Fiscal Sustainability of Local Governments in Nepal: Challenges, Prospects, and Policy Implications

The Constitution of Nepal, enacted in 2015, abolished the long-standing centralized monarchical system and adopted a federal democratic republic with three tiers of government: federal, provincial, and local government. Given the constitutional recognition, autonomy, and major responsibilities of local governments in service delivery and local development, their fiscal capacity, accountability, and overall success will determine the future of federalism in the country. However, the early experience reveals several challenges, including vertical and horizontal fiscal imbalances, growing audit irregularities, and the dependence of most local governments on grants and transfers. These obstacles threaten fiscal sustainability and decentralized governance in Nepal. This study aims to reflect the current state of fiscal decentralization, following a decade of federal practice in Nepal. It includes both urban and rural local governments to examine how fiscal design and its implementation affect overall local fiscal sustainability in Nepal. Applying a mixed-methods approach, it analyzes local fiscal trends to understand how fiscal federalism operates at the grassroots-level. The preliminary findings suggest that the current local fiscal health appears balanced owing to external transfers and budget surpluses resulting from poor execution. However, the persistent deficit of the federal treasury waves a red flag for local fiscal health and Nepal’s overall federal system.