VZCZCXRO4165
RR RUEHLH RUEHPW
DE RUEHIL #3077/01 3571450
ZNR UUUUU ZZH
R 231450Z DEC 09
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 6591
INFO RHEHNSC/NSC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RUEAIIA/CIA WASHDC
RUEHNE/AMEMBASSY NEW DELHI 5918
RUEHBUL/AMEMBASSY KABUL 1329
RUEHLO/AMEMBASSY LONDON 2064
RUEHLH/AMCONSUL LAHORE 8324
RUEHKP/AMCONSUL KARACHI 2725
RUEHPW/AMCONSUL PESHAWAR 7385

UNCLAS SECTION 01 OF 02 ISLAMABAD 003077 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EAID PGOV PK
SUBJECT: FISCAL FEDERALISM OR FISCAL FOOLISHNESS? 
 
REFTEL:  A) PESHAWAR 214  B) ISLAMABAD 2829 
 
¶1. (SBU) Summary: In a move heralded in the Pakistani press as a 
"historical shift to provincial autonomy" and a "victory for 
democracy," the National Finance Commission (NFC) reached a 
consensus on the formula for revenue division between the federal 
and provincial governments on December 11.  Agreed upon unanimously 
by the NFC after four months of active negotiations (and seven years 
of deadlock), the formula awards a significantly expanded percentage 
of the pool of GOP funds to the provinces.  What remains to be seen, 
however, is whether the provincial governments have the capacity to 
deliver needed social services and the fiscal responsibility to stay 
within their newly expanded budget parameters.  If the provinces 
overspend or spend poorly, the federal government will be hard 
pressed to avoid budget-busting assistance, to the detriment of 
IMF-agreed spending targets.  End Summary. 
 
- - - - - - 
Background 
- - - - - - 
 
¶2. (SBU) The federal and provincial governments reached consensus on 
the National Finance Commission (NFC) award on December 11, setting 
the formula for the division of the country's financial resources 
through the Commission for the first time since 1997 (Ref B).  The 
Constitution of Pakistan mandates that the NFC examine and agree 
upon the division of tax revenue between the federal government and 
the provinces of Pakistan every five years.  However, attempts to 
find consensus through an NFC have failed since 2002.  In the 
absence of an NFC award under the Musharraf administration, the 
division of resources was announced through executive order.  This 
latest award is the seventh in the history of Pakistan. 
 
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The Structure of the Award 
- - - - - - - - - - - - - - 
 
¶3. (SBU) Under the new award, the provinces will receive 56 percent 
of the total pool during the first year of the award (Pakistani 
FY10-11) and 57.5 percent of the total funds for the four remaining 
years of the award.  This "vertical" distribution between federal 
and provincial funds currently gives the provinces 47.5 percent of 
the divisible pool. 
 
¶4. (SBU) For the first time in Pakistan's history, the provinces 
agreed to divide the pool of funds on the basis of multiple 
criteria, instead of solely on population.  The less populous 
provinces of NWFP and Balochistan had been lobbying for the 
inclusion of more criteria since the 1980s and Dr. Gulfaraz Ahmed, 
Balochistan NFC representative, reported that from the earliest 
meetings of this NFC, the group had agreed that the new formula must 
be more comprehensive.  The final award was based upon the following 
criteria, weighted to percentages agreed to by the group: 
population (82 percent), poverty (10.3 percent), revenue collection 
(5 percent), and low population density (2.7 percent). 
 
¶5. (SBU) Representatives from Sindh, home of business hub Karachi, 
were eager to have collection of revenue be one of the criteria 
included in the formula.  As revenue collection is credited to a 
business's headquarters no matter where in the country transactions 
take place, Sindh would have by far the greatest share of revenue 
collection among the provinces.  In order to create a more equitable 
division, the NFC allocated an equal weight to revenue generation 
and revenue collection under the "revenue collection" criteria.  In 
exchange, Sindh was awarded a one-time transfer of $71.2 million (at 
a rate of 84 Pakistani Rupee to the dollar) from the federal 
government. 
 
¶6. (SBU) Based upon the weighted criteria, the final shares of the 
divisible pool for the various provinces will be as follows:  Punjab 
51.74 percent, Sindh 24.55 percent, NWFP 14.62 percent and 
Balochistan 9.09 percent. 
 
- - - - - - - - - - - - - - - - 
Tax Collection: A Welcome Chore 
- - - - - - -- - - - - - - - - - 
 
¶7. (SBU) Shaukat Tarin, Federal Finance Minister and NFC Chairman, 
announced that the fee currently charged by the federal government 
to collect the general sales tax on behalf of for the provinces 
would be reduced from five percent of the total pool to one percent, 
 
ISLAMABAD 00003077  002 OF 002 
 
 
increasing the divisible pie by four percent.  The federal 
government also agreed to the provinces' demand to implement their 
constitutional right to collect a sales tax on services, essentially 
allowing each province direct access to a revenue stream previously 
controlled by the federal government. 
 
- - - - - - - - - - - - - - - - 
Special Packages Seal the Deals 
- - - - - - - - - - - - - - - - 
 
¶8. (SBU) The new award recognizes the NWFP's fiscal burden due to 
the ongoing conflict by providing the province an additional one 
percent of the entire, undivided pool of resources.  Dr. Gulfaraz 
remarked to EconOff that with this formula, each of the three other 
provinces and the federal government are giving the NWFP a portion 
of their funds, thus sharing the burden of the war on terror, borne 
by NWFP alone up until now. 
 
¶9. (SBU) Although the agreed-upon formula awarded Balochistan 7.17 
percent of the divisible pool, the federal government and provinces 
agreed that Balochistan's special development needs warranted a 
share of 9.09 percent.  Indeed, Finance Minister Tarin announced 
Balochistan would receive at minimum $985 million (roughly 
equivalent to the 9.09 percent) for every year of the award, and if 
resources were not available from the divisible pool, the federal 
government would make up the difference from its own resources.  Net 
profits owed the provinces by the parastatal Water and Power 
Development Authority (WAPDA) for hydro-electric power generation 
were also paid out by the federal government before the third round 
of NFC negotiations (Refs A and B). 
 
- - - - - - - - - - - - - - - - - - - 
With Resources Comes Responsibility... 
- - - - - - - - - - - - - - - - - - - 
 
¶10. (SBU) Dr. Gulfaraz proudly reported to EconOff that all federal 
grants to the provinces, which had equaled around 10 percent of the 
federal share of the divisible pool under the previous award, would 
be done away with in this NFC award on the unanimous demand of the 
provinces.  "The provinces need funds to stabilize their 
governments," he said.  "This is a long-term project and the 
provinces should not have to continuously look to the federal 
government for money."  Dr. Gulfaraz applauded this move towards 
fiscal federalism and said he looks forward to greater prosperity 
and governmental effectiveness for the provinces under the new 
award. 
 
¶11. (SBU) However, Safdar Parvez, an economist at the Asian 
Development Bank, expressed concern about the distribution of such a 
large percentage of the divisible pool to provincial governments 
that have limited experience effectively spending large sums of 
money on development.  The provinces have a history of over-spending 
and now will be given full rein to spend without oversight from the 
federal level.  More money to the provinces will likely lead to a 
waste of resources Pakistan can ill-afford, Parvez postulated. 
 
¶12. (SBU) Furthermore, the federal government must now meet its 
financial obligations with less money, Parvez added.  Of primary 
concern are obligations such as interest payments on domestic and 
international debt, which the GOP must meet in order to retain its 
good standing with the IMF.  Military spending and large-scale 
public sector development projects could also be squeezed. 
 
¶13. (SBU) Comment:  This is fundamentally a good news story, given 
the history of failure on the part of the predecessor governments to 
work out an equitable distribution of funds.  Even the ADB's 
skeptical Safdar Parvez admitted that the NFC's ability to come to 
amicable (if hard-won) consensus was "the best news we've seen in 
the papers for a long time."  Nevertheless, the award could pose 
long-term risks as well.  Past performance indicates that the 
provinces may well spend the country's carefully divided money with 
a recklessness Pakistan can ill-afford.  If the provinces do come 
back to the hard-pressed federal government for additional funds and 
the GOP cannot muster the political will to resist, they could drive 
Pakistan into further debt to either the State or commercial banks. 
 
PATTERSON