Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 135776-NP

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT

FOR

A PROPOSED

DEVELOPMENT POLICY CREDIT

IN THE AMOUNT OF SDR 72.2 MILLION (US$100 MILLION EQUIVALENT)

TO

NEPAL

FOR THE

SECOND PROGRAMMATIC FISCAL AND PUBLIC FINANCIAL MANAGEMENT

DEVELOPMENT POLICY CREDIT

May 10, 2019

Macroeconomics, Trade and Investment and Governance Global Practices South Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their

official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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NEPAL-GOVERNMENT FISCAL YEAR

July 16 – July 15

CURRENCY EQUIVALENTS

(Exchange Rate US$1 = NPR 111.40) Effective as of April 24, 2019)

ABBREVIATIONS AND ACRONYMS

CCFF Climate Change Financing Framework CPF Country Partnership Framework DP Development Partner DPC Development Policy Credit DRM Disaster Risk Management DRRM Disaster Risk Reduction and Management GDP Gross Domestic Product GoN Government of Nepal FCGO Financial Comptroller General’s Office FFPFR Federal Fiscal Procedures and Financial Responsibility GRB Gender Responsive Budgeting IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IPFMR Integrated Public Financial Management Reform IT Information Technology LGO Local Government Operations MDTF Multi-Donor Trust Fund MFD Maximizing Finance for Development MoF Ministry of Finance MOFAGA Ministry of Federal Affairs and General Administration MoHA Ministry of Home Affairs MTEF Medium-Term Expenditure Framework NPC National Planning Commission OAG Office of the Auditor General PEFA Public Expenditure and Financial Accountability PFM Public Financial Management NNRFC National Natural Resources and Finance Commission SDR Special Drawing Rights SUTRA Subnational Treasury Regulatory Application US United States WBG World Bank Group y/y year-over-year

Vice President:

Country Director: Practice Director: Practice Director:

Country Manager:

Practice Managers:

Task Team Leaders:

Hartwig Schafer Idah Z. Pswarayi-Riddihough Lalita M. Moorty (MTI); James Brumby (Governance) Faris H. Hadad-Zervos Manuela Francisco (MTI); George Addo Larbi (Governance) Kene Ezemenari (MTI); Frank Bessette (Governance)

NEPAL SECOND PROGRAMMATIC FISCAL AND PUBLIC FINANCIAL MANANGEMENT

DEVELOPMENT POLICY CREDIT

Table of Contents

1. INTRODUCTION AND COUNTRY CONTEXT .................................................................................................. 1

2. MACROECONOMIC POLICY FRAMEWORK .................................................................................................. 3

2.1 RECENT ECONOMIC DEVELOPMENTS ..................................................................................................... 3

Table 1: Key Macroeconomic Indicators........................................................................................................... 4

2.2 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ................................................................... 6

Table 2: Fiscal Indicators ................................................................................................................................... 6

Table 3: BOP Financing Needs and Sources ...................................................................................................... 8

2.3 IMF RELATIONS ..................................................................................................................................... 11

3. THE GOVERNMENT’S PROGRAM ............................................................................................................... 12

4. THE PROPOSED OPERATION ...................................................................................................................... 12

4.1 LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION ................................................ 12

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS .......................................................... 13

Pillar 1: Establish a framework to move towards fiscal federalism ..................................................... 13

Pillar 2: Improve the policy framework for public financial management .......................................... 19

Table 4: Changes in the Results Framework from DPC1 ................................................................................ 23

Table 5: DPO Prior Actions and Analytical Underpinnings ............................................................................. 26

4.3 LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY ................................................... 27

4.4 CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS ............................................... 28

5. OTHER DESIGN AND APPRAISAL ISSUES.................................................................................................... 29

5.1 POVERTY AND SOCIAL IMPACT ............................................................................................................. 29

5.2 ENVIRONMENTAL ASPECTS .................................................................................................................. 29

5.3 PFM, DISBURSEMENT AND AUDITING ASPECTS ................................................................................... 30

5.4 MONITORING, EVALUATION AND ACCOUNTABILITY ........................................................................... 32

6. SUMMARY OF RISKS AND MITIGATION .................................................................................................... 32

Table 6: Summary Risk Ratings ....................................................................................................................... 33

ANNEX 1: POLICY AND RESULTS MATRIX ...................................................................................................... 34

ANNEX 2: LETTER OF DEVELOPMENT POLICY ................................................................................................ 37

ANNEX 3: FUND RELATIONS ANNEX .............................................................................................................. 40

ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE ............................................................ 46

ANNEX 5: ACHIEVEMENTS UNDER DPC1 ....................................................................................................... 48

List of Tables:

Table 1: Key Macroeconomic Indicators……………………………………………………………………………….………….………...4

Table 2: Fiscal Indicators…………………………………………………………………………………………………………………….……....6

Table 3: BOP Financing Needs and Sources………………………………………………………………………….………….…….……8

Table 4: Changes in the Results Framework from DPC1……………………………………………………………………….……23

Table 5: DPO Prior Actions and Analytical Underpinnings………………………………………………………………………...26

Table 6: Summary Risk Ratings……………………………………………………………………………………………………………......33

List of Figures:

Figure 1: Nepal: Indicators of Public and Public Guaranteed External Debt under Alternative Scenarios

2019-2029………………………………………………………………………………………………………………….………….…..10 Figure 2: Nepal Indicators of Public Debt Under Alternative Scenarios, 2019-2029………………….….….…….....11

The proposed Fiscal and Public Financial Management Development Policy Credit was prepared by a team consisting

of Kene Ezemenari (Task Team Leader, GMTSA), Franck Bessette (co-Task Team Leader, GGODR); Nayan Krishna Joshi,

Mehwish Ashraf and Saurav Rana (GMTSA); Yogesh Bom Malla, and Timila Shrestha (GGODR), Sunita Kumari Yadav

(SACNP); Hiroki Uematsu (GPV06); Suiko Yoshijima (GEN06); Kamran Akbar and Avani Mani Dixit (GSU18); Carolin e

Mary Sage and Jaya Sharma (GSU06). The team is grateful for the overall guidance provided by Manuela Francisco,

Mona Prasad (GMTSA), Christian Eigen-Zucchi (SACBN); George Larbi (GGOES), Qimiao Fan, Faris Hadad-Zervos, and

Idah Pswarayi-Riddihough (SACBN); Bigyan Pradhan (SACNP); as well as the support and guidance of peer reviewers:

Barbara Cunha, Appolenia Mbowe, and Fabian Seiderer; and Corporate reviewers: Sati Madani (OPCSCE); Vipasha

Bansal and Junko Funahashi (LEGES); Natalie Marie Weigum (GCCSO); Sibel Kulaksiz (SARDE). The team gratefully

acknowledges the excellent collaboration of the Nepalese authorities and development partners.

SUMMARY OF PROPOSED CREDIT AND PROGRAM TO

NEPAL

SECOND PROGRAMMATIC FISCAL AND PUBLIC FINANCIAL MANANGEMENT DEVELOPMENT POLICY CREDIT

Borrower Government of Nepal

Implementation Agency

Ministry of Finance

Financing Data SDR equivalent of US$100 million IDA Credit

Operation Type Second in a programmatic series of two Development Policy Credits

Pillars of the

Operation and

Program

Development

Objective(s)

The Fiscal and Public Financial Management Development Policy Credit supports the government in its efforts to:

(i) Establish a framework to move towards fiscal federalism; and (ii) Improve the policy framework for public

financial management.

Result

Indicators

(Baseline

FY2016; Target

FY2021, unless

otherwise

mentioned)

Share of the education budget devolved to the provincial and local governments

Baseline: 0

Target: At least 60 percent

Consolidated expenditure produced on an annual basis, one fiscal year prior to the budget

Baseline: None

Target: Expenditure of previous fiscal year of all 3-tiers of GoN submitted to Parliament with annual budget

Own revenue sources of provincial and local governments

Baseline: 2 percent of consolidated revenues

Target: At least 10 percent increase

Share of federal transfers spent by local governments Baseline: 0 percent

Target: At least 40 percent

Equalization and conditional grants in FY20 budget made as per the formula

Baseline: Not applicable

Target: Grants made to all provincial and local governments

Number of provinces that have adopted gender responsive budgeting

Baseline: None

Target: All 7 provinces

Consolidated public expenditure data publicly available within 6 months of end-FY

Baseline: Not available

Target: FY2019 Expenditure on FCGO’s website

Number of provinces adopting the MTEF guidelines Baseline: None

Target: All 7 provinces

Deviation between consolidated revised budget estimates and actual consolidated spending

Baseline: Not available

Target: 20 percent or lower deviation

Proportion of federal capital expenditure undertaken in the last quarter

Baseline: 75 percent

Target: 65 percent

Audit irregularities reported by the OAG report Baseline: Audit irregularities of 7 percent for federal government agencies (OAG 2016 report)

Target: Audit irregularities of 6 percent or less across all 3-tiers of government (2020 OAG report)

Adoption of DRM framework by local governments Baseline: No framework in place

Target: At least 1 municipality in each province

Timely availability of information on revenue collection Baseline: Data on 90 percent of tax collection available with a lag of two months.

Target: Data on 100 percent of revenue collection for federal government available real-time, 60 percent of revenue collection for provincial governments available real-time and 40 percent of local government revenue collection available by mid-January following the concerned fiscal year.

Overall risk rating

Substantial

Climate and disaster risks

No

Operation ID P168869

1

IDA PROGRAM DOCUMENT FOR A PROPOSED DEVELOPMENT POLICY CREDIT TO NEPAL

1. INTRODUCTION AND COUNTRY CONTEXT

1. The proposed operation is the second and last in a programmatic series to support the Government of Nepal (GoN) in its efforts to establish a framework to move towards fiscal federalism and improve the policy framework for public financial management. This operation, in the amount of SDR equivalent of $100 million, builds on reforms supported under the first Development Policy Credit (DPC) in the programmatic series. DPC1 supported reforms to establish the legal frameworks to govern resource allocation across the three tiers of government and guide operations of local governments. It also supported measures to strengthen budget execution and PFM systems at the federal level. This operation builds on these reforms by establishing some of the subsequent elements of the legal framework and supporting local governments in the implementation of the legislations enacted under DPC1. It also draws from prior analytical work, ongoing Public Financial Management (PFM) activities and World Bank and other donor assistance to the government in fiscal devolution.

2. The move towards federalism is expected to improve service delivery but risks arising from capacity concerns of provincial and local governments, especially during the transition, remain. The transition to fiscal federalism has begun. Fiscal transfers to provincial and local governments (provincial and local) were 8.3 percent of GDP in FY2018 and are expected to increase as devolution continues. An annual budgeting process is in place at the provincial and local level with guidelines issued by the federal government. The continuation of the development of local government infrastructure, IT systems, human resources management and capacity are critical for enhancing public financial and revenue management. All these improvements will contribute to more effective service delivery. However, during the transition period, underdeveloped PFM systems and institutions, particularly at the local level, pose risks to effective use and management of resources for service delivery. Critical reforms are needed in the short term to strengthen budget systems including revenue and expenditure management and tracking. In addition, there continues to be understaffing in provincial and local governments level and confusion over concurrent responsibilities linked to both spending and revenue assignment.

3. Good progress has been made, and as expected in reforms of this magnitude, Nepal is going through some challenges in the early stages of the transition to federalism. This is primarily due to limited capacity at the provincial and local level and challenges around the devolution of federal staff to local levels. This has been a key constraining factor to the implementation of federalism and execution of provincial and local government budgets. In addition, federalism start-up costs linked to construction of local level government building and purchase of equipment have contributed to larger deficits. Given that the move to a federal structure is just over a year old and that the government is still putting in place the basic building blocks, a comprehensive assessment of the process is not yet available. Despite this, progress has been made in establishing the fiscal and PFM framework at the federal level (supported by DPC1) that will support the transition and put in place the laws, budget processes and systems for tracking expenditure. Transfers have been made to local and provincial governments, budgets have been approved on time, consolidated funds have been established, and FY2018 expenditure data of provincial and local governments have been collected, analyzed and made publicly available, as per the laws supported by DPC1. The proposed operation furthers these reforms by supporting legislation that governs budget execution, fiscal discipline, and revenue assignment among the three tiers of government. It also supports implementation of laws enacted in DPC1 and the guidelines to provincial and local governments to enable them to adopt medium-term expenditure frameworks (MTEFs), gender responsive budgeting, and strengthened expenditure controls. The Bank is undertaking analytical work and is providing technical assistance to improve spending efficiency through the Public Financial Management Multi-Donor Trust Fund (PFM MDTF) as well as through the Federalism Implementation Support Platform and Federalism Capacity Needs Assessment. Adjustments and mid-term

2

corrections will be inevitable as federalism proceeds, more systems become operational and gaps in the existing systems become more evident.

4. This proposed second operation in the programmatic DPC series (DPC2) is supported through other World Bank and donor engagements. DPC2 supports reforms under two pillars. Pillar 1 supports measures to establish a framework to move towards fiscal federalism through various legislations, policies and regulations while Pillar 2 supports reforms to improve the policy framework for public financial management at the provincial and local levels. The DPC series is complemented by other WBG instruments and activities of other donors supporting various aspects of the federalism transition. The Integrated Public Financial Management Reform Project (IPFMR), effective since October 2018, supports implementation of key reforms linked to strengthening budget execution and systems for reporting under the new federal structure. The Government has also embarked on reforms to strengthen legislation and the related framework for public investment management and Public Private Partnerships (PPPs), and define the role of provincial and local governments. This is being supported through the upcoming Maximizing Finance for Development (MFD) DPC. The reforms supported by this fiscal and PFM DPC series also complement the overall support to federalism being provided by Development Partners (DPs) through the multi-donor trust fund (MDTF).1 A World Bank-UNDP supported Federalism Capacity Needs Assessment including assessments of all three tiers of government, as well as a mapping of DP’s support is being undertaken to assess capacity gaps for the transition to federalism at the request of the Government and its development partners. There is also a ‘federalism DPs working group’ comprising several DPs that meets regularly to harmonize assistance to the government on federalism transition.

5. Poverty has been on a declining trend and recent progress with federalism will help mitigate the risks from fragility. The proportion of Nepalese households living in poverty (as measured by the international extreme poverty line) fell from 46 percent in 1996 to 15 percent in 2011.2

Nepal has also had impressive performance on shared prosperity. From 2003 to 2010, consumption growth of the bottom 40 percent was 7.5 percent compared to 4 percent on average across all households and is projected to be 10 percent in 2019. With a higher poverty line of $3.20 a day, the poverty rate is projected to decline to 42 percent in 2019, from 51 percent in 2010. The key drivers of improvement in the twin goals have included an increase in the amount and the number of households receiving remittances, an increase in labor income derived from wage and nonwage employment, and changes in the demographic structure with a lowering of the dependency ratio. Progress with reform implementation at the provincial and local level has included establishment of a budgeting process and guidance issued by the federal government that include accounting processes; successful fiscal transfers based on a transparent formula, adoption of key legislation that provide a transparent framework for resource allocation and increased accountability of provincial and local government operations. These reforms point to progress with federalism, despite the capacity challenges and delays in devolution and will help reduce the risks associated with fragility.

6. Overall, substantial risks to the operation stem largely from the level of capacity, as well as the political and stakeholder context. Jurisdictional overlap between the three tiers of government, lack of clarity and coherence between policies and devolved powers could undermine coordination across government agencies, impede reform implementation and disrupt service delivery. Resistance from some stakeholders that benefit from the current policies and status quo could further slowdown reforms. Weak institutional capacity and enforcement of rules and regulations, particularly at the provincial and local

1 The MDTF is managed by the World Bank with funding from U.K. Department for International Development (DfID), Government of Norway, Department of Foreign Affairs and Trade Australia (DFAT), United States Agency for International Development (USAID), European Union (EU) and the Government of the Swiss Confederation. 2 Based on International US$1.90 (2011 PPP) per day per capita, Nepal Systemic Country Diagnostic 2017.

3

government levels, form significant sources of fiduciary risks and fragility. These risks are mitigated by strong government commitment to needed reforms, including those supported by this operation and extensive donor engagement to build institutional capacity.

2. MACROECONOMIC POLICY FRAMEWORK

2.1 RECENT ECONOMIC DEVELOPMENTS

7. Gross Domestic Product (GDP) growth in Nepal remained strong at 7.1 percent in FY2019. On the supply side, the main growth drivers were the service and agriculture sectors. Within services, there was a boost in retail, hotel and restaurant subsectors, primarily driven by an uptick in tourist arrivals and remittances fueled private consumption. Agriculture grew by 5.0 percent year-over-year (y/y) in FY2019, well above its 30-year average of 3.1 percent. This was due to good monsoon together with the commercialization of agriculture, availability of fertilizers and seeds, and improved irrigation facilities. Industrial growth was equally strong at 8.1 percent year-on-year (y/y) in FY2019, well above its 25-year average of 4 percent. This was due to improved power availability due to increased generation and higher imports from India and post-earthquake housing reconstruction, which is in full swing. On the demand side, both private investment and consumption contributed to growth; with private investment growing at 19.5 percent and private consumption growing at 6.5 percent. Foreign direct investment (FDI), while still at very low levels, also grew by a healthy 32 percent (y/y) in FY2018 (Table 1).

8. Inflation remained subdued in FY2018. Average inflation was 4.2 percent in FY2018. Prices for non-food items grew at 5.3 percent while food prices, which mirror the trend in India, rose by 2.8 percent. In the first half of FY2019, inflation picked up and was driven by non-food items but moderated again during the second half of the year. The Nepalese rupee is pegged to the Indian rupee at the rate of 1.6 Nepalese Rupees to 1 Indian Rupee (India is the largest trading partner) and, thus, inflation follows the price movements of the nominal anchor but with a lag.

9. The trade deficit widened to 37.4 percent of GDP in FY2018, driven by a surge in reconstruction and capital related imports. Exports registered record growth of 15.6 percent (y/y) due to expansion into new markets in China and Turkey, as the country recovered from the trade disruption of FY2016. Imports, however, grew at a faster pace due to higher oil prices, and needed inputs to support earthquake reconstruction and the establishment of provincial and local government offices.

10. The growth rate of remittances, which financed almost all imports in previous years, has slowed down. The volume of remittance inflows is still large at US$7.2 billion in FY2018. Remittances grew by 10 percent, but as a share of GDP declined from 26.0 percent in FY2017 to about 25 percent in FY2018 (Table 1). In FY2019, various factors have contributed to the increase in remittance receipts. The depreciation of the Nepalese rupee against the US dollar has encouraged migrant workers to remit a greater share of their savings to benefit from the favorable exchange rate. This coupled with an increased use of formal channels for remittances contributed to an increase in officially recorded remittance inflows in the first six months of FY2019. In addition, Nepalese migrants are increasingly going to and remitting money from Japan and the Republic of Korea, where wage rates are much higher. However, growth in remittances are expected to slow down from FY2020 as the impact of the depreciation and one-off increase from the use of formal channels wanes. The main destinations for Nepali migrants are countries in the Gulf (Qatar, Saudi Arabia, United Arab Emirates) and Malaysia. Malaysia, the largest destination of Nepalese migrants (or 29 percent of the total), closed some agencies that process visas for Nepalese migrant workers due to concerns about overcharging migrant workers. In the Gulf countries, fiscal pressures led to expenditure cuts which could adversely affect

4

the demand for migrant workers.

Table 1: Key Macroeconomic Indicators

FY2016 FY2017 FY2018(e) FY2019(f) FY2020(f) FY2021(f) FY2022(f)

Real economy (Percentage change, unless otherwise stated)

Nominal GDP, current prices (NPR, billions) 2,253 2,674 3,031 3464 3993 4604 5042

Real GDP growth (at market prices) 0.6 8.2 6.7 7.1 6.4 6.5 6.5

Real GDP growth (at factor prices) 0.2 7.7 6.3 6.8 6.4 6.5 6.5

Contributions to GDP growth:

Agriculture (percentage points) 0.1 1.8 0.9 1.6 1.4 1.4 1.4

Industry (percentage points) -1.0 1.8 1.5 1.3 1.3 1.4 1.4

Services (percentage points) 1.1 4.1 3.9 3.9 3.7 3.6 3.7

Consumer prices (period average) 9.9 4.4 4.2 5.0 4.7 5.0 4.7

Fiscal sector (As percentage of GDP, unless otherwise indicated)

Total revenue and grants 23.3 24.1 25.2 27.6 29.6 30.5 30.9

Expenditures 21.9 27.2 30.9 31.0 33.2 35.6 35.7

Fiscal balance (including grants) 1.4 -3.1 -5.7 -3.4 -3.6 -5.1 -4.8

Total public debt 27.9 26.3 30.3 30.0 31.1 32.7 34.1.4

Domestic 10.6 10.8 13.7 13.3 13.1 13.6 14.38

External 17.3 15.5 16.6 16.6 18 19.2 19.9

Monetary sector (Percentage change, unless otherwise indicated)

Broad money 19.5 15.5 19.4 …. …. …. ….

Domestic credit 17.4 21.4 24.9 …. …. …. ….

Private sector credit 23.2 18.0 22.3 …. …. …. ….

Balance of payments (As percentage of GDP, unless otherwise

indicated)

Current account balance 6.2 -0.4 -8.1 -8.0 -6.6 -5.5 -4.2

Exports of goods and services 9.5 9.0 8.9 9.0 9.1 9.3 9.8

Imports of goods and services 39.3 42.4 46.3 50.8 49.6 48.4 47.6

Remittances (as percentage of GDP) 29.5 26.0 24.9 28.2 27.3 26.5 26

Gross official reserves ($, millions, eop) 8,340 8,730 9,479 7,892 7,679 7,867 8,519

Gross official reserves (in months of prospective imports

of goods and services) 11.1 9.0 7.7 6.4 5.5 5.0 4.9

Rupees per U. S. dollar (period average) 106.4 106.2 104.4 … … … …

5

Memorandum items:

Nominal GDP, current prices (USD, billion) 21.2 25.2 … … … … …

Population, million 29.0 29.2 … … … … …

GDP per capita, USD current 731 863 … … … … …

Source: Nepal authorities and World Bank staff estimates

11. Consequently, the current account balance has recorded a sizeable deficit. Slower growth of remittances and a surging trade deficit have begun to put pressure on the current account. The trade deficit reached a historic high of US$10.9 billion in FY2018. Remittance inflows of only US$7.2 billion were insufficient to offset the trade deficit. Consequently, the current account recorded a deficit of 8.1 percent of GDP in FY2018 compared to a deficit of 0.4 percent the previous year and a surplus that averaged 5 percent of GDP during FY2012-FY2016. Given that FDI and external borrowing and other financing sources remained low, Nepal’s foreign exchange reserves fell to US$9.3 billion in July 2018 from a peak of US$9.5 billion in January 2018. However, this is equivalent to a comfortable 8.2 months of imports.

12. Credit growth picked up while the slower deposit growth continues. Credit growth rose steadily during the second half FY2018 to reach 22.4 percent (y/y) in July 2018 driven by increased lending to all sectors. Deposits also grew by 18.8 percent (y/y) in July 2018 mainly due to the uptick in remittance inflows in the last quarter of FY2018. However, deposits growth lagged that of credit and resulted in liquidity tightening. Interest rates increased as the banking sector’s core capital plus deposit (CCD) ratio remained close to the 80 percent regulatory limit – 76.8 percent in July 2018.

13. The banking sector remains stable but faces pressures on the availability of loanable funds. The Capital Adequacy Ratio (CAR) of commercial banks stood at 14.6 percent as of July 2018, meeting the regulatory minimum of 10 percent. The Non-Performing Loan (NPL) ratio remains low at 1.3 percent of the total loan portfolio, and loan loss provisions are adequate. Nevertheless, there are concerns of bad loan evergreening. The forbearance measures introduced by Nepal Rastra Bank (NRB, the Central Bank of Nepal) to address the negative impact of the 2015 earthquake and 2015–2016 trade disruptions have been fully rolled back. However, challenges in the financial sector persist and need to be monitored. The decision to allow provincial and local governments to deposit half of their funds in commercial banks led to a loosening of liquidity in the current year. In response, NRB has taken macroprudential measures to contain credit growth like reduction in loan to value ratios and loan to deposit ratios. The NRB remains committed to strengthening supervision and raising capital and provisioning buffers and is receiving technical assistance from the IMF and DfID in some of these areas.

14. Annual revenue growth is robust, but government spending has picked up significantly resulting in a higher fiscal deficit. In FY2018, the revenue target was met because of the heavy reliance on trade taxes. Elevated imports during the year led to healthy tax collection. Total expenditure has also grown substantially due to spending linked with the federalism transition. Recurrent expenditure reached 23.1 percent of GDP, with fiscal transfers to provincial and local governments comprising 8.3 percent of GDP. This is the largest budget item in the Government of Nepal’s budget. Capital spending was at 7.8 percent of GDP in FY2018 – same as in FY2017. As a result, the consolidated fiscal deficit increased to 5.7 percent of GDP in FY2018 compared to 3.1 percent in FY2017 (Table 2) and was financed partly by tapping into government deposits and partly through domestic debt. Consequently, public debt reached 30.3 percent of GDP by end-FY2018 (Table 1).

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2.2 MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

15. GDP growth is projected to average 6.5 percent over the medium term driven primarily by investments. On the supply side, services are expected to continue driving growth, underpinned by steady remittance inflows and high tourist arrivals under the Visit Nepal 2020 program. Agriculture growth is expected to average 4.5 percent over the forecast period, supported by programs to promote improved inputs, storage facilities, irrigation and agribusiness value chains. Construction activities, new investments in the cement and hydropower sectors and improved capacity utilization in the manufacturing sector, as the availability of electricity improves, will help support growth in industry. On the demand side, the government plans to shift from a consumption to an investment-based growth model in the long-run. For this purpose, the government has emphasized engaging the private sector and raising the low levels of FDI through increasing investment. Overall, infrastructure investment needs are estimated at 10-15 percent of GDP annually for the next 10 years, to accelerate growth. FDI is showing an upward trend, but critical reforms will be needed to address the factors that are constraining its flow (Table 3). Many reforms that are expected to boost growth are being supported through the Maximizing Finance for Development DPC, which focuses on improving the environment for domestic and foreign investors and deepening credit markets for private financing of investments. In addition, the recently concluded financial sector DPC series focused on financial sector stability and improving access to formal financial services while the on-going energy DPC focuses on improving the financial viability and governance of the electricity sector. Inflation is projected to increase to 4.8 percent over the medium term due to an expected increase in aggregate demand, a continued increase in global oil prices, and depreciation of the exchange rate. NRB’s policy is also to ensure adequate liquidity to support growth and achieve domestic credit growth of around 22 percent.

Table 2: Fiscal Indicators (As percentage of GDP, unless otherwise indicated) FY2016 FY2017 FY2018(e) FY2019(f) FY2020(f) FY2021(f) FY2022(f)

Total Revenue and Grants 23.3 24.1 25.2 27.6 29.6 30.5 30.8

Total revenue 21.5 22.9 24.0 26.5 28.3 29.1 29.5

Tax revenue 18.7 20.7 21.7 23.6 25.7 26.5 26.7

Taxes on Goods and Services (incl. VAT, excise) 9.1 10.4 11.3 11.8 12.2 12.6 12.8

Direct Taxes 5.1 5.4 5.5 6.0 7.0 7.1 7.1

Taxes on international trade 3.6 3.9 4.0 4.6 5.3 5.5 5.6

Nontax revenue 2.7 2.1 2.3 2.3 2.6 2.6 2.8

Grants 1.8 1.2 1.2 1.2 1.3 1.4 1.4

Total Expenditure 21.9 27.2 30.9 31.0 33.2 35.6 35.7

Current expenditure 16.5 19.4 23.1 23.4 24.6 26.4 26.3

Wages 4.0 4.4 3.7 3.7 3.9 4.2 4.2

Goods and services 2.0 2.1 2.76 2.7 2.8 3.0 3.1

Interest payment 0.4 0.4 0.8 1.0 0.8 0.8 0.8

Current transfer 10.2 12.4 15.9 15.9 17.0 18.3 18.3

Of which fiscal transfers 8.3 8.3 8.3 8.3 8.3

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Capital expenditure 5.4 7.8 7.8 7.7 8.6 9.3 9.3

Overall balance (excluding grants) -0.4 -4.3 -6.9 -4.6 -4.9 -6.5 -5.8

Fiscal balance (including grants) 1.4 -3.1 -5.7 -3.4 -3.6 -5.1 -4.5

Net financial transactions (including overdraft) -1.4 3.1 5.7 3.4 3.6 5.1 4.5

Net acquisition of financial assets (includes on-lending) 1.7 1.7 1.9 0.1 0.1 0.1 0.1

Net incurrence of liabilities (financing needs) 2.4 3.2 5.6 3.5 3.7 5.2 4.5

Foreign 0.7 1.3 1.5 2.1 2.2 3.0 2.9

Domestic 1.7 1.9 4.1 1.4 1.5 2.2 1.6

Source: Nepal authorities and World Bank staff estimates

16. NRB’s stated monetary policy stance aims to maintain the exchange rate peg with the Indian rupee and currently, they have adequate reserves to maintain the peg. Open market operations are the main instrument used to conduct monetary policy. For fiscal and monetary policy coordination, the Secretary of Finance sits on the NRB Board that sets monetary targets. The NRB estimates potential growth at 7 percent and conducts policy by ensuring that private sector credit growth is aligned with growth of broad money and within the inflation ceiling. However, interbank interest rates in Nepal have fallen below the band of the Interest rate corridor (IRC), to nearly 1 percent as against the IRC band of 3.5 to 6.5 percent. Therefore, the interest rate gap, relative to India has increased and this puts pressure on the peg. The NRB, however, remains committed to the peg. 17. The current account deficit, which grew in FY2018, is expected to narrow over the medium term. Most of the growth in the external deficit in FY2018 was driven by strong import demand (from federalism related costs, post-earthquake reconstruction, and construction) and higher oil prices. However, Nepal continues to have adequate reserves and its external debt is low. Over the medium term, as the one-time spending on federalism related infrastructure and post-earthquake reconstruction taper down, the growth in imports will also reduce. But investments are likely to remain high which will keep the current account deficit (CAD) high over the medium term. The efforts aimed at boosting exports will have an impact only over the longer run. Remittances as a share of GDP are expected to stabilize at 27 percent over the medium-term. The external gap will be financed primarily by long term borrowing and a drawdown of international reserves. The current account deficit is expected to moderate to 4.2 percent of GDP and international reserves are likely to cover around 5 months of imports by FY2022. There are negligible portfolio investments in the country and despite some expected increase in FDI, it will continue to remain low (Table 3). 18. Government expenditure is expected to increase over the medium-term primarily because of the implementation of fiscal federalism. Government spending as a percent of GDP increased by 3.7 percentage points between FY2017 and FY2018, primarily driven by a higher wage bill, larger transfers to local government to implement federalism, and earthquake-related reconstruction activities. The transfers to the local government alone increased to 8.3 percent of GDP in FY2018. From FY2019, revenue sharing transfers of around 2 percent of GDP come into effect resulting in total transfers of around 10 percent of GDP over the medium term. In the next three years (FY2019-FY2021), total expenditure is likely to grow as a result of the implementation of the federal structure and stabilize around 35 percent of GDP over the medium term. 19. Fiscal consolidation efforts are primarily aimed at increasing revenues. These efforts can broadly be classified into (i) rationalization of VAT related refunds and exemptions, (ii) wider tax base for property taxes, (iii) increased tax on tobacco and vehicles (iv) revision of import reference prices based on market signals,

8

and (v) tax administration improvements, including an integrated customs management system, strengthened tax accounting system and tax incentives for tax officials. Taxes on imports, luxury items and higher income brackets and a broadening of the tax base will help increase revenue and grants to 30.8 percent of GDP by FY2022. Non-tax revenues are also expected to increase because of dividends from institutions (such as Nepal Telecom) and royalties from new hydropower projects. Some of these measures were adopted as part of the FY2019 budget. At the provincial and local level, efforts are focused on establishing the legal and institutional framework to support enhanced own-tax revenue collection. However, sharp revenue increases are not sustainable in the long run. Therefore, reforms are also being undertaken to increase spending efficiencies over the short to medium term. This is being supported by the current operation (through MTEF, fiscal procedures, delegation of spending authority), the Integrated Public Financial Management Reform Project (IPFMR) on budget execution and capacity strengthening efforts by donors.

20. The challenges related to the transition to federalism have resulted in lower than budgeted spending in FY2019. As a result, the fiscal deficit is estimated to reduce to 3.4 percent of GDP. In the subsequent years, as the provincial and local governments become fully functional, the fiscal deficit is projected to increase, rising to 5.1 percent of GDP in FY2021. From FY2022 onwards, greater expenditure efficiencies will help reduce the deficit. The transition to federalism is the key factor driving the fiscal deficit. Initially, the assumed cost (as presented in the DPC1 program) was 3 to 4 percent of GDP per year over the medium-term. The government has set up a commission to review and suggest measures to improve spending efficiency. In addition, the DPs, including the WB, are working to improve various facets of PFM and PIM. Also, once the Federalism transition has ended and there is more information on unit costs for delivery of services at the local level, some spending efficiency can be achieved. The fiscal deficit will be financed by a mix of domestic and international borrowing. The availability of concessional financing from international DPs is expected to continue, as the transition to a federal structure proceeds.

Table 3: BOP Financing Needs and Sources in US$ millions FY2016 FY2017 FY2018(e) FY2019(f) FY2020(f) FY2021(f) FY2022(f)

Financing requirements 1,153 -263 -2,528 -2,234 -2,098 -1,995 -1,636

Current Account deficits 1,320 -95 -2,349 -2,398 -2,266 -2,176 -1,826

Debt amortization -167 -168 -178 164 168 181 190

Financing Sources -1,153 263 2,528 2,234 2,098 1,995 1,636

FDI and portfolio investment (net) 56 127 168 209 310 437 522

Long term borrowing 338 589 956 905 957 991 1,034

Others (trade credits, currency deposits, misc

items etc)

100 129 1,651 483 619 755 732

Changes in reserves (minus sign indicates

increase)

-1,647 -583 -247 637 212 -187 -652

Source: Nepal authorities and World Bank staff estimates

21. Results from the most recent DSA indicate that Nepal remains at low risk of debt distress, primarily due to the important role of remittances. All external debt and debt service indicators are projected to be comfortably below their policy-dependent indicative threshold values. Following a prolonged decline, to 26 percent of GDP in FY2015, the sum of external and domestic public debt rose to 30.3 percent of GDP in FY2018. A further rise in total public debt is projected, to average about 32 percent of GDP over the period

9

FY2019 to FY2022 and around 46 percent over the long term; the present value of debt to GDP will remain below 30 percent. Fiscal and current account deficits will persist, as the GoN proceeds with key reforms to implement fiscal federalism, and ease constraints to investment and finance, with the goal of accelerating growth. Stress tests show a vulnerability to growth shocks and natural disasters and underscores the importance of implementing sound macro-economic policies including structural reforms in support of productivity-led growth and improved spending efficiency.

22. Nepal’s macroeconomic policy framework is adequate for development policy financing. Despite several severe shocks in the past (including conflict, unstable governments, earthquakes, and trade disruptions), Nepal’s macroeconomic fundamentals have been sound: high growth in revenue, low debt to GDP ratio, a stable financial sector and comfortable reserves. Going forward, the GoN remains committed to macro-fiscal prudence, as evident in its efforts to increase revenues to finance the higher cost of federalism, its decision to undertake a spending review to contain expenditures and improve their efficiency and continued commitment to maintain the peg with the Indian Rupee. After more than a decade, the country now has policy stability that will support growth. The key risks are on the fiscal and external front. The transition to a federal structure will increase government spending and keep the fiscal deficit high. Risks are mitigated, to an extent, by the fact that there is considerable donor support for this transition, both in terms of technical assistance and concessional financing. The external deficit is also likely to remain elevated. Reforms supported by the proposed DPC series will help improve spending efficiency to reduce fiscal risks, particularly during the federalism transition. It will also support government efforts to raise additional revenues. In addition, through the Federalism Platform, the WB will provide technical assistance to strengthen local revenue generation and fiscal discipline which should have a positive effect on the twin deficits. The MFD DPC series will help improve the investment climate and competitiveness, which will support export growth and help maintain reserve adequacy. Nepal is also vulnerable to climatic shocks that could disrupt growth; reforms supported by the Fiscal, Energy, Financial sector and MFD DPCs along with other engagements will help mitigate this risk.

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Sources: Country authorities; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. Stress tests with one-off breaches are also presented (if any), while these one-

off breaches are deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-

off breach, only that stress test (with a one-off breach) would be presented.

2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department.

Threshold

0.9%0.9%

100%

Interactions

No

User definedDefault

Terms of marginal debt

* Note: All the additional financing needs generated by the shocks under the stress tests are

assumed to be covered by PPG external MLT debt in the external DSA. Default terms of marginal

debt are based on baseline 10-year projections.

Market Financing n.a.n.a.

Tailored Tests

5.0%

6

34

5.0%

34

6

Combined CLs

Natural Disasters

Figure 1. Nepal: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2019-

2029

Most extreme shock 1/

No

Size

Customization of Default Settings

Historical scenario

External PPG MLT debt

Baseline

Borrowing Assumptions for Stress Tests*

Shares of marginal debt

Avg. grace period

Note: "Yes" indicates any change to the size or

interactions of the default settings for the stress tests.

"n.a." indicates that the stress test does not apply.

Commodity Prices 2/

Avg. nominal interest rate on new borrowing in USD

USD Discount rate

Avg. maturity (incl. grace period)

No

n.a.n.a.

No

No

-5

0

5

10

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25

2019 2021 2023 2025 2027 2029

Debt service-to-revenue ratio

Most extreme shock is One-time depreciation

-150

-100

-50

0

50

100

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300

2019 2021 2023 2025 2027 2029

PV of debt-to-exports ratio

Most extreme shock is Combination-20

-10

0

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60

2019 2021 2023 2025 2027 2029

PV of debt-to GDP ratio

Most extreme shock is Combination

-5

0

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25

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Debt service-to-exports ratio

Most extreme shock is Exports

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2.3 IMF RELATIONS

23. The last Article IV Consultation with Nepal was discussed at the IMF Board on February 8, 2019. The Article IV Staff Assessment noted the progress made in establishing the fiscal federalism framework and highlighted the need to ensure fiscal sustainability, make budgets more realistic and spending more efficient, and build implementation capacity. It emphasized the importance of building policy implementation capacity and instituting a sound public financial management framework at the provincial and local level. The Bank team is closely coordinating with the Fund on PFM capacity building, the federalism agenda, and overall reforms to raise investment and accelerate growth.

Baseline Most extreme shock 1/

Public debt benchmark Historical scenario

Default User defined

59% 59%

37% 37%

-166% 4%

0.9% 0.9%

34 34

6 6

-1.8% -1.8%

7 7

1 1

-4% -4.0%

Sources: Country authorities; and staff estimates and projections.

Figure 2. Nepal: Indicators of Public Debt Under Alternative Scenarios, 2019-2029

Borrowing Assumptions for Stress Tests*

Shares of marginal debt

External PPG medium and long-term

Domestic medium and long-term

Domestic short-term

1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. The stress test with a one-off breach is

also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off

breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off

breach) would be presented.

Domestic MLT debt

Avg. real interest rate on new borrowing

Avg. maturity (incl. grace period)

Avg. grace period

Domestic short-term debt

Avg. real interest rate

* Note: The public DSA allows for domestic financing to cover the additional financing needs generated by the shocks under

the stress tests in the public DSA. Default terms of marginal debt are based on baseline 10-year projections.

External MLT debt

Avg. nominal interest rate on new borrowing in USD

Avg. maturity (incl. grace period)

Avg. grace period

Terms of marginal debt

0

20

40

60

80

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160

2019 2021 2023 2025 2027 2029

PV of Debt-to-Revenue Ratio

Most extreme shock is Growth

0

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2019 2021 2023 2025 2027 2029

Most extreme shock is Growth

0

2

4

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18

2019 2021 2023 2025 2027 2029

Debt Service-to-Revenue Ratio

Most extreme shock is Growth

PV of Debt-to-GDP Ratio

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3. THE GOVERNMENT’S PROGRAM

24. The Constitution includes equality and justice as fundamental rights and successive governments have set out ambitious plans in social and infrastructure programs to support these rights. The current Periodic Plan (i.e., 14th Plan) aims to achieve middle income status by 2030 and outlines an ambitious investment program. This periodic plan guides the annual development policy directives and strategic directions of the annual budget. The ongoing exercise to prepare the next five-year (15th) Periodic Plan (to be launched in FY2020) is expected to give high focus to maximizing finance for development in addition to ongoing priorities highlighted in the current 14th Periodic Plan. Improved public financial management is identified as a cross cutting area to help achieve these objectives. The Government’s second-generation PFM Reform Program, Public Financial Management Reform Program (or PFMRP II) draws from the 2015 PEFA. The PFMRP II aims to achieve eight outcomes which are derived from critical dimensions of the PEFA Framework and covers all key areas of the PFM cycle.

4. THE PROPOSED OPERATION

4.1 LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

25. The transition to federalism is an on-going and dynamic process. DPC1 focused on umbrella laws while DPC2 is operationalizing these laws and furthering fiscal federalism at the provincial and local level, with adaptations along the way, to meet the dynamic needs of the federalism transition process. The government went in for a ‘big bang’ approach to decentralization in the context of constrained local capacity. As more information became available and challenges arose, the government had to adapt its approach to the changed environment. The DPC series supports an ambitious set of reforms by the three tiers of government and the changes in DPC2 reflect the changes in the government’s program, capacity constraints and the evolving nature of the transition to federalism.

26. The first operation in the DPC series supported umbrella legislations at the federal level to govern fiscal federalism. Under the first operation, three primary framework laws governing fiscal federalism were adopted – the Intergovernmental Fiscal Arrangement Act, the National Natural Resources and Fiscal Commission Act and the Local Government Operations Act. These three laws spelt out the legal framework for resource allocation among the three tiers of government, fiscal transfers to be made to the provincial and local governments and the operational procedures and management of local governments. In addition, to strengthen various aspects of public financial management, the government mandated the preparation of MTEFs at the Federal level, undertook steps to improve budget execution and operationalized a management information system for real time reporting on revenues at the federal government.

27. Building on the progress achieved with the first operation (summarized in Annex 5), DPC2 aims at furthering the fiscal federalism process, focusing on reforms at the second and third tier of the government. The series is organized under two pillars: (i) establish a framework to move towards fiscal federalism, and (ii) improve the policy framework for PFM. DPC2 supports the implementation of umbrella Acts approved under DPC1 (i. e. the Intergovernmental Fiscal Arrangement Act, Local Government Operations Act, National Natural Resources and Fiscal Commission Act, Disaster Risk Reduction Management Act). Implementation of these Acts was initiated with the fiscal transfers made to provincial and local governments in FY2018 that were based on the newly established framework of laws. In addition, under DPC2 support, real time information on revenues will be available at the Provincial level (and is already in place at the Federal level because of DPC1 support) and a system for quick authorization of local government spending is adopted so that spending can begin soon after budget approval, thereby minimizing delays and reducing under execution of the budget. In addition, the Nepali Constitution provides a clear role for the

13

federal government to provide standards, norms, templates, and guidelines but also limits its power to mandate or control the legal and regulatory activities of provincial and local governments. This is reflected in the issuance of guidelines by the federal government to the provincial and local levels for gender responsive budgeting, medium-term expenditure frameworks and disaster risk management which will guide their implementation at the provincial and local levels. Progress has been made on the reforms supported by DPC1 and they are being furthered by DPC2 to achieve tangible results.

28. The transition to a federal state in Nepal is an ambitious agenda and the WBG, along with other development partners, are supporting the government in fulfilling this goal. The legal framework for federalism, which is being supported by this series, incorporates key lessons learned from other countries. As an example, in the Nepali fiscal federalism context, the design of fiscal transfers includes the following lessons learned from other federal states: (i) Effective and efficient revenue collection is achieved through centralization of revenue collection efforts around major tax sources; (ii) Adequacy of funding for provincial and local governments is ensured through predictable, formula-based allocations; and (iii) Effective implementation of federalism reforms requires strong and relevant capacity support to provincial and local governments.

29. The partnership between the government and the development partners3 will be crucial for the

sustainability of the proposed reforms as the government progresses with the federalism agenda. The transition to a federal state is likely to be a long-term process spanning 5-7 years or more. The continuation of the reforms initiated by the current programmatic series of operations will be supported through other WB engagements as well as donor support. Key among them include the PFM MDTF through which the World Bank and other development partners are supporting the areas identified in the Government’s PFM Reform Program II. These are: (i) improved budget credibility including timely implementation of the budget within realistic ceilings; (ii) improved comprehensiveness and transparency of the budget; (iii) improved predictability and control in budget execution, particularly internal control and auditing; (iv) improved quality and timeliness of budget reports; and (v) improved external scrutiny and audits. The WB led federalism platform is also supporting various facets of the fiscal federalism agenda including provincial and local level taxes and debt management. In addition, several donors are also working with the government to provide support to the transition to federalism.

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS 30. The reforms supported by this operation are organized under two pillars as described below.

Pillar 1: Establish a framework to move towards fiscal federalism

Fiscal Arrangements in the Federal Context

Prior Action 1: The Cabinet has endorsed and submitted to Parliament the Federal Fiscal Procedures and Financial Responsibility Bill which governs budget execution and increases fiscal discipline and accountability.

31. Nepal has embarked on an ambitious compact between the state and citizens to move from a unitary to a federal government system. One of the key objectives of this transition to federalism is to establish a legal framework that governs budget execution at all three levels of government for increased efficiency and expansion of basic service delivery. Previously, budget planning and execution procedures were operating through directives only. To strengthen the legal framework, the Cabinet has endorsed and

3 A Development Partners coordination group on Federalism, jointly chaired by the Swiss Development Corporation and the WBG, has been formed to coordinate DPs support to the government to implement federalism.

14

submitted to Parliament the Federal Fiscal Procedures and Financial Responsibility Bill (FFPFR). This FFPFR combines two Bills that had previously been proposed as stand-alone Bills, namely the: (i) Fiscal Responsibility and Budget Management Bill; and (ii) Federal Financial Procedures Bill. In addition to establishing the legal framework to govern budget execution, combining these two Bills into the FFPFR is now aligned with international good practice4. 32. The Federal Fiscal Procedures and Financial Responsibility Act (FFPFR) will now govern public financial management and budgeting. Specifically, it will regulate: (i) operations of federal consolidated funds; (ii) formulation, approval and spending of the budget; (iii) accounting and reporting of financial transactions, internal control, internal audit; and (iv) establishment of a three-year medium-term expenditure framework (MTEF). It will also streamline financial procedures at the federal, provincial and local levels and provide provincial and local governments with the basis to frame their financial procedures. The federal financial procedures are expected to help formalize the committee responsible for preparing resource estimates and expenditure limits, the three-year periodic plan, coverage and content of the budget virement, internal controls and reporting. With the approval of this Bill by the Parliament and subsequent adoption by respective local government councils, interim budget directives to facilitate local government spending will cease to exist. This legislation constitutes a considerable improvement in the legal and regulatory framework supporting the transition to federalism. 33. This Act will also ensure fiscal discipline, guide annual budget formulation, and improve accounting and financial reporting to strengthen fiscal policy execution. The fiscal procedures will address key systemic issues constraining effective fiscal management, namely low execution of the capital budget, high recurrent spending, inability to spend as per the budget, rising audit observations on annual expenditure and outstanding settlements or recovery thereof. The key elements of the law that address the systemic issues include: mandating the MTEF as a tool for expenditure prioritization; budget release authority based on annual approved plans; creation of internal audit and control committee in each budget agency; Ministerial level annual review of the budget and expenditure. The provisions will also guide PFM institutional arrangements and mandates making public expenditure reviews public. These provisions complement the actions to further strengthen the requirement for budget agencies to implement the parliament approved budget on the first day of the new fiscal year. The Bill focuses on establishing the foundational legislation, regulations, procedures and related incentives that support fiscal discipline and would pave the way for the next generation of reforms to establish fiscal rules. Going forward, implementation support will be crucial. The Bank will remain engaged through technical assistance to provincial and local governments to strengthen their planning and budget processes, own revenue collection and debt management. 34. The action is now framed as Cabinet endorsement and submission to Parliament (instead of Parliament approval as framed under DPC1). There is strong government commitment and consensus to adopt the bill, which is currently under discussion in the Parliament. However, the backload of other bills that had to be passed by Parliament within a stipulated deadline (as defined in the Constitution), led to a delay in passing the Federal Fiscal Procedures and Financial Responsibility Bill.

4 The Budget system is a coherent set of operations that start with the preparation of macroeconomic forecasts, costed multi-year plans, budget proposals, implementation, accounting, reporting etc. It is considered good practice internationally that the legal system reflects this coherence. As noted in “The International Handbook of Public Financial Management” Allen, Hemming, Potter, 2013, Palgrave Macmillan page 67: “Since the budget system itself is coherent, it is most useful to consolidate all functional areas of budgeting into a single law.” The areas of budgeting covering fiscal issues, including medium-term macroeconomic and fiscal projections, budget implications of extra budgetary funds as well as fiscal rules should be part of the same law.

15

Prior Action 2: The Finance Act 2018 has been enacted, which clarifies revenue allocation by amending: (i) provisions in the Intergovernmental Fiscal Arrangement Act related to tax administration and revenue assignment for motor vehicle tax, land and building registration fee, entertainment tax and advertisement tax; and (ii) provisions in the Local Government Operations Act related to the local tax base for property tax and land tax.

35. Implementation of the Intergovernmental Fiscal Arrangement Act has brought to light issues of overlap in tax jurisdiction. The approval of the Intergovernmental Fiscal Arrangement Act and the Local Government Operations Act were supported under DPC1. The Parliament approved the Intergovernmental Fiscal Arrangement Act5 in November 2017, which specifies the governance framework for provincial and local level PFM, including resource allocation between the central, provincial and local government. However, challenges emerged during implementation. For example, provincial and local governments have the authority to levy taxes with small bases (such as property taxes). However, within those areas that provincial and local governments have jurisdiction, tax assignments (as enshrined in the Constitution) overlap. Given this lack of clarity in jurisdiction raises risks of double taxation or could lead to tax competition, thereby undermining tax revenues. This legal framework has now been amended to clarify tax jurisdiction particularly for local levels of government. This amendment also highlights the dynamic nature of the transition to federalism which will evolve over the next few years. 36. The amendments to the Intergovernmental Fiscal Arrangement Act and the Local Government Operations Act clarify the allocation of revenues for six taxes which were deemed concurrent (i.e, shared by Provinces and local governments) as per the Constitution. These taxes include: (i) land and building registration fee, levied by provinces and collected by local entities; (ii) entertainment tax, levied by provinces and collected by local entities; (iii) advertisement tax, levied by provinces and collected by local entities; (iv) motor vehicle tax, levied and collected by provinces to help incentivize a reduction in carbon emissions; (v) property tax levied and collected by the local government and (vi) land tax also levied and collected by the local government. The amendments, effected through the Finance Act 2018, require local entities to deposit 60 percent of the tax collected from (i), (ii), and (iii) at their local reserve funds and the remaining 40 percent to provincial reserve funds every month. Additionally, the amendments require the creation of the provincial divisible fund for the allocation of the tax collected from (iv), whereby 60 percent will be deposited at the provincial reserve fund and 40 percent at the local divisible fund. Funds from the local divisible fund will be allocated to the various local governments as per formulas developed by the National Natural Resources and Finance Commission (NNRFC) and deposited at local reserve funds every month by provincial governments. The amendment also clarifies the tax base for the property tax and land tax (levied by local government), which the Constitution allocates to local governments under the Local Government Operations Act.

Functioning of Local Governments in the Federal Context

Prior Action 3: All Local Governments have established Local Consolidated Funds and at least 25 percent of Local Governments have delegated spending authority to the Chief Administrative Officer within 7 days of approval of the annual budget as certified by letters issued by the Ministry of Finance.

37. The powers of the local level governments have been outlined in the Constitution of Nepal in the spirit of cooperativeness, co-existence and coordination among the federal, provincial and local levels. To implement the Constitution, the Local Government Operations (LGO) Act (prior action under DPC1) defines functions, duties and rights of local governments; establishes procedures for assembly meetings and working systems; outlines procedures related to management of local assembly; provides guidance on the formulation and implementation of local development plans; earmarks the fiscal jurisdiction of local

5 WBG supported through PFM Multi-Donor Trust Fund (MDTF).

16

governments and provides the local financial working procedures. The implementation of the LGO act will support effective functioning of the local governments and some aspects of the implementation are being supported by the proposed operation. 38. All local government revenues need to be deposited into the Local Consolidated Fund and all expenditures need to be channeled from this fund. In addition, spending needs to start soon after the local budget is approved to minimize underspending and bunching of expenditures in the last part of the fiscal year. A functional Local Consolidated Fund is critical to enable the municipalities to better manage their fiscal affairs for both revenues and expenditures and bring an end to the current practice of off-budget activities that have limited the accountability of funds use. As per the Constitution, the establishment of such a fund was a pre-condition for the Minister of Finance to authorize the transfer of grants to local governments. To start spending soon after the budget is approved, as mentioned in the LGO Act, at least 25 percent of the 753 local governments have delegated spending authority to their Chief Administrative Officer within 7 days of approval of the annual budget by their local assembly. As per the survey undertaken by the Financial Comptroller General’s Office (FCGO) during November 15-December 9, 2018 to verify these results at the local level, all 753 local governments had opened their consolidated funds and 29 percent had delegated spending authority to their Chief Administrative Officer. The remaining municipalities are also making progress. The ability to initiate the execution of the budget soon after the annual budget is approved will allow local governments to perform their service delivery functions efficiently and in a timely manner. It will also contribute to reduce the bunching of the budget that has resulted in over 60 percent of the capital budget consistently being executed in the last quarter of the fiscal year, over the past 5 years. Under the LGO Act, initiation of spending of the annual budget is the responsibility of the Chief Administrative Officer (CAO), head of the local government’s administration, responsible for executing the budget. Fiscal Transfers, Inclusion and Gender Budgeting

Prior Action 4: The National Natural Resources and Fiscal Commission, has (i) adopted the framework for the calculation and devolution of the equalization grants and the conditional grants, and (ii) included forest cover as one of the indicators in the motor vehicle tax revenue sharing formula between Local Governments and Provincial Governments to mitigate carbon emissions.

39. Implementation of the 2015 Constitution is assisted by commissions which provide further guidance on specific areas. A number of these commissions focus on specific target groups (to promote inclusion) and ensure transparency and accountability. 6 The National Natural Resource and Fiscal Commission (NNRFC) is one of the eleven commissions to provide policy guidance on the design of natural resources mobilization,7 and revenue and grant8 sharing between all three tiers of the government. DPC1 supported Parliamentary approval of the NNRFC Act. The NNRFC is empowered in its role of providing policy guidance and designing natural resource mobilization and revenue sharing under the National Natural

6 National Women Commission (NWC); National Dalit Commission; National Inclusion Commission; Adibashi Janajati Commission; Madhesi Commission; Tharu Commission; Muslim Commission; Commission for the Investigation of Abuse of Authority; Public Service Commissions; Election Commissions; National Human Rights Commission; and National Natural Resources and Fiscal Commission. 7 Nepal is a hydro power rich country and royalty from this natural resource could potentially be an important revenue source for some local governments. 8 17 Resource Mobilization Indicators: revenue situation and revenue raising capacities; investment capacity; proportions of benefit sharing; utilization of proportion of benefit; condition of infrastructure and requirement; and economic condition and geographical structure. 18 Revenue Sharing Indicators: population and its composition; area; human development index; expenditure requirement; efforts towards revenue collections; infrastructure development; and, special conditions. Grant Sharing Indicators: Revenue status; Need; Service provided to the citizens; status of infrastructure development; human development index; sustainable development; status of economic, social and other discrimination; and availability of education, safe drinking water and others.

17

Resources and Fiscal Commission Act (supported under DPC1). The commission contributed to the setting of the FY2019 budget ceiling for provincial and local governments. 40. To ensure further progress on fiscal federalism, the NNRFC has adopted the framework for the calculation and devolution of the equalization and conditional grants and has made the framework public. In line with the Constitution, these transfers are expected to contribute to a more balanced development across provinces and regions, and support and uplift underserved regions and groups. The equalization grant is based on the revenue and expenditure needs of the provincial and local governments, taking into account their population and the level of development. Conditional grants are transfers to provincial and local governments for project implementation aligned to national policies and standards. In addition, to mitigate carbon emissions, the motor vehicle tax is levied by each provincial government and shared between the provincial and related local governments in the ratio of 60:40, using forest cover as one of the indicators in the revenue sharing formula between local and provincial governments. The 40 percent share to local governments is allocated according to the following variables and weights: a) forest area (5 percent); b) road length (50 percent); and c) total population (45 percent). By including forest area, the sharing mechanism also accounts for environmental factors and is meant to mitigate the impacts of motor vehicle emissions. The larger the forest area, the more revenue will be allocated. This aims to incentivize local governments to keep more forest area to counter greenhouse effects which could also help counter climate related disasters and ensure environmental sustainability at the local level. The framework was first used for preparation of the FY19 budget.9 To ensure transparency, the NNRFC has made the framework (including the formulas under it) public.

41. Climate change mitigation incentives captured in the revenue sharing formula are reinforced by a Climate Change Financing Framework that integrates climate change in planning and budgeting. A Climate Change Financing Framework (CCFF) was prepared building on the Climate Change Policy 2011 as a policy framework to mobilize, manage and target finance in support of realizing the country’s strategic climate goals and targets. The Inter-Ministerial Committee to oversee implementation of the framework was formed in February 2018 and the first meeting was conducted on January 7, 2019. The MoF has taken important steps to develop an expenditure reporting system capable of producing a consolidated report on climate expenditures. It has also revised the budget guidelines and budget calendar to integrate climate change. The CCFF reinforces the incentives provided by the revenue sharing formula to increase forest cover and is helping to improve integration of climate change costs in public expenditure allocations, resource management and investment decision making, to generate better climate policy outcomes.

Prior Action 5: The 2017 Federal Guidelines for Gender Responsive Budgeting have been issued to: (i) the Provincial Governments through a letter by the Ministry of Finance and (ii) the Local Governments through a letter by the Ministry of Federal Affairs and General Administration.

42. In FY2008, the MoF formally introduced a system requiring sectoral ministries to categorize their program budget based on the extent to which they are responsive to gender equality. The Budget Management Information System (BMIS) and the Line Ministry Budget Information System (LMBIS) of the sector ministries used Gender Responsive Budgeting (GRB) classification criteria in their budgeting systems. At the federal level, this practice led to an increase in the percent of the total budget allocated to GRB from 11.3 percent in FY2008 to 38.3 percent in FY2019. However, the exercise of classifying budgetary activities according to their gender responsiveness is largely subjective and undertaken by budget officials whose capacity varies across line ministries. Consequently, the quality of information on GRB is not adequate to

9 MoF is responsible for two channels namely, the: 1) special grant and 2) complementary grant.

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assess the extent to which gender gaps and inequality are being addressed. In general, program or results-based budgeting (including its application to GRB) is a work in progress, given the capacity constraints.

43. The new federal setup requires GRB to be applied to all three tiers of government. To guide and introduce GRB at the provincial and local levels, the 2017 Federal Guidelines for Gender Responsive Budgeting have been issued to provincial governments by the MOF and to local governments by the MOFAGA. There is a need to adapt the federal GRB indicators and sub-indicators by identifying simpler indicators for the provincial and local levels while maintaining coherence and consistency with the Federal GRB system. The LMBIS indicators and their weights also need to be adapted and incorporated in the SUTRA, in order to integrate GRB into the new provincial and local government information systems. This will require hands-on and long-term training for the relevant government officers and stakeholders which is being provided. Various training programs are underway to apply the GRB system at the provincial and local levels. For example, MoFAGA has developed a training manual for local elected officials incorporating one session on GRB; the Nepal Administrative Staff College (NASC) has prepared a training manual with a module on GRB for new and existing government officers. In addition, NPC is providing training at the Federal level.

44. Issuance of the GRB guidelines to provincial and local governments will help them incorporate a gender perspective in their planning and budgeting framework. Budgets are categorized into directly gender responsive, indirectly gender responsive and gender neutral. The GRB guidelines outline the criteria for gender responsive budgeting including weights to determine the budget categories. These guidelines will serve to ensure that public resources at decentralized levels are allocated in a manner that advances gender equality and women’s empowerment. The guidelines will provide a roadmap for incorporating the differentiated needs, priorities and situations of women, girls, men and boys including from different ethnic groups, caste and economic status within the overall budget allocation of the provincial and local governments. This will have a positive impact on women and girls and contribute towards accountability not only for women’s rights and gender equality but also greater public transparency on gender related budgeting. It will help develop plans which will have positive distributional effects including the promotion of women’s rights and gender equality. Based on the issued guidelines, provincial governments will initiate GRB in their overall budget allocation from FY2020 and the local governments from FY2021 onwards.

45. The action on GRB replaces the previous action on Gender Based Violence (GBV), to establish a 24-hour helpline for services to victims. The action to establish the gender-based violence hotline was achieved and to show further progress and to align the prior action more closely with the fiscal agenda, it was replaced by the action to strengthen gender-based budgeting at the provincial and local levels. Specifically, a 24-hour toll free helpline including an inbuilt case management system was officially launched. The helpline includes access to shelter, health care, psychosocial support, legal aid, child support and improved service delivery with a focus on preventing revictimization of the survivors. Since its launch, there have been a total of 1,275 cases, up till November 30, 2018.10

46. Expected key results under Pillar 1 are: (i) The overarching legal framework to ensure fiscal discipline and financial procedures at all three levels of government has been adopted; (ii) gender responsive budgeting has been extended to the local levels; (iii) local revenue base has been expanded.

10 http://nwc.gov.np/wp-content/uploads/2018/12/Sambodhan-Publication.pdf.

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Pillar 2: Improve the policy framework for public financial management

Public Financial Management Systems

Prior Action 6: To strengthen the PFM framework: (i) Two-thirds of all Local Governments have adopted Budget Management Legislation governing their own budget processes as certified by a letter issued by the Ministry of Federal Affairs and General Administration; and (ii) the Financial Comptroller General’s Office has made the consolidated report of Local Governments’ expenditure publicly available.

47. The adoption of the new legislation that organizes and regulates the budget cycle of local governments will help systematize the mobilization of resources and execution of expenditures in a timely and rules-based manner. DPC1 supported strengthening of PFM systems at the federal level while DPC2 supports it at the local level. Currently, local governments have no legally binding framework in place to govern their own local government budgets. A Model Local Procedures Act has been published and disseminated by the MOFAGA, that draws from existing rules and regulations, ongoing consultations that have informed drafting of the Federal Law (prior action 1), as well as the DPC1 supported Intergovernmental Fiscal Arrangement and the Local Government Operations Acts. Based on this model act, local governments are in the process of adopting Financial Procedures Regulation Act which encompasses the operation of the local consolidated fund, formulation of the budget, spending, preparation of the financial report, internal controls and audits, among others. Once the Federal law (prior action 1) is approved, there may be some minor adjustments to the Model Local Procedures Act to strengthen coherence. Some local governments have adopted all provisions related to budget management in a single act while others have adopted more than one act to specify the provisions. Two-thirds of the local governments have adopted Budget Management Legislation that organizes and regulates their financial operations. They have started publishing these adopted laws on the internet to instill a system of monitoring and compliance as well as create a repository where citizens can access locally Gazetted laws.11 48. With the creation of a federal structure, transparency on public expenditure demands that expenditure information be made public for all three tiers of the government. Expenditure reports are already available on the Financial Comptroller General’s Office (FCGO) website for the federal level. Currently, the treasury system captures expenditure data at the provincial level. This is facilitated by the integration of all public financial management systems onto one platform. In FY2019, local government expenditure data for FY2018 was collected. While around 40 percent of local governments are using the Subnational Treasury Regulatory Application (SUTRA) for reporting, FCGO has set up a survey-based approach to collect local government budget execution annual data and has used this survey approach to produce a budget execution report for FY2018. The consolidated expenditure report, including expenditure data for all provinces and local governments for FY2018 was submitted to the Office of the Auditor General (OAG) on January 9, 2019 and published on February 1, 2019 on FCGO’s website. This process will be replicated for FY2019 expenditure data. The requirement of public disclosure of the consolidated report by the Federal Government within six months following the fiscal year is also provisioned in the Federal Fiscal Procedures Bill (PA 1). The government’s objective is to have full electronic automation of the process for FY2020 data through the roll-out of SUTRA. The availability of local government expenditure reports supports transparency and greater accountability of funds use. In addition, the availability of government spending data for public consumption will facilitate citizen engagement at all levels of the government, especially at the local level.

11 At the Provincial level, all seven provinces have used Model Laws to prepare and pass their respective Budget Management Legislation which draws on the Fiscal Procedures and Financial Responsibility Bill (under different names but maintaining the substance of the Bill).

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Budget Execution and Controls Prior Action 7: The National Planning Commission has issued MTEF guidelines as part of the Plan Formulation Guidelines for Provincial Governments and Local Governments that take into account sustainable development goals including climate change.

49. Nepal was the first country in the South Asia region to implement Medium-term Expenditure Frameworks (MTEFs), in 2003, which was then discontinued. Continued government and staff turn-over contributed to a weakening of institutional memory and capacity leading to a temporary discontinuation of the approach. In the absence of MTEFs since 2014, lack of realism in the budget (measured by the deviation of actual spending from planned outlays) has increased. The average budget deviation between FY11-FY14 and FY15-FY17 increased from 17 percent to 23 percent. With an anticipated increase in public expenditure in support of fiscal federalism, the reinstatement of MTEFs at the federal level will help ensure prudent fiscal and budget management (supported by DPC1). Also, climate change budget projections for the next three fiscal years as well as climate change coding are now included in the MTEF. While DPC1 mandated the preparation of MTEFs at the federal level, DPC2 supports the preparation of MTEFs at the provincial and local levels. 50. While the federal government’s annual budget is anchored in the national development plan, the same is not true for the local governments due to the absence of local plans. The Intergovernmental Fiscal Arrangement Act and Local Government Operations Act (both supported under DPC1) mandate the preparation of Local Government Development Plans, which will guide local budgets and MTEFs. A next step will be the preparation of the local MTEFs, anchored in those Local Government Development Plans. The National Planning Commission (NPC) has issued the Plan Formulation Guidelines which include the guidelines for the periodic plans (3- or 5-year plans based on the long-term vision), MTEFs and the annual development programs. These guidelines were issued to all provinces and local governments to guide their budget planning and preparation of MTEFs.12 Lack of knowledge regarding the needed inputs for preparing local MTEFs and capacity constraints are major hurdles. MTEF guidelines have integrated environment and climate change aspects through project prioritization criteria that are based on the sustainable development goals (i.e., goal 13 on climate action). Local governments are currently unable to apply the project prioritization criteria or forecast revenues. To support local government capacity, the NPC is providing training on the MTEF including guidance to integrate environment and climate change in local development plans and MTEFs. Technical assistance will also be provided through the Integrated Public Financial Management Reform. Other DPs are also providing support toward implementation of the MTEF through the Multi-Donor Trust Fund.

Prior Action 8: To strengthen expenditure controls (i) the Cabinet has endorsed and submitted to the Parliament the Audit Bill 2018; and (ii) the Ministry of Finance has approved the new internal control guidelines.

51. It is critical to strengthen expenditure controls, in addition to improving budget execution, given that there is a possibility for audit observations13

to increase with expanded local government spending units. The previous practice was that OAG audits were often submitted near the end of the following fiscal year. The approval of the 2018 Audit Bill will bring forward the timing of audits to address irregularities in a timely manner. Specifically, it will regularize performance audits, enforce the recovery of irregularities within a specific timeframe, and establish audit offices in all seven provinces14. The provincial audit offices, once established, will also cover audits of the respective local governments, in a given province. At the local levels, the LGO Act mandates internal audit of the local governments while external audit remains under the

12 Province 4 has produced an MTEF and shared it with the MoF. 13 Audit observation is when Office of Auditor General flags a financial rule that may have been side stepped in financial transactions. 14 This is supported by on-going Strengthening of OAG through MDTF.

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mandate of the OAG. Internal control guidelines are based on international norms for internal control which provide principles and procedures that ensure that public money is used for the intended purposes and public assets are properly safeguarded. The internal control guidelines outline the overall framework for federal agencies and provincial and local governments to develop their agency-specific internal control procedures. Ministry of Finance approval of the new internal control guidelines developed by the FCGO, and its implementation, will help strengthen the control environment and procedures pertaining to payment requests, document control and the timely settlement of advances. Disaster Risk Management and Climate Resilience

Prior Action 9: The Ministry of Federal Affairs and General Administration has issued disaster management policy guidelines to local governments taking current risk profiles and future climate change into consideration.

52. Nepal is one of the most disaster and climate vulnerable countries in the world and this puts a big strain on the government’s budget. More than 80 percent of Nepal’s population is at the risk of multiple natural hazards such as floods, landslides, windstorms, hailstorms, fires, earthquakes and Glacial Lake Outburst Floods (GLOFs). It is therefore important under the new federal structure to build local capacity to manage disasters and climate change taking into account local-level risk profiles, including investments in post-disaster reconstruction, early warning preparedness, and long-term climate resilience. Strong coordination across localities, in particular, to effectively manage national level disasters will be critical. The Disaster Risk Reduction and Management (DRRM) Act (supported under DPC1) is expected to help manage the disaster response through better coordination among local, provincial and federal government, other public-sector entities, International/National Non-Governmental Organization, Private Sector and Local Communities. The Act also requires the government to set up a separate fund, for disaster management. Cognizant of the topographical fragility of the country, the Constitution has made a provision for fiscal transfers to local governments (linked to special grants) to address local specific disaster response. DPC2 supports implementation of the DRRM Act at the local level. Ongoing policy dialogue in the context of an upcoming CAT-DDO operation will support implementation of these reforms. 53. Disaster management policy guidelines will strengthen local level response to disasters and help shield the budget from natural disasters. Specifically, these policy guidelines have been issued in the form of (i) a model act for Rural/Urban Municipality Disaster Risk Reduction and Management and (ii) Model Operating Procedures for Rural/Urban Municipality Disaster Management Fund. These were prepared by MOFAGA in close coordination with Ministry of Home Affairs (MoHA) and issued to local governments. The disaster management policy guidelines provide guidance on incorporating DRM in local government development plans and define the procedures for responding to disasters at the local level. They will also help reduce the fiscal risks posed by Nepal’s vulnerability to disasters and climatic shocks, particularly at the local levels. Revenue Management Information System

Prior Action 10: For revenue data collection: (i) the Ministry of Finance has established a Revenue Management Information System at the Provincial Government level to provide real time information on revenue collections; and (ii) the Office of the Auditor General has approved a template for revenue data collection at the Local Government level.

54. Increased spending under federalism will require the various levels of government to effectively raise, collect and track the revenues assigned to them. To this end, it will be necessary to have strong tax administration at the various tiers of government and timely revenue information. At the Federal level, an

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electronic platform to monitor revenue collection of major tax streams on a real-time basis is now operational (supported under DPC1). This serves as a database for tax collection, to enable evidence-based research, analysis and policy making. At the provincial and local levels, provinces15 and local governments16 will collect revenues assigned to them. Also, one of the parameters governing federal transfers to the local units is local level own source revenue collections. Hence, it will be critical to gather information on local government revenue collections, which will be enabled by the establishment of a revenue information system at the provincial and local levels. This database will support more effective local level tax policies and administration and facilitate the collection of indicators that would partly determine the amount of grants allocated to local governments. The system will also increase, the regularity and timeliness of reporting, and provide a fuller picture of the government’s consolidated revenues. In October 2018, the Minister of Finance approved an IT Strategy for the deployment of Revenue Management Information System (RMIS) at the provincial level. The existing RMIS covers 100 percent of all federal tax collection and is used in all seven Provinces. The federal data is available daily on the FCGO website and is reliable.

55. At the local level, a system has been developed with formalized procedures, reporting templates and timelines. This system puts in place the institutional processes that are needed to facilitate reporting. FY2019 data will be constructed using a new template provided by the FCGO and compliant with Nepal’s version of the international public-sector accounting standards (NPSAS). The new template will enable the systematic collection of tax information from local governments in a standardized format using either a manual or an automated approach. As mandated by law, these templates have been approved by the OAG, which is responsible for the independent audit of the government’s finances. It is expected that the FCGO17 (which is responsible for preparing the government’s financial statements) will have 100 percent of tax collection data at the three levels of government in an automated fashion from FY2020 onwards. An automated electronic module for local tax collection will be rolled-out as part of the SUTRA package. This roll-out is planned for June 2019. 56. Expected results under Pillar 2 are: (i) Increased transparency in local spending as evidenced by making the consolidated budget execution data available in the public domain; (ii) more timely availability of revenue data; (iii) improved spending efficiency by reducing underspending and bunching of the budget; (iv) improved processes for incorporating DRM in local plans and procedures.

57. Changes have been made to some of the prior actions but the strength of the overall package of policy reforms has been maintained. The changes to the prior actions are detailed in table 4a below. These changes have been made to accurately reflect the developments and achievements since DPC1 given the evolving federalism process. The Government has had to adapt to changing local conditions and modify its approach as new information became available. Changes in the prior actions reflect this adaptation process. The prior action on GBV has been replaced with an action to expand gender responsive budgeting to provincial and local governments. The wording of prior actions 3 and 6 were adjusted to reflect the degree to which local governments had adopted the related actions, based on a survey of the 753 local governments and the 7 provinces which were carried out by FCGO between November 15 and December 9, 2018. Since the information was not centrally available, the survey by the FCGO was used to assess the achievement of

15 Provincial revenue assignment: land and house registration tax; vehicle tax; entertainment tax; advertisement tax; tax on tourism and agriculture income; service charges and penalties. 16 Local government revenue assignment: local property tax; house rent tax; fee on registration of houses and land; vehicle tax; service fee; tourism fee; advertisement tax; business tax; land revenue; fines; entertainment tax. 17 The Financial Comptroller General Office (FCGO) is primarily responsible for treasury operations of the Government of Nepal. The FCGO facilitates budget implementation, oversees expenditure, tracks the collection of revenue and administers the loan, investment and grants of all Government and constitutional bodies. The FCGO office is also responsible for the design and development of accounting system and formats.

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these two prior actions and the Bank has relied on certifications by the Government based on this survey. In addition, for prior actions 4, 5, 7 and 9 the approval of guidelines was made following a deliberative (paper based) process that culminated with a final sign-off by a decisionmaker at either the Minister or Secretary level. For prior action 5, changes to the phrasing of the action were needed to reflect government issuance procedures. For prior actions 4, 7 and 9, since there is no other seal or memo of approval, the relevant ministry or the MOF has provided a letter to certify achievement of the action (in addition to the published frameworks and guidelines). Given the above changes to prior actions, some of the results indicators have been modified and these changes are captured in Table 4b.

Table 4: Changes in the Results Framework from DPC1

A. In the Policy Matrix: Trigger, Fiscal DPC1 PD, Board Discussion

version, March 20, 2018 Prior Action, ROC stage Nature of change

Trigger #1. The Parliament has approved the Federal Financial Procedures Bill which provides guidance on budget execution (Cabinet Approval/ CA-2017). Trigger #7. The Cabinet has endorsed and submitted to Parliament the Fiscal Responsibility and Budget Management Bill (FRBMB) to ensure fiscal discipline and increase accountability.

Prior Action #1. The Cabinet has endorsed and submitted to Parliament the Federal Fiscal Procedures and Financial Responsibility Bill which governs budget execution and increases fiscal discipline and accountability.

Reflects the fact that the Federal Financial Procedures BiIl and the Fiscal Responsibility Bill are now merged into one Bill called Federal Fiscal Procedures and Financial Responsibility Bill (with the substance maintained). Parliamentary approval was delayed because other bills with a constitutionally mandated timeline had to be prioritized.

Prior Action #2. The Finance Act 2018 has been enacted which clarifies revenue allocation by amending: (i) provisions in the Intergovernmental Fiscal Arrangement Act related to tax administration and revenue assignment for motor vehicle tax, land and building registration Fee, entertainment tax and advertisement tax; and (ii) provisions in the Local Government Operations Act related to the local tax base for property and land Tax.

New action aimed at clarifying local level tax jurisdiction and tax base governed by the Intergovernmental Fiscal Arrangement Act. This also reflects, in part, the evolving transition to federalism where a continuous process of change will be the norm as the country makes a successful transition to a federal state.

Trigger #2. Local governments have (i) established the Local Consolidated Fund; and (ii) issued regulations to authorize the Chief Administrative Office to initiate spending within seven days of approval of the annual budget by the local assembly.

Prior Action #3. All Local governments have established Local Consolidated Funds and at least 25 percent of Local Governments have delegated spending authority to the Chief Administrative Officer within 7 days of approval of the annual budget as certified by letters issued by the Ministry of Finance.

Modified to reflect the progress on the ground wherein 29 percent of the local governments had delegated spending authority, till December 9, 2018. The process is taking longer than was originally anticipated because of capacity issues.

Trigger #3. The National Natural Resources and Fiscal Commission has (i) adopted the framework for the calculation and devolution of two grants (equalization and conditional) and has made the formula for the equalization grant public; and (ii) issued climate resilient investment guidelines to the sub national governments.

Prior Action 4: The National Natural Resources and Fiscal Commission has (i) adopted the framework for the calculation and devolution of the equalization grants and the conditional grants, and (ii) included forest cover as one of the indicators in the motor vehicle tax revenue sharing

Part (ii) of this prior action has been changed as the government decided against issuing investment guidelines and instead wanted to issue MTEF guidelines which would include the climate resilience component. This is covered under prior action 7. Part (ii) of this prior action was instead replaced by including forest cover

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formula between Local Governments and Provincial Governments to mitigate carbon emissions.

as one of the components for sharing motor vehicle taxes.

Trigger #4. National Women Commission has (i) established a 24-hour Helpline manned by trained staff; (ii) established a case processing system to track service provision; and, (iii) issued protocols and guidelines for survivor support, case prioritization and service access.

(Replaced with) Prior Action #5. The 2017 Federal Guidelines for Gender Responsive Budgeting have been issued to: (i) the Provincial Governments through a letter by the Ministry of Finance and (ii) the Local Governments through a letter by the Ministry of Federal Affairs and General

Administration.

This trigger on gender-based violence has been dropped even though the government has achieved it. This was done to capture the additional progress made and also to better align the policy reform with the fiscal agenda. This trigger was replaced by gender responsive budgeting guidelines.

Trigger #5. To strengthen state and local governments’ public financial management, (i) the Local Governments have adopted the Local Finance Procedures Bill and its directives and the Local Administrative Revenue Bill and its procedural directives; and (ii) to increase transparency and support citizens’ engagement the government has instituted a system of public disclosure of local government expenditure reports by making them available on the website of the Financial Comptroller General’s Office.

Prior Action #6. To strengthen the PFM framework: (i) Two-thirds of Local Governments have adopted Budget Management Legislation governing their own budget processes as certified by a letter issued by the Ministry of Federal Affairs and General Administration; and (ii) the Financial Comptroller General’s Office has made the consolidated report of Local Governments’ expenditure publicly available.

Modified to capture the proportion of local governments that have adopted the Acts – not all of them have been able to do so because of capacity constraints. Provisions linked to revenue administration are included in another set of Bills at the local levels. The revision also focuses on the original intent of disclosure of reports which is more readily verifiable.

Trigger #6. To ensure budget realism at the local level, the local governments’ council has mandated the preparation of a 3-year MTEF in line with the Local Government Development Plan.

Prior Action #7. The National Planning Commission has issued MTEF guidelines as part of the Plan Formulation Guidelines for Provincial Governments and Local Governments that take into account sustainable development goals including climate change.

To facilitate the process of preparation of MTEFs at the provincial and the local levels, especially in a capacity constrained environment, the trigger was changed to the issuance of MTEF guidelines by the NPC. This would help facilitate the process at the provincial and local level and the guidelines also include provisions related to the SDGs and to climate change.

Trigger #9. To strengthen disaster management response and initiate disaster risk reduction actions, the federal government has (i) established the National Disaster Risk Reduction and Management Center; (ii) approved the disaster management national policy and plan; and (iii) issued disaster management policy guidelines to state and local governments taking current risk profile and future climate change into consideration.

Prior Action #9. The Ministry of Federal Affairs and General Administration has issued disaster management policy guidelines to local governments taking current risk profiles and future climate change into consideration.

The change in trigger 9 reflects the slower than anticipated progress to date and consolidation and prioritization of critical reforms. The National Disaster Risk Reduction and Management Center has not yet been established. However, part (ii) of the original trigger has been achieved. The action has been streamlined to focus on the disaster management guidelines for local governments.

Trigger #10. The MoF has established the Revenue Management Information System at the state and local level to provide revenue collection information.

Prior Action #10. For revenue data collection: (i) the Ministry of Finance has established the Revenue Management Information System at the Provincial Government level to provide real time information on revenue collections; and (ii) the Office of the Auditor General has approved a template for revenue data collection at the Local Government level.

The change reflects the slower than anticipated progress at the local level. While the RMIS was established in the 7 provinces, the PFM systems in the 753 local governments are at various stages of completion. Therefore, a system has been instituted to collect revenue data manually based on a template for the time being and till the PFM systems are up and running in all local governments.

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B. To Results Indicators: As in Fiscal DPC1 PD, Board Discussion

version, March 20, 2018 At ROC stage Nature of change

Result Indicator#1. Expenditure on public primary education: Baseline: Undertaken by the federal government (FY2016) Target: Fully undertaken by the local governments (FY2019)

Result Indicator#1. Share of the education budget devolved to the local governments: Baseline: 0 Target: 65 percent

The spending on education by the local governments depends on the transfer and availability of civil servants. Since this has been delayed, the original result indicator might not capture the intended results. Hence, the change.

Results Indicator #3. Own revenue sources of local governments: Baseline: 2 percent of consolidated revenues Target: 4 percent of consolidated revenues

Added to reflect the inclusion of Prior Action #2.

Result Indicator#4: Share of federal transfers spent by local governments: Baseline: 0 Target: 75 percent

Result Indicator#4: Share of federal transfers spent by local governments: Baseline: 0 Target: 65 percent

Reduced the ambitiousness of the result indicator to make it more realistic.

Result Indicator#4. Equalization grant in FY19 budget made as per the new equalization formula: Baseline: NA (FY16) Target: To all local governments

Results Indicator #5. Equalization and conditional grants in FY2020 budget made based on the new formula: Baseline: Not Applicable Target: Grants made to all local governments

Reflects the revision to capture the actual reform and target date

Results Indicator#5. Share of service referrals (legal, health, police and shelter homes) on Gender Based Violence cases that are closed. Baseline: None Target: 80 percent

Dropped because the associated prior action has been dropped.

Result Indicator #6. Number of provinces that have adopted gender responsive budgets Baseline: None Target: All 7 provinces

Added to reflect the inclusion of Prior Action #5 on gender responsive budgeting.

Results Indicator#6. Consolidated public expenditure data available in the public domain. Baseline: NA Target: FY2020 budget

Results Indicator #7. Consolidated public expenditure data available in the public domain within 6 months of the end of the fiscal year. Baseline: NA Target: FY19 expenditure on FCGO’s website

Defines the indicator more precisely.

Results Indicator #8. Number of provinces adopting the MTEF Guidelines: Baseline: None Target: All 7 provinces

Reflects the newly modified action linked to the MTEF.

Results Indicator#9. Audit irregularities reported by the OAG report: Baseline: Audit irregularities of Rs. 97.44 billion (OAG 2016 report). Target: 2019 OAG report with 40 percent reduction in the amount of irregularities reported compared to the 2016 OAG report.

Results Indicator #11. Audit irregularities reported by the OAG report: Baseline: Audit irregularities of Rs. 97.44 billion (OAG 2016 report). Target: 2020 OAG report with 30 percent reduction in the amount of Federal Government irregularities reported compared to the 2016 OAG report.

Modified to reflect FY2020 target date and to make it more realistic.

Results Indicator 11. Funds allocated to the Disaster Management Fund: Baseline: Zero Target: TBD

Results Indicator #12. Adoption of DRM framework by local governments: Baseline: 0 Target: At least one municipality in each province

Reflects the change in the prior action because of slower than anticipated progress.

Results Indicator#12. Availability of information on tax collections: Baseline: Data on 90 percent of tax

Results Indicator #13. Availability of information on revenue collection: Baseline: Data on 90 percent of tax collection

Reflects the progress in the context of the

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collections available with a lag of two months. (FY2016) Target: Data on 90 percent of tax collections available on a real-time basis (FY2019)

available with a lag of two months. Target: Real-time data available from FY19 onwards as follows: 100 percent of federal revenue collection; 60 percent of provincial revenue collection; and 40 percent of local government revenue collection available by mid-Jan following the concerned fiscal year.

ambitiousness of Prior Action #10.

58. The design of the proposed DPC operation is underpinned by extensive analytical work. The details for the second operation are presented below (Table 5).

Table 5: DPO Prior Actions and Analytical Underpinnings

Prior actions Analytical Underpinnings

Pillar I Prior Action 1: The Cabinet has endorsed and submitted to Parliament the Federal Fiscal Procedures and Financial Responsibility Bill which governs budget execution and increases fiscal discipline accountability.

• PFM Gap Analysis 2015; • MTEF Gap Analysis 2015; • NLSS 2003; • Census 2011; • Federal Fiscal Act, Institution and Social Security; • Intergovernmental Fiscal Transfers.33

Prior Action 2: The Finance Act 2018 has been enacted which clarifies revenue allocation by amending (i) provisions in the Intergovernmental Fiscal Arrangement Act related to tax administration and revenue assignment for motor vehicle tax, land and building registration fee, entertainment tax and advertisement tax; and (ii) provisions in the Local Government Operations Act provisions related to the local tax base for property tax and land tax.

• Note on Fiscal Responsibility and Budget Management; • Policy and Advisory Technical Assistance for Strengthening Subnational Public Management 2017; • Note on Local Level Expenditure 2017; • Report on Unbundling/Detailing List of Exclusive and Concurrent Powers of the Federation, the State and the Local Level Provisioned.

Prior Action 3: All Local governments have established the Local Consolidated Fund and at least 25 percent of Local Governments have delegated spending authority to the Chief Administrative Officer within 7 days of approval of the annual budget as certified by letters issued by the Ministry of Finance.

Prior Action 4: The National Natural Resources and Fiscal Commission (NNRFC), has (i) adopted the framework for the calculation and devolution of the equalization grants and the conditional grants, and (ii) included forest cover as one of the indicators in the motor vehicle tax revenue sharing formula between Local Governments and Provincial Governments to mitigate carbon emissions

• Note on revenue rights; • Note on Institutional set up for fiscal transfer; • Note on Formula-based Budget;

• Allocation Framework in the Federal Context of Nepal.

Prior Action 5: The 2017 Federal Guidelines for Gender Responsive Budgeting have been issued to: (i) the Provincial Governments through a letter by the Ministry of Finance and (ii) the Local Governments through a letter by the Ministry of Federal Affairs and General Administration.

• PFM Gap Analysis 2015; • National Action Plan on gender-based violence; • Nation Women Commission Act 2002; • Domestic Violence Act (Crime and Punishment) 2009.

Pillar II

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Prior Action 6: To strengthen the PFM framework: (i) Two-thirds of all

Local Governments have adopted Budget Management Legislation governing their own budget processes as certified by a letter issued by

the Ministry of Federal Affairs and General Administration; and (ii) the

Financial Comptroller General’s Office has made the consolidated

report of local governments’ expenditure publicly available.

• PFM Gap Analysis 2015;

• MTEF Gap Analysis 2015.

Prior Action 7: The National Planning Commission has issued MTEF

guidelines as part of the Plan Formulation Guidelines for Provincial

Governments and Local Governments that take into account

sustainable development goals including climate change.

• Note on Fiscal Responsibility and Budget

Management; • MTEF Gap Analysis 2015.

Prior Action 8: To strengthen expenditure controls (i) the Cabinet has endorsed and submitted to the Parliament the Audit Bill 2018; and (ii)

the Ministry of Finance has approved the new internal control

guidelines.

• Nepal Project Performance Review(s);

• PFM Gap Analysis 2015.

Prior Action 9: The Ministry of Federal Affairs and General Administration has issued disaster management policy guidelines to provincial and local governments taking current risk profiles and future climate change into consideration.

• National Strategy for Disaster Risk Management -2009; • Disaster Response Framework - 2013; • Post Disaster Need Assessment, 2015.

Prior Action 10: For revenue data collection: (i) the Ministry of Finance has established a Revenue Management Information System at the Provincial Government level to provide real time information on revenue collections; and (ii) the Office of the Auditor General has approved a template for revenue data collection at the Local Government level.

• PFM Gap Analysis 2015.

4.3 LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY 59. This operation is one component of the broader support the World Bank is providing to the government in the transition to federalism. This operation focuses only on the PFM and fiscal part of the transition to federalism. The WBG has a much broader engagement on the federalism agenda with the GoN.

60. This operation is central to achieving improvements in implementation capacity, accountability and transparency at the federal, state and local levels. A strong fiscal devolution framework and PFM system provide the foundations for achieving and sustaining the activities under the three focus areas of the CPF. Reforms under this series are anchored in the Country Partnership Framework (2019-2023) and aligned to CPF Focus Area 1— Public Institutions through reforms that strengthen public expenditure management at all levels of government, to mitigate the PFM and fiduciary risks from the transition to federalism; and CPF Focus Area 3 – Inclusion and Resilience through reforms to address vertical and spatial inequities in service delivery, with particular attention to gender aspects, and accounting for vulnerabilities to climate change and natural disasters.

61. Reforms under this DPC series will be sustained through technical assistance work under the PFM MDTF and ongoing support to fiscal federalism. The PFM MDTF is an ongoing engagement between the government and the development partners and is managed by the World Bank. It supports PFM reform activities to strengthen the performance, transparency and accountability in PFM in Nepal. The policy dialogue underlying the proposed operation was facilitated by activities of the PFM MDTF and the 2015 PEFA Assessment. In addition, the World Bank is also leading the donor coordination committee to support the government in the implementation of fiscal federalism. This includes supporting activities to align the country’s economic, social, environmental and other policies with the new federal state systems, and activities to develop sound civil administration systems and ensure continuation of service delivery with

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minimum disruptions for the 7 provinces and 753 local government units. Results from the World Bank-UNDP led Needs Assessment of Federalism is also informing the policy dialogue and TA support toward implementation of reforms supported by this DPC.

62. This operation supports the WBG’s twin goals of eliminating extreme poverty and boosting shared prosperity through improved public service delivery and strengthened fiscal management. The 2015 Constitution devolved the provision of basic services such as healthcare, primary education, local roads, local drinking water and sanitation, and social assistance to the local governments. The policy reforms supported by this operation help the government in its efforts to provide local governments with the operating framework and resources needed for effective service delivery. The reforms also support greater citizen engagement to enhance accountability of local governments. These efforts will strengthen public service delivery and help the poor and bottom 40 percent who depend more on public services. More effective PFM and an increase in tax revenues will help the government increase its investment in physical and human capital. This will also help the poor and support economic growth.

4.4 CONSULTATIONS, COLLABORATION WITH DEVELOPMENT PARTNERS 63. The government has undertaken broad-based consultations with all relevant stakeholders on the reforms supported by this operation. This is particularly relevant for measures that address disaster management and gender responsive budgeting (including gender-based violence, where extensive public consultations and outreach activities were held by the government). The main gender related issues that were raised by stakeholders included (i) non-reporting of cases due to stigma, (ii) risk of revictimization of the survivors as they recounted their incident in multiple institutions when accessing services, (iii) poor documentation of follow up actions, and (iv) inadequate quality of support services. In disaster management, the key issues raised included the need to: (i) ensure hazard-resistant reconstruction of the assets damaged from recent disasters to avoid creating new risks; (ii) strengthen disaster preparedness and early warning systems at various levels of the government and societies; (iii) establish and operationalize the institutional set-up envisaged under the recently enacted Disaster Risk Reduction and Management Act 2017; and (iv) explore disaster risk financing and insurance options in the Nepalese context to prevent the diversion of planned development funds to unplanned disaster recovery. In the case of other reforms, the consultations included the main stakeholders, largely within the government. Most suggestions from stakeholders were incorporated into the reforms supported by the government.

64. Government reforms on fiscal and expenditure management are an on-going activity supported by development partners through the PFM MDTF. The MDTF, managed by the World Bank, is supported and funded by the U.K. Department for International Development, Government of Norway, Australia DFAT, United States Agency for International Development (USAID), European Union and the government of the Swiss Confederation. It supports fiscal and expenditure management reform activities that have led to improvements in PEFA scores. The MDTF members and the government hold meetings regularly to share information and discuss PFM reform support. This series complements the ongoing PFM reform program.

65. Development partners are also supporting federalism under an umbrella platform. A ‘federalism working group’ comprising several development partners meets regularly to harmonize the assistance to be provided to the government. The reforms supported by this series complement the overall support on federalism that is being provided to the government.

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5. OTHER DESIGN AND APPRAISAL ISSUES

5.1 POVERTY AND SOCIAL IMPACT

66. Most prior actions under the DPC are expected to have neutral or potentially positive poverty and distributional effects in the long run. Overall, the prior actions support the government's effort to improve transparency and accountability by establishing a governance framework that clarifies the roles and responsibilities by all three tiers of the governments. Improving the overall governance framework across all three tiers of the governments is expected to have a long-term positive effect on the overall quality of public service delivery, which can ultimately contribute to poverty reduction.

67. Prior actions to strengthen budget execution for more effective service delivery; clarify tax jurisdiction for greater equity; improve gender responsive budgeting; and reduce risks from climate change (to which the poor are more vulnerable) are likely to have significant positive effects on the vulnerable. Improving budget processes at the local level are expected to improve service delivery for the poor (Prior Action 1); also reforms to clarify tax jurisdiction given that the tax bases are mostly tied to the nonpoor, (Prior Action 2) will support improved distributional effects. This could potentially have positive effects on poverty. Increasing allocation to gender-based programs (Prior Action 5), would also result in improved distributional effects tied to gender. Finally, climate change measures could help reduce the effects on the welfare of the poor. This includes measures for budget coding to capture spending tied to climate mitigation or adaptation (Prior Action 2, 4, 7) through improved application of the CCFF that covers the full budget planning and execution. Local level DRM policies and guidelines on how to incorporate climate change in local development plans (Prior Action 9) will help strengthen local level response to DRM and help improve the management of climate change, and therefore protect the most vulnerable who are typically the most affected by natural disasters. The model laws adopted by the provincial and local governments will support increased local capacity for disaster risk management and help strengthen coordination of disaster risk and climate change management

5.2 ENVIRONMENTAL ASPECTS

68. Most reforms supported by this operation are expected to have neutral or potentially positive effects on the environment. The Federal Fiscal Procedures and Financial Responsibility Bill (prior action 1); and local governments’ adoption of a Bill (prior action 6) that governs the budget and ensures fiscal discipline and accountability for all three levels of government could lead to positive environmental effects through implementation of the Climate Change framework, which applies to the full budget and facilitates tracking of climate change spending. Amendment of the Intergovernmental Fiscal Arrangement Act (prior action 2) could help reduce carbon emissions through the Motor Vehicle tax. The inclusion of an indicator for forest cover in the revenue sharing formula between local and provincial governments (prior action 4) is expected to help reduce carbon emissions and increase forest cover (which is considered carbon sinks).

69. In addition, the Implementation of MTEF guidance (prior action 7) on how to integrate climate change considerations into planning and budgeting could help reduce the effects of CO2 emission. This reform could contribute to: reduce CO2 emission from transport and industries, contribute to maintain forest areas, ensure access to sustainable energy, build resilience to disaster and climate extreme events, build resilient infrastructure, and promote inclusive and sustainable industrialization. Finally, implementation of the disaster management policy guidelines in the planning process of provincial and local governments (prior action 9) will support coordination and management of all activities pertaining to disaster management, disaster risk reduction, disaster recuperation and disaster response as well as monitoring and mitigation measures. Strengthening the policy and institutional capacity for disaster risk

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management will facilitate mainstreaming of DRM and climate-change-adaptation policies and practices both at the national and provincial and local levels, leading to environmentally-friendly planning of essential infrastructure.

70. Moreover, the Climate Change Financing Framework (CCFF) currently in place will reinforce the expected likely effects of the reforms supported by this operation. The CCFF ensures climate change and environmental sustainability are captured in local level development planning and budgeting. The CCFF ensures that funds are better targeted to reach the most vulnerable local population groups and improve effectiveness of existing climate finance through reforms to planning and budgeting guidelines and other tools for more informed decision-making. Since the move to a federal structure, the country’s climate budget has increased from 19 to 31 percent18 of the total budget. The goal is to spend 80 percent of climate budget allocation at the provincial and local level. In addition to systems in place, an ongoing capacity building needs assessment (conducted in collaboration with donors) will help identify priorities for strengthening local governments’ functions including environmental assessments and the sustainable management of natural resources. A joint, donor funded mechanism is planned to fund identified capacity building measures.

71. However, reforms to support improvement in budget execution, including of capital spending, can potentially have adverse effects on the environment, if these are not mitigated. This is particularly the case for public investment at the local level. The absence of land use or territorial planning and weak enforcement of environmental impact assessment for investment project approval could potentially put pressure on natural resources. As investment capacity improves, it will be critical to place more emphasis on efficient management of natural resources to minimize costs and maximize benefits. Nepal currently has different laws and systems for reducing adverse environmental effects and enhancing positive effects. Among these are the Environmental Protection Act (EPA 1997) and the related Environmental Protection Rules, the Protected Areas legislations, the National Parks and Wildlife Conservation Act and various other policies pertaining to environmental protection, conservation, protection of biodiversity and ecosystems. The umbrella EPA is currently being updated. Relevant regulations will also be updated to clarify responsibilities of environmental management across the 3 tiers of government. In addition, legislation on land rights and use are in place (including the 2015 Land Use Policy); however, implementation needs to be strengthened. The on-going and planned engagements with the government including the REDD+ Readiness project (AF), the Emission Reduction Program for the Terai Arc Landscape and the preparation of the “Forests for Prosperity” project will assist the government to address related risks. The ongoing Environmental Sector Diagnostic will further identify policy gaps and make recommendations to strengthen environmental policies, planning and implementation in the context of transition to federalism.

72. The climate co-benefits of this operation (DPC2) are being estimated.

5.3 PFM, DISBURSEMENT AND AUDITING ASPECTS 73. The government’s PFM structures and processes have improved. The 2015 Public Expenditure and Financial Accountability (PEFA) Assessment concluded that Nepal has made substantial progress in deepening the structures and processes of PFM, particularly related to the use of Information Technology (IT). As compared to the first PEFA Assessment (2007), the second assessment (2015) recorded improvements in 16 indicators. There are nonetheless areas that need continued improvement especially in the federal context which this DPC is designed to strengthen. For example, as in the previous audit reports, the 2017 Auditor General’s Report highlights systemic weaknesses in internal control systems. The current DPC series is designed to strengthen PFM and support reform to reduce audit irregularities, include the

18 MOF (2017) Climate Change Financing Framework.

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expenditures of local governments in the central system, integrate all three tiers of the government’s budget spending with the central financial management information system and adoption of prudent fiscal regulations/policies, among others. In addition, the integrated PFM project under the MDTF comprises a component on internal controls and internal audit to improve capacity in this key area.

74. The government’s budget classified by functions, functionaries and charts of accounts is publicly available. Budget information by geographical locations and monthly expenditure reports by functions are all available at FCGO’s website. An integrated PFM information platform (budget execution) is operational and information is shared with the line ministries. All financial transactions have been unified under a single treasury at the federal level.

75. The Public Procurement Monitoring Office (PPMO) continues to improve transparency in public procurement processes by adopting international standards and IT. The Public Procurement Act and Public Procurement Regulations approved in 2007, and compliant with United Nations Commission on International Trade Law, provide an international standard procurement legal framework. Anchored in this Act and the supporting Regulations is the single e-GP (Electronic Government Procurement) portal which is facilitating the availability of standard bidding documents on-line for common procurements to all interested parties and on-line procurement progress monitoring by the PPMO. This e-GP platform has fostered transparency and competition and enabled faster remedial actions by the authorities. As part of the government’s on-going procurement reform program, the Bank is supporting the government in implementing its PFM reform agenda through an ongoing project - Integrated PFM Reform Project with a procurement reform component.

76. The recent IMF Staff Report, approved on February 8, 2019, noted some areas in need of improvement related to safeguards. Specifically, external and internal audit arrangements and financial reporting practices need strengthening. The legal framework should also be enhanced to strengthen the central bank’s autonomy and governance arrangements. The IMF is providing technical assistance on the internal audit function and will continue to engage with the authorities on necessary remedial steps. The 2018 Article IV Staff Report also noted significant vulnerability to cyber risks at the NRB, due to weak IT infrastructure and practices.

77. Disbursements. The proposed operation is the second in a programmatic series of two DPCs. The credit proceeds will be made available to the Government upon approval of credit effectiveness and meeting of the standard withdrawal tranche release conditions. The government will submit a withdrawal application in the requested format to the World Bank once the credit has been approved and the World Bank has notified the credit effectiveness to the government. At the request of the MoF, the disbursement in USD will be made into the treasury account of the government maintained at the NRB that forms part of the country’s foreign exchange reserves which will later be transferred into NPR equivalent of the Government’s consolidated fund (the General Fund). The Government will confirm to the World Bank, within 30 days, of receipt of the proceeds and its credit in the Treasury account, including the date of receipt, and the exchange rate applied to convert the credit proceeds into Nepalese Rupees.

78. Confirmation and eligible expenditure. The MoF will provide to the Bank a confirmation that the amount of the operation has been credited to an account that is available to finance budget expenditures. If, after the proceeds are deposited in the government account, the proceeds of the operation are used for ineligible purposes as defined in the Finance Agreement, the Bank will require the Government, upon notice from the Bank, to refund an amount equal to the amount of said payment to the Bank. Amounts refunded to the Bank upon such request shall be cancelled.

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79. Reporting, auditing and closing date. No audit will be required for the proposed operation as funds will be transferred to the government’s treasury and not to a dedicated account. The closing date of the proposed loan will be June 30, 2020.

5.4 MONITORING, EVALUATION AND ACCOUNTABILITY 80. The MoF is leading the effort in coordinating the overall implementation of the DPC. MoF has experience and is conversant with World Bank policies and procedures through lending and TA operations. Given the long history of budget support operations in Nepal, some institutional capacity has been built up on data requirements and overall monitoring arrangements. Nepal has implemented the IMF’s Enhanced General Data Dissemination System and data is generally available through the MoF website, the central Bank’s website and the Statistical Agency. The World Bank team will continue to provide support to government in monitoring the reform progress and results.

81. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a World Bank Development Policy Operation may submit complaints to the responsible country authorities, appropriate local/national grievance redress mechanisms, or the WB’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Affected communities and individuals may submit their complaint to the WB’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org.

6. SUMMARY OF RISKS AND MITIGATION

82. The overall risks to the operation are Substantial. Political and governance, institutional capacity, fiduciary and stakeholder risks are assessed to be Substantial. Political and governance risks arise from jurisdictional overlap between the three tiers of government, lack of clarity and coherence between policies and devolved powers that may undermine coordination across government agencies, leading to a duplication of efforts that impedes reform implementation. Political and governance risks are compounded by stakeholder, fiduciary and institutional capacity risks. This is a multi-sectoral operation with participation from several line ministries and also different tiers of government, some of which have weak institutional capacity. In addition, weak implementation capacity and lax enforcement of rules and regulations increase fiduciary risks, particularly at the local government level. These risks are linked to weaknesses in the areas of internal control and internal audit, delay in follow-up actions on audit recommendations, separation of responsibilities between treasury and audit function, and issues related to timeliness of audits at the budget agency or project levels. Stakeholder risks remain substantial, primarily from vested interest groups that benefit from the current policy regime and would prefer the status quo, which could delay or derail reforms.

83. The above risks are largely mitigated by several factors linked to a stable government, strong government ownership, and donor support (including actions under this operation). Political and governance and stakeholder risks are mitigated by strong commitment of the Minister of Finance to ensure progress on the current programmatic series and a democratically elected government with a two-thirds majority in Parliament. Improved transparency and accountability arising from the reforms supported in this DPC will also help mitigate the stakeholder risks. In addition, this DPC supports reforms to clarify tax

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jurisdiction which will help manage this risk. Institutional capacity risk is mitigated by the extensive development partner engagement to build institutional capacity including through the MDTF PFM trust fund and the Federalism Working Grouping (co-chaired by the World Bank) that is supporting capacity building of elected governments and their institutions. Capacity building is further supported by reforms under this Fiscal and PFM DPC series; the Integrated Public Financial Management Reform Project; and continuous dialog with the government. In the case of fiduciary risks, this DPC supports reforms to revamp the rules that govern budget implementation working closely with identified champions at the National Planning Commission, Financial Comptroller General Office, Public Procurement Monitoring Office and Office of the Auditor General. With the approval and implementation of the new fiscal procedure and financial responsibility law and internal control guidelines, increased accountability and transparency should lower fiduciary risks. Fiduciary risks are also mitigated through on-going institutional capacity strengthening activities funded through the MDTF, centered around the rules governing budget implementation. The risk ratings are summarized in the Table 6.

Table 6: Summary Risk Ratings

Risk Categories Rating (H, S, M or L)

1. Political and governance S

2. Macroeconomic M

3. Sector strategies and policies M

4. Technical design of project or program M

5. Institutional capacity for implementation and Sustainability S

6. Fiduciary S

7. Environment and social M

8. Stakeholders S

9. Other

10. Overall S

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ANNEX 1: POLICY AND RESULTS MATRIX

Completed Prior Actions under DPC 1

(2018)

Prior Actions under DPC 2 (2019)

RESULTS INDICATORS Baseline: FY2016 and Target: FY2020 (unless otherwise mentioned)

Pillar one: Establish a framework to move towards fiscal federalism

Prior Action 1: To implement fiscal federalism the Parliament has approved the Intergovernmental Fiscal Arrangement Act which provides the legal framework for resource allocation among the three tiers of government (Official Gazette/2017).

Prior Action 1: The Cabinet has endorsed and submitted to Parliament the Federal Fiscal Procedures and Financial Responsibility Bill, which governs budget execution and increases fiscal discipline and accountability. Prior Action 2: The Finance Act 2018 has been enacted, which clarifies revenue allocation by amending: (i) provisions in the Intergovernmental Fiscal Arrangement Act related to tax administration and revenue assignment for motor vehicle tax, land and building registration fee, entertainment tax and advertisement tax; and (ii) the provisions in the Local Government Operations Act related to the local tax base for property tax and land tax.

Results Indicator 1: Share of the education budget devolved to the provincial and local governments Baseline: 0 Target: At least 60 percent Results indicator 2: Consolidated expenditure produced on an annual basis, one fiscal year prior to the budget: Baseline: None Target: Expenditure of previous fiscal year of all 3-tiers of GoN submitted to Parliament with annual budget Results indicator 3: Own revenue sources of provincial and local governments: Baseline: 2 percent of consolidated revenues Target: At least 10 percent increase e

Prior Action 2: The Parliament has approved the Local Government Operations Act- 2017, which will govern the operation and management of local governments (Official Gazette/2017).

Prior Action 3: All Local governments have established the Local Consolidated Fund and at least 25 percent of Local Governments have delegated spending authority to the Chief Administrative Officer within 7 days of approval of the annual budget as certified by letters issued by the Ministry of Finance.

Results Indicator 4: Share of federal transfers spent by local governments: Baseline: 0 Target: At least 40 percent

Prior Action 3: The Parliament has approved the National Natural Resources and Fiscal Commission Bill which will govern federal transfers to provincial and local governments. (Official Gazette/2017).

Prior Action 4: The National Natural Resources and Fiscal Commission, has (i) adopted the framework for the calculation and devolution of the equalization grants and the conditional grants, and (ii) included forest cover as one of the indicators in the motor vehicle tax revenue sharing formula between Local Governments and Provincial Governments to mitigate carbon emissions.

Results Indicator 5: Equalization and conditional grants in FY20 budget made as per the formula: Baseline: Not Applicable Target: Grants made to all provincial and local governments

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Completed Prior Actions under DPC 1 (2018)

Prior Actions under DPC 2 (2019)

RESULTS INDICATORS Baseline: FY2016 and Target: FY2020 (unless otherwise mentioned)

Pillar one: Establish a framework to move towards fiscal federalism

Prior Action 4: The National Women’s Commission has adopted an integrated platform that provides a comprehensive response system and coordinates and expands access to services for Gender Based Violence cases (Ministry Notification).

Prior Action 5: The 2017 Federal Guidelines for Gender Responsive Budgeting have been issued to: (i) the Provincial Governments through a letter by the Ministry of Finance and (ii) the Local Governments through a letter by the Ministry of Federal Affairs and General Administration to the local governments.

Results Indicator 6: Number of provinces that have adopted gender responsive budgeting Baseline: None Target: All 7 provinces

Completed Prior Actions under DPC1

(2018)

Prior Actions under DPC 2 (2019)

RESULTS INDICATORS Baseline: FY2016 and Target: FY2020 (unless otherwise mentioned)

Pillar Two: Improve the policy framework for public financial management

Prior action 5: To strengthen public financial management systems, the MoF has: (i) integrated all public financial management systems onto one platform - Public Financial Management Information System (MoF website, PFMIS/11-2017) and (ii) provided access to the PFMIS to all federal ministries (Ministry of Finance Directive/2017).

Prior Action 6: To strengthen the PFM framework: (i) Two-thirds of all Local Governments have adopted Budget Management Legislation governing their own budget processes as certified by a letter issued by the Ministry of Federal Affairs and General Administration; and (ii) the Financial Comptroller General’s Office has made the consolidated report of local governments’ expenditure publicly available.

Results Indicator 7: Consolidated public expenditure data publicly available within 6 months of end-FY. Baseline: Not available Target: FY2019 expenditure on FCGO’s website

Prior action 6: To strengthen budget realism, the MoF has: (i) Mandated the preparation of a three-year MTEF at the federal level for the FY2019 budget cycle - (Financial Procedure Directives/ 2017); and (ii) mandated the preparation of the Local Government Development Plan which will anchor the local annual budgets and the local MTEFs (Ministry of Finance Directive/2017).

Prior Action 7: The National Planning Commission has issued MTEF guidelines as part of the Plan Formulation Guidelines for Provincial Governments and Local Governments that take into account sustainable development goals including climate change.

Results Indicator 8: Number of Provinces adopting the MTEF guidelines: Baseline: None Target: All 7 provinces Results Indicator 9: Deviation between consolidated revised budget estimates and actual consolidated spending. Baseline: Not available Target: 20 percent or lower deviation.

Prior action 7: To improve budget execution, the MoF has: (i) issued a decree which requires all new aid funded and national priority projects to have secured project filter clearance for issuance of budgetary funds (Cabinet Approval -CA); (ii) adopted the System for Automatic Spending Authorization and Program Approval

Prior Action 8: To strengthen expenditure controls (i) the Cabinet has endorsed and submitted to the Parliament the Audit Bill 2018; and (ii) the Ministry of Finance has approved the new internal control guidelines.

Results indicator 10: Proportion of federal capital expenditure undertaken in the last quarter: Baseline: 75 percent Target: 65 percent Results Indicator 11: Audit irregularities reported by the OAG report:

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Completed Prior Actions under DPC1 (2018)

Prior Actions under DPC 2 (2019)

RESULTS INDICATORS Baseline: FY2016 and Target: FY2020 (unless otherwise mentioned)

Pillar Two: Improve the policy framework for public financial management

for all spending units which will assist in budget execution from day one of new fiscal year (Financial Procedure Directives/ 2017); and (iii) adopted a system of payments by account payee only to expedite payments (Financial Procedure Directives/ 2017);

Baseline: Audit irregularities of 7 percent for federal government agencies (OAG 2016 report). Target: Audit irregularities of 6 percent or less across all 3-tiers of government (OAG 2020 report).

Prior Action 8: The Parliament has approved Disaster Risk Reduction and Management Act -2017, which will govern coordination and management of all activities pertaining to disaster management, disaster risk reduction, disaster recuperation and disaster response as well as monitoring and mitigation measures on climate change and global warming (Official Gazette/2017).

Prior Action 9: The Ministry of Federal Affairs and General Administration has issued disaster management policy guidelines to local governments taking current risk profiles and future climate change into consideration.

Results Indicator 12: Adoption of DRM framework by local governments: Baseline: No framework in place Target: At least one municipality in each province

Prior action 9: The MoF has established the Revenue Management Information System at the federal level to provide real time information on revenue collections. (FCGO Web/9-2017).

Prior Action 10: For revenue data collection: (i) the Ministry of Finance has established a Revenue Management Information System at the Provincial Government level to provide real time information on revenue collections; and (ii) the Office of the Auditor General has approved a template for revenue data collection at the Local Government level.

Results Indicator 13: Timely availability of information on revenue collection: Baseline: Data on 90 percent of tax collection available with a lag of two months. Target: Data on 100 percent of revenue collection for federal government available real-time, 60 percent of revenue collection for provincial governments available real-time and 40 percent of local government revenue collection available by mid-Jan following the concerned fiscal year.

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ANNEX 2: LETTER OF DEVELOPMENT POLICY

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39

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ANNEX 3: FUND RELATIONS ANNEX

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42

43

44

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ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE

Prior actions Significant poverty, social or

distributional effects positive or

negative (yes/no/to be determined)

Significant positive or negative

environment effects (yes/no/to be

determined)

Pillar One: Establish a framework to move towards fiscal federalism

1. The Cabinet has endorsed and submitted to Parliament the Federal Fiscal Procedures and Financial Responsibility Bill, which governs budget execution and increases fiscal discipline and accountability.

This Bill can potentially have positive effects as it could govern budget execution across all three tiers of government and help strengthen the fiscal and budget framework. Improved budget processes at the local level are expected to improve service delivery for the poor.

Environmental effects could be neutral to positive based on the implementation of the Climate Change Financing Framework which applies to the full budget and provides facility for tracking climate change related spending.

2. The Finance Act 2018 has been enacted,

which clarifies revenue allocation by amending: (i) provisions in the Intergovernmental Fiscal Arrangement Act related to tax administration and revenue assignment for motor vehicle tax, land and building registration fee, entertainment tax and advertisement tax; and (ii) provisions in the Local Government Operations Act related to the local tax base for property tax and land tax.

Poverty or distributional effects are expected to be neutral or positive. This prior action clarifies tax jurisdiction across three tiers of the governments and does not directly introduce new taxes. However, the increased clarity in jurisdiction could increase collected taxes leading to potential positive distributional effects.

There could be significant environmental effects given the design of the tax aimed at reducing carbon emissions through the Motor Vehicle tax (linked to engine size).

3. All Local governments have established the Local Consolidated Fund and at least 25 percent of Local Governments have delegated spending authority to the Chief Administrative Officer within 7 days of approval of the annual budget as certified by letters issued by the Ministry of Finance.

No significant poverty or social effects. No significant effects on the environment.

4. The National Natural Resources and Fiscal Commission, has (i) adopted the framework for the calculation and devolution of the equalization grants and the conditional grants, and (ii) included forest cover as one of the indicators in the motor vehicle tax revenue sharing formula between Local Governments and Provincial Governments to mitigate carbon emissions.

Increased resources to local governments for service delivery can have significant positive distributional effects.

Taxes to reduce carbon emissions and increase forest cover (which is considered carbon sinks) are expected to have significant positive effects on the environment. In the framework, this indicator is given a weight in the formula to capture climate change risks.

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5. The 2017 Federal Guidelines for Gender Responsive Budgeting have been issued to: (i) the Provincial Governments through a letter by the Ministry of Finance and (ii) the Local Governments through a letter by the Ministry of Federal Affairs and General Administration.

Gender sensitive allocation of the budget is expected to have significant positive gender and distributional effects.

No significant effects on the environment.

Pillar Two: Improve the policy framework for public financial management 6. To strengthen the PFM framework: (i) Two-thirds of Local Governments have adopted Budget Management Legislation governing their own budget processes as certified by a letter issued by the Ministry of Federal Affairs and General Administration; and (ii) the Financial Comptroller General’s Office has made the consolidated report of local governments’ expenditure publicly available.

Neutral or potentially positive effect on

the poor if improved budget execution

at the local level is coupled with

increased transparency and

accountability (and greater citizen

engagement making public spending

public) leading to improved access and

efficiency in service delivery.

Neutral or potentially positive if there is

particular attention in the budgeting

process toward accounting for sustainability

and climate change/mitigation aspects in

the planning and implementation of the

budget both through following the MTEF

guidance or implementation of the Climate

Change Financing Framework that covers

the full budget.

7. The National Planning Commission has issued MTEF guidelines as part of the Plan Formulation Guidelines for Provincial Governments and Local Governments that take into account sustainable development goals including climate change.

No significant poverty or social effects. Potential positive effects given that the MTEF guidance includes guidance on incorporating climate change in the MTEF.

8. To strengthen expenditure controls (i) the Cabinet has endorsed and submitted to the Parliament the Audit Bill 2018; and (ii) the Ministry of Finance has approved the new internal control guidelines.

No significant poverty or social effects. No significant effects on the environment.

9. The Ministry of Federal Affairs and General Administration has issued disaster management policy guidelines to local governments taking current risk profiles and future climate change into consideration.

Potentially positive as the adoption of the local disaster management policy guidelines (in local budget and development plans) would strengthen local level management and response to disasters and facilitate management of climate change aspects to which the poor are most vulnerable.

Potentially positive effects given the guidance and regulations to local governments to improve disaster prevention, management and mitigation of climate change.

10. For revenue data collection: (i) the Ministry of Finance has established the Revenue Management Information System at the Provincial Government level to provide real time information on revenue collections; and (ii) the Office of the Auditor General has approved a template for revenue data collection at the Local Government level.

No significant poverty or social effects. No significant effects on the environment.

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ANNEX 5: ACHIEVEMENTS UNDER DPC1

Completed Prior Actions under DPC 1

Achievements and Progress

Prior Action 1: To implement

fiscal federalism the

Parliament has approved the

Intergovernmental Fiscal

Arrangement Act which

provides the legal framework

for resource allocation among

the three tiers of government

(Official Gazette/2017).

This act includes a framework for revenue sharing among the three tiers of

government. It defines the category of grants (including conditional and

equalization) and also includes framework provisions for the receipt of

foreign assistance at federal, provincial and local level, and the provisions for

provincial and local government borrowing. It also mandates the preparation

of the budget and the MTEF at all levels of government, including revenue

projections. It mandates establishment of consolidated funds into which all

resources should flow and from which all spending should occur. It also

mandates establishing an Intergovernmental fiscal council to facilitate

coordination across the levels of government on matters related to

intergovernmental fiscal relations. It outlines fiscal relations among the

three tiers of the government.

Results: Since the enactment of the Intergovernmental Fiscal Relations Act,

NNRFC has recommended formulas to be used for fiscal transfers to

provincial and local governments (DPC2, PA4) and total transfers of 8.3

percent of GDP have been made to the provincial and local levels. In

addition, local consolidated funds have been established (PA3, DPC2) to

facilitate on-budget spending and a move towards a single treasury account

across all levels of government.

As implementation of the Intergovernmental Fiscal Arrangement Act

progressed, the overlaps in the tax jurisdiction became evident. As a result,

the Act was amended (through the Finance Act 2018) to clarify tax

jurisdiction and revenue sharing (PA2, DPC2).

Prior Action 2: The Parliament

has approved the Local

Government Operations Act-

2017, which will govern the

operation and management of

local governments (Official

Gazette/2017).

The LGO Act outlines provisions on the operation of local governments, to

institutionalize the legislative, executive and judiciary branches of

government at the local level. It outlines the number and demarcation of

local governments/municipalities and process for naming or changing the

name of a municipality or ward; criteria for merging/changing boundaries of

a municipality; and population criteria for creating a municipality. Provisions

also outline the functions, roles and responsibilities of municipalities

including social service delivery, and other services related to vehicle

registration, land management and transport services. It outlines the

responsibilities of the Chief Executive Officer/Mayor, and Ward Chair, and

other members of the local assemblies. It defines the periodicity and

procedures for meetings, rules for delegation of authority and the operation

of the local assemblies. It also outlines provisions for developing local

development plans, local construction permits, jurisdiction of roads, and

operation of the local judiciary. There are also provisions for calculation of

local taxes and the formation of the following committees: the local revenue

advisory committee charged with formulation, amendments and oversight

of tax policy; a resource ceiling committee charged with determining the

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Completed Prior Actions under DPC 1

Achievements and Progress

budget ceiling based on available resources and related projects; and the

budget committee charged with budget formulation and prioritization. The

LGO Act grants rights for local borrowing that should not exceed 25 years

and that cannot be defaulted on (defaults are deducted from fiscal

transfers). It mandates the creation of local consolidated funds and

stipulates what qualifies to be deposited into the fund. It outlines

procedures for tabling the budget, preparing financial accounts, internal

controls, audits and public procurement. It also outlines duties/functions of

local officers/staff and district councils.

Results: Since the enactment of the LGO Act, local consolidated funds have

been established and the authority to spend has been granted to some of

the local chief administrative officers (DPC2, PA3). In addition, Budget

Management legislation has also been adopted by many local governments

(DPC2, PA6(i)).

Prior Action 3: The Parliament

has approved the National

Natural Resources and Fiscal

Commission Bill which will

govern federal transfers to

provincial and local

governments. (Official

Gazette/2017).

Outlines the roles, responsibilities and functions of the NNRFC which

includes developing and recommending the revenue formula, managing

conflict in revenue sharing, recommending natural resource use,

determining required investments for natural resources and grant sharing.

Results: Since the enactment of the law, the commission was headed by a

Secretary and the Commission has recommended the formula used to make

fiscal transfers in FY2018. A commissioner head has recently been

appointed. In addition, the NNRFC has adopted the formula for equalization

and conditional grants and determined the basis for sharing the motor

vehicle tax revenues between the provinces and local governments (DPC2,

PA4).

Prior Action 4: The National

Women’s Commission has

adopted an integrated

platform that provides a

comprehensive response

system and coordinates and

expands access to services for

Gender Based Violence cases

(Ministry Notification).

The platform has since been operationalized and has been used to handle

cases reported to the helpline. The helpline is in heavy demand and

government is exploring ways to expand its operations.

Results: A 24-hour toll free helpline including an inbuilt case management

system was officially launched. The helpline includes access to shelter,

health care, psychosocial support, legal aid, child support and improved

service delivery with a focus on preventing revictimization of the survivors.

Since its launch, there have been a total of 1,275 cases, up till November 30,

2018.

Prior action 5: To strengthen public financial management systems, the MoF has: (i) integrated all public financial management systems onto one platform - Public Financial Management Information

MoF has recently reoriented its priorities in this area and has adopted a vision (IT Note) where a full integration of the existing PFM systems would be achieved in the medium-term (4 to 5 years). Results: (i) A comprehensive IFMIS study is underway and will lay out possible options for IT integration. (ii) All federal ministries now have access to the PFMIS.

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Completed Prior Actions under DPC 1

Achievements and Progress

System (MoF website, PFMIS/11-2017) and (ii) provided access to the PFMIS to all federal ministries (Ministry of Finance Directive/2017).

(iii) The SUTRA IT system is being rolled out at the local level for budgeting, reporting and tax accounting.

Prior action 6: To strengthen budget realism, the MoF has: (i) Mandated the preparation of a three-year MTEF at the federal level for the FY2019 budget cycle - (Financial Procedure Directives/ 2017); and (ii) mandated the preparation of the Local Government Development Plan which will anchor the local annual budgets and the local MTEFs (Ministry of Finance Directive/2017).

Results:

At the federal level, MTEFs were produced along with the FY2019 budget.

At the provincial and local level, NPC has issued MTEF guidelines to local

governments and provincial governments (DPC2, PA7) and has initiated a

training program on the MTEFs.

In addition, the World Bank is providing TA support for NPC training on the

MTEF at the federal and the provincial and local levels under the PFM MDTF.

Prior action 7: To improve budget execution, the MoF has: (i) issued a decree which requires all new aid funded and national priority projects to have secured project filter clearance for issuance of budgetary funds (Cabinet Approval -CA); (ii) adopted the System for Automatic Spending Authorization and Program Approval for all spending units which will assist in budget execution from day one of new fiscal year (Financial Procedure Directives/ 2017); and (iii) adopted a system of payments by account payee only to expedite payments (Financial Procedure Directives/ 2017);

Results: (i)The project filter was implemented at the federal level. Aid-

funded projects are very limited at the provincial and local level and they

require approval at the federal level. Project filters at the provincial and

local level will be applied in a manner similar to the federal project filters.

The Bank is providing TA toward establishing a project bank or inventory of

projects to feed into the MTEF.

(ii) The automatic spending authority is progressing well. The approved

LMBIS is used for automatic spending by spending units. The challenge is on

virements (moving budgets between different budget lines) where spending

units will have to go to MoF for approval manually.

(iii) The MoF has already initiated electronic funds transfer (EFT) across the

country at the federal level. This covers contractual obligations only. To

strengthen this process, there is a need to establish payment gateways and

also the EFT to the tax /revenue system.

Prior Action 8: The Parliament has approved Disaster Risk Reduction and Management Act -2017, which will govern coordination and management of all activities pertaining to disaster management, disaster risk reduction, disaster recuperation and disaster response as well as monitoring

Based on the DRM Act 2017, model laws were developed to govern local

level coordination of DRM activities. Indications are that some LGs have

already prepared acts based on the model acts which will need to be voted

by the local assembly (DPC2, PA8)

Results: An Organizational and Management (O&M) Survey was conducted

defining the operational structure and needed staffing and resources for the

DRM Authority. The functions assigned to the DRM Authority have been

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Completed Prior Actions under DPC 1

Achievements and Progress

and mitigation measures on climate change and global warming (Official Gazette/2017).

defined based on the legal provisions of the Act. The DRM Authority is likely

to be established in the next 2 months.

Prior action 9: The MoF has established the Revenue Management Information System (RMIS) at the federal level to provide real time information on revenue collections. (FCGO Web/9-2017).

MoF has established the RMIS at the provincial level. The RMIS design is not

able to support the large number of local governments and also because it

was difficult to adapt the RMIS to the local level requirements. Instead, the

SUTRA will be used which is web-based and specifically tailored for local

governments. The SUTRA tax module for local governments is under

development currently. For FY2018, the FCGO has published revenue data

for local governments which were collected manually (PA10, DPC2).

Results: The RMIS is fully functional at the federal level and is providing real

time information on revenue collections.