Review of 7th NFC Award – II

This is the second part of the Review of the 7th NFC Award. The first part was published last week in this newspaper. It highlighted the salient features of the Award and the increase in the magnitude of transfers, overall and to individual Provinces. 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.