Who framed the NFC?

The federal government appeared to have chosen a debt feast over an NFC diet

Who framed the NFC?


n recent times the National Finance Commission has appeared to be a soft target. The first to paint a bull’s eye on its back was the World Bank, whose regional vice president, visiting Pakistan in November last year, asked for a review of the NFC award.

This triggered chatter on how the 7th Award had shortchanged the Centre; how the provinces had squandered their windfall; and how a cash-strapped federal government could no longer indulge what was essentially a bad deal gone worse. When the newly appointed finance minister started talking with the IMF delegation on the last tranche of the ongoing standby agreement, the ‘backbench’ grumbling went ‘mainstream.’

Several national dailies have since reported that the IMF wants the resource shares to be renegotiated so that the government of Pakistan gains some fiscal breathing room. The question is: how should the government respond?

The demand might look reasonable in a global context. A study by the Organisation for Economic Cooperation and Development, drawing on a sample of 101 countries, has set the benchmark for sub-national government revenue at 9 percent of the total public revenue for all countries and 17 percent of the total public revenue for federal countries.

Among the subset of lower-middle income countries where Pakistan finds itself this mean rises to about 21 percent of total public revenue. Of course, there’s significant variation around this mean but the 7th NFC Award’s 56-44 split of the federal divisible pool favouring the provinces is globally exceptional. In fact, even regionally it is exceptional. In India, the 15th Finance Commission has recommended a 41 percent share for states in federal taxes, for the 2021-26 period.

It can be argued that the statistics reflect current practice, not necessarily the best practice. Unfortunately, fiscal federalism doesn’t offer much in the way of best practice; only certain foundational principles. The subsidiarity principle states that public decisions should be made, services provided and functions performed at the level closest to the people whose lives will be affected.

This is exactly what the 18th Constitutional Amendment attempted to achieve. A total of 47 subjects were devolved to the provinces. On ground, however, less than a third of the functions performed by dissolved ministries actually found their way to the provinces. Federal ministries abolished under the original plan have been resurrected in new and creative ways. The ministry of agriculture has become the ministry of food security; the ministry of education the ministry of federal education and professional training; the ministry of health the ministry of health national health services, regulation and coordination.

Even more revealing is a look under their hoods to find clusters of attached departments tasked with functions that border on the farcical. For instance, the Livestock and Dairy Development Board under the ministry of food security is working to fatten yaks in Gilgit Baltistan and set up slaughterhouses across the country. Another gem is the Agriculture Policy Institute, mandated to conduct research on “broader agriculture policies” and “emerging policy issues,” while publishing a Journal of Agricultural Economics whose last downloadable edition was issued a decade ago.

The belt-tightening required by the 7th NFC Award did not happen because the federal government wasn’t willing to lose the weight. The appetite for spending in devolved domains did not end with the claw-back of devolved ministries, it has extended to vertical programmes in devolved subjects. A recent World Bank study found that federal spending in devolved domains actually increased from 0.4 to 0.5 percent of the GDP from 2009 to 2022.

The NFC had proposed enhancement of the revenue collection effort to take the national tax-to-GDP ratio to 15 percent by the terminal year of the Award, i.e. 2014-15. This did not happen.

But this is not the whole problem. The NFC had proposed that an enhancement of revenue collection effort to take national tax-to-GDP ratio to 15 percent by the terminal year of the Award, i.e. 2014-15. This did not happen. The ratio has hovered around 10 percent since the NFC Award, reaching 9.2 percent in FY23. Both the federal and provincial governments failed here – but it appears that the federal failure was worse. Over the 2011-23 period, federal tax revenue grew by 339 percent, from Rs 1.6 trillion to Rs 7.2 trillion. But during the same period, provincial tax effort mobilised 906 percent more revenue from Rs 64.6 billion in FY11 to reach Rs 649.5 billion in FY23.

The fact remains that suboptimal revenue collection is a historical default. Tax-to-GDP performance has been poor — but it has been consistently poor, both before and after the 7th NFC award in 2010-11. While the FBR collected taxes amounting to 9.1 percent of the GDP in FY11 this charts as a flat line to 8.5 percent of the GDP in FY23. Similarly, the provinces have barely moved from collecting 0.36 percent of the GDP to 0.77 percent of the GDP over the same period. While the lack of growth is unfortunate, it does not sufficiently explain the present crisis. What then has changed over the two decades? Where does the federal fiscal pressure originate? Who framed the 7th NFC?

A simple thought experiment might provide some clues. What if there was no 7th NFC? What if we take it out of the equation and see how the fiscal parameters might have moved without it? If we derive compounded growth rates from a 10-year prior period -from FY01 to FY10 - for federal revenue and expenditure and then project them forward till FY23, what do we get? This is obviously an oversimplified simulation of the current fiscal position of the government of Pakistan. But how does it compare with the actual position, after 22 years of the 7th NFC?

Well, the net federal receipts would be 33 percent greater in the no-NFC scenario, which is to be expected since the provincial share was lower. We’d also be spending about a fifth more in federal expenditures; no surprises there. The more we have, the more we’re likely to spend. The real difference between the no-NFC 2023 and the actual 2023 fiscal position is the federal expenditure exclusive of markup payments. When we take out debt servicing cost, the federal government’s expenditure drops off a cliff, in the actual 2023 position vs the simulated 2023 position.

The real culprit was right under our noses all along: debt. Interest payments have risen an eye-watering 716 percent from FY2011-23, growing from 28 percent of federal expenditure to 50 percent. The irony is that in terms of overall budget balance there is hardly a difference between actual and simulated 2023. With the NFC, we have a deficit of some Rs 6.6 trillion (7.8 percent of the GDP) without it, we might have had a slightly larger one, at RS 7.3 trillion (8.6 percent of the GDP). Either way, the government of Pakistan would still be one of the most highly leveraged financial enterprises on the planet.

The federal government chose a debt feast over an NFC diet. It’s not an issue of either the size of the cake or how it was sliced. Turns out, the real problem was that the federal government had been eating cake bought on store credit for over two decades. Now that the bill has come due and the creditors are at the door, the provinces are being gas-lit into pitching in.

The writer is a governance and public policy professional with over 17 years of experience in the international development sector.

Who framed the NFC?