Municipal Finance Framework for the National Urban Development Strategy (NUDS) of Nepal

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TOWN DEVELOPMENT FUND

Municipal Finance Framework for the National Urban Development Strategy-Nepal

Final Report

Yuba Raj Khatiwada, PhD, Team Leader Ganga Datta Awasthi, Member

Kapil Dev Ghimire Member Khim Lal Devkota, PhD, Member

Pratap P. Pradhan, Member

October 2015

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Acknowledgements

This study report on Municipal Finance Framework for the National Urban Development Strategy-Nepal intends to develop financing framework for urban infrastructure covering the Own Source Revenue (OSR), Inter-Governmental Fiscal Transfer (IGFT) and Borrowings to leverage revenue surplus and government grants to multi-year infrastructure investments required for sustainable and decent urban development of Nepal. This report, while primarily based on the infrastructure-financing gap estimated by the National Urban Development Strategy (NUDS), makes an updated assessment of the urban financing need in line with the added number of Municipalities in the recent years.

This study report has been prepared with the support and input from various institutions, agencies, and experts. The study has benefited from the valuable cooperation and strong support received from the Executive Director of Town Development Fund (TDF) Mr. Shusil Gyewali, Mr. Maniram Singh Mahat, Director and Mr. Nawa Raj Koirala, DeputyManager. The guidance of Mr. Gyewali in preparing the report, technical and logistic support of Mr. Mahat in shaping the report and untiring efforts of Mr. Koirala in financing concepts, fixing the data problems and information gaps are duly acknowledged. Data analysis support of Mr. Saroj Basnet is highly appreciated. Other several officials of the TDF deserve appreciation for their support throughout the preparation of this report. I would also like to thank the related officials and experts from the various sectors for their time and willingness to share information for the study.

This study report has been prepared with the collaborative efforts of experts having a long experience in local development and urban financing. In this respect, I would like to recognize the contributions made by Mr. Pratap P. Pradhan, Mr. Ganga Datta Awasthi, Mr. Kapil Ghimire, and Dr. Khim Lal Devkota in drafting and consolidating several chapters of this report. I would also like to thank Mr. Rajivan Krishnaswami of the World Bank for his valuable suggestions and Ms. Yoonhee Kim, Sr. Urban Economist, Task Team Leader of UGDP/ETP for her genuine feedbacks for the study. The opinions expressed in this report are solely those of the authors and do not necessarily reflect those of TDF.

Yuba Raj Khatiwada, Ph.D Team Leader October, 2015

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Acronyms and Abbreviations

ADB Asian Development Bank ADDCN Association of District Development Committees of Nepal AWPB Annual Work Plan and Budget CA Constituent Assembly CAC Citizen Awareness Center CBOs Community Based Organizations CCI Chamber of commerce and Industries COs Community Organizations DDC District Development Committee DDF District Development Fund DIP Decentralization Implementation Plan DIMC Decentralization Implementation and Monitoring Committee DIMWC Decentralization Implementation Monitoring Working Committee DOED Department of Electricity Development DoF Department of Forestry DoI Department of Immigration DoLIDAR Department of Local Infrastructure and Agriculture Roads DOLR Department of Land Revenue DoM Department of Mines DoNPW Department of National Parks and Wildlife DPs Development Partners DPMAS District Poverty Monitoring Assessment System DRM Disaster Reduction Master Plan DWSS Department of Water Supply and Sewerage DUDBC Department of Urban Development and Building Construction DTO District Technical Office DTCO District Treasury Comptroller office EO Executive Officer FCGO Financial Comptroller General Office FMIS Financial Management Information System FNCCI Federation of Nepalese Chamber of Commerce and Industries FY Fiscal Year GDP Gross Domestic Product GOI Government of India GoN Government of Nepal HALT House and Land Tax IGFT Inter Governmental Fiscal Transfers

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I/NGOS International Non Governmental Organizations IPFC Integrated Plan Formulation Committee IPT Integrated Property Tax JFA Joint Financial Arrangement JFTA Joint Financial Technical Assistance KUKL Kathmandu Upatyaka Khanepani Limited KVDA Kathmandu Valley Development Authority LAs Line Agencies LBs Local Bodies LBFC Local Bodies Fiscal Commission LBFAR Local Bodies Financial Administration Rules LDO Local Development Officer LDTA Local Development Training Academy LDF Local Development Fund LGCDP Local Governance and Community Development Program LIDP Local Infrastructure Development Policy LMs Line Ministries LMBIS Line Ministry Budget Information System LNGO Local Non-Government Organizations LSGA Local Self Governance Act LSGR Local self-Governance Regulation MCPM Minimum Conditions and Performance Measures M&E Monitoring and Evaluation MDF Municipal Development Fund MoAD Ministry of Agriculture Development MDAC Ministry Level Development Action Committee MoCS Ministry of Commerce and Supply MoE Ministry of Education MoF Ministry of Finance MoFALD Ministry of Federal Affairs and Local Development MoHP Ministry Of Health and Population MoI Ministry of Industry MOU Memorandum of Understanding MoUD Ministry of Urban Development MoTC Ministry of Tourism and culture MRF Municipal Reserve Fund MSWM Municipal Solid Waste Management MTEF Medium Term Expenditure Framework MuAN Municipal Association of Nepal

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NAVIN National Association of Village Development Committee of Nepal NBC Nepal Building Code NDAC National Development Action Committee NEA Nepal Electricity Authority NNRFC National Natural Resources and Fiscal Commission NPC National Planning Commission NUDS National Urban Development Strategy NWSC Nepal Water Supply Corporation OC Other Charges OAG Office of the Auditor General OPMCM Office of the Prime Minister and Cabinet of Ministers OSR Own Source Revenue PAA Program Alignment Assistance PEFA Public Expenditure and Financial Administration PMAS Poverty Monitoring Assessment System PPP Public Private Partnership RBM Result Based Monitoring RBN Road Board Nepal STWSSSP Small Towns Water Supply and Sanitation Sector Project SWAP Sector Wide Approach SWC Social Welfare Council SWM Solid Waste Management TA Technical Assistance TDC Town Development Committee TDF Town Development Fund TLO Tole Lane Organization TSA Treasury Single Account UDTC Urban Development Training Center UEIP Urban Environment Improvement Program UGDP Urban Governance and Development Program VDC Village Development Committee VDFs Village Development Funds VGF Viability Gap Funding WB World Bank WCF Ward Citizen Forum

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EXECUTIVE SUMMARY

1. Background

Nepal is passing through the stage of state restructuring towards federal set up of three layers of government – federal, provincial, and local - with the promulgation of new constitution of the country by the Constituent Assembly in September 2015. The constitution has provided mandates of development activities and resource mobilization for the provincial and local governments including the municipalities. As such, the municipal government is assigned a larger functional, semi judicial and fiscal authority.

The government is mulling for converting many Village Development Committees (VDCs) into municipalities, as some of the villages are now emerging as towns and are having large populations as well. In this process, the government has declared additional 159 municipalities on fiscal year 2014/15 and 2015/16 resulting in a number of municipalities to reach 217 by October 2015. With this, population of the municipalities has reached about 42 percent of the total population. The process of rapid urbanization and conversion of more VDCs into municipalities is making urban population growth much faster than the overall population growth of 1.3 per cent.

The existing municipalities suffer a lot from infrastructure deficit; particularly, they lack paved roads, drainage, public transport system, solid waste management system, safe drinking water and sewage, vehicle parking facilities,public parks and greeneries, etc. Most of them are financially weak to create such infrastructure on their own efforts. The National Urban Development Strategy (NUDS) prepared by the Government of Nepal (GoN) flags on the need for developing a financing framework and institutional structures that facilitate these investments.

The objective of this study is to develop a detailed Municipal Finance Framework (MFF) covering comprehensive assessment of Own Source revenue (OSR), Intergovernmental Fiscal Transfer (IGFT) and borrowing frameworks, and recommend reforms to address the bottlenecks in the existing system along with suggesting an action plan to implement the reforms.

This study is based on the primary data and information collected from the existing municipalities, secondary data collected from government and municipal publications, information collected from the stakeholders, and consultations done with the relevant ministries. The total funding requirements for the 217 municipalities for the next 15 years has been estimated on the basis of their projected population,infrastructure deficit in road, piped water supply network, electricity, solid waste management, storm drainageand sewerage,and their per unit cost.

2. Own Source Revenue of Municipalities

At present, revenue base of the municipalities is very weak and revenue potential has not been fully mobilized. OSR of the municipalities on average accounts only 27% of the total income. Taxes and fees are the major sources of OSR of the municipalities.

The Constitution of Nepal has given new power and responsibilities to the municipalities in providing various services in its jurisdiction like drinking water supply, small electricity generation, alternative energy, local roads, and irrigation. The Constitution also provides

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rights in raising the OSR for meeting those responsibilities, which are in addition to those provided under Local Self Governance Act (LSGA).

The main sources of tax revenue of the municipalities are house and land tax (HALT), integrated property tax (IPT), land revenue tax, entertainment tax, advertisement tax, rent tax, business tax, vehicle tax commercial video tax.Historical data of OSR for 2008/09 to 2013/14 of 58 municipalities shows annual average growth rate of 13.8 per cent. Local tax is the highest (47.6 per cent) contributor of the OSR followed by service charges and fees (42.4 per cent), and property rental (7.6 per cent).

Efficiency of the revenue management system depends upon its database. Property tax is the main source of income of the municipalities but its database is weak, as property records of IPT and HALT data are only about 80% and 40% respectively. The collection efficiency is much lower than the actual database. As an efficient revenue management system calls for automation of tax administration, most municipalities are using property tax software and some other software related to revenue management developed by a private firm for tax management.

Business tax, another potential source of income, has not been fully utilized by most municipalities as their major income source. Collection of this tax is not a big problem if the municipality tax collectors go to collect tax at their business premises. A few municipalities have worked in coordination with the local Chamber of Commerce and Industry (CCI) to collect this tax and part of the total collection is provided to the CCI. Problems in collecting the business tax are lack of up to date record of the taxpayers, frequent movement of businesses entities, close down of business, etc.

One of the weaknesses of the revenue management system of the municipalities is the billing system. Municipalities do not issue invoice to the clients. Invoice is raised at the time of making payment. Moreover, the municipal management does not get correct information about taxes and charges to be collected. Inefficient tax administration system and poor collection efficiency of the municipalities are the key challenges in raising taxes.

Projection of OSR has been done up to FY 2030/31 bases on three scenarios: (i) historical growth rate of municipal revenue, (ii) a higher growth of revenue based on improved revenue collection through improved efficiency of tax collection, and (iii) significantly improved revenue collection with widened tax base and rates, among others.

In base line projection (Scenario 1), projection of OSR is done using the historical growth rate for 58 municipalities and half of this rate for the new municipalities for the first three years and the same historical rate for all there after. In this scenario, total revenue collection of municipalities is projected increases from Rs. 3,070 millionin FY 2014/15 (base year) to Rs 65,087 million in FY 2030/31).

In Scenario 2, a 50% increase in the historical growth rate of taxes and service charges has been assumed. In this scenario, municipalities' revenue administrations are expected to run more efficiently with better collection efficiency through an improvement in taxpayer‟s database for the collection of property taxes and business tax. According to this scenario, total revenue collection increases from Rs. 3,070 million in FY 2014/15 (base year) to Rs 101,136 million in FY 2030/31.

In Scenario 3, a 75% increase in historical growth rate of taxes and service charges has been assumed. In this scenario, it is assumed that municipalities will have more innovative and

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sophisticated system for revenue collectionusing GIS system for revenue management;tax base will widen with additional investment in urban infrastructure; and citizens will be willing to pay higher tax rates and service charges due to better facilitiesprovided. According to this scenario, total revenue collection increases from Rs. 3,070 million in FY 2014/15 (base year) to Rs 130,696 million in FY 2030/31.

The recommended strategies in OSR are strengthening revenue administration, improving tax database, revision of tax rates, raising revenue collection efficiency, and exploring new avenues for revenue collection.

In strengthening revenue administration, the proposed activities are (i) review of MCPM performance, (ii) strengthening the role of Revenue Advisory Committee (iii) reviewing staffing requirement of Revenue Section, (vi) holding workshop and interaction programs, (v) introducing house numbering, and (vi) preparing revenue implementation plan.

For updating tax base and making tax system functional, the proposed activities are (i) computerizing OSR data, (ii) linking data with other sections of the municipality, (iii) coordinating and sharing data with government agencies, and (iv) making computer system functional.

In revising tax rates and making them effective, the proposed activities are (i) carrying out feasibility study of revenue sources, (ii) introducing IPT system in all the municipalities,and (iii) revising rates of taxes, fees and charges periodically.

To make revenue collectioneffective and efficient, the proposed activities are (i) introducing billing system, (ii) applying "carrot and stick' in tax compliance, (iii) holding regular revenue campaignsand awareness programs, (iv) using banking system for revenue collection, and (v) regularly exploring potential sources of OSR

Other strategies include (i) framing out cost recovery policy of infrastructure systems operated by the municipality, (ii) cost sharing by implementing projects through User Groups, and (iii) implementing projects under PPP model and widening the revenue base.

3. Intergovernmental Fiscal Transfer to Municipalities

Intergovernmental Fiscal Transfer (IGFT) from the central governments to the municipalities is the principal source of fund for most of the municipalities. Currently municipalities are getting a fixed grant and formula-based additional grants against the performance of the municipalities. The types of grants they receive are both conditional and unconditional.

The unconditional capital grant comprises two systems that are (a) basic (fixed) entitlements grants, and (b) formula-based grant comprising of (i) population (50%), (ii) weighted poverty (25%), (iii) area (10%), and (iv) weighted tax effort (15%). Performances are assessed as per indicators set in the Minimum Conditions and Performance Measures (MCPM) system.

Municipalities are highly dependent on fiscal transfers from GON. A significant share of municipal expenditure i.e. 72 percent of total expenditure is incurred as capital expenditure and 28 percent as current expenditure. There are still long lists of municipal functions, which are actually seen as unfunded responsibilities of the municipalities.

Currently, there are eleven different types of fund transferring practices from center to municipalities. As part of the recurrent grant system, the central government line ministries provide municipalities with different sectoral conditional grants through their line agencies at

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district level. The current sectoral block grants approach follows a project-based or supply-based approach, only capital grants transfers from MoFALD are formula-based and other grants provided by the center are conditional.

Although the municipalities' block grants are in principle unconditional, increased conditions have slipped into the provision of these grants. This practice not only does reduce the discretion of the municipalities to use the limited grant resources for their highest priority, it also results in a (often undesirable) fragmentation of municipal spending.

Average growth of municipal grants in the last 10 years is 29 percent. Total IGFT to the municipalities increased from Rs. 1,350 million in the FY 2006/07 to Rs. 9,730 millionfor FY 2015/16. The percentage of untied and tied grants to municipalities is 52 and 48 percent respectively. The transfer of resources is very inconsistent, gets often delayed, and is not predictable which pose difficulty for municipalities to procure and implement the planned and budgeted programs in an efficient and accountable manner.

IGFT is forecasted for the next 15 years taking the FY 2014/15 as the base year and with the assumptions that number of municipalities will be constant (217 in number) over the years and National Budget and IGFT growth rate will be similar to that of the GDP i.e. 12.5% (for unconditional grant). On these assumptions, the IGFT for the FY 2020/21, FY 2025/26 and FY 2030/31 is projected to be Rs. 17,530 million, Rs. 31,590 million and Rs, 56,940 million respectively.

IGFT is ever growing, but consistency and predictability is less ensured and continues to be determined in a quite ad hoc manner, at least with respect to the vertical division of resources between the central government and the municipal government. Most of the municipalities arecomfortable with the performance based grants system. However, formula-based allocations cover a small portion of grants only; other sectoral resources are currently allocated to the municipal level on a discretionary basis.

The formula-based “horizontal” allocation mechanism for allocation of the municipal block grants is quite sound, despite having certain concerns. The present fiscal transfer criteria of 'weighted tax' are inadequate and there is a need to consider own source revenue growth perspectives while designing mechanisms of capital grants to the municipalities in the future. Even after the introduction of equity-related criteria like poverty and weighted tax, the present system of transfers is being questioned on equity grounds.

Concerns are raised towards distribution of fiscal equalization grants to municipalities on the basis of their need for expenditure, their capacity in generating revenue and their efforts on raising revenue. Adoption of formula-based grants allocation by all the sectoral ministries is necessary. Design of the sectoral grants allocation has to be closely linked with the municipal development plan. It is desirable that the MOF directly allocates sectoral grants to the municipalities after approval of the GON Annual Program and Budget.

The creation of urban infrastructures, as planned under NUDS, demands additional resources for investment at the municipality level. The GON will have to provide additional Municipal Infrastructure Development Grants with set criteria for funds transfer to municipalities. A number of social accountability tools could also be used to analyze whether sectoral transfers received by the municipalities are actually being spent within the intended sector.

Key recommended strategies of IGFT include transparency and predictability of IGFT, equity in transfer system and performance based grant allocation.

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On transparent and predictable fiscal transfer system, the proposed activities are (i) refined positioning for appropriate and fair municipal grants and (ii) making IGFT predictable.

For promoting equity in the fiscal transfer, the proposed activities are (i) facilitating legitimate municipal grants, (ii) allocating grants systematically and equitably,(iii) establishing funds for municipal infrastructure development conditional grants for the implementation of NUDS, (iv) making functional revenue transfer to municipalities from central ministries/departments, and (v) preparing multi-year investment plan and fiscal framework to complement attainment of aims and objectives of the Municipal Development Plan.

Regarding strengthening performance based grant system, the proposed activities are (i) allocating formula-based sectoral unconditional grants to the municipalities, (ii) allocating sectoral conditional grants to the municipalities, (iii) transforming municipal processes to e-Municipalities, and (iv) strengthening monitoring and evaluation.

4. BorrowingAspects of Municipal Financing

Review of municipal income and expenditure levels and patterns shows that the existing sources of municipal budget expenditureare not enough for meeting growing urban infrastructure investment demand. While municipal government is responsible for local infrastructure, meeting the shortfall in the capacity and resources to deliver both current services and future demand for urban infrastructure services require effective and innovative financial framework comprising of clear assignment of revenue and expenditure responsibilities, authority and discretionary power to adjust revenues and to generate sufficient local government own revenue sources, predictable financial relationships between central and local governments, and a prudent borrowing strategy.

The NUDS (2015) estimates investment needed to fulfill the existing infrastructure deficit in 58 municipalities at Rs 372 billion in 15 years' time. The investment need has been calculated for the infrastructure deficit based on existing and desirable state of infrastructure of the municipalities. The infrastructure investment requirement includes new roads construction, up-gradation of existing roads, piped water supply connection, construction of toilets, electricity connection, solid waste collection and management, storm drainage construction and sewerage connection. More than two thirds of the urban investment requirement is for new road construction and existing road up-gradation.

Urban infrastructure investment requirement is estimated with basic parameters of urban infrastructure such as (i) more than 10 persons per hectare of land, (ii) road length at 7.5 km per sq. km for old municipalities and 5 km per sq. km for new municipalities, (iii) 80% of the urban households to have piped water supply, (iv) 100% of the households to have toilet facilities connected to the sewage system, (v) 100% households to have electricity connection, (vi) all municipalities to have landfill sites, (vii) 60% of the road length to be covered by storm drainage, and (viii) 20% of road length in core city to be covered by sewerage.

Achieving even 60%, 75% or 90 % of the physical targets of the municipalities by 2030 would require investment of Rs 1,398 billion, Rs 1,747 billion and Rs 2,097 billion respectively in the next 15 years. Estimation of total financing need based on the NUDS analysis and additional financing needs of the new municipalities shows that about Rs 2,330 billion is required for the next 15 years both for old and new municipalities to meet 100% target of the basic urban facilities.

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The proposed investment requirement can be financed from different funding sources such as revenue surplus, IGFT and market borrowing of the municipalities as per their maximum borrowing capacity leading to a net financing deficit of Rs 571 billion during the entire period of next 15 years if 60 per cent of the physical infrastructure need is met in 15 years. If 75 per cent of the proposed physical infrastructure to be met in the next 15 years, the net financing deficit in the same period is projected at Rs 921 billion. The situation becomes even more challenging if 90 per cent of the proposed urban infrastructure is to be met within next 15 years, the net financing deficit would be Rs 1,270 billion.

Borrowing has not so far been a major source of municipal financing, as current borrowing comprises only 0.85% of municipal total revenue (or 3 per cent of municipal internal revenue) in average. However, taking into account the huge infrastructure financing gap and the prospect for commercially viable infrastructure projects at the municipal level, it is worthwhile to assess their borrowing capacity in the context of their projected internal revenue generation for the next 15 years.

There are at least two windows that municipalities can use for borrowing –namely the TDF and the banks and financial institutions. The latter sources are hardly used by the municipalities. Currently, Town Development Fund (TDF) is the only organization in public sector for financing urban infrastructure development through loans and grants. It has financed several urban infrastructure projects for long term financing schemes -about 20 years. Despite an incentive mechanism of topping some loans by grants and very concessional terms of lending, the municipal demand for loan from the TDF is very low.

Town development Fund Act 2053 gives TDF a scope and autonomy to function as a financial intermediary institution for the development of urban infrastructure in Nepal. So it is logical to restructure TDF as a full-fledged financial intermediary though a legislation which provides this institution with clear autonomy, mandate and responsibility to finance urban infrastructure projects. The objectives, functions and rights of the restructured TDF as a financial intermediary require to be enshrined in the TDF Act.

Large capital base, transfers (grants) and loans from the federal government, borrowings of the government from the international financial institutions, long term borrowing of the TDF through the issuance of market based instruments like the bonds and deposit certificates can be the sources of fund for the proposed financial intermediary.

Given the huge investment demand for urban infrastructure, the proposed financial intermediary will have to possess at least Rs 20 billion of capital at the beginning along with an equal amount of other sources of fund. Other sources of funds can be generated through Institutional Long Term Deposits, Long term borrowing from national and international financial institutions (IFIs), Issuance of Long-term Bonds etc.

There is a need that a full-fledged financial law is enacted to operationalize TDF as a fully functioning financial intermediary. Key features of the proposed law governing the TDF could be the following:

(i) TDF, as a financial intermediary will be operated within a special act formulated for municipal financing as the existing laws on banks and financial institutions will not serve the special purpose of this institution.

(ii) The intermediary will have a strong capital base mostly owned by the government institutions and development partners.

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(iii) The intermediary will be a specialized agency to infrastructure financing and will co-work with other financial institutions to finance large municipal infrastructure projects.

(iv) The intermediary will be able to raise its equity capital through public offering of the shares up to 40 per cent and also would be enabled to raise fund from the capital market by issuing bonds and certificates of deposits for institutional savers.And,

(v) The organizational structure of the intermediary will be overhauled to make it more a business organization than as an agent of the government to carry forward ministerial task to the urban level.

The recommended strategies of creating bigger borrowing windows for the municipalities include restructuring TDF as a financial institution, strengthening its capital base, enhancing municipalities' borrowing capacity, and strengthening the borrowing capacity of TDF.

The proposed activities for evolution and restructuring TDF are (i) bringing TDF under the umbrella of MoF from MoUD and (ii) creating special legislation for the operation of TDF as an autonomous institution.

The proposed activities for restructuring the capital base of TDF are (i ) working on new capital structure with owners of equity and TDF Board and (ii ) approving TDF's capital structure and raising its public equity share.

The proposed activities for enhancing municipalities' borrowing capacity include (i) raising revenue performance of the municipalities, (ii) enabling municipalities to borrow for financially viable projects, and (iii) enhancing borrowing capacity appraisal System.

The proposed activities for strengthening TDF's borrowing capacity are (i) undertaking credit rating of TDF, (ii) strengtheningits staffing and business model, (iii) innovating proper instruments for borrowing (bonds, certificates, etc.), and (iv) approaching international financial institutions for soft loans.

Besides, the strategy for expansion of financing to innovative projects/areas include (i) getting PPP law enacted, (ii) setting proper operational guidelines for PPP projects, (iii) setting proper operational guidelines for PCP, (iv) developing cost recovery mechanism of PCP projects, (v) developing capacity for undertaking consortium projects, and (vi)getting first right to loan recovery from sales of collateralized assets.

5. Institutional Development for Municipal Financing

The Constitution of Nepal, Local self-Governance Act (LSGA) and other sectoral Acts and regulations have provisioned various institutions at central, regional/provincial and local levels.NPC and MoF are the national level institutions involved to finalize program and budget for LBs and other sectoral Ministries and departments. These two agencies are also responsible for mobilization of foreign grants and loans for national developments and that are executed through respective Line Ministries/departments and local Bodies (LBs).

Ministry of Federal Affairs and Local Development (MoFALD) is the link ministry for LBs and responsible for facilitating LBs including municipalities on their systematic, institutional and individual capacity development and coordination with other central level agencies including the NGOs, civil society, Development Partners (DPs) and private sector.

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Ministry of Urban Development (MoUD) provides technical services/financial resources to the Municipalities as conditional budgets, helps to develop small towns and market centers,does urban land use planning, and prepares master plans for the municipalities. It operates through its implementing arms including the Town Development Fund (TDF). It has not yet established its sectoral sections within the municipalities despite its heavy involvement for providing services within municipal jurisdiction. The parallel operation from center through its specialized departments, division offices and authorities has caused weak synergy among the activities within municipal jurisdiction. The sectoral Ministries those operate their activities are working parallel through their agencies up to lowest levels and their functionaries those are working at local level, are still accountable to their respective parent departments.

Nepal Water Supply Corporation (NWSC) is the current owner and operator of the water supply system within the municipal areas. In many of the urban areas, this has been substituted by independent water supply management boards. A separate Nepal Water Tariff Fixation Commission also exists to monitor and regulate the water tariff. This has often posed problems in service delivery.

Most of the municipalities are engaged in the solid waste management including the sewerage construction works with the partnership of communities however they are not charging any taxes or charges for their investments. DWSS collects charges but revenue is not shared between DWSS and Municipalities.

Several other agencies are involved in municipal service delivery, which include Nepal Electricity Authority, Nepal Telecommunication Authority, Nepal Telecom and other IT service providers. Otherline agencies such as Department of Road, DoLIDAR, etc.also operate their functions within municipalities; however, they have least horizontal linkages.

The revenue collecting departments/offices such as land revenue, in-land revenue, transport management, tourism and archeology departments are supportive for contribution of municipal revenues through sharing of resources and representing in municipal revenue advisory committee as well. But sharing of institutional information and data by these officesis observed very weak. Similarly, many of the development partners and I/NGOs are involved in development of municipal infrastructures and strengthening management capacity through TDF, MoFALD and MoUD. There are, however, duplications and also gaps in the assignment of duties and responsibilities of various agencies.

Key institutional weaknesses and challenges for municipal infrastructure development and resource mobilization are observed as (i) absence of elected representatives at local levels since last 15 years, (ii) stagnated devolution process, (iii) parallel functions and funding within the municipalities causing duplications, (iv) weak institutional capacity of municipalities to manage enhanced responsibilities, (v) insufficient TDF capital base to meet the growing urban needs as identified by NUDS.

There is urgent requirement to revisit the existing laws and initiate process to draft new acts and regulations or amend existing provisions as per the new constitution.Along with restructuring of local governments, administrative restructuring process has also to be initiated for local government institutions along with the TDF. To manage the financial frameworks and other activities, capacity enhancement programs have to be continued with establishment of separate institution for capacity development.

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The strategies recommended for institutional strengthening include (i) drafting new federal organic law, provincial and municipal laws, (ii) draftingrules and regulations side by side, (iii) delineating concurrent functions and other functional assignments given in constitutional schedules 5,6,7&8 through detail activity mapping,(iv) restructuring organizational structures of local governments in line with functional assignments and responsibilities, and (v) activity mapping in federal organic law.

Strategy for enacting New TDF Act includes (i) drafting new law so that TDF will act as an autonomous financial intermediary to finance municipal capital investments as well as social infrastructures, and (ii) regulatingmunicipal borrowing that is streamlined/channeled only through TDF.

Strategy for organization restructuringof TDF and making it functional include (i) restructuring TDF Board as per the provisions of the revised act, (ii) constituting new Board of Directors (BOD) from the shareholders, and (iii) administrative restructuring of TDF as assigned new roles and responsibilities.

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Contents Acknowledgements i Acronyms and abbreviations ii Executive Summary v List of Tables xiv

CHAPTER I: Overview of Municipal Financing Framework 1–9 1.1 Background 1 1.2 Objectives 2 1.3 Methodology of the Study 2 1.4 Major Milestones and Key Deliverables 4 1.5 Organization of the Study Report 5 1.6 Concept, Issues and Lessons in Municipal Financing 5 1.6.1 Urban Growth and Financing Gaps 5 1.6.2 Global Initiatives and National Response to Urban Development 6 1.6.3 National Urban Development Strategy (NUDS) 2015 and Municipal Financing Framework 7 1.6.4 TDF Business Plan 2014/15-2017/18 and Urban Financing Strategy 7 1.6.5 Key Issues in Urban Infrastructure Financing 8 1.6.6 Functional Assignment in the Constitution and Responsibility of Municipalities 9

i.Key Strategic Concerns in Urban Financing and Implication on Urban Development 9

CHAPTER II: Assessment of Own Source Revenue of the Municipalities 10–24 2.1 Legal Provisions for OSR 10 2.2 Review of Internal Revenue Resources 11 2.3 Provisions of Resource Mobilization in the Constitution 2015 14 2.4 Assessment of Revenue Management System 15 2.5 Quantitative Assessment of the Existing OSR 19 2.6 Projection of OSR 21

CHAPTER III: Assessment of Intergovernmental Fiscal Transfer 25–40 3.1 Rationale for IGFT and Municipal Financing 25 3.2 Legal Provisions for IGFT 26 3.3 IGFT Process to Municipalities 27 3.4 Criteria for Fiscal Transfer 28 3.5 IGFT Focus for Stable Revenue Growth 30 3.6 IGFT Assessment 31 3.7 National Budget and Intergovernmental Fiscal Transfer to Municipalities 34 3.8 Tied and Untied Grants 35

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3.9 Predictability of IGFT 36 3.10 Multi-year Investment Perspectives 37 3.11 Expenditure Analysis of Municipalities 38 3.12 IGFT Projection 39

CHAPTER IV: Borrowing Framework and TDF Business Strategy 41–58 4.1 Demand for Municipal Financing 41 4.2 Sources of Capital Spending 41 4.3 Municipal Infrastructure Investment Gap 42 4.3.1 Urban Infrastructure Investment Demand 43 4.3.2 Resource availability for Urban Infrastructure Financing 46 4.4 Borrowing Capacity of the Municipalities 48 4.5 Role of TDF as a Financial Intermediary 52

CHAPTER V: Situation Analysis of the Existing Institutional Framework 59–78 5.1 Key Actors/ Institutions related to Local Bodies/Municipal Financing at National Level 59 5.2 Key Institutions of Municipal Financing at the Local Level 68 5.3 Assessment of Role of Private Sector in Municipal Financing 70 5.4 Assessment of the Role of the Communities 72 5.5 Assessment of Local Horizontal/Vertical Transfers, Revenue Sharing and Borrowing 73

5.6 Identification of Institutional Changes after the Promulgation of New Constitution 74

5.7 Institutional Interventions required for the Implementation of Financial Framework 75

5.8 Restructuring TDF for Municipal Infrastructure Financing 77

CHAPTER VI: Summary and Findings 79–88 6.1 Overview of Municipal Financing Framework 79 6.2 Own Source Revenue of the Municipalities 80 6.3 Inter-governmental Fiscal Transfers 81 6.4 Borrowing Aspects of Municipal Financing 84 6.5 Institutional Development 87

CHAPTER VII: Recommended Strategies 89–98 7.1 Own Source Revenue 89 7.2 Intergovernmental Fiscal Transfers 92 7.3 Borrowing Aspects of TDF 95 7.4 Institutional Development for Urban Financing 97 REFERENCE 99

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ANNEXES

Annex 1.1: Assumptions for Own Source Revenue & Recurrent Expenditure Projections 101 Annex 1.2 Assumptions for the Calculation of Investment Requirement for urban Infrastructure 101 Annex 2.1: Summary of Differences between HALT and IPT 106 Annex 2.2: Summary Tax Rates of Business Taxes 107 Annex 2.3: Vehicle Tax Rates 108 Annex 2.4: Forecast of Own Source Revenue 109 Annex 2.5: Comprehensive Revenue Management Improvement Plan… 112

Annex 4.1 Projection of Infrastructure Financing Gap of the Municipalities 115 Annex 4.2 OSR Estimated with 50% Increase in Historical Growth of Taxes and Fees 117 Annex 4.3 OSR Estimated with 75% Increment in Historical Growth of Taxes and Fees 119

Annex 5.1: Key Institutions related to Financing provisioned under LSGA 121 Annex 5.2: Institutional Structures as provisioned in New Constitution of Nepal 129 Annex 5.3: Budget Ceiling, Guidelines, Authorization, Funds Flow & Revenue Sharing Mechanism 132 LIST OF TABLES

Table 2.1 Revenue Assignment in the Constitution 14 Table 2.2 Software using Municipalities 17 Table 2.3 Own Source Revenue of the Municipalities (Rs million) 20 Table 2.4 Total Revenue and Expenditure of the Municipalities (Rs million) 20 Table 2.5 Main Sources of Own Source revenue of the Municipalities (Rs million) 21 Table 2.6 OSR Forecast under Three Scenarios (Rs million) 23

Table 3.1 IGFT Projection (Rs million) 39

Table 4.1 Urban Infrastructure Investment Requirement and Financing Sources 44 Table 4.2 Net Infrastructure Financing Requirement (Rs billion) 45 Table 4.3 TDF Financing Requirement of Urban Infrastructure 46

Table 7.1 Recommended Strategies and Implementation Plan for OSR 89 Table 7.2 Recommended Strategies and Implementation Plan for IGFT 92 Table 7.3 Recommended Strategies and Implementation Plan for Borrowing 96 Table 7.4 Recommended Strategies and Implementation Plan for ID 97

LIST OF FIGURES

Fig 2.1 Growth of OSR as per Scenario 1 22 Fig 2.2 Growth of OSR as per Scenario 2 22 Fig 2.3 Growth of OSR as per Scenario 3 23

Fig. 3.1 Unconditional Municipal Grants (Rs Million) 32 Fig 3.2 Ratio of LDF to Municipal Grant (%) 33

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Fig 3.3 Conditional Municipal Grants (Rs Million) 33 Fig 3.4 Percentage of Municipal Grants to National Budget and GDP 35 Fig 3.5 Composition of Municipal Expenditure 38 Fig 3.6 % of Infrastructure Investment Deficits in Municipalities 38

LIST OF BOXES

Box 3.1 Fiscal Transfer Provision in the Constitution 26 Box 3.2 Supply–Based IGFT 36 Box 4.1 Examples of "Land for Infrastructure" Projects Implementation (Road Construction & Urban Development) as per BT scheme in Vietnam 47 Box 4.2 Bond Issue Experience of Ahmedabad Municipality 49 Box 4.3 Colombian Municipal Development Fund (FINDETER). 51

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CHAPTER I

Overview of Municipal Financing Framework

1.1 Background

Nepal is passing through a stage of state restructuring with federal set up of three layers of government – federal, provincial, and local - with the promulgation of new constitution of the country by the Constituent Assembly (CA) on 20 September 2015. The constitution has provided mandates of development activities and resource mobilization for the provincial and local governments including the municipalities. In the new set up, 'Gaon Palika' will replace the present local institution of Village Development Committee (VDC) while existing institution of Municipality will remain the same. As per the principal of subsidiary, the local government is envisaged to comprise of village government and municipal government with a larger functional, semi judicial and fiscal authority delegated constituted to these bodies authorities.

Meanwhile, the government is mulling for converting many Village Development Committees (VDCs) into municipalities, as some of the villages are now emerging as towns and are having large populations as well. The government has responded to this changing urbanization scenario by declaring more VDCs as municipalities. In this process, government declared additional 159 municipalities on fiscal year 2014/15 and 2015/16 resulting in a number of municipalities to reach 217 by October 2015. With this, urban population (defined as population of the municipalities) has reached about 42 percent of the total population. As Nepal already has one of the highest urban population growth rates in South Asia, estimated at 3.43 percent, the process of rapid urbanization and conversion of more VDCs into municipalities is making urban population growth much faster than the overall population growth of 1.3 per cent. If the current urban population growth rate continues, the share of urban population in total population is estimated to be around 48-50per cent by the next 10 years even if the number of municipalities does not increase from the existing level.

The existing municipalities suffer a lot from infrastructure deficit and many of them are not even in a position to be named as municipalities. Particularly, they lack paved roads, drainage, public transport system, vehicle parking facilities, safe drinking water and sewage, public parks and greeneries, solid waste management system, etc. Most of the municipalities are financially weak to create such infrastructure on their own efforts. Thus, the urban economy operates under severe constraints in Nepal, with very limited urban infrastructure in most cities and towns. These facts suggest to the need for formulating a municipal financing framework for rapid and sustainable urban development in Nepal.

In recognition of this need, the Government of Nepal (GoN) has prepared a National Urban Development Strategy (NUDS) that has defined a strategy for municipalities to plan, design, create, and pay for the multi-year investments made in infrastructure development. The strategy flags on the need for developing a financing framework and institutional structures that facilitate these investments. The financing strategy, as embodied in NUDS, is based on four premises: (i) municipal infrastructure is best created locally as envisioned under the Local Self Governance Act (LSGA), (ii) fiscal transfer system must be rational, predictable and untied so that municipalities can leverage capital grants with debt, (iii) municipal own source revenues such as Integrated Property Tax (IPT) must be modernized so that municipalities can capture the benefits of rising land values, and (iv) Town Development

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Fund (TDF) has to evolve into a financial intermediary that functions as an open-access criteria-based lender for municipal infrastructure. To improve the current system of financing projects and to move towards designing an innovative financing system, reforms are needed in all the three components of the municipal financing system, namely the Own Source Revenue (OSR), the Inter-Governmental Fiscal Transfer (IGFT) and the Borrowing Framework.

The current municipal finance system operates under constraints. First, own-source revenue has yet to establish billing systems and valuations that are updated regularly. This results in systemic inefficiency and inability to judge standard performance metrics such as collection ratios etc. Second, various components of the capital grants are often tied to specific sectoral targets and they are sometimes delayed. These characteristics add to unpredictability of municipal revenue streams and disincentives for multi-year planning of infrastructure projects. Third, a proper borrowing framework is lacking, and municipalities have no access to borrowings in a regular and demand driven basis. The municipal financing framework under TDF is neither simple nor sufficient to meet the ever-growing demand for municipal financing.

The TDF, set up in 1987 to provide long-term finance for municipal infrastructure, has limited capital, stressed loan assets, low earnings and high liquidity. TDF functions more as an agent for on-lending multilateral loans for pre-selected municipalities and their projects. Its lending is also insignificant as it accounts for less than 5 percent of the annual municipal capital spending. Hence there is a need for reforms in the municipal financing framework in all of its three aspects - the OSR, IGFT and the borrowing framework - so that the NUDS could be effectively implemented over the medium term.

1.2 Objectives

The objectives of this study is to develop a detailed Municipal Finance Framework (MFF) covering the OSR, IGFT and the borrowing system that helps to leverage scarce government grants to the multi-year infrastructure investments required for sustainable and decent urban development of Nepal. This study undertakes a comprehensive assessment of the OSR, the IGFT and the borrowing framework, their scope and limitations, and recommends reforms to address bottlenecks in the existing system along with suggesting an action plan to implement the reforms.

The specific objectives of the study are to: a) Review own sources revenues (OSR) of municipalities and suggest OSR enhancement

framework that allows municipalities with more financial autonomy, b) Review IGFT and suggest IGFT framework, which ensures municipal multi-year

planning, c) Review the status of municipal borrowing and suggest borrowing system that can

leverage the municipal revenue, and d) Suggest the road map for TDF to emerge as an effective financial intermediary and

prepare a three-year implementation plan for the municipal finance strategy implementation.

1.3 Methodology of the Study

This study is based on the primary data and information collected from the existing municipalities, secondary data collected from government and municipal publications, information collected from the stakeholders, and consultations done with the relevant

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ministries. Discussions were held with Ministry of Federal Affairs and Local Development (MoFALD), Ministry of Urban Development (MoUD), Ministry of Finance (MOF) and National Planning Commission (NPC) to get views and perspectives on municipal financing. Consultation with the current municipal financing institutions such as the TDF was carried out for a detailed assessment of the current municipal finance system and the size of the current leverage to propose reforms that can significantly improve this leverage. The study team interacted with the World Bank and other development partners to discuss the key findings.

The study team reviewed the existing information, rules, plans that have been prepared and approved for municipal development and financing. In case of the discrepancies in the data from various sources, the data and information contained in Financial Detail Analysis of different fiscal years published by Local Bodies Fiscal Commission areconsidered. The data gap has been met with the primary database of TDF and the same processed by its officials. A few field visits were done to clarify and update the data and information.

The projection of infrastructure financing gap and its financing sources is made with standard statistical tools. The projection of own source revenue, recurrent expenditure and inter-governmental fiscal transfer are made with standard statistical tools like measures of central tendency, measures of variation, correlation, regression and trend analysis. Historical data of the past 10 years are analyzed for the projection of the financing gap for the old municipalities while average revenue and expenditure of the municipalities excluding the metropolitan and sub metropolitan cities has been taken as reference for the projection of financing gap of the new municipalities. Inter-governmental fiscal transfer is projected to follow the current trend. The total funding requirements for all 217 municipalities for the next 15 years (i.e. till 2031) has been set according to the type of the city on the basis of population and per unit cost with different parameter of urban area and its existing situation and deficit funding requirements for road, piped water supply network, toilet in households, electricity connection, solid waste management, storm drainage; and sewerage (as shown in Annex 1.1). Graphical presentations of the data are made wherever relevant.

The internal revenue (OSR) is projected separately for those old (58) and new (159) municipalities. While projecting revenue, average growth of past 10 years has been considered and assumed that the growth of revenue of old municipalities will be constant over the years. However, revenue projection for new municipalities is based on population (per person basis). Moreover, major revenue heads of OSR such as local tax, service fees, property rental, etc. are projected separately.

The IGFTis projected for the next 15 years taking the FY 2015/16 as the base year. It has been assumed that the existing number of municipalities will be constant at 217 over the years and growth of IGFT will be similar to that of the projected nominal GDP i.e. 12.5%. In the IGFT, conditional and unconditional grants are projected separately. While projecting the conditional grant, the concurrent list of expenditure as mentioned in the Constitution of Nepal 2015 has also been taken as the consideration. As per the conditional grant, currently municipalities are receiving that for agriculture road, grant from road board, TDF grant for social and economic sector spending, etc. It has been assumed that after five years,municipalities will receive various types of conditional grants as per the functional assignments including concurrent list of expenditure in the constitution. The figures of concurrentexpenditure are derived on the basis of allocations made in the Details of Income and Expenditure of the Government 2014/2015.

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The study team held series of meetings with the Executive Director and senior officials of TDF and discussed the contextual background of the assignment along with objectives, process and outputs of the study. The study team collected necessary documents and studies for review and analysis purpose including NUDS, TDF Business Plan, municipal revenue and expenditure formats and other relevant documents. Initial workshop on the draft report was conducted among key urban finance professionals and steering committee members and the second workshop was conducted among steering committee members and selected stakeholders for validation.

The study team reviewed the proposed Sustainable Development Goals (SDGs) report prepared by the National Planning Commission (NPC, 2015) as the long run development road map up to 2030. It is observed that the SDGs would be milestone for urban development strategies, as Goal 11 of the SDGs proposes to make cities and human settlements inclusive, safe, resilient and sustainable. The SDGs also suggest for global support to least developed countries, including through financial and technical assistance, in developing sustainable urbanization, in supporting economic, social and environmental links between urban, peri-urban and rural areas by strengthening national and regional development planning and in promoting sustainable and resilient buildings utilizing local materials.

The study team had an overview of the provisions made in the constitution regarding the roles, responsibilities, and authorities of the local bodies, which is going to shape the functioning of the municipalities in the federal set up. Several unclear provisions in the roles, responsibilities and authorities of the federal, provincial and local governments in the constitution are also observed.

1.4 Major Milestones and Key Deliverables

The study is focused on five key deliverables comprising of Own Source Revenue (OSR) assessment, Inter-Government Fiscal Transfer (IGFT) assessment, assessment of borrowing framework and TDF business strategy, suggesting appropriate financing strategies for the municipalities and recommend the implementation plan. OSR assessment comprises of (i) quantitative analysis of the existing own source revenues, and their buoyancy over 10 years period, (ii) review of existing revenue management system of municipalities and tax billing efficiency, (iii) analysis of legal framework for effecting valuation and rate hikes, penal actions for non-compliance, etc. and (iv) suggesting reforms that can strengthen existing OSR system.

IGFT Assessment comprises of (i) making quantitative assessment of the existing revenue and capital grants and criteria for fiscal transfers with the specific objective of using these grants for multiyear investments, (ii) estimating tied/untied grants, punctuality of the transfers, and expected growth of the grants over a 10 year period, (iii) analyzing the criteria of these transfers from the perspective of providing stable revenue streams for municipalities to plan their investments; and (iv) suggesting reforms that can strengthen existing IGFT system.

Borrowing Framework and TDF Business Strategy includes (i) assessing and developing the business concept and strategy in harmony with the TDF Articles of association (functions, objectives, core principles), (ii) assessing the current product mix and proposing a product mix for servicing municipalities, (iii) proposing medium-long term business development forecast with financing plans in two or three scenarios based on the NUDS, and (iv) making municipal financing projections of the TDF.

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Institutional framework for municipal investments and financing strategies includes (i) assessment of key institutions/actors involved in national/ regional and local level for LBs/municipal financing, (ii) assessing role of private sector, I/NGOs and communities, (iii) assessing horizontal/vertical transfers and borrowing mechanisms identifying regional level urban projects, (ii) assessing the efficacy of the financing of projects that have regional impacts, (iii) assessing the roles of local bodies, central government line agencies at local level and other stakeholders, and (iv) identifying institutional changes needed (if any) for the urban infrastructure investments and their implementation.

1.5 Organization of the Study Report

This study comprises of seven chapters. The First Chapter introduces the subject matter with key issues in municipal governance and development, state of municipal infrastructure development, existing municipal financing framework, review of existing policy and frameworks define the objectives of the study and draw the methodology adopted for the study. The Second Chapter analyzes the Own Source Revenue structure of the municipalities and delves on the issues and challenges in mobilizing OSR. The chapter also forecasts the OSR for the forthcoming fiscal years. The Third Chapter focuses on Inter-Governmental Fiscal Transfers and discusses the issues and challenges in the flow of IGFT. A forecast of IGFT has been made based on the present budgetary trends and practices. The Fourth Chapter discusses the borrowing aspects of the municipal financing and delves in the business strategy of the TDF. The Fifth Chapter reviews the existing institutional framework for investments at the municipal level and recommends appropriate financing strategies. The Sixth Chapter summarizes the findings and makes concluding observations. The Seventh Chapter has recommended key strategies, activities/tasksand proposed a road map across short/medium/long termimplementation planalong with identified responsible agencies for the municipal finance strategy.

1.6 Concept, Issues and Lessons in Municipal Financing

1.6.1 Urban Growth and Financing Gaps

The United Nations (UN) estimates the population of cities in developing countries to increase by 2.4 billion between 1995 and 20251. This massive scale of urbanization is more pronounced in developing countries. An ADB study shows that 95 percent of Asian population will be residing in urban areas by 2050 (ADB, 2010). The study also shows that by 2050, Asia will be transformed, as its urban population will nearly double from 1.6 billion to 3 billion. Asia‟s cities, which already account for more than 80 percent of economic output, will be the centers of higher education, innovation, and technological development. The quality and efficiency of urban areas would determine Asia‟s long-term competitiveness and its social and political stability. Asia needs to take advantage of being early on its urbanization growth curve to promote compact, energy-efficient, and safe cities. This unprecedented urbanization in developing countries presents a challenge to government authorities to meet the needs of modern society. This applies to Nepal as well - the urban population is expected to double in a decade. This will have a significant impact on the already taxed urban infrastructure of cities and towns, and further strain efforts of municipal governments to address present and future demands for local infrastructure services. This is

1Municipal Finance: Innovative Resourcing for Municipal Infrastructure and Service Provision; Report prepared by Mr. Ilias Dirie for the Commonwealth Local Government Forum in cooperation with ComHabitat; www.dgf.org.uk

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more so with the devolution of revenue and expenditure functions and service delivery responsibilities to the provincial and local governments under the new constitution.

The constitutional provision indicates that the lowest level of government has to provide the most comprehensive response to the most complex developmental challenges including basic education and health care to utilities. But the policy-making process and institutional arrangements are yet to develop and past arrangements have often been deeply flawed. This can be evidenced from the local bodies' revenue and expenditure performance even after the promulgation of LSGA in 1999. To meet these challenges, municipalities need to be transformed from passive service providers to more proactive facilitators of infrastructure and services. However, this transformation cannot occur without imparting real authority, responsibility and resources to local governments through an institutional process of empowerment with resources and autonomies. A vital component of this transformation is strengthening the municipalities' ability to mobilize resources from own sources, transfers from the central government and other agencies, and through borrowings to create and maintain urban infrastructure.

1.6.2 Global Initiatives and National Response to Urban Development

The global community is growingly concerned over the unplanned and unsustainable growth of urban areas with large migrations and rising density of poverty in the cities. Given global demographic trends, local governments are entrusted a greater responsibility in the preparation of long-term strategies for investments in health, education and infrastructure to reduce poverty and spur economic growth. In this process, many of the responsibilities for addressing multi-dimensional aspects of poverty and social welfare are devolved, or being devolved, to the local level.

The world community has now come up with Sustainable Development Goals (SDGs) with 17 goals, which include making cities and human settlements inclusive, safe, resilient and sustainable as one of the goals to be achieved by 2030. It is estimated that half a million people are living in slums and squatters in the country. It is also estimated that seven percent of total urban population lives in squatter settlements (NPC, 2015)2. As limited number (29.8 percent) of houses is considered to be safe, there is huge demand of building safe houses in urban areas. Currently, very limited number of roads and public vehicles are considered safe as per international criteria. In 2014, only 45 percent of municipalities had been provided with sewerage services and only one-tenth (9.4 percent) of the households have underground drainage systems. This indicates that there is still a challenge to connect every household into the underground drainage system.

Although the SDGs are global goals and targets are adapted at the national context, they need to be addressed at the sub-national and local levels for substantive outcome. The exercise of localizing the SDGs implies that actors and institutions at sub-national have a fundamental role to play if the SDGs are seriously taken as an opportunity to improve all people‟s lives. Adaptation of the SDGs to fit local realities ensures that the national development goals will be achieved at both national and sub-national levels. Urban infrastructure development strategy will have to be developed to localize the SDGs at the provincial and local level once the federal system set up is completed. This calls for added demand for municipal financing.

The catastrophic earthquakes that struck Nepal on 25 April and 12 May 2015 have destructed urban infrastructure with the severe damages occurring in Kathmandu metropolitan city, 2SDG Report, draft, NPC, 2015.

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Lalitpur and Bhaktapur sub-Municipal cities and several municipalities in central region of the country. Two thousand and nine hundred cultural and religious heritages, which mostly remained in Kathmandu valley and were at least a century old were either destroyed or extensively damaged. This has added responsibility of the municipalities for reconstruction along with new construction. The challenge has been magnified by the recent blockade at the Southern border that Nepal faced in the recent months following the promulgation of new constitution. This is for the reason that the revenue base of the municipalities has eroded substantially and the cost of reconstruction and new construction has been obstructed for some time on account of the acute shortage of fuel and construction materials. This is likely to add up the financing gap and the cost of infrastructure development in the urban areas. 1.6.3 National Urban Development Strategy (NUDS) 2015 and Municipal Financing

Framework The NUDS prepared by MoUDprovides a medium and long-term strategic vision of a desirable national/regional urban system with some mention of the financing framework. It assesses existing conditions of infrastructure, environment, economy and governance; establishes benchmarks and desirable standards; and identifies prioritized strategic initiatives for investment in infrastructure and environment to realize the comparative advantages of urban areas. NUDS highlights the deficiency of urban infrastructures in terms of water supply, sanitation, solid waste management, housing, transport and energy. The report shows a considerable disparity in infrastructure among ecological regions; the quality and quantity of drinking water is insufficient in all urban regions; and conditions of sanitation system and solid waste management are also critical. Further, the report also flags on the lack of affordable housing and increasing squatter settlements. The NUDS makes a projection of financing need of the municipal infrastructure projects. Major milestones by 2031 include annual investment of 2 percent of GDP in urban infrastructure development, access to piped water and 100 lpcd in urban areas, sewerage in all urban core areas, total electrification in all urban areas with 80% of households with alternative sources, road density of 7.5km/sq.km and 80% paved road in existing municipalities, 50% of new residential housing through land readjustment, 100% solid waste collection, high speed internet availability in all large and medium towns, at least 2.5% of land as open space at ward level in old and 5% in new municipalities, and disaster risk management plan and capability in all municipalities. To meet the infrastructure deficit in 58 municipalities, the investment requirement is estimated to be NRs 372 billion. The amount is calculated based on existing and desirable state of municipalities. However, approximate investment channeled to the municipalities for infrastructure development in the FY2013/14 was Rs 20.07 billion3amounting to only 1% of national GDP. The NUDS recommends for the creation of self-reliant and financially solvent urban areas through the development of an optimized inter-governmental fiscal transfer system, enhanced mobilization of own-source revenue of municipalities, improved access to debt financing through strong financial intermediary institutions, and investment mobilization through alternative financing instruments. 1.6.4 TDF Business Plan 2014/15-2017/18 and Urban Financing Strategy

The Business Plan of TDF, first of its kind, proposes its financial transactions for the four years beginning 2013/14. The Plan by clustering municipalities into three groups and taking KMC separately envisaged a capital investment need of Rs 45 billion for 58 municipalities as 3NUDS calculated this amount on the basis of LBFC, 2013 and annual program (FY 2013/14) of central line agencies that provide grants to the municipalities.

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per their periodic plans which reflects demand side perspective. The revenue (income) of the municipalities including IGFT and grants was, however, Rs 10 billion only at the same time - to reflect the supply side perspective of municipal financing. Of this, only Rs 5 billion was the actual capital expenditure. This shows an annual shortfall of Rs 40 billion to meet the demand for municipal infrastructure investment.

The Business Plan also analyses the borrowing capacity of the municipalities during 2008/09-2010/11 and estimates total borrowing capacity4 of the 58 municipalities at only Rs 795 million. Of this, only 24 municipalities had the capacity to borrow more than Rs 10 million. The Plan also mentions that average share of TDF financing in total capital expenditure of municipalities was less than 3 percent. The Plan proposes to make investment of Rs 10.9 billion during 2014-18 of which Rs 7.3 billion would be loan and Rs 3.6 billion as grant (TDF, 2014)5.

1.6.5 Key Issues in Urban Infrastructure Financing

Federal government under the new constitution has a key role in creating the right conditions for a successful municipal finance system. Federal government can provide an environment to promote marketability of municipalities' financial resource mobilization from non-government sources through (i) appropriate macroeconomic and regulatory policies – especially those which are conducive to the accumulation of resources to invest through long-term savings pools – to help municipalities have access to borrowing; (ii) the removal of the bottlenecks to private banks lending to local government units and leveling the playing field with government finance institutions; and (iii) devolving sufficient powers to local government. However, municipalities have also to be in the center stage of creating an enabling environment for infrastructure development through urban development strategies, capital improvement plans, improvements in financial management and accounting, development of a comprehensive public information system and sustainable partnerships with the communities, private sector, and NGOs.

At present, municipalities suffer from various constraints in developing urban infrastructure of which low revenue efforts, limited transfers from the central government, and capacity constraints to mobilize alternative financing sources are prominent. The LSGA 1999 provides reasonably fair basis for local revenue mobilization for municipal spending. However, the revenue collection authority assigned to municipalities under the Act and its regulation is poorly implemented and adopted. Also, the LSGA contradicts with dozens of other existing acts. There is hardly any revenue surplus left after meeting recurrent expenditure of the municipalities. Thus financing of capital expenditure of the municipalities has to resort on IGFT, which is unpredictable and less fungible. In recent years, MoFALD initiated transfer of performance-based grants by implementing Minimum Conditions and Performance Measures-MCPM. This has created logical base for providing grants based on municipalities‟ performance. However, many municipalities have not performed well, as MCPM reveals. Beside the performance based transfer system, the ministry continues with other unconditional grants from reserve fund, which has undermined MCPM compliance of municipalities.

Amid very low level of municipal revenues from taxes and fees, municipalities are facing ever increasing funding and financing gap due to low volume of fiscal transfer systems from the central government and burden of un-funded responsibilities. There is also limited access to 4Measured in terms of debt servicing to be about 25 percent of net operating surplus of municipalities. 5 Business Plan FY 2013/14-2017/18), Town Development Fund, Kathmandu, Nepal

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loans and other forms of debt financing for the municipalities (NUDS, 2015). This has resulted in grossly under-spending in capital expenditure, particularly in infrastructure.

Most municipalities are marred by capacity constraints to mobilize revenue, IGFT and borrowings and then undertaking capital spending. Shortage of qualified staff and lack of technical and administrative capacities to plan, implement, operate and maintain urban infrastructure facilities, resistance for devolution of power, resources and authority by central agencies as provisioned by LSGA, inefficient delivery due to overlapping/unclear implementation mandates of implementing agencies, insufficient legal and administrativeframeworks for PPP, lack of capacity for transparent and reliable planning and procurement processes, and lack of elected council in municipalities to drive the development work are the key factors underlying their capacity constraints.

In addition to the above, a large number of municipalities and towns are small and financially weak; there is lack of strong domestic capital markets for commercial borrowing; there is also lack of mechanisms and instruments to finance urban infrastructure projects; and even the mechanism for mobilizing funds for maintenance of existing infrastructures is very weak. However, a few municipalities have developed capacity to mobilize more funds and implement the infrastructure projects. 1.6.6 Functional Assignment in the Constitution and Responsibility of Municipalities Nepal's new constitution describes the assignment of expenditure and revenue functions to the federal, provincial and local governments. Moreover the constitution also defines the mechanism for intergovernmental fiscal transfers and borrowing system. The constitution has also established a powerful body named National Natural Resources and Fiscal Commission (NNRFC) for administering fiscal transfers and revenue sharing systems, among others. The constitution also allows for concurrent functions of the local bodies and the federal and provincial governments in some of the revenue and expenditure assignments. This approach, however, poses some challenges for fiscal governance. As functions have not been defined, the constitutional arrangement needs to be carefully detailed in order to avoid confusion, overlaps and duplication in the allocation of functions between the federal, provincial and local governments. The new legislation will have a strong impact on how urban infrastructure could and should be financed in Nepal. There is also a fear that the provincial governments might compete with municipal governments for resource sharing and pass on the service delivery responsibility to the local governments. Thus, the infrastructure financing condition is likely to be impacted by several legal and institutional set-ups under considerations. 1.6.7 Key Strategic Concerns in Urban Financing and Implication on Urban

Development Urban infrastructure investments can be sustainably financed through a mix of local revenue, transfers from central and provincial levels of the government, borrowing from dedicated financial intermediaries for urban development like the TDF, by forging partnership with private sector, NGOs and community organizations, and resorting to commercial borrowing for financially viable projects. The infrastructure-financing gap is less likely to be met with conventional sources of funding, nor could TDF at its current business policies and practices, meet the gap. While evolving TDF as the most responsible financial intermediary for financing urban infrastructure, enhancement of its institutional capacity through legal and regulatory reform and organizational restructuring is crucial. Exploring all other complementary and sustainable ways of financing for urban infrastructure along with enhancing the financial intermediary role of the TDF is the strategic orientation of the municipal financing framework.

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CHAPTER II

Assessment of Own Source Revenue of the Municipalities

Own Source Revenue (OSR), defined as revenue generated by the municipalities internally from their own efforts, is critical for the municipalities to exercise local autonomy and deliver basic facilities to the citizens. Main areas of OSR are taxes, service charges/fees, fines/penalties, rental income from municipal properties and other income. However, the municipalities have not been able to mobilize adequate OSR for meeting the ever-increasing spending requirement, particularly in the infrastructure. The following sections delve on the legal, structural and operational aspects of revenue administration of the municipalities. Projection of OSR for the next 15 years is also made to assess the availability of municipal financing resources of the municipalities.

2.1 Legal Provisions for OSR Nepal has a long history of decentralization. Different governments in the past have attempted to decentralize power to the Local Bodies (LBs) of which fiscal decentralization is one important aspect. In this context, local bodies have been empowered to make themselves self-reliant. After the people's movement of 1990 and subsequent enactment of the Constitution of 1990, the strategy of decentralization took new dimension. The government promulgated Local Self-Governance Act 1999 with the intention of providing more power and resources to the local bodies; and Local Self Governance Regulations 2000 was framed out. In the LSGA and LSGR, local bodies are given powers in financial administration system. Local Bodies Financial Administration Regulation 2007 (LBFAR) has given detail procedures in the implementation of financial administration system. LSGA address the legal provisions for management ofall three local bodies but this chapterdeals only Own Source Revenue (OSR) of the municipalities.

In financial administration, LSGA spells out the power, duties and responsibility to the Municipal Council, which addresses the policy of fiscal decentralization of the government. According to LSGA (section 96), it is mandatory for the Municipal Council to carry out following functions and duties:

(a) To prepare annual budgets, plans and programmes of the Municipality and submit them to the Municipal Council,

(b) To keep accounts of incomes and expenditures, and other documents pertaining thereto in an up-dated manner,

(c) To spend money to execute the decisions of the Municipality, subject to the limits of the approved budget, and

(d) To raise taxes, charges and fees etc. approved by the Municipal Council.

Raising taxes, charges and fees approved by the Municipal Council is one of the main functions and duties of the Municipal Council. At present, revenue base of the municipalities is very weak and revenue potential has not been fully mobilized. OSR of the municipalities on average accounts for only 27% of the total income and the remaining income is received from the governmental transfers.

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2.2 Review of Internal Revenue Resources

The importance of generation of internal resources was recognized by the local bodies after the enactment of LSGA. As the local bodies explored the possibilities of increasing OSR, some municipalities set example in increasing the internal resources (i.e. Bhaktapur introduced tourist entrance fee). Unfortunately, the pace of innovative ideas of internal revenue generation slowed down due to the absence of elected bodies at the municipal level from 2002. Octroi, which used to be the main source of revenue of most municipalities in the past, was replaced by Local Development Fee (LDF) in 1999; and this was collected at the border points along with the custom duty. LDF was initially distributed to the municipalities on the basis of their past octroi collection records, and initially municipalities treated it as OSR. LDF was abolished in 2009 as a condition agreed with the entry of Nepal in World Trade Organization (WTO). LDF is now treated as government transfer (details in Chapter III).

The LSGA has empowered the municipalities to generate income from local taxes, fees, service charge, duties, rent, etc. in its jurisdiction at the range of rates prescribed by the LSGR and approved by the Municipal Council. Revenue is collected from the citizens at the time of using the service or monthly or on annual basis for receiving municipal services as user charges depending upon the type of services. However, it cannot raise taxes and charges from the government, diplomatic missions and not-for-profit organizations except for any service charges for providing services to these organizations. These sources of income are described in the following sections.

2.2.1 Tax Revenue

The main sources of revenue from taxes are house and land tax, integrated property tax, land revenue tax, entertainment tax, advertisement tax, rent tax, business tax, vehicle tax commercial video tax. They are briefly described below.

House and Land Tax and Integrated Property Tax:LSGA has made provision for two types of property tax i.e. (i) House and Land Tax (HALT) and (ii) Integrated Property Tax (IPT). Property tax is levied on house land owned by the citizens. It is an equitable tax system and easy to administer. It is equitable because people own their properties having different value at different locations of the municipality according to their affordability.

Municipalities can opt for one of these two taxes. Most municipalities (48 out of 58)6 have been using IPT but bigger municipalities are still using HALT. Although Municipalities report that the present rates of HALT generates more revenue in properties having higher value compared to the present provision of IPT rates prescribed in the LSGA, no detail study has been conducted to support this claim. IPT is a more scientific system of property tax, and the government encourages the municipalities to adopt IPT. In determining the value of the property, a valuation committee is formed; and the value is determined for different locations. Valuation can be revised once in every three years. The taxpayers can also declare the value of their properties. As per the regulation, the municipality has to issue bill for amount due every year, but none of the municipality has done so. The fundamental differences between HALT and IPT are: (i) land revenue is integrated in IPT but in HALT land revenue is levied

6As of FY 2013/14, Biratnagar, Siraha, Janakpur, Jaleshore, Gaur, Birgunj, Kathmandu, Kirtipur, Lalitpur, Bhaktapur, Madhyaput Thimi, and Pokhara municipalities are using HALT (LBFC, 2015). Since then, Birgunj and Pokhara municipalities have adopted IPT.

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separately, (ii) basis of valuation of property are different, (iii) rate of tax is different, and (iv) depreciation method of property is different. Details are given in Annex 2.1.

Properties exempt from tax are government (buildings, hospitals, educational institutes, trust land, corporation operating as not for profit), not-for-profit organizations, land and building of religious institutions (temples, monasteries, churches, mosques etc.), public utilities (drinking water reservoir, electric power house, cremation spots, airfields, bus bark, stadium, garden parks etc.), and foreign missions (embassies, consular, mission, diplomatic mission).

Land Revenue: Land revenue is determined on the basis of land productivity divided into four categories of Abbal, Dwoyam, Seem and Chahaar. This is the basis of collecting land revenue for agricultural land. In HALT, the taxpayers have to pay land revenue as well but in the case of IPT, land revenue is integrated in IPT.

Land Tax: The municipality can opt to levy land tax in certain area of the municipality instead of land revenue with the approval of the GoN. Municipal Council determines land tax considering its use for commercial, residential, trust, agriculture or forestland. If land tax is collected, then land revenue cannot be levied.

Business Tax: Municipalities are empowered to collect business tax on all types of businesses run for commercial purpose. Tax is collected from big commercial and industrial establishments to very small shops in the Haat bazaar or fair. Annual minimum and maximum rates for each category of business are determined according to the local condition, and the volume of business. A summary of minimum and maximum tax rates is presented in Annex - 2.2.

Vehicle Tax: Vehicle tax is levied on the vehicle registered in its jurisdiction and on vehicles entering in the municipal area from any other location. Municipalities can levy one time entry fee on vehicles entering in its jurisdiction only in the municipal roads. Details of vehicle tax rates are given in Annex - 2.3.

Entertainment Tax: Municipalities may levy entertainment tax on the entrance fee of cinema hall, video hall, cultural program hall, music theatre, exhibition ground, historical place, archaeological place, and religious place.

Advertisement Tax: advertisement tax is collected on the signboards, globe boards, stall etc. permitted to fix at nearby roads, junctions, public places etc. under their jurisdiction.

Rent Tax: Rent tax is collected by the municipalities on the rented properties i.e. house, shop, garage, go down, stall, shed, factory, land or pond wholly or partly within their jurisdiction. Besides rent tax on these properties, municipalities can levy a tenancy tax on shops constructed, operated and managed by the municipality or on temporary shops operated with the permission of the municipality in public places, unregistered land (Aailani) or roadside shops.

Although there are nine heads of taxes in the legal provision, property tax and business tax are only two main sources of income, which have buoyancy of generating OSR. The amount of other tax income is very nominal.

2.2.2 Service Charges and Fees

The municipalities are empowered to raise various types of service charges for providing services to their citizens in areas like solid waste, public utilities, parking, public toilet, haat

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bazaar, slaughter house, street light, sewerage, road, swimming pool, park, building permit, recommendation, property valuation, etc. They are briefly described below.

(a) Solid Waste Charge: Solid waste management is one of the important functions of the municipalities. It can levy service charge for providing solid waste management service and other services like sewerage, drainage, and sanitation facilities.

(b) Parking Charge: Parking charge is collected in the bus park and public parking places. The rate of parking charges is fixed on the duration of parking time.

(c) Public Utility Charge: Municipalities can provide various public utility services and charges for providing such services like electricity, drinking water, water tap, telephone and similar other services.

(d) Maintenance Charge: Municipality may determine the expenditure required for the repairs and maintenance of roads, sewerage, bridges, pavements, courtyards, alleys, drainage, electricity, water supply etc. constructed by the municipality and collect annual service charge from the beneficiaries.

(e) Building Permit Fee: This is an important source of income of most municipalities. The building permit rates vary in different municipalities. It is normally charged on the basis of per square feet of the plinth area.

(f) Tourism Fee: This income source is limited to only a few municipalities. Kathmandu, Lalitpur and Bhaktapur municipalities have introduced this fee.

(g) Other fees: Valuation fee and recommendations fee are other regular source of internal revenue.

In service charges and fees, building permit fee, tourism fee and recommendation fee are the main sources of income. Income from other service charges and fees are nominal. Rental income from the shopping complex, and other rental properties like swimming pool, bus park, town hall etc. are income from commercial activity of the municipalities.

2.2.3 Users' Contribution

Users' contribution (UC) for the construction of infrastructures like road, water supply, school building, religious places, etc. is also a source of revenue of the municipalities. The community is ready to contribute for such costs, which enables the municipalities in spreading out its limited resources to a wider area of the municipality services. This program is more popular in the municipalities located at the hills. It is gaining popularity in the Tara based municipalities as well. There is no consistency in accounting users' contribution. Some municipalities have kept it outside the accounting records of the municipal system and some open a separate account to deposit this amount.

2.2.4 Public Private Partnership (PPP)

Various commercial infrastructures can be built in partnership with the private sector. Private sector is in a better position to build and operate the commercial type of municipal infrastructure like solid waste management, shopping mall, electricity system, water system, hospitals, transportation, etc. Such partnerships expedite construction and operation of the commercial infrastructures of the city. Fund necessary for such investment is managed by the

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private sector and the municipality can concentrate in other important activities in which it has to make investment.

2.3 Provisions of Resource Mobilization in the Constitution 2015

In the Constitution of Nepal 2015, federal, provincial and local governments have shared authority to raise taxes, service charges and fees as given in the annexes of the Constitution. Table 2.1 summarizes the revenue assignment among the three levels of the government.

Table 2.1: Revenue Assignment in the Constitution

Federal Provincial Local

Customs Registration Fee -Land & House Registration Fee-Land & House

Excise-duty Property Tax

Value Added Tax (VAT) House Rent Tax

Individual Income Tax Land Tax (land revenue)

Corporate Income Tax Tax on Agricultural Income Business Tax

Tax on Remuneration Vehicle Tax Vehicle Tax

Passport Fee Entertainment Tax Entertainment Tax

Visa Fee Advertisement Tax Advertisement Tax

Tourism Fee Tourism Fee Tourism Fee

Service Charge/Fee Service Charge/Fee Service Charge/Fee

Penalties and Fine Penalties and Fine Penalties and Fine Source: Constitution of Nepal 2015

The Constitution of Nepal 2015 has not made substantial changes in existing base of OSR of the municipalities. The authority of raising taxes, service charges and fees as given in LSGA has been continued. In addition, the authority of raising rent tax has been given to the local bodies. This new provision will be a major potential source of internal revenue of the municipalities.

Taxes and fees are the major sources of OSR of the municipalities. The Constitution of Nepal has given new power and responsibilities to the municipalities in providing various services in its jurisdiction like drinking water supply, small electricity generation, alternative energy, local roads, and irrigation. These services need to be handled with care to make them sustainable. There will be additional burden of resources on the existing limited municipal fund in order to operate such services. Municipality should frame out a cost recovery policy in order to operate these services effectively and efficiently. If the cost recovery policy is not implemented at the start of their implementation, operation of these services will not be efficient and the limited resources of the municipality will be diverted to keep these services operational. Diversion of limited resources to these activities will have direct impact in other essential developmental works.

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2.4 Assessment of Revenue Management System

Revenue management is a very important function of the municipality. Without proper and scientific system, revenue collection efficiency of the municipalities will not improve. Considering the importance of revenue management system, municipalities have to give due importance in keeping the records of all tax payers, collecting taxes and other income, providing tax clearance certificate, updating the tax data base, keeping land registration records, and making adjustments on the tax rates and sources of tax. Main components of revenue management system are described below.

2.4.1 Compliance of Minimum Condition and Performance Measure (MCPM)

MCPM gives high importance in complying with different conditions in the financial administration system. In MCPM, municipalities have to comply with all 10 minimum conditions to be eligible to receive unconditional grant amount. One of the minimum conditions is to keep the records of taxes and income sources. In performance measure, there are five working areas with 40 indicators which have been given a total of 100 points weight. Financial management has 11 indicators with total score of 28. Grading of the municipalities is done on the basis of the score received by the municipalities based on the total score.

According to minimum condition indicator number four, municipalities should maintain detail records of taxes and income sources. In performance measure, there are four indicators related to revenue management. They are: (i) feasibility study on revenue potentiality and its projection, (ii) revenue administration management, (iii) integrated property tax, (iv)public private partnership (PPP), and (v) mobilization of local resources. Feasibility study on revenue is done to assess the potentiality of future revenue and based on this study, annual forecast of revenue should be made. Revenue administration covers maintaining of up to date and correct records of sources of income and tax payers, efficient tax collection system, billing system, etc. PM encourages to use IPT for building up tax and PPP in implementing projects by forming a promotion committee. Mobilization of internal resources has three important performance measures: (i) extending the tax net and increasing the number of tax payers, (ii) increase of OSR by at least of 15% compared to the previous year, (iii) increase of OSR by 20% or above compared to the previous year (details in Chapter III).

Although the PM has three criteria which should encourage the municipalities to enhance OSR but these criteria will not have much impact in the overall PM score. Increase on OSR will have direct impact in the government budgetary system. If the municipalities become more self reliant in OSR, then there will be less demand for the IGFT. For example, IGFT is not a major concern of Bhaktapur municipality as its OSR is quite substantial. The government should consider revising OSR criteria in the forthcoming revision in MCPM scoring system so that there is a positive incentive to leverage OSR.

LBFAR, Clause 12 requires the municipalities to keep updated detail records of taxes and income sources. But most of them have not been able to meet this requirement. Out of 58 municipalities, capital grants to 29 municipalities were reduced by 10 to 20 percent (10% reduction for 11 of them, 15% reduction for 8 of them and 20% reduction for 10 of them) based on their PM assessment in FY 2013/14 (LBFC, 2015).

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2.4.2 Role of Revenue Advisory Committee (RAC)

There is a provision in the LSGR to form a municipal level Revenue Advisory Committee (RAC) with five members 7 . The municipality decides the working procedure of the committee. The main function of the committee is to advise the municipality in streamlining and increasing the internal revenue. This is a very important committee provided the committee is active and the municipality wishes to make use of the committee effectively.

2.4.3 Data Base of Tax Payers

Efficiency of the revenue management system depends upon its database, which should be complete and reliable. Property tax is the main source of income of the municipalities and its database should be kept up to date. Property records of IPT and HALT base are about 80% and 40% respectively (Ghimire, 2011). The collection efficiency is much lower than the actual database. These data do not include the properties which are exempt from property tax. It is essential to maintain their inventory of these properties as well for planning and budgeting. It is desirable to keep records of these properties, calculate their property tax and it can be made one of the criteria for allocation of grant to the municipalities.

Business tax is another potential source of income. Although its potential is very promising, most municipalities have not been able to fully utilize this income source. Collection of this tax is not a big problem if the municipality tax collectors go to collect tax at their business premises. Some municipalities have been very proactive in collecting this tax and they send tax collectors to the business entities to collect annual tax. 8

Few municipalities have worked in coordination with the local Chamber of Commerce and Industry (CCI) to collect this tax and part of the total collection is provided to the CCI9. Problems in collecting the business tax are lack of up to date record of the taxpayers, frequent movement of businesses entities, close down of business, etc.

Vehicle tax is collected by the central as well as local governments. In the case of the central government, collection of vehicle tax is effective due to intervention by the traffic police. In the case of municipalities, there is no such mechanism. Most municipalities are collecting very limited amount of annual vehicle registration tax. In the case of one time entry fee in the municipal roads, collection will not be much as there is limited number of municipal roads.

2.4.4 Automation of Revenue System

In the present age of information technology and automation, an efficient revenue management system is very important. Most municipalities are using property tax software and some other software related to revenue management developed by a private firm. 7The Mayor of the municipality acts as the coordinator and the chief executive office is the member secretary. Other representatives are from Land Revenue Office (LRO), Inland Revenue Office (IRO), District Treasury and Comptroller Office (DTCO), Chamber of Commerce and Industry (CCI), one member from the taxpayer. 8 Dharan municipality works in coordination with the local chamber of commerce and they send the tax collectors along with chamber staff to collect tax every year. In Siddharthanagar, out of 3,979 businesses only 1582 taxpayers (40%) have paid business tax in FY 2071/72 amounting to Rs. 3.38 million. Tillotaama is a new municipality but its business tax collection in FY 2071/72 was Rs 2.55 million. For a new municipality, this is a big amount and this collection was possible due to door-to-door collection campaign (field visit). 9In Lalitpur municipality, this partnership has worked well. They deposit 25% of the total collection in a separate bank account and it is used in projects related to commerce and industry on mutual agreement. Butwal and Bharatpur municipalities entered in agreement with CCI but discontinued it, as CCI were not committed in this venture.

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MoFALD officials mention that most of the 58 municipalitiesare using software system in different tax collections as shown in Table 2.2.

Table 2.2: Software using Municipalities

Types of Tax Software No. of Municipalities

Property Tax (IPT and HALT) 50

Business Tax 17

Land Revenue 9

Vehicle Tax 6

Other Taxes 4 Source: MoFALD

Use of software has a long-term impact in any organization and it costs money to develop or procure the system and train manpower. It is therefore important to plan carefully before making decision in procuring or developing the software. It the past, Integrated Property Tax software was developed by a consulting for “Urban Environmental Improvement Project” implemented by Department of Urban Development and Building Construction (DUDBC). This software was tested and introduced in eight project municipalities but without much success. After the end of the project, the municipalities could not get backup support and it was discontinued. Recently, Urban Governance Development Project (UGDP) has hired a consulting firm to develop revenue software for six project municipalities. Development of the software is completed and it is being tested. The government should learn lesson from the UEIP project and ensure that the software should have a reliable support service. If this software is successfully developed and implemented, then the government can replicate it in other municipalities.

Linking of the revenue system and Geographical Information System (GIS) is very essential to make the revenue management system efficient10. Information of each building is fed in the system along with their photographs. The image of the building pops up in the screen when the taxpayer comes to pay tax. Image of the building can be verified and this image can also give information of whether the property is a residence, a commercial, an industrial and whether it has been rented. Property tax, business tax and rent tax collection can be monitored by using this software. In order to implement the GIS system, house numbering of all the properties is the first requirement. In the long run, municipalities, with the help of government, should aim to implement such sophisticated system.

2.4.5 Billing System

One of the weaknesses of the revenue management system of the municipalities is the billing system. Municipalities do not issue invoice to the clients. Invoice is raised at the time of making payment. It is the right of the taxpayers to know about the amount payable before the due date. This gap in providing information to the citizens has direct impact in the collection efficiency of taxes. Moreover, the municipal management does not get correct information 10GIS software was developed to link it with the revenue system in Institutional Strengthening Municipal Project and Strengthening Municipalities for Urban Service Delivery Project (ISMP, SMUSDP projects). This system was piloted in Dharan municipality.

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about taxes and charges to be collected. Follow up in collecting taxes is weak. As Municipality is a corporate body, it should be run as a business entity.

Inefficient tax administration system and poor collection efficiency of the municipalities are the key issues in raising taxes. It is a universal phenomenon that the taxpayers will find loopholes either to evade or avoid tax. They alone should not be blamed for not paying tax. The tax collectors should be smarter to bring the taxpayers in the tax net. If they do not come in the tax net after making efforts, then other measures like imposing penalties, ceasing the property, and shutting down the business should be taken.

2.4.6 Staff Capacity Development

Efficiency of the revenue administration system depends upon a number of factors. Some of the basic requirements are qualified, efficient and dedicated staff, working environment, logistic support, morale of staff, etc. Staff capacity development has not been given much importance. Revenue section is manned by limited number of staff and they receive very little training. There are basic weaknesses in cash management e.g. lack of control on number of cash receipts printed and issued to revenue section, and delay in depositing cash in the bank (Awasthi, 2013). Capacity development plan of staff was assessed by SMUSD project and it was identified that on the job training was necessary to enhance the capacity of staff of expenditure, revenue and internal audit sections (CFMIP, 2014)11. Staff Training has been aimed at enhancing knowledge on general financial management systems including audits and computer software applications to all financial management staff.

2.4.7 Public Awareness Campaign

It is the responsibility of the municipality to provide information to the citizens about their duties to pay taxes. Such information has an impact in the efficiency of tax collection. Municipalities are at different stages of revenue collection efficiency. Some municipalities are proactive and provide information to the citizens to pay due amount in time and provide discount if the payment is made within specified time limit. But some municipalities are indifferent and do not make much effort in making collections. Most important factor in raising tax is to let the taxpayers know their duty to pay taxes in time and receive the benefit of discount or pay penalty for delays. Each municipality should develop a public awareness campaign plan. Such campaign should be based on the rationale of campaign, targeted populations, event schedules, workshop of stakeholders, TV/FM radio, newspapers, pamphlets illustrating the municipal services etc.

2.4.8 Coordination with Government Offices

Database of business taxes and rented properties are not complete and up to date. Inland Revenue Department is also responsible to collect income tax on businesses and rent tax on rented properties. Data sharing with Inland Revenue Office (IRO) could be explored so that both institution benefit from such effort. Introduction of building codes is in the early stage. There is a potential of increasing revenue from this source if the building codes are strictly implemented. After the recent earthquake in the country, the government has made a commitment in introducing the building code in the country. This commitment is positive for 11SMUSD suggested for (i) specific training on the application of accounting, revenue and inventory software on the specific needs of each municipality and (ii) specific training on the operation of new revenue software modules e.g. business tax module. Accordingly, on-the-job training/coaching was aimed at carrying out day-to-day activities related to revenue, expenditure accounting, inventory management and internal audit throughout the project implementation period, both at the time of visiting the municipalities and remotely from Kathmandu.

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the municipalities. Implementation of building codes should be coordinated with the DUDBC and MoFALD.

Municipalities do not have information about the vehicle registered in their jurisdiction. Collection of vehicle tax is not possible unless there is a strong database. It is essential to establish proper coordination with Transport Management Office to receive data of vehicles registered in the municipality. Since TMO has automated its database, municipalities can benefit if TMO shares it data with municipality.

Municipalities collect land revenue in their jurisdiction but up to date land records are kept at the Land Revenue Office (LRO). Some municipalities copy the land revenue data from the LRO on periodic basis to update their record and some update it when the citizens come to pay tax. The records of LRO have now been automated. Municipalities should coordinate with LRO to receive the data periodically to update its database.

Municipalities have constructed a number of sewer systems in the city but they have not been successful in raising service charge from such system. Instead, Nepal Water Supply Corporation (NWSC) or Kathmandu Uppatyaka Khanepani Limited (KUKL) has been collecting 50% of the water bill for sewer charge in the system constructed by the municipality. It is necessary for the municipalities to coordinate on this matter and receive their share of revenue.

2.4.9 Revenue Management Improvement Plan

Institutional Strengthening of Municipal Project (ISMP) and Strengthening Municipalities for Urban Service Delivery (SMUSP) implemented by MoFALD and DUDBC12have provided support in strengthening (i) urban planning, (ii) Geographical Information System (GIS) and (iii) financial management system. Development of a Comprehensive Financial Improvement Plan (CFMIP) to improve the overall financial management was one of the outputs of the project, which included revenue administration system as one of the main features. The SMUSD was approved by the Municipal Council of the four municipalities where the project was implemented. Such process is important to plan and monitor progress made. There was a positive impact in enhancing the revenue of project municipalities after its implementation (SMUSDP, 2014). As an example, revenue part of CFMIP of Nepalgunj municipality- one of the project implementing municipalities- is given in Annex -2.1.

2.5 Quantitative Assessment of the Existing OSR

Historical data of OSR for six years (2008/09 to 2013/14) of 58 municipalities is presented in Table 2.3. According to the historical data, average annual OSR for the last six years is Rs 1,949 million and the annual average growth rate is 13.8%. Historical data show that local tax is the highest contributor of the OSR which is 47.6% (containing average growth 17.2%) followed by service charges and fees 42.4% (containing average growth 17.2%), property rental 7.6% (with average growth 17.4%) and others 3.6% (with average growth 22.5%).

12ISMP project municipalities are Kathmandu, Biratnagar, Birgunj and Butwal (2010-2012) and SMUSD project municipalities are Dharan, Janakpur Siddharthanagar and Nepaljunj (2013-2014)

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Table 2.3: Own Source Revenue of the Municipalities (Rs million)

Internal Revenue 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 Average OSR

% share in OSR

Annual Average

Growth Rate (%)

Local Tax 632 582 770 905 1,556 1,123 928 47.61 17.21

Service Charge Fees & Fines 644 619 755 625 964 1,263 812 41.64 17.23

Property Rental 98 124 107 125 178 205 140 7.16 17.44

Other Revenue 73 84 28 73 99 67 71 3.63 22.48

Total OSR 1,446 1,409 1,659 1,728 2,797 2,657 1949 100.00 15.24

Source: Data of the municipalities compiled by LBFC

The shares of OSR to total revenue and expenditure of the municipalities are on average 26.0% and 31.0% respectively during the last six years (Table 2.4). The share of OSR in total revenue and expenditure shows a fluctuating trend over years.

Table 2.4: Total Revenue and Expenditure of the Municipalities (Rs million)

Revenue and Expenditure 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 Average

Total OSR 1,446 1,409 1,659 1,728 2,797 2,657 1,949

Total Revenue 6,390 7,480 8,180 7,601 7,650 7,133 7,406

Total Expenditure 5,130 6,040 7,073 6,794 6,769 6,200 6,334

OSR to Total Revenue (%) 22.63 18.84 20.29 22.74 36.56 37.26 26

OSR to Total Expenditure (% ) 28.19 23.33 23.46 25.44 41.32 42.86 31

Source: Data of the municipalities compiled by LBFC

2.5.1 Main Sources of Taxes and Service Charges

Property tax (IPT and HALT), business tax, service charges and rental income are the mains sources of revenue of 58 municipalities (Table 2.5). It is interesting to note that the average share of HALT in the property tax is 32.9% compared to IPT of 12.2% although 46 municipalities were using IPT (as of FY 2013/14). Since then, two more municipalities have introduced IPT. It is estimated that municipalities implementing IPT have better database with 80% properties coverage compared to only 40% database of municipalities using HALT (Awasthi 2012, Ghimire 2011). This is due to inclusion of land records in the IPT system whereas in HALT, land revenue is independent and citizens get away with paying only land revenue, which most people do not miss to pay. Property tax (HALT and IPT) contributes about 45.0% of the internal revenue and this is the single highest source of income.

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Table 2.5: Main Sources of Own Source revenue of the Municipalities (Rsmillion)

Internal revenue 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 Average OSR

Share in Average OSR (%)

IPT 174 169 199 269 397 213 237 12.2 HALT 477 465 547 558 1081 717 641 32.9 Business tax 72 70 83 79 78 193 96 4.9 Service Charge 578 564 664 625 964 1263 776 39.8 Property rental 101 99 116 125 178 205 137 7.0 Others 43 42 50 73 99 66 62 3.2 Total OSR 1446 1409 1,659 1729 2797 2657 1950 100.0

Source: Authors' analysis based on LBFC's published and unpublished data

Municipalities provide various services to the local business community and they need to pay business tax for these services. This is a potential source of tax but the share of contribution of this tax is only about 5% to 6%. This is mainly due to inefficiency of tax collection system.

In service charges, main sources of income are building permit fee, recommendation fee, and tourism fee (Kathmandu, Bhaktapur and Lalitpur). According to data compiled by TDF (for 49 municipalities) in FY 2014/15, contribution of building permit fee, recommendation fee and tourism fee in total OSR are 16.5%, 5.1% and 14.3% respectively. Building permit will remain an important source of income in future with an increase in population and urban area, application of stringent building code, making the citizens complaint in taking building permit. Increase in recommendation fees will have its consistent growth rate in proportion to the size of urban population.

Rental income is received from the rented properties of the municipalities. For most municipalities this can be a regular source of income. Share of property rental just averages at 7.1% of their income in the last three years. Construction of infrastructures like shopping mall and bus park are popular rental properties of the municipalities, which they have yet to tap.

2.6 Projection of OSR

Projection of OSR of the municipalities has been done up to FY 2030/31 bases on their historical growth rate. This historical growth rate has been used to forecast revenue of 58 as well as other new 159 municipalities with some consideration in the case of newest municipalities. Following three scenarios have been used in estimating the OSR.

2.6.1 Scenario 1: Projection of OSR at historical growth rate for 58 municipalities and half of this rate for the rest 159 municipalities for the first 3 years

In this scenario, growth rate of 58 municipalities is the same as the historical growth rate given in Table 2.1 and in the case of 159 new municipalities it is assumed to remain half of the growth rate of existing 58 municipalities in the first 3 years and then at the same rate as that of old municipalities after that. New municipalities are of difference sizes, have different levels of development, and are at different geographical locations. It will take them some time to build up their capacity and follow the revenue system and procedures properly13. Based on this assumption, projection of OSR from FY 2014/15 to FY 2030/31 is made and shown in 13For example, in Tilottama municipality, local politicians are against introducing IPT. At present municipality collects property tax of Rs 100 only for each floor of building (field visit).

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Fig 2.1. The projected amount of OSR is Rs. 13,083 million for FY 2019/20, Rs. 27,068 million for FY 2024/25 and Rs 65,087 million for FY 2030/31) from the base year (FY 2014/15)amount of Rs. 3,070 million. Details of OSR forecast table is given in Annex – 2.4.

Figure 2.1: Growth of OSR as per Scenario 1

2.6.2 Scenario 2: A 50% increase in the historical growth rate of taxes and service charges

In this scenario, municipalities are expected to run more efficiently with better collection efficiency of taxes and service charges. The assumption is an improvement in taxpayer‟s database and collection of property taxes and business tax. In this scenario, it is assumed that there could be a 50% increase in taxes and service charges from the historical growth rates of 16.8% and 15.2% respectively. The assumed growth rates will then be 25.2% for taxes and 22.8% for service charges. Increment in property rental and other income has been taken at the same historical growth rate. Projection of OSR as per this assumption is shown in Figure 2.2. The projected OSR amounts to Rs. 15,609 million in FY 2019/20) Rs. 39,149 million in FY 2024/25 and Rs 101,136 million in FY 2030/31 from the base year (FY 2014/15)amount of Rs. 3,070 million. Details of projected OSR as per this scenario is given in Annex – 2.4.

Figure 2.2: Growth of OSR as per Scenario 2

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2.6.3 Scenario 3: A 75% increase in the historical growth rate of taxes and service charges

In this scenario, it is assumed that municipalities will have more innovative and sophisticated system for revenue collection. They will be using GIS system for revenue management; additional investment in infrastructure will attract more people in the urban area; and tax base of the municipalities will significantly widen as better infrastructure will create demand for additional houses and other services. As service level of the municipalities will improve, citizens will be willing to pay higher taxes and service charges. So it is assumed that there could be an improvement in the growth of taxes and services charges by 75% in the historical growth rate. Hence the growth of taxes and service charges are assumed to be 29.4% and 26.6% respectively. Increment in property rental and other income has been taken at the same historical growth rate. Figure 2.3 shows the growth of OSR under this scenario. The OSR will amount to Rs. 17,118 million in FY 2019/20, Rs. 48,309 million in FY 2024/25 and Rs 130,696 million in FY 2030/31 from the amount of Rs. 3,070 million in FY 2014/15. Details of the OSR projection under this scenario are given in Annex – 2.4.

Figure 2.3: Growth of OSR as per Scenario 3

Projections of the OSR based on the three scenarios is shown togther in Table 2.6. If the OSR is accumulated over a period of five, ten, fifteen and seventeen years, the total revenue collection in scenario 1, 2 and 3 would be Rs 43.4 billion, Rs 47.3 billion and Rs 49.5 billion during 2015-19 and the same for the whole period (2015-31)under the three scenarios could be as much as Rs 439.1 billion, Rs 634.7 billion and Rs 788.9 billion respectively (Annex 2.6).

Table 2.6: OSR Forecast under Three Scenarios (Rs million)

Fiscal Year Scenario 1 Scenario 2 Scenario 3

2015/16 8,550 8,938 9,132

2016/17 9,491 10,202 10,570

2017/18 10,549 11,699 12,323

2018/19 11,740 13,481 14,471

2019/20 13,083 15,609 17,118

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Fiscal Year Scenario 1 Scenario 2 Scenario 3

2020/21 15,126 18,706 20,949

2021/22 17,490 22,451 25,711

2022/23 20,228 26,984 31,642

2023/24 23,397 32,479 39,046

2024/25 27,068 39,149 48,309

2025/26 31,319 47,253 59,919

2026/27 36,243 56,052 72,277

2027/28 41,947 64,953 83,802

2028/29 48,556 75,276 97,174

2029/30 56,213 87,248 112,690

2030/31 65,087 101,136 130,696

Total OSR 439,155 634,684 788,901 Source : Authors' analysis, 2016

The scenario analysis shows that under the current revenue efforts, OSR will increase by a moderate rate but if we assume additional revenue efforts to be made by the municipalities, the OSR collection would be very impressive. Given that the municipal infrastructure financing gap would be very high, it is necessary that municipalities take revenue reform measures to move along scenario 2 and ideally to scenario 3.

Experience has shown that one of the fastest changing assets prices is of the urban property and real estates. In a lowly financialized economic system like ours, this is one significant area of hedging property and making speculations. But while current municipal tax system has not been able to capture such prices in tax assessment, the widened tax base has not been covered by tax administration. The infrastructure created by the municipalities are not contributing much to the revenue sources of the munikcipalities. In the absence of elected representatives at the municipalities for more than a decade, the drive for revenue collection has rested in the hands of government officials whose motivation and responsibilities are limited in this regard. There is also a tendency to look for more intergovernmental government transfers to meet the infrastructure financing need rather than taking innovatative approaches to mobilize local resources. The newly constituted municipalities are not yet in a position to get proper information about their tax base, put their tax administration system in place, and mobilize local resources for their infrastructure investment requirements.

Overall, while utmost efforts should be made to maximize OSR for financing the huge infrastructure financing gap of the municipalities, there is also a need to devolve more revenue sources to the municipalities with capacity development support from the central government if they are to function autonomously and effectively.

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CHAPTER III

Assessment of Intergovernmental Fiscal Transfer Intergovernmental Fiscal Transfer (IGFT) is critically important in the intergovernmental relations in a federal or devolved government system. The transfer system is important to the central budget of Government of Nepal (GON) as budget is devolved to the municipal government through different line ministries. This chapter makes an assessment of the IGFT in the context of historical experience of devolution as per LSGA and the need for meeting infrastructure-financing gaps in the context of new constitution and expected role of the municipalities in the new system.

3.1 Rationale for IGFT and Municipal Financing Basically intergovernmental fiscal transfers serve three basic objectives of:

(a) Addressing vertical imbalance - the inadequacy of revenues of sub-national governments to discharge effectively their expenditure liabilities, arising from assignment of functional responsibilities and insufficient own resources among different governmental levels,

(b) Alleviating horizontal imbalances - the disparities in the revenue capacity of the local bodies in order that all of them may be in a position to provide basic public services to their citizens at a reasonable level, and

(c) Offsetting inter-jurisdictional cost and benefit spillovers or for merit good reasons.

In addition, transfers may also be given to carry out some agency functions for the central government.

Intergovernmental relations, both vertical (between levels of government) and horizontal (within levels) are important for the development and operation of an efficient and effective public sector. In a nutshell, the objective of intergovernmental fiscal arrangements is to ensure that these intergovernmental responsibilities are carried out in the spirit of co-operation, equity and efficiency. A sound system of intergovernmental fiscal transfers is considered as a pre-condition for stable decentralization process. The need for intergovernmental fiscal transfers arises mainly due to fiscal imbalances between own source revenue of municipalities and its expenditure needs. The retention of key revenue sources at the central government has been found as the principal reason for such imbalances.

The low revenue base, caused by such policies and the high expenditure needs for discharging services at the municipal level along with responsibility for development causes fiscal imbalance at the local level. Such imbalances can be vertical or horizontal in nature - the vertical dimension, concerned with the distribution of revenues between central governments and municipalities and the horizontal dimension, concerned with the allocation of financial resources among the recipient municipalities. A vertical imbalance occurs when the expenditure responsibilities of sub-national governments do not match with their revenue raising power whereas, a horizontal imbalance occurs when the fiscal capacities of sub-national government to carry out the same functions differ across municipal governments. This necessitates transfer of resources from the central government to the municipal governments.

These vertical imbalances are addressed through a system of unconditional and conditional grants from GON to local bodies. The horizontal imbalances are catered by shifting financial resources as unconditional and conditional grants from the center to municipal levels and

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conditional grants to take into account issues of horizontal imbalances among municipal governments. However, as decentralization progresses, a mismatch between expenditure requirements, revenue collection and fiscal capacity emerges leading to vertical and horizontal fiscal imbalances. To contain these imbalances across the level of government, a system of intergovernmental fiscal transfer is adopted. Such transfers from Central government to municipalities are made in the form various conditional and unconditional grants. Overtime, such resource transfers from central government to local government units has helped minimize and, to some extent,to contain the vertical as well as the horizontal imbalances among local bodies. Nevertheless, local bodies are still facing serious financial crisis in implementing various economic and social development programs to meet the expectation of their people (LBFC, 2009). The IGFT system plays an important role in Nepal at the municipal level, as the transfer system provides nearly two-fifth of the total municipal level financial resources (MOUD, 2015). The National Urban Development Strategy, 2015 has also set principals that the IGFT will continue to play a key role in the framework of municipal government finance.

3.2 Legal Provisions for IGFT The Constitution of Nepal, 2015 embodies three tiers of government - Federal, Provincial and Local. The Constitution refers to spheres of competence as - federal functions, provincial functions, local functions, and concurrent functions of federal and provincial governments, and concurrent functions of federal, provincial and local governments14. GON's initial vision of the country's intergovernmental transfer is laid down in the Constitution (highlighted in Box 3.1) and Local Self-Governance Act, 1999 (LSGA).

Box 3.1: Fiscal Transfer Provision in the Constitution The Government of Nepal shall make necessary arrangements to equitably distribute the revenue

generated by it from its sources, between the federation, province and the local level entities. The amount of the fiscal transfer, the province and the local level entities are to receive shall be as

recommended by the National Natural Resources and Fiscal Commission. The Government of Nepal shall distribute fiscal equalization grants to province and local level entity on

the basis of their need for expenditure, their capacity in generating revenue and the efforts made by them. The province shall distribute fiscal equalization grants received from the Government of Nepal and the

revenue generated from its sources, to the local level entities under it on the basis of need for their expenditures and their capacity to generate revenue, in accordance with provincial law.

The Government of Nepal shall make arrangements regarding conditional grants to be provided through the Federal Consolidated Fund, complementary grants, or the special grants for other purposes.

The distribution of revenue between the federal, provincial and the local level entity shall be transparent. Source: Clause 60 of Constitution of Nepal, 2072

The LSGA addresses the provision for central government transfers to local bodies. The section 236 of the Act clearly states that "the Government of Nepal shall have to provide the Local Body each year with minimum grant prescribed and also with additional grants on such basis as population, level of development, possibility and capability of mobilizing resources, necessity of financial resources, regular record keeping of incomes and expenditures, situation of auditing and financial discipline of the concerned Local Body.”

14As functions have not been defined, the constitutional arrangement needs to be carefully detailed in order to avoid confusion, overlaps and duplication in the allocation of functions.

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The Act has provisioned expenditure assignments including the level of development indicators and sectors. Additional grants provided are specific. However, it appears that the grants covered under this section would provide funding not only for the overall operation of the Local Body, but also for the specific sectoral functions that have been assigned to Local Bodies in the Act, such as primary education, basic health services, and so on.

Currently, GoN transfers resources to the municipalities as per provisions made in the Local Self Governance Act, 1999 (LSGA) that specifies system of intergovernmental transfers to channel needed resources to municipalities. It ensures unconditional and conditional grants to the local bodies including minimum grants. There are clear guidelines for the procedures for the mobilization and management of unconditional and conditional grants, program or project budget, and all types of grant made available by development partners and other agencies. The operating procedures specify internal revenue of the local body, local development fees, money provided following revenue apportioning, and loans borrowed by the local body, in addition to grants provided by DDC in the case of VDCs and municipalities and all types of resources made available to the local body(MOFALD, 2013).

3.3 IGFT Process to Municipalities

In Nepal, as a mechanism of intergovernmental fiscal transfer, Ministry of Federal Affairs and Local Development (the then Ministry of Local Development) started providing block grants to municipalities since 1980s. In the absence of any systematic mechanism, distribution of block grants, until recently, was motivated more by political consideration and access to power. Often times, question was raised about the basis of such distribution system, both at the grass-root level and at the Centre. With a view of addressing this concern and initiating a formula based grant distribution system, MoFALD constituted a Commission to design a formula for distributing block grant to local bodies. The Commission recommended an interim formula, which has been adopted for distributing grants to the local bodies since FY 2003/04. Current types of fund transferring practices from center to municipalities (MOFALD, 2013)are stated below:

(i) Recurrent grant: (a) salaries, allowances, daily travel allowance (TA/DA) of civil servants deputed at the local body by the GON and employees of administration grant approved by the Ministry and office overheads, (b) capacity development costs, and (c) social mobilization costs.

(ii) Capital grant: (a) minimum capital grant, (b) formulae-based capital grant, and (c) revenue sharing.

(iii) Other grants: (a) thematic conditional grant, (b) program or project-wise conditional grant/budget, (c) grant/budget available at the local level by signing MOU with INGOs/NGOs and development partner organizations, (d) loans provided by financial institutions/trusts, (e) technical assistance, (f) commodity support, (g) local development fees disbursed by the MoFALD to municipalities and grants for projects to be implemented on cost-sharing basis under the Reserve Fund, (h) other grants made available to the local body.

Currently municipalities are getting fixed grant and formula-based additional grants against the performance of the municipalities. They also receive recurrent grants to pay for the salary and allowances of employees and to meet minimal operational expenditures. Administration grants to municipality are determined on the basis of administrative liability of the central government. Performances are assessed as per indicators set in the Minimum Conditions and

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Performance Measures (MCPM) system 15 . In addition, they are receiving a mixture of capacity enhancement grants and social mobilization grant. Various line ministries, donor agencies, and I/NGOs are also providing program-based grants.

Municipalities currently receive two types of IGFT i.e. unconditional (block grants) and conditional grants. With regard to the unconditional grants, the Ministry of Finance (MOF) directly delegates authority to the municipalities and provides the supervision duties to MoFALD. Authorization creates the right of fund transfer, which is given by MOF. Conditional grants are provided by MoFALD and respective line ministries. For conditional grants, the line ministries provide authority to the municipalities. Such funds are released by the Financial Comptroller General Office (FCGO) and its field office District Treasury Comptroller Office to the municipality on the basis of authorization by respective ministries.

Municipalities submit their financial report to Ministry of Federal Affairs and Local Development (MOFALD) and District Treasury Comptroller Office. The reporting is on monthly, trimester and annual basis. In the case of conditional grants, they must submit their respective expenditure statement to the concerned ministries.

3.4 Criteria for Fiscal Transfer

Transfers from the central governments are the principal source of revenue of most of the municipalities. The municipal grants are of three types. The first type is unconditional grant in which the municipalities are given the discretion to spend the grant fund in the programs/projects of their choice by getting the program and budget approved from the Municipal Council. The second type of grant is conditional grant in which the municipalities have to spend on specified purpose/activity. This type of grant varies from one year to another depending upon the needs of the municipalities or the requirement of the center to get specific task/s carried out by the municipalities. The municipal fiscal transfer (unconditional capital grant) comprises two systems:basic (fixed) entitlements grants, and (b) formula- based grant.

Besides, municipalities are currently getting a fixed grant (minimum grant) up to Rs. 3 million and additional grants against their performance. The additional formula-based grants are performance-based with the annual performance of municipalities based on planning and budgeting, financial management, fiscal resource mobilization, communication and transparency, budget releases and program execution, monitoring and evaluation, etc.

3.4.1 Formula-based Block Grant System

The progress towards introduction of formula-based grants started in the mid2000s, which was rolled out throughout the country with performance elements called Minimum Conditions and Performance Measures (MCPM) in the year 2008. A formula-based approach is used in the allocation of municipal capital grants in which population, weighted poverty, area, and weighted tax efforts comprise weights of 50%, 25%, 10%, and 15% respectively. As per Local Body Resource Mobilization and Management Operation Guideline, 2013 the formulas based grant should not be less than 70% of the total unconditional capital grant. The meaning of this provision is that the fixed grant should not be more than 30% of the total municipal unconditional capital grants. This system has been introduced to encourage the MCPM system.

15MCPM is assessed by the Local Bodies Fiscal Commission (LBFC), an autonomous body, which makes suggestions in this regard; but that is ultimately the decision of the central government.

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In the budgeting and spending of municipal capital grant resources, municipal authorities have to comply with a number of general conditions; for instances, municipal governments shall abide by financial standards and budget procedures as mandated by LBFAR; hence currently all municipal authorities should abide by all technical and professional standards in the delivery of municipal services as set forth by the respective sectoral ministries. Furthermore, municipal governments have to comply with specific sectoral block grant conditions specified by the respective line ministries in the local budget guidelines. Since the formula-based allocation is determined objectively, municipal governments will have greater stability in their budget allocations and should be better able to engage in their financial planning and budgeting process. However, it is partially applicable in the case of municipal governments currently.

Implementation of the NUDS in general, and infrastructure financing in particular, demands increased IGFT as other sources of municipal financing are inadequate. For this reason, there is a need of considering the following matters:

(i) Increasing the current size of intergovernmental transfers to municipal governments by introducing formula based approach for all municipalities. Although the benefits of introducing formula-based allocation mechanisms are unmistakable, it would have been a mistake to introduce the new formulaic approach overnight. Instead, a gradual phasing-in of the formula-based approach has to be put in place to prevent large sudden increases in resource allocations to previously under-resourced municipalities and to prevent inefficient allocation or even misappropriation of resources by municipal governments. Besides, during the transition from of the Federal system the previous IGFT approach, all municipalities have to be held harmless against decreases in their resource allocation; no single municipal government should receive fewer resources than the amount it was receiving earlier.

(ii) Providing municipalities with different sectoral conditional grants for the devolved sectors i.e. education, health and agriculture and other non-devolved sectors such as building, roads, water and sanitation, solid waste management, environment conservation, etc. in the future as part of the recurrent grant system by the central government line ministries as against the line ministries currently allocating resources to the devolved sectors through their line agencies.

3.4.2 Minimum Conditions and Performance Measurements

For the evaluation of annual performance of the local governments, the GoN introduced a Performance-Based Grants system that has been fully functional after 2008. The system has had a positive impact on the legal compliance, financial management and accountability in the local governance system. The system installs a system of stronger accountability and transparency, promotes strong incentives to improve performance in pre-identified areas, and annually reviews and assesses the capacity and functional performance of local bodies. The Local Bodies Fiscal Commission carries out the evaluation annually and further recommends the government to increase or decrease additional grants to local governments (Devkota, 2014).

Most of the municipalities are found relatively comfortable with the performance based grants system as the successful municipalities in the MCPM evaluations could expect predicted topping up grants annually. Although the MCPM sounds good, there are certain areas for improvement.

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First, it should be noted that the governance environment has an important impact of the effectiveness of performance-based grants. One particular concern is the absence of elected local councils, and the relative ineffectiveness of top-down controls over the municipal level. As a result, there may not currently be an appropriate institutional structure in place that is capable of responding to the incentives being produced by the MCs and PMs.

Second, it should be noted that, there is a clear geographic pattern with regard to municipalities that fail their MCs. This underlying pattern is not desirable and may have political implications for the grant system. This pattern is reinforced by the fact that there is a high recidivism rate among failing municipalities. This makes it quite likely that there are underlying economic, fiscal or social conditions present that result municipalities from responding to the incentives provided by the MCPMs (e.g., high revenues from other sources or the complete lack of public and social accountability may make the grant irrelevant).

Third, large chunk of budget transfer to municipalities such as LDF is not counted as IGFT where MCPM is not effective.

Fourth, while MCPMs may be an appropriate mechanism to promote certain good local governance practices using the carrot of supplementary (typically donor-funded) grants, MCPMs should often not be applied in the same way to core government funding provided to local bodies. In particular, problems may occur if the MCs are specified in a way that is too strict. It is important to remember that MCs should only function as an “emergency break” which should only be applied if providing the grant would result in catastrophic failure or certain and complete abuse of funds.

Finally, a concern is that - especially in the case of joint government-donor grant schemes- the MCPM process get overloaded with MCs and PMs that are programmatic rather than systematic in nature, which starts to infringe upon the discretion of municipal governments. For instance, imposing requirements that a certain percentage of funds should be spent in a certain way (e.g., on a “women‟s project”) becomes highly arbitrary procedural issue, which is often unrelated to whether the grant is being spent in accordance with the true needs of the community including its women‟s members (Boex, 2012).

3.5 IGFT Focus for Stable Revenue Growth

Municipalities are highly dependent on fiscal transfers from GON for capital spending. At present,a significant share (72 percent) of municipal expenditure is incurred as current expenditure and only (28 percent) as capital expenditure (NUDS, 2015). There are still long lists of municipal functions, which are actually seen as un-funded responsibilities of the municipalities. Sharing of functions between central and municipal governments should be based on sharing of funding sources based on the principles of subsidiarity. The addition of urban infrastructures, as planned under NUDS, demands additional resources at the municipality level.

Formula-based transfer considers weighted tax as one of the criteria for IGFT and is calculated on the basis of average OSR of three years and incremental basis of two years, while the trend of municipal own source revenue is inconsistent (please refer to Chapter 2). It indicates that allocation of unconditional grants on the basis of revenue growth might not be equitable because the current IGFT criteria less complements to stable revenue growth.

The IGFT is significant to attain the NUDS objectives, which demands its increased volume to plan and accomplish the urban infrastructure development programs from the

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municipalities. It implies that the present fiscal transfer criteria of 'weighted tax' is inadequate, and there is a need to consider own source revenue increment perspectives while designing mechanisms for the transfer of unconditional capital grants and/or urban infrastructure grants, including loan and grants, to municipalities in the future.

In many municipalities, there is still a lack of consolidated database on revenue potentials and inadequate capacity on revenue management including financial management. At present, the municipal database cannot be disseminated horizontally and vertically. Data can be generated within the municipality and also from outside sources that are supporting management development of municipalities such as external development partners. But in the absence of adequate computerizations support, they cannot be used. Development of e-municipalities package might be appropriate in this regard.

3.6 IGFT Assessment

3.6.1 Municipal Intergovernmental Transfer

Municipal grants have been provided since the mid-1980s, and have been evolving for almost three decades, increasing over time in size and sophistication. Currently, there are different types of fund transferring practices from center to municipalities, which are (i) Municipality Grant (Recurrent and Capital), (ii) LDF (Recurrent and Capital),(iii) Agriculture Road, (iv) Road Maintenance, (v) Reserve Fund (Jageda Kosh), (vi) Social Security Grant, (vii) TDF Grant, (viii) LGCDP Grant (Recurrent and Capital), (ix) Direct Fund transfer from Development Partners incorporated in budgetary system, (x) Other Grant in Cash, and (xi) Commodity Grant.

The grant system is inconsistent and continues to be determined in a quite ad hoc manner, at least with respect to the vertical division of resources between the central government and the municipal government. That vertical allocation is determined on an annual basis through the budget process, almost as a residual rather than proactively intentional, to support decentralization. Further thought and progress is needed to more clearly identify the “equitable shares” of government revenues, which should be systematically allocated to sub-national level governments.

The increment in grants to local bodies is inconsistent and unpredictable (Figure 3.1). Average increment of grants to local bodies in the last 10 years is 18 percent, whereas it is 29 percent in case of municipalities. The municipal grant is a bit more predictable compared to total local bodies grant (Figure 3.1).

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Fig. 3.1: Unconditional Municipal Grants16 (Rs Million)

Source: Authors' analysis based on LBFC & MOFALD data.

3.6.2 Local Development Fee

The Local Tax called 'Octroi' was abolished in 1999 after promulgation of the LSGA and replaced it by the Local Development Fee (LDF). The Customs collects a local development fee of 1.5 percent of on the value of imports and the government transferred revenues generated from such tax on the basis of a three-year-average income from Octroi before abolition from the Fiscal Year 1999/2000.

The LDF is not a tax, nor is it a classical grant. However, the redistributive character is more linked to classify the LDF as an unconditional grant rather than an own source tax revenue for municipalities. There are, however, divergent opinions on the character of LDF. The reasons why LDF is presented under the chapter of grants is because there will be no single local tax that can replace by volume the amount of funds collected by LDF.

Fig 3.3 and Fig 3.4 below clearly show the importance of the LDF in own source revenue of the municipalities. The ratio of LDF to municipal grant ranges between 39 percent and 87 percent during FY2006/07 to FY2014/15 respectively (Figure 3.2). The aggregated figures for the local development fee hide an important deficiency of the current local development fee allocation. The local development fee is not well allocated to all municipalities.

16Without including revenue sharing amount

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Fig 3.2: Ratio of LDF to Municipal Grant (%)

Source: Source: Authors' analysis based on LBFC & MoFALD data 2015

Nepal has agreed to abolish the LDF after its accession to the World Trade Organization on April 23, 2004. Since then, however, no discussion has started how to replace the LDF. Some areas such as extensions of tax base for selected axes, and simplification of tax procedures and administration have been identified for improvement. However, the debate is whether such potentials would replace in volume the amount of revenues that is being collected by LDF.

3.6.3 Conditional Grant

The conditional grants provided to the municipalities range from Rs 275 million in FY 2009/10 to Rs 360 million in 2013/1417 with an average of Rs. 339.4 million per year. The trend of conditional grant is inconsistent, as its growth has ranged from 28% in FY 2011/12 to (-) 28% in FY 2012/13 and 18% in FY 2013/14 (Figure 3.3).

Fig 3.3: Conditional Municipal Grants (Rs Million)

Source: LBFC Financial Detail Analysis of different years

17 Conditional municipal grants from Agriculture Road, Road Board, TDF Grant and Other Grant (with unknown Income)

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3.6.4 Revenue Sharing

There is a system of intergovernmental revenue sharing where ministries and departments allocate share of their revenues to local bodies especially to the DDCs. The LSGR defines revenue sharing mechanisms from different sectors such as land registration charges, royalties generated from mines, royalties from forestry resources, royalties received from the production and sales of hydropower, fees and royalties received from trekking and national parks and wildlife, etc. Municipalities are receiving share of land registration charges from the government and such share amounted to Rs 138.3 million in FY 2011/12, Rs 306.9 million in FY 2012/13, Rs 271.4 million in FY 2013/14 and Rs 238.9 million in FY 2014/1518.

The LSGR also defines horizontal revenue sharing mechanisms among local bodies as given below:

(a) DDCs share revenue grants and provide program budgets to VDCs, and VDC share land revenue to DDCs.

(b) DDCs also exceptionally share revenue grants and provide program budget to Municipalities.

(c) Local line agencies also transfer horizontally their resources to local bodies as per specified parameters such as land registration tax.

There are also provisions that the DDCs have to share 25 percent to 50 percent of their revenue resources such as source utilization tax, sales tax, etc. to the municipalities. The share of revenue transfer from DDC to municipality is 4 percent of the total municipal revenue (TDF, 2015).

3.7 National Budget and Intergovernmental Fiscal Transfer to Municipalities

The share of municipal grants in national budget has not been consistent during the last decade. The percentage of municipal IGFT ranges from 0.57 percent to 1.18 percent of the national budget in the last 10 years with an average of 0.89 percent. Average ratio of to municipal IGFT to the GDP is 0.42 percent only (Fig 3.4). The amounts determined each year are supposed to be guided by the government's longer term view of development as well as Medium-term Expenditure Framework (MTEF) and Public Expenditure Framework (PEF) which is less happening as desired.

18Other vertical intergovernmental revenue transfers to municipalities were unavailable.

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Fig 3.4: Percentage of Municipal Grants to National Budget and GDP

Source: GDP, International Monetary Fund, World Economic Outlook Database, April 2015. Budget:

MOF, various years' budget speeches

3.8 Tied and Untied Grants

As part of the recurrent grant system, the central government line ministries provide municipalities with different sectoral conditional grants (for the devolved sectors i.e. education, health and agriculture and other non-devolved sectors such as building, roads, water and sanitation, solid waste management, environment conservation etc.) through their line agencies at district level. The current sectoral block grants approach follows a project-based or supply-based approach; only capital grants transfers from MOFALD are formula-based; and other grants provided by the center are conditional.

Each recurrent sectoral block grant provides municipal government resources jointly for personnel evolvements and other charges in that sector, and allows municipal authorities to distribute their resources between these categories within that sector, as long as the municipal authority complies with the constraints imposed by the municipal budget guidelines.

The shares of untied and tied grants to municipalities are 52 percent and 48 percent respectively(TDF, 2012). Development partners such as World Bank, Asian Development Bank, GIZ etc. are also providing municipal development support. If one includes such budget that is conditional, the percentage of tied grants to municipal governments would be more than 80 percent.

Although the municipal block grants are in principle unconditional, increased conditions have slipped into the provision of these grants. Municipalities are expected to make provisions for children (10%), women (10%), and disadvantaged or marginalized groups (15%), requiring municipalities to earmark a share of their resources for each these purposes (MOFALD, 2013). In addition, instructions were given by Cabinet at the beginning of the FY 2014/15 to set aside an additional 15% of their grant resources for agriculture projects. This is not necessarily a good development. Not only does this practice reduce the discretion of the municipalities to use the limited grant resources for their highest priority, the practice also results in a (often undesirable) fragmentation of municipal spending.

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Box 3.2: Supply –based IGFT

The current sectoral block grants approach follows a project-based or supply-based approach. There is a need to introduce formula-based sectoral block grant approach to entail a shift away from the supply driven approach inherent to the Minimum Condition (MC) approach. Assuring that funding is driven directly by (a proxy for) the level of demand for government services rather than indirectly through the cost of inputs may seem a trivial difference, but it reflects a major shift in the philosophy of municipal government service delivery. The MC approach treats municipal governments largely as passive agents of the central government, in which success is not defined by the efficient and successful delivery of government services but rather by the degree of conformity to national norms. In contrast, a demand-driven grant system provides an incentive for municipal governments to respond to local communities needs in a creative and flexible manner in a way that a more centralized system is generally not able to do (and which the current system encourages).

Municipal governments do not have adequate revenue autonomy to fund any significant portion of these expenditures, and should be expected to under-fund these programs given their national (rather than local) nature. Since the national government has policy-setting and regulatory control over these sectors, it should provide 'ring-fenced' funding for these sectors through sectoral grants. The level of funding for these sectoral grants should be in proportion to the service level that the central government wishes to achieve.

The central government has to develop umbrella formula for sectoral grants, and each sector has also to develop exact formula on the basis of the umbrella formula and provide block grants to the municipal government.

3.9 Predictability of IGFT

Municipalities are heavily dependent on central government resource transfers. To effectively use these grant resources, these funds need to be predictable, timely, and stable to allow municipalities to plan, budget and implement as planned. Interactions at the field level confirm that intergovernmental transfer of resources flow inconsistently, often delayed, and are not predictable, making it difficult for municipalities to procure and implement the planned and budgeted amounts in an efficient and accountable manner.

Size of transfer of funds to municipal governments is determined on an annual basis and is not properly guided by MTEF, PEF, etc. It is not working in an integrated manner in actually determining the amounts that are being budgeted for specific areas for funds transfer to municipalities. Since the budget policy documents give guidance for the upcoming budget year, this allows sectoral ministries to strategically increase the amount of sectoral funding available to the line ministry at the expense of municipal government funding. This type of system effectively results in municipal governments receiving fewer resources for the delivery of key public services, whereas line ministries may increase the share of sectoral resources under its control to its line agencies at district/municipal level. This example reveals that local governments are at a distinct disadvantage when their verticals share of resources protected by a funding rule, since (unlike sectoral ministries) municipal governments lack their voice at the central government level during the budget process.

Effective decentralization requires adequate and consistent resources to fund the mandated set of expenditure responsibilities. Field discussions confirm the need to improve the timely flow of the grants, as late and unpredictable flows has created problems for planning, budgeting and implementation. Funds often arrive too late to allow adequate time to spend the money properly in the given Fiscal Year. This causes municipalities to roll over the funds, when permitted, and to reprogram the funding for the subsequent Fiscal Year. Such situations also forces municipal governments to roll over these funds into the subsequent Fiscal Year.

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Municipal governments can be criticized for not being able to absorb the level of allocated funding, while actually they could possibly absorb the funding if given sufficient time to follow the necessary procurement processes for accountable expenditure implementation.

The resources set for municipal government activities are determined on a year-to-year basis in the context of annual budget process. The intergovernmental transfers as a volume of the national budget have remained almost constant in the last 10 years. Rather than determining the size of the sectoral block grants from year to year as part of the annual budget process, vertical funding rules may be specified in a number of ways that protect municipal governments against such opportunistic cuts in the level intergovernmental grants by the central government. For example, one could specify a rule that a block grant pool has to be at least a certain percentage of the national GDP tied up to urban infrastructure, urban health, education, etc. As number of municipalities have increased and could also increase in the future, block grants should befixed as at least certain percent of the national GDP. Alternatively, the funding rule may guarantee a minimum increase in grants on year-to-year, such as on the basis of rate of inflation.

While there are many advantages to having a vertical funding rule to determine the pool(s) of resources made available to municipal governments, introduction of such a funding rule could also be counter-productive in the near future if sectoral transfer pools might possibly increase in the coming years. As such, it is worthwhile for the time being to continue the current approach of adjusting the size of intergovernmental transfer pools annually as part of the budget process, in line the with the budget priorities of the public sector with specified percentage allocation of national budget to municipal grants. The Ministry of Finance has to closely monitor the resources provided to the municipal government level to prevent sectoral ministries to arbitrarily 'pulling back' resources provided to the local government level in order to increase ministry's own budget release to its line agencies at district/municipal level. In this line, the government may wish to revisit the vertical allocation approach every few years, as it may be appropriate to introduce rule at some point in the future.

3.10 Multi-year Investment Perspectives

Municipalities prepare Periodic Plan that covers multi-year investment perspectives. However, it was observed during field visits that the municipal Annual Development Programs are not found fully aligned to the Periodic Plan. As stated by the key stakeholders met during the field visits, most of the municipalities do not prepare multi-year investment plan and Medium-term Expenditure Framework. Thus, there is a need to initiate multi-year investment and multi-year fiscal framework by municipalities to attain NUDS objectives.

Multi-year investment and fiscal framework can be a vital tool for municipal governments, especially for those struggling with difficult financial conditions. It allows decision-makers to set long-term priorities and work toward goals, rather than making choices based only on the needs and politics of the moment. This is important when resources are limited, as they are in many fiscally strained localities, but can also be beneficial to all communities in avoiding future stress.

The multi-year investment plan and municipal multi-year fiscal framework should be based on NUDS. The GoN will have to establish funds for conditional Municipal Infrastructure Development Grants with set criteria for size of transfer to municipalities and set formula based approach to allocate such grants to municipalities on a per capita basis. The objective of the grants has to be infrastructure development with the provision of free grants, and low interest based loan and grants. These types of grants have to be performance oriented with

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clear linkage to the current performance measures of the GoN. Two types of funds need to be created for such purposes; (i) municipal infrastructure development grants, (ii) municipal infrastructure development low interest rates loans and grants with defined allocation criteria. At the outset, the government has to endow certain funds to establish such grant mechanism.

3.11 Expenditure Analysis of Municipalities

Municipalities spend a significant chunk of their resources as capital expenditure. For instance, of the total expenditure of Rs 6.1 billion in FY 2011/12, about 77% of total expenditure went on capital spending and current expenditure (salary of staffs, office expenses such as electricity, telephone, repairs, travels, etc.) comprised only 23% of total expenditure. The average of expenditure of municipalities during FY2009/10 to 2011/12 was 23% in current expenditure, 1% in debt repayment,12% in social development, 2% in ordinary capital and 62% in capital investment.

Fig 3.5: Composition of Municipal Expenditure

Source: LBFC (2013).

Although municipalities spend considerable percentage of their available resources as capital investment, there is significant investment deficit in for maintaining and upgrading urban infrastructure. The deficits are in new roads (41%), upgradation of roads (26%), water supply (2%), toilet (0.5%), electricity (0.2%), landfill site (0.2%), storm drainage (20%), and sewerage (10%) (Fig 3.6).

Fig 3.6: % of Infrastructure Investment Deficits in Municipalities

Source: (MOUD, 2015)

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3.12 IGFT Projection

The IGFT has been tentatively projected for the next 15 years taking the FY 2015/16 as the base year. It is assumed that (i) the number of municipalities will be constant (217 in number) over the years, (ii) national budget and IGFT growth rate will be similar to that of the nominal GDP assumed to be 12.5% (for unconditional grant), (iii) municipalities will continue receiving conditional grants from the central government (it is also possible from provincial government, however, the chances are nominal), (iv) the growth of conditional grant will be constant over the years at the rate of 2.8% for the first 5 years for 217 municipalities, (v) forecasts of the conditional grants figures after five years are derived from the concurrent list of Constitution of Nepal, 2072, (vi) growth of revenue transfer will be constant over the first 5 years at the rate of 13% for 217 municipalities. It is also anticipated that municipalities will receive 50% of vertical revenue transfer after 5 years. After 5 years, 20% of the district level program and budget from the central budget will be allocated to the municipalities. The projection of IGFT based on those assumptions is given in Table 3.1.

Table 3.1: IGFT Projection (Rs million)

Fiscal Year Unconditional IGFT

Forecast

Conditional IGFT

Forecast

Revenue Transfer

Forecast

2015/16 9,730 9,550 1,310

2016/17 10,950 9,820 1,480

2017/18 12,310 10,100 1,670

2018/19 13,850 10,390 1,900

2019/20 15,580 10,680 2,160

2020/21 17,530 13,510 3,630

2021/22 19,720 14,720 4,320

2022/23 22,190 16,030 5,140

2023/24 24,960 17,470 6,120

2024/25 28,080 19,030 7,280

2025/26 31,590 20,740 8,680

2026/27 35,540 22,590 10,340

2027/28 39,990 24,610 12,330

2028/29 44,990 26,820 14,700

2029/30 50,610 29,220 17,540

2030/31 56,940 31,830 20,920

Source: Authors' analysis, 2015

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3.12.1 Resetting Targets for Municipal Unconditional IGFT

Theory and international practice generally identify a typical distribution of expenditure functions, although with some variation by country. In some countries, there is even an asymmetric approach, recognizing the differences between rural and urban local governments and the diversity among local governments depending on factors such as the levels of economic development, size and capacity. Countries can therefore assign various expenditure functions differentially across local governments. Recognizing the need to allocate different functions across differential spatial regions has led countries to develop special districts to manage schools, water basins, transportation, sewerage, etc. To balance the respect for diversity and the advantages of economies of scale, many countries have a two-tiered system of local governments in urban areas (metropolitan and urban governments) and one-tiered system in rural areas.

The major findings with the scenario analysis of municipal fiscal resources are:

(a) Municipalities are heavily dependent on IGFT; up to 70% of the municipal revenue is accrued by grants.

(b) The ever-growing volume of conditional grants (48%) of total revenue) puts municipalities in a dilemma while preparing programs and budget. Currently municipalities get only 9% of revenue through central transfer as unconditional grants, which actually give them a chance in investment decision. There is a need to increase unconditional grants to municipalities.

(c) There is an investment deficit in urban infrastructure development in municipalities.

(d) As the umber of municipalities has increased from 58 to 217 and as there are possibilities that this trend would continue in the future, municipalities must be ensured of predictable and sizable IGFT to meet the infrastructure deficit.

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Chapter IV

Borrowing Framework and TDF Business Strategy

The previous chapters have analyzed the scope and challenges for mobilizing own source revenue and inter-government fiscal transfers for financing municipal development. As it is evident from the analysis, the existing sources of municipal budget expenditure - as also their trend shows - are not enough for meeting growing urban infrastructure investment demand. The NUDS (2015) has highlighted that the old 58 Municipalities are under tremendous financial constraints to keep pace with increasing infrastructure needs, upgrading their quality, and improving service delivery. Besides, the newly announced municipalities have no urban infrastructure to even call them municipalities. The potential local revenue resources of the old municipalities are yet to be mobilized to address the financing need of the cities. There are even legal confusions and institutional capacity constraints in the municipalities to mobilize potential resources. This chapter analyses investment demand of municipalities, financing gap for infrastructure development, and borrowing framework for the TDF as a financial intermediary.

4.1 Demand for Municipal Financing

Growing urbanization, declaration of new municipalities followed by high expectation from the people towards urban infrastructure, and high migration from rural to urban areas have created high demand for basic services like transportation, water, sanitation, modern energy, and housing. This requires big capital investment by the municipal government in infrastructure amid resource constraints posed by limited decentralization of revenue authority, under performance in revenue collection, and insufficient transfers from the central government. While municipal government is responsible for local infrastructure, meeting the shortfall in the capacity and resources to deliver both current services and future demand for urban infrastructure services require effective and innovative financial solutions.

At present, amid limited resources available for spending, the lack of efficient organizational management of the municipalities has resulted in larger portion of spending in recurrent revenue expenditure and a little is left for capital spending. The experience of 58 municipalities with about 30 per cent of spending being of recurrent nature shows that expenditure is clearly skewed to recurrent expenditures (and primarily salaries) and only about 70 percent allocated in capital investment. The situation has deteriorated over years resulting in even larger gaps in infrastructure financing. The previous chapters have clearly flagged on the scope and limitations of conventional sources of urban infrastructure financing. This is why the search for alternatives or additional options for mobilizing resources for investment for infrastructure development have become so important.

4.2 Sources of Capital Spending

The discussion in the previous chapters have illustrated that municipalities cannot fully resort to central government transfers and traditional sources of local revenues for meeting huge capital expenditure requirement. Unpredictable and insufficient levels of central government fiscal transfers have forced municipalities to explore other avenue of sources, especially from domestic capital markets and to look at how they can use the resources to generate more revenue while also creating infrastructure. As this requires a prudent financial framework for municipalities, such framework has to comprise of clear assignment of revenue and

42

expenditure responsibilities, authority and discretionary power to adjust revenues and to generate sufficient local government own revenue sources, strong financial management and accountability systems and procedures, efficient and accountable budget procedures, predictable financial relationships between central and local governments, and planned infrastructure development strategy.

There are global experiences on effective financing framework for municipalities that Nepal could refer to. The key issue is how finance (revenue sources and transfers or grants are distributed between the central, provincial and local governments including the municipalities; and how borrowing authorities are assigned to the local bodies. While the LSGA outlines clear lines of responsibility on the types of services that municipalities are assigned to deliver, they do not always get sufficient authority in terms of the ability to manage expenditures and to determine (within limits) revenues to deliver these services. In most municipalities, there is a fundamental imbalance in the vertical assignment of expenditures and revenues and hence a need for intergovernmental fiscal transfers and domestic borrowing to close the gap. Further, formulation of the local government legislations commensurate to the new constitution is crucial to balance the expenditure assignment with the revenue and other resource mobilization authority.

4.3 Municipal Infrastructure Investment Gap

Municipalities are facing ever increasing funding and financing gap due to (i) low volume of fiscal transfer systems from the central government, (ii) very low level of municipal revenues from taxes and fees, (iii) burden of unfunded responsibilities; and (iv) limited access to loans and other forms of debt financing (NUDS, 2015). In most cities and towns, the tax base of urban authorities is very small and the tax revenue is quite inadequate to meet their expenses. While most cities depend largely on incomes derived from Integrated Property Taxation (IPT) and service charges, the central government controls the more lucrative revenue sources such as income taxes, VAT and business taxes. Most cities, therefore, have no choice but to depend, to a large extent, on allocations from the central government, which are generally inadequate.

In spite of investment made in capacity development for municipalities, the following weaknesses remain on the path of sustainable financing. These include: (i) shortage of qualified staff and lack of technical and administrative capacities to plan, implement, operate and maintain urban infrastructure facilities; (ii) inefficient delivery due to overlapping/unclear implementation mandates of implementing agencies; (iii) insufficient legal and administrative frameworks for PPP; (iv) lack of capacity for transparent and reliable planning and procurement processes, and improved/accrual accounting system in municipalit ies; and (v) eroded accountability image due to lack of elected council in municipalities.

The impediments to improving urban infrastructure financing include (i) large number of municipalities and towns are small and financially weak; (ii) lack of strong domestic capital markets, undeveloped municipal credit institutions, (iii) asymmetrical decentralization and possible retrenchment of central transfers once federal restructuring is undertaken; (iv) institutional and policy impediments to the development of municipal credit institutions, (v) lack of mechanisms and instruments to finance urban infrastructure projects, and (vi) poorly developed mechanism for mobilizing funds for maintenance of existing infrastructures.

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4.3.1 Urban Infrastructure Investment Demand

Municipal Investment Demand Analysis: The NUDS estimates the investment needed to fulfill the existing infrastructure deficit in 58 municipalities at Rs 372 billion in 15 years' time. The investment need has been calculated for the infrastructure deficit based on existing and desirable state of infrastructure of the municipalities. The infrastructure investment requirement includes new roads construction, upgradation of existing roads, piped water supply connection, construction of toilets, electricity connection, solid waste collection and management, storm drainage construction and sewerage connection. More than two thirds of the urban investment requirement is for new road construction and existing road upgradation. Obviously most of such projects are of social infrastructure type and generate low rate of financial return. It would be then difficult to make them bankable projects.

The NUDS analysis indicates that there is a significant investment deficit for maintaining and upgrading urban infrastructure. The outlay by the central government has been much less than the contribution of the urban sector to the GDP. Further, there is no rational distribution of investment, which has exacerbated regional imbalances in resource allocation. Private sector investment in urban infrastructure development has not been forthcoming and policies to encourage such investment have not been explicit. The government has come forward with Public Private Partnership (PPP) policy and implemented BOOT Act for some time now. Still, not much breakthrough has taken place in either of them.

In the recent years, additional 159 municipalities have been constituted by consolidating 759 VDCs to the extended municipal area with increasing number of sub metropolitan city too, thus reaching the total number of municipalities to 217 including 12 Sub Metropolitan and one Metropolitan city. The infrastructure of these municipalities is pathetic; and this requires quick response from the government and TDF to create basic infrastructure in these newly constituted municipalities. There has been no survey of the new municipalities as to their exact infrastructure deficits. So for the present purpose, the infrastructure deficit and the financing need of the previously declared municipalities is assumed to apply for the new ones as well. With this assumption, the urban infrastructure financing need of all municipalities is worked out.

Estimation of total financing need based on the NUDS analysis and additional financing needs of the municipalities based on above-mentioned assumption is shown in Table 4.1, Table 4.2 and Table 4.3. The financing need is estimated for achieving basic urban infrastructure by 2030, which includes the following parameters of urban infrastructure. They are –more than 10 persons per hectare of land, road length at 7.5 km per sq. km for old municipalities and 5 km per sq. km for new municipalities, 80% of the urban households to have piped water supply, 100% of the households to have toilet facilities connected to the sewage system, 100% households to have electricity connection, all to have landfill sites, 60% of the road length to be covered by storm drainage, and 20% of road length in core city to be covered by sewerage.

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Table 4.1: Urban Infrastructure Investment Requirement and Financing Sources (Rs billion)

Source and Use of Municipal Funds 2015/16 2018/19 2021/22 2024/25 2027/28 2030/31 Total

1. Own Source Revenue 8.55

11.74

17.49

27.07

41.95

65.09

427.54

2. Recurrent Expenditure 7.11

10.81

16.45

25.01

38.04

57.85

389.04

3. Previous Debt Services 0.09

0.20

0.33

0.30

0.28

0.28

4.11

4. Revenue Surplus (1-2-3) 1.35

0.72

0.71

1.76

3.62

6.96

34.38

5. Unconditional Grant (IGFT) 9.73

13.85

19.72

28.08

39.99

56.94

424.85

6. Revenue Sharing (IGFT) 1.31

1.90

2.93

4.90

8.20

13.79

81.15

7. Conditional Grant (IGFT) 9.55

10.39

14.72

19.03

24.61

31.83

277.56

Amount Available for Capital Investment (4+5+6+7)

21.94

26.86

38.09

53.77

76.43

109.5

817.9

Total Investment Need (Scenario 1: to

meet 60% of physical target)

67.11

75.58

84.98

95.54

107.4

120.8

1,397.9 Total Investment Need (Scenario 2: to

meet 75% of physical target)

83.89

94.47

106.22 119.4 134.3

151.0

1,747.4

Total Investment Need (Scenario 3: to

meet 90 % of physical target) 100.7 113.4 127.5 143.3 161.1

181.2

2,096.9

Source: estimation of the study team

Table 4.1 shows three scenarios of investment requirement depending upon the goals of achieving 60%, 75% or 90 % of the physical targets to be met by 2030. In the first scenario, only priority infrastructure is taken into account and only 60% of the proposed infrastructure requirement is supposed to be met during the next 15 years. In this scenario, the projected investment requirement for the next 15 years amounts to Rs 1,398 billion. In second scenario where 75% of the physical targets of basic urban facilities are set for 2030, Rs 1,747 billion would be needed for the next 15 years. If both the old and new municipalities were supposed to meet 90% physical target for infrastructure set for 2030, then the total investment requirement for the next 15 years would be Rs 2,097 billion. Estimation of total financing need based on the NUDS analysis and additional financing needs of the new municipalities based on above-mentioned assumption shows that about Rs 2,330 billion is required for the next 15 years both for old and new municipalities to meet 100% target of the basic urban facilities.

The proposed investment requirement can be financed from different funding sources such as revenue surplus, IGFT and market borrowing of the municipalities as per their maximum borrowing capacity leading to a net financing deficit1 of Rs 571 billion during the entire period of next 15 years in scenario 1 (Table 4.2). Details of the estimates are shown in Annex 4.1.

In an alternate scenario with 75 per cent of the proposed physical infrastructure to be met in the next 15 years (Scenario 2), the investment gap in the same period is projected at Rs 921

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billion and it creates additional funding challenges to the municipalities. Unless TDF enhances its lending capacity along with mobilizing other stakeholders in urban infrastructure development, the investment gap is likely to suppress expected physical development of the municipalities. The situation becomes even more challenging if 90 per cent of the proposed urban infrastructure is to be met within next 15 years. The net financing deficit would be Rs 1,270 billion (Table 4.2).

Table 4.2: Net Infrastructure Financing Requirement (Rs billion)

Financing of Investment Need 2015/16 2018/19 2021/22 2024/25 2027/28 2030/31 Total

Revenue Surplus 1.35 0.72 0.71 1.76 3.62 6.96 34.38 Total IGFT 20.59 26.14 37.37 52.01 72.80 102.56 783.56 Market Borrowing (Capacity Constraints as 25% of Revenue Surplus)

0.34 0.20 0.19 0.43 0.90 1.74 8.69

Net Financing Requirement19 (Scenario 1)

44.84 48.54 46.71 41.33 30.09 9.53 571.41

Net Financing Requirement (Scenario 2) 61.62 67.44 67.95 65.22 56.95 39.72

920.90

Net Financing Requirement (Scenario 3) 78.40 86.33 89.20 89.10 83.80 69.92

1,270.39

Source: estimation of the study team, 2015

The net financing requirement could be partly met through innovative and special financing vehicles. The investment requirement of TDF is arrived at after making some assumptions about the contribution of those innovative financing vehicles for urban infrastructure. In scenario 1, it is assumed that municipal cost sharing could cover about 3% of the total investment requirement while PPP and PCP are supposed to cover 3% and 2% of the investment requirements respectively. On these assumptions, the urban infrastructure financing need of the TDF would be Rs 526 billion for the next 15 years (Table 4.3). In the second scenario, the investment requirement would be Rs 847 billion with the same assumptions as in scenario 1. In the third scenario, if cost-sharing portion was raised to 5%, then the TDF investment requirement would be as much as Rs 1,143 billion. If cost sharing is maintained at the same level as in scenario 1 and 2 (i.e. 3%), then investment requirement for TDF would be even higher at Rs1,169 billion.

19The projected financing gap has been arrived at by assuming 15% growth of recurrent expenditure, 16% growth of revenue, and 12.5% growth of IGFT. Average recurrent expenditure growth of 35 municipalities (except Metro and Sub Metro) has been taken for the projection of recurrent expenditure of remaining all 170 municipalities (which is 15% and derived by adding up 3% to the 12% actual growth rate). Own Source Revenue is assumed to increase by 16% for old 58 municipalities but for the remaining new 159 municipalities, it is assumed to grow by 8% (half the rate of old municipalities) for first three years and then by 16% throughout the projection period.

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Table 4.3: TDF Financing Requirement of Urban Infrastructure(Rs billion)

Financing of Investment Need 2015/16 2018/19 2021/22 2024/25 2027/28 2030/31 Total

Net Financing requirement (Scenario 1)

44.84

48.54

46.71

41.33

30.09

9.53

571.41

Cost Sharing (3% of total investment requirement)

1.35

1.46

1.40

1.24

0.90

0.29

17.14

PPP projects (3%of total investment requirement)

1.35

1.46

1.40

1.24

0.90

0.29

17.14

PCP (including NGOs, 2% of total investment)

0.90

0.97

0.93

0.83

0.60

0.19

11.43

TDF Financing Requirement (Scenario 1)

41.25

44.66

42.97

38.03

27.68

8.77

525.70

Net Financing requirement (Scenario 2) 61.62 67.44 67.95 65.22 56.95 39.72

920.90

Cost Sharing (3% of total investment requirement)

1.85

2.02

2.04

1.96

1.71

1.19

27.63

PPP projects (3%of total investment requirement)

1.85

2.02

2.04

1.96

1.71

1.19

27.63

PCP (including NGOs, 2% of total investment)

1.23

1.35

1.36

1.30

1.14

0.79

18.42

TDF Financing Requirement (Scenario 2)

56.69

62.04

62.52

60.00

52.39

36.55

847.23

Net Financing requirement (Scenario 3) 78.40 86.33 89.20 89.10 83.80 69.92 1,270.4

Cost Sharing (5% of total investment requirement) 3.92 4.32 4.46 4.46 4.19 3.50 63.52

PPP projects (3%of total investment requirement) 2.35 2.59 2.68 2.67 2.51 2.10 38.11

PCP (including NGOs, 2% of the total investment) 1.57

1.73

1.78

1.78

1.68

1.40

25.41 TDF Financing Requirement (Scenario 3) 70.56 77.70 80.28 80.19 75.42 62.93 1,143.4

Source: estimation of the study team, 2015.

4.3.2 Resource availability for urban infrastructure financing

Revenue Situation: As discussed in Chapter 2, the revenue base of the municipalities is very weak. In FY 2013/14, out of the total revenue (Rs 7,132.74 million) of the old 58 municipalities, own source revenue (OSR) was 37.26 per cent only comprising of Rs 2,657.40 million. Taxes and service charges together made up around 90 per cent of the OSR in fiscal year 2013/14.

The largest share of revenue has been the service charges (around 41.23 per cent on average during last five years (FY 2009/10-2013/14) levied by the municipalities to provide different kinds of services. Second major source of OSR has been the property tax, which contributes around 40.83 per cent on average during same period. Some municipalities have started mobilizing resources under partnership with community i.e. cost sharing in infrastructure projects especially urban roads, toilets and drains. The overall trend of internal revenue

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growth is not satisfactory and consistent to be predictable for future projection and strategic analysis.

Inter-governmental Fiscal Transfer: As discussed in Chapter 3, municipalities receive sizable conditional and unconditional grants from the central government budgets in the context of high spending requirement and low revenue base of the municipalities. No doubt, it is more efficient and effective for the central government to transfer fund for the development of local infrastructure that itself indulging in it. As such, a clear and objective oriented intergovernmental transfer system has many benefits including a) providing predictability that helps cities plan long term investments; b) providing a creditworthy base of cash flows which can be leveraged, c) balancing differences in financial capacities of different cities and d) ability to design credible incentives to encourage cities to meet policy goals (NUDS, 2015). However, the ever-growing demand for conditional or unconditional grants and their unpredictability put municipalities in a situation difficulty while preparing budgets and programs.

Other sources of municipal financing: Urban infrastructure financing can take place through several instruments like public private partnership, public community partnership, foreign direct investment, or even through commercial borrowing by the municipalities. Some innovative financing strategy and tools exercised in different contexts are as follows:

(i) Value capture: The investments made by the state in roads, bridges, public offices, universities, hospitals, etc. in the municipalities tend to increase the land value surrounding the facilities. However, the land and house taxes in those areas tend to be similar to other parts of the municipalities. In Nepal also, integrated property tax (IPT) cannot sufficiently differentiate the changing value of the landed property because of public investment in infrastructure. The taxes normally capture the value to a minimum level only and the valuations remain unchanged for several years. Hence, value added or betterment levies, land pooling in the areas adjacent to an infrastructure for resale, and land development schemes need to be used as tool to capture the property value in parts of cities where new infrastructure investment takes place. This raises the internal resource base of the municipalities making them capable to invest in other infrastructure projects.

Box 4.1: Two Examples of "Land for Infrastructure" Projects Implementation (Road Construction & Urban Development) as per BT scheme in Vietnam

These projects were executed by POSCO and GS Consulting & Engineering Corporation (GSEC), respectively, both of South Korea. HCMC‟s Belt Road No. 1 project (10 kilometers) was led by GSEC, while POSCO led a road development project that connects Hanoi with the northern Hong River area. Under these projects, road construction is executed and funded by these companies that are granted the concession rights by the GOV, with the roads transferred to the government upon completion. The companies receive land development rights in return for bearing the cost of road construction, and construct residential properties and commercial buildings. The revenue realized from the sale of these properties is then used to recoup the cost of construction.

Source: World Bank, 2013

(ii) Viability gap funding: Public sector alone will in no way be able to meet all the infrastructure financing requirement whereas not all the projects will be commercially viable. In the case of the infrastructure projects, which private sector could take up with public sector support and financing could be taken up in the framework of viability gap funding. This investment model will help the municipalities to mobilize private

48

investment and save public resources from being held up in limited number of projects that they would otherwise have to invest on. This kind of special purpose vehicle (SPV) not only mobilizes private sector resources, but also benefits from the knowledge and technology that private sector can impart. But there should be an objective criteria or mechanism for viability gap funding. There should be no municipal subsidy on purely commercial urban infrastructure projects where projects are bankable or PPP is possible.

(iii) Commercial borrowings and public offerings: Mobilization of fund from capital market like public issue of the shares of commercially viable infrastructure projects, consortium financing, and bond issues on project specific needs are some other means of infrastructure financing. Commercial borrowing, PPP and use of public land as an equity in the infrastructure projects can provide a strong framework to finance capital investments.

(iv) External borrowing: The constitution of Nepal allows external borrowing on central government approval at the provincial level only and local governments are not directly allowed to mobilize external grant or loan. However, the local bodies including the municipalities can take the initiatives to mobilize external resources for infrastructure through the central or provincial government, which has been in practice for some time now in the country. The Municipal Infrastructure Improvement Project (MIIP) in Kathmandu Metropolitan City from ADB assistance is an example in this respect.

4.4 Borrowing Capacity of the Municipalities

The global experience in municipal financing shows varied levels of municipal borrowings, which is normally measured in proportion to their revenue as simple parameters such as debt stock or debt service flow. For example, in Brazil, municipalities can borrow if their debt stock remains below 60% of their operating revenues or if their debt service (the interest payments on outstanding debt and amortization) remains below 15% of operating revenues (Catherine and Kopanyi, 2014).

Currently Nepalese municipalities have borrowed only up to 3% per cent in average of their internal revenue (TDF, 2015). The borrowing capacity of the municipality is assumed to be not more than 25% of revenue surplus of the municipalities (revenue surplus is defined as recurrent revenue minus recurrent expenditure). Based on this assumption, the additional borrowing capacity of municipalities for the next 20 years is estimated at Rs 19.75 billion as per past historical data of 2009/10-2013/14 for 39 municipalities for which data are available (TDF, 2015). If loans are repaid from STIUEIP & IUDP's sub project revenue, the municipality will have additional borrowing capacity of Rs 1.90 billion as for further loan; and then total borrowing capacity of the 39 municipalities would be Rs 21.65 billion. As the new municipalities do not have historical data on revenue, it is difficult to estimate their borrowing capacity. Nevertheless, given the nature of municipal revenue and expenditure, we can infer that the borrowing capacity of the municipalities would be limited unless the norm of limiting borrowing to 25 per cent of revenue surplus is relaxed or a massive drive in revenue mobilization and containing recurrent spending is exercised.

4.4.1 Domestic Borrowings of the Municipalities

Amid high resource gap, municipal government borrowing is needed to enhance the flexibility of long-term infrastructure investment planning. Given that central government holds municipalities mostly responsible for the creation of basic infrastructure facility, local government borrowing becomes indispensable. This arrangement can provide municipalities

49

with strong incentives for improving project design, cost-recovery practices, budget transparency, and financial management. Increasing demand for local capital investment is stimulating innovative approaches to expanding local government access to private credit markets, as illustrated by the successful stories of municipalities in several countries (see Box 4.2 & 4.3).

Box 4.2: Bond Issue Experience of Ahmedabad Municipality

In 1996, Ahmedabad Municipal Corporation (AMC) of India had a rating for its municipal bond issue for water and sewerage expansion. Ahmedabad‟s water and sewerage projects were subsequently financed through resource proceeds from the bond issue. AMC‟s own revenue, loan from banks and financial institutions helped to expand services. Through the project, Ahmedabad‟s local government learned to use bonds as a financial tool to raise investments for its capital investment priorities.

Source: PADCO (2003).

No doubt, there are several constraints to local government capital market borrowing. Municipalities in Nepal have very limited borrowing powers, even to finance lucrative investment projects. Also it is important that too much borrowing might lead to insolvency or unstable financial situations of the municipalities. The challenge is to strike the right balance between the need and ability to absorb the loan. Lack of creditworthiness, inability to develop bankable projects, and the strict regulations and cumbersome procedures for the local government borrowing make the borrowings an extreme solution to municipal financing gap. To date, only a few countries have introduced clear rules on local government borrowing. Some countries (e.g. Zambia) have used pension funds as credit facilities for the local government, but generally this source is also limited. Some countries (e.g. Ghana) have developed ceilings and clear and transparent general rules on borrowing. Learning from the evidence, Nepal needs more developed and detailed regulation of the purpose of the municipal borrowing, the amount and the conditions, the timing, the procedures for handling borrowing, the sources of borrowing and other technicalities.

Borrowing has not so far been a major source of municipal financing in Nepal, as current borrowing comprises only 0.85% of municipal total revenue (or 3 per cent of municipal internal revenue) in average. However, taking into account the huge infrastructure financing gap and the prospect for commercially viable infrastructure projects at the municipal level, it is worthwhile to assess their borrowing capacity in the context of their projected internal revenue generation for the next 20 years.

There are at least two windows that municipalities can use for borrowing –namely the TDF and the banks and financial institutions. As municipal financing need is much higher than the present income of the municipalities, debt financing is an option, which makes municipalities able to finance beyond the capacity of their present revenue mobilization. As such, the commercial infrastructure projects could be designed in such a way that the principal and interest of the investment could be recovered from user-fees, charges, or local taxes raised from the facility users.

Currently, Town Development Fund (TDF) is the only organization in public sector for financing urban infrastructure development through loans and grants. It has financed several urban infrastructure projects ranging from urban roads to city bus terminals for long term financing schemes -about 20 years. Despite an incentive mechanism of topping some loans by grants and very concessional terms of lending, the municipal demand for loan from the TDF is very low. As of July 2015, the outstanding borrowing of the municipalities was only Rs

50

1,136 million.1Also, as discussed earlier, the borrowing capacity of municipalities is still very low as total borrowing capacity of the municipalities for the FY 2015/16 would only be Rs 340 million. Municipal borrowing capacity is assessed against the ability to repay through internal revenue mobilization, the borrowing capacity will be enlarged if the municipalities enhance their existing revenue performance.

20Currently, TDF has been able to provide long-term loans for up to 20 years on a fixed-rate basis, which is not possible from the financial institutions in the local capital market. Nepalese commercial banks have recently started to lend to infrastructure projects for a period of up to 12 years, that too on a floating-rate basis. Due to the nature of their sources of fund, banks and financial institutions cannot put much of their investment for long run projects and they cannot also go below the market interest rate. Further, commercial banks do not have municipal financing framework in their Credit Policy Guide. TDF, on the other hand, has been able to provide municipalities the long-term loans up to 20 years at interest rates well below the market rate. TDF has also taken significant credit risk that the commercial banks would not have been able to take up. This role of TDF is quite different from typical urban financing institutions in other countries (see Box 4.3).

But unsustainable financing framework of TDF such as grants topping the loan, interest rates charged far below the market rates, excessive risk taking, limited loan loss provisioning, and no direct right to confiscate the public sector collaterals in case of default require a total restructuring. The loan repayment rate on TDF lending was only 84.7% percent at the end of July 2014, which increased 88.2% percent in July 2015.

In principle, municipalities can borrow on longer-term basis from the banks and other capital market institutions. However, the current outstanding level of municipal borrowing from the TDF is 1,136 million in July 2015. Similarly, the borrowing capacity as level of debt service payment in July 2015 is Rs 340 million only. There is no any case that municipalities have undertaken borrowing from bank or financial institution for long term infrastructure financing. The low loan off-take of the municipalities from the capital market is due to their low level of creditworthiness mainly in terms of ability for loan payback. Thus, TDF has been taking up the financing task even for the bankable projects.

20As per TDF record dated 16 July 2015, the total outstanding loan was Rs 3,435 million including the principle and interest balance amount under STWSSSP I, II & III program. The loan amount for water supply project is considered as contingent liability of the respective municipalities and DDCs, which was excluded and then taken balance amount (Rs 1,136 million) as outstanding borrowing of the municipality.

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Box 4.3: The Colombian Municipal Development Fund (FINDETER)

The FINDETER acts as a refinancing institution, encouraging the financial institutions (commercial banks) to lend directly to local governments and to corporatized entities under the control of a local government. FINDETER is a local government development finance company with 90 percent ownership of the government, with the rest being held by local governments. It gets funding from the national government and donors (e.g., loans). FINDETER lends at a discounted rate to a commercial bank, to cover all or part of a loan first provided by the bank to sub-national entities. The commercial banks conduct loan appraisal based on FINDETER‟s credit evaluation guidelines, and fully absorb the credit risks. The loans made to local governments are mostly secured by constitutionally mandated transfers from the central government.

FINDETER flow of funds

Source: World Bank, 2013

There are several areas of reform that will make municipalities eligible for more commercial borrowing from the banks and financial institutions. The selection of commercially viable projects, pre-determined user-fees or charges to be collected from the users of the infrastructure, expansion of the internal revenue base and its effective collection, effective provision of loan recovery through legal actions including acquiring of the collaterals pledged for loan and central government incentive mechanism like topping the loan by matching grants for social type of infrastructure projects are some of the areas of reform and putting a system in place.

In sum, so far as municipalities do not feel their accountability to their people and improve the efficiency of local revenue generation, and only look for the support from central government in terms of transfers, there will be no commercial borrowing efforts for municipal financing. Thus, the municipal financing mechanism of the central government should be based on the efforts made and performance shown by the municipalities towards mobilizing local revenue resources, efforts made to borrow and mobilize TDF and capital market resources, and the nature of the project that central government should be funding through conditional grants or transfers. A proper mix of financing opportunities, which strategically utilizes own-source revenue, grants, borrowing (loans and bonds), and equity could be leveraged together to finance their priority projects to a larger extent.

Debt & EquityDiscount

PublicSources

DebtPrivateSources

FINDETERSub nationBorrowers

First TierFinancialInstitution

Inter GovernmentFiscal Transfer

Loan Loan

Recourse

Key : Flow of ResourcesLoanRepayment (& tariffs)Recourse

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4.4.2 External Borrowing of the Municipalities

The existing financing gap of the municipalities cannot be met without external assistance (grant or loan) being mobilized for infrastructure financing. Of the two ways of mobilizing the assistance – directly by the central government and allocating the resources to the local bodies or approving the local bodies' proposal to mobilize external resources – the latter is more accountable way of financing. There are several international donor programmes at the local levels at both the international and local levels as also mentioned before. International development agencies like the World Bank, IFC, ADB, UN Agencies, etc. are actively supporting the urban infrastructure and human resource development to effectively and efficiently deliver local public services. They are also providing a range of technical assistance facilities focused on addressing the policy and regulatory constraints to private sector participation in infrastructure service delivery. USAID, UN-Habitat, and similar agencies are also working on slum upgrading and infrastructure creation in developing countries. Nepal can very much use those opportunities as well. Along with infrastructure development, the donor-sponsored facilities have a role in supporting capacity building in local government in our country.

4.4.3 Public Community Participation (PCP) for Infrastructure Financing

Community dwellers in the municipalities are growingly eager to participate in the local infrastructure that is feasible to be developed with their financial and management participation. An extensive network of the municipalities with the community people and community organizations not only helps for meeting the infrastructure-financing gap but also ensures efficiency and effectiveness in resource uses. This has been extensively demonstrated in the practices of several municipalities. However, municipal redtapism and hesitation to work with people often neglects the potential for resource mobilization and creation of social and economic infrastructure. As such, municipalities that have developed and maintained strong networking and partnerships arrangements with communities have benefited from improved infrastructure with less investment than in other projects.

4.5 Role of TDF as a Financial Intermediary

4.5.1 Present Situation

Town Development Fund Act 1996 gives TDF a scope and autonomy to function as a financial intermediary institution for the development of urban infrastructure in Nepal. With rapid urban population growth, fast trend of urbanization along with declaration of more and more villages as municipalities have resulted in large demand for urban facilities including infrastructure. This demands huge investment in the public sector as not many of the urban infrastructure projects can generate revenue to attract private investment. With devolution of revenue and expenditure functions at the local level through the new constitution, it is necessary that municipalities have ability to create basic infrastructure on their own. The best they can do this is through enhancement of own revenue sources, getting more transfers from provincial and federal or central government, borrowing from financial intermediary, and creating an environment for private investment for the commercially viable infrastructure projects and undertaking collaborative infrastructure projects in the framework of public private partnership (PPP) or pubic community partnership (PCP). While the preceding sections have discussed the scope and challenges for generating more public resources for infrastructure financing, this section focuses on the borrowing scope of the municipalities and the role of TDF in this respect.

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4.5.2 Banks and Financial Institutions as Sources of Municipal Financing

The Nepalese banking system is governed under Banks and Financial Institutions Act (BAFIA), whichset rules for bank lending. The directives of Nepal Rastra Bank based on this Act are the basis for bank lending to business including the infrastructure projects. Often times as the responsibility of the banks is to protect the deposits of the savers or clients and giving reasonable profit to the shareholders, banks are preoccupied primarily with the notions of safety and profitability. In doing so they have to maintain adequate liquidity and ensure commercial viability of the projects while also maintaining solvency to serve the depositors. Thus strong collateral base, cash flow sufficient enough to repay the loan and interest in time, and a maturity structure of the loan in accordance with the nature of the deposit are their key considerations. The directives of the NRB set regulations on minimum capital adequacy, cash and liquidity ratios, limits of credit, sectoral exposure norms, liquidity standards, and single obligor limit among others. Thus the lending scope and capacity of banks and financial institutions in urban infrastructure projects hinges on the capital base of the banks and financial institutions, their commercial viability, business interest of the banks in infrastructure projects, their capacity to assess the viability of large infrastructure projects, nature (short or long term) of deposits and other sources of fund, risk management (insurance including) and nature of borrowing institution or company.

Some existing NRB directives are crucial to judge the borrowing possibilities of the municipalities for infrastructure projects. First, the present capital base of banks and financial institutions amounts to Rs 160 billion. The banks can lend only up to 25 percent of their capital fund to a single project and up to 50 percent if it is a hydro project. So putting together the financial strength of all the banks and financial institution together, they can lend in principle to an infrastructure project of Rs 40 billion. But as pulling all the banks and financial institutions in a single project is a practically impossible, the consortium of 10 banks with average capital of say Rs 4 billion each will then be able to finance a project of Rs 10 billion.

Second, there is a sectoral limit to exposure of banks and financial institutions to any specific area, which implies that not more than 40 percent of bank lending goes to a single sector. This limits the lending exposure of banks in limited infrastructure projects.

Third, the nature of sources of fund of the banks and financial institutions is of short-term nature. Current, saving and call accounts, which are of short-term nature comprise of more than 60 percent of bank deposits. Fixed deposits comprising nearly one third of the total deposits also mostly mature in a year or less. There are no deposits of the long run nature with the banks so that they also could lend for long term. Banks have not issued so far any certificates of deposits or long-term bonds or debentures to raise capital for long term lending. So to avoid a balance sheet or liquidity mismatch, they cannot lend short-term sources of fund for projects needing long-term financing. As infrastructure projects have a long commencement period and as such projects demand interest capitalization for several years, this would also adversely affect the cash flow of the banks.

Fourth, banks normally intend to invest for trade commerce and industries, which generate cash in the short-run and minimize the risk. The infrastructure projects are, however, of several uncertainties and relatively higher risk and the banks have to wait for long to get loan and interest repaid. This is because the interest on lending is normally capitalized for the period of project construction. In such a situation, the bank officials and investors, who want

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short-term profit and dividend than the long run one, give low priority to long-term projects. This constrains the financing to urban infrastructure projects as well. So even if private sector is willing to take up some commercially viable urban infrastructure projects, banks are not readily coming forward to serve their requirement.

Fifth, there is capacity constraint in the banks to assess loan applications for infrastructure projects, and they lack engineers and technicians to evaluate infrastructure development loan proposals from the private sector. Experience with hydropower project financing is revealing in this regard and this is one reason why most of big projects are looking for external debt financing.

Finally, the financial market in Nepal is very volatile with remittances driving the liquidity of banks and financial institutions and this determining the cost of capital (interest rate) of the banks. Not being sure of how much they have to pay for depositors is future days, banks are hesitant to commit fixed interest loan to infrastructure projects whereas such projects become viable only under some conditions including the cost of capital or interest rate. As banks often propose variable interest rate (revising it up as it deems necessary) to the developers of infrastructure projects, the borrower cannot absorb such risk and the project financing schemes fail.

4.5.3 Need of TDF as an Urban Infrastructure Financing Institution

The above mentioned issues Imply that (i) existing banks and financial institutions can not cater the demand for large borrowings for infrastructure projects; (Ii) they can not serve investment demand in infrastructure projects of long term nature and of low rate of return (below the cost of capital); (iii) they cannot finance social infrastructure projects without supporting viability gap funding by other agencies like the government, municipality or the TDF; (iv) they are not interested in public sector or even PPP projects because of the political risk of the project; and (v) banks feel that financing municipal infrastructure projects incurs loan recovery hassles unlike for the private sector projects whose loan collateral could be captured and auctioned to recover the loan as per the law.

The foregoing facts lead to the point that a financial intermediary outside the domain of BAFIA is necessary to finance municipal infrastructure projects which are commercially viable, or which could be made viable through viability gap funding mechanism. The financial intermediary would have both the roles of promoting urban infrastructure and financing them on its own or in consortium with other financial institutions. As TDF has already got the mandate to function as the financial intermediary, and as it has long experience of working with municipalities and their infrastructure development financing, it is logical to restructure TDF as a full-fledged financial intermediary though a legislation which provides this institution with clear autonomy, mandate and responsibility to finance urban infrastructure projects. The objectives, functions and rights of the restructured TDF as a financial intermediary require to be enshrined in the TDF Act. The supervisor of the TDF could be the one who oversees the Employees Provident Fund (EPF), Citizen Investment Trust (CIT), or the proposed Labour Bank.

Currently, there are private sector initiatives to promote infrastructure development banks with reasonably high paid up capital under the existing banking law. This initiative would complement the financing activities of the TDF as a financial intermediary; for, they can pool resources and go on consortium financing for the large projects, along with sharing expertise on long term project financing. Besides, operation of any infrastructure-financing bank under

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BAFIA would also help and guide the TDF as a financial intermediary to streamline its financing procedures and practices.

4.5.4 Sources of Fund of the Proposed Financial Intermediary

Large capital base, transfers (grants) and loans from the federal government, on-lending of the borrowings of the government from the international financial institutions, long term borrowing of the TDF through the issuance of market based instruments like the bonds and deposit certificates will be the sources of fund for the proposed financial intermediary. They are elaborated as follows:

(i) Capital Fund: Paid up capital and reserves would be the first financial strength of the proposed financial intermediary. The capital base of the proposed financial intermediary has to be large enough to cater the huge urban infrastructure investment requirement. Given the huge investment demand for urban infrastructure, the proposed financial intermediary will have to possess at least Rs 20 billion of capital at the beginning along with an equal amount of other sources of fund. The current capital of TDF amounting to less than Rs 2 billion implies that strong government commitment will be needed to be a majority shareholder of the TDF as a financial intermediary. Besides, several other public sector entities like EPF, CIT, Town Development Committees, Municipalities and others can be participating in the shares of the proposed financial intermediary. The proposed large capital base would itself serve as the primary source of financing urban infrastructure for the TDF. The capital base can be strategically raised up within a period of several years and with the invitation of international equity funding agencies like the IFC to share participate in the financial intermediary.

(ii) Institutional Long term Deposits: Mobilization of institutional deposits of long-term nature would be the next source of fund for lending to urban infrastructure. Such deposits could be of long term nature with a maturity of at least 5 years and going up to 15 years. Such deposits could take the form of certificate of deposits, which could also be traded in the capital market through the stock exchange. The institutions that could buy such deposit instruments are the contractual saving institutions, which save for long-term period like the provident, the pension, and the insurance funds. The sovereign funds of the governments like the employment promotion fund, telecom development fund, social security fund, contingent insurance fund and employees' retirement/welfare fund could be other sources of financing for such instruments. The welfare funds of the army, police, central bank, and other agencies could also be the potential clients of such instruments.

(iii)Long term borrowing from national and international financial institutions (IFIs): Borrowings could also be considered as a source of fund for the TDF as a financial intermediary. Such borrowing could take place from (i) banks and financial institutions operating under BAFIA, (ii) international multilateral institutions like the World Bank, Asian Development Bank, Asian Infrastructure Investment Bank, International Finance Corporation, and (iv) other agencies. The government can negotiate long-term concessional loan with the IFIs to be on lent to the TDF for financing urban infrastructure as it has been doing for several public entities like the Nepal Electricity Authority or the Civil Aviation Authority. However, borrowing from domestic banks will be viable only in a situation of reasonable spread between the interest cost of borrowing and the interest

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income (return) on lending to urban projects. When TDF has to compete with the banks in some urban infrastructure financing such as building commercial buildings, shopping malls, modern bus parks, entertainment or amusement parks, and the like, borrowed resources from the banks would work only when TDF can function at a lower interest margin (spread) than the banks. In normal times banks are operating in an average interest rate spread of about 4-5 per cent. Borrowing from banks to lend for the similar types of projects that banks under BAFIA have been lending implies that TDF has to operate at an interest spread of not more than 2-3 per cent. This could still be viable if TDF has a lower operating cost and higher credit appraisal capacity so as to properly assess the risk underlying the lending. Besides, the wholesale nature of the TDF financing would enable this institution to function in a lower operating expense. The motivation for social business and corporate objective of working for normal profit, compared to abnormal profit that other financial institutions tend to achieve, will also make TDF to function in the lower interest spread with borrowed fund from the banks and financial institutions.

(iv) Long-term Bonds: Issuance of long-term bonds could be a proposition in case easier options to raise fund for investment does not work. Issuance of such bonds would, however, be feasible on several conditions. First, there will be a need for credit rating of TDF by a reputed rating agency before that could be approved from the Securities Exchange Board. Second, in case the credit rating does not work, the government might have to guarantee the bonds for their redemption. (This is, however, contingent on the institutional credibility, as even in absence of Credit Rating Agency and Government Guarantee, several Commercial Banks have issued long term Debentures/bonds on a stand alone basis for a period ranging from 5 Years to 10 Years to manage their supplementary capital. Market response to these bonds is quite encouraging.) Third, while credit rating will largely determine the interest rate offered on such bonds, the interest rate offered will have to be comparable with other financial instruments available in the market like the long term deposits or government bonds. Finally, viability of such scheme will depend on the stability of the financial market in terms of interest rate structure and the status of financial liquidity in the market.

4.5.5 Current Financing and Pricing Policies of TDF and Proposed Reforms

The TDF has inbuilt social development features namely (a) loan triggered urban infrastructure growth - supplemented by grants in appropriate situation, (b) focus on need-specific capital projects to be undertaken by municipalities compatible with their technical and commercial capabilities, (c) linkage with matched contributions by municipalities/user groups based on the current revenue generating capability/ capacity, (d) upgrading of organizational capability of the municipalities through development of long-range perspective and strategy for urban infrastructure development, (e) prioritization and sequencing of their competing community needs, (f) enhancement of their capability to identify capital projects, (g) work out of the technical/economic details, plan and execute such projects within budgetary constraints, and (h) optimization of the use of scarce resources through innovation and improvisation appropriate to local circumstances.

TDF has financed water scheme projects to small towns, where government grant is about 65-70%, community upfront cash contribution is 5% and remaining TDF loan is about 30 to 35% depending upon grant mix. Borrowings could also be considered as a source of fund for the TDF as a financial intermediary institution. Based on this framework, TDF facilitates the water user groups to determine the tariff of water per connection or household based to make

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the system sustainable. This includes debt service (20-25 years), and OPEX of water scheme for longer term. However, this tariff does not include the major maintenance or rehabilitation.

Based on empirical data of 29 Towns under STWSSSP I, tariffs presently fixed, are mostly too low to recover cost, resulting in poor utility performances. Only twelve towns have fixed tariff more than 90% in line with TDF recommendation. The weighted average tariff of 28 towns as planned was RS 212 (US$ 2.83) and in actual for the same period, it was found to be Rs 153 (US $ 2.04) only. The minimum tariff for 10 cm ranges from Rs 100 to Rs 300 in the planned period, where as in actual data it ranged from Rs 38 to Rs 300 (Gyawali, 2012). The water tariff depending on the project costs and loan grant mix ratio. Similarly, sewerage/drainage project (Biratnagar) has been calculated based on required cash flow for debt service to TDF with OPEX of the system. Since loan portion in these schemes are fairly low (11%), municipality has to cross subsidize this sector through other sources of municipal own source revenue.

Overall, the foregoing discussion flags on the point that pricing of urban utilities need to be worked out in a business manner. The tariff requires to be reviewed periodically by a relevant/competent pricing authority, which is not happening now. The central level price fixing commissions are unable to address the issue in robust way.

At least the O&M expenses of the social infrastructure projects and capital cost of the commercially viable or business type of projects could be recovered by the municipalities so that the revenue so generated could be invested in new infrastructure projects. Unless, proper pricing policies of the utilities and infrastructure services provided by the municipalities are not set forth, any urban financing initiative through borrowings by the municipalities either from the market or from the TDF will not work. More importantly, subsiding the cost to the urban population would eventually mean taxing other population of today or all population of tomorrow, which is not justified from social ground.

4.5.6 Legal Reforms for the Transformation of TDF to a Financial Intermediary

The existing legislation allows TDF to function as a financial intermediary. But in the absence of sufficient legal provision regarding lending procedure, practices, loan recovery mechanism, enforcement of the recovery conditions and seizure or confiscation of collateral, the role of TDF as a financial intermediary has been subdued. There is a need that a full-fledged financial law is enacted to operationalize TDF as a fully functioning financial intermediary. Key features of the proposed law governing the TDF could be the following:

(i) TDF, as a financial intermediary will be operated within a special act formulated for municipal financing as the existing laws on banks and financial institutions will not serve the special purpose of this institution.

(ii) The intermediary will have a strong capital base mostly owned by the government institutions and development partners.

(iii) The intermediary will be a specialized agency to infrastructure financing and will co-work with other financial institutions to finance large municipal infrastructure projects.

(iv) The intermediary will be able to raise its equity capital through public offering of the shares up to 40 per cent and also would be enabled to raise fund from the capital market by issuing bonds and certificates of deposits for institutional savers.

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(v) The intermediary will come under the umbrella of the ministry of finance to better coordinate international funding agencies and mobilize resources from the domestic capital market. And,

(vi) The organizational structure of the intermediary will be overhauled to make it more a business organization than as an agent of the government to carry forward ministerial task to the urban level.

Overall, the pace of urbanization and demand for infrastructure investment and limited own source revenue and central government transfers lead to the conclusion that TDF can, and has to, evolve as a strong financial intermediary to finance revenue generating infrastructure projects of the municipalities. Being a strong financial intermediary then requires sufficient legal, financial, management strength.

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CHAPTER V

Situation Analysis of the Existing Institutional Framework

This chapter describes key actors and institutions related to LBs/municipal financing both at central and local levels as provisioned by different policy and legal frameworks. Similarly role of private sector, I/NGOs and communities also sketched out. A quick assessment of local horizontal/vertical transfers, revenue sharing and borrowing mechanisms is also presented. Institutional provisions and mechanisms of new constitution are also laid out briefly. Restructuring TDF for municipal infrastructure financing institution is also analyzed.

5.1 Key Actors/Institutions Related to Local Bodies/Municipal Financing at National Level

5.1.1 Decentralization Implementation and Monitoring Committee (DIMC)

DIMC is an apex level institution chaired by Prime minister to monitor and implementation of decentralization policies as specified in LSGA. Decentralization Implementation and Monitoring Working Committee (DIMWC) is provisioned as a working committee to translate the policy guidance and other provisions of LSGA/R into actions and submit periodic reports to DIMC. However, these two committees are not observed effective for fulfilling their responsibilities, as its Decentralization Implementation Plan (DIP) and road map of fiscal decentralization are not operationalized as envisaged. DIMC meeting was held only four times during last sixteen years and even not taken initiatives to review even DIP and even the serious issues such as local elections never discussed formally despite of the interim constitutional provisions and Supreme court orders.

5.1.2 Local Bodies Fiscal Commission (LBFC)

At present the Local Bodies Fiscal Commission (LBFC) is formed under the chairpersonship Minister for MoFALD along with other nine members represented from concerned stakeholders/Agencies. Major objectives of LBFC, “is to support for expedition on fiscal decentralization process in Nepal and mainly responsible for i) institutionalize four pillars of fiscal decentralization21 ii)to study and research to recommend GoN within its given scope of works iii) suggest related issues related expenditure management including the accounting and auditing systems of LBs iv) design allocation criteria for performance based conditional/ un conditional grant including formula for grant allocations v) suggest tax and revenue sharing system and mechanisms from central level and among LBs. It has conducted different studies however findings and recommendations of the study are still not fully complied.

Several shortcomings are observed in functioning of LBFC. It could not (i) conduct study on expenditure needs and requirements of the local bodies for financing systematically and equitably, (ii) explore and suggest on appropriate revenue bases and rates suitable for LBs, (iii) take initiatives to explore sustained institutional arrangements for LB‟s borrowing for their capital investment, (iv) suggest to consolidate, regulate, simplify, systematize, standardize and blend multiple grant allocation channels to transfer resources, (v) be able to track revenue sharing resources transferred to LBs as committed by central agencies within time and was unable to compile data and holistic picture of transfers. it was also unable to 21Expenditure assignments, revenue assignments, Intergovernmental fiscal transfers and borrowings

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suggest GoN whether the LBs also took initiatives to share these resources among them vertically/horizontally upward and downward or not.

5.1.3 National Planning Commission (NPC)

National planning commission is a high level institution formed to advise government on national policies and development plan, program and budget. The main responsibilities of the Commission are to develop perspective and medium term national development plans and intensively engaged in preparation and monitoring of annual development program of GoN, to produce the expected results as envisioned in national development plan within the limit of resource forecasted every year by national resource projection committee which is chaired by NPC Vice Chair (VC). It explores internal and external resources, innovative technologies, and approaches for sustainable development. It also advises GoN on accepting any kind of Aid (kind or Cash) and aid agreements (MoF, 2015).

NPC also facilitates LBs by providing directives and instructions for formulation of Local Periodic Plans and assumption is that; on the basis of periodic plans the local annual development plans will be formulated in an integrated way. It provides annual budget ceilings and guide lines to respective sectoral Ministries as well as to LBs within give timeframe22 to initiate their central and local annual planning and budgeting. However, timely release of consolidated budget ceilings and guidelines to LBs that complies LSGA‟s provisions, is not attained. It is also not fully successful to regulate program and budget as envisaged to facilitate hard budget constraints on national priorities following the MTEF and national priorities.

However, NPC could not insist on to classify national/sectoral agency‟s functional activities on three categories i.e. central, regional and local through a detailed activity mapping for institutionalization of devolution as per the provisions of LSGA. As a consequence, the devolution process that was initiated could not expedited and parallel planning and implementation through Line Ministries and their de-concentrated offices are still dominated up to local level.

5.1.4 Ministry Of Finance (MoF)

This ministry plays an important role in framing national fiscal policies including borrowing and suggests revenue sharing mechanisms for LBs. “It is responsible for mobilization and optimal use of resources from foreign aid for accomplishing the developmental goals and charged with analyzing trends and issues like government expenditure, revenue mobilization, budgetary deficit, internal and external debt, price and inflation and monetary and foreign exchange policy. It also improves, coordinates, monitors, develops and expands the banking and financial sectors and also responsible for formulating revenue policy & guidelines. (MoF, 2015). It also submits national annual policies, plan, programs and budget in the parliament and authorizes unconditional grant directly to LBs and sectoral conditional grant and program budget to respective ministries and MoFALD. It expedites Fund Release and tracking through FCGO/ DTCOs and Operationalize LMBIS and adopts control measures to regulate budget expenditures and facilitates for financing sectoral priority projects by allocating budget head transfers.

The Ministry is observed weak on matters of coordination with sectoral agencies to operationalize devolution policies despite of strong legal and policy provisions as advocated

22For LBs within November 15 and for sectoral ministries within December

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by LSGA and budget formulation guidelines, 2007 issued by MoF it self. Also it has yet to develop the mechanisms to track LBs programmed expenditure allocations and reflect local revenue collected amounts in national accounts. Adopting hard budget constraints, it also allocates or transfers budgetary resources at the end of the Fiscal Year, without assessing the actual budgetary requirements and capacity of LBs and undermining the priorities of local periodic and annual plans.

5.1.5 Financial Comptroller General Office (FCGO)

The FCGO oversees all government expenditures against the budget, records revenue collection and other receipts centrally and prepares consolidated financial statements (MoF, 2015). It is also comptroller of the GON budgets and releases resources as per approved budgetary authorizations to respective accounting units through DTCOs. It has introduced Single Treasury Account (TSA) system for effective management, tracking and maintains FMIS and PFM. A lot of gaps are observed in the budget release and transfer process. These gaps are: (i) budget ceilings are rarely consistent with actual budget figures, (ii) approved budget is hardly released in time even if released not fully absorbed by accounting units, (iii) even if budget is released and spent, timely reporting is not complied in prescribed formats by accounting units.

The FMIs is software based reporting system and provides treasury position to GoN even on daily basis. However the LBs revenue and OSR expenditures are out of access of FMIS. The local expenditures carried out by LBs, DPs and INGOs and NGOs are also not well-captured and tracked through present LMBIs and FMIS. The internal audit system is virtually observed weak to reduce the volume of final audit objections.

5.1.6 Ministry of Federal Affairs and local Development (MoFALD)

Ministry of Federal Affairs and Local Development (MoFALD) is the central agency responsible for federal and local governance and development for promotion of both urban and rural governance. It is a link ministry for LBs and responsible for facilitating LBs on their systematic, institutional and individual capacity development and coordination with other central level agencies including the NGOs, civil society, Development Partners (DPs) and private sector. It undertakes Minimum Conditions and Performance Measures (MCPM) as a popular score-based monitoring instrument to monitor local bodies on the basis of indicators, through LBFC and allocates performance based unconditional grant allocations based on the results of MCPM.

MoFALD works for delineation of the functional assignments (expenditures and revenue) along with responsible for setting numbers and boundaries of LBs, facilitates the work of Local Body Fiscal Commission (LBFC), and works as a secretariat of DIMWC and DIMC, and link agency for LDTA.

The following institutional mechanisms are in place to systematize local revenues and allocate LDF grants:

(i) LBs Revenue Recommendation Committee: LBs Revenue recommendation committees at Ministry level has been formed and coordinated by the First class officer of the Ministry nominated by secretary and represented from different relevant stake holders. The role of the committee is to suggest Ministry on LBs tax, fees, charges, sales and other revenue matters and suggests ways and means on emerging revenue related

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issues. It also responsible for recommending on rates that has to be revised and to develop revenue collection process and procedures within the mandate of LSGA/R.

(ii) Local Development Fee (LDF) Fund Management Committee: Local Development Fund management Rules has provisioned a committee to manage the fund at central level. The Committee formed on the chairpersonship of secretary other representatives are from relevant ministries and departments of GoN and other concerned agencies. Originally the fund was created to replace Octri through the fund received from different custom offices collected from local development fee at a rate of 1.5% at the origin but later on due to provisions of WTO this collection was stopped and replaced through substitute grant.

At present, the LDF fund is allocated to municipalities as a partnership fund based on the project proposals received from the existing 58 municipalities. The municipalities contribute certain percentage of matching fund as per the nature of the project and submit the deposit bank voucher in advance for release of funds from Ministry. The municipality also collects certain percentage of resources from community households to finance the projects. However the projects are appraised and decided at central level before sanction of the funds.

5.1.7 Department of Local Infrastructures and Agriculture Roads (DoLIDAR)

DoLIDAR is established to provide technical support to LBs to fulfill the objectives as laid out in Local Infrastructure Development Policy, 2004 (LIDP) and national strategies. It is also made responsible to supervise technically to maintain quality of the programs and projects implemented through LBs. It also mandated to establish linkages with other technical departments for quality outputs and coordinates with different departments concerning local infrastructures. It instructs its District Technical Offices (DTOs) to provide support to concerned LBs for local infrastructure planning, budgeting, implementation, monitoring and reporting and follow-ups. It also provides technical support to MoFALD to formulate infrastructure related policies/strategies

Local Infrastructure Development Policy (LIDP) mandates DoLIDAR to provide technical support on areas23 of local infrastructures to all LBs at local level.

But DoLIDAR has very thin linkages with municipalities and is limited itself up to DDC/ VDC level only, and do not have any institutional setup within municipalities despite the mandate given by LIDP. It only authorizes maintenance fund to municipalities received from Road Board Nepal (RBN) to finance the operation and maintenance plan of Municipalities.

5.1.8 Local Governance Academic and Training Institutions

As there are limited academic institutions, which can educate people regarding decentralization and local governance and are also more oriented to centralized system of governance, Local Development Training Academy (LDTA) has been established as an autonomous institution for that purpose. Under it exist about eight training centers (five rural, one urban and two women development) in different parts of the country. They are established for research and development including imparting trainings to local government 23(i) local transport (district and rural/ agriculture roads, municipal roads, helipad, suspension bridge, motor bridges and culverts, etc), (ii) irrigation and river control, (iii) micro hydro and alternative energy, (iv) drinking water, sewerage and sanitation, (v) buildings and urban development, (vi) solid waste management, and (vii) social infrastructures.

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officials and political representatives in different disciplines of administrative, fiscal, organizational, accounting, planning, social mobilization, revenue mobilization, and management areas that are working at local and central levels. But institutional capacity of LDTA is observed very weak to impart its assigned responsibilities and in building capacity of local bodies.

5.1.9 Ministry of Urban Development (MoUD)

Ministry of Urban Development (MoUD) is new creation of GoN for priority focus on growing urbanization and deal with urban issues technically and systematically. It provides technical services to the Municipalities, small towns and market centers. It is also made responsible to prepare urban land use planning and Master plans and to carry out specialized functions such as urban and regional planning, urban development, new towns and government buildings to systematize development within the urban jurisdiction. It is also made responsible for developing and managing to provide urban basic infrastructure and services by partnering with related stakeholders such as private sector and with concerned municipalities. .

MoUD operates through its implementing arms comprising namely Department of Water Supply and Sewerage (DWSS), Solid Waste Management (SWM), Department of Urban Development and Building Construction (DUDBC), and about 16 other different organizational entities including Town Development Fund (TDF). MoUD furthermore keeps oversight on regional planning authorities like Kathmandu Valley Development Authority (KVDA) and 197 Town Development Committees (TDCs). In some cases, TDCs tend to be influential stakeholder within the municipal space as they own and control substantial amount of land.

MoUD has not yet established its sectoral sections within the municipalities despite its heavy involvement in providing technical services and resources within municipal jurisdiction. The parallel operation from center through its specialized departments, division offices and authorities has caused weak synergy among the activities within municipal jurisdiction and created confusions for sharing municipal budgets with these technical agencies. Lack of joint advance planning culture through shared technical and financial resources from the very beginning of the planning cycle from central level agencies have caused duplication and overlapping. If operated jointly, these institutional resources can bring greater synergy and improve municipal technical capability, performance and service delivery (MoUD, 2015).

5.1.10 Department of Urban Development and Building Construction (DUDBC)

The DUDBC has been providing technical and financial support to municipalities to prepare municipal integrated action plans (IAP), and periodic plans and master plans. However these plans are centrally operated. DUDBC operates through its 25 division offices, which are limited to certain district headquarters. But, much of the plan implementation suffers from weak municipal organization and capability. Several municipalities still lack basic organizational structure to manage works to deal with issues such as disaster risk management, enforcement of building regulations, planning bye- laws, building code, urban planning norms and standards are non-existent or have become forced measures in most municipalities rather than pre-empted responses.

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5.1.11 Other Sectoral Line Ministries and Line Agencies

As provisioned in the LSGA and Decentralization Implementation Plan (DIP), the sectoral ministries are responsible to devolve or delegate their functional responsibilities to LBs. The GoN has devolved four key sectors such as agriculture, basic health, education and local infrastructures to LBs in 2002, but the major chunk of local functions, funds and functionaries (line agencies) are directly allocated to their line offices working in parallel at Local levels with de concentrated approach. The functionaries of Line Ministries, which are working at local level, are still accountable to their respective parent departments, and DDCs and municipalities also have not been able to establish sectoral sections within their organizational setups. It has caused parallel programming and duplication in programmed activities, and has caused increased transaction costs both at demand and supply side. Better coordination can be achieved if central agencies/ Ministries instruct to Local setups for maintaining synergy for program implementation at local level.

5.1.12 Institutions Related with Water Supply

The institutional arrangement of water supply in urban areas has been undergoing restructuring for the last one decade. Nepal Water Supply Corporation (NWSC) is the current owner and operator of the water supply system within the municipal areas. Many of the urban areas have gradually been substituted by independent water supply management board in the specific municipality or in a cluster of municipalities. For example, Kathmandu Upatyaka Khanepani Ltd. (KUKL) is entrusted for the operation and maintenance of system under lease contract for 30 years by Kathmandu Valley Water Supply Management Board, which has taken over the ownership from NWSC few years back. A separate Nepal Water Tariff Fixation Commission has also been established to monitor and regulate the water tariff in the country. Similarly, Kavre Valley Water Supply Management Board (KVWSMB) has been established to manage water supply system for Dhulikhel, Banepa and Panauti Municipalities. Similar Water Supply Management Boards have been established in Bharatpur and Hetauda municipalities. Such boards are observed effective to build ownership of local institutions for resolving the issues of water source and maintain water rights of the local communities.

5.1.13 Institutions Related with Sanitation

In 28 large municipalities, Nepal Water Supply Corporation (NWSC) is responsible for sanitation. In smaller towns, Department of Water Supply and Sanitation (DWSS) is the responsible agency. In others, the responsibility rests on the municipalities. There is little coordination between NWSC and the municipalities. The major institutional problem in water supply and sanitation is weak and fragmented planning and programming among inter and intra ministerial agencies and consequent lack of clear responsibilities and coordination. (NUDS, 2015)

Local bodies are at present heavily involved in the nationwide campaign to declare their respective LBs as Open Defecation Free (ODF) with the close coordination of related GoN and other agencies. The local coordination committees are formed under the chairpersonship of respective LBs chief and other concerned agencies are members of the committee. Most of the municipalities are engaged in the solid waste management including the sewerage construction works with the partnership of communities; however, they are not charging any taxes or fees for their investments. DWSS collects charges but revenue is not shared between DWSS and Municipalities.

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There are various stakeholders in the MSWM like institutional actors (national government, local government etc.), the private sector agencies (formal and informal), the civil society organization (CBOs, TLOs and NGOs) and the citizens. Furthermore there are other actors like 'external support agencies' (multilateral and bilateraldevelopment partners) as important stakeholders with power and influence (ADB, 2013).

5.1.14 Sectoral Agencies (Nepal Electricity Authority, Nepal Telecommunication Authority, Nepal Telecom and other IT service providers)

Specialized authorities do not provide any grants, loan assistance and technical services to municipalities on a regular basis. They operate and finance their projects and programs independently through their respective agencies without having institutional linkages, cooperation and coordination with municipalities. It has caused many overlapping and duplication in carrying out municipal infrastructures. Formally, these authorities operate largely on municipal jurisdiction and get earned most of their revenues from municipal residents. It demands a strong coordination mechanism under municipal leadership for better coordination, linkages and control to operate municipal infrastructures, utilities and services through one door system.

5.1.15 Institutions Related with Road Infrastructure

Department Of Roads (DoR) implements strategic roads networks (SRN) all over the country through its division offices and carries out the feeder road and even local road construction that fall under the jurisdiction of LBs. DoR implements such types of local roads even though the municipal roads are supposed to be under municipality. There is a very thin or non-existent institutional linkage of DoR with respective municipalities. It also implements road maintenance and safety works within the SRN and municipal roads. It has not yet handed over the maintenance works to municipalities. Presently, maintenance works are carried out through three agencies such as DoR, Road Board through DoLIDAR and from municipal funds through their engineering sections. DoR needs to hand over local roads and bridges to LBs especially to municipalities because most of the municipalities have their engineering sections and DoR has to be fully concentrated on mainly to SRN and feeder roads.

Road Board Nepal (RBN): This provides 70% of the estimated amount for the rehabilitation, maintenance and emergency repair of highways (within the municipal area) and other urban roads under category A (Highways and Semi-highways) and B (Blacktopped urban roads). Remaining 30% is channeled to municipalities and other DDCs. Municipalities prepare their annual development plan and send it to DOLIDAR for review. Afterwards the plans are being forwarded to the Road Board Nepal. DOLIDAR compiles an integrated annual development plan for the construction, rehabilitation, maintenance and repair of urban and district roads (Category B roads), based on district and municipal development plans. RBN has to support LBs to prepare their short /medium term maintenance plans and develops partnership with LBs for maintenance especially municipal roads. It has further to establish direct linkages with concerned municipalities rather than through DoLIDAR.

Town Development Fund (TDF): This was established in 1989 as „TDF-Board‟ under the Development Board Act 1956 as an autonomous urban financing institution with the objective24of providing funds for municipal development activities in the form of loans/ soft

24 TDF‟s specific roles are defined as: (i) strengthening the organizational capability of municipalities in implementing need-specific investment projects adjusted to their technical and administrative potentials; (ii) loan financing of urban infrastructure development, supplemented by grants in appropriate situations, and linkage

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loans and grants. The TDF25 is considered as an innovative institution on the way for self-sustaining municipal financing systems that can also tap domestic and international capital markets for financing in future. TDF's scope of work is defined as 'an agency established for supporting development of the municipal infrastructures by channeling grants and soft or normal loans, along with technical support to municipalities as well as to fund urbanizing VDCs, DDCs, Urban Local Bodies Joint Committees (as per LSGA and Regulations), Town Development Committees (TDC), and public corporation boards'.

Development partners are also involved in municipal financing in the form of Technical Assistance (TA), grant, and loan financing for capital investments in the municipalities as tied-up or untied funds. The TDF has to seek prior clearance for mobilizing external resources from GoN through Ministry of Finance. The objectives of the donors‟ support are not only geared to provide conditional credit to local governments and to other institutions investing in municipal and social infrastructure but also in setting vision to develop institutional and managerial capacities as well as to build up a financially autonomous intermediary including policy, rules and regulations to ensure successful and sustainable processing and financing of infrastructure and revenue generating projects in future. (Taraschewski &Chhetri, 2008).

5.1.16 Institutions related with Revenue Generation

Department of Land Management and Land Revenue: This department plays key role in property management. All the land records are based in this department and its 75 branch offices based at district levels. It is responsible for land registration, and collects large amount of resources that are shared and transferred to municipalities and DDCs through its local offices. But institutional coordination and communication is observed very weak to share data and information with DDC and municipalities. Despite that IPT is the main source of revenue, municipalities lack up to date data on land and properties to assess the taxes at local level. The local offices of the department update the value of land and property annually as per the land classification, and most of the municipalities base their property taxes on these approved values. Similarly, cadastral survey department has the maps of the land ownership as well. These records are rarely shared with municipalities.

Department of Transport Management: All the vehicles are registered under this department through its zonal offices but the registration records are hardly communicated to concerned municipalities. The vehicle records are strong base for vehicle charge of the municipality, but municipal wise vehicle registration data is not properly systematized. So municipalities lack predictable base for tax computation and collection.

Department of Inland Revenue: This department is important for collection of taxes (income, VAT, rent,etc.) in Nepal. Two-way communication between the department and municipalities for sharing information especially for the collection of business taxes and rent is observed weak. This information is rarely shared; and thus, institutional linkage between agencies for compliance needs to be improved.

with matched contributions by municipalities and central government based on the current revenue generating capability and capacity; and (iii) supporting clients in master planning, project identification and prioritization of competing community needs, concept development, project design and engineering, tendering and supervision of construction. 25The board of TDF is chaired by MOUD secretary, and other members are represented from MoFALD, MoF, Nepal Engineer‟s Association, Association of Chartered Accountants, and five mayors, each from five development regions; and Executive Director of the TDF is the Member Secretary of the Board.

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Departments of Tourism, Archeology and Immigration: Department of Archeology plays important role in the conservation, improvement and maintenance of historical and cultural heritage of the country especially most of the heritage is located in Kathmandu Valley. This department maintains coordination with respective municipalities for maintaining these places. These historical places are counted as living museum and key income source of Bhaktapur, Kathmandu and Lalitpur municipalities. These touristic places are visited by most of the tourists. But there is very weak relation for sharing the tourist related information,including that related to hotel and restaurant service businesses for collection of taxes as well.

5.1.17 Local Bodies Associations (ADDCN, MUAN, NAVIN)

Association of District Development Committees of Nepal (ADDCN), Municipal Association of Nepal (MUAN) and National Association of Village Development Committees of Nepal (NAVIN) are the three associations of LBs in Nepal. All the DDCs, Municipalities and VDCs are members of their respective associations. These associations are registered under the directive act. They play a proactive role to enhance capacity of their respective LBs and play pragmatic roles through collective advocacy in favor of strengthening decentralization and local governance in Nepal. Presently these associations are also facing moral challenge -as the local elections have not been held since last 15 years,but legally they can continuetill they will have to handover the responsibility to newly elected representatives, which has not yet taken place. Due to the long absence of elected local representatives, these associations are also loosing their credibility.

5.1.18 Development Partners

Many of the development partners are engaged in the capacity development activities of the LBs. Some of the programs are directed to support specific components such as environment, social security and child friendly governance. MoFALD has initiated LGCDP to harmonize all programs by putting coordination mechanism at central level with different DPs for strengthening demand and supply side capacity of governance stakeholders. One of the outcomes is to enhance capacity of DDC/VDCs and Municipalities in strengthening and promoting public finance management system as envisaged in LSGA/R and LBFAR and supporting to reduce fiduciary risks at local level.

5.1.19 Civil Society Organizations; I/NGOs

After 1990s with the revival of multi party democracy, nongovernmental organizations are multiplying in a geometric means. Similarly, professional organizations are also in existence in different disciplines. The INGOs are also playing proactive role in development of governance system and service delivery even in remote areas with their comparative advantage in different professional disciplines. These INGOs are registered under Social Welfare Council Act where as local NGOs (LNGOs) are registered in District Administration Office (DAO) under Society Registration Act, 1977, and accredited by SWC. LNGOs are mostly dependent on DPs or INGOs resources. SWC is also mandated to supervise and monitor the programs/ activities carried out by INGOs. INGOs have formed their loose federation at national level in the name of Association of International NGOs (AIN)26 and they have been working in the municipalities also to support governance.

26The registered Number of INGOs operating in Nepal at present is about 221 and non-registered are counted as 85. Similarly, the number of total LNGO is estimated at 47000 whereas in most cases their capacity is observed very weak. Federations of Local NGOs are also in existence; however, some of them are highly politicized and

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5.2 Key Institutions of Municipal Financing at the Local Level

5.2.1 Municipal Councils and Committees

Municipal councils are legislative councils of municipalities. They are final authority within their functional jurisdiction to approve their plans, programs and budgets, to discuss audit irregularities and direct to municipalities, to grant approval of positions, salaries and allowances of the staff of municipalities, to approve bylaws, to constitute a three member accounts committee and other committees accountable to their council. The councils are authorized to decide the rates of OSR within the given range of LSGR, andaccept grants and loans from national/International agencies with prior approval of MoF. Similarly, each municipality has its executive committee chaired by municipal mayor as an executive chief of the institution. Municipalities prepare their revenue projections, loan proposals and take initiatives for resource mobilization to implement planned activities, coordinate with different GoN/ I/NGOs under their jurisdictions, conduct internal and final audits, including public/ social audits and public hearings.

Each Municipality has its planning, revenue and account sections as well. Their capacity is observed weak because they are not well equipped with appropriate staff and equipment and system. Most of the municipalities have used software based revenue and accounting management systems but still database of taxpayers is not systematized. There is very weak institutional relation between account and revenue sections to communicate their information on daily basis about updated information on revenue position. Municipalities have also formed revenue advisory committee represented from land revenue, tax, DTC offices and local chamber of commerce. This committee is responsible to advice on potentials of tax bases and rates, revenue raising strategies and sharing of institutional information. However horizontal institutional coordination and communication is also observed weak to share records and information to update tax bases at municipal levels. Presently municipalities are receiving directly 75% of land registration fees from local land revenue offices horizontally as revenue sharing and large amount of revenue is received from LDF substitution grant as a partnership fund from MoFALD.

5.2.2 District Council (DC) and District Development Committee (DDC)

At present DDC is the second tier institution of LBs comprised of all VDC chairs and vice chairs and municipal mayors and deputy mayors. LSGA has provided authority for tax collection from natural resources, service fees, charges, and sales of natural resources. They are also authorized for borrowings as well. Out of the revenue resources collected they have to share 35-50% to VDCs and municipalities within their boundaries. On top of that, they receive the revenue from revenue sharing from different sources. But these resources are rarely shared to other VDCs and municipalities. Recently Government has decided to provide land registration fee directly to municipalities from respective district land revenue offices. As such, DDC has very weak linkages with municipalities.

5.2.3 Committees of LBs Provisioned under LSGR at Local Level

Public Private Partnership (PPP) Promotion Committee: Each LB is mandated to form PPP promotion committee to promote and systematize public private partnership system within

work as sister organizations of political parties. The local coordination committees are also formed at LBs level and some of DDCs and municipalities have their NGO Coordination Desks.

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their jurisdiction. The chairperson of the committee is assigned as respective chair/mayor and DDC president and other members are representatives from local Chamber of Commerce and Industry (CCI) and other concerned stakeholder from civil society and experts. Further, MoFALD has also approved PPP policy to systematize and regularize PPP within LBs. The LBs are also authorized to approve their procedures with regards to promote and contextualize PPP within their areas.

Inter LB Joint Coordination Committee: The LBs are authorized by LSGR to form inter LBs joint coordination committee to coordinate and to build backward and forward linkages between and among the LBs on horizontal basis, such as VDC-Municipality and Municipality- DDC as well. In such committee, local subject matter specialists may also be invited. Through this mechanism, they can work jointly on nine different programs and share their revenue to carry out the proposed activities as well.

Line Agencies (LAs), I/NGOs, Private Sector and Civil Society: At district level government line agencies, I/NGOs and civil societies are also taken as local partners of LBs to carryout the local plans and programs as approved by local councils. But LAs and others are rarely engaged in participatory planning process; however, their planned activities are annexed in the district/local plans for reference only. The GoN has also mandated LBs to coordinate with I/NGOs' local programs at local level. The media and other agencies are also engaged in joint monitoring and other events such as social audits/ public hearing and other communication activities for transparency and accountability purposes.

Town Development Committee: There are altogether 197 town development committees formed by the MoUD. They generally overlap their functions with municipalities. Internal coordination and communication between these two agencies is observed weak. In keeping with functional jurisdictional issues, LBFC and other study reports have recommended that these TDCs have to be scrapped (especially those formed within municipal jurisdiction) and their functions have to be taken over by respective municipalities.

Inter-Agency Coordination Committee: LBs are authorized to form interagency functional coordination committee as required for planning, implementing, coordinating and networking. Some of the committees, which are functional, are as follows:

(i) Integrated Plan Formulation Committee (IPFC): IPFCs are presently provisioned under local resources mobilization procedures, 2013 at municipal levels as well because of the absence of the elected ward committees even though they were limited within DDCs only by LSGA. These local level IPFCs are formed presently as an inclusive and represented from WCFs, civil societies, political parties and GON line agencies working at local level. The role of IPFC is to prioritize the local plans that are forwarded by Ward Citizen Forum (WCF) to municipal committees and by plan formulation committees at DDC level, and to build synergy among the plans and programs of different agencies and forward to respective LB to get approval from their respective councils.

(ii) Plan Formulation Committee: There are different subject specific plan formulation committees which are also functional to prioritize subject specific programs at local level especially submitted by respective line agencies and other agencies working at local level.

(iii) Ward Citizen Forum (WCF): WCFs are also formed in each ward of municipality to make the local governance system inclusive, representative and participatory, especially

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in the absence of elected Ward Committees at local level. They comprise of about 25 to 30 members. These WCFs are made responsible for preparation, compilation, integration, and prioritization of different projects/ programs received from different communities/groups from the settlement/Tole levels. They are also authorized to monitor and oversee the local projects within their jurisdiction and engage in public audits and public hearing systems. They also keep eye on the performance of local users committees.

(iv) Tole Lane Organization (TLO) and Other Socially Mobilized Groups: Social mobilization is a process adopted to empower weaker section of people residing at different settlements/Toles and mainstream them in development process. The government agencies, financial institutions such as Small Farmer‟s Development Bank and I/NGOs operate these social mobilization programs at community level. There are different types of social mobilization programs operated at local level. They are presently classified as targeted or broad based adopting transactional approach.

Citizen Awareness Center (CAC): Another type of social mobilization program has adopted REFLECT model, adopted transformation approach conceptualized on to transform society from deprivation to prosperity and discrimination to just and equity. This model exposes REFLECT groups with different situations of deprivation and exposes with the causes of deprivation and different forms of discriminations prevailing within the society. Under REFLECT model of social mobilization, CACs are formed in one each Wards of municipalities as REFLECT group that comprises about 30 members from marginalized people representing weaker familyand are gradually expanded to all wards to ensure wider coverage of the weaker families. This modality is implemented by DDCs, VDCs and different I/NGOs as well. This approach has contributed to aware the people about the available resources programs are allocated and implemented at local level for them and empowered to facilitate access with information, services available at local level. But the coverage of this model is very limited.

5.3 Assessment of Role of Private Sector in Municipal Financing

5.3.1 Concept and PPP Policy

Public-private partnership refers to contractual agreements formed between a public agency and private sector entity. This allow for greater participation in the delivery of infrastructure or social projects. PPP is a situation where the private sector harnesses its financial and managerial resources to provide social amenities and infrastructure on behalf of the government or the public sector agencies. To promote PPP at local level, Public- Private Partnership policy and strategy for LBs is also in place and some of the municipalities are engaged for its implementation within their jurisdiction.

Private sector participation can take varieties of forms, which provide opportunities for local governments especially to expand their scope of operations and revenue generation such as (a) contracting out27, (b) concession28, (c) a franchise29, and (d) self-help groups30. MoFALD has developed institutional frameworks for private sector to build active partnership at central and 27 Through competitive bidding to private sectors 28„Selected private operator is awarded a license to provide specified services over a certain period of time

Exists when a private firm provides a service to residents within a specific geographic area and when service provider is paid (price or user fee) directly by the users

30Self-help programs are designed so that individuals or neighbor hoods provide services for themselves

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with LBs at local level. Private sector representatives are represented in central level commissions and committees; such as LBFCs and Revenue recommendation committee and revenue mobilization advisory committees at local level. Partnership is built to carry out developmental works through private sector investments to built, operate and management and similarly in the collection of revenues such as business taxes at municipal level. The PPP center will be established under NPC and aseven member regulatory committee will be formed on the chairpersonship of secretary of NPC31 to (i) systematize the functions of PPP (ii) provide guidance to the center, and (iii) facilitate coordination among implementing agencies.

The duties and responsibilities of the PPP center are, among others, to: (i) conduct feasibility study, appraise independently the procurement and agreement documents related to model projects submitted by project executing agency, (ii) facilitate public and private entities for project preparation, construction and management, (iii) conduct capacity development programs for all organs, entity and mechanisms on PPP, (iv) conduct studies on best practices on PPP within or outside of the country and replicate and promote those best practices. MoF may establish a Fund for Viability Gap Funding (VGF) to make viable the financially unviable projects to be undertaken by the private sector. The policy has provisioned for preparation of a detailed guideline to finance from VGF.

As the PPP policy is recently approved and provides a policy framework, other legal acts need to be enacted; and rule and regulations, and sector specific guideline manuals are yet to be developed. First, the institutions as provisioned have to be established and then the center has to work on above legal and regulatory frameworks with close coordination of the concerned PIUs. No budget limit or maximum ceiling is provisioned for local projects implemented by local authorities. But in case of VGF fund or central grant is required, then they have to take approval of the steering committee. The local authorities can consult and take advice with PPP center for execution related matters.

Financing Strategies for Urban Infrastructure, 2013 recommends departure from traditional mode of infrastructure financing from their budgets or revenue generated by LBs themselves. They have to explore alternative private sources of financing adopting any forms suitable to the nature of services. Limited empirical evidence shows that some services produced by private sectors promote efficiency and equity. On the debt side also, they can issue municipal bonds, pooled finance mechanism, and term loans. On the equity side, emphasis has been put on Public Private Partnerships (PPPs), both to obtain finance as well as to improve delivery methods. There are ample opportunities to contextualize and replicate some of its success models in Nepal as well.

5.3.2 Federated Institutions Related with Private Sector

Federation of National Chamber of Commerce and Industries (FNCCI): It has nation-wide chapters in each district and even municipal levels, and it represents and builds partnership at local level municipalities in the areas of construction, revenue raising and collection of business taxes.

Confederation of Nepalese Industries: It has a membership base consisting of nearly all of the big corporate houses of Nepal, Nepalese blue-chip companies, joint venture companies etc. spread across a wide and diversified spectrum constituting sectors related to manufacturing,

31 Other members are joint secretaries from MoF, MoHA, MoPIT, MoFALD, MoLRM, expert nominated by committee and PPP center chief will work as member secretary.

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information, communication and entertainment, banks and financial institutions, insurance, travel tourism and hospitality, utilities, infrastructure and construction etc.

Federation of Nepal Cottage & Small Industries (FNCSI): Since its inception as Association of Cottage and Small Industries in 1990, FNCSI has been working for the promotion of Micro, Cottage and Small Industries (MCSIs) through wide range of activities and services including in arranging events that propagate the development of small and cottage industries in Nepal. FNCSI also collaborates with government line agencies and local bodies for policy formulation and revision inclusive of MCSIs policy and strategic planning.

5.4 Assessment of the Role of the Communities

Communities are actively engaged in the developmental and social promotional activities. They are engaged in the program cycle from initiation, implementation, monitoring and oversight of developmental activities. LSGA has also provided legal and institutional framework to engage communities in the developmental activities. These communities are engaged as organized of unorganized institution such as user‟s groups, Tole Lane Organizations (TLOs) or the associations or cooperatives or supervision committees. The following types of groups are there in organized way:\

i) User‟s groups-registered or non registered,

ii) Socially mobilized groups: saving and credit groups, targeted community groups formed for highly marginalized and deprived communities (women, Dalit, ethnic, CACs and TLOs,etc.),

iii) Cooperatives: Federated from saving and credit groups such as women development cooperatives and small farmer‟s cooperative societies,

iv) Associations: Community forestry groups, specialized associations such as consumer‟s, transport, water users,etc.,

v) Construction committees: engaged as construction and management of infrastructures, play oversight role on contractors as well, and

vi) Unorganized groups organized for only certain purpose and dismantled after the completion of the projects

In the municipal areas, communities are engaged in the collection of resources from each household for sharing resources on cost sharing basis ranges from 40 to 80 % of the total estimated and actual costs to finance their priority project. Such projects are basically concentrated on road, sewerage,etc.including their construction and maintenance. Similarly, communities are also engaged in the construction of social infrastructures such as school buildings, health posts and hospitals. Individuals are also engaged to share their resources in alternative energies such as solar, biogas and cook stoves. The participation of the community is mainly for creation of positive environment for successful implementation.

Socially mobilized groups also carry out developmental activities by engaging themselves in the planning and oversight process and link their effective demand with supply side governance agencies (GoN, LBs, DPs and I/NGOs). Many of the social mobilizers, voluntary workers such as Female Community Health Workers (FCHVs) and School/health Management Committees etc. are engaged to carry out the process.

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Other mode of partnership is land pooling in which communities are engaged for pooling their land for promotion of infrastructures and organized settlement planning for commercial purposes. They are motivated because the price and value of land increases tremendously after the development of the land.

5.5 Assessment of Local Horizontal/Vertical Transfers, Revenue Sharing and Borrowing Mechanisms

Ministry of finance authorizes unconditional minimum and performance based grants to municipalities upon the recommendation of MoFALD/LBFC. Conditional grants are authorized through MoFALD specifying sectors and project specific allocations to LBs. MoUD/DUDBC and other central level line ministries/authoritiesdo authorize their program specific budgets to their respective line agency/ offices vertically for implementation of program within the LBs (municipal) jurisdiction. In such cases, municipalities have very limited authority for planning and management of such projects. Such projects are centrally supply driven with limited coordination and communication with respective municipalities, which is against decentralized principles and policies of GoN. It has caused overlapping and duplication of resources and efforts between sectoral agencies and with concerned LBs. Similarly, DPs resources channeled through respective departments/I/NGOs have to bear the same fate.

At present, the LDF grant fund is allocated on the basis partnership project based financing as a matching fund contributions from respective municipalities and communities for specific projects. LDF fund is transferred as per the nature of the project and category of the municipality and competency of municipality to bear the matching funds.

Revenue sharing is also observed one of the important income sources of a few LBs including municipalities. Concentration of such resources is limited to those districts/municipalities where natural resource potentials are harnessed. For example, royalty from hydropower is shared to concerned DDCs within the development region and only those DDCs of Mid and Western regional districts are mostly benefited from hydropower projects. Similarly Mountaineering/ Trekking resources are also limited to few districts where tourist flow is observed high. There is absence of empirical data on exact amount of such transfers received by the municipalities as a form of revenue sharing from DDCs. The amount of revenue sharing from land registration is also based on those LBs especially to the municipalities where land and property transaction is observed high.

At present, municipalities are directly receiving land registration fee as revenue sharing from respective land revenue offices of the districts. The forest and mines resource is also limited where transport facility is not available. The remote districts are least benefited from present revenue sharing mechanisms. So challenges are there to share these resources equitably among all LBs. Most of the resources are transferred to DDCs except land registration; and DDCs hardly share such revenue resources or its income as provisioned in LSGA. The land revenue fees are collected by respective municipalities and upward sharing provision of transfer is there to respective DDCs; but this system is also rarely implemented.

The following key issues are noticed:

i. The GoN has specifically not allocated pool of transfer funds for meeting the sectoral objectives as a conditional grants to the LBs vis a vis to municipalities,

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ii. The devolution of fund, functions and functionaries from central government is not materialized,

iii. The local governments are not functioning as per legal, policy and institutional provisions envisaged due to the national prevailing circumstances and political environment and they are also not restructured to absorb the transfers/sharing resources so that central government can trust their capacity to absorb

iv. Expenditure requirements of LBs as per their expenditure assignments not assessed to transfer of resources equitably through IGFT and revenue sharing mechanisms, despite of their periodic plan projections,

v. Mismatch between capacity of demand and supply side of governance actors especially for meeting their priorities and resources flow gaps,

vi. Absence of locally elected representatives in the LBs has raised serious concerns of accountability at local level,

vii. Transfer mechanisms and institutions as per new constitutional provisions yet to be established as per the provisioned in functional assignments,

viii. Revenue sharing issues hardly discussed at the revenue recommendation committee at central and local resource advisory committee at municipal levels to systematize vertically and horizontally,

ix. Central Government yet to develop criteria for transfer of resources on certain percentage basis of total national expenditure ascertaining predictability and systematization of locally available resources on planned basis as per local priorities

x. Only TDF observed as a financial intermediary for lending to municipalities with only limited capital base and with limited autonomy.

5.6 Identification of Institutional Changes after the Promulgation of New Constitution

The core state structure of Nepal now consists of three spheres as Federal, Provincial and Local level governments and the exercise of sovereignty and state power is vested to each orders of government including local government. The constitution has set seven provinces having eight to 14 districts within each province. Local level will have Gaunpalika, Nagarpalika (Municipality) and District council (DC) and District Coordination Committee (DCC). The ward numbers of Gaunpalika and municipalities will be as per the provisions of Federal law. For the purpose of social cultural protection or for balanced economic development special, protected or autonomous regions may be created by the federal law.

Each level of government has the legislative powers to enact their laws relating to financial rights, conferred authority to formulate their annual budgets, take decisions, prepare policies and programs and implement them within their functional jurisdictions. The residual powers will remain with Federal government. The federal level has also authority to enact the law relating to concurrent functions along with other financial authority and can formulate policies, standards and legislations binding for provinces as well. The provincial and local governments have to prepare their budget within the timeframe prescribed by federal government.

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The Constitution has provisioned for a National Natural Resource and Fiscal Commission (NNRFC). The functions, duties, and powers of NNRFC are to determine extensive grounds and measures, among others, for (i) distribution of revenue from the federal consolidated fund to federal, provincial and local level governments, and recommend distribution of the equalization grants to provincial and local governments, (ii) suggest provincial and local governments in compliance with national policy and program and standards on state of infrastructure, (iii) recommend distribution of revenue between provincial and local governments from the provincial consolidated fund as well. It will also determine and recommend the base for computing the share of investment and return for three levels of government while exploiting natural resources and also recommend about coordination and mitigation of disputes likely to arise regarding distribution of natural resources between the federation and province and between the provinces, between province and local level entity, or between local level entities.

The Gaunpalika and Municipal councils are authorized to enact their acts within the jurisdiction of Constitutional schedule as well as more authority specified by federal and provincial laws. There will be a local treasury in each Gaunpalika and municipality. All the revenues, grants received from federal and provincial governments and loan taken by Gaunpalika/Municipality and income received from other sources of revenue will be deposited in their treasury. The Gaunpalika and Municipalities have to get approval the projections of their revenue and expenditures from their respective councils.

5.7 Institutional Interventions Required for the Implementation of Financial Framework

Above institutional mapping portrays different roles and responsibilities assigned at different levels of governance structures contributing for the implementation of financial framework even for Municipalities as well. To meet requirements for achieving desired results from the assigned responsibilities, the following strategies need to be undertaken at different levels i.e. federal, provincial and local levels.

5.7.1 Federal Level

The organic law of provincial and local governments has to be enacted as provisioned in the constitution of Nepal and side by side generic rules related procedures such as, administrative, financial, revenue and procurement for detailing out the roles and responsibilities, structures and process of governance structures stated at provincial and local levels including municipalities. Those rules need to delineate responsibilities of different actors such as political and administrative, between government and non-government, civil societies and private sector. It also requires to elaborate functional assignments (expenditure and revenue) through activity mapping of different levels as specified in the schedules of the constitution especially of concurrent functions that overlaps at different levels. Similarly, other relevant new acts and regulations have to be enacted and developed as required.

The present executing departments those are located at central level require to be restructured and placed at provincial levels after holistic O&M studies of provincial level governance structures according to the provincial geography and context. The present regional and zonal structures of government and public corporations need to be scraped.

Similarly, model of local level structures - both Gaunpalika and municipalities -needs to be prescribed for restructuring the municipalities so that local elected authorities may take those models as a guide. NNRFC also needs to develop fiscal parameters to transfer funds from

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central consolidated funds to provincial and local levels and similarly from provincial consolidated funds to local level. Similarly it also has to issue broader guidelines for collection and mobilization of OSR of the municipalities. It has further to develop criteria and norms for sharing of revenues horizontally and vertically. Similarly, it has to develop borrowing criteria and parameters for Local and provincial level Governments also from national and international agencies.

5.7.2 Provincial Level

The provincial level revenue generation and accounting management needs to be installed to accommodate new innovation and technologies as per meeting the objectives of e-governance. The coordination and communication mechanism among government institutions along with non-government and private sector agencies needs to be built properly. The vertical linkages with federal and local governments have to be established for two way communication and information and resource flow. The provincial laws have to be enacted and systems and institutions have to be established accordingly. The sector specific provincial level Ministries have to be made fully responsible for provincial level projects only. The provincial level projects also require to be implemented with close coordination of respective local governments from the very initiation to mitigate conflicts, overlaps and duplications among different layers of the government.

5.7.3 Local Level

The municipality has to foresee the assigned responsibility and need to be adjusted concurrent functions of Federal and local governments and accordingly the organizational structures need to be designed, especially the planning, Functional, finance and revenue departments/ divisions/sections have to be structured. Under functioning departments of core functions such as road, drinking water and sewerage, solid waste management, public health, education, building construction,etc. have to be well thought out. The technical and planning departments should have the capability to assess the capital development projects that to be funded through loans from different agencies and under PPP.

The revenue sectionsof the municipalities have to be competent enough to have the data and information base so that the revenue raising and mobilization strategies could be developed and compliance to potential revenue is secured at highest levels. It have to adopt e-governance tools such as finance, revenue, other basic services wherever possible so that people can have easy access to those services. The control mechanisms need to be adopted so that revenue, expenditures and projects will be well monitored and tracked.

Municipality can form inter jurisdictional authority to carryout larger projects and District Coordination Committee can facilitate coordination. The sectoral agencies have to assign responsibilities with resources to municipalities to operate through those authorities. Federal/Provincial sectoral agencies may support technically along with capital investments to those authorities. TDF also can support those authorities technically along with capital investments.

As present, most of the urbanizing VDCs and municipal boundaries and functions overlap with the existing Town Development Committees (TDCs). To avoid the duplication, those TDCs may be assimilated under present respective municipalities and TDCs functions and resources have to be shifted to concerned municipalities/VDCs. So a quick survey has to be conducted on the basis of certain parameters and criteria to reclassify VDCs and municipalities into four to five categories. It will also further support TDF, or provincial and

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federal governments, to carryout focused activities on municipalities as per the grouping based on their assigned functional assignments and responsibilities.

5.7.4 Private Sector/ INGOs

Private investors interested in urban infrastructure have to prepare their investment projects with close consultation of the municipalities as specified in PPP policy and legal frameworks. Government has to create incentive mechanisms and positive environment for private sector investments. Similarly, I/NGOs have to build up partnership with each level of governments and carry out programs maintaining close coordination as per the assigned task jurisdictions. Community based organizations and groups that are formed on formal or informal basis, can play active role in planning and management of local projects/ programs and actively participate voluntarily for infrastructure development on cash and non cash basis (such as labour, land, time and efforts).

5.7.5 Development Partners

The DPs have also to align and harmonize their resources with the municipalities. The present steering/ coordination committees and PCUs of different projects have to be placed at appropriate levels of provincial and local governments. Federal level has to avoid practices of creating such PCUs and steering committees at central level to avoid overlapping/duplications and respect the autonomy of the local governments.

5.8 Restructuring TDF for Municipal Infrastructure Financing

With the implementation of new constitution, GoN has taken initiatives for amendments of existing legal, institutional and administrative centralized unitary structures to decentralized federal ones by forming different task forces and committees at central ministerial levels to work out for necessary recommendations. At this context, the TDF also may require legal amendments and replace existing TDF ACT for its administrative and organizational restructuring to enable it as a stable lending institution to finance municipal social and physical infrastructures.

It is an opportunity to review the present legal frame works, institutional and procedural provisions of TDF to accommodate and align itself with the present federal structures. It will have to have strategic visions, strategies, business plan and scope of works along with accessible institutional and organizational layouts at provincial levels after carrying out O&M studies. The provincial level structures have to be created so that it can deliver technical services with efficient and cost effective way, generate effective demand and facilitate financially to its clients - especially the urban governance structures.

TDF has already adopted its goal for transforming this institution into a financially sustainable, operationally efficient and a visible Urban Development Bank/Financial Institution in the coming two business-plan periods (up to the end of 2021/22). Now it is right time to review risks and benefits associated with its goal to convert it as a financial intermediary under specific act or widen its scope with stable and viable intermediary financial institution having the provision of minimum secured seed capital, to meet basic requirements to serve growing urban areas and municipalities.

Currently, GoN is the owner of TDF and its Board is mostly represented from GoN and municipal organizations. It should consider developing itself into an autonomous organization outside the control of government but operating within the financial regulations of the

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government designated regulator. If TDF is formed as a financial institution, then its link ministry should be MoF for facilitation coordination with other financial institutions for easy access of fund mobilization, PPP promotion and VGF financing as well.

TDF has to initiate process to establish its branches to serve municipalities within provincial level as well. This initiation needs to be based on the consideration of economic viability and accessibility approach. At the beginning, it could be started with five provinces and gradually expand along with the expansion of its business. Establishment of such branches is required to justify growing numbers of municipalities at present. The present association of TDF with Municipal Learning Centers (MLCs) as a facilitation center could be a viable strategy but it needs strengthening technically itself first, so that it can be a responsive institution to support municipalities responsibly and accountably as a credible institution.

For defining the scope of operation of TDF about supporting regional level projects, which falls under the functional jurisdiction of provincial level, it has to move strategically for viable projects, which facilitate connectivity and provide basic services to municipalities. In such cases, joint authority of the concerned local level and provincial governments can be initiated and supported.

The development partners are supporting TDF through tied-up and untied funds, and tied up funds have undermined its financial performance. TDF has to discourage lines of financing as project based funding. It has to develop strong strategy to receive funds as a grant or soft loan in the form of block or conditional grant rather tied up lines of financing.

To resolve the issue of low disbursement of TDF fund, the concerned municipalities have to be fully authorized for municipal programs by following principle of devolution and shared responsibilities as autonomous institutions. Similarly municipalities also have to restructure their technical departments for better accessing TDF resources. TDF as well as federal/ provincial governments and line departments/Ministries will have to focus to strengthen municipal capacity along with standard setting and follow ups in projectimplementation.

TDF may also explore more on “public-private partnership” in municipal service delivery system (e.g. solid waste collection) and management contract for operating municipal assets (bus-park, shopping center, etc.). It can also replicate successful institutional learning from neighboring countries. It has also to build its linkages with social mobilization programs to create demand for infrastructures from the communities on partnership basis with the support of municipalities. The communities may contribute certain percentage of resources to tie up with loan funds. Similarly, municipalities can levy user charges on municipal infrastructures so that municipalities can repay their loan in time. Finally, MoFALD and TDF need to focus to avoid policy and operational duplication or overlapping between LDF substitution grants and loan amounts.

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CHAPTER VI

Summary of Findings

6.1 Overview of Municipal Financing Framework

The municipalities comprise about 42 percent of the country's population. If the current urban population growth rate continues, the share of urban population in total population could reach 48-50 per cent by the next 10 years even if the existing number of municipalities at 217 do not increase. The existing municipalities suffer a lot from infrastructure deficit. Particularly, they lack paved roads, drainage, public transport system, safe drinking water and sewage,solid waste management system,vehicle parking facilities,public parks and greeneries, etc. Most of the municipalities are financially weak to create such infrastructure on their own efforts. These facts suggest to the need for formulating a municipal financing framework for rapid and sustainable urban development in Nepal.

The current municipal finance system operates under constraints, as own-source revenue has yet to evolve as a reliable source of revenue; and inter-governmental fiscal transfers are limited in amount and unpredictable over time. A proper borrowing framework of the municipalities is lacking; and they have no access to borrowings in a regular and demand driven basis. The municipal financing framework under TDF is neither simple nor sufficient to meet the ever-growing demand for municipal financing.

Nepal has been signatory to the Sustainable Development Goals (SDGs) as the next 15 yeas' development agenda and includes making cities and human settlements inclusive, safe, resilient and sustainable as one of the 17 goals to be achieved by 2030. In this context, urban infrastructure development strategy will have to be developed to localize the SDGs at the provincial and local level once the federal system set up is completed. This requires large investment in the urban infrastructure also through the local government efforts.

The National Urban Development Strategy prepared by MoUD has developed a medium and long-term strategic vision of a desirable national/regional urban system based on existing trends and regional resource potentialities. It highlights the deficiency of urban infrastructures by the situation of water supply, sanitation, solid waste management, housing, transport and energy. It also makes a projection of financing need of the municipal development projects. To meet the infrastructure deficit in 58 municipalities, the investment requirement is estimated to be Rs 372 billion for a period of 15 years from 2015, based on existing and desirable state of infrastructures in the municipalities.

At present, municipalities suffer from various constraints in developing infrastructure of which low revenue efforts, limited transfers from the central government, and capacity constraints to mobilize alternative financing sources are prominent. Amid very low level of municipal revenues from taxes and fees, municipalities are facing ever increasing funding and financing gap due to low volume of fiscal transfer from the central government and burden of un-funded responsibilities. There is also limited access to loans and other forms of debt financing for the municipalities. A large number of municipalities and towns are small and financially weak; there is lack of strong domestic capital markets for commercial borrowing; there is also lack of mechanisms and instruments to finance urban infrastructure projects; and even the mechanism for mobilizing funds for maintenance of existing infrastructures is very weak.

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6.2 Own Source Revenue of the Municipalities

LSGA has given power, duties and responsibility to the municipalities to raise taxes, service charges, fees, fine and penalties; and this is one of the important functions of the Municipal Council. Municipalities generate only about 27% of the total revenue from internal sources. There is a huge funding gap in order to fulfill the infrastructure needs of the urban sector, as annual fund requirement and internal revenue generation of 58 municipalities is Rs. 37 billion and Rs 3.18 billion respectively (as of FY2014/15). Main sources of internal revenue are taxes, service charge, fees, fines and penalties within its jurisdiction.

Revenue management is an important task of municipalities to raise mobilize internal resources. It includes keeping records of the tax payers, collecting taxes and services fees to the optimum, revising tax rates and service charges, and putting tax base information system in place. Government through MCPM, evaluates the performance of the municipalities. One area of assessment is financial management with specific focus on internal revenue management system. Through this system, municipalities performing well are rewarded and those in default are penalized. Overview of the tax potentials and actual tax collection reveals that municipal revenue mobilization efforts need to be revamped.

Taxes are the main sources of municipal internal revenue. In taxes, property tax and business tax are the two main sources of revenue. Of the 58 municipalities, most (48) are using the IPT system but 10 are still using HALT. The status of new 159 municipalities is yet to be known. Business tax is a potential tax but the collection efficiency is very low. Collection of other taxes i.e. land revenue, land tax, vehicle tax, entertainment tax, advertisement tax, rent tax, commercial video tax do not generate insignificant amount of tax. Rent tax can be a potential source of revenue in future as collection of this tax has been given to the local bodies in the new constitution.

Municipalities are empowered to raise various types of service charges. Some of the important charges and fees are collected from solid waste management, public utilities, parking, public toilet, haat bazaar, slaughter house, street light, sewerage, road, swimming pool, park, building permit fee, recommendation fee, property valuation fee, tourism fee, etc. Of them, building permit fee, recommendation fee and tourism fee are the main sources of service revenue. Collection from other charges and fees are not significant. Tourism fee is an exception as it is limited to three municipalities of Kathmandu valley. Rental income from municipal properties is fairly high and it has potential of growth in future.

Historical data of the last ten years show that the annual average growth of OSR is 13.8%. The contribution of the local tax and service fees accounts for 88 % of the OSR. Remaining sources of revenue are rental income, auction sale, forfeiture of deposits, fines, interest, sale of assets, contribution of users, public private partnership etc.

OSR forecast for the next 15 years has been made using three scenarios. In scenario 1, the historical growth rate of revenue of the 58 municipalities is taken for projection of their revenue for the next 15 years; but in the case of new 159 municipalies, the growth rate used is half of this rate taken into account their early stage of institutionalization of tax management and narrow tax base. In scenario 2, the growth rate is assumed to go up by 50% from the historical rate assuming that the revenue administration will strengthen with significant improvement in staff capacity, improved logistic support and enhancement in the collection efficieny. In scenario 3, it is assumed that the revenue growth will improve by 75% from the historical rate with widening of tax base, introdiuction of GIS system and linking it with the revenue system, application of building codes, increased collection efficiency, and automated

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revenueadminsitration system. Given the narrow tax base and weak tax efforts at present, a much higher revenue collection on account of both the base and rate effects along with strong revenue management system is very much possible.

Assessment of revenue management system indicates necessity of improving the revenue system. Key areas of improvement to be addressed are house numbering, improving the data base of tax payers, issuing invoices for taxes due, launching tax campaign program and informing the citizens about their duties, coordinating with the central government agencies, etc. Automation should be given importance and the software system of the revenue department should be integrated to other sections of the municipality e.g. building permit section. Introduction of GIS system for revenue enhancement should be an ultimate goal. Overall improvement in the revenue administration system is essential in order to increase internal revenue of the municipalities. In order to achieve this goal, a Revenue Management Improvement Plan should be framed out and approved by the Municipal Council.

Municipalities have not given due importance to increase internal revenue. They rely more on the IGFT, as it is a much easier source of revenue. When elected representatives were on board, they did not want to take aggressive measures to increase tax in order to remain popular amongst their citizens. Government employees, who have been officiating as the mayor in the absence of the elected bodies, do not feel the urgency to take any bold decision. Moreover they are deputed for a limited time period and enhancement of revenue does not fall in their priority.

There is a big scope in enhancing the internal revenue by controlling tax leakages. Municipalities have not yet reached to the tax payers to collect tax. Brining all tax payers in the tax net should be the first priority followed by the tax collection drive. Rules and regulations in collecting taxes and service charges should be strictly implemented. Any citizen who has not paid taxes or service charges should not be entitled to use any municipal services.

Experience has shown that one of the fastest changing assets prices is of the urban property and real estates. But while current municipal tax system has not been able to fully capture such prices in tax assessment, the widened tax base has not been covered by tax administration. Besides, infrastructure created by the municipalities are not contributing much to the revenue sources of the municipalities. Capacitating the municial governments in effective revenue management through the central government support and devolving more revenue sources to the municipalities are the necessary steps to make them more autonomous and self governing entities.

6.3 Inter-Governmental Fiscal Transfers

IGFT is ever growing, but consistency and predictability is less ensured. It continues to be determined in a quite ad hoc manner, at least with respect to the vertical division of resources between the central government and the municipal governments. The vertical allocation is determined on an annual basis through the budget process, almost as a residual rather than proactively intentional, to support decentralization. If one takes into account the earmarked funds that have been provided to the sectoral ministries and departments through ministerial budget, the proportion of national budgetary resources transferred to the local line agencies at district/municipal level might actually have increased over the last ten years.

Some municipalities also receive off-budget funds at the end of the fiscal years, which can disrupt local planning and predictability of resources, which can contribute to an inefficient use of resources. In general, more timely and predictable flow of central-local transfers by the

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central government will provide an environment for improving the quality and accountability of local planning and service delivery.

Under the new federal governance structure, there will be a need to restructure the grant system, channeling funds across the three levels of federal, provincial and local governments. International best practice would call for a simplification of the grant system, a move towards relying on formula-based transfers for both recurrent and capital grants, and a dynamic balance between a mix of block and categorical grants in line with accountability and capacity for delivering performance.

Most of the municipalities are found comfortable with the performance based grants system. Although the MCPM sounds good, there are certain areas for improvement. Formula-based allocation only covers a small portion of grants i.e. the unconditional grant being provided to the municipalities; the sectoral resources are currently being allocated to the municipalities on a discretionary basis. It is quite possible to choose a transfer system that relies on sectoral block grants to fund the delivery of sectoral services at the municipal level rather than relying exclusively on a single unconditional block grant. The study team ascertains possibilities that future intergovernmental fiscal systems will have to rely extensively on formula-based sectoral (block) grants.

The formula-based “horizontal” allocation mechanism for allocation the municipal block grants in Nepal is quite sound, however, there are certain concerns. One of them is the fair share of resources to municipalities. The main concerns has been the degree to which the formula takes into account variations in local expenditure needs. Since all municipalities are given the fixed grant (minimum grant) up to Rs. 3 million and additional grants against their performance, the criteria does not take into account the higher needs of municipalities that are relatively more remote and underdeveloped. Even after the introduction of equity-related criteria like poverty and weighted tax, the present system of transfers is being questioned on equity grounds. Further thought and review is needed to more clearly identify the 'equitable shares' of government revenues, which should be systematically allocated to municipal governments.

Adoption of formula-based grants allocation by all the sectoral ministries is necessary. All the sectoral ministries have to adopt formula-based grants allocation approach on the basis of umbrella formula developed by GoN to bring consistency with their sectoral strategic approach and strategies of the municipalities for infrastructure development and service delivery. Design of the sectoral budget allocation has to be closely linked with the municipal development plan. The central government has to develop umbrella formula for sectoral grants and each sector has also to develop exact formula on the basis of the central level formula and budget block grants to the municipal government accordingly. It is desirable that the MoF has to directly allocate sectoral grants to the municipalities through the District Treasury Comptroller Office after approval of the GoN Annual Program and Budget.

The allocation of the sectoral grant pools between municipal government authorities should occur on the basis of a transparent objective formula. The formula-based division of resources assures that resources are divided among municipal government authorities consistent with their relative service delivery needs, again consistent with their sectoral strategic approach.

Municipalities prepare Municipal Periodic Plan as a rolling plan and function accordingly, but most municipalities do not prepare Multi-year Investment Plan and Multi-year Fiscal Framework. Almost all the municipalities have prepared Municipal Periodic Plan and function as per their defined strategies. However, Annual Municipal Development Plan and

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annual program and budget are not found well linked to the Municipal Periodic Plan. Most of the municipalities have not started preparation of multi-year investment plan and municipal multi-year fiscal framework. Such multi-year investment plan and fiscal framework has to be a pre-condition for the implementation of NUDS at the municipal level.

As the current financial resources available with the municipal governments will be inadequate for the implementation of the NUDS, the GoN will have to provide conditional Municipal Infrastructure Development Grants with set criteria for funds transfer to municipalities on a per capita basis. The objective of the grants has to be infrastructural development with the provision of free grants, and low interest based loan and grants. These types of grants have to be performance oriented with clear linkage to the current performance measures of the GoN.

The government will have to create two types of funds for municipal infrastructure developmentconditional grants:(i) Municipal Infrastructure Development Grants, (ii) Municipal Infrastructure Development Loans at low interest rate with defined allocation criteria.

The Municipal Infrastructure Development Grants has to be allocated to all municipalities and has to be used for smaller scale infrastructure. In order to maintain balance between evolving municipalities and grown municipalities, 80 percent of the Municipal Infrastructure Development Grants has to be allocated to evolving municipalities with a population less than 100 thousand (especially to the municipalities where there are less chances for PPP due to low return on investment on debt financed projects).

Allocation of Municipal Infrastructure Development Loans have to be based on proposal based projects demand with feasibility studies from the municipalities. Government of Nepal has to establish such funds at the outset. Such municipal infrastructure development loans and grants have to be closely linked with the increase of own source revenue of the recipient municipalities.

It is also desirable that such funds needs to be formula-based and to be channeled through a very limited number of institutions to avoid local government picking of 'cheap' funds such as the Town Development Fund (TDF) as a distributing entity to ensure technical expertise.

There is a need for producing an annual Local Governance Fiscal Review to make sure that the IGFT is properly mobilized and resultsare attained by the municipal government. There is a need to produce a policy-analytical document (i.e. Local Government Fiscal Review) by the central government based on more aggregate local revenue and expenditure data. Such a document would allow national policy makers, local government officials and other stakeholders to track the overall financial status of the municipal governments, and would allow stakeholders to compare the fiscal performance (and compliance with grant conditions) of individual local governments. The current compliance monitoring carried out by the MOFALD under LGAF does not fully address the financial compliance.

Monitoring and analysis of local government finances is weak. Municipal governments are provided grants from the center with guidelines and conditionality in order to ensure that they spend the block grant funding in pursuit of sectoral strategic objectives. In this context, an adequate monitoring and reporting system has to be set up to allow central government to keep municipal governments accountable for the use of central government resources.

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Concerted efforts should be made to establish a joint reporting and monitoring system that allows both MOF and MOFALD to achieve their respective functions. MOFALD has to be made more responsible for monitoring and overseeing the budget execution of each individual local body on a one-by-one basis, whereas MOF has to be made responsible for assuring the overall fiscal integrity of the local government finance system.

In order to assure the central government and development community that sectoral block grants are indeed used for their intended purpose (and no diverted to alternate uses), the system of local government finances should be closely monitored. A number of social accountability tools such as Public Expenditure Tracking System, Social Audit, Public Audit, etc. could also be used to analyze whether sectoral transfers received by the municipalities are actually being spent within the intended sector. Use of social accountability tools will enhance credibility and transparency.

6.4 Borrowing Framework and TDF Business Strategy

Municipal infrastructure creates a primary linkage for local, district, regional, and national level urban infrastructure system. OSR and IGFT play an important role towards initiation and accomplishment of the urban infrastructure system. The NUDS has visualized attainment of this process through channeling of municipal financial resources where along with OSR and IGFT, municipal borrowings becomes a crucial component for its success.

Estimation of total financing need is based on the assumptions of achieving all or some portions of the basic urban infrastructure requirements by 2031. It is estimated that meeting all of the basic urban infrastructure of both the old and new municipalities as suggested by NUDS in the next 15 years (2015/16 to 2030/31) requires about Rs 2,330 billion. If only 60% of the proposed infrastructure is supposed to be met during the next 15 years (scenario 1), the projected investment requirement for the next 15 years amounts to Rs 1,398 billion. In second scenario where 75% of the physical targets of basic urban facilities is set to be met in the next 15 years' time, Rs 1797 billion would be needed for infrastructure investment. If both the old and new municipalities were supposed to meet 90% physical target for infrastructure set for 2030/31, then the total investment requirement for the next 15 years would be Rs 2097 billion.

The proposed investment requirement can be financed from different funding sources such as revenue surplus, IGFT and market borrowing of the municipalities as per their maximum borrowing capacity. In scenario1 (meeting 60% of the infrastructure target in 15 years), net financing deficit will be Rs 571 billion during the entire period of next 15 years. In scenario 2 with 75 per cent of the proposed physical infrastructure to be met in the next 15 years, the investment gap in the same period is projected at Rs 920 billion and it creates additional funding challenges to the municipalities. The situation becomes even more challenging if 90 per cent of the proposed urban infrastructure is to be met within next 15 years; as the net financing deficit would be as high as Rs 1270 billion. Unless TDF enhances its lending capacity along with mobilizing other stakeholders in urban infrastructure development, the investment gap is likely to suppress expected physical development of the municipalities.

The net financing requirement could be partly met through innovative and special financing vehicles with the residual being met by the TDF. The investment requirement of TDF is arrived at after making some assumptions about the contribution of those innovative financing vehicles for urban infrastructure. Assuming that municipal cost sharing could cover about 3% of the total investment requirement while PPP and PCP are supposed to cover 3% and 2% of the investment requirement respectively, the urban infrastructure financing need of the TDF in

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scenario 1 would be Rs 531 billion for the next 15 years. In the second scenario, the investment requirement would be Rs 856 billion with the same assumptions as in scenario 1. In the third scenario, even if cost-sharing portion were raised to 5%, the TDF investment requirement would be as much as Rs 1181 billion for the next 15 years.

Currently, municipalities have borrowed only 3% per cent in average of the internal revenue. The additional borrowing capacity of municipalities for the next 20 years is estimated NRs 19.75 billion and if loans are repaid from some of the older projects, the municipality will have additional borrowing capacity of Rs 1.90 billion and total borrowing capacity of the 39 municipalities would be Rs 21.65 billion. This indicates very low borrowing capacity of the municipalities in comparison to the investment requirement in infrastructure.

Currently, Town Development Fund (TDF) is the only organization in public sector for financing urban infrastructure development through loans and grants. Currently, TDF has been able to provide long-term loans for up to 20 years, which is not possible from the financial institutions in the local capital market. TDF, on the other hand, has been able to provide municipalities the long-term loans up to 20 years at interest rates well below the market rate. TDF has also taken significant credit risk that the commercial banks would not have been able to take up.

There are several areas of reform that will make municipalities eligible for more commercial borrowing from the banks and financial institutions. The selection of commercially viable projects, pre-determined user-fees or charges to be collected from the users of the infrastructure, expansion of the internal revenue base and its effective collection, effective provision of loan recovery through legal actions including the acquiring of the collaterals pledged for loan and central government incentive mechanism like topping the loan by matching grants for social type of infrastructure projects are some of the areas of reform and putting a system in place.

The existing financing gap of the municipalities cannot be met without external assistance (grant or loan) being mobilized for infrastructure financing. Of the two ways of mobilizing the assistance – directly by the central government and allocating the resources to the local bodies or approving the local bodies' proposal to mobilize external resources – the latter is more accountable way of financing.

Community dwellers in the municipalities are growingly eager to participate in the local infrastructure that is feasible to be developed with their financial and management participation. An extensive network of the municipalities with the community people and community organizations not only helps for meeting the infrastructure-financing gap but also ensures efficiency and effectiveness in resource uses.

The Nepalese banking system is governed under Banks and Financial Institutions Act (BAFIA), which sets rules for bank lending. The directives of the NRB set regulations on minimum capital adequacy, cash and liquidity ratios, limits of credit, sectoral exposure norms, liquidity standards, and single obligor limit among others. As the present capital base of banks and financial institutions amounts to Rs 160 billion (at July 2015), the provision of single borrower obligation at 25 percent of their capital fund puts banks at a constraint of maximum investment of Rs 40 billion to an infrastructure project. But bringing all banks to finance a single project is simply impractical.

Also there are other limits to exposure of banks and financial institutions to infrastructure projects. The short-term nature of sources of fund of the banks and financial institutions limit

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the scope of banks for financing infrastructure projects needing long-term investment. Capacity constraint in the banks to assess loan applications for infrastructure projects is one reason why most of big projects are looking for external debt financing. This leads to the point that a financial intermediary outside the domain of BAFIA is necessary to finance municipal infrastructure projects which are commercially viable or which could be made viable through viability gap funding mechanism.

Town development Fund Act 1996 gives TDF a scope and autonomy to function as a financial intermediary institution for the development of urban infrastructure in Nepal. But given more specific role, the objectives, functions and rights of the restructured TDF as a financial intermediary require to be enshrined in the TDF Act. The supervisor of the TDF could be the one who oversees the Employees Provident Fund (EPF), Citizen Investment Trust (CIT), or the proposed Labour Bank.

The capital base of TDF as the proposed financial intermediary has to be large enough to cater the huge urban infrastructure investment requirement. Given the huge investment demand for urban infrastructure, the proposed financial intermediary will have to possess at least Rs 20 billion in the medium term along with an equal amount of other sources of fund.

Mobilization of institutional deposits of long-term nature would be the next source of fund for lending to urban infrastructure. Such deposits could be of long term nature with a maturity of at least 5 years and going up to 10 years. Such deposits could take the form of certificates of deposits, which could also be traded in the capital market through the stock exchange.

Borrowings could also be considered as a source of fund for the TDF as a financial intermediary. Such borrowing could take place from (i) banks and financial institutions operating under BAFIA, (ii) international multilateral institutions like the World Bank, Asian Development Bank, Asian Infrastructure Investment Bank, International Finance Corporation, and (iii) other agencies.

Issuance of long-term bonds could be a proposition in case easier options to raise fund for investment does no work. Issuance of such bonds would, however, be feasible only when there is credit rating of TDF or government gives guarantee on the bonds for their redemption. Also the interest rate offered will have to be comparable with other financial instruments available in the market like the long term deposits or government bonds.

The existing legislation allows TDF to function as a financial intermediary. But in the absence of sufficient legal provision regarding lending procedure, practices, loan recovery mechanism, enforcement of the recovery conditions and seizure or confiscation of collateral, the role of TDF as a financial intermediary has been subdued. There is a need that a full-fledged financial law is enacted to operationalize TDF as a fully functioning financial intermediary. The intermediary will be a specialized agency to infrastructure financing and will co-work with other financial institutions to finance large municipal infrastructure projects.

The intermediary will be able to raise its equity capital through public offering of the shares up to 40 per cent and also would be enabled to raise fund from the capital market by issuing bonds and certificates of deposits for institutional savers. The organizational structure of the intermediary will be overhauled to make it more a business organization than as an agent of the government to carry forward ministerial task to the urban level.

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6.5 Institutional Development

The urban infrastructure financing challenges can only be addressed by creating legal frameworks for institutional restructuring along with modifications of functional responsibilities of all levels of the government. Many of the present central level institutions have to be converted in the federal level institutions such as NPC, MoF, MoFALD, LBFC; and other sectoral ministries will have to be restructured, amalgamated, and even renamed. The present structure of DIMC/DIMWC will be replaced and federal law will make necessary institutional arrangements both at federal and provincial levels to maintain coordination among federal, provincial and local levels” as provisioned in the constitution.

The role of NPC has also to be revised and confined to advice on macro-economic policies, to facilitate on resource mobilization, forecasting budget ceilings for all three levels as per the recommendations made by NNRFC and involved in outcome monitoring and impact evaluation periodically by involving independent review teams as and where necessary. It will also have to advice the federal government to apply hard budget constraints with revenue and expenditure tracking and facilitate PPP to all three levels. It will have to follow strictly the strategies to achieve national goals and objectives as outlined in the National development plans. It will also have to advice/ instruct provincial and local governments to develop their periodic development plans at the broader frameworks provided by NPC.

MoF will have to track the provincial and local revenue as assigned by the constitution and ensure the fiscal discipline at all levels through control and facilitating measures. The MoF will have to be responsible to share the resources as recommended by NNRFC at all levels.

The Financial Intermediary institutions such as TDF should be placed under direct supervision of MoF for better coordination and facilitation.

The role of sectoral Line Ministries, Departments and authorities has also to be changed as per the functional assignments outlined in the annexes of the constitutions. A clear activity mapping of the functions have to be worked out and concurrent functions for each level of governments needs to be delineated and accordingly the institutional and organizational setups have to be placed. The local governments should concentrate on effective service delivery as per the set standards by federal/provincial line Ministries. The federal/provincial projects have to be implemented with prior consultation and participation of concerned local governments to avoid duplication and overlapping with meaningful participation to ensure ownership of local governments within their jurisdiction.

The legislations (Acts and Rules) have to be enacted in keeping with the spirit of PPP policy and accordingly the steering committee, regulatory committee, PPP center within NPC be established to expedite PPP projects. Similarly, PIU‟s have to be established within the line Ministries to prepare, study and systematize the procurement process as well as to facilitate cooperation, coordination, agreement and implementation with private agency. MoF may establish Viability Gap Funding (VGF) to finance the deficit in the business viability of projects, which are crucial for urban infrastructure. The Local authorities can consult and take advice with PPP center for execution related matters. Partnership can be built with FNCCI, CNI and FNCSI as well for mobilizing national and international private sectors. The banking institutions have also to be capable to invest on private sector proposals as lead agency to mobilize internal and external resources.

National Natural Resource and Fiscal Commission (NNRFC) will have to be constituted with priority and legislations (acts and rules), and internal procedures have to be developed and

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enacted. The institutional memory of present LBFC should be the asset of NNRFC as well. It has to conduct studies for expenditure needs of provincial and municipal governments. It has also to develop the norms, criteria and procedures to transfer funds predictably to different levels of governments as conditional and unconditional grants. The grants have to maintain equity and justice and encourage for exploration of harnessing their potentials with full efforts. The transfer criteria should not be based on soft budget and should follow perform based measures with incentives. It has also to develop the borrowing criteria for provincial and municipal level governments for their capital investments as well.

Restructuring of TDF along with drafting new Act or substantial amendments of legislation is critical for evolving it as a strong financial intermediary so that it may work as full-fledged autonomous financial lending institution. A quick review of its present legal frame works, institutional and procedural provisions has to be carried out to accommodate and align itself with the present federal structures both intensively with strategic visions, strategies and business plan and scope of works and extensively by creating accessible institutional and organizational layouts at provincial levels. The provincial structure have to be designed after carrying out O&M studies with clear roles and responsibilities to support as an extended wing of central level institution. It has to serve to meet the fiscal gaps for meeting basic urban needs as specified in NUDS and other studies. It also has to cater effective demand and facilitate technically and financially to its clients especially urban governance structures as grant and loan funds for social and capital developments respectively. It has also to facilitate with TA support as well to enhance their capacity. Further it should have its minimum seed capital as required minimum for development bank for financial security. It has to be authorized to issue bonds as well.

For mobilization of external resources it has to accept as a conditional grants/loan at block and discourage tie up funds that to be channeled through line departments. The loan funds be provided directly to the concerned municipalities to the feasible projects identified by the municipal council. The existing institutional structures may be used, if required new project setup can be created to complete the project effectively and timely by the municipalities for the capital investment projects. For multi sectoral projects the authority may also be created within the municipal management by having representatives from respective agencies for better coordination among agencies.

It has to restructure its present management board. It is suggested that TDF should consider developing itself into an autonomous organization outside the direct control of government but operating within the financial regulations (of the government designated regulator). The link Ministry of TDF should be MoF for better coordination and securing the funds. It has to establish provincial offices as required at the beginning initiate from five and gradually be expanded to other regions as per the feasibility for serving municipalities.

Provincial, local and municipal government structures will have to be restructured to make them able to better manage infrastructure projects. The present municipal government structure also has to be restructured as per the basis of the functional responsibilities assigned to particular levels of government. At the beginning the model organizational structures of municipalities may also be prescribed as per the potentials and location of the local governments. As such, the structures of Metropolitan city may have different structures and those of sub metropolitan cities and other municipalities may also vary.

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CHAPTER VII

Recommended Strategies

This chapter delves on the recommended strategies of enhancing revenue collection, making intergovernmental fiscal transfer more predictable and meaningful, transforming TDF to a strong urban financial intermediary, and making institutional changes to enable the municipalities and the TDF to deliver the basic urban infrastructure facilities to the people. The focus is on medium term strategy of TDF and action plan to meet the urban financing gaps and meet the infrastructure deficits.

7.1 Own Source Revenue

LSGA empowers the municipalities in raising internal revenue from taxes, service charges, fees, penalty and fines. Because of deficiencies in revenue administration system, a number of municipalities have not been able to generate sufficient amount of internal revenue. Table 7.1 gives the strategies to be followed, activities to be completed, time line for achieving those activities and the responsible agency for accomplishing those activities in order to enhance internal revenue.

Table 7.1: Recommended Strategies and Implementation Plan for OSR

Strategies Activities Tasks Time Frame

Responsible Agency

1. Revenue administration system strengthened

Review MCPM performance (revenue management)

Review MCPM score in the previous year

Prepare strategy to improve MCPM score

Every Year Municipality

Strengthen the role of Revenue Advisory Committee (RAC)

Develop RAC's coordination and communication mechanism

Review the progress made in revenue collection periodically

Discuss on the potential new sources of revenue

Make RAC a catalyst to coordinate with government and private sector stakeholders

Every Year Municipality

Review staffing requirements of Revenue Section

Assess the staffing needs of revenue section

Provide adequate and efficient staff with experience in revenue administration

Every Year Municipality

Hold workshop and interaction programs

Hold regular interaction program with different sections of the municipality

Visit other municipalities having good examples to expose the revenue section staff

Hold workshop with the stake holders (business houses, civil societies, press, political parties) to collect suggestions on revenue enhancement

Every Year Municipality, MoFALD

Introduce house numbering Issue house numbers to existing houses within the given time frame

May 2020 Municipality, DUDBC,

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Strategies Activities Tasks Time Frame

Responsible Agency

Issue house numbers to the new constructions at the time of approving the building permit

MoFALD

Prepare Revenue Implementation Plan

Approve action plan to improve the revenue management system

Make regular follow up to see the achievements made against the action plan.

Jan 2017 Municipality

2.OSR data base updated and made functional

Computerize OSR data Introduce software for OSR

Enter all hard copy data (property and business tax data) in the computer system within a given time frame

Collect and update data of all properties in the municipality in the database including properties not liable to pay taxes

Update records of the tax payers on a regular basis

July 2020 Municipality, MoFALD

Link data with other sections of the municipality

Introduce GIS system for uses by revenue, planning and building permit section

Link revenue data with GIS system Link revenue system with other

sections of the municipality

July 2016 to July 2020

Municipality, MoFALD

Coordinate and share data with government agencies

Coordinate with Land Revenue Office to share land parcel data on a regular basis

Exchange business and rent tax data with Inland Revenue Department

Coordinate with Transport Management Department to share vehicle data

Coordinate with water supply, electricity. telephone authorities to identify and update tax payers records

Periodic Municipality, MoFALD, LRO, IRO, TMO,

Make computer system functional

Train staff in the application of computer system

Arrange logistics for making computer system effective and efficient

Arrange for timely and efficient support system

July 2016 to July 2020

Municipality, MoFALD

3. Tariff system revisited and made effective

Carry out feasibility study of revenue

Review achievements made in the previous feasibility study of revenue

Conduct new feasibility study Implement the recommendations made

in the feasibility study

Periodic Municipality

Introduce IPT system Encourage all municipalities to introduce IPT

Arrange trainings to prepare for the introduction of IPT

Arrange IPT preparation budgets for financially weak municipalities

July 2018 Municipality, MoFALD

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Strategies Activities Tasks Time Frame

Responsible Agency

Revise rates for taxes fees and charges periodically

Collect information from the municipalities regarding revision in the tax rates, fees and charges

Revise legal provisions in raising taxes, fees and charges periodically

Periodic Municipality MoFALD

4. Revenue collection made efficient and effective

Introduce billing system Provide information to tax payers about their dues in the beginning of each year

Consider 80/20 rule when collecting revenues owed32.

Focus tax collections in areas that bring the greatest return for the effort made.

July 2020 Municipality, MoFALD

Introduce carrot and stick method

Provide discount for timely payment of taxes in the beginning of the year

Introduce penalty to the defaulters at the progressive rate (10% first year, 15% second year 20% third year, etc.)

Immediate Municipality

Hold regular revenue campaign programs

Use news media, social network, hoarding boards, television etc. to inform the citizens to pay taxes

Distribute brochures to the tax payers explaining about duties in paying taxes and the services municipality provides to its citizens

Participate in exhibition and fairs and provide information to the citizens

Hold annual function to honor the tax payers

Every Year Municipality, CCI, Citizens

Use banking system for revenue collection

Use banks to collect payment instead of cash payment

Use other methods of making payments e.g. personal cheques, bank draft, credit card

Consider opening a bank counter in the municipal premises

July 2018 (in bigger municipalities)

Municipality

Introduce “Recommendation" tool for realization

Make clearance of revenue section mandatory to provide any “Recommendation”

Follow the policy of “No Recommendation” without clearing dues by all senior officials

Immediate Municipality

5. Alternative avenues for potential OSR explored and enforced

Explore possibility of potential OSR

Explore and identify the sources of potential OSR

Include such ideas in the feasibility study

Periodic Municipality

Frame out cost recovery policy of infrastructure systems operated by the municipality

Recover cost for providing specific services e.g. sewerage, water supply, electricity services etc.

Ensure that the revenue collection for specific service is used for maintaining such services

May 2017 Municipality, MoFALD, DUDBC

32 Some 80% of the due amount can generally be collected from 20% of the accounts.

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Strategies Activities Tasks Time Frame

Responsible Agency

Ensure that revenue for sewer system constructed by the municipality is collected by the municipality and not by the water authority

6. Project implemented through Users Group and PPP model encouraged

Implement projects through User Groups

Prepare guidelines for the selection of projects implemented by the User contribution

Select projects having strong willingness of the community in making financial contribution

Make provision for O&M costs

Every Year Municipality, MoFALD

Implement projects under PPP model

Form PPP promotion committee to identify and implement commercially viable projects under PPP model

Consider PPP policy 2003 and PPP Guidelines 2004 in implementing PPP projects

Select projects based on the policy and guidelines

Every Year Municipality, MoFALD

Use private sector in solid waste management

Explore use of private sector in solid waste management

Encourage solid waste management staff of the municipality to form a commercial entity to take up this function.

Immediate Municipality

7.2 Intergovernmental Fiscal Transfers

Transfers from the central governments are the principal source of financing for most of the municipalities. As such, municipal governments are heavily dependent on central government resource transfers. Currently municipalities are getting a fixed grant and formula-based additional grants against the performance of the municipalities. They also receive recurrent grants to pay for the salary and allowances of employees and to meet minimal operational expenditures. The types of grants they receive are conditional and unconditional. In helping municipalities to better invest in infrastructure projects, a predictable and unconditional transfer system is deemed necessary. The recommended strategies for the IGFT as per the infrastructure investment requirement are presented in Table 7.2.

Table 7.2: Recommended Strategies and Implementation Plan for IGFT

Strategy Activity Tasks Timeframe Responsibility

1. Transparent and predictable fiscal transfer system established to promote autonomy

Refine positioning for appropriate and fair municipal grants

Review the size of existing municipal IGFT and expenditure needs of municipalities for the implementation of NUDs

Prepare position paper for the size of IGFT to municipalities (estimated amount 0.75 to 1% of GDP)

Submit proposal to Cabinet to approve increment of municipal grants

Aug 2016 MoFALD

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Strategy Activity Tasks Timeframe Responsibility

Consider own source revenue while designing mechanisms for the transfer of unconditional capital grants and/or urban infrastructure grants.

Make IGFT predictable

Make decisions on size of transfers to municipalities on time

Include such information while informing municipalities their annual budget ceiling

Allocate grants to municipalities on time

Monitor planning and allocation of municipal grants from sector ministries

Strengthen internal and external audit from municipalities mandatory and on time

Tie-up release of upcoming municipal grants with the use of social accountability tools from municipalities

Sep 2016 MOFALD Other Sector Ministries

2. Equalization system enhanced to promote equity in the fiscal transfer

Facilitate legitimate municipal grants

Transform LDF into unconditional capital grants and include it under MCPM system

Introduce ratio of unconditional and conditional grants (not exceeding 40%)

Introduce Municipal Infrastructure Investment Grants

Aug 2016 MoFALD

Allocate grants systematically and equitably

Conduct study on expenditure needs and requirements of the municipalities

Assess municipal capacity in

generating and raising revenues Make arrangements to allocate

fiscal equalization grants to municipalities on the basis of their need for expenditure and OSR

Feb 2017 LBFC

Establish funds for municipal infrastructure development conditional grants for the implementation of NUDS

Prepare position paper for two types of Municipal Infrastructure Grants i.e. Municipal Infrastructure Development Grants (MIDG), and Municipal Infrastructure Development low interest rates loans and grants

Define allocation criteria for the grants

Submit proposal to Cabinet for approval

Make institutional mechanisms for the mobilization of MIDG33

Aug 2017 MOUD

33As this fund will have to be established with endowed amount from the government and will be of revolving nature, it is desirable that such funds needs to be channeled through very limited number of institutions to avoid

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Strategy Activity Tasks Timeframe Responsibility

Make functional revenue transfer to municipalities from central ministries / departments

Implement municipal revenue transfers as per policy provisions from the center

Set criteria for the mobilization of revenue transfers in municipalities

Aug 2016 Sectoral Revenue Generating Ministries

Prepare multi-year investment plan and fiscal framework to complement attainment of aims and objectives of the Municipal Development Plan

Revisit Directives for the preparation of Municipal Development Plan

Incorporate format and processes for the preparation of Multi-year Investment Plan and Multi-year Fiscal Framework while Municipal Development Plan formulation

Establish linkages of Municipal Development Plan (programs and budget) with Multi-year Investment Plan and Multi-year Fiscal Framework

Align intergovernmental transfer system with municipal development plan to allocate grants through single door

Produce Annual Municipal Governance Fiscal Review Report

Aug 2016 MOUD MOFALD

3. Performance based grant system strengthened

Allocate formula-based sectoral unconditional grants to the municipalities.

Develop umbrella formula for sectoral capital grants allocation from the government as a guiding principal for sectoral ministries

Make mandatory arrangements to provide sectoral unconditional grants to municipalities34

Scale up MCPM evaluation system to total municipal finances35

Aug 2017 MoFALD Sectoral Ministries

Allocate sectoral conditional grants to the municipalities.

Make mandatory arrangements to provide sectoral conditional grants to municipalities

Issue directives to avoid allocation of resources to devolved sectors - education, health and agriculture and other non-devolved sectors - building, roads, water and sanitation, solid waste management, environment conservation through district level line agencies from line ministries

Allocate sectoral conditional grants to municipalities for expected municipal

Aug 2017 MoFALD Sectoral Ministries

municipal government picking of “cheap” funds such as the Town Development Fund (TDF) as a distributing entity to ensure technical and financing expertise. 34 It should guide development of formula-based sectoral capital grants from each sector ministry/ department for the allocation of grants to municipal governments. 35 Municipal finances refers to total amount of unconditional and unconditional grants, revenue transfer, project grants, borrowing, municipal own revenue etc.)

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Strategy Activity Tasks Timeframe Responsibility

services (MOF to allocate such grants to the municipalities after approval of Annual Program and Budget)36

Provide technical backstopping to the municipalities from the sectoral line agencies including observation of progress (program and budget) under conditional grants

Transform municipal processes to E-Municipalities

Develop an e- Municipal Master Plan (e-MMP)

Upgrade operational effectiveness of municipalities utilizing computerization

Enhance capability of municipalities in all areas of its operation utilizing Information & Communication Technology (especially technical, revenue generation and financial management)

Aug 2017 MoFALD

Strengthen monitoring and evaluation

Prepare municipal fiscal management tolls to facilitate Monitoring and reporting of municipal finances as well as the monitoring of compliance with financial conditionality

Monitor conditions of municipal finances by Financial Comptroller General Office, MOF

Incorporate municipal finances under performance audit of Office of the Auditor General

Monitor sector ministry/ departments' fiscal transfer to municipalities by FCGO to prevent sectoral ministries to arbitrarily 'pulling back' resources provided to the municipalities

Nov 2017 MOFALD (Including MOF, OAG, FCGO etc.)

7.3 Borrowing Aspects of TDF

The foregoing analyses have shown that the existing sources of municipal income are not enough for meeting growing urban infrastructure investment demand. The role of TDF as a financing institution is constrained by both the demand and supply side weaknesses. Given the urgency to develop basic urban infrastructure and a crucial role of TDF in this regard, several actions plans for the municipalities and for the TDF to be implemented during the next medium term are suggested. Table 7.3 summarizes the implementation plan for enhancing borrowing of the municipalities and evolving TDF as a financial intermediary with strong capital base and capable management.

36 Establish close linkage between sectoral program and budget and Municipal Development Plan while formulation of sectoral program grants to municipalities

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Table 7.3: Recommended Strategies and Implementation Plan for Borrowings

Strategy Task Activity Timeframe Responsibility 1. TDF as a

financial intermediary institution restricted and evolved

Enact of the new TDF Act

Bring TDF under the umbrella of MoF from MoUD

Draft special legislation for the operation of TDF as an autonomous institution

Get the new TDF Act approved Enact bylaws of financial

procedures and business operations

July 2016 July 2017 October 2017 December 2017

MoUD, MoF, TDF TDF, MoF, MoLJ Legislative parliament TDF, MoF

2. TDF's capital base restructured

Consolidate existing sources of capital Increase capital to Rs 5 billion Increase capital to Rs 10 billion Increase capital to Rs 20 billion including by public share offerings

Conduct study of TDF's new capital structure

Agree on new capital structure with owners of equity and TDF Board

Approve the capital structure Approve the capital structure

July 2016 July 2017 July 2020 July 2025

TDF TDF, MOF TDF, MOF TDF, MOF

3. Municipal / Client's borrowing capacity assessment mechanism enhanced

Establish system for assessment of borrowing capacity of clients for entity financing

Frame work borrowing capacity assessment approved

Establish mechanism for updating of financing data of clients

Establish system for authentication of borrowing capacity assessment report

July 2017 July 2017 Dec 2017

4. Tariff system for municipal utilities designed and enhanced

Establish a functional system for recommending/fixing tariff system at central/local level

Develop guidelines for setting tariff for municipal utilities/ sectors (water, waste management, sewerage...)

Establish legal/institutional mechanism for setting tariff

July 2017 Dec 2017

5. Appraisal system enhanced

Approve entity appraisal system/borrowing capacity assessment Approve project appraisal manual

Draft borrowing capacity assessment guidelines

Draft project appraisal manual

July 2017 July 2017

6. Financial operations of TDF strengthened

Enhance loan portfolio by raising disbursements 1.5 billing in FY 2017/18 Improve loan recovery (90% by 2018/19)

Open offices in provinces to widen financial services

Restructure staffing and develop specialized cadre in project appraisal

Establish SCROW Accounts in selected projects

July 2018 July 2017 July 2018

TDF TDF TDF

7. Borrowing capacity of TDF strengthened

Enhance borrowing capacity of TDF Adopt borrowing tools Maintain TDF balance sheet clean

Undertake credit rating of TDF Strengthen staffing and business

model Innovate proper instruments for

borrowing (bonds, certificates, etc.)

Approach international financial institutions for soft loans

July 2017 July 2017 July 2018 Dec 2017

TDF TDF MoF, TDF

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8. Financing to innovative projects/areas

Promote PPP model of financing commercial projects

Get PPP law enacted Set proper operational guidelines

for PPP projects Set proper operational guidelines

for PCP

July 2017 Oct 2017 Oct 2017

TDF TDF, NPC

TDF, MoFALD

Promote PCP model of financing community infrastructure projects

Develop cost recovery mechanism of PCP projects Enhance transparency through credible people's participation in projects

July 2017

TDF, MoF

Join consortium with other financial institutions for financing mega projects

Set proper rules and guidelines for consortium financing

Develop capacity for undertaking consortium projects

Get first right to loan recovery from sales of collateralized assets

July 2018 Jan 2019 July 2018

TDF, MoF TDF TDF, MoF

7.4 Institutional Development for Urban Financing Different policy and legal frameworks have been suggested for institutional arrangements of municipal financing to meet the infrastructure financing needs. The previous sections have already shown high expenditure requirements of the municipalities to serve more than 42% of urban population with basic minimum infrastructures by the next 15 years. In this context to develop and maintain basic urban infrastructure a proper institutional set up is required at three levels, i.e. federal, provincial and local, that are provisioned in the present constitution of Nepal. Key Strategies and Implementation plan for institutional development is presented in table 7.4

Table 7.4: Recommended Strategies and Implementation Plan for Institutional Development

Strategy Activity Tasks Timeframe Responsibility

Federal, Provincial and Municipal Laws enacted

Draft new federal organic law, Provincial and Municipal laws, rules and regulations Delineate concurrent and other functional assignments given in Constitutional schedules through detail Activity mapping for each level of governments Restructure organizational structures of Local Governments as suggested by LG Restructuring Commission in line with functional assignments and responsibilities Include Activity Mapping in annexes of Federal organic law

Review existing laws including sectoral acts, rules

propose new draft of legislations for each spheres of governments or amendments as suggested by review reports

Each line Ministries has to prepare expenditure and revenue assignments for all three levels as per constitutional schedules

Conduct workshop with concerned Line Ministry officials to finalize activity mapping of functional assignments

Classify Municipalities in different categories (Metropolitan, sub-Metropolitan and others in four categories)

Conduct O& M studies for each categories

September, 2016 July, 2017

MoFALD All responsible Sectoral Ministries/ agencies

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Strategy Activity Tasks Timeframe Responsibility

Design administrative organizational structures of each levels

New TDF Act Enacted

Draft new Law to enable TDF to act as an autonomous financial intermediary to finance municipal investment Regulate municipal borrowing that is streamlined/channeled only through TDF

Review of existing acts including BAFIA

Conduct Study of international practices

Assign Nepal Rastra Bank as a regulatory institution so that it can monitor as other financial intermediaries

July 2017 TDF MoF

TDF organization restructured and made functional

Restructure TDF Board as per the provisions of the revised act Form Board of Directors (BOD) from new shareholders Do administrative restructuring of TDF as assigned new roles and responsibilities

Conduct O&M study for federal and provincial levels

Design administrative

organizational structures of TDF for each levels

Establish provincial level offices

August 2017 July, 2017 Dec 2017

GoN/MoF TDF TDF TDF

NNRFC Constituted

Formation of NNRFC Collect CV from professionals by constitutional commission as per criteria outlined in the constitution

Scrutinize CV by competent authority and recommend names to commission in appropriate numbers

July 2016 Constitutional Commission Federal Government

NNRFC Legitimized

Draft Legislation of NNRFC Rules and procedures

Scoping study conducted Get NNRFC law and rules in place

December , 2016

NNRFC GoN

Institutional arrangement for municipal capacity development evolved and operationalized

Establish competent institution to enhance capacity of municipal officials including elected especially on Financial framework and other aspects of Municipal Business

Reorganize present LDTA/ UDTC structures and capacitate it with qualified professionals

Conduct Capacity Gap study and conduct Training Need Assessment of Municipalities, Prepare HRD Plan

Conduct Need based trainings as Suggested by TNA and outlined in HRD plan with especial focus on financial frame works

Generate demand for financial investments

December 2016 July 2017

MoFALD

Municipal management capacity enhanced to execute Municipal Finance System

Upgrade capacity of municipalities and Municipal officials/ staff

Fill Revenue/finance sections with properly qualified and adequate number of staff

Provide capacity development trainings on a regular basis

Make exposure visits to other municipalities having good examples

Conduct trainings for elected officials

Conduct orientations to revenue advisory board members of municipalities

Continuous MoFALD LDTA/UDTC or assigned training institution

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REFERENCES

Adhikary, Dileep K. (2014). Review of TDF's Capital Structure, Scoping Study. Kathmandu: PRAM Associates. Awasthi, G.D. (2013). Status of Internal Revenue Mobilization of the Municipalities and their Feasibility: Kathmandu : Local Body Fiscal Commission. ADB (2010). Asia 2050, Realizing the Asian Century. Manila: Asian Development Bank. ADB ( 2012 ). Capacity Building for Waste Management, TA Consultant's Report. Kathmandu: Asian Development Bank. Boex, Jamie ( 2012). Review of Criteria and Grant Allocation Formulas for Block Grants to DDCs and VDCs in Nepal. Kathmandu : LBFC Catherine F. & Kopanyi, F.V ( 2014 ) . Municipal finances a handbook for local governments. Washington DC : The World Bank CFMIP, (2014) . Comprehensive Financial Management Improvement Plan (Dharan, Janakapu, Siddharthanagar, Nepalgunj), Kathmandu : Department of Urban Development and Building Construction and Minitry of Federal Affairs and Local Development. Devkota, KL.( Dec 04, 2014). Carrot and Stick. Kathmandu Post. Dec 04, 2014. Ghimire, Banshidhar (2011). Stock Taking of Fiscal Decentralization Policies (Revenue Assignment). Kathmandu : LBFC, 2011. GoI ( 2013) . Scheme and Guidelines for Financial Support to Public Private Partnerships in Infrastructure, Government of India, Ministry of Finance, Department of Economic Affairs, 2013 Gyawali (2012). Strengthening the Town Development Fund Capacity for Public Private Partnership (TA – 7668 NEP), 29 Towns Assessment Under Small Towns Water Supply Sanitation Sector Project (STWSSSP I). Kathmandu: Town Development Fund. Kelly, Roy (2011). Stock Taking of Fiscal Decentralization Policies: Consoloidated Report. Kathmandu : Local Body Fiscal Commission. Khan, Harun R, (2013). Paper presented by Deputy Governor at the Conference on Financing Strategies for Urban Infrastructure organized by the Centre for Advanced Financial Research and Learning (CAFRAL) on July 18, 2013 Mumbai . LBFC (2005). Designing Intergovernmental Fiscal Transfer Formula and Expenditure Needs Assessment of Selected Devolved Tasks. Kathmandu : L Local Body Fiscal Commission. LBFC (2009). A Study on the Design of a Formula Based Grants System for VDCs and Update Grant System for DDCs in Nepal. Kathmandu : Local Bodies Fiscal Commission LBFC (2013). Policy, Program and Budget of LBFC FY 2009/10 to 2012/13. Kathmandu : Local Body Fiscal Commission. LBMB (1999). Local Self Governance Act, 1999. Kathmandu: Law book Management Board. LBMB (2000). Local Self Governance Act, 1999 Kathmandu: Law book Management Board. LBMB (2007). Local Body Financial Administration Rules 2007 Kathmandu: Law Book Management Board.

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LBMB (2015). The Constitution of Nepal, 2015 Kathmandu: Law book Management Board. MLD ( 2004 ). Local Infrastructure Development Policy. Kathmandu : Ministry of Local Development, Kathmandu, Nepal MOFALD. (2013). Local Body Resource Mobilization and Management Operation Guidelines. Kathmandu : Ministry of Federal Affairs and Local Development MOUD. (2015). National Urban Development Strategy. Kathmandu : Ministry of Urban Development. MoF (2014) .Development Cooperation Policy, 2014 Kathmandu : Ministry of Finance ------ (2015 A). Public Expenditure and Financial Accountability (PEFA) Assessment, 2015 Kathmandu : Ministry of Finance MoF (2015 B). Public private partnership policy, 2015, Nepali Version MoLD (2009). Municipal Reserve Fund Implementation Procedures, 2009, Ministry of Local development, Kathmandu, Nepal MoUD (2015). National Urban Development strategy, 2015: Ministry of Urban development, Singh Durbar, Kathmandu, Nepal NPC (2011). White Paper on Public Private Partnership (PPP), National Planning Commission, Singh Durbar, Kathmandu, March, 2011. Sharma, Raghunandan & Devkota (2015). A Study of Proposed Institutional Arrangement for Intergovernmental Transfer in Nepal. Kathmandu : report prepared for Local Bodies Fiscal Commission and Ministry of Federal Affairs and Local Development. SMUSDP. (2014). ADB TA 7982 NEP: Sthrengthening Municipalities for Urban Service Delivery : Kathmandu : DUDBC, MoFALD. Srivastava, D.K. (2011) . Key Elements of a New Fiscal Regime in Federal Nepal Madras School of Economics Chennai, India Prepared for the Forum of Federations Ottawa, Canada Taraschewski & Chhetri (2008 ). Municipal Finance System in Nepal: Status quo of Revenues, Expenditures and Transfers, Dr. Thomas Taraschewski & Ram B. Chhetri,gtz/udle programme June 2008 TDF. (2012). Business Plan 2013/14-2017/18. Kathmandu : Town Development Fund. ------ (2015). All Municipality Revenue Statement. Kathmandu : Town Development Fund. UDLE. (2008). Municipal Finance System in Nepal: Status Quo of Revenues, Expenditures and Tranfers. Kathmandu : Urban Development through Local Efforts World Bank (2013). Assessment of Financing Framework for Municipal Infrastructure In Vietnam, Final Report- ACS5919. ------ (2014 ). Local Service delivery in Nepal, Report – 87922-NP,The World Bank, June, 2014.

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ANNEXES

Annex 1.1: Assumptions for Own Source Revenue and Recurrent Expenditure Projections

1. Average recurrent expenditure growth of 35 municipalities (except for Metro and Sub Metro) taken for projection of remaining all 170 municipalities. The average growth rate of recurrent expenditure during the fiscal years 2009/10-2013/14 was 12%; but as new municipalities are assumed to have high recurrent expenditure to meet the growing service need of their citizens, an additional 3% has been added to the historical growth rate for projecting overall municipal recurrent expenditure.

2. Own Source Revenue is assumed to increase by 16% for old 58 municipalities (as per average growth of last five years - FY2009/10 to FY2013/14) &by half the rate (8%) for remaining new 159 municipalities for first three years; and then by 16% throughout the projection period.

3. The achievement of physical target of municipal infrastructure till the year 2030 is set at 60% for scenario 1, 75% for scenario 2, & 90% for scenario 3 for all the 217 municipalities.

4. Market Borrowing Capacity is assumed at 25% of the revenue surplus of the municipalities. Revenue surplus is defined as OSR minus recurrent expenditure.

Annex 1.2: Assumption for the Calculation of Investment Requirement for Urban Infrastructure

5. 58 municipalities having difference population growth during 2001-11 categorized as: less than 0% (Dasarathchand), 0 to 1%, 1 to 2%, 2 to 3%, 3 to 4%, 4 to 5% & more than 5% (i.e. Damak, Itahari, Madhyapur, Pokhara).

6. The population projection for the next two decades (till 2031) has been made on the basis of the growth bands. Following four different growth bands have been assumed for this purpose of projection.

Growth Type

Growth Population Population Ratio

Existing Proposed Existing Projected 2001-11 2011-31 2011 2021 2031 2011 2021 2031

High 3.0% 3.50% 2,577,708 3,198,552 4,511,881 59% 55% 58% Medium 2.0% 2.50% 684,880 751,451 1,019,033 16% 13% 13% Low 1.0% 1.50% 959,844 1,470,147 2,013,263 22% 25% 26% Zero 0% 0% 183,613 390,242 183,613 4% 7% 2% Total 3.2% 2.8% 4,406,045 5,810,392 7,727,790 100% 100% 100%

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7. If both the existing municipalities and newly declared municipalities are considered, the total urban population in 2011 was 40% and by the next 20 years, half of the population would be living in the municipalities.

Existing Projected

2011 2021 2031

Nepal Population 26,620,809 30,789,678 35,919,562

Growth Rate 1.41% 1.47% 1.55%

Urban Population 10,780,534 13,410,635 17,941,965

Existing Municipalities 5,125,29637 5,810,468 7,727,976

New Municipalities 5,655,238 7,600,167 10,213,989

Rural Population 15,840,275 17,379,043 17,977,597

Urban Population 40% 31% 35%

Existing Municipalities Muni 19% 19% 22%

New Municipalities 21% 12% 14%

Rural Population 60% 69% 65%

8. Population Density is one of the major parameters to classify the area as urban center. In National Urban Policy, 10 ppha is suggested to be necessary to declare an urban area. The 58 municipalities falling under different bands of population density are considered as follows :

> 200 ppha Kathmandu

100 to 200 ppha Lalitpur, Bhaktapur

50 to 100 ppha Madhyapur, Butwal, Birgunj. Nepalgunj, Banepa, Pokhara, Dharan

25 to 50 ppha Kirtipur, Janakpur, Biratnagar, Birendranagar, Rajbiraj, Malangawa, Hetauda, Itahari

10 to 25 ppha Kalaiya, baglung, Bharatpur, Bhadrapur, Lahan, Siddhartha Nagar, Dhulikhel, Gaul, Tansen, Tulsipur, Jaleshwor, Waling, Ratnanagar, Dhangadhi, Damak, Tribhuvan Nagar, Inaruwa, Siraha, Byas, Mechinagar, Panauti, Itam Lekhnath, Tikapur, Mahendra Nagar

<10 ppha Bidur, Triyuga, Prithbinarayan, Dhankuta, Putalibazar, Kamalamai, Kabipbastu, Ramgram, Dipayal Silgadhi, Gulariya, Dashrathchanda, Narayan, Bhimeswor, Amargadhi, Khadbari

37While calculating the investment requirement, the population before merger i.e. 4,406,045 has been taken into

consideration due to unavailability of updated information on these adjoined areas.

103

9. The existing state of urban infrastructure is assessed through nine different parameters, with about one third of the designated urban area still having population density of less than 10 ppha and to possess rural characteristics.

Parameters Basis Min Max Mean

Urban Area % > 10 ppha 0% 100% 63%

Road Density Km/Sqkm of Buildable Area 1.58 35.27 6.24

Access to Piped Water Supply HH 9% 96% 55%

Access to Toilet Facilities HH 40% 99% 81%

Access to Electricity HH 58% 99% 90%

RCC Roof Building House 2% 84% 45%

Solid Waste Collection HH 1% 100% 44%

Storm Drainage Percent of Road Length 0% 70% 13%

Sewerage Percent of Road Length 0% 87% 9%

10. The desired level of urban infrastructure and the minimum desirable state of urban infrastructure for existing municipalities and new towns are taken from the norms prepared by DUDBC and those suggested for the small Indian cities; the infrastructure parameters and their unit costs are mentioned in the following table.

Urban Infrastructure

Old 58 Municipalities New 159 Municipalities Parameters Unit Cost Parameters Unit Cost

Population Density 10 ppha 10 ppha Road Density 7.5 km/Sq Km 5 km/ Sq Km New Roads Rs. 20 Million Rs. 20 Million Upgradation Rs. 10 Million Rs. 10 Million Piped WS 80% of HH Rs. 30,000 80% of HH Rs. 30,000 Toilet 100% of HH Rs. 10,000 100% of HH Rs. 10,000 Electricity 100% of HH Rs. 5,000 100% of HH Rs. 5,000 Landfill Site Must have Rs. 1000 Must have Rs. 1000 Storm Drainage 60% of Road Rs. 10 Million 60% of Road Rs. 10 Million Sewerage Core City (20% of

road length) Rs. 15 Million Core City (20% of

road length) Rs. 15 Million

11. Regarding investment requirement for desired state (58 old municipalities), a tentative costing has been made to arrive at the requirement of fund to bring all the existing municipalities into the minimum desired level of infrastructure. The cost below is based on the 2011 prices and according to which Rs. 257,244 million would be required to meet the investment requirement. That calls for per capita investment of about Rs. 58,400. Of this more than 70% fund would be required for the upgradation of existing roads and the extension of new roads. This funding requirement is based on the population of 2011, additional cost would be required to fulfill the increased demand due to the population rise in coming years. The detail of the future demand is calculated on the basis of current per capita requirement.

104

SN Urban Infrastructure Unit Rate in Rs. Amount in Rs. Million Percent Per Capita

(Rs.)

1 New Roads Km 20,000,000 105,033 40.82 23,838

2 Upgradation of Existing Roads

Km 0,000,000 72,576 28.21 16,472

3 HH With Piped WS HH 30,000 7,353 2.86 1,669

4 HH Having Toilet HH 10,000 1,032 0.40 234

5 HH having Electricity HH 5,000 313 0.12 71

6 SW Collection & Mgmt HH 1,000 637 0.25 145

7 Storm Drainage Km 10,000,000 46,944 18.25 10,654

8 Sewerage Km 15,000,000 23,390 9.09 5,309

Total 257,277 100.00 58,392

12. Besides above municipal infrastructure, every municipality must have its office premises and the city bus parks. Most of the existing municipalities have their own office complex; however most of these buildings require major renovation works and some of which may have to be demolished for the new ones. Regarding bus parks, 32 out of 58 municipalities have their own but only 14 of them are in good and 6 in moderate condition. 38 municipalities therefore either require a new bus parks or complete renovation. Many new municipal offices are running in rented buildings or continued their operation in the existing VDC buildings. The requirement of total funding including the municipal buildings and bus parks for the next 15 years is estimated at Rs. 2,345 billion. This is summarized below:

Old Municipalities (58)

New Towns (159)

Total (Rs. Million)

Municipal Infrastructure (2031) 412,995 1,916,926 2,329,921

Municipal Buildings 1,096 4,060 5,156

Bus Parks 2,228 8,120 10,348

Total (Rs. in Million) 416,319 1,929,106 2,345,425

13. The priority investment for the next 15 years i.e. till 2031 has been set according to the type of the city and on the basis of population. The existing municipalities with the population greater than 200,000 is targeted to achieve 100% of the requirement while the towns having less than 20,000 population are supposed to have the target of 60% of desired infrastructure only. The medium towns shall have the infrastructure targets that range between 70% and 90%. Similarly, for the new towns the maximum target for the next 15 years has been set at 60% only and the minimum target set is 20% for the population of less than 20,000. Since the new towns do not fall into A and B category, the maximum physical target shall hence be 40% only.

105

Population City Type Existing Towns New Towns < 20,000 E 60% 20% 20,000 to 50,000 D 70% 30% 50,000 to 100,000 C 80% 40% 100,000 to 200,000 B 90% 50% >200,000 A 100% 60%

2016-21 2021-26 2016-31 Total Existing Towns 65,324 95,958 178,527 339,808 New Towns 121,141 178,667 287,628 587,437 Total (Rs. in Million) 186,465 274,625 466,155 927,244 Percent to Total Requirement 8% 12% 20% 40% Percent to 20 Years' Priority 20% 30% 50% 100%

14. Since the infrastructure investment requirement cannot be met by the internal resources of the municipality, the major contribution (50% to 60%) is proposed from the government through fiscal transfer. The development partners may have contribution up to 30% while the municipality may contribute around 5% to 10% of the total requirement. Further 2% to 5% would be contributed by the community and private sector. The involvement of community would be on the water supply, inner urban roads, drainage and sewer whereas the private sector may be involved in the construction of bus parks through PPP.

106

Annex 2.1: Summary of Differences between HALT and IPT

HALT IPT Land revenue is levied on land without building. Land revenue is not levied. IPT is charged in total value

of land and building or land alone. Valuation rates: Valuation of building is fixed at the rate given rates according to the construction materials in Rupees per sq, ft. (i) mud mortar and unbaked bricks or stone Rs 450 (ii) mud mortar with baked bricks or stone Rs 525 (iii) cement mortar and baked brick or stone Rs 575 and (iv) frame structure Rs 635. In the case of land it is valued by the valuation committee or value of Land Revenue Office is used.

Valuation rates: Valuation of land and building is determined by the valuation committee depending upon different location of the property i.e. commercial, residential located at different zones of the city.

Tax Rates: Up to the first one million rupees - None Up to one million thereafter - Rs. 300.00 Up to three million thereafter - 0.05 percent Up to five million thereafter - 0.25 percent Up to ten million thereafter - 0.50 percent For Remaining amount - 1.50 percent

Tax Rates: Upto Rs 1 million – Rs 25 - 200 From Rs 1 ml to 2 ml – Rs 250 to 400 From 2 ml to 3 ml – Rs 500 to 1,000 From 3 ml to 5 ml – Rs 1,200 to 3,000 From 5 ml to 10 ml - Rs 3,500 to 10,000 From 10 ml to 20 ml - Rs 12,000 to 20,000 From 20 ml to 50 ml - Rs 25,000 to 60,000 Above 50 ml – Rs 2/thousand

Depreciation rates are predetermined. It is 3% to 0.75% and life of assets is 25 to 100 years.

Depreciation rates are more realistic

107

Annex 2.2: Summary Tax Rates of Business Taxes

Business Tax Annual Tax Rates Rs Classification of Businesses Min Max

1 Commercial Goods (a) Wholesale and retail business of cigarette, liquor, jewelry, video,

cassette recorder and player. 750 10,000

(b) Wholesale and retail business of construction materials, computer, electric goods, camera, television, radio, carpet, petroleum materials and the like.

500 5,000

(c) On the wholesale and retail business of foods of daily use, cotton fabrics etc.

360 1,000

(d) Vehicle seller 360 10,000 2 Experts, Consultants and Other Professional Services 360 3,000 Institutional Painters 5,000 15,000

3 Construction Business 2,000 10,000 4 Production Oriented Industries 2,000 10,000 5 Energy Oriented Industries 2,000 5,000 6 Agricultural and forest-oriented industries 1,500 10,000 7 Mineral Industries 1,500 10,000 8 Tourism Industries 10,000 50,000 9 Service Industries 4,000 7,000 10 Construction Business 1,000 10,000 11 Communication Services 360 3,000 12 Financial Services

(a) Commercial Banks 5,000 50,000 (b) Finance Companies 5,000 10,000 (c) Branch Office of Finance Companies 1,000 3,000 (d) Insurance Companies 5,000 10,000 (e) Foreign Currency Exchange, Securities Transactions, Cooperatives 1,000 3,000

13 Health Services (clinic, nursing homes, hospitals) 500 5,000 14 Education Services (school, college, university, research, training, INGO 360 5,000 15 Repairs and Maintenance Service 100 3,000 16 Other Services 360 5,000

Cable Net (on the basis of customer) 5,000 50,000 17 Other Business

Park, picnic spot, tour operator, massage parlour 750 4,000 Casino 5,000 100,000

18 Temporary Haat Bazaar 1 25 19 Others (business not included in the above list) 100 5,000

108

Annex 2.3: Vehicle Tax Rates

Vehicle Tax Annual Tax Rates Rs Classification of Vehicle Tax Min Max

1 Vehicle Registration and Annual Vehicle Tax (a) Bus, Truck, Lorry and Other Heavy Vehicle 1,000 3,000 (b) Car and Jeep (on hire) 200 500 (c) Auto Rickshaw (on hire) 100 300 (d) Mini Bus (on hire) 500 1,000 (e) Car, Auto Rickshaw, Mini Bus (private) 100 300 (f) Scooter, Motorcycle and Others 50 200 (g) Cart and Rickshaw 15 25

2 Temporary Vehicle Tax (constructed by the municipality or handed over to it)

(a) Bus, Truck and Tractor (private or on hire) 5 20 (b) Mini Bus 5 10 (c) Others up to 5

3 Registration and Operation License Fee (for the registration giving numbers to cart, rickshaws, horse driven carts)

15 50

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Annex 2.4: Forecast of Own Source Revenue

Scenario 1: Estimate at historical growth rate for 58 municipalities and for the 159 municipalities at half of this rate

(Rs in Million) Internal Revenue 2013/14 Growth

% Muns 2015/16 2018/19 2021/22 2024/25 2027/28 2030/31

Local Tax 1123 16.83 58 1,533 2,444 3,897 6,214 9,909 15,800 8.41 159 2,151 2,740 4,055 6,466 10,311 16,442

Total 3,683 5,184 7,952 12,680 20,220 32,243

Service Charge Fees

& Fines 1263

15.2 58 1,676 2,563 3,918 5,990 9,157 13,999 7.6 159 2,368 2,950 4,212 6,440 9,846 15,052

Total 4,044 5,513 8,130 12,430 19,003 29,052

Property Rental 205

11.07 58 252 346 474 649 890 1,219 5.54 159 363 426 555 760 1,042 1,428

Total 615 772 1,029 1,410 1,932 2,647

Other Revenue 67

13.07 58 86 124 179 258 373 540 6.53 159 122 147 201 290 419 606

Total 207 271 379 548 793 1,146 Total OSR 2657 8,550 11,740 17,490 27,068 41,947 65,087 Forecast for 58 Municipalities 3,547 5,476 8,467 13,111 20,329 31,559 Forecast for 159 Municipalities 5,003 6,264 9,023 13,957 21,618 33,529

Scenario 2: Increase in growth rates of taxes and service charges by 50% on the

historical growth rate (Rs in Million)

Internal Revenue 2013/14 Growth % Muns 2015/16 2018/19 2021/22 2024/25 2027/28 2030/31

Local Tax 1123 25.25 58 1,643 3,228 6,341 12,458 22,831 36,407 12.62 159 2,234 2,847 4,212 6,717 10,711 17,081

Total 3,877 6,074 10,554 19,175 33,542 53,487

Service Charge Fees & Fines 1263

22.8 58 1,787 3,309 6,128 11,348 18,493 28,272

11.4 159 2,452 3,054 4,361 6,668 10,194 15,584 Total 4,239 6,363 10,489 18,015 28,686 43,856

Property Rental 205

11.07 58 252 346 474 649 890 1,219 5.54 159 363 426 555 760 1,042 1,428

Total 615 772 1,029 1,410 1,932 2,647

Other Revenue 67

13.07 58 86 124 179 258 373 540 6.53 159 122 147 201 290 419 606

Total 207 271 379 548 793 1,146 Total OSR 2657 8,938 13,481 22,451 39,149 64,953 101,136 Forecast for 58 Municipalities 3,768 7,006 13,122 24,713 42,587 66,437 Forecast for 159 Municipalities 5,170 6,474 9,329 14,435 22,366 34,699

110

Scenario 3: Increase in growth rates of taxes and service charges by 75% on the historical growth rate

(Rs in Million)

Internal Revenue 2013/14 Growt

h % Muns 2015/16 2018/19 2021/22 2024/25 2027/28 2030/31

Local Tax 1123

29.45 58 1,698 3,684 7,991 17,336 33,941 54,123

14.73 159 2,276 2,900 4,291 6,843 10,911 17,400

Total 3,974 6,584 12,282 24,179 44,853 71,523

Service Charge Fees & Fines 1263

26.6 58 1,842 3,738 7,585 15,391 25,858 39,531

13.3 159 2,493 3,106 4,436 6,781 10,367 15,850

Total 4,336 6,844 12,021 22,172 36,225 55,381

Property Rental 205

11.07 58 252 346 474 649 890 1,219

5.54 159 363 426 555 760 1,042 1,428

Total 615 772 1,029 1,410 1,932 2,647

Other Revenue 67

13.07 58 86 124 179 258 373 540

6.53 159 122 147 201 290 419 606

Total 207 271 379 548 793 1,146

Total OSR 2657 9,132 14,471 25,711 48,309 83,802 130,696

Forecast for 58 Municipalities 3,878 7,891 16,229 33,635 61,062 95,413

Forecast for 159 Municipalities 5,254 6,580 9,482 14,674 22,740 35,283

112

Annex – 2.5: Comprehensive Revenue Management Improvement Plan (Nepalgunj)

SN Status Actions for improvement Objective/Target Time Frame Responsibility

Institutional Capacity Development

1 A1 Setup separate counters for taxes and fee by partitioning office space of Revenue Section and also manage waiting facilities to the tax payers

Improved physical facilities for congenial working environment and services to the tax payers

Within Mid July, 2012 Revenue Section, Financial Administration Section and

Executive Officer

2 A3 Acquire new files and file racks to improve filing system of Revenue Section

Improved and safe documentation system Within Mid July, 2012 Revenue Section, Financial Adm. Section and Executive Officer

3 A1 Carry out revenue potential study of Parking Fee and Vehicle Tax

Identify revenue potentials from the revenue sources and suggest appropriate collection system

Within Mid June, 2012 Revenue Section, Executive Officer, Revenue Advisory

Committee and Municipal Board

Tax Awareness Campaign

4 A2 Disseminate information through pamphlets, notice boards and media to conduct revenue awareness campaign.

Prepared and used materials for revenue awareness campaign

January, 2012

Revenue Section, Ward Offices

5 A2 Continue revenue awareness campaign in active participation of ward offices.

Facilitated in revenue collection by increasing tax awareness to the citizens

Make it a regular program

Revenue Section, Ward Committees and other sections

6 A2 Improve service delivery along with revenue campaign and improvement in revenue collection.

Taxpayer's friendly tax administration Immediate and continue

All Divisions

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Integrated Property Tax

7 A1 Correct errors occurred in IPT computer software and provide training on software operation

Increased revenue collection and required reports will be generated

Within Mid January 2012 Revenue Section, Executive Secretary

8 A1 Data entry of all tax payers Updated property information of all tax payers Mid June, 2012 Revenue Section 9 B Integrate property tax data base with house

numbering and GIS system

Increased tax base and municipal internal revenue

FY 2013/14 – 10%, FY 2014/15 – 20%, FY 2015/16

– 30%, 100% in 4th Fiscal Year

Revenue Section and GIS Section

10 B Update property data based and issue IPT bills All taxpayers will be pre informed about the IPT liability

From FY 2013/14 Revenue Section

11 A1 Manage necessary staff to deliver letters to the tax payers. Make one staff responsible for preparing list of big tax payers and closely monitor and follow up and review the progress made periodically.

Improved revenue collection February, 2012 Revenue Section

Vehicle Tax

12 A1 Start process to establish a system of no annual renew of vehicles by the Transport Management Office without vehicle tax clearance of the municipality.

Expected revenue from the vehicle tax will be realized

Mid February, 2012 Municipal Board,Executive Officer and Revenue Section,

Business Tax 13 A2 Enter into dialogue with the local chamber of

commerce and hold regular meeting with them for their support.

Build up trust and cooperation Continue Municipal Board, Executive Officer, Revenue Section

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14 A3 Start exchange of data and sharing experiences with Inland Revenue Office.

Improved collection and exchange of information From FY 2011/12 Executive Officer, Revenue Section, Revenue Advisory

Committee

15 A2 Establish business tax administration computer software and provide training; Data entry of available Business tax records.

Managed business tax records and improve in revenue collection

February, 2013 Revenue Section, and Executive Officer

16 A3 Constitute a Task Force to collect business records and tax with the support of ward offices and local CCI and professional associations.

Updated business records

March, 2012 Revenue Section

17 B Integrate business tax records with integrated Property Tax data base

Introduction of one door municipal tax collection

FY 2013/14 – 10% , FY 2014/15 – 20%, FY 2015/16 – 30% , 100% in 4th Fiscal

Year

Revenue Section

Building Permit Fee

18 A3 Maintain and update the building permit records in digital format.

Improved recording system

From 2012/13 Building Permit Section

19 B Maintain close linkage with the GIS and Revenue Section.

Improved coordination

After establishing GIS System under DUDBC

Revenue Section, Building Permit Section, GIS Section

Solid Waste Management Fee 20 A3 Frame out a policy in introducing the solid

waste management fee. Policy formulated to in introducing SWM fee

June 2012 SWM Section, Revenue Section and Municipal Board

21 A3 Introduce Solid Waste Management Fee at 5% of Integrated Property Tax

Fee collection system will start for solid waste management

FY 2012/13 Municipal Council and Finance Section

22 B Increase Solid Waste Management Fee from 5% to 20% of Integrated Property Tax to operate additional urban services established under IUDP

Additional fund collected to operate and maintain infrastructures established under IUDP

FY 2015/16 Municipal Council and Revenue Section

Source: ADB TA, Strengthening Municipalities for Urban Service Delivery (CFMIP Nepalgunj)

A1 = CFMIP Activity Completed, A2 = CFMIP Activity in Progress, A3 = CFMIP Activity No Progress, B = CFMIP Activity Planned in Future.

115

Annex 4.1: Projection of Infrastructure Financing Gap of the Municipalities (Rs in billions)

Source and Use of Municipal Fund 2015/16

1st Five Year 2nd Five Year 3rd Five Year Total 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26 2026/27 2027/28 2028/29 2029/30 2030/31

1) Own Source Revenue 8.55 9.49 10.55 11.74 13.08 15.13 17.49 20.23 23.40 27.07 31.32 36.24 41.95 48.56 56.21 65.09 427.54

2) Recurrent Expenditure 7.11 8.18 9.40 10.81 12.44 14.30 16.45 18.91 21.75 25.01 28.76 33.08 38.04 43.75 50.31 57.85 389.04

3) PREVIOUS DEBT SERVICES 0.09 0.11 0.19 0.20 0.30 0.34 0.33 0.32 0.31 0.30 0.29 0.29 0.28 0.28 0.28 0.28 4.11 4) Revenue Surplus (1-2-3) 1.35 1.20 0.96 0.72 0.34 0.48 0.71 0.99 1.33 1.76 2.26 2.88 3.62 4.53 5.62 6.96 34.38 5) Unconditional Grant (IGFT) 9.73 10.95 12.31 13.85 15.58 17.53 19.72 22.19 24.96 28.08 31.59 35.54 39.99 44.99 50.61 56.94 424.85 6) Revenue Sharing (IGFT) 1.31 1.48 1.67 1.90 2.16 2.47 2.93 3.48 4.12 4.90 5.81 6.90 8.20 9.75 11.59 13.79 81.15 7) Conditional Grant (IGFT) 9.55 9.82 10.10 10.39 10.68 13.51 14.72 16.03 17.47 19.03 20.74 22.59 24.61 26.82 29.22 31.83 277.56 8) Amount Available for Capital Investment (4+5+6+7) 21.93 23.45 25.04 26.86 28.77 34.00 38.09 42.69 47.89 53.77 60.41 67.92 76.43 86.08 97.04 109.51 817.94

Total Investment Need (Scenario 1: meeting 60% of physical target) 67.11 69.90 72.68 75.58 78.59 81.72 84.98 88.36 91.88 95.54 99.35 103.31 107.42 111.70 116.15 120.78 1,397.95

Total Investment Need (Scenario 1: meeting 75% of physical target) 83.89 87.37 90.85 94.47 98.24 102.15 106.22 110.45 114.85 119.43 124.19 129.13 134.28 139.63 145.19 150.98 1,747.44

Total Investment Need (Scenario 1: meeting 90% of physical target) 100.67 104.85 109.02 113.37 117.88 122.58 127.46 132.54 137.82 143.31 149.02 154.96 161.14 167.56 174.23 181.17 2,096.93

Financing Revenue Surplus 1.35 1.20 0.96 0.72 0.34 0.48 0.71 0.99 1.33 1.76 2.26 2.88 3.62 4.53 5.62 6.96 34.38 Total IGFT 20.59 22.24 24.08 26.14 28.42 33.52 37.37 41.70 46.56 52.01 58.14 65.04 72.80 81.55 91.42 102.56 783.56 Market Borrowing (Capacity Constraints as 25% of Revenue Surplus)

0.34 0.30 0.24 0.18 0.09 0.12 0.18 0.25 0.33 0.44 0.57 0.72 0.91 1.13 1.41 1.74 8.60

Net Financing Requirement (Scenario 1)

44.84 46.15 47.40 48.54 49.74 47.60 46.71 45.42 43.66 41.33 38.38 34.67 30.09 24.49 17.70 9.53 571.41

Net Financing Requirement (Scenario 2)

61.62 63.63 65.57 67.44 69.38 68.03 67.95 67.51 66.63 65.22 63.21 60.50 56.95 52.42 46.74 39.72 920.90

Net Financing Requirement (Scenario 3)

78.40 81.10 83.74 86.33 89.03 88.46 89.20 89.60 89.60 89.10 88.05 86.33 83.80 80.34 75.78 69.92 1,270.39

Cost Sharing (3%) 1.35 1.38 1.42 1.46 1.49 1.43 1.40 1.36 1.31 1.24 1.15 1.04 0.90 0.73 0.53 0.29 17.14

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Source and Use of Municipal Fund 2015/16

1st Five Year 2nd Five Year 3rd Five Year Total 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26 2026/27 2027/28 2028/29 2029/30 2030/31

PPP (3%) 1.35 1.38 1.42 1.46 1.49 1.43 1.40 1.36 1.31 1.24 1.15 1.04 0.90 0.73 0.53 0.29 17.14 PCP (included NGO) (2%) 0.90 0.92 0.95 0.97 0.99 0.95 0.93 0.91 0.87 0.83 0.77 0.69 0.60 0.49 0.35 0.19 11.43

TDF Financing Requirement (Scenario 1) 41.25 42.46 43.61 44.66 45.76 43.79 42.97 41.79 40.16 38.03 35.31 31.90 27.68 22.53 16.29 8.77 525.70

Cost Sharing (3%) 1.85 1.91 1.97 2.02 2.08 2.04 2.04 2.03 2.00 1.96 1.90 1.81 1.71 1.57 1.40 1.19 27.63 PPP (3%) 1.85 1.91 1.97 2.02 2.08 2.04 2.04 2.03 2.00 1.96 1.90 1.81 1.71 1.57 1.40 1.19 27.63 PCP (included NGO) (2%) 1.23 1.27 1.31 1.35 1.39 1.36 1.36 1.35 1.33 1.30 1.26 1.21 1.14 1.05 0.93 0.79 18.42

TDF Financing Requirement (Scenario 2) 56.69 58.54 60.33 62.04 63.83 62.59 62.52 62.11 61.30 60.00 58.16 55.66 52.39 48.22 43.00 36.55 847.23

Cost Sharing (3%) 3.92 4.05 4.19 4.32 4.45 4.42 4.46 4.48 4.48 4.46 4.40 4.32 4.19 4.02 3.79 3.50 63.52 PPP (3%) 2.35 2.43 2.51 2.59 2.67 2.65 2.68 2.69 2.69 2.67 2.64 2.59 2.51 2.41 2.27 2.10 38.11 PCP (included NGO) (2%) 1.57 1.62 1.67 1.73 1.78 1.77 1.78 1.79 1.79 1.78 1.76 1.73 1.68 1.61 1.52 1.40 25.41

TDF Financing Requirement (Scenario 3) 70.56 72.99 75.37 77.70 80.13 79.61 80.28 80.64 80.64 80.19 79.25 77.69 75.42 72.31 68.20 62.93 1,143.35

i) The projected financing gap has been arrived at by assuming 15% growth of recurrent expenditure, 16% growth of OSR, and 12.5% growth of IGFT based on estimated amount for 2015/16. Average recurrent expenditure growth of 35 municipalities (except Metro and Sub Metro) has been taken for the projection of recurrent expenditure of remaining all 170 municipalities (which is 15% and derived by adding up 3% to the 12% actual growth rate). Own Source Revenue assumed to be increased by 16% for old 58 municipalities but for the remaining new 159 municipalities, it is assumed to grow by 8% (half the rate of old municipalities) for first three years and then by 16% throughout the projection period..

ii) The Investment Need Target is set as 60% for scenario 1, 75% for scenario 2 & 90% for scenario 3 for 217 municipalities on the basis of amount estimated by NUDs for 58 municipalities

iii) Market Borrowing (Capacity Constraints) is considered as 25% of Revenue Surplus that means constraints of market borrowing with potential municipal revenue for capital investment

117

Annex 4.2

Scenario 2: OSR estimated with 50% Incremental in the Historical Growth Trend of Taxes and Service Fees (Rs billion)

Source and Use of Municipal Fund 2015/16 1st Five Year 2nd Five Year 3rd Five Year

Total 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26 2026/27 2027/28 2028/29 2029/30 2030/31

1) Own Source Revenue 8.94 10.20 11.70 13.48 15.61 18.71 22.45 26.98 32.4 39.15 47.25 56.05 64.95 75.28 87.25 101.14 622.68 2) Recurrent Exp. 7.11 8.18 9.40 10.81 12.44 14.30 16.45 18.91 21.75 25.01 28.76 33.08 38.04 43.75 50.31 57.85 389.04 3) Previous Debt Services 0.09 0.11 0.19 0.20 0.30 0.34 0.33 0.32 0.31 0.30 0.29 0.29 0.28 0.28 0.28 0.28 4.11 4) Revenue Surplus (1-2-3) 1.74 1.91 2.11 2.46 2.87 4.06 5.67 7.75 10.42 13.84 18.20 22.69 26.63 31.25 36.66 43.01 229.52 5) Unconditional Grant (IGFT) 9.73 10.95 12.31 13.85 15.58 17.53 19.72 22.19 24.96 28.08 31.59 35.54 39.99 44.99 50.61 56.94 424.85

6) Revenue Sharing (IGFT) 1.31 1.48 1.67 1.90 2.16 2.47 2.93 3.48 4.12 4.90 5.81 6.90 8.20 9.75 11.59 13.79 81.15 7) Conditional Grant (IGFT) 9.55 9.82 10.10 10.39 10.68 13.51 14.72 16.03 17.47 19.03 20.74 22.59 24.61 26.82 29.22 31.83 277.56

8) Amount Available for Capital Investment (4+5+6+7)

22.32 24.16 26.19 28.60 31.29 37.58 43.05 49.45 56.97 65.85 76.34 87.73 99.43 112.80 128.08 145.56 1,013.09

Total Investment Need (Scenario 1: meeting 60% of physical target) 67.11 69.90 72.68 75.58 78.59 81.72 84.98 88.36 91.88 95.54 99.35 103.31 107.42 111.70 116.15 120.78 1,397.95

Total Investment Need (Scenario 1:

meeting 75% of physical target) 83.89 87.37 90.85 94.47 98.24 102.15 106.22 110.45 114.85 119.43 124.19 129.13 134.28 139.63 145.19 150.98 1,747.44

Total Investment Need (Scenario 1:

meeting 90% of physical target) 100.67 104.85 109.02 113.37 117.88 122.58 127.46 132.54 137.82 143.31 149.02 154.96 161.14 167.56 174.23 181.17 2,096.93

Financing

Revenue Surplus 1.74 1.91 2.11 2.46 2.87 4.06 5.67 7.75 10.42 13.84 18.20 22.69 26.63 31.25 36.66 43.01 229.52 Total IGFT 20.59 22.24 24.08 26.14 28.42 33.52 37.37 41.70 46.56 52.01 58.14 65.04 72.80 81.55 91.42 102.56 783.56 Market Borrowing (Capacity Constraints as 25% of Revenue Surplus)

0.43 0.48 0.53 0.62 0.72 1.02 1.42 1.94 2.60 3.46 4.55 5.67 6.66 7.81 9.16 10.75 57.38

Net Financing Requirement (Scenario 1) 44.36 45.26 45.96 46.36 46.58 43.12 40.51 36.97 32.30 26.23 18.46 9.91 1.33 -8.91 -21.09 -35.53 327.48

118

Source and Use of Municipal Fund 2015/16 1st Five Year 2nd Five Year 3rd Five Year

Total 2016/17 2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26 2026/27 2027/28 2028/29 2029/30 2030/31

Net Financing Requirement (Scenario 2) 61.13 62.74 64.14 65.26 66.23 63.55 61.75 59.06 55.28 50.12 43.30 35.74 28.19 19.02 7.95 -5.34 676.97

Net Financing Requirement (Scenario 3) 77.91 80.21 82.31 84.15 85.87 83.98 83.00 81.15 78.25 74.00 68.13 61.56 55.05 46.94 36.99 24.86 1,026.46

Cost Sharing (3%) 1.33 1.36 1.38 1.39 1.40 1.29 1.22 1.11 0.97 0.79 0.55 0.30 0.04 -0.27 -0.63 -1.07 9.82 PPP (3%) 1.33 1.36 1.38 1.39 1.40 1.29 1.22 1.11 0.97 0.79 0.55 0.30 0.04 -0.27 -0.63 -1.07 9.82 PCP (included NGO)(2%) 0.89 0.91 0.92 0.93 0.93 0.86 0.81 0.74 0.65 0.52 0.37 0.20 0.03 -0.18 -0.42 -0.71 6.55

TDF Financing Requirement (Scenario 1) 40.81 41.64 42.29 42.65 42.85 39.67 37.27 34.02 29.72 24.13 16.98 9.12 1.23 -8.20 -19.40 -32.69 301.29

Cost Sharing (3%) 1.83 1.88 1.92 1.96 1.99 1.91 1.85 1.77 1.66 1.50 1.30 1.07 0.85 0.57 0.24 -0.16 20.31 PPP (3%) 1.83 1.88 1.92 1.96 1.99 1.91 1.85 1.77 1.66 1.50 1.30 1.07 0.85 0.57 0.24 -0.16 20.31 PCP (included NGO)(2%) 1.22 1.25 1.28 1.31 1.32 1.27 1.24 1.18 1.11 1.00 0.87 0.71 0.56 0.38 0.16 -0.11 13.54

TDF Financing Requirement (Scenario 2) 56.24 57.72 59.00 60.04 60.93 58.47 56.81 54.34 50.85 46.11 39.83 32.88 25.94 17.50 7.31 -4.91 622.81

Cost Sharing (5%) 3.90 4.01 4.12 4.21 4.29 4.20 4.15 4.06 3.91 3.70 3.41 3.08 2.75 2.35 1.85 1.24 51.32 PPP (3%) 2.34 2.41 2.47 2.52 2.58 2.52 2.49 2.43 2.35 2.22 2.04 1.85 1.65 1.41 1.11 0.75 30.79 PCP (included NGO)(2%) 1.56 1.60 1.65 1.68 1.72 1.68 1.66 1.62 1.56 1.48 1.36 1.23 1.10 0.94 0.74 0.50 20.53

TDF Financing Requirement (Scenario 3) 70.12 72.19 74.08 75.74 77.29 75.59 74.70 73.04 70.42 66.60 61.32 55.41 49.54 42.25 33.29 22.37 923.81

Note: At this Scenario 2, OSR is estimated with 50% Incremental in the Historical Growth Trend of Taxes and Service Fees. This assumption growth rates will then be 25.2% for taxes and 22.8% for service charges.

119

Annex 4.3

Scenario 3: OSR estimated with 75% Incremental in the Historical Growth Trend of Taxes and Service Fees (Rs billion)

Source and Use of Municipal Fund 2015-16

1st Five Year 2nd Five Year 3rd Five Year Total

2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29 2029-30 2030-31

1) Own Source Revenue 9.13 10.57 12.32 14.47 17.12 20.95 25.71 31.64 39.05 48.31 59.92 72.28 83.80 97.17 112.69 130.70 776.70

2) Recurrent Expenditure 7.11 8.18 9.40 10.81 12.44 14.30 16.45 18.91 21.75 25.01 28.76 33.08 38.04 43.75 50.31 57.85 389.04

3) Previous Debt Services 0.09 0.11 0.19 0.20 0.30 0.34 0.33 0.32 0.31 0.30 0.29 0.29 0.28 0.28 0.28 0.28 4.11

4) Revenue Surplus (1-2-3) 1.93 2.28 2.73 3.45 4.38 6.31 8.93 12.41 16.98 23.00 30.87 38.91 45.48 53.15 62.10 72.57 383.54

5) Unconditional Grant (IGFT) 9.73 10.95 12.31 13.85 15.58 17.53 19.72 22.19 24.96 28.08 31.59 35.54 39.99 44.99 50.61 56.94 424.85

6) Revenue Sharing (IGFT) 1.31 1.48 1.67 1.90 2.16 2.47 2.93 3.48 4.12 4.90 5.81 6.90 8.20 9.75 11.59 13.79 81.15

7) Conditional Grant (IGFT) 9.55 9.82 10.10 10.39 10.68 13.51 14.72 16.03 17.47 19.03 20.74 22.59 24.61 26.82 29.22 31.83 277.56

8) Amount Available for Capital Investment (4+5+6+7) 22.52 24.53 26.82 29.59 32.80 39.82 46.31 54.11 63.54 75.01 89.01 103.95 118.28 134.70 153.52 175.12 1,167.11

Total Investment Need (Scenario 1: meeting 60% of

physical target) 67.11 69.90 72.68 75.58 78.59 81.72 84.98 88.36 91.88 95.54 99.35 103.31 107.42 111.70 116.15 120.78 1,397.95

Total Investment Need (Scenario 1: meeting 75% of

physical target) 83.89 87.37 90.85 94.47 98.24 102.15 106.22 110.45 114.85 119.43 124.19 129.13 134.28 139.63 145.19 150.98 1,747.44

Total Investment Need (Scenario 1: meeting 90% of

physical target) 100.67 104.85 109.02 113.37 117.88 122.58 127.46 132.54 137.82 143.31 149.02 154.96 161.14 167.56 174.23 181.17 2,096.93

Financing

Revenue Surplus 1.93 2.28 2.73 3.45 4.38 6.31 8.93 12.41 16.98 23.00 30.87 38.91 45.48 53.15 62.10 72.57 383.54

Total IGFT 20.59 22.24 24.08 26.14 28.42 33.52 37.37 41.70 46.56 52.01 58.14 65.04 72.80 81.55 91.42 102.56 783.56

Market Borrowing (Capacity Constraints as 25% of Revenue Surplus) 0.48 0.57 0.68 0.86 1.09 1.58 2.23 3.10 4.25 5.75 7.72 9.73 11.37 13.29 15.53 18.14 95.89

Net Financing Requirement (Scenario 1) 44.11 44.80 45.18 45.13 44.69 40.32 36.43 31.15 24.10 14.78 2.63 -10.37 -22.23 -36.28 -52.89 -72.48 134.96

120

Source and Use of Municipal Fund 2015-16

1st Five Year 2nd Five Year 3rd Five Year Total

2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 2024-25 2025-26 2026-27 2027-28 2028-29 2029-30 2030-31

Net Financing Requirement (Scenario 2) 60.89 62.28 63.36 64.02 64.34 60.75 57.68 53.24 47.07 38.67 27.46 15.46 4.63 -8.36 -23.85 -42.29 484.45

Net Financing Requirement (Scenario 3) 77.67 79.75 81.53 82.92 83.99 81.18 78.92 75.33 70.04 62.55 52.30 41.28 31.49 19.57 5.19 -12.09

833.94

Cost Sharing 3% 1.32 1.34 1.36 1.35 1.34 1.21 1.09 0.93 0.72 0.44 0.08 -0.31 -0.67 -1.09 -1.59 -2.17 4.05

PPP 3% 1.32 1.34 1.36 1.35 1.34 1.21 1.09 0.93 0.72 0.44 0.08 -0.31 -0.67 -1.09 -1.59 -2.17 4.05

PCP (included NGO) 2% 0.88 0.90 0.90 0.90 0.89 0.81 0.73 0.62 0.48 0.30 0.05 -0.21 -0.44 -0.73 -1.06 -1.45 2.70

TDF Financing Requirement (Scenario 1) 40.58 41.22 41.57 41.52 41.12 37.10 33.52 28.66 22.17 13.60 2.42 -9.54 -20.45 -33.38 -48.66 -66.68 124.16

Cost Sharing 3% 1.83 1.87 1.90 1.92 1.93 1.82 1.73 1.60 1.41 1.16 0.82 0.46 0.14 -0.25 -0.72 -1.27 14.53

PPP 3% 1.83 1.87 1.90 1.92 1.93 1.82 1.73 1.60 1.41 1.16 0.82 0.46 0.14 -0.25 -0.72 -1.27 14.53

PCP (included NGO) 2% 1.22 1.25 1.27 1.28 1.29 1.22 1.15 1.06 0.94 0.77 0.55 0.31 0.09 -0.17 -0.48 -0.85 9.69

TDF Financing Requirement (Scenario 2) 56.02 57.29 58.29 58.90 59.19 55.89 53.06 48.98 43.30 35.57 25.27 14.22 4.26 -7.69 -21.94 -38.90 445.69

Cost Sharing 5% 3.88 3.99 4.08 4.15 4.20 4.06 3.95 3.77 3.50 3.13 2.61 2.06 1.57 0.98 0.26 -0.60 3.99

PPP 3% 2.33 2.39 2.45 2.49 2.52 2.44 2.37 2.26 2.10 1.88 1.57 1.24 0.94 0.59 0.16 -0.36 2.39

PCP (included NGO) 2% 1.55 1.60 1.63 1.66 1.68 1.62 1.58 1.51 1.40 1.25 1.05 0.83 0.63 0.39 0.10 -0.24 1.60

TDF Financing Requirement (Scenario 3) 69.90 71.78 73.37 74.62 75.59 73.06 71.03 67.80 63.03 56.30 47.07 37.15 28.34 17.61 4.67 -10.88 750.54

Note: At this Scenario 3, OSR is estimated with 75% Incremental in the Historical Growth Trend of Taxes and Service Fees. This assumption growth rates will then be 29.4% for taxes and 26.6% for service charges.

121

Annex 5.1: Key Institutions Related for Financing (Transfers, OSR and Revenue Sharing, Auditing)

Provisioned under LSGA

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

National Planning Commission (NPC):

- Provide budget ceilings and guide-lines for local planning by November 15 as suggested by resource committee

- Provide directives for formulation of local periodic and annual plans

- Approve local conditional &unconditional grants and program budgets

- Classifies programs as P1, P2 and P3

- Provide guidelines for M&E and harmonization for bringing uniformity in the local plan structures (LIDP)

District Council (DC)

- Approve District periodic plans, annual plans and budgets, including sectoral programs and budgets submitted by DDC

- Approve bylaws, manuals, guidelines

- Formation of account committee, and other sectoral committees

- Approval of the tax rates, fee, charges rates

- Approval of capital development projects for borrowing

- Settlement of audit arrears and objections

Village/Municipal Council (VC/MC)

-Approve of VDC/Municipal periodic and annual plans, programs and budgets submitted by VDC/Municipality - Approve recommended projects

from municipality for financing from TDF and LDF

- Approve tax rates, fee, charges rates

- Approve capital development projects for borrowing

- Appoint auditors - Settle audit arrears and objections

Ministry of Finance (MoF)

- Allocation and mobilization of local and foreign resources

- Approval of local plans, programs, projects and budgets as per recommended categories of NPC

- Issue authorization letters for budget release to respective ministries

- Authorize unconditional grants directly to Local Bodies as recommended by MoFALD

District Development Committee (DDC)

- Implement plans, programs as approved by DC, and follow the instructions of DC

- Planning, implementation, monitoring, evaluation and maintenance of District level projects including infrastructures

- Develop district periodic plan and DTMPs

- Establish district plan formulation committees and integrated plan formulation committee

Village Development Committees (VDC) and Municipalities

- Implement, monitor and maintain programs within VDC/Municipality

- Prepare periodic plans, resource maps, feasibility studies

- Prioritize and select projects - Coordinate among different GoN

agencies and I/NGOs Implement, manage ,supervise, monitor and review projects under their jurisdictions

- Select feasible physical, social,

122

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

- Review national priority programs on bi-monthly basis

- Fund release and tracking through FCGO/ DTCOs

- Prepare resource maps, conduct feasibility studies, prioritize and select projects

- Coordinate among different GoN agencies and I/NGOs at district level for resource mobilization/ use of resources

- Form users groups and identify NGOs for implementation of projects

- Supervise, monitor, review and evaluate projects

- Establish sector specific sections to carry out development functions

- Coordinate VDC, Municipalities and Line agencies, to share and allocate resources among LBs and Line agencies as conditional, unconditional and revenue sharing grants to VDCs

- Select final auditors for VDCs and conduct internal auditing of VDC accounts

- Conduct public/social audits, public hearings

environmental projects for borrowing

- Identify projects for financing from Municipal Reserve fund and deciding the percentage of matching grant

-Conduct internal and final audits of VDCs/Municipalities - Conduct public/social audits

Local Body Fiscal Commission (LBFC)

- Advice GoN to institutionalize four pillars of fiscal decentralization 38 in Nepalese context - carryout studies and research on different pillars of fiscal

Public Private partnership (PPP) promotion committee

- to promote and systematize public private partnership system within their jurisdiction

- Identify PPP projects - Conduct Feasibility studies of PPP

Public Private partnership (PPP) promotion committee

- Identify, promote and systematize public private partnership system within municipal jurisdiction

- Identify PPP projects - Conduct Feasibility studies of PPP

38 Expenditure assignments, revenue assignments, Intergovernmental fiscal transfers and borrowings

123

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

Decentralization such as revenue potentials - develop system on expenditure management including accounting and auditing system of LBs - design and suggest allocation

criteria and formula for performance based conditional/ un conditional grant to maintain equalization grant allocations

- suggest tax and revenue sharing system and mechanisms from central level to LBs and among LBs

projects, support projects for implementation

- Setup proper organizational structures within DDC

projects, support projects for implementation

- Setup proper organizational structures within municipality

Ministry of Federal Affairs and Local Development (MoFALD)

- Focal Ministry for local bodies - Support to policy formulation on

decentralization and local governance and development,

- support local planning implementation, monitoring and standard setting, and information management,

- Coordinate with different Ministries, agencies, development partners and institutions I/NGOs, private sector and Local Bodies for resource mobilization

- Provide directives and guidelines to LBs

- Deputes LDO, Executive Officers and VDC secretary as well as other officials upon request of

Subject specific plan formulation committees

- Scrutinize construction-related programs and projects that are received from Ilaka level service centers, line departments and other agencies and forward to IPFC

Integrated Plan Formulation Committee (IPFC)

- Recommend plans and programs that are submitted by different ward citizen forums (WCFs) to respective VDCs/Municipalities

124

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

concerned LBs Integrated plan

Formulation Committee (IPFC)

- Recommend synergized plan and programs that are submitted by different subject specific plan formulation committees to DDC

Ward Citizen Forums (WCFs)

- Prepare compile, integrate and prioritize different projects/ programs received from different communities/groups from settlement and neighborhood levels

Ministry of Urban Development

- Responsible for formulation, implementation, monitoring, regulate and evaluation of Urban development and infrastructure development policy and plans/ programs

- Approve NUDS for resource mobilization by gap identification

- Provide support and coordinate Municipal infrastructure including physical planning and implementation , coordination , Monitoring and Evaluation of Municipal level projects supported through respective departments, urbanized areas and Town Development Committees

- Urbanization, urban land use planning and its implementation

- Support to maintain Drinking water, sanitation and sewerage system from respective departments/authorities

- Municipal roads except strategic road network

Ilaka level, service centres

- Examine and prioritize programs and projects that are submitted by VDCs/Municipalities and make recommendations to different Subject Specific plan formulation committees at DDC level

Community groups and users

- Identify and submit projects to WCFs

- Contribute financial resources for projects as matching funds

- Implement selected projects within their jurisdiction even contributing their time, labor and efforts

- Conduct public audits

125

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

- Link agency for TDF, KDVA, KUKL, NDWC, SWMC, Drinking Water Tariff charge determination commission

- Design and construction of specialized urban structures

Financial Comptroller General Office (FCGO)

- Release capital andoperational budget according to authorization letter of MoF, and other Ministries

- National Treasury management, - tracking expenditures and manage

FMIS

District Technical Office (DTO)

- Provide technical support to LBs for planning, implementation, supervision, monitoring, evaluation and reporting

- Prepare district specific norms and specifications and establish quality control labs or ensure quality control

- Support local mechanisms for ensuring technical quality, develop guidelines and manuals for DDCs and other LBs

- Prepare cost estimates, bid documents, design, drawings, agreement documents, measurement books, and other construction related documents and submit for approval to respective agencies for management and final payment activities

- Conduct technical supervision of local level infrastructure projects and prepare cost variations

- Prepare progress reports and forward to respective agencies, including DDCs and DoLIDAR

Construction committees, User Groups

- Facilitate participation by users of services

- Promote inclusive, representative and gender friendly construction committees for project implementation

- Establish monitoring committee during construction

- Conduct public audits - Conduct local procurement of

goods and services - Collect service charges - Report to concerned LBs and

other respective agencies

126

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

Department of Local Infrastructure Development and Agricultural Roads (DoLIDAR)

- Mandated to provide technical support to LBs including municipalities to fulfill the objectives and mandate of the LIDP

- Provide support to DDC/VDC for Planning, budgeting, implementation, monitoring and reporting along with technical guidance and follow-up

- Provide technical supervision of programs and projects implemented by DDCs/VDCs, GoN and different DPs for maintaining quality

- Provide technical support to MoFALD to formulate local infrastructure policies/strategies and operational guidelines for LBs

- Develop manuals, guidelines, technical norms, standard specifications related to local infrastructure services

- Coordinate with different departments, LBs and other stakeholders concerning local infrastructure

- Collects operation and maintenance plans of local roads(municipal and district) and allocates maintenance budget received from RBN

District Treasury Comptroller Office (DTCO)

- Releases budget to LBs as per authorization letters

- Manages TSA at local level - Conduct internal audits of GoN

offices, however DDC/VDC account is audited by internal auditor appointed by DDC itself

- Municipal accounts also audited by private auditors

- -

I/NGOs - Carry out different development and

empowerment related programs at local level with coordination of DDCs

- Carryout programs by mobilizing matching funds

- Support capacity development of LBs including DDCs

- Support to implement innovative programs for wider replication on other areas

Private sector (contractors, consulting firms)

- Provide services for the implementation of local level infrastructures, environment and disaster related projects

- Provide consulting services for designing, supervision and technical quality control

- Conduct IEE/EIA, monitoring and reporting

127

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

DUDBC, Water and sanitation related agencies/departments (KUKL, NWC, SWMC inter agency authorities)

- Support technically to municipalities for building subject specific infrastructures with consultations with LBs especially municipalities

- Provide development budgets to the municipalities for infrastructures and implement through their divisions, line agencies/offices

Inter LB joint coordination committees

- Coordinateand build backward and forward linkages between and among the LBs on horizontal basis, such as VDC-VDCs, VDC-Municipality, Municipality- DDC and DDC- VDC

- develop joint mechanisms, process and manage jointly on LSGR specified areas

Local Chamber of commerce and industries (CCI)

- represent and build partnership at local level with LBs in the areas of construction, revenue raising and collection of business taxes

Revenue recommendation Committee

- suggest MoFALD on LBs tax, fees, charges, sales and recommend on rates - develop revenue collection process and procedures within the mandate of LSGA/R

-

Town Development Committees(TDCs)

MoUD forms TDCs for overall development towns and emerging towns, facilitates town development land use and master plans, Sets norms and standards within the town, Pools land and sales the land, creates physical infrastructures including roads,

Local Development Fee”(LDF) Fund Management Committee

- Responsible for distribution of Local development Fee substitute grant to all municipalities

- Established Municipal Reserve fund to Finance Municipal social, environmental and physical infrastructure development projects on community/ municipal cost sharing basis

-

Town Development Fund(TDF)

- Strength organizational capability of municipalities for implementing need-specific investment projects - Loan financing of urban infrastructure development,

-

128

CENTRAL GOVERNMENT LEVEL DISTRICT LEVEL VILLAGE/MUNICIPAL LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

supplemented by grants - Support to municipalities in

formulation of master plans, project identification and prioritization of competing community needs, concept development, project design and engineering, tendering and supervision of construction.

- supports design and supervision management (DSM) of social and economic infrastructures and revenue earning projects

- Mobilizes resources from GoN, DPs and other resources for TA, grant support and for loan services to municipalities

Source: Authors' derivation 2015

129

Annex 5.2: Institutional Structures as Provisioned in New Constitution of Nepal

FEDERAL GOVERNMENT LEVEL PROVINCIAL LEVEL LOCAL (VILLAGE/MUNICIPAL) LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

Federal Government

- Federal government will focus mostly on Policies and Mega projects of National interest

- About 35 functional (expenditure and revenue) assignments are provisioned in annex-5 of the constitution

- Authority to formulate their annual budgets, prepare policies and programs and implement them within their functional jurisdictions.

- Residual powers will remain with Federal governments

- Relations between three levels will be based on the principles of cooperation, coexistence and coordination

- Enact law relating to concurrent functions along with other financial authority and can formulate policies, standards and legislations binding for provinces as well

- The GoN will provide equalization grant to provincial and local levels on the basis of expenditure requirements and revenue raising capacity

- right to accept foreign loan, grants and enact legislation to manage fiscal deficit, maintain other fiscal discipline at Federal, provincial and local level

- share revenue collected judiciously and equitably among each level of

Provincial council and provincial government

- Provincial government is responsible for implementing provincial level projects

- 21 functions, and on top of 25 Concurrence functions between federal and provincial governments and 15 concurrent assignments for three level of governments

- Authority to formulate their annual budgets, prepare policies and programs and implement them within their functional jurisdictions.

- Authority to approve their program and budget

- Share its resources as equalization grants on the basis of expenditure requirements and revenue capacity to local level

- Provincial legislative council has the authority to submit its finance bill regarding the revenue assignments

- Manage financial administration including accounting and auditing.

- Borrowing of the province will be guided by federal law.

- Provision of provincial consolidated treasury.

- Authority to manage all the financial matters and procedures through

Gaunpalika and Municipal councils and executives

- Constitution has authorized local assignments (annex-8) comprises 22 functions, and 15 concurrent assignments (annex9) for three level of governments

- The Gaunpalika and Municipalities have to get approval the projections of their revenue and expenditures from their respective councils.

- If needs to submit deficit budget they have to follow the provisions of federal and provincial laws

- The local law will decide about all the procedures for expenditures out of that consolidated local treasury

- Authorized to approve their rules, by laws and procedures

-

130

FEDERAL GOVERNMENT LEVEL PROVINCIAL LEVEL LOCAL (VILLAGE/MUNICIPAL) LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

government provincial procedural law - The provincial council may resolve

the dispute upon coordination and consultation with respective gaunpalikas, Municipalities and District coordination committees. The dispute settlement procedures will be detailed in provincial laws

- Provincial cabinet will act as an executive of provincial council. The number will not exceed 20% of the council members

National Natural Resources and Fiscal Commission

- Determine extensive grounds and measures, regarding the distribution of revenue from the federal consolidated fund to all three levels of governments

- Making recommendations on distribution of equalization grants to all three levels from federal consolidated fund.

- Authorized to conduct research and studies for distribution of conditional grants to provincial and local governments

- Recommend for determining extensive grounds and measures regarding the distribution of revenue between provincial and local governments

- Recommend measures of reforms on responsibilities of expenditures and revenue generation for internal loans for each levels

- Recommend base for computing share

Inter provincial council for dispute settlements

- Provisioned for resolving political disputes arose between federal and provincial and between the provinces

District Council and district Coordination Committee

- Bring coordination between Municipalities and Gaunpalikas

- Monitor for maintaining balance between development and construction works.

- To maintain coordination between existing federal and provincial government offices and Municipalities and Gaunpalikas.

- Other responsibilities process and procedures of district council will be detailed out by provincial law

131

FEDERAL GOVERNMENT LEVEL PROVINCIAL LEVEL LOCAL (VILLAGE/MUNICIPAL) LEVEL

Institutional stakeholder Main roles and responsibilities Institutional

stakeholder Main roles and responsibilities Institutional stakeholder Main roles and responsibilities

of investment and return for exploiting natural resources and coordination and mitigation of disputes likely to arise regarding distribution of natural resources among and between different entities

Constitution Bench of Supreme court

- Authorized to repeal contradictory acts that contradict with federal law

- Decide on conflict raised regarding their authority among and between governments

- Decide on cases related to election of the members and their disqualification

Local level Judicial committee

- Responsible for to settle disputes

within their jurisdiction

Auditor General - Responsible for conducting audit even for provincial and local level councils and offices on the basis of regularity, economy, efficiency, effectiveness and rationality.

Public service Commission

- Responsible for conducting examinations of even public entities

Source: The constitution of Nepal, 2015

132

Annex: 5.3: Budget Ceiling, Guidelines, Authorization, Funds Flow & Revenue Sharing Mechanism

Source: Authors' derivation 2015

Note: NPC = National Planning Commission, MoF = Ministry of Finance, MoFALD = Ministry of Federal Affairs and Local Development, MoUD = Ministry of Urban Development, LMs = Line Ministries, FCGO = Financial Comptroller General Office, Dept./Auth. = Department & Authorities, TDF = Town Development Fund, RBN = Road Board Nepal, RGD = Revenue Generating Department, DTCO = District Treasury Comptroller Office, DDC/DDF= District Development Committee/District Development Fund, DLAs = District Line Agencies, DRGOs = District Revenue Generating Office, I/NGO & Pvt. = International / Non-Governmental Organization & Private Sectors, Mun./MDF = Municipalities/Municipal Development Fund.

DPS MOF

DTCO

FCGO

DDC/DDF

MUN./MDF

OTHER LMS

MOFALD MOUD

NPC (RESOURCE

COMMITTEE)

TDF DEPT./

AUTH. RBN RGD

I/NGO/ &

PVT.

COMMUNITIES

DLAS DRGOS