Assessing the National Finance Commission Award – Bilquis

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On December 31, 2009, the federal government and finance ministers from Pakistan’s provinces signed the 7th award of the National Finance Commission, a development that was widely regarded as a positive step in Pakistan’s political and economic progress. Below, Bilquis, a consultant from Lahore, assesses the NFC award and whether it should actually be considered a success:

In December 2009, rallies were held all over Pakistan to celebrate the approval of the 7th National Finance Commission (NFC) Award. In March 2010, President Zardari officially signed and approved the award. Numerous critics applauded the NFC award as a major accomplishment and a product of the democratic process. However, I’ve often wondered if it really is a silver lining.

The NFC is a government body that is responsible for redistributing tax funds that are collected by the government to all provinces. As per Article 160 of the 1973 Constitution, it is mandatory for the government to meet every five years and present a NFC award that allocates resources among the federal and provincial governments (PGs). Provinces then re-distribute revenues amongst themselves, through a revenue-sharing formula.

The 7th NFC award was an enormous success for numerous reasons:

In horizontal distribution (distribution of resources among the provinces), it introduces the landmark multiple-criteria formula for redistribution. The multiple-criteria replaces the single criterion ‘population density’ formula that has been in place since the 1st NFC award in 1974. The single criterion was not only an outdated way of distribution of income, but it also unfairly favored Punjab province at the cost of Baluchistan, NWFP [Khyber-Pakhtunkhwa] and Sindh. Although, these provinces fought for a fairer distribution, a positive conclusion was never reached in horizontal distribution of funds. There was a lack of political will from the federal government and Punjab province to a) relinquish their share and/or b) to hold tangible talks that would resolve the matter. Hence, the multiple criteria is a commendable step forward as it indicates that actual effort was made by the government, especially Punjab, to settle a four decade old debate. Now, distribution is based on 82% weightage to population, 10.3% to poverty, 5% linked to revenue generation and collection and 2.7% to other areas.

Another major accomplishment of 7th NFC award is that the federal government recognizes the rights of the provincial government (PG) over their resources and has agreed to compensate NWFP and Baluchistan for past arrears especially from hydropower profit and on gas surcharges and royalty. NWFP will receive Rs.110 bn. for arrears of hydel profits and Baluchistan will receive Rs. 10 bn. for arrears of GDS. This is one of the main reasons why the 7th NFC was a success. Previously, the government’s refusal to either recognize or offer any type of compensation to the two provinces usually led to a deadlock in discussion and embittered feelings toward the federal government. The 7th NFC award also accepts the right of PGs to retain 5% of their provincial sales tax collection.

Moreover, in the past, when spending funds from the divisible pool, the federal government has been accused of demonstrating an expenditure bias towards Punjab, which continuously disillusioned the other provinces. To address the issue, in vertical distribution (distribution of resources between the Centre and the provinces), the 7th NFC allocates a higher percentage of funds to the provincial governments (PGs) from the divisible pool than to the federal government. As a result:

1. PGs total share from divisible pool has increased from 47% to 56%.
2. The award removes the grants and other special awards taken by the federal government. This was a substantial amount—10% out of the total divisible pool.
3. It has decreased the revenue collection charges taken by the federal government from 5% to 1% and this amount would also be added to the divisible pool.

By providing higher revenue to provinces through increased share and reduced charges, the 7th NFC award directly addresses the past grievances of smaller share in revenue, especially that of Baluchistan and Sindh. It also indicates a move towards provincial fiscal autonomy as PGs will more efficiently allocate resources that best serve and closely represent the provincial wants and needs than the federal government.

On paper, expansion of revenue to provinces in both vertical and horizontal and recognizing rights over resources is a fantastic deal, as it ticks all the correct boxes and appeases old animosities. However, the federal government has taken a substantial cut in its revenue and has overestimated its revenue generation. With rising debt servicing and defence and security-related expenditures, a reduction in its share will result in a large budget deficit for the federal government. Dr. Ashfaque H Khan points out that, “the total expenditure of the federal government on these four items (defense, security, public debt and civil administration) alone will rise from Rs 1,540 billion to Rs 2,075 billion, while resources are projected to rise from Rs 1,337 billion to Rs 2,146 billion.

If other expenditure such as pensions, subsidies, grants and development programmes are added, it is quite apparent that federal government resources will not be sufficient. Secondly, for the NFC to successfully deliver, the federal government needs to add further clarity on defining expenditure assignments to PGs and the PGs need to drastically develop their capacities to spend their resources efficiently and effectively. Otherwise it may lead to the failure of the IMF program which depends on fiscal prudence.

Overall, the 7th NFC award is historic because it succeeded in eliminating an approx 15 year deadlock in discussion and bringing around positive and tangible changes within our federal and provincial revenue distribution. It also highlights the strategic role played by the federal government as it tried its best to ease mistrust between itself and the four provinces. Shaukat Tarin, ex-finance Advisor, stated during the NFC award inauguration speech in Baluchistan, “We asked the provinces to bring forth all of their grievances—such an open house/table of mitigated previous grievances that often resulted in deadlock.” Nevertheless, the success of the NFC depends on the ability to overcome the challenge of fiscal discipline by the federal government and PGs. If the current spending patterns of the PGs are not changed, Pakistan will land in a more difficult fiscal situation, with the country’s debt burden further worsening the situation.

The contribution is the sole opinion of the author and does not necessarily represent the opinion of CHUP. If you would like to contribute a piece to CHUP, please email Kalsoom at changinguppakistan[at]gmail[dot]com. Pieces should be no longer than 800 words please. For past contributions, click here.

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Microfinance in Pakistan: A Q&A with Kashf’s Roshaneh Zafar

Roshaneh receiving Vital Voices’ economic empowerment award (Marie Claire)

In 1996, the Kashf Foundation became Pakistan’s first microfinance institution, empowering both women and families in an attempt to replicate the Grameen Bank model in the country in a nuanced way. Today, 14 years later, Kashf has 152 branches nationwide, boasts 305,938 supported families, and operates its branches using a franchise model, allowing for closely managed growth. Below, Kashf’s founder, social entrepreneur Roshaneh Zafar, describes what inspired the microfinance organization, its successes and obstacles, and the young Pakistanis involved in the process:

Q: Kashf was started in 1996 and was Pakistan’s first microfinance institution. What inspired you to establish the organization?

Many factors impacted me in making the plunge in 1995 to set up an organization that specifically catered to women’s financial needs.  The first imperative was of course the fact that women in our society do not get the due acknowledgement they deserve for their contribution to the overall economy.  Time and time again, during my travels while I worked for the World Bank in Pakistan, women from all walks of life – rural women, urban women, educated women, illiterate women, working women, home makers – would tell me the same thing, that they wanted a better life for themselves and their families, however, they lacked economic opportunity.  This resonated across the country, from when I sat with shy and veiled women in Kalat in Balochistan to when I engaged with highly empowered and articulate women from the plains of the Punjab.  The second was related to my own commitment, I had grown up in a Pakistan where I had not faced any discrimination on the basis of gender.  I was and am strongly committed to the notion that we can build a world free of gender discrimination – that comes with two strategies, empowering women economically (providing them a financial voice) and investing in their social status (through education and health).

Q: Although the Grameen Bank model has been tremendously successful in Bangladesh, there were many who believed that microfinance would not be as successful in Pakistan. Why do you think this may have been true in the past and how is the Kashf model different?

There are many firsts in the Kashf model, which can highlight some of the success factors of our approach. Our approach to financial services delivery has always been to build the business case for investing in women’s economic development.  There is no doubt that societies that fail to invest in their women – essentially 50% of their work force – can never prosper or develop.  This continues to be a major hurdle for the development of Pakistan and Kashf’s first and primary objective has been to prove the business case for investing in women.  There have been many firsts in Kashf’s life:

• We were the first specialized MF programme in Pakistan targeting women (essentially we were the precursor to the microfinance ordinance of 2001)
• We were the first to offer an array of women friendly products: loans for productive purposes, for consumption needs, insurance products and housing loans.
• We were the first to replicate Grameen’s solidarity lending methodology successfully in Pakistan and subsequently the first to move to individual lending as the market matured.
• We were the first MF entity to become financially sustainable (2003)
• We were the first MF entity to raise loans from commercial banks (2007)
• We were the first MF institution to undertake a credit rating and to get an investible grade rating from an independent company
• We were the first MFI to look at introducing and scaling up a responsible finance approach

Q: Have any of Pakistan’s endemic issues – from the volatile security situation, its political upheavals between military to democratic rule, to its rampant corruption – hindered Kashf’s growth? What have been some of the major obstacles Kashf has faced in the last 14 years?

Until 2008 we were able to grow our programme at an average rate of 40-50% annually, however, the economic meltdown in 2008 combined with rapid inflation led to a major slowing down of operational outreach.

Furthermore in 2008, much like other sectors, the microfinance sector was impacted by the deteriorating economic and political situation. Pakistan’s economy shadowed the meltdown of the global financial system, through the second half of 2008 and 2009. While this impacted the entire economy, households at the bottom of the pyramid, which form a majority of microfinance users, were especially hurt.  Overall inflation had a regressive impact on low-income households, i.e. the increase in food prices eroded their purchasing power, since they tend to spend a large proportion of their income on basic consumption needs; a food security research conducted by Kashf Foundation in August 2008 reveals that households were spending up to 70% to meet monthly food requirements. Thus, low-income households’ ability to invest in the overall needs of their families has been severely constrained and strides made in the past decade to improve the economic conditions of low income households have been negatively affected.

Additionally, the ability of microfinance users to make payments on their existing loans has been somewhat impaired, due to business failures and decreased economic activity that has reduced the quality of the microfinance portfolio in Pakistan. At the same time, the demand for microfinance loans has increased multi-fold, as a result of inflation and the decline in the exchange rate, which means that people need larger loans to set up small businesses. The economic recession coupled with rising defaults and business failures amongst microfinance users has increased liquidity and refinancing risk for microfinance providers, both in terms of being able to raise additional funds and to meet current debt obligations.  The recent “Banana skins” report taken out by Citibank and CGAP has revealed that credit risk is an emerging issue across the global microfinance sector, while costs of undertaking microfinance operations are negatively affecting the sustainability of many institutions.

Moreover, the economic turbulence has been coupled with socio-political disorder at multiple tiers, and microfinance providers face a high level of political risk as there is an increased perception of the dwindling writ of the state and a deteriorating security situation. Additionally, a precedent for popular mobilization has been set which increases the risk of political intervention in the microfinance sector as different tiers of government are largely unclear of the role microfinance has on pro-poor growth. There has also been an increased tendency of governments and political parties to introduce populist unsustainable income support programs, which suffer from typical targeting and rent seeking symptoms, and are contrary to the spirit of sustainable financial services. Consequently, uncertainties stemming from the political set-up have adversely affected the economy, especially microfinance providers.

Q: Kashf Foundation hires many young Pakistanis who work as loan officers for the organization. What has been your experience working and mentoring these young officers and what has inspired them to work on the ground?

I would not describe it as any other way but inspirational. It is for us to give hope, encouragement and positivity to the youth of Pakistan.  At Kashf, we hire men and women fresh out of college, who then become harbingers of change within their communities.  The fact that they are part of a socially responsible institution unleashes their inner and latent potential – I have seen loan officers get promoted to Area managers in a matter of years.  In Pakistan we don’t lack talent, we lack good institutions to harness that talent.  We have to focus on building institutions that can provide opportunities to young people, and at the same time we have to build their entrepreneurship skills. For this reason, we decided to initiate a youth empowerment programme at Kashf.

Q: What have been some of the organization’s greatest successes? Where do you see Kashf in the next 5 years?

The most rewarding part of my work has been seeing real life changes.  Only a few weeks ago I was visiting Kasur, an area hemmed very close to the Indian border, and which is famous for its leather works.  I had the opportunity to visit a mature client Baji Jamila, who had been working with us for the past seven years.  I entered the courtyard of her small house which had an uneven brick flooring, part of the house had been newly constructed and was built a little higher than the rest, creating two levels of access.  When I arrived, I saw Baji Jamila busy in small ante chamber that she had converted into a mini loom factory.

Six years ago, Jamila had invested in a small spindle machine, which she purchased secondhand for US$150 to spool thread, package it and sell it in the local market.  This business had proved quite profitable and she now has four such spindles working simultaneously, spooling different colored thread on small spools.  Jamila’s husband Muhammad Mansha, seeing the success of his wife’s business left his job as a small time clerk and began working for her, taking care of purchasing the raw thread and getting it dyed, while she ran the spindles and managed the 20 women who work for her to package the thread.  It’s stories like these that really warm one’s heart and make one realize that the impossible is possible.

Overall all, we have seen a successful ramping up of our programme and since 1996 have disbursed loans to 1 million entrepreneurs across the country and provided US$225 million in working capital.  We have also seen that over 60% of our clients invest in new businesses, which has a multiplier effect on the local economy. Within the family this leads to higher income, higher savings and lower food vulnerability and often it translates into better education and healthcare of children.  We often see evidence of improvements in women’s self esteem (90% of mature clients state that they feel more empowered) and easing in tensions between family members.  On a financial level, Kashf Foundation has demonstrated a sustainable approach to delivering MF to low-income communities especially women.

Our aim is to reach out to 650,000 active clients by 2014.

This interview first appeared in Dawn Newspaper on Friday, May 14, 2010.

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