GTZ Report on Urban Finance System - LGCDP

Urban Development through Local Efforts
Programme
A joint programme of the Ministry of Local Development (MLD) and
the German Technical Cooperation (<strong>GTZ</strong>)
Municipal Finance System in Nepal:
Status Quo of Revenues, Expenditures
and Tranfers
June 2008

<strong>Report</strong> prepared by: Dr. Thomas Taraschewski (<strong>GTZ</strong>) & Ram B. Chhetri (<strong>GTZ</strong>)
2

List of Abbreviations
ADDCN……………………………………….Association of District Development Committee of Nepal
CA……………………………………………………………………………………. Constituent Assembly
DANIDA………………………………………………..……. Danish International Development Agency
DoLIDAR…………………...Department of Local Infrastructure Development and Agricultural Roads
DUDBC…………………………………Department of Urban Development and Building Construction
FINIDA………………………………………………………… Finish International Development Agency
FNCCI…………………………..……..Federation of Nepalese Chamber of Commerce and Industries
<strong>GTZ</strong>………………………………………………………………….……..German Technical Cooperation
LBFC…………………………………………………………...…………Local Bodies Fiscal Commission
LSGA…………………………………………………………………......……..Local Self Governance Act
MLD………………………………………………………………………….Ministry of Local Development
MoF……………………………………………………………………………………… Ministry of Finance
MPPW……………………………………………………………Ministry of Physical Planning and Works
MRF…………………………………………………………………………...……Municipal Reserve Fund
MuAN……………………………………………………………………….Municipal Association of Nepal
NAVIN………………………………National Association of Village Development Committee of Nepal
NPC…………………………………………………………………..……..National Planning Commission
SAARC…………………….……………………….. South Asian Association for Regional Cooperation
SNV……………………………………………………………….Netherlands Development Organisation
TDF………………………………………………………………………..………Town Development Fund
udle……………….…………………………..….Urban Development through Local Efforts Programme
Acknowledgments
This report was compiled under udle (MLD-<strong>GTZ</strong>).
The authors would like to thank the colleagues from MLD, MPPW, LBFC, DUDBC, TDF, Planco
Consulting, and <strong>GTZ</strong> for their valuable inputs and kind support.
3

Table of Contents
1. INTRODUCTION AND OBJECTIVES 5
2. HISTORICAL BACKGROUND 7
2.1 Present Strategy on Decentralisation and Local Government Finance 8
3. LEGAL FRAMEWORK- ENHANCING MUNICIPAL FINANCE 9
4. EXISTING MUNICIPAL REVENUE MOBILIZATION AND EXPENDITURE
PATTERN SITUATION 10
4.1 Revenue Composition- Present Scenario 10
4.1.1 Internal Sources of Income 11
4.1.2 External Sources of Income 12
4.2 Expenditure Pattern – Present Scenario 13
4.2.1 Expenditure Composition 13
4.2.2 Capital Investment Pattern 14
5. INTERGOVERNMENTAL FINANCE TRANSFERS 16
5.1 Existing System of intergovernmental transfers 16
5.1.1 Ministry of Local Development 16
5.1.2 Department of Urban Development and Building Construction 20
5.1.3 Road Board Nepal 21
5.1.4 Town Development Fund 22
5.1.4.1 Objectives of TDF and Donor’s support 22
5.1.4.2 Financing Programmes 23
5.1.5 The Role of Line Agencies 24
6. CONCLUDING REMARKS & RECOMMENDATIONS 26
ANNEXES 28
A I: Comparison of Grant Policy of TDF under KfW funding and of MLD under Reserve Fund 28
A II: Detailed Fund disbursement to municipalities from Department of Urban Development and
Building Construction (DUDBC) under MPPW during Fiscal Year 20064/65 30
A III: Matrix of interdependence between municipal category (A, B, C), type of project (social
infrastructure, revenue generating) and modes of TDF financing (loan, soft loan, grants) 32
4

"Budgets are not just about numbers. They are about the difference
government can make in the lives of people."
(Neil Cole, Ministry of Finance, South Africa)
1. Introduction and Objectives
Despite the comparatively low level of urbanization in Nepal (only about 15-17 % of country’s total
population currently lives in cities), urbanization understood as a process is tremendously dynamic.
The annual growth rate of the country’s urban population of almost 7 % is about three times higher
than the country’s total annual demographic growth of estimate 2.0 %. Nepal’s urban demographic
growth is concentrated within the Kathmandu Valley, the Pokhara sub-metropolitan area and the
municipalities in the Terai region.
Challenges, which Nepalese municipalities must meet, are both multifaceted and complex:
• counteracting a social and/or ecological overload scenario within urban areas;
• participatory and transparent design of planning, budgeting, and decision making
processes and fulfillment of good urban governance criteria;
• poverty reduction and income generation; social inclusion, especially of marginalized
and/or disadvantaged groups;
• conservation of urban cultural heritage and improvement of social and physical
infrastructure and last but not least,
• adequate and effective fiscal management, budgeting and resource mobilization.
Additionally, Nepalese municipalities have the challenging role, to fulfill their defined role as per
LSGA as a provider of urban services for the rapidly growing population, which lives in the
country’s 58 municipalities.
The urban development through local efforts programme (udle), a cooperation programme of the
Government of Nepal and the Federal Republic of Germany and jointly implemented by the
Ministry of Local Development (MLD) and German Technical Cooperation (<strong>GTZ</strong>), supports
Nepalese municipalities in rising to this challenging overall scenario.
One of the major areas of the programme’s technical support is municipal finance and municipal
management. Fiscal decentralization is considered as the backbone of the ongoing overall
decentralization process.
The terms financial transfers, revenue generation and expenditure management are only some of
the currently discussed and reviewed key areas of the municipal finance system.
During the Nepalese Fiscal Year 2062/63 (2005/06) more than one third of the municipalities’ total
revenues were transferred as Local Development Fee (LDF) from central level. The totally
transferred amount of nearly 1 billion Rupees equals about 74% of the municipalities’ aggregated
own source revenues.
5

Despite the fact that municipalities have been given authority to collect various taxes, fees, service
charges, property rental etc, most municipalities depend highly on central government finance
transfers. In general, finance transfer from central down to local level plays a tremendously
important role in municipalities’ revenue composition. As a result of Nepal’s accession to the World
Trade Organization (WTO) in 2004, LDF has to be abolished latest in 2011. The reform the
country’s transfer system (horizontally and vertically), as well as mobilization of resources and the
improvement of the municipalities’ Own Source Revenue (OSR) collection are major upcoming
challenges.
At the moment municipal own source revenue collection is considerably weak. Together all 58
municipalities collected a total amount of about 880.8 million Rupees in Own Source Revenues
(excluding LDF) during Fiscal Year 2062/63. LDF, received by municipalities during the same
period was 112 % of total own source revenues aggregated. The total amount of intergovernmental
funds transferred to municipalities was almost three times higher than the cities’ OSR. The given
limitation of municipal revenues stimulates the ongoing discussions on reforming the municipal
finance system.
The municipal finance system in Nepal is complex, partly incoherent, and under transition. Different
ministries and central level institution are disbursing grants and loans to the country’s municipalities
on a regular or irregular base. The number of sources for grants is high: at least 15 different
conditional and unconditional grants as well as loans are being provided from central level to
municipalities. The totally transferred amount per annum is an estimated 2.47 billion Rupees
(combined average transfers from different sources from Nepalese Fiscal Year 2062/63 and
2063/64). As there is no centrally steered and/or maintained data collection system, both disbursed
amounts, names, and number of beneficiated municipalities are not transparent. In a nutshell one
could state that it is relatively unknown which funds (type and amount) are being disbursed to
which municipality.
This report was compiled with the intention to provide a profound overview of the Municipal
Finance System in Nepal and to reflect on both the status quo as well as structure of transfers,
revenues and expenditures in order to support further discussions and the ongoing reform process.
6

2. Historical Background
The two quotations 1 :
"While promoting financial discipline, provide local bodies with the power to collect tax revenue to
cover at least 25 per cent of the total spent on local public services, and devolve a certain
percentage of national and provincial revenues to local bodies"
"Allocate development funds strictly through local bodies in order to control patronage politics and
encourage the growth of representative institutions at the grassroots level"
--very clearly indicate an intense interrelationship between decentralisation and local government
finance.
Empowerment of local government should be one of major areas of decentralisation process and
fiscal decentralisation plays a vital role in overall process of decentralisation concept.
Strengthening the decentralisation concept, policies and their implementation is one of the major
functions of the present democratic government.
The importance of decentralisation was already emphasised in the government’s 10th
Development Plan (2002-2007) as well as it is reflected in the Three Years Interim Development
Plan (covering the period from 2008 to 2010). This shows a strong commitment to the
administration of development through democratic and decentralised local government. The
strategic importance of decentralisation within the local government functions and responsibilities
are well rooted in "Local Governance Rules 1999 & Local Institutions (Financial Administration)
Rules 1999." To make these efforts more applicable and sustainable, a number of donors including
<strong>GTZ</strong> are or were supporting Nepalese Government in strengthening the local governments and
decentralization.
From July 2008 onwards, Local Governance and Community Development Programme (LGCDP)
will be implemented. The programme will be the basis for the national GoN programme in support
of decentralisation and local governance, to which MLD and development partners recently
committed.
Since 2002, all local bodies are running without elected political representatives. Instead,
municipalities, VDC and DDC are under the guidance of central government officials. However,
some mechanisms such as Seven-Party-Committees have been established for smooth
functioning of local bodies.
Meanwhile, the overall framework has been changed after 2 nd Jan-Andolan (People’s Movement)
for greater democracy in April 2006. After the historic and successful completion of “Constituent
Assembly Election”, held April 10 th , 2008, Nepal now is entering a new era of politic, social and
economic development. The first ever Constituent Assembly Meeting was summoned May 28 th ,
2008.
1 Source: Human Development in South Asia 1999
7

2.1 Present Strategy on Decentralisation and Local Government
Finance
Decentralization is mentioned in the "Directive Principles" of the constitution of the Nepal, 2047
(1990) as well as in the interims constitution-2063, which means providing opportunities for
maximum involvement of the people in affairs of governance and sharing the benefits of
democracy.
Both, Government’s 10 th five years plan as well as the Three Years Interims Plan had emphasized
on strengthening of local bodies to make the decentralization process more effective.
Currently, there are 3,913 village development committee (VDC), 58 municipalities and 75 district
development committee (DDC) at the local level.
In July 2003, the “Local Authority Fiscal Commission" was formed under the chairmanship of
National Planning Commission. Other members were representatives from Ministry of Local
Development (MLD), Ministry of Finance (MoF), Association of District Development Committee
(ADDCN), Municipal Association of Nepal (MuAN), National Association of Village Development
Committee of Nepal (NAVIN) and Federation of Nepalese Chamber of Commerce (FNCCI). The
commission developed a future strategy and reviewed the suggestions given by the ad-hoc
commission and re-furnished “Decentralization Implementation Work Plan” (DIP) developed by the
commission. Basically, one of LBFC’s major objectives is to support the progress of fiacal
decentralization process in Nepal.
Considering all pros and cons of Nepalese Local Government Fiscal Decentralisation recent
approach, the following build the framework for local fiscal decentralization:
• Legal Framework – Constitution 2 , Local Self-Governance Act and Regulation
• Institutional Set-Up – MLD, ADDCN, MuAN, NAVIN, 58 Municipalities, 75 DDC and 3,913
VDCs, Decentralisation Implementation and Monitoring Committee and Local Authority
Fiscal Commission
• Policy Framework – Decentralization Implementation Work Plan (DIP), Policy Paper on
Decentralization (Prepared for National Development Forum- 2002)
• Selective Supporting Document - Decentralization in Nepal (Prospects and Challenges
prepared by HMG/Nepal and Donors), <strong>Report</strong> of the Local Authorities Fiscal Commission
and Analysis of conflicting sectoral acts (prepared by ADDCN)
The commission now is headed under the chairmanship of Cabinet Minister of MLD, which was
formerly restructured after 2 nd Jan Andolan.
Since July 2002, the country's local governments (District Development Committee, Village
Development Committee and Municipalities) are running without democratically legitimized/elected
representatives. Nevertheless, alternative mechanisms are in place. The most awaited Constituent
2 A new constitution will be worked out by a Constitutional Assembly, elected by the Nepali people on 10 th of April,
2008.
8

Assembly Election recently concluded and members of the Constituent Assembly 3 will now focus
on writing of a new constitution for Nepal. It can be assumed that local institutions will be another
2-3 years without locally elected political representatives. Nevertheless, since quite some time
Multi-Party-Committees have overtaken the role of political decision making local institutions.
Local institutions need to prepare their annual budget with programs and implement it accordingly.
Thus, talking about good governance topics and objectives, these institutions should be able to tell
their taxpayers about the composition of Local Government Fund "where does it comes from and
where it goes".
Governance is a popularly used term covering anything from elected representatives to institutional
set-up; and within institutional set-up, a sound regulatory financial framework and its enforcement,
capable institutions, skilled human resources, and effective monitoring and supervision are
important prerequisites for any efficient organization.
3. Legal Framework- Enhancing Municipal Finance
Historically, it was an established belief in many countries that "Central government can do the job
best way". Over the last decades scenario has been changed and steps are now taken to enhance
the capabilities of regional and local government. Local level issues and problems need to be
addressed by local level institutions not by the central government. In fact, the last decade was
dedicated in strengthening the decentralisation process all over the world and to implement the
spirit of decentralisation.
In the early 1980s, Nepal had formulated a Decentralisation Act. Power devolution or
decentralisation to local institutions was the main concept when the act was formulated during the
panchayat regime. However, local institutions could not act so efficiently due to lack of proper
implementation of the Decentralisation Act, 1982. Just after the reinstallation of Democracy in the
country, local institutions related acts (VDC Act, Municipality Act and DDC Act 1991) were
introduced to replace the Decentralisation Act 1982. However, most sections or sub-sections of
these acts were not sufficiently clear and descriptive; even there was not an adequate balance
between the local institutions' functions, powers and responsibilities.
Hence, in 1998 the government has introduced the Local Self-Governance Act (LSGA), to cover all
the three local level institutions’ (District Level, Village Level and Municipal Level) functions,
powers and responsibilities. Apart from the existing act (Local Self Governance Act, 1998) powers
and responsibilities defined by other prevailing acts and rules are delegated to the local
governments.
3 The CA comprises altogether 601 members, including 335 members elected by proportionate method, 240 members
directly elected and 26 members nominated by political parties.
9

4. Municipal Revenue Mobilization and Expenditure
Pattern Situation
4.1 Revenue Composition- Present Scenario
The changing scenario of Nepalese politics basically agreed that the decentralised financial
management is one of the key elements of good governance that covered financial accountability
and transparency. In the context of Nepalese Municipalities, Financial Resource Mobilisation is
now one of the main issues. After the enactment of the new Local Self-Governance Act, 1998 from
29 April 1999, Nepalese Municipalities (58 including 1 Metropolitan and 4 Sub-Metropolitan) faced
some structural changes within their revenue structure. With the introduction of new act, Nepalese
Municipalities had to say final good-bye to "octroi" 4 which contributed more than two thirds of
municipal own source revenues.
However, central government introduced Local Development Fee (LDF-collected from custom
entry point at 1.5% on imported consignment) to replace the “octroi”. LDF distribution to
municipalities was and still is based on their average "octroi" collection of the past three years. In
fact, this arrangement has been materialized after several rounds of debate and discussion with
central government, municipal authorities and Federation of Nepalese Chamber of Commerce and
Industries (FNCCI). Re-distribution of collected Local Development Fee is now under the joint coordination
of Municipal Association of Nepal and Municipal Management Division of Ministry of
Local Development. The very recent (FY 2005/06) financial data show that 58 municipalities' own
source revenues (local taxes - including local development fee, fees and fines, income from
municipal property rental and other revenues but without any grants, loans and last year balance)
were Rs. 1,867.447 million and contribution from one single source i.e. Local Development Fee
was Rs. 986,640 (52.29% of OSR) million. Kathmandu Metropolitan City claimed the biggest share
(23.99%). Similarly, Birgunj and Biratnagar shared nearly 12.62% and 7.18% of total Local
Development Fee.
5
Table 1: Tax composition of Municipalities (aggregated)
Particulars
FY 2004/05 FY 2005/06
Increment Rate
Amount Weight Amount Weight of Weight in %
(In %)
(In %)
Local Development Fee 990,470,000 73.50 986,640,089 74.19 -1.34%
Vehicle Tax 31,578,768 2.34 31,422,526 2.36 -0.52%
House, land tax and integrated 233,996,182 17.36 229,139,993 17.23 -2.16%
property Tax
Professional Tax 63,384,792 4.70 57,321,042 4.30 -9.60%
Other Direct/Indirect Taxes
20,828,894 1.55 21,470,622 1.61 3.08%
(House Rent, Contract, Local
Market, Sales Taxes)
Others taxes and arrears 7,091,115 0.55 4,154,186 0.31 -41.42%
Total Local (Direct/Indirect)
Taxes
1,347,349,751 100.00% 1,330,148,458 100.00% -1.56%
Source: Annual <strong>Report</strong> on Detailed Revenue and Expenditure Breakdown published by MLD/MMD, LBFC and
gtz/udle
4 octroi was levied by municipalities as an indirect tax on the transportation of goods from one municipality to another
and consumption volumes; the charge was 1% on the total value of consumed goods
5 Source: Detailed Revenue And Expenditure Breakdown and Basic Financial Information of 58 Municipalities – Jointly
prepared by: Ministry of Local Development/Municipal Management Section and gtz/udle
10

As mentioned before a big share of tax revenue (34.54% of Total Revenue) comes from "Local
Development Fee" – an alternative of octroi. Contributions from other potential direct taxes are
quite negligible. The above table 1 gives an overview of some of the direct and indirect tax
collection trends.
In FY 2005/06 all 58 municipalities together collected a total amount of Rs. 2,856.135 million as
total revenue, which comes around 63.12% of their target budget. Similarly, municipal own source
revenues (tax and non-tax revenue) consisted nearly 65.38% of total revenue, which fetched
around 76.74% of the projected target.
The following table 2 provides an overview of municipal revenue composition as a whole:
Table 2: Municipal Revenue Composition (in Rs.’000)
Major Revenue Heads FY 2005/06
(Projected Budget)
FY 2005/06
(Actual)
Budget
Achievement in %
Own Source Revenue:
Local Development Fee
House/Land and Property Tax
Other Tax Revenue
Fees and Fines
Property Rental
Other Revenue
2,433,442
995,396,
303,171
170,968
623,104
144,256
196,547
1,867,447
986,640
229,139
114,369
385,820
79,030
72,449
76.74
99.12
75.58
66.89
61.92
54.79
36.86
Miscellaneous Income 218,146 91,961 42.16
Grants:
HMG/Administrative
HMG/Development
DDC and Other Agencies
1,527,881
45,439
681,877
735,006
662,753
44,148
313,269
296,879
43.38
97.16
45.94
40.39
Town Development Fund
65,559
8,457
12.90
(TDF)
Loans (TDF and Others) 162,828 39,844 24.47
Balance Forward 182,444 194,130 106.41
TOTAL REVENUE 4,524,741 2,856,135 63.12
Source: Annual <strong>Report</strong> on Detailed Revenue and Expenditure Breakdown published by MLD/MMD, LBFC and
gtz/udle
4.1.1 Internal Sources of Income
To cover day to day administrative/current expenditure as well as “public expenditure” (includes
ordinary and capital expenditure) municipalities are authorized to raise revenues from different
taxes and non-taxes. Tax revenues (including LDF) shared nearly 46.59% of total revenue of Rs.
2856.135 million (71.25% of Own Source Revenue).
As per LSGA, Municipalities are entitled to collect various taxes, fees, service charges, property
rental etc. as internal revenue. In fiscal year 2005/06, municipalities' total revenue was Rs. 3105.54
million, which was 72.04% of their target budget. Similarly, municipal own source revenue (tax and
non-tax revenue) consisted nearly 62.26% of total revenue and this was 87.72% of their projection.
Almost one third (31.89% of Total Revenue) of tax revenue comes from "Local Development Fee"
and contributions from other potential direct taxes are still negligible.
11

The following table 3 gives an overview of some of the direct and indirect tax collection trends:
Table 3: Tax composition of Municipalities (aggregated) (Rs. In ‘000)
Particulars
FY 2004/05 FY 2005/06
Increment Rate
Amount Weight Amount Weight of Weight in %
(In %)
(In %)
Local Development Fee 990,470 73.50 986,640 74.19 -1.34%
Vehicle Tax 31,578 2.34 31,422 2.36 -0.52%
House, land tax and integrated 233,996 17.36 229,139 17.23 -2.16%
property Tax
Professional Tax 63,384 4.70 57,322 4.30 -9.60%
Other Direct/Indirect Taxes
20,829 1.55 21,470 1.61 3.08%
(House Rent, Contract, Local
Market, Sales Taxes)
Others taxes and arrears 7,092 0.55 4,155 0.31 -41.42%
Total Local (Direct/Indirect) 1,347,349 100.00% 1,330,148 100.00% -1.56%
Taxes
Source: Annual <strong>Report</strong> on Detailed Revenue and Expenditure Breakdown published by MLD/MMD, LBFC and gtz/udle
Financial data further reveal that mobilisation of other direct taxes and fees are not as encouraging
in compare to LDF. In the context of Nepalese Municipalities, the provision of a couple of new
taxes/fees has been made in the act (Land Revenue and House and Land Tax - Section 136, Rent
Tax - Section 137, Professional Tax - Section 138, Property Tax - Section 140 and Service Charge
- Section 145). House, Land and Integrated Property Tax, which is one of the most potential and
sustainable revenue source contributes less than 1/5 of total local taxes. Similarly, “professional
tax”, which could be another important source especially for “bigger municipalities”, fetches very
negligible income.
Previously, in this regards, some municipalities (Dharan, Butwal, Siddharthanagar, Pokhara,
Hetauda, Bharatpur, Banepa, Birgunj, Dhangadhi and Nepalgunj) have already initiated House
Numbering Information System for local resource mobilisation through the technical support of
FiMa (Financial Management) Component of gtz/udle, which improved the generation of direct
taxes (Integrated Property Tax, House and Land Tax and Professional Tax) in municipalities.
However, the process is slow and naturally there is a degree of reluctance of local representatives
and politicians to approach their own constituents to pay (more) taxes while in the past the octroi
tax yielded enough revenue to keep the municipalities going at their pace. In the meantime, for
example, Dharan has shown very promising results after using the taxpayers’ database. 6
4.1.2 External Sources of Income
As most municipalities recognize LDF as a revenue from own sources (as replacement of the self
levied octroi), they perceive Nepal’s central government contributions to municipal income as
6 The database was developed with technical support of gtz/udle. As an result revenues from both Professional Tax
and Integrated Property Tax increased significantly. “House/Land and Integrated Property Tax” increased from Rs.
142.044 million to Rs. 229.139 million (between FY 2003/04 to FY 2005/06). Similarly, Profession Tax increased from
Rs. 47.586 million to Rs. 57.321 million during the same fiscal year. In regards of Dharan, “Integrated Property Tax”
increased from Rs. 2.372 million to 5.462 million; “Professional Tax” went up to Rs. 1.685 million from Rs. 0.999 million
during the years.
12

comparatively low. However, considering fiscal autonomy, financial data indicate that Nepalese
Municipalities are very much dependent from central government grants and other transfers,
despite the fact that they enjoy a high level of financial autonomy. Nepal’s central government
contributions are relatively high in the overall revenue structure of the municipalities. Alone with
LDF, administrative grant and development grant central government contributed about 50% of
total municipal income in FY 2005/06. For a detailed overview of central government grants and
other transfers please refer to chapter 5.
4.2 Expenditure Pattern – Present Scenario
The overall expenditure pattern of 58 municipalities (FY 2005/06) indicates that nearly 34.97% of
total expenditure goes to manage day to day administrative/current expenditure of municipalities in
Nepal whereas Social Program, Ordinary Capital and Capital/Public Expenditure takes rest of the
total expenditure.
4.2.1 Expenditure Composition
Municipal expenditure assignment can be divided into five broader categories for analyzing
purpose. All expenditures are assigned by Section 32 of "Local Body (Financial Administration)
Regulation, 2056 as classified and explained in Annex 28 of the regulation. The following table 4
provides an overview of municipal expenditure of all 58 municipalities in FY 2062/63 and its
projection. In an average, current expenditure incurred more than 34.97% whereas as capital
investment and social program shared nearly 65.03% of total expenditure (Rs. 2,412.28 million).
Similarly, staff salaries and allowances consumed 60.54% of administrative/current expenditure. In
this regard, "Local Body Financial Administration Regulation 2056 (1999)” clearly spells out in
section 27 that "for the purpose of sub-section (2) of section 126 of LSGA, municipal bodies may
spend 25 to 40% of total expenditure as current/administrative expenditure”.
Regarding expenditure projection, it has been observed that public/capital expenditure projection
always differ with big projected amount. Rs. 2,950.09 million was projected for public expenditure
in FY 2005/06 but actual comes only Rs. 1,128.28 million (i.e. only 38% achievement of projected
amount). The main reason of lower achievement of projected public expenditure is due to
unrealistic projection of external revenue and low yields of internal revenue resources. The
following table gives an overview of municipal expenditure composition as a whole:
Table 4: Municipal Expenditure Composition (in Rs.’000)
Major Expenditure Heads FY 2005/06
(Budget)
FY 2005/06
(Actual)
Budget Variance
in %
Current/Administrative Expenditure:
Salary
Allowances
Services
Fuel
Contingencies
Other Current/Admin. Expenditure
999,985
499,816
63,365
61,044
73,893
122,737
179,130
843,457
463,244
49,833
46,322
72,342
75,759
135,957
15.40
7.32
21.36
24.12
2.10
39.09
24.13
Debt Payment 75,702 57,780 23.67
Social Program 463,942 306,749 33.88
Ordinary Capital (Furniture, Equipment) 97,359 76,007 21.93
Capital Investment (Public Expenditure) 2,950,092 1,128,288 61.75
TOTAL EXPENDIUTRE 4,584,083 2,412,283 47.38
Source: Annual <strong>Report</strong> on Detailed Revenue and Expenditure Breakdown published by MLD/MMD,
LBFC and gtz/udle
13

The recent report on municipal financial analysis disclosed that for example out of Rs. 571.929
million of Kathmandu’s total expenditure, around 37.7% is covered by administrative/current
expenses. The rest was covered by social services, procurement of ordinary capital and
development activities of the municipality. Similarly salaries and allowances add up to more than
43.57 % of administrative/current expenditure.
Likewise, in Butwal more than 27% of total expenditure (Rs. 75.191 million) consists of
current/administrative expenditures. Salaries and allowances covered 74% of administrative/
current expenditure.
Hetauda Municipal’s expenditure performance indicates that more than 37% of total expenditure
(Rs. 49.38 million) went to administrative/general expenditure. The remaining resources are
covered by development expenditures, including social services and other capital projects. Within
general/administrative expenditure, a huge share is consumed by staff salary (including sanitation
workers salary); allowances come around 80% of administrative cost.
Financial Analysis report also indicates that Jaleswor, as one of the more negative examples,
spent more than 71% of total expenditure alone in current/administrative expenses. Therefore,
development activities are limited by few remaining financial resources. Similar trends are followed
by Lahan (65.99%), Nepalgunj (63.91%), Panauti (55.53%) and Rajbiraj (55.31%). In contrast to
these indications, Itahari spent only 17.66% to cover its administrative costs. Remaining resources
were allocated for development expenditures. Therefore, Itahari can be considered as one of the
best performing municipalities in this regard. Other good performers are Kalaiya (18.10%), Tansen
(18.50%), Dhankuta (18.57%) and Lekhnath (19.67%).
The average share of current/administrative expenditure in total expenditure comes around 34.97%.
25 municipalities have crossed the average ceiling in FY 2005/06.
4.2.2 Capital Investment Pattern
In order to provide basic municipal services (e.g. road, drainage and water supply) Nepalese
municipalities have invested nearly Rs. 1,128.288 million as "Capital Investment" in FY 2005/06.
To cover these investments, municipalities have to raised their revenues from different sources i.e.
from own sources (tax and non tax revenue). However, physical investment complied by other line
agencies is not included within municipal accounting system. On average, Nepalese Municipalities
incurred Rs. 344,380 for "Capital Investment" in every sq. km improvement (Total Municipal Area –
3276.28 sq. km).
It is important to consider the immense disparities in capital investments patterns between the
different municipalities. For example, Triyuga Municipality covered the larger area (319.88 sq. km
with 194.43 population density), invested only Rs. 21,432 to improve per sq. km of municipal area
which is far below than average expenditure (Rs. 467,578) of Nepalese Municipality. Similarly,
Kamalamai Municipality (207.95 sq. km with 172.25 population density) invested Rs. 66,898.
Likewise, Mahendranagar (171.24 sq. km with 511.36 population density) invested Rs. 62,536.
Table 5 provides an overview of some of the municipalities' area, population density and per sq. km.
capital investment for providing municipal services.
14

Additionally, the table indicates that lower the area with highest density could invite highest
investment from the municipality. The valley towns, the urban areas with the highest population
Table 5: Municipal Capital Expenditure Pattern
(considering municipal area and population density of selected
municipalities)
Municipality Area Population Capital Expenditure
(In sq. km) Density (In per sq. km)
Bhadrapur 10.56 1,845.35 Rs. 1,145,591
Rajbiraj 11.96 2,779.51 Rs. 436,100
Malangawa 9.39 2,189.88 Rs. 509,328
Banepa 5.56 3,128.77 Rs. 1,592,666
Bhaktapur 6.56 11,829.72 Rs. 3,012,856
Kathmandu 49.45 16,388.85 Rs. 4,953,432
Lalitpur 15.15 12,345.61 Rs. 3,580,920
Dharan 103.38 1,066.40 Rs. 326,636
Triyuga 319.88 202.21 Rs. 25,166
Kamalamai 207.95 177.73 Rs. 66,898
Bharatpur 162.16 669.54 Rs. 290,291
Dhangadhi 103.73 766.52 Rs. 106,370
Mahendranagar 171.24 525.17 Rs. 57,900
Amargadhi 138.95 138.27 Rs.27,665
Source: Annual <strong>Report</strong> on Detailed Revenue and Expenditure Breakdown
published by MLD/MMD, LBFC and gtz/udle
Property Tax - Section 140 and Service Charge - Section 145).
density have invested the most
funds in capital investment. In
contrast, the towns located
mainly in the Terai have very
low level of capital investment
per sq. km due to their huge
un-build area (and low
population density). Financial
data further reveal that
mobilisation of other direct
taxes and fees are not that
encouraging in comparison to
LDF. In the context of
Nepalese Municipalities, the
provision of a couple of new
taxes/fees has been made in
the act (Land Revenue and
House and Land Tax - Section
136, Rent Tax - Section 137,
Professional Tax - Section 138,
However, due to lack of adequate information of urban tax payers, all these revenues are not
collected as per expectation of municipal authorities. Henceforth, establishment of tax-payers
database is one of the prime pre-requisite for proper mobilization and collection of all the above
mentioned taxes.
15

5. Intergovernmental Finance Transfers
5.1 Existing System of intergovernmental transfers
There are altogether 58 municipalities in Nepal at present. Among them one is categorized as
metropolitan city (Kathmandu), four as sub-metropolitan cities (Pokhara, Lalitpur, Birgunj,
Biratnagar) and rest as municipalities. In the past, their
main source of income was octroi collected by
themselves with other grants provided by the government
and donors through government institutions. The
scenario has been changed, especially after the abolition
of the octroi.
During Fiscal Year 2005/06 about 2.470 billion Rupees
have been transferred to municipalities. As Figure 1
shows, at present the Ministry of Local Development
(MLD) is the main source of development funds to
municipalities (1.9 billion Rupees). Others are the
Department of Urban Development and Building
Construction (DUDBC; 130.6 million Rupees), Town
Development Fund (TDF; 293.8 million Rupees) and
Road Board Nepal (RBN; 137.9 million Rupees).
Most of Nepalese municipalities are highly depended on the described transfer system. Own
source revenues only can cover some of the necessary municipal expenditures. Including the Local
Development Fee, about two thirds of municipalities’ total revenues are allocated by the urban local
bodies through a transfer system which includes both ministries as well as autonomous finance
institutions such as TDF. The existing transfer system is partly incoherent. For example, MLD’s
Municipal Reserve Fund is in competition with TDF. This chapter of the report provides a structured
overview of existing fund flows from central level towards municipalities.
5.1.1 Ministry of Local Development
The Ministry of Local Development (MLD) provides development funds to municipalities in various
forms. During Fiscal Year 2005/06 MLD disbursed a total amount of approximately 1.908 billion
Rupees to Nepalese municipalities, out of which alone Local Development Fee had a share of
almost 51.7 % (986.6 million Rupees). For details please refer to figure 2.
At present, there are four major types of funds under MLD:
Figure 1: Share by Source of funds
disbursed to municipalities (in Percentage,
FY 2006/07)
11.9
5.3
5.6
77.2
MLD
TDF
DUDBC
a) Local Development Fee (LDF): All 58 municipalities receive LDF in the same proportion as
of the octroi they were collecting in the past, plus an additional amount of 10 %. As
mentioned before, LDF is the most important source of income for Nepalese municipalities
and contributes about 74 % to the municipalities own source revenues (aggregated for FY
2005/06). In the same year about 986.6 million Rupees have been transferred to the
municipalities, corresponding with about 34.5 % of the municipalities total revenues.
RBN
16

The crux: the bigger the municipality, the higher the disbursed LDF. Metropolitan, Submetropolitan
and booming Terai cities close to the Indian boarder by far have the biggest
share on LDF. Smaller, peripheral towns are being penalized.
b) Municipal Reserve Fund (MRF) is under the supervision the Ministry of Local
Development (MLD). The fund is financed through surplus funds of the Local Development
Fee (LDF), which replaced the octroi after its abolishment in 1998. The Local Development
Fee Operating Committee (LDFC) reserves some fund out of the collected Development
Fee to finance and manage the reserve fund.
Only those municipalities having feasible projects in hand receive this development grant.
To get access to this fund, municipalities have to forward applications to MLD with designs
and cost estimate/s of planned projects. The distribution of the fund however, depends on
the locations of the municipalities.
The following conditions are applicable while participating in the reserve fund:
• The municipality can apply for two projects at a time. Upon completion of two projects
as planned additional projects can be asked. The municipality can request only 5
projects in a fiscal year.
• The municipality should only request projects mentioned in MRF guideline.
• Total cost of a project should not be more than Rs. 5 million. For projects to be
executed jointly by two or more municipalities additional Rs. 5 million per municipality
can be provided.
During the last 12 months of Fiscal Year 2007/08 Municipal Reserve Fund provided total
funds of approximately 107.1 million Rs. to municipalities.
Figure 2: Share (in Percentage) per grant type disbursed by MLD
5.6 0.15
Local Dev elopment Fee
26.2
Unconditional
Dev elopment Grant
51.7
Conditional
Dev elopment Grant
Municipal Reserv e
Fund
16.3
others
17

c) Unconditional Development Grant: 7 under the umbrella of “Unconditional Development
Grant”, MLD disburses eight different types of grants to the municipalities (Figure 3). In
Fiscal Year 2007/08 a total amount of about 311 million Rs. is disbursed.
• Administrative Grant - All 58 municipalities receive an annual
Administrative Grant of Rs. 400,000 up to 800,000 Rs., depending upon
the level of the executive officer. The grant’s objective is mainly to pay the
Executive Officer’s salary and to cover his/her other small scale expenses.
The total amount distributed to 58 municipalities under this Grant in the
Fiscal Year of 2007/08 is Rs. 35.70 million.
• Development Grant – Municipalities with an annual own source revenue
of less than 10 million Rs. are eligible for the development grant. Certain
criteria, mainly based on population and area covered by the municipality
define the funds, disbursed to the municipalities. In general the fund flows
according to the rule "the lower the municipal own source
revenues/income, the higher its individual share on development grant."
However, recently some discussions regarding the future distribution of
the grant are ongoing. Major argument for restructuring the disbursement
is the lack of incentives for low income municipalities to increase their own
source revenues if the benefit utmost from the development grant. The
policy of providing development grant to municipalities with less than 10
million Rupees annual own source revenues has encouraged them in
receiving more development grants than mobilizing internal resources.
During the Fiscal Year 2007/08 altogether 47 municipalities 8 received a
total amount of 216.50 million Rs., disbursed under this grant.
• Matching Grant – The disbursement of this grant is basically based on
existing demands and depends firstly on the priority, given to the
proposed projects to be implemented. Secondly, the estimated amount to
be allocated as matching grant for individual projects is decisive.
Organizations and institutions, such as Town Development Fund (TDF)
request matching grants from MLD. The total amount disbursed under
TDF, RUPP and HRD components during the Fiscal Year 2007/08 is 23
million Rs. (9.00 million TDF, 12 million RUPP, and 2 million HRD,
respectively).
• Resource Mobilization Grant – It is a demand based grant mainly for
human resource development in municipalities (e.g. training for municipal
staff). The maximum amount one municipality receives upon request is Rs.
200,000. There are no specific criteria for the disbursement of the
7 Although the term “unconditional grant” can be irritating especially in the context of the listed grant subcategories, the
mentioned grants, provided by MLD are considered “unconditional” due to the fact that they are part of the regular
municipal budget and that they are being allocated every year.
8 Municiplities not eligible for this grant are: Mechinagar, Biratnagar, Kathmandu, Lalitpur, Dhulikel, Banepa, Gaur,
Birganj, Butwal, Siddharthnagar, and Nepalgunj.
18

Resource Mobilization Grant. A total amount of 2 million Rs was disbursed
to 11 municipalities in Fiscal Year 2064/65.
• Social Mobilization Grant (SMG) 9 – This grant was provided to
municipalities through RUPP (Rural Urban Partnership Programme)
mainly for community development and poverty reduction where RUPP
was active. The total value of SMG was 12 million Rupees/year. RUPP
phased out in December 2007. Still, the disbursement of an alternative
grant of equivalent amount continues. 20 municipalities where RUPP was
active continue to receive transfers.
• Grant for Landfill Sites – This grant is provided for the
development/management of landfill sites. During Fiscal Year 2007/08
only three municipalities have received a total amount of 5 million Rs. The
disbursement of this grant is based upon municipal proposals to develop
landfill sites. This fiscal year Bhadrapur received a amount of 3 million Rs.,
and both Kamalamai and Dhankuta received 1 million each. Any
municipality submitting a proper proposal with a piece of land suitable to
develop a landfill site is eligible for this Grant. 10
• Fire Fighting vehicle Grant - This grant is mainly for the operation of fire
fighting vehicles. Only municipalities with fire fighting vehicles are eligible
for this grant. The amount is almost fixed as Rs. 400,000 for each and
every municipality having fire fighting vehicle/s and is used mainly to cover
salaries of relevant staff and their allowances and urgently needed repair
works. In total 32 municipalities received this grant (accumulated 13
million Rs.) in Fiscal Year 2006/07.
Figure 3: Share (in Percentage) per unconditional grant type disbursed
by MLD in FY 2006/07
0.6
11.5
3.9 1.6 4.2 1.3
Administrativ e Grant
Dev elopment Grant
7.4
Matching Grant
Resource Mobilization
Grant
Social Mobilization Grant
Grant for Landfill Sites
Fire Fighting Vehicle Grant
69.5
Guest House Grant
9 Resource Mobilization Grant is not a regularly disbursed grant. Nevertheless, SMG is listed because it was disbursed
through MLD under RUPP until it phased out end of 2007 on an annual base.
10 So far TDF did not provide any funding for Landfill Side development in municipalities. TDF however is highly
interested in channeling government funds, allocated for this purpose.
19

• Guest House Grant – This grant is provided to municipalities for the
repair and maintenance of guest houses. Only municipalities with guest
houses are eligible for the grant. In Fiscal Year 2007/08 a total amount of
4.2 million Rs. is disbursed to 14 municipalities (300,000 Rs. per
municipality)
d) Conditional Development Grants (CDG) – CDG are provided to municipalities with some
pre-conditions. The total amount provided to municipalities under CDG during FY 2006/07
was 500 million Rupees. The total amount disbursed under CDG varies each year and
depends on existing demands.
In total 42 municipalities received donor support through CDG last Fiscal Year 2006/07.
The disbursement of grants under CDG depends on municipalities’ covered territories and
number of population. In addition disburses grants to municipalities in a more or less
regionally balanced disbursement pattern.
Beside above mentioned grants, MLD has allocated Rs. 3 million to be spent on human resource
development through Municipal Association of Nepal (MuAN) from Fiscal Year 2007/08 onwards.
However, the distribution procedure is not clear yet. MuAN will decide on disbursement criteria.
Additionally, there is also a Social Security Grant, which is disbursed to municipalities through
District Development Committees. This grant provided to municipalities focuses on support to
elderly people, widows and disables, mainly in the form of allowances.
Additionally, for Fiscal Year 2008/09 MLD will provide some funding for Poverty Reduction
activities in some municipalities.
5.1.2 Department of Urban Development and Building Construction
The third department/institution funding municipal infrastructure and supporting municipal planning
is the Department of Urban Development and Building Construction (DUDBC) under MPPW.
It provides funds mainly to
a) construct government buildings (4.9 million Rs were disbursed to 6 municipalities
in Fiscal Year 2007/08) 11 ,
b) social infrastructure (83.3 million Rs were disbursed to 12 municipalities in Fiscal
Year 2007/08 ) 12,
c) conservation measures (1.2 million Rs were disbursed to 4 municipalities in Fiscal
Year 2007/08) 13
d) land pooling (4.55 million Rs were disbursed to 4 municipalities in Fiscal Year
2007/08) 14
e) to prepare and/or support municipal planning (periodic plans, physical
development plan, master plan, integrated action plan, and digital mapping; 14.69
11 Municipalities which received funds: Janakpur, Lalitpur, Kirtipur, Tribhuwanagar, Kathmandu, and Syangja
12 Municipalities which received funds: Lalitpur, Kirtipur, Tribhuwanagar, Rajbiraj, Kathmandu, Pokhara,
Birendhranagar, Amargadhi, Dasarathchanda, Ramgram, Kalaiya, and Itahari
13 Municipalities which received funds: Lalitpur, Kathmandu, Pokhara, and Bhimeshwore
14 Municipalities which received funds: Rajbiraj, Mechinagar, Ilam, and Nepalgunj
20

million Rs were disbursed to 17 municipalities in Fiscal Year 2007/08) 15 .and
f) other activities (e.g. trainings, consultancies, studies; 2 million Rs were disbursed
upon request to a unknown number of municipalities).
For detailed fund disbursement scheme please refer to Annex II.
The ratio of financial support in the preparation of periodic plans is 50:50 (50% by DUDBC and
50% by the concerned municipality), whereas for building construction, social infrastructure and
conservation measures the financial support provided by DUDBC is 100%. The number of
municipalities getting such support varies from year to year. In Fiscal Year 2006/07 the number has
reached 34 and the total budget disbursed is Rs. 110.635 million Rupees. 16
With the beginning of 2008, MPPW disbursed an additional 20 million Rs as matching grant to TDF.
5.1.3 Road Board Nepal
Another Institution providing grant to municipalities is Road Board Nepal, which provides 70% of
the estimated amount for the rehabilitation, maintenance and emergency repair of highways (within
the municipal area) and other urban roads under category A (Highways and Semi-highways) and B
(Blacktopped urban roads). With regard to the procedure how the fund is provided to municipalities,
the followings are the steps:
• The Department of Roads (DOR) prepares the integrated annual development plan for the
country as a whole and forwards it to the Road Board Nepal. The development plan
includes Highways and Semi Highways (Category A roads).
• Municipalities prepare their annual development plan and send it to DOLIDAR
(Department of Local Infrastructure Development and Agricultural Roads) for review.
Afterwards the plans are being forwarded to the Road Board Nepal
• DOLIDAR prepares an integrated annual development plan for the construction,
rehabilitation, maintenance and repair of urban and district roads (Category B roads),
based on district and municipal development plans. DOLIDAR forwards its annual
development plan to the Road Board of Nepal.
• The Road Board Nepal prepares the final annual development plan for roads based on the
plans developed by DOR and DOLIDAR. During the preparation of this plan, the Board
gives priority to the following:
• character of the repair (emergency or regular)
• Strategic importance of the road
• Traffic volume
Elements of RBN planning considering category B roads are being implemented through
15 Municipalities which received funds: Birendranagar, Amargadhi, Dasarathchanda, Ramgram, Prithivinarayan, Trijuga,
Narayan, Tribhuwanagar, Tulsipur, Birgunj, Kirtipur, Madhyapur/Thimi, Dhankuta, Mechinagar, Damak, Bhadrapur,
Kathmandu
16 In addition, a total amount of 37.3 million Rs were disbursed to emerging towns.
21

municipalities themselves. In FY 2063/64 the RBN provided support to 50 municipalities through
DoLIDAR for rehabilitation, maintenance and repair of urban roads of a total amount of 137.09
million Rs. As the disbursement of financial resources is decided centrally by DoLIDAR,
municipalities can not apply for funding.
The total fund mobilized through DOR for maintenance of Strategic Road Network is the Rs.
630.019 million in Fiscal Year 2007/08
5.1.4 Town Development Fund
A fourth Institution providing funds to municipalities as loans, soft loans and grants is the Town
Development Fund (TDF). TDF was established in 1989 as ‘TDF-Board’ under the Development
Board Act 1956 as an autonomous urban financing institution with the objective of providing funds
for municipal development activities in the form of loans/ soft loans and grants. For this purpose,
municipalities are divided into three different categories; A, B and C. For details, how the funds are
provided and in what form and what are the procedures, please refer to Annex A II and the Loan
and Grant Policy published by TDF.
Currently, TDF Board has one representative each from the Ministry of Local Development (MLD),
Ministry of Finance (MoF), Nepal Engineer’s Association, Association of Chartered Accountants,
and five Mayors from five development regions. The Secretary of the Ministry of Housing and
Physical Planning (MPPW) is the Chairman, and Executive Director of the Fund is the Member
Secretary of the board.
The TDF is considered as a progressive instrument in preparing the way for self-sustaining
municipal credit systems that can also tap domestic and international capital markets for financing
in future.
Until the end of 2006, the TDF disbursed a total amount of Rs. 308 million, out of which 19.4 %
(59.8 Mio.) were disbursed as grants and 80.6 % (248.2 Mio.) as soft loans and loans. Additionally,
Rs. 25.3 million were spent for studies, supervision and/or service charges for these funded
projects. In recent years TDF disbursement increased significantly: alone in Fiscal Year 2063/64
about 293.8 million Rupees have been disbursed as loan, soft loan and grants to the municipalities
(incl. TDP II, STWSSSP, DHP, UEIP). 17
5.1.4.1 Objectives of TDF and Donor’s support 18
TDF’s objectives are defined as follow:
• Strengthening the organizational capability of 58 municipalities in implementing needspecific
investment projects adjusted to their technical and administrative potentials.
• Loan financing of urban infrastructure development, supplemented by grants in appropriate
situations, and linkage with matched contributions by municipalities and central
government based on the current revenue generating capability and capacity.
17 For TDP II TDF disbursed 40.6 million, for DHP 53.7 million and for ADB (STWSSSP & UEIP) 194.4 million Rupees.
In addition some fund was spent on supervision, studies etc.
18 Source: The Role of TDF in Municipal Finance. Strategy Paper, prepared by PLANCO/<strong>GTZ</strong>/udle in 06/2007.
22

• Support to the clients’ in master planning, project identification and prioritization of
competing community needs, concept development, project design and engineering,
tendering and supervision of construction.
The objectives of the donors’ support are not only geared to provide conditional credit to local
governments and to other institutions investing in municipal and social infrastructure. The vision is
to develop institutional and managerial capacities and to build up a financially autonomous
intermediary with policy, rules and regulations to ensure successful and sustainable processing
and financing of infrastructure and revenue generating projects in future.
5.1.4.2 Financing Programmes 19
Over almost 20 years, the TDF has implemented a wide range of urban infrastructure projects
which were financed by grants, soft loans and loans with the support of the German Technical and
Financial Cooperation (<strong>GTZ</strong>/KfW), World Bank (IDA) and Asian Development Bank (ADB). 20
Ongoing programmes, implemented by TDF are:
A.) Town Development Programme Phase II
Based on satisfactory results of the TDP I it was agreed to continue support to TDF under Phase II
with further grant commitment of KfW of Euro 8.04 million (equivalent to NPR 684 million) for loan
and grant financing to 58 municipalities. The deadline for final disbursement was fixed to
December 2007.
Initially, project identification and implementation as well as repayment of loans were satisfactorily.
But poor progress in subsequent years of widespread violence, blockades and general strikes
throughout the country have given substantial concern regarding target achievement in
disbursement of the available funds. So far, fund utilisation was slow with 51.8 % in terms of total
commitment and 29.6 % in terms of total disbursement. The structure of committed funds revealed
70% as loans, and 30 % as grants, including grants for studies and supervision, and TDF service
charge. With much hope on the results of the ongoing peace process substantial progress is
expected in the performance of TDP II during second half of 2007. If the political situation remains
favorable, it is expected that commitment will increase substantially from the fourth quarter of year
2007 onwards and could reach the ceiling set for TDP II already in year 2008. Consequently, total
disbursement would reach full target achievement about one year later, i.e. in year 2009.
19 Source: The Role of TDF in Municipal Finance. Strategy Paper, prepared by PLANCO/<strong>GTZ</strong>/udle in 06/2007.
20 Programmes, implemented by TDF in the past were
<strong>GTZ</strong> Grant: Initial grant contributions made under Germany Technical Cooperation (<strong>GTZ</strong>) were fully utilised for
approved grant and soft loan projects by July 1997 resulting in 303 grant projects in 36 municipalities with a total grant
fund of NPR 99.7 million, and 13 loan projects in 9 municipalities with a total of NPR 13.5 million.
IDA Loan: Under the loan agreement entered with the International Development Association (IDA) of the World Bank
in 1998, 28 projects in 187 municipalities with a total of NPR 126 million have been implemented. However, due to
slow disbursement of funds IDA cancelled US $ 7.5 million out of US $ 10.5 million in loans in March 1995.
Town Development Programme Phase I: In 1994, the TDF Board requested the German Financial Cooperation (KfW)
for grant financing of DM 10 million which has been successfully completed as planned until 2001. The proportion of
use of funds during the first phase of Town Development Programme (TDP I) achieved was 44% (NPR 113.5 million)
for loans provided for the financing of 17 project in 14 municipalities and 56% (NPR 197.5 million) remaining for grant
financing.
23

B.) Small Town Water Supply and Sanitation Sector Project
A subsidiary loan agreement was signed between the TDF and the Asian Development Bank
(ADB) in 2001 for an amount of $12 million (equivalent to about NPR 840 million) to TDF and to be
repaid to the GoN. TDF on-lends this loan which constitutes in 30% of total project cost of water
supply to Water User Associations in 30 small towns. From the differentials in lending and onlending
terms the TDF shall cover its services. TDF has already approved sub-loans for 29 town
projects out of 30 towns enlisted in all three batches and has signed sub-loan agreement for all 29
towns. Total funds disburse has reached 46%, however, as most of the constructions are lagging
behind the schedule there is strong demand for time extension of this programme.
C.) Urban and Environmental Improvement Project
The Urban and Environmental Improvement Project (UEIP) is funded under the Sub-Loan
Agreement by the ADB with 3.38 million US$ (equivalent to NPR 236.6 million). TDF shall cover its
service and administrative costs from the interest rate spread between lending from GoN and onlending
to 8 selected towns bordering the Kathmandu Valley. TDF has not disbursed any loan in
UEIP projects, however some projects are in the early stage of implementation. The progresses of
projects are not satisfactory as per the target.
D.) District Health Project
The District Health Project (DHP) is financed from funds of the German Financial Cooperation
(KfW). The program supports the implementation of physical rehabilitation, operational
improvement and procurement of medical equipment for 6 selected health care facilities. The
Executing Agency is the Department of Health Services (DHS). TDF is in charge of the technical
functions of project implementation and, in turn, employs local consultants for the design and
supervision of physical rehabilitation measures. Total project construction costs are calculated at
about NPR 169 million. The disbursement of funds was slow during the past but progress was
made during recent months and full disbursement of committed funds is now expected until the
year 2008.
5.1.5 The Role of Line Agencies
In Nepal line agencies do not provide any grants or loan assistance to municipalities on a regular
base. The further development of some key sectors is designed and financed independently by the
respective agencies.
However, the following are just some samples of Line Agency support to municipalities in selected
key sectors. A more detailed report on Line Agency support/engagement to/in municipalities will be
compiled under udle programme in near future.
Water Supply:
The agency in charge, Nepal Water Supply Corporation (NWSC), does not provide any funds
directly to the municipalities. Instead, the corporation finances the further development/expansion
of the water supply network, water sources, pumps etc for the benefit of municipal population.
According to NWSC, the corporation’s expenditures depend on size/population of respective
municipalities as well as on existing demands:
24

• in category A municipalities (Kathmandu, Lalitpur, Biratnagar, Pokhara, Birgunj) NWSC
spends around 5.0 million Rupees or even more
• in category B municipalities (e.g. Butwal, Bharatpur, Hetauda etc.) NWSC spends around
2.0 - 2.5 million Rupees
• in category C municipalities (e.g. Lahan, Rajbiraj, Bhadrapur etc.) NWSC spends around
1.0 – 1.5 million Rupees
for maintenance and expansion of water supply network.
During Fiscal Year 2006/07 NWSC spent about 140.8 million Rupees for maintenance and
expansion of water supply networks in 22 municipalities; approximately 78 % of all resources have
been invested into projects within the Kathmandu Valley.
Road Network:
As mentioned before, the Department of Roads (DOR) spends some budget for repair and
maintenance of highways. There is no substantial record of how much resources have been spent
by the Department for the repair of roads within municipal boundaries.
For detail please refer to chapter 5.1.3.
Electricity:
The responsible Nepal Electricity Authority does not provide any funds directly to municipalities.
With regard to expenditures in municipalities, the authority forces the expansion of High Voltage
lines. 21
Communication:
Nepal Telecom does not provide any funds to municipalities. Nepal Telecom forces the expansion
of its network independently.
21 In most of the smaller municipalities (e.g. Kalaiya, Ramgram, Kapilvastu etc.) electricity line extension can be done if
necessary logistic (wooden polls, wire) is provided by the municipality itself. Once the line is extended, the property
belongs to “Nepal Electricity Authority”
25

6. Concluding Remarks & Recommendations
Due to the various reasons, Nepal’s economy growth rate is in a very regressive trend (in between
3.0 to 3.5 % per annum) which is considered one of the lowest economic growth rates within
SAARC countries. Similarly, Nepal is experiencing a high ratio of urban population growth.
Obviously, it is municipal governments’ prime responsible to cater at least basic services to the
urban population within the country.
As stated at the beginning of this report, Nepal’s municipal finance system is partly incoherent. It is
hardly known, how much fund is channeled to which municipalities on regular or irregular base.
The country’s cities depend highly on fiscal transfers (with a few exceptions small and medium size
municipalities more than bigger ones) and are mostly unable to reduce this high dependence with
increasing Own Source Revenues, for example. Municipalities still depend excessively on the
Local Development Fee, which is provided in form of grant. LDF has to be abolished until 2011; the
financial/fiscal future of Nepalese municipalities seems to be uncertain at the moment. The future
absence of LDF, which recently contributes 74.19% of local tax revenue in municipalities, will
create a big resource crisis for municipal governments.
Henceforth, it is a high-time that municipal governments must have a clear strategy on improving
the existing resource mobilization scheme. The upcoming new arrangement of political alliances for
municipal development and administration will certainly have to look in this matter with utmost
seriousness for amicable and long term sustainable solution for improving municipal financial
management.
Taking additionally the ongoing process of state restructuring into account, the reform of the
municipal finance system as such seems to be an option for the near future in order to secure
sustainability in finance management at local level. If cities are being considered as vibration of
economic growth and corners stone of development the redesign of development efforts with the
inclusion of municipal management (within high priority of national development goal) is needed.
Besides these measures, the following other points need to be considered for betterment of
municipal financial management:
• Emphasis on “public-private partnership” in municipal service delivery system (solid waste
collection) and management contract for operating municipal assets (bus-park, shopping
center etc.)
• Explore new arenas of revenue generation (e.g. revenue from cattle market – Damak, and
royalty from hydro-power – Khadbari)
• Full-fledged implementation of “integrated property tax”, “property/business tax” and
“hoarding/bill board tax” in potential municipalities
• Formula to be developed (if agreed by all stakeholders) for sharing corporate/income tax,
value added tax and revenue from land registration
• Initiation of “tax awareness campaign” – a possible and applicable model to be developed.
• Inventory of public property/assets (to be used for resource mobilization scheme and it is
necessary for implementing “Corporate Accounting System”)
• Automation of “Tax Payers Register” – software to be developed with greater involvement
of municipal staffs (working in finance section) as well as MLD and LBFC.
• Introduction of “Corporate Accounting System” – A details work-plan and strategy need to
be developed jointly with municipal staffs as well as MLD and LBFC
26

• Implementation of MC/PM (Minimum Conditions and Performance Measures) for fiscal
transparency, good governance and accountability.
• Central Government (MLD) should become more pro-active in supporting and committing
the municipalities in developing their own local tax base and in compelling the citizens to
pay for their local governments.
Nevertheless, it is quite clear, that an even significantly improved municipal Own Source Revenue
scheme can and will not replace the LDF in future.
Furthermore, the report has shown that criteria for disbursement of grants to municipalities are not
always clear and the total amount of disbursements to be made varies each year. Methods
adopted by the Nepalese government for distributing grants to municipalities are neither scientific
nor transparent. For the urgently needed increase of internal/local resource mobilization they have
even been contra productive. With this comparatively comfortable centralized finance system in
place most municipalities do not have any motivation to improve their performance in collecting
taxes, fees and fines etc at local level.
In recent past, LBFC with udle support developed an Indicator Based Grant Distribution System
(Minimum Conditions/Performance Measures) for municipalities in order to stimulate the local
authorities’ motivation to perform in an efficient, effective, accountable and transparent way and to
fulfill the municipalities’ duty as service deliverer for urban population. It is expected that this
system, yet to be piloted and approved, contributes to the backstopping of good local/municipal
governance, the transparent and responsible use of financial resources (including revenue
allocation, management and expenditure), participation, an efficient administration, and
performance-related financial benefits for municipalities.
In case of improving the municipal financial system, many measures and suggestions have been
already formulated and suggested by different study teams. Many were not taken seriously by the
concerned and responsible officials/leaders involved in municipal development and, therefore, not
being implemented.
In a nutshell, municipal finance system needs to be optimized and the following aspects have to be
considered at macro level during the recommended reformation process:
• Review of role (incl. duties, rights and responsibilities) of municipalities in a future federal
system
• Definition and design of criteria for Local Governance Finance/ Composition of Revenues
(Taxes, Fees, Fines, Grants etc)
• Design of future tax allocation at local level (e.g. fixed taxes on basis of fixed assets
(land/property); flexible taxes, depending on economic development (e.g. individual
income tax, corporate income tax)
• Design of criteria for future grant distribution/ intergovernmental transfer system
27

Annexes
A I: Comparison of Grant Policy of TDF under KfW funding and of MLD
under Reserve Fund
(Source: <strong>Report</strong> on MRF and TDF comparison, prepared by udle (2007)
No. MLD Reserve Fund No. TDF/KfW Grant Fund
1 Eligible municipalities are 58 1 Eligibility municipalities are 53
2
Maximum grant amount Rs. 10 million in a
Maximum grant amount Rs. 4 million in 5 years for any
2
year for 2 projects
number of projects
3
Cost of a project should not exceed Rs. 5
million
3 No limit on the cost of the project
4
Matching fund 25% to 60% depending upon 65% matching fund for B class municipalities and 35%
4
nature of the project
for C class in year 2004
5
15% of the matching fund could be deducted
5% annual increment in matching fund contribution for
for municipalities with income less than Rs. 5
all municipalities
10 m.
6 No specific condition to receive grant 6 B class municipalities to take loan before taking grant.
7 No specific condition on study of a project 7 10% matching fund from B and 0% from C for study
No specific condition on supervision of a
10% matching fund from B and 5% from C for
8
8
project
supervision
Priority to those municipalities who contribute
9
9 No such condition in this policy.
highest % of the matching fund.
10
11
No. of projects limited to 2 in a year in a
municipality
Project appraisal and approval process not
clear.
For all municipalities
10
11
Types of Eligible Projects
1 Landfill site 1 Public toilet
2 Mini-bus park 2 Pavement
3 Shops 3 Footpaths
A project will be appraised only after the approved
project is completed physically, administratively and
financially.
While appraising and approving necessity, feasibility,
environment, social and cultural impact, cost
effectiveness and operation and maintenance aspects
of the project are taken into consideration.
For B and C class municipalities
4 Drainage 4 New school building
5 Park, ponds and greenery 5 Repair of old school building
6 Community halls and public toilet 6 Toilet and furniture for school
7
Reconstruction of infrastructure due
unforeseen event
7 Public library
8 Solar energy
9 Water supply tanker For C class municipalities only
28

10 Roads and bridges 1 Pond and park
11 Community schools and physical facilities 2 Drainage
12 Improvement of tax system 3 Simple treatment plant
13 Poverty mapping survey 4 Solid waste management
14 Support for natural disaster and fire
Process of Application of a Project
1 Decision of the municipal Board 1 Decision of the municipal Board
2 Approval from the municipal Council 2 Land ownership certificate
3
Project is mentioned in the budget with
necessary matching fund
4 Design, drawing and estimate of the project
3
Detailed design and estimate of the project, and
other information for the appraisal and
implementation
29

A II: Detailed Fund disbursement to municipalities from Department of Urban Development and Building
Construction (DUDBC) under MPPW during Fiscal Year 2007/08
(in Rs. in 1,000; source: calculation according to DUDBC information)
Municipality
Construction of
Government Buildings Social/Physical Infrastructure Conservation Measures Land Pooling Planning others
amount activity amount activity amount activity amount activity amount activity amount activity
Amargadhi
- - 500 Physical Infrastructure - - - - 500 Masterplan - -
Banepa - - - - - - - - 150 Gosaikunda - -
Bhadrapur - - - - - - - - 116.25 Pro. Plan - -
Bhimeshwore
- - - - 200
Birendranagar - - 800
Conservation
of Rajhiti - - - - - -
Construction of Picnic
shed - - - - 500 Masterplan - -
- - 4800 Road/drain - - - - - - - -
Biratnagar - - - - - - - - - - 50 Design
Birgunj - - - - - - - - 320 Periodic Plan 50 Design
Bidur - - - - - - - - 500 Masterplan - -
Damak - - - - - - - - 116.25 Pro. Plan - -
Dasarathchanda - - 5600 Road/drain - - - - 500 Masterplan - -
Dhankuta - - - - - - - - 320 Periodic Plan - -
Hetauda - - - - - - - - 300 Masterplan - -
Ilam
- - - - - - 700
Land
pooling - - - -
Itahari
Road/Brigde/Causeway;
Land
- - 49500 Regulator/Syphon - - 2000 pooling - - - -
Janakpur 800 Theater - - - - - - 500 Masterplan - -
Kalaiya - - 4800 Road/drain - - - - - - - -
Conservation
of Kumaristhan
Kathmandu
and Balkhu
- - 1700 Footpath; Road/drain 700 Tempel - - 116.25 Pro. Plan - -
Kirtipur
Community
1000 Bld 4800 Road/drain - - - - 320 Periodic Plan - -
30

Lalitpur
Repair of
800 Service Bld 3100 Cycle track, Road/drain 100 temple area - - - - - -
Madhyapur/Thimi - - - - - - - - 320 Periodic Plan - -
Mechinagar
Nepalgunj
Narayan
- - - - - - 300
- - - - - - 950
Land
pooling 116.25 Pro. Plan - -
Land
pooling - - 50 Design
- - - - - - - - 500 Masterplan 1000
Rajbiraj
Land
- - 300 Road/drain - - 600 pooling - - - -
Ramgram - - 4800 Road/drain - - - - 500 Masterplan - -
Pokhara
Conservation
- - 1600 Road/drain 200 of Monument - - - - - -
Prithivinarayan - - - - - - - - 500 Masterplan - -
Siddarthanagar - - - - - - - - - - 50 Design
Syangja 1300 City hall - - - - - - - - - -
Tribhuwanagar 1000 Eld. Home 1000 Road/drain - - - - 320 Periodic Plan - -
Trijuga - - - - - - - - 4800 Masterplan - -
Landfill
site study
Physical
Tulsipur
Development
- - - - - - - - 1000 Plan - -
different
Seminars,
municipalities - - - - - - - - 2370 Digital map 800 Trainings
Total 4,900.00 83,300.00 1,200.00 4,550.00 14,685.00 2,000.00
31

A III: Matrix of the interdependence between municipal
category (A, B, C), type of project (social infrastructure,
revenue generating) and modes of TDF financing (loan, soft
loan, grants)
Source: TDF
32