Modernizing the NFC Award - A Blockchain for NFC Transfers

Pakistan is a federal state having different tiers of government; the federal government at the centre, and the four provincial governments. There is also a third tier, i.e. local governments. Being a central type of government, a huge chunk of revenue is collected by the federal government and then redistributed vertically between federal and provincial governments and horizontally among the provinces. For that purpose, the Constitution of Pakistan requires that the National Finance Commission (NFC) be constituted every five years to recommend the annual distribution of national revenue between the federation and the provinces as well as among the provinces.

As the government is in the process of forging consensus on the distribution of resources under the eleventh National Finance Commission (NFC) Award, it is apt to have a look at the history of NFC awards in Pakistan. Besides offering an overview of the NFC Awards, the instant write-up offers a blockchain-based framework for NFC transfers so as to help policymakers address critical challenges.

In Pakistan, the distribution of finances between the federal and provincial governments occurs through the National Finance Commission which is constituted under Article 160 of the 1973 Constitution. It consists of the federal minister for finance (Chairman), the provincial finance ministers and such other persons as may be appointed by the President after consultation with the governors of the provinces.

Adoption of the NFC award

Pakistan's first real institutional effort to manage resource distribution began under Liaquat Ali Khan's premiership, which was known as the Raisman Program in 1951. The program was later terminated by PM Khan who renamed it as National Finance Commission. Since 1951, the program had enacted only three NFC awards of 1961, 1964 and 1970, which all of these were given in unusual circumstances and remained inconclusive.

Following the adoption of the 1973 Constitution, the NFC took a firm shape. Article 160 (1) of the constitution provides for the establishment of the NFC. Moreover, Article 160 (2) provides for the mandate of the NFC saying that its duty is to make recommendations to the President as to

(a) the distribution between the Federation and the Provinces of the net proceeds of the taxes mentioned in clause (3);

(b) the making of grants-in-aid by the Federal Government to the Provincial Governments;

(c) the exercise by the Federal Government and the Provincial Governments of the borrowing powers conferred by the Constitution; and

(d) any other matter relating to finance referred to the Commission by the President.

Disbursement of NFC Award

The federal government, through institutions like the FBR, gathers taxes and other revenues that constitute the divisible pool. Based on the NFC Award formula, the finance division calculates the provincial shares and authorizes the State Bank of Pakistan to transfer funds to the respective provincial accounts.

Despite constitutional provisions to announce the award after every five years, the 8th, 9th and 10th NFC awards were not finalized. The 7th NFC award, which was due to expire in 2015, was extended repeatedly by the President and remains in effect as of 2025 as the 10th NFC award. The process to devise the 11th NFC Award has been started and in its inaugural meeting on December 4, the Commission agreed to consider KP’s share in the Award after the merger of FATA and PATA into the province. Under the current NFC Award, population carries 82% weight, while poverty, revenue generation and inverse population density carry smaller weights. The Planning Ministry has proposed changes that could reduce Punjab's share by about 10% and Sindh's by 0.5%.

Concept of “fiscal federalism”

Fiscal federalism, a term introduced by the German-born American economist Richard Musgrave in 1959, can be defined as financial relations between units of governments in a federal government system. Fiscal federalism is part of broader public finance discipline. It deals with the division of governmental functions and financial relations among various levels of government. At the heart of this theory is that governments should focus on economic stability and income redistribution in line with local preferences and conditions.

Challenges faced by Pakistan

While the NFC Award, under fiscal federalism, aims to foster national cohesion and provincial autonomy, its effectiveness is often hindered by the traditional modus operandi of fund transfer. The current system heavily relies on outdated methods and a centralized nature, characterized by administrative failures, time lags and a lack of real-time, verifiable data. In this era of digitization, Pakistan should learn lessons from other countries before designing its NFC Award for resource distribution.

China, the United States, Canada and Australia, by their technological advancements, have merged AI-based technology into federalism. Pakistan's fiscal federalism is far behind that in other developing countries like Bangladesh, India and China. Since the inception of the NFC Award and the 18th Amendment, there has been criticism on the methods and delayed distribution of federal resources. These systemic weaknesses create a fertile ground for provincial leakage, a term that refers to the unaccounted-for or misallocated funds that fail to reach their intended provincial recipients.

The current NFC criteria

Under the current NFC Award, population carries an 82% weight, while poverty, revenue generation, and inverse population density carry smaller weights. According to a Planning Ministry report, while the NFC Award envisioned shared responsibility for revenue generation, provincial revenues have not expanded in line with the Award's objectives.

How current model is vulnerable

First and the foremost, the distribution of resources under the present system is often prone to delays as funds are not immediately made available to the stakeholders, including provincial financial institutions. The mollification of accounts is a laborious, post-facto procedure that often entails months, during which time disputes can arise over the amounts transferred and received. This insidious approach makes it difficult to scrutinize the exact point of leakage.

Second, the system's approach makes it exploitative to political dominance and human errors. Decisions to release or withhold funds can be subject to political considerations; it hampers the constitutional spirit of the NFC Award. The dependence on manual or conventional digital record-keeping reflects that transaction logs are not immutable and can be altered or deleted, making forensic audit of fund flows a challenging and often uncomfortable exercise. The deprivation of a single, shared and tamper-proof ledger of transactions makes it impossible for both federal and provincial governments to have a tangible source of truth.

A blockchain-based framework

Is blockchain a suitable method for NFC transfers? Yes, because it is a decentralized and distributed ledger technology that securely gathers transactions across a wide range of computers. This manifests that each transaction is justified, traceable and cannot be altered arbitrarily without the consent of network partners. A blockchain-based system for NFC transfers offers a solution to the vulnerabilities of the current mechanism.

In this proposed framework, the NFC transfer system would operate on a private or consortium blockchain network under the umbrella of the Federal Ministry of Finance, the State Bank of Pakistan and the provincial finance departments serving as network nodes. Every transaction, from the collection of revenue at the federal level to its distribution to the provinces, would be estimated as a block on this shared ledger.

Introduction to smart contracts

The modus operandi for blockchain technology would be smart contracts—self-executing contracts with the terms of the agreement directly written in code. In the context of NFC transfers, a smart contract would be programmed with the precise formula of the NFC Award. Once a verification is done—for instance, the FBR logs a tax collection on the blockchain—the smart contract would be triggered to automatically evaluate the fund transfer. The funds would move from the federal digital wallet to the provincial ones in real-time, without the need for manual approval or bureaucratic interventions.

For example, suppose the federation collects petroleum levy countrywide. According to the present framework, provinces might receive their shares a few weeks later due to manual documentation, in which discrepancies may occur. With a blockchain-backed NFC system, when levy is deposited, a smart contract would automatically disburse the exact provincial shares according to the NFC formula. Each province's digital wallet receives its funds instantly, and the transaction is visible to all stakeholders, ensuring there is no gap left for misreporting or withholding.

Implementation challenges

Certainly, the benefits of a blockchain-based NFC transfer system are compelling; its reinforcement is, however, fraught with challenges.

From a regulatory perspective, Pakistan's legal framework for finance and governance is not equipped to handle blockchain technology. The legal framework of smart contracts, the jurisdiction over disputes and the rules governing digital wallets and assets would all need to be established through new legislation.

The technical challenges are also daunting. Building a secure and amenable blockchain infrastructure requires substantial investment in hardware, software and cybersecurity. The lack of a skilled workforce with expertise in blockchain developments and smart contracts auditing is another significant milestone.

Finally, political opposition is probably the most pressing challenge. The transition to fully transparent and automated system could suffer opposition from those who benefit from the current system's weaknesses.

Conclusion

By maintaining an efficient, transparent and secure blockchain-based system, the core issues of corruption, administrative inefficiency and inadequate enforcement will be resolved. This approach is based on a sense of pragmatism to redress critical challenges and avoid economic stagnation.