The provinces are not to blame

The World Bank's detailed examination of Pakistan's public finances, in its new report 'Strengthening Fiscal Federalism in Pakistan' (2026), delivers a message that Islamabad would do well to absorb.

The 18th Amendment and the 7th NFC Award of 2010 represented a major step towards fiscal federalism by assigning provinces a larger share of national revenue — 57.5% of the divisible pool — to enable them to handle newly devolved responsibilities in critical areas such as education, health and social welfare.

Yet the federal government failed to match this transfer of financing with a corresponding reduction in its own spending and administrative footprint. Instead, it retained and, in several cases, expanded its presence in precisely those devolved domains. This fundamental mismatch lies at the heart of the structural federal fiscal deficit, which continues to weigh heavily on the national economy more than 15 years later.

Every few months, as economic pressures mount, debt levels rise and fiscal space shrinks, voices in the federal capital rediscover their preferred culprit: the provinces and the NFC Award that constitutionally allocates resources to them. The argument is straightforward and politically convenient. If only provincial shares could be trimmed, the centre’s chronic difficulties would vanish. It is a comforting story for those reluctant to examine their own record, but it is also one that the evidence increasingly contradicts.

Consider the debt picture that anchors so much of this debate. As of March 2026, official public debt stood at Rs83.3 trillion. When one incorporates a fuller accounting that includes liabilities of state-owned enterprises, borrowing for commodity operations, circular debt accumulated in the power and gas sectors, and items such as State Bank external liabilities including swaps, friendly deposits and SDR allocations, the total climbs to roughly Rs97 trillion. This represents a gap of around Rs14 trillion between what is officially reported and the more comprehensive reality of the state’s debt.

The gap itself has widened dramatically; in 2020, it was closer to Rs4.8 trillion. These are not minor statistical discrepancies or provincial creations. Circular debt, SOE losses, commodity operations and on-lending to loss-making entities all reflect policy and operational decisions taken at the federal level in Islamabad, not in Lahore, Karachi, Peshawar or Quetta.

The accusation that provinces are consuming an ever-larger portion of the national pie, thereby starving the centre, collapses under closer examination of the data. NFC transfers as a share of GDP have remained roughly flat since 2010, hovering near 5.0% with no dramatic expansion or contraction. In fact, they declined from their peak level of 5.97% of GDP in FY2016-17 to 4.90% in FY2025-26.

The provinces’ effective share of total federal revenue has declined in recent years from around 46.2% in 2019-20 to 34.4% in 2025-26 and from 61.5% of tax revenue to 47.9%. This erosion stems not from any renegotiation of the NFC formula itself but from the federal government’s deliberate expansion of revenue streams that fall outside the divisible pool entirely. Chief among these are the petroleum levy and profits transferred from the State Bank of Pakistan.

By inflating these non-sharable sources, the centre enlarges its own slice of the fiscal pie while the provincial entitlement under the constitutional award remains unchanged. Two distinct phenomena should not be conflated. The first is the structural deficit that emerged after 2010 when financing was shifted toward the provinces without a parallel contraction in federal functions and expenditures.

The second is the more recent dilution of provincial revenue shares achieved not by correcting the original mismatch but by the centre routing new resources through non-divisible channels. Both point to the same underlying conclusion: the provinces are not the dynamic, expanding element in Pakistan’s fiscal troubles. The moving parts originate at the federal level.

Let’s look at the federal debt. Debt-to-GDP ratios have genuinely improved, falling from 98.8% in 2019-20 on fuller measures to around 72.5% by March 2026. Interest payments, which once forced the government to borrow simply to service existing debt, have declined noticeably. These developments are often presented as triumphs of fiscal discipline. In truth, the story is more mixed. New borrowing moderated under the discipline of IMF programmes, as the IMF insisted on generating a primary surplus.

However, the larger contribution came from monetary policy easing. The State Bank reduced its policy rate from a peak of 22% to 11.5%, and with roughly 85% of the government’s interest bill tied to domestic debt linked to that rate, the adjustment delivered savings exceeding Rs2 trillion just last fiscal year. Meanwhile, the same petroleum levy and State Bank profits that have diluted provincial shares have also propped up headline federal revenue figures. Non-tax revenue nearly quadrupled in recent periods, but the FBR’s tax-to-GDP ratio advanced only modestly from 9.4% to 10.2% over six years. Removing these windfall elements reveals that no real improvement in broadening the tax base or collections took place.

The persistent focus on provincial shares serves a clear purpose. It deflects attention from uncomfortable questions about why the federal government employs significantly more people than it did in 2009, why civilian spending has risen sharply in certain periods while the tax base expanded anemically. For example, the spending on running the civilian government increased from Rs530 billion in FY2021-22 to over Rs1 trillion in FY2025-26 — an increase of about 93% over four years. Over the same period, military spending rose by around 75%. Civilian expenditure therefore grew faster, adding further pressure to the federal fiscal position.

Attacking the NFC requires no meaningful change in areas the centre controls — no overhaul of the FBR’s chronic underperformance on real estate, retail trade or wealth taxation, and no serious downsizing of a bureaucracy whose mandates have outlived the logic of centralisation. It simply involves redirecting resources that five NFC Awards since 1974, grounded in constitutional principle and negotiated in good faith, have allocated to Punjab, Sindh, Khyber Pakhtunkhwa and Balochistan. That is not reform. It is a raid on the federation’s foundational compact.

None of this implies the existing arrangements are flawless or beyond improvement. The inter-provincial distribution formula remains anchored in outdated 1998 census data and weighting that few would defend today. Provinces have underperformed on their own revenue potential, particularly in agriculture and urban property taxation. Local government, the tier closest to citizens’ daily needs, continues to suffer from provincial reluctance to devolve real power and resources — just as the federal level has resisted genuine downsizing.

These shortcomings are real and must be addressed through coordinated national effort. However, the debate must be anchored firmly in hard facts. Neither the NFC Award nor the headline debt figures fully explain Pakistan’s fiscal challenges and their underlying complexities. The real and persistent failure has been the inability to build a broad, sustainable tax base that can support the needs of a growing population and economy.

This core weakness has been compounded by a bloated federal bureaucracy and a long record of financing ambitious mega projects largely through debt rather than genuine revenue mobilisation. Until Islamabad confronts and corrects these fundamental issues under its direct control, the blame game directed at the provinces will continue and the country will remain trapped in the same unproductive fiscal cycles.

The writer is former head of Citigroup’s emerging markets investments and author of ‘The Gathering Storm’.

Disclaimer: The viewpoints expressed in this piece are the writer's own and don't necessarily reflect Geo.tv's editorial policy.

Originally published in The News