Understanding federal grants in fiscal federalism

Local budgets are where democracy meets the daily lives of citizens—this is a key principle of participatory governance.

Yet, 39 local levels across the country have missed the mandatory deadline of Asar 10 (June 24 this year) to pass their annual budget for the upcoming fiscal year 2082/83 (2025/26). 

Of them, Kathmandu Metropolitan City and Dharan Sub-Metropolitan City, two of the country’s largest and resource-intensive urban areas that cater to the needs of millions, are at the centre of conversation.

In Kathmandu, the municipal assembly could not convene due to a stalemate between Mayor Balendra Shah and the rest of the representatives and officials, including Deputy Mayor Sunita Dangol and Chief Administrative Officer Saroj Guragain. It’s Mayor Harka Raj Rai and Deputy Mayor Aindra Bikram Begha against each other, which has prevented the Dharan municipal assembly convention.

According to Section 21 (3) of the [federal] Intergovernmental Fiscal Arrangement Act, 2017, the village and municipal executives—administrative wing of the local government—must submit their budget to the respective village and municipal assembly—the legislative wing.

Meanwhile, the provinces geared up to present budgets to respective assemblies by Asar 1 (June 15 this year), per Section 21 (2) of the 2017 Act. Six of the seven provinces tabled their budgets by evening, while Karnali made the deadline just before midnight. These annual budgets outline how each province intends to spend in the upcoming fiscal year 2025/26 (BS 2082/83).

A breakdown of the budgets highlights a significant dependency on federal grants, with over a third of most provincial budgets sourced from the centre.

Income tax, Value-Added Tax (VAT), and customs duty are subject to the federal government. Of these, the federal government is liable to share revenues from VAT and customs duty with the provinces, per frameworks determined by the National Natural Resources and Fiscal Commission (NNRFC), a fully constitutional body provided in Article 68 (8) and 250-252.

Apart from these, the federal government disburses intergovernmental fiscal transfers, commonly known as grants, according to the guidelines and recommendations of the NNRFC and the National Planning Commission (NPC).

Four types of grants

To help reduce disparities among provinces and fund public services, the federal government provides these four grants: equalisation (समानीकरण), conditional (सशर्त), complementary (समपूरक) and special (विशेष).

Equalisation grants, which are also unconditional, form the highest portion of the federal grants. The NNRFC determines this based on population, human development index (HDI), price index, and revenue potential. These grants are designed to address regional disparities in revenue capacity and service needs.

In conditional grants, both the provincial and the federal government commit amounts for specific purposes, like school building. Such grants come with strict spending guidelines and supervision from federal agencies.

Under complementary grants, federal and provincial governments share the cost for large infrastructure or multi-government projects in the ratio set by the Working Procedure relating to Complementary Grants, 2025.

The cost-sharing ratio of the federation to Karnali is 70-30. The ratio for Sudurpashchim is 65-35, Madhesh 60-40; Koshi, Gandaki, and Lumbini each 50-50; and Bagmati 40-60. The ratio is determined by evaluating the economic, social, infrastructure status and revenue generation capacity of the provinces.

How deprivation shapes funding

Special grants are provided for emergencies like floods, earthquakes, etc or unique regional needs as provided in the Working Procedure relating to Special Grants, 2025.

The Procedure categorises provinces following a deprivation indicator, which is based on socioeconomic assessment, on a scale of no deprived to most deprived, ranging from 0 to 1. 

Poverty rate, illiteracy, access to basic services like health, roads, electricity, geographic remoteness, disaster vulnerability and HDI, among others, are taken into account for the assessment.

Karnali is the most deprived province with a deprivation score of 0.8442, followed by Sudurpashchim with 0.6436, Madhesh 0.5069, Koshi 0.4821, Lumbini 0.4511, Gandaki 0.3688, and Bagmati—the least deprived—0.2232.

Under special grants, the provinces can get anything between NRs 50 million and not exceeding NRs 100 million for—three years in case of an infrastructure project and one year for programmes that are carried out annually. Such grants are more flexible but generally discretionary with the National Planning Commission (NPC) in line with the Procedure.

Grants from the federal to the local level

The same process as federal to province is applied when it comes to grants from the federal to local governments.

The NPC classifies all 753 local levels in seven groups—from A (क) to G (छ), and determines the cost-sharing ratio for complementary grants on parameters similar to provinces.

Those in ‘A’ are eligible to get 80% of financing from the federal government, and those in ‘B’ can receive 70%. With the gradual change of 10% down each group, those in ‘G’ can get 20% of the total cost.

For instance, there are 19 local levels in the group ‘G’. It includes five metropolitans—Kathmandu, Lalitpur, Pokhara, Bharatpur and Biranagar; four sub-metropolitans—Hetauda, Butwal, Itahari and Dharan, and 10 municipalities such as Tilottama of Rupandehi and Tarkeshwor of Kathmandu districts.

When applying for a project under complementary grants, they chip in 80% of the total cost and get 20% from the federal government.

The remaining Birgunj metropolitan is classified in the ‘F’ group, alongside six other sub-metropolitans—Jitpursimara, Janakpurdham, Nepalgunj, Ghorahi, Tulsipur, and Dhangadhi, and the other 32 municipalities like Rupandehi’s Siddharthanagar, Kathmandu’s Gokarneshwar, and Surkhet’s Birendranagar. They chip in 70% of the total cost and get 30% from the federal government.

The remaining Kalaiya sub-metropolis is classified in the ‘E’ group, alongside 117 other municipalities and rural municipalities. They chip in 60% for the project under a complementary grant from the federal government. The number of local levels in ‘A’, ‘B’, ‘C’ and ‘D’ is 155, 150, 125, and 147, respectively.

For special grants, the related procedure sets guidelines according to the administrative structure of the local level. Metropolitans and sub-metropolitans are eligible to receive anything between NRs 2.5 million and NRs 50 million for three consecutive years in case of an infrastructure project and one year for annual programmes.

Municipalities and rural municipalities can get a minimum of NRs 2.5 million and not exceeding 30 million, with duration provision the same as metros and sub-metros.

In addition to that, the Procedure provides deprivation indicator scores to all 753 local levels to determine their prioritisation accordingly.

She Phoksundo Rural Municipality of Dolpa district in Karnali is the most deprived with 0.9988, followed by 10 more rural municipalities of the same province. Kathmandu Metropolitan is the least deprived with 0.0124 score, followed by Butwal sub-metropolitan of Rupandehi and Tokha municipality of Kathmandu—each with 0.0146.

The NPC ranks and filters projects based on the combined evaluation. The local level’s administrative type ensures the project is appropriate for the applicant’s scope, and the deprivation score boosts chances for the underserved and poor-performing units.

Similarly, provincial governments also provide all four types of grants to local levels within their respective territory as per their respective provincial legislation and advisory agencies—following procedures similar to those of the federal government.

Additionally, according to a source at the Madhesh Province Policy and Planning Commission, the volume of equalisation and special grants provided by the federation to the provinces significantly decreased for the upcoming fiscal year.

Previously, each province could submit any number of project proposals, but for 2025/26, they were limited to only 10 proposals each. The same applies to each local government.