THE federal government has started informal consultations with provinces again for the next National Finance Commission (NFC) award amid warnings from the International Monetary Fund (IMF) that the existing pattern of fiscal devolution must change as it poses serious challenges to the federations` fiscal framework.

IMF Resident Representative Tokhir Mirzoev and Senior Economist Tasneem Aslam have written a comprehensive chapter as part of Article-IV consultations and have identified serious shortcomingsof the seventh five-year award that is continuing for the ninth year.

Without clearly saying so, the IMF appears supporting the federal government`s argument for creating a national security fund to be jointly funded by the federation and provinces when it advocates for building a contingency fund to meet unforeseen shocks.

The federal government has been advocating, with little success, setting aside at least seven per cent of gross revenue collections for joint responsibili-ties like additional security costs and development of special areas like tribal areas, Gilgit-Baltistan and Azad Kashmir.

While it would almost be impossible to develop consensus for the ninth NFC award before the next year`s budget because of pre-poll dynamics, the debate around IMF suggestions could cover enough distance to begin structural negotiations soon after the new governments take over in the wake of elections.

The IMF has a positive view of the basic design of Pakistan`s fiscal decentralisation for being in line with many principles. However, it finds problems with the rollout of the NFC award, saying it has been unbalanced in several important areas.

First, it says the devolution of fiscal resources was not tied to the devolution of expenditure responsibilities and was delayed. Consequently, the federal government expenditure could not adjust at a pace of the resource transfer, and the NFC award made no provision for ex-post reconciliation of the vertical resource allocation.

Second, although federal tax revenue has increased substantially in the past several years, incentives for the federal government in raising additional revenue became skewed.

Third, provincial incentives to raiserevenue diminished owing to increased availability of revenue from the divisible pool.

Moreover, the devolution of fiscal resources was not synchronised by strengthening public financial management frameworks at the provincial level.

The limited and uneven capacity to absorb additional resources and use them efficiently has likely contributed to limited success with improving the provision of basic services and may have increased disparity across provinces.

On top of that, as a multi-year revenue framework, the NFC award did not adequately account for contingencies. It did not include a strategy to counter unexpected fiscal shocks. The NFC included a possibility of federal assistance to provinces in times of unforeseen calamities, but no such provision was made in case of a need for reverse assistance in times of national emergencies like securityrelated expenditure.

Moreover, the award was found largely silent by the IMF about sharing the burden of financing joint responsibilities of national importance which fall under the jurisdiction of the Council of Common Interests (CCl). By default, these functions continue to be financed by the federal government. Ensuring a consistent fiscal stance across the layers of govern-ment had also been a challenge and even the decisions of recently established fiscal coordination committee of the finance secretaries have not always been implemented for being legally non-binding.

The IMF found that macroeconomic imbalances increased after the seventh NFC award. Despite conditions under the IMF programme, the federal budget deficit was higher than in the NFC framework despite being on a downward trajectory in the past three years.

Provincial revenue growth was substantially below expectations, owing both to challenges at the federal level and the provinces` own tax efforts. Reflecting changed incentives and tax reform challenges, the increase in federal revenue was slower than expected initially while provinces` own tax efforts seemed to have focused on improving the service tax collection. Tax collection from other key potential sources such as real estate and agriculture largely remained flat as a percentage of GDP.

The IMF also noted that provinces increased resource envelope went disproportionately into current spending whereas the expected scaling up of public investment did not materialise.

Ultimately, these outcomes translated into very different balance sheet effects.On the one hand, they led to faster increase in public debt despite sizable consolidation efforts. On the other hand, provinces accumulated cash balances of over Rs600 billion, or 2pc of GDP during the period of the seventh NFC Award.

Furthermore, progress with respect to basic service delivery one of the key economic justifications for fiscal decentralisation has been mixed.

Notwithstanding some improvements, notably with respect to child immunisation rates, overall social outcomes with respect to basic services in some cases did not improve amid gradually increasing but still low levels of spending in these areas.

There were also notable differences across provinces in these outcomes and point to capacity constraints in public administration and public finance management systems which vary across provinces.

As a way forward, the IMF is advocating the creation of a technocratic fiscal council under the CCI to keep a close vigil and coordination on fiscal operations of the provinces and the Centre, a permanent national tax commission to widen the tax net in areas of joint jurisdictions and the creation of a contingency fund under a joint supervision of the federal and provincial governments. •