Executive Summary 

In 2015, Nepal commenced a pivotal transition from a unitary governance structure to a federal system, leading to the establishment of three tiers of government: federal, seven provincial, and 753 local levels, as articulated in the 2015 Constitution. The provincial governments, formally established in 2018 following the 2017 elections, are entrusted with the responsibility of delivering an array of services to the population. An objective analysis of the provinces’ standing in the domain of public financial management (PFM) is essential, as effective PFM constitutes a fundamental element for fostering developmental outcomes.

Purpose and management 

The purpose of this PEFA Assessment is to develop a better understanding of PFM at the subnational level. The assessment was undertaken by the Government of Gandaki Province as a self-assessment with technical support from the World Bank. The findings provide Gandaki’s provincial government with a diagnostic regarding the performance of its PFM system, processes, and institutions, which can help to identify priority areas for PFM reform activities. As such, the findings of this subnational PEFA Assessment will provide policy makers and stakeholders with valuable data and evidence to support provincial-level PFM reform decision-making processes. 

The Assessment will also help prioritize reforms, allocate resources efficiently, and design interventions tailored to the specific needs and challenges faced by subnational entities. It also provides a baseline for the subsequent evaluation of PFM performance. Furthermore, it highlights the importance of strengthening PFM systems at the subnational level, thereby supporting the federalism process and empowering provincial governments in Nepal. Given that the PFM characteristics are largely similar throughout the subnational level, the findings are expected to be relevant for other provincial governments. Hence, it should also help calibrate other subnational PFM reform programs.

Main PFM Strengths and Weaknesses in the Gandaki Province 

The legal and regulatory framework for PFM is robust, and the institutional framework provides clearly established roles and responsibilities between the different entities. There are also well-defined reporting lines. Furthermore, several PFM information systems are in place to manage the utilization of resources, support control functions, and enhance accountability. The PFM system has elementary, but adequate, foundational functions in place for transparency of public finances, predictability and control in budget execution, and accounting and reporting. PFM performance is sound and in line with many or all elements of good international practices in the following areas: budget classification, budget documentation, transfers to subnational governments, and predictability of in-year resource allocation. In other areas, however, performance is at a basic or below basic level. The PFM system exhibits several deficiencies, particularly in the realms of budget reliability, the management of assets and liabilities, policy-driven fiscal strategy and budgeting, as well as external scrutiny and auditing. The actual outcomes of the budget reveal a significant degree of underperformance. Currently, there is an absence of a reliable database for monitoring procurement activities, and the procurement planning process lacks the necessary robustness. Although a framework for fiscal risk reporting and monitoring has been established, there exists a deficiency in documentation to substantiate its implementation. Furthermore, the medium-term perspective in budgeting is considerably inadequate. Public investment management faces critical shortcomings in the project selection, appraisal, and monitoring processes. The performance of payroll controls and internal audits is below the basic level. Additionally, delays have been encountered in the submission of external audit reports to the provincial assembly, as well as the legislative review of audit reports. The PFM performance of Gandaki’s provincial government averages a score close to a ‘C’. Overall, the PFM system has a basic level of performance. Figure ES.1 shows the pillar-level scores. The distribution of 32 indicators and 98 dimensions across scores is shown in the subsequent table. The full set of scores is shown in Tables ES.1 and ES.2.

Impact of PFM performance on budgetary and fiscal outcomes

The PFM system’s performance relative to the three budgetary and fiscal outcomes is as follows: Aggregate fiscal discipline. The existing PFM system in the Gandaki Province supports minimal aspects in achieving aggregate fiscal discipline. Significant discrepancies between budgeted and actual expenditures and revenues reflect a lack of realism in budgeting and present notable challenges to effective budget implementation. Such deviations have the potential to undermine fiscal discipline, resulting in unplanned borrowing or reductions in essential services. Furthermore, deficiencies in public investment management, characterized by the absence of established guidelines for economic analysis and inadequate monitoring of projects, undermines fiscal discipline and may lead to inefficient resource allocation.

In addition, inadequate fiscal risk reporting creates substantial oversight challenges, as unaudited annual financial statements from local governments remain unpublished and contingent liabilities are reported as “non-available.” This deficiency hampers the government’s capacity to effectively oversee and manage potential fiscal risks, thereby increasing the likelihood of unexpected fiscal pressures. While Gandaki Province currently has no outstanding debt, the lack of a medium-term debt management strategy could lead to suboptimal borrowing decisions and increased debt servicing costs over time. 

Despite these challenges, certain PFM elements exhibit robustness in supporting aggregate fiscal discipline. The predictability of in-year resource allocation enables spending units to effectively plan and commit expenditures for a minimum of six months in advance, ensuring alignment with budget appropriations. Additionally, the generation of monthly budget reports enhances governmental oversight and facilitates timely corrective actions, which are critical for controlling expenditures and preventing unplanned fiscal deficits. Internal controls governing non-salary expenditures also demonstrate a high level of compliance, ensuring that expenditures adhere to budgetary provisions and minimizing the risk of overspending. Moreover, the government’s maintenance of minimal expenditure arrears significantly contributes to a lower fiscal risk profile.

Strategic allocation of resources. The PFM system modestly supports the attainment of allocative efficiency. The provincial government’s budget classification system is robust and comprehensive, facilitating clear resource allocation across sectors and programs. The transparent and rule-based transfer system for local governments ensures equitable distribution of resources, enabling effective budget planning and implementation. Additionally, procedures to inform taxpayers enhance compliance and revenue predictability. The revenue accounting systems deliver accurate and timely information on revenue streams, while in-year budget execution reports support effective monitoring and corrective actions. Together, these components strengthen the government’s strategic resource allocation. 

The assessment also noted deficiencies in the PFM system that could impair strategic resource allocation. Higher variances in expenditure composition indicate that budget execution is not effectively aligned with planned objectives, which may hinder the government’s ability to achieve its policy goals. The lack of established guidelines for economic analysis and project selection limits the targeted allocation of resources to high impact investment projects. Additionally, the restricted scope of the Provincial Assembly’s budget scrutiny diminishes the effectiveness of the budget approval process. Moreover, the revenues and expenditures of the EBUs remain outside financial reports, potentially leading to incomplete oversight and ineffective planning. Delays in fiscal transfers from higher levels of government, as well as the delayed availability of collected revenues for expenditure, can lead to cash flow challenges. These challenges may necessitate mid-year budget adjustments, which may undermine strategic resource allocation and hinder the effective implementation of fiscal policies. 

Efficient service delivery. The PFM system supports the efficient delivery of services comparatively well. The government publishes information regarding performance plans, resource allocation for frontline service delivery units, and results achieved. This transparency enables legislators, government officials, and the public to evaluate whether budgetary resources are being utilized for service delivery as intended. Furthermore, rule based fiscal transfers enhance local governments’ ability to allocate resources consistently. Predictability in resource availability allows budgetary units to implement service delivery plans effectively, while the use of competitive procurement methods and adequate internal controls ensures value for money. Reliable financial information and timely reporting allow the government to monitor service delivery progress and make necessary corrections promptly

Despite these strengths, several challenges need to be addressed to improve service delivery efficiency. A higher expenditure composition variance indicates that resources allocated for service delivery may not have been used effectively, with the lack of performance evaluations representing a missed opportunity to assess their appropriateness and efficiency. Additionally, the absence of public consultations during the budget-making process further limits the optimization of resource allocation. Weaknesses in personnel data and payroll management may contribute to inaccuracies in salary payments and hinder effective personnel administration, thereby diminishing service delivery efficiency. Furthermore, the Gandaki provincial government’s lack of a procurement database restricts its ability to monitor public procurement efficiency and value for money. Inadequate internal audit practices and delays in legislative scrutiny of external audit reports undermine accountability. Consequently, systemic weaknesses identified during audits may remain unresolved for protracted periods that may adversely affect the quality and efficiency of public service delivery.

Performance changes since the previous PEFA assessment 

Not applicable, since this is the baseline assessment for the Gandaki Province. 

PFM Reform Agenda

The first Five-Year Plan of the Gandaki Province (FY2019/20–FY2023/24) outlined a PFM strategy with priority activities. Similarly, an Approach Paper for the second Five-Year Plan (FY2024/25–FY2028/29) highlights PFM as a key reform area. Since the provincial governments were formed in 2018, the Provincial Assembly has enacted several laws and regulations relating to PFM. These include the Financial Procedure and Fiscal Accountability (FPFA) Act in 2022 and the FPFA Regulation in 2023. Numerous directives and guidelines across different PFM areas have also been issued. The provincial government is explicitly working to ensure that the regulatory framework is followed by all spending units. 

Ongoing or planned provincial PFM reform activities include increasing own-source revenues; enhancing systems to improve the management of the motor vehicle tax; preparing cash forecasting procedures to assure the availability of cash for timely payments; consolidating transactions of extra-budgetary units (EBUs) in financial statements; establishing the Gandaki Province Personnel Record (GPPR) Unit as a separate unit; and updating personnel records in the Personnel Information System (PIS). The provincial government participates in the GoN reform programs, such as the Provincial and Local Governance Support Program (PLGSP), which aims to enhance the capabilities of institutions and organizations at the SNG level. Joint federal–provincial reform initiatives include fiscal federalism, budgeting, accounting, reporting, and oversight functions.

Furthermore, the federal Ministry of Finance (MoF) is implementing reform initiatives that will also benefit SNGs. For example, these include upgrading to PFM information systems (improvements to reconciliation of banks, payments, revenue, and advances); the development of a fiscal risk monitoring system; and the preparation of a commitment management system. Similarly, improvements to external audit procedures undertaken by the OAG will help to improve external accountability procedures in relation to the provincial and local governments. The federal MoF is finalizing the PFM Reform Strategy (PFMRS) for 2025-30. This is the first PFMRS being prepared within a federal context in consultation with provincial and local governments. During consultations, the Government of Gandaki Province identified several key challenges, including issues related to budget realism, unrealistic budget allocations, deficiencies in project initiation and appraisal, inadequate equalization grants, misalignment and delays in conditional grants, inconsistent tax rates, and limitations in mobilizing natural resources. To address these, the PFMRS proposes reforms to enhance the effectiveness and efficiency of PFM at the provincial level. The strategy will be finalized and implemented from the start of FY2025/26