Seven years on the way to a new statehood

Nepal’s adoption of a new Constitution on September 20, 2015 marked a turning point in its recent history.¹The document not only changed the form of government, declaring the country a Federal Democratic Republic, but also marked the end of a decade of painful political transformation that followed a bloody civil war (1996-2006).³Federalism for Nepal is not just an administrative reform or a fashionable trend in public administration, which some experts say has become the “dominant political currency” in Asia.⁵It is the cornerstone of the 2006 Comprehensive Peace Agreement and the fundamental basis of a new social contract to address the country’s age-old problems: deep-rooted regional inequalities, social exclusion and discrimination based on caste, class, gender, ethnicity and region.³

The historically unitary system with rigid centralization of power in Kathmandu has resulted in vast rural areas and numerous ethnic groups such as Madhesi, Tharus, Dalits and others being marginalized politically and economically.⁹It was this marginalization that became one of the main causes of the civil conflict, which claimed thousands of lives and slowed down the country’s development for decades.⁴Therefore, the new Constitution was intended to “deconstruct the existing centralized and unitary structure”¹⁰and, as its preamble states, to end all forms of discrimination and oppression in order to achieve “perpetual peace, good governance, development and prosperity.”⁸

However, the path to federalism was rocky from the start. The adoption of the Constitution sparked protests in the southern regions of the country, populated by the Madhesi and Tharu ethnic groups, who considered the new administrative division unfair. This led to a months-long economic blockade by India, which dealt a serious blow to Nepal’s already weak economy.¹²

More than seven years after these dramatic events, it is time for a balanced assessment of this ambitious national project. To what extent has Nepal succeeded in implementing the principles laid down in the Constitution? What real successes have been achieved in decentralizing power and resources? What systemic failures has the reform encountered? And, most importantly, how have these processes affected the quality of life of ordinary people in the provinces and the investment climate of the country, sandwiched between two giants – India and China? This article is an analysis of the results of Nepal’s seven-year path to a new statehood, based on facts, reports of international organizations and expert opinions.

Architecture of Power: How Nepali Federalism Works

The 2015 Constitution laid the foundation for a radical overhaul of the state machine, replacing the unitary model with a complex three-tier federal system.⁷This system, developed after studying the experience of 28 federal states, is designed to bring power as close as possible to the people and ensure a fair distribution of powers.⁷

The structure of Nepalese federalism includes:

1. Federal Government in the capital Kathmandu.
2. Seven Provincial Governments, formed on September 20, 2015 by grouping together the districts that existed at that time.²
3. 753 local authorities, which in turn are divided into 6 metropolitan areas, 11 sub-metropolitan areas, 276 urban municipalities and 460 rural municipalities (gaunpalikas).¹⁵

The key feature of this architecture is the unprecedented delegation of powers to lower levels, especially to the local level, in Nepal. The Constitution contains special schedules that clearly delineate exclusive and joint (competing) powers for each level of government.⁷

• Federal level (Appendix 5) was given 35 exclusive powers, including defense, foreign policy, the monetary system, federal taxes, citizenship and passports, and the management of major infrastructure projects.⁷
• Provincial level (Appendix 6) was given 21 exclusive powers, including the creation of a provincial police force, management of provincial roads, lands, provincial tourism and higher education.⁷
• Local level (Appendix 8) was given 22 exclusive powers, effectively turning local governments into full-fledged local governments. They were given jurisdiction over city police, cooperative management, local taxes (property, rent, land and building registration), basic and secondary education, basic health and sanitation, local roads, water supply, market management and environmental protection.⁷
• Joint powers are set out in Schedules 7 (federal and provincial levels) and 9 (all three levels) and cover such complex areas as civil and criminal law, social security, natural resource management and others.¹⁵

To better understand the scope of decentralization, let us present the key powers in the form of a table.

Table 1: Distribution of key exclusive powers between levels of government in Nepal

Source: Compiled from data from Schedules 5, 6, 8 of the Constitution of Nepal.⁷

Moreover, local authorities were given the right to form their own legislative (municipal and village assemblies), executive (executive committees) and even judicial bodies (judicial committees for resolving minor disputes).¹⁷This means that, theoretically, they have all the tools to independently manage and develop their territories.

But it is precisely in this ambitious architecture that the seeds of future problems are sown. Analysts note that the Nepalese model has an “hourglass structure.”²¹In this model, the federal center and local governments have significant and clearly defined powers, while the intermediate link, the provinces, is relatively weak and has an ill-defined role. This weakness of the provinces prevents them from becoming an effective buffer and coordinator between the center and the local level.

At the same time, the presence of a large number of “joint” powers creates extensive grey areas and grounds for jurisdictional conflicts.³Who bears ultimate responsibility for the management of forests or rivers if this right is listed as jointly administered? How to divide income from tourism or mining? The lack of clear answers to these questions in legislation, which is adopted with great delays, creates a power vacuum. This vacuum, as practice in recent years shows, is immediately filled by the federal center, which, under the pretext of the need for coordination and control, retains the real levers of control, thereby undermining the very essence of decentralization.

Real Successes: Glimmers of Hope on the Ground

Despite all the difficulties of the transition period, it would be wrong to consider the Nepalese federalism project a complete failure. Over the past seven years, significant, and in some areas, truly historic, successes have been achieved. It is noteworthy that the main achievements at this stage are not so much in the economic as in the political and social planes. Federalism has already begun to bring that very “peace dividend” for which the reform was undertaken.

The most fundamental and undeniable success has been the restoration of democracy at the grassroots level. The holding of local elections in 2017 and 2022 put an end to almost two decades of local communities not having elected representatives.²²This power vacuum, exacerbated by the civil war, led to the degradation of institutions and the paralysis of the public service delivery system.²⁴The elections brought back basic principles of accountability and representation to Nepalese politics, allowing citizens to directly influence the governance of their villages and towns.²⁵

The second major achievement was genuine political inclusiveness. The federal system opened up new opportunities for ethnic and caste groups that had historically been excluded from decision-making processes – Madhesi, Dalits, Muslims, and Tharus.⁹But the most striking example is the breakthrough in gender representation. Thanks to constitutional quotas, the share of women among elected representatives at the local level has reached 41%.¹⁰This is not just a statistic, but a direct solution to one of the key problems of the old system that contributed to the conflict.

The third area of ​​success is concrete results in infrastructure development and service delivery, made possible by devolving authority and resources to the local level. Provincial governments, despite limited capacity, have demonstrated the ability to implement significant projects. For example, Karnali Province, one of the poorest regions, has built 215 km of paved roads, Sudurpaščim Province has built 550 km, and Lumbini has built over 1,160 km.²³World Bank-supported projects have built thousands of metres of new bridges and provided access to clean drinking water to more than 1.4 million people, mostly in rural areas.²⁷

In addition to large infrastructure projects, unique social innovations are emerging on the ground. A striking example is the Bagmati Province initiative “One Public School – One Nurse,” aimed at improving health care for students.²³Such programmes demonstrate that, given autonomy, local authorities are able to develop solutions that meet the specific needs of their populations.

Finally, significant progress has been made in modernizing public administration systems. With the support of international partners such as the Asian Development Bank (ADB), a nationwide electronic public procurement (e-GP) system has been introduced, making the process more transparent and efficient, reducing costs and corruption risks.²²To manage finances at the local level, the SuTRA (Subnational Treasury Regulatory Application) system was developed and implemented, which covers planning, budgeting, accounting and reporting, creating the basis for modern financial management.²⁸

Thus, it can be argued that at this stage federalism has already proven its worth as an instrument of democratization, inclusion and peacebuilding. Restoring legitimate power at the local level and creating channels for women and minorities to participate in governance is the foundation on which future economic growth can be built. The economic failures that will be discussed below are not due to the inadequacy of the idea of ​​federalism itself, but to defects and sabotage of its implementation by the center.

Systemic Failures: Why the Singh Durbar Didn’t Reach Every Village

The optimism generated by the initial successes is clouded by a number of deep systemic problems that prevent federalism from realizing its full potential. The loud slogan of the reform is “Singh Durbar in every village” (referring to the seat of government in Kathmandu)²⁹, which promised to transfer real power to the local level, remained an unfulfilled dream for many Nepalese. The reasons for this are not the mistakes of individual officials, but the systemic resistance and structural defects of the transitional model itself.

The main obstacle to decentralization has been the stubborn resistance of the federal government and the central bureaucracy in Kathmandu. Despite constitutional provisions, the old elites retain a “centralized mindset” and are unwilling to share real power and, more importantly, control over resources.¹⁸This manifests itself in the deliberate delay in passing key laws without which subnational governments cannot fully function. For example, critical laws on the federal civil service and on education have been stuck in parliament for years, creating a legal vacuum and leaving provinces and municipalities in limbo.²³

But at the root of most of the problems is a glaring fiscal imbalance. The federal government accumulates the lion’s share of national income – by various estimates, from 85% to 92%.³At the same time, the provinces and 753 local governments, which are responsible for providing most basic services to the population, from education to health, account for only a small share. As a result, subnational governments find themselves completely financially dependent on the center. According to the ADB, local budgets are 78% made up of grants and transfers from Kathmandu.²⁸

The situation is aggravated by the fact that the center prefers to allocate “conditional” grants, the funds of which can only be spent on predetermined purposes. The share of “unconditional” grants, which local authorities could use at their own discretion to solve pressing problems, is constantly decreasing.³²This financial stranglehold prevents local authorities from engaging in long-term planning and makes them mere executors of Kathmandu’s will. In 2023, the situation reached a critical point: due to the reduction of federal revenues and transfers, the fiscal balance of provinces and local governments became deficit for the first time since the reform.³⁵

This fiscal dependence creates another systemic failure: low institutional capacity and a shortage of personnel at the local level. Without stable and predictable funding, subnational governments cannot attract and retain qualified specialists. Up to 35% of positions in provincial administrations remain vacant, and 250 municipalities do not have heads of administration.²⁸The lack of experts in planning, budgeting, and project management leads to chronic underutilization of even the meager funds allocated from the center. According to the World Bank, in 2023, provinces failed to utilize 34% of their budgets, and local governments – 24%.³⁵

Finally, the most sad and socially dangerous result of the reform was the “decentralization of corruption.”³⁶Corruption schemes, previously concentrated in the corridors of power in Kathmandu, have trickled down to the provincial and local levels. The absence of effective control and oversight mechanisms, weak accountability, and a lack of transparency at the local level have created fertile ground for abuse. As a result, Nepalese analysts note, corruption has become institutionalized and has spread throughout the country, right down to the level of individual rural districts (wards).³⁶

These systemic failures create a vicious circle of inefficiency that holds back the country’s development. Fiscal dependence on the center leads to low capacity of local authorities. Low capacity and the inability to provide quality services breed corruption and frustration among the population. And this inefficiency, in turn, is used by the central bureaucracy as a convenient pretext to continue to maintain control and sabotage reforms under the slogan “we can’t trust them, they can’t cope.” Thus, this is not just a set of individual problems, but a self-sustaining system that benefits both the central elites who maintain control and unscrupulous local actors who benefit from chaos and weak oversight.

Quality of Life in the Provinces: A Mixed Picture of Change

How have all these successes and failures of federalization affected the daily lives of millions of Nepalese in the provinces? The picture is extremely heterogeneous and full of contradictions. On the one hand, there are objective improvements in some areas, on the other, stagnation and even degradation in others. The quality of life of citizens, as it turns out, directly depends on how clearly powers were delineated between levels of government in a particular area.

Let’s start with the overall indicators. Despite all the difficulties, some macro indicators show positive dynamics. According to the World Health Organization, life expectancy at birth in Nepal has increased significantly: from about 65.4 years in 2015 to 70 years in 2021.³⁹This is a significant achievement for one of the poorest countries in the world. In addition, the regions most affected by the devastating 2015 earthquake have seen a marked improvement in the quality of life. Large-scale reconstruction programs, in which local governments were actively involved, have built new, earthquake-resistant housing, improved infrastructure, and reduced poverty in these areas.⁴⁰

However, a closer look at key sectors paints a less rosy picture.

Healthcare: 

The transfer of responsibility for basic health care to the local level was theoretically supposed to improve access and quality of services. In practice, the sector has descended into a state close to chaos. The main problems cited by experts and health workers themselves include: poor coordination between the federal, provincial, and local levels; duplication of programs and purchases; persistent delays in central funding; and severe shortages of personnel and medicines at the local level.³⁰Access to health services remains highly uneven, with the situation particularly dire in remote mountainous areas, where shortages of personnel and medicines make quality care virtually inaccessible.⁴¹

Education: 

The education sector faced similar challenges. Responsibility for basic and secondary education was devolved to 753 local governments, bringing school management closer to communities and raising high hopes for improved learning.⁴⁴However, these hopes were dashed by a legal vacuum and financial dependence. The absence of a federal law on education that would clearly delineate powers has given rise to a host of unresolved questions: Who hires, fires, and certifies teachers? Who is responsible for curricula and standards?⁴⁵Funding for the sector remains tightly centralized. By some estimates, up to 91% of the education budget that is transferred to localities is “notional,” meaning its distribution is predetermined in Kathmandu, leaving local authorities little room to maneuver or take local specifics into account.¹⁰

Infrastructure and socio-economic divide: 

Despite some successes in road construction²³, federalization has so far failed to address one of Nepal’s key problems: the huge development gap between cities and rural areas. That gap, some analysts say, not only persists but may be getting worse.³⁷The expected influx of investment and rapid development in rural areas did not materialize. This is largely due to inefficient use of funds and corruption at the local level, due to which allocated resources do not reach real projects.³⁷As a result, young people continue to leave villages in droves for cities or abroad in search of work and a better life, further draining rural areas.⁴⁷

For clarity, we present the key socio-economic indicators of Nepal in dynamics.

Table 2: Key Economic and Social Indicators of Nepal (2015–2024)

Source: Compiled based on data from the sources indicated.

The analysis shows that improvements in the quality of life of citizens occur mainly in those areas where local authorities have clearexclusivepowers and where a specific, measurable project can be implemented (for example, building a road, renovating a school, installing a water supply). At the same time, stagnation and chaos are observed in sectors with joint or vaguely defined powers (health, education) that require complex interdepartmental coordination and stable funding. This system is practically non-functional in Nepal. Thus, the welfare of citizens has become directly dependent on the clarity of constitutional design in a given area, which is a direct consequence of the defects in the “architecture of power.”

Investment Climate: Between Opportunities and Risks

For the business community, both local and international, Nepal’s move to federalism has created a whole new reality, fraught with both risks and opportunities. This section, key for business publications, examines how decentralization has affected the business environment and investment climate in the country.

Let’s start with the risks, since they are the most tangible. Despite the government’s regular statements about its desire to attract foreign investment, in practice serious systemic barriers remain: chronic political instability, widespread corruption, cumbersome bureaucracy, and inconsistent application of laws.⁵¹Federalization not only failed to solve these problems, but in some respects it worsened them, creating new types of risks.

The main new challenge for business has become tax uncertainty. The Constitution granted the right to levy taxes to all three levels of government.⁵³In the absence of a clear federal framework and weak oversight, provincial and local governments began to interpret their powers in their own way, introducing a variety of fees: property taxes, tourist fees, taxes on the use of local resources, various license fees and royalties.⁵⁴This has created chaos and a real risk of double or even triple taxation for companies operating in multiple regions. In addition, the lack of uniform rules for interprovincial trade creates the risk of tariff and non-tariff barriers, which could seriously hamper logistics and pricing.⁵⁴

The second major risk is complication of administrative procedures. Instead of one decision-making centre in Kathmandu, businesses now potentially have to deal with 7 provincial and 753 local regulators. This increases the bureaucratic burden many times over.⁵⁴The process of registering a business remains complex and multi-step: first, you need to register your company with the central Office of the Registrar of Companies (OCR), then get registered with the local municipality where your office is located, and only then register for tax purposes to obtain a PAN number.⁵⁵Each stage requires interaction with different levels of government, which takes time and resources.

Paradoxically, decentralization of power has led to centralization and multiplication of risks. If earlier all risks (corruption, bureaucracy) were concentrated in Kathmandu and were relatively predictable, now they have “multiplied” throughout the country. For an investor, the unpredictability of tax policy at the local level and the need to deal with hundreds of regulators have become, perhaps, a more serious barrier than the old, albeit slow, centralized system.

However, federalization has also opened up new opportunitiesfor possibilities of forward-thinking investors.

First of all, it is the growth of regional markets. The gradual dispersion of population and economic activity from overcrowded Kathmandu to provincial capitals and other cities is creating new consumer markets. For businesses, especially in the service, retail and construction sectors, this is a strategic opportunity to carve out a niche in growing markets ahead of competitors.⁵⁴

Secondly, the provinces are starting to compete for investment. By identifying their priority development sectors—whether hydropower and tourism in Gandaki and Karnali provinces, or agriculture in Madhesh province—regional governments can offer investors special incentives, subsidies, and more favorable regulatory regimes.⁵¹This creates a healthy competitive environment that was not present in the unitary system.

Thirdly, certain steps have been taken at the federal level improving investment legislation. In particular, the adoption of the Foreign Investment and Technology Transfer Act (FITTA) simplified some procedures, reducing the time frame for FDI approval and profit repatriation. A Single Window Service Center was also created to operate on a one-stop-shop basis for investors.⁵¹

However, these positive developments cannot yet outweigh the overall economic problems. Nepal’s economic growth remains unstable and stands at around 4%, which is well below the 7% needed for a qualitative leap in development.⁴⁸The country suffers from a huge trade deficit, growing public debt and a worrying trend towards deindustrialization – the manufacturing sector’s share of GDP has almost halved over the past decade.48In this environment, investing in Nepal still requires high risk appetite and a long-term strategy.

Conclusion: Unresolved Issues and a Look to the Future

Seven years is enough time to draw preliminary conclusions from one of the boldest political experiments in modern South Asian history. The analysis shows that Nepalese federalism is neither a resounding success nor a complete failure. It is an extremely complex, contradictory and, most importantly, unfinished project that is at a crossroads.

On the one hand, the reform has brought undeniable results in the political sphere. The restoration of democracy at the local level after a twenty-year break and a significant increase in the representation of women and marginalized groups are fundamental achievements that have strengthened the foundations of peace and stability in the country.¹⁰The basic institutional and legislative framework for the functioning of the three-tier system of government has been created.²⁷The discussion today is no longer about the abolition of federalism, but about its “refining” and improvement, which indicates its rooting in the political system of Nepal.²³

On the other hand, in the economic and social spheres, the results are much more mixed. Federalization has not led to the expected economic breakthrough and poverty reduction. On the contrary, it has created new problems, such as fiscal chaos, decentralization of corruption, and the growth of bureaucratic barriers to business. The quality of life in the provinces has improved very unevenly, and key public services such as health care and education suffer from confusion and underfunding.

Nepal’s international partners, such as the World Bank and the Asian Development Bank, while continuing to provide significant financial and technical support, have clearly identified the root of the problem in their reports. Their recommendations boil down to three key points:

1. Reforming the system of interbudgetary transfers: The share of unconditional grants needs to be increased to give subnational authorities real financial autonomy and the ability to plan development based on local needs.²⁸
2. Clear delineation of powers: The missing federal laws should be adopted as soon as possible and ambiguities in areas of shared competence should be eliminated in order to stop jurisdictional disputes.²⁷
3. Capacity Building: Provincial and local governments need extensive training and technical assistance programs to enhance their capacity in planning, budgeting, project management and service delivery.¹⁶

The Government of Nepal, recognizing these challenges, has developed a roadmap based on a large-scale study, “Capacity Building Needs Assessment for Federalism” (FCNA), conducted with the support of the World Bank and UNDP.¹⁶The future of the reform will depend on the political will and ability to implement this map in practice.

Ultimately, the future of Nepalese federalism will be determined by the outcome of a struggle between two opposing forces. On the one hand, there is the centripetal force – the desire of the political and bureaucratic elite in Kathmandu to maintain control over the country through financial and administrative levers. On the other, there is the centrifugal force, represented by the growing demands of provinces and local communities for real autonomy, backed by their constitutional rights.

The outcome of this struggle will determine whether Nepal will become a truly federal state capable of delivering balanced development and prosperity to all its citizens, or whether its complex system will become a mere “decorative” decentralization masking the old unitary essence. For Nepal’s investors and business partners, understanding the dynamics of this core systemic conflict will be critical in assessing the risks and opportunities in the Himalayan republic in the coming years. for sustainable economic growth and restore hope for the future of its citizens in their native land.

Alpha Business Media

A publishing and analytical center specializing in the economy and business of Nepal. Our expertise includes: economic analysis, financial forecasts, market trends, and corporate strategies. All publications are based on an objective, data-driven approach and serve as a primary source of verified information for investors, executives, and entrepreneurs.

See Full Bio