundamental question is why despite larger outlays, the progress in social indicators has not been commensurately greater. There are three possible explanations.. First, within social sectors, the priorities may have been altered. For example, there is evidence of far greater emphasis on curative health rather than on preventive measures, including provision of safe drinking water. Second, local governments were far more active in the pre 7th NFC Award period. They probably did a better job in reflecting peoples’ preferences and in achieving more effective delivery of services in the face of potentially greater accountability at the ground level. Third, it is likely that the cuts in development spending, due to the constraints imposed by the IMF programme, limited significantly the expansion in coverage of services.

 What are the lessons for the ongoing deliberations on the 9th NFC Award? First, there is need to recognise the constitutional autonomy of the Provinces, especially after the 18th Amendment, and not require cash surpluses to be generated by cuts in development spending. Second, there is need to bring back the active role of local governments in the delivery of basic services and, third, to focus on outcomes in the 9th NFC Award rather than only on targets of revenues and expenditures.

 We wish success to the 9th NFC in arriving at an Award, which furthers the process of fiscal decentralisation in line with the 18th Amendment and promotes greater fiscal equalisation among Provinces in Pakistan. This will contribute greatly to strengthening the Federation.

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