This Selected Issues paper and Statistical Appendix reviews agricultural productivity in Nepal and examines its links at the regional and aggregate levels to the amounts of available inputs such as chemical fertilizers, irrigation water, and improved seeds, as well as rainfall, rural credit, and foreign aid. The paper highlights factors that are statistically correlated with agricultural productivity and, as importantly, those that are not. The paper examines causes for the recent export slowdown. The bottom-heavy civil service structure is also described.


This Selected Issues paper and Statistical Appendix reviews agricultural productivity in Nepal and examines its links at the regional and aggregate levels to the amounts of available inputs such as chemical fertilizers, irrigation water, and improved seeds, as well as rainfall, rural credit, and foreign aid. The paper highlights factors that are statistically correlated with agricultural productivity and, as importantly, those that are not. The paper examines causes for the recent export slowdown. The bottom-heavy civil service structure is also described.

III. Fiscal Decentralization29

A. Introduction

1. Nepal remains among the poorest countries in the world with forty percent of the population living in poverty. Poverty incidence has not declined over the last two decades, with disparities perceived to be widening across regions, ethnic groups, and genders. The forthcoming Poverty Reduction Strategy Paper identifies poor service delivery in the rural areas resulting from inefficient public resource management as among the main causes of pervasive poverty.

2. The government has decided to devolve a significant part of spending responsibilities especially in social areas to improve service delivery, and to a lesser extent, revenue-raising responsibilities. This action stems from the belief that local governments are in principle better equipped to design and implement policies tailored to local residents’ needs and preferences—especially of the poor. In addition, a higher degree of local autonomy and hence local participation in collective decision-making is believed to reduce perception of alienation among residents outside the major urban centers. Proponents of decentralization argue that, if these effects in fact could be realized, decentralization would also weaken the base for support for the Maoist movement.

3. A legal framework and implementation plans for decentralization are being prepared. The Local Self-Governance Act (LSGA) was enacted in 1999 and associated regulations were issued in 2000. They define legal and institutional framework for the local government structure geared toward decentralization. However, other relevant laws have not been amended in line with provisions of the LSGA. As a consequence, the current legal framework contains duplications and inconsistencies with regard to roles and responsibilities of central and local governments.30 To move ahead with decentralization, the government issued in January 2002 a Decentralization Implementation Plan (DIP), a comprehensive strategy to implement fiscal decentralization. In addition, an Immediate Action Plan (LAP) was issued in July 2002. The IAP contains a plan to develop a grant allocation formula based on poverty situations in individual jurisdictions and to devolve management of limited numbers of primary schools and health sub-posts to local communities.

4. The chapter discusses the status of these plans and the future prospects for decentralization. It first describes Nepal’s current local government system along with its revenue base and expenditure assignments. The next two sections discuss the government’s ongoing reform initiatives and challenges ahead. The paper concludes with a few key observations including the need to proceed carefully to ensure benefits of decentralization can be reaped.31

B. Local Government Structure

Levels of Local Governments

5. Nepal has two tiers of local governments: district governments at the higher tier, and municipal and village bodies at the lower tier (Figure III.1). The LSGA spells out roles and responsibilities of these local governments.

Figure III.1.
Figure III.1.

Nepal: Intergovernmental Relations

Citation: IMF Staff Country Reports 2002, 206; 10.5089/9781451829952.002.A003

6. District Development Committees (DDC), district level governments, coordinate between the central government and lower-tier local governments. There are 75 DDCs. DDCs plan and monitor implementation of development projects within the jurisdiction, and participate in the central government’s budgetary process. DDCs also provide technical, managerial, and financial support to lower-tier local bodies. Each district has a district council comprising mayors and deputy mayors of municipalities, chairpersons and vice chairpersons of village development committees, and chairperson, vice chairperson, and members of the concerned DDC. All these officials are elected through local elections every five years.32

7. Municipalities and village councils constitute second-tier local governments. The 58 municipalities govern local urban areas and each municipality (an average population size of 60,000) has a council consisting of mayor, deputy mayor, and nominated members. The 3,913 village bodies are called Village Development Committees (VDC) served by chair and vice chairpersons. The average population size of a village is 5,000.

8. The LSGA authorizes local governments to hire their own staffs but the center sends staff to facilitate and monitor local government management. Local government staffs are generally limited to lower-level civil servants. The central government appoints a secretary in each local government to monitor local government activities, and deputes additional professional staff such as accountants and engineers at DDCs. They are paid by and accountable to the central government. Nevertheless, the overall extent of monitoring is weak, reflecting lack of established monitoring standards and insufficient (and sometimes undermotivated) deputed central government staff—350 VDC secretary positions are currently vacant.

Revenue Base of Local Governments

9. Local governments’ own revenue collection is limited despite the provisions of the LSGA, which in principle allow them to collect various taxes and fees (Table III.1). Local revenue collection is low as business opportunities in most jurisdictions are limited and the capacity of local tax officials is weak. Also, as the legal framework does not define the role of each level of the government consistently, the central authorities continue to provide most public services needed in local jurisdictions. This reduces local authorities’ incentives to raise own revenues as they depend on the center for provision of necessary services.

Table III.1.

Financial Resource Base in Local Governments

(As of July 2002)

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Source: Financial Provision of Local Self-Governance Acts 1999.

An interim measure to supplement revenue loss from the abolishment of the Octroi tax in 1998/99.

Released amount was reduced by up to 50 percent in 2001/02.

10. Local governments as a result depend heavily on development and administrative grants from the central government but total central government transfers are declining in real terms. The nominal amount of the transfers has stayed relatively constant at Nr3 billion for the last five years (0.7 percent of 2001/02 GDP, or 4 percent of central government total spending in the same year) and its real value has declined by 35 percent over the same period. Of this amount, DDCs receive Nr 700–800 million, municipalities Nr200–300 million, and VDCs nearly Nr2 billion.


11. Central government grants are the largest resources available to DDCs. Development grants cover 40 percent of the cost of selected development and self-help programs. However, criteria for selecting projects eligible for grants are not clear. Other revenue sources in DDCs, albeit limited, include taxation on rural roads and bridges, licensing and renewal fees for video equipments, and sales of natural resources. Some revenue sharing with VDCs and municipalities has also been in place.


12. Total resource available to municipalities is about Nr 1.5 billion a year or ½ percent of 1998/99 GDP (Table III.2). The local development fees (LDF) account for Nr 700½800 million. LDF replaced the Octroi tax (1 percent of invoice of any goods entering a jurisdiction) with the enactment of LSGA 1998/99. LDF is collected at the customs at a rate of 1.5 percent of import duties and allocated across municipalities in proportion to each municipality’s 1997/98 Octroi collection. Because LDF was introduced as an interim measure to replace revenue loss from the abolishment of the Octroi tax, the central government plans to phase out the LDF within five years by broadening municipal revenue sources.

Table III.2.

Municipality Resources, 1996/97–98/99

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Source: Ministry of Local Development.

Percent of total refers to percent of nominal GDP.

13. Central government grants are around 15 percent of available municipal resources. All municipalities receive administrative grants based on the number of local staff. Development grants are provided to less developed municipalities, defined as those with annual revenue generation of less than Nr 10 million. Municipalities can also finance selected social infrastructure projects and revenue generating projects through loans from the Town Development Fund—established in 1989 under the assistance from the World Bank and Germany (GTZ) as a fully autonomous financial institution. Loans are provided for 90 percent of eligible project costs, and repaid at 6 percent interest rate for 10 years after a grace period of two years.


14. VDCs own revenues are also limited. Most of the recurrent fiscal activities in the VDCs are supported by the administrative grant from the central government—an equal amount of Nr 0.5 million for each VDC.33 Collections from other sources, including taxation, fees, and revenue sharing, are reported to be almost negligible at this stage.

Expenditure Assignment

15. Spending responsibilities of central and each level of local governments are not clearly defined. The LSGA defines national or economy-wide functions (for example defense) as those of the central government while services with substantial local benefits (including social sectors, local road maintenance and garbage collection) as those that should be performed by local governments. However, local governments have not taken over most of these responsibilities because (i) preparation for devolution with a timetable and supporting measures started only with DIP; (ii) local governments do not yet have sufficient financial resources or technical capacity to carry out what are described in the LSGA as local government responsibilities; and, most importantly (iii) the central government has continued to provide public services in most jurisdictions due in part to the ambiguities in the legal framework as discussed above. It is also said that central ministries have been reluctant to devolve functions that were under their purview.

16. A significant part of local government spending appears to be recurrent expenditures, and given limited resources, spending on social sector programs is limited DDCs spent Nr 1,360 million in 1999/2000, of which Nr 660 million was recurrent. In case of municipal expenditures, the share of current expenditures increased consistently, reaching about the same level as capital expenditures in 1998/99 (Table III.3). Debt payments on principal and interest have been limited to around 3 percent of the total expenditure. Spending in the VDCs is reported to be almost exclusively on general administration, mostly in the form of salaries and various types of allowances.

Table III.3.

Municipality Expenditure, 1996/97–38/99

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Source: Ministry of Local Development.

Percent of total refers to percent of nominal GDP.

C. Summary of the Ongoing Reform Initiatives

17. With the approval of the DIP and the IAP, implementation of the fiscal decentralization is expected to accelerate. Limited basic education and health services will be devolved to local committee as pilot cases in the IAP, and the Budget 2002/03 has been formulated to incorporate such activities.

Decentralization Implementation Plan (DIP)

18. The government has prepared the DIP after the enactment of the LSGA in 1999 with the aim of formulating a comprehensive time-bound plan toward decentralization. The DIP incorporates views and recommendations of a wide range of concerned parties including government agencies, donors, representatives of the local government associations, and Public Expenditure Review Commission. With the DIP, the government hopes that all decentralization efforts including those made with donor assistance can be brought into a unified and consistent framework.

19. The DIP addresses many important decentralization issues, including planning, budgeting, capacity building, legal framework, and monitoring. It emphasizes the need to enhance local governments’ capacity to raise and manage fiscal resources. DIP also identifies sectors to be devolved in different phases: primary education, basic health, agricultural extension, and postal services in the initial phase; and drinking water, irrigation, road, and rural electrification in the next phase.

20. The DIP consists of 26 major tasks, divided into more than 60 activities, to be implemented by different ministries. Each activity is classified into three different time horizons: short-term activity (within one year), medium-term activity (within three years), and longer-term activity (within five years).

  • Short-term activities focus on building strong revenue base in the local governments by identifying new local revenue sources and establishing an appropriate tax collection system. A grant allocation system will also be designed reflecting local needs and differences (see below), and preparations will be made to introduce proper auditing and accounting systems.

  • In the medium-term, emphases are placed on the implementation of the agenda established in the short-term. These include: implementing the new grant allocation system, reviewing and restructuring local tax and service rates, enhancing local governments’ human capital, ensuring local governments’ functions are properly funded, and installing adequate monitoring and accounting systems.

  • Longer-term activities aim to establish self-governance at local levels. Transfer of local development fees to the municipalities will be eliminated, replaced by sufficient own revenue mobilization. The local government structure will be reviewed, and possibly be streamlined from an efficiency standpoint.

Immediate Action Plan (IAP)

21. The TAP focuses on activities that can be implemented in the immediate future—within this fiscal year. While the DIP provides a comprehensive list of measures toward successful decentralization, its coverage is broad and its proposed measures are still not specific enough for implementing decentralization. To address this and wider economic problems the country is facing, the government has formulated IAP identifying key measures to be implemented immediately. The Plan includes decentralization as part of an important reform agenda.34

22. The first key IAP task associated with fiscal decentralization is to develop a poverty based grant allocation formula by October 31, 2002 to be used in the Budget 2003/04. Survey on human resource development provides necessary information on district-wise indicators of relative poverty.35

23. The other important task in the IAP is to support the devolution of the primary education and basic health sectors in 10 to 12 selected districts, In case of primary education, operation (including management and teacher recruitment) of the 100 public primary schools36 will be handed over to the School Management Committee (SMC) of the concerned schools. Draft of the new Education Act contains a provision which will facilitate the transfer of school management. An elected parent will serve as chairperson of the SMC, and members of the committee will consist of parents and representatives from corresponding local governments.

24. In the health sector, management of about 1,000 sub-health posts will be handed over to the Local Health Office Operating and Management Committee at the VDC level by the end of 2002/03. So far, 20 sub-health posts in ten districts have been identified for immediate devolution. The concerned VDCs and the District Health Offices will be responsible for monitoring the operational status of the sub-health posts including range of services and staff attendance.

D. Challenges Ahead

25. Successful decentralization should lead to better resource allocation and improved service delivery on the ground. This success will, however, be predicated on improved information on local public finance and enhanced accountability and administrative capacity of local authorities. Also, local governments will need to have sufficient financial resources to fund devolved activities. If any of these elements is missing, decentralization efforts could end up in transferring inefficiencies, and possibly corruption, from the center to local levels. Nepal faces significant challenges because many of these required elements are not yet in place.

Capacity of Local Governments

26. The administrative capacity of local governments in planning and delivering public services is weak. Most local governments suffer from insufficient human and physical resources. In particular, management skills are in short supply. Significant technical assistance from the central government and/or donors is needed to address this issue. It is also expected to take some time before adequate skills are accumulated at local levels.

Accountability of the Local Governments

27. Local governments are not held accountable by local residents or the central government mostly because the central government has been providing important public services. But if decentralization is to work well, accountability will be key to success—residents should be able to demand that local governments provide services tailored to their needs while the central government, when it supports local bodies financially, should be able to see to it that the service quality exceeds the minimum acceptable standards. The latter is particularly important when services provided have a large impact outside a single local jurisdiction—such as primary education or flood control.

Monitoring of Local Government Activities

28. Monitoring, reporting, and evaluation of local government fiscal activities have been virtually nonexistent. Collecting and analyzing information on local government finance—and making collected information available—is critical for holding local governments accountable. So far, there is no firm requirement for local governments to report their full budgetary accounts to the central government or make its detail public. The central government on the other hand does not insist on monitoring and evaluating fiscal activities of local governments even though it deputes a secretary to each local government. As a result, no comprehensive local government revenue and spending data are compiled even at aggregate levels.

Financial Resources

29. Local governments do not have sufficient financial resources to carry out devolved functions. Their revenues barely cover basic administrative expenses. The authorities need to gauge the costs of devolved activities, and ensure that local governments can finance them with their own revenues supplemented, as needed, by transfers from the central government. The authorities are in the process of designing a grant allocation formula that takes the local poverty levels into account (as an indicator of social service needs). But, a simple gap-filling grant reduces local governments’ incentives to raise revenues and increases incentives to inflate their needs. Also as the authorities have recently found out, poorer regions tend to have less implementation capacity. It would be important to devise a grant allocation framework that ensures funding without distorting local governments’ incentives to raise revenues or willingness to address poverty issues.

E. Concluding Remarks

30. The concept of fiscal decentralization is appealing, particularly in view of Nepal’s diversity and geographical characteristics as well as its security problems. Decentralization should in principle improve public service delivery meeting the needs of residents and lead to better resource allocation.

31. However, building blocks required for implementing decentralization successfully are largely absent in Nepal. These building blocks include: improved information on local public finance and adequate administrative capacity, as well as accountability of the local authorities. As in many other developing countries, even the most basic demographic information is not available for local units in Nepal, not to mention information on potential revenue capacity of local governments or cost of public service provision. With the lack of available information, it is difficult to hold local governments accountable. Furthermore, administrative capacity of local officials is limited.

32. In this environment, rapid devolution of fiscal activities can pose a significant threat to the central government in maintaining overall fiscal discipline. Examples of such cases can be found in a number of countries, in which fiscal decentralization places severe constraints to macroeconomic management (Ter-Minassian, 1997).

33. Decentralization should thus be implemented cautiously. There should be a clear understanding by both central and local authorities on the activities to be devolved and the timing of devolution, Implementation should be in small steps so that it would be consistent with the pace of development of local capacity. In this regard, the ongoing efforts to start decentralization through transferring to communities management of 100 primary schools and 20 sub-health posts with close monitoring by and technical assistance from both the central government and donors appear appropriate. Larger scale decentralization could take place only after sufficient experience is gained in managing and monitoring the process by both local and central governments.

34. Clear understandings are also needed on the revenue base of local governments and a system of intergovernmental transfers. Such understandings should provide an effective budget constraint to local governments. It is important that the formula for grant allocation should contain no discretionary (or negotiated) element so that local governments’ budget constraint is hard. The formula should also allow local governments to provide an acceptable level of required social services while maximizing incentives to raise local government revenues. Nepal could also learn from other country experience in designing a strategy for decentralization with an appropriate formula for grant allocation.


  • Khadka, Rup, 2002, Municipal Finance in Nepal: With Special Reference to Taxation, CEGG-Nepal, Kathmandu, Nepal.

  • Ministry of Local Development of Nepal, 2000, Detailed Revenue and Expenditure Breakdown of 58 Municipalities in Nepal, 1995/96–1998/99, Kathmandu, Nepal.

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  • National Planning Commission of Nepal, 2002, “Implementation of Reform Agenda,” in Nepal Development Forum 2002, Kathmandu, Nepal.

  • Ter-Minassian, T., 1997, Fiscal Federalism in Theory and Practice, International Monetary Fund, Washington.


Prepared by Joong Shik Lee (APD).


The government has identified 23 sectoral acts conflicting with the LSGA. Of these, 14 acts have been redrafted to make them consistent with the LSGA and submitted to Parliament, but none has been enacted.


Financial information pertaining to local governments in Nepal is extremely limited. Only very rudimentary data are available for municipalities as discussed below.


However, elected posts in the local bodies have been vacant since the tenure of the elected officials expired on July 16, 2002, as previously scheduled local elections were not held due to security reasons in the affected areas. The central government expressed its intention to make appointments to replace all elected representatives instead of extending the tenure of the local elected representatives. This action has been criticized as against the spirit of decentralization—including by the donor community.


In 2001/02, the actual release had been reduced by up to 50 percent in view of the escalated security expenses in the midst of the Maoist insurgency.


Implementation of IAP is linked with prospective budget support by several donors, which, if approved, could total up to US$128 million.


It has, however, been found through NPC’s field surveys that poorest districts have the least absorptive capacity in terms of community institutions and awareness.


As of end-2000, there are about 26,000 primary schools in Nepal.