Beyond the divide: rethinking federal-provincial collaboration for economic transformation—I
As Pakistan stands at a critical economic crossroads—grappling with slow growth, rising debt, and deepening inequality, the need for deeper and more effective federal-provincial collaboration has never been more urgent. Real prosperity will not come from centralization or control, but from empowering provinces to be the architects of their own development.
Stabilizing the economy, attracting foreign investment, and unlocking the country's vast untapped potential requires a governance model that empowers provinces to act as true partners in national development. While fiscal federalism is enshrined in Pakistan's constitutional framework, it remains weakened by fragmented planning, uncoordinated policymaking, and an inequitable allocation of resources.
The 18th Constitutional Amendment marked a pivotal step toward decentralization, devolving significant powers to the provinces. Yet, the envisioned collaborative framework between federal and provincial tiers has struggled to take shape. This disconnect not only impedes coherent economic strategy but also undermines the ability of provinces to mobilize their unique assets. National prosperity depends on activating subnational growth engines—but a highly centralized system continues to restrict provincial autonomy in areas such as fiscal authority, investment facilitation, and infrastructure control.
This article makes the case that unlocking Pakistan's true economic potential demands a bold reimagining of federal-provincial collaboration—one built on trust, accountability, and a commitment to shared national goals. Using Khyber Pakhtunkhwa (KP) as a vivid example, it highlights both the immense opportunities and the systemic institutional hurdles holding back progress. The insights here are inspired by a compelling conversation between KP's Finance Minister Muzzamil Aslam and renowned economist Dr. Nadeemul Haq, whose perspectives shed light on the urgent need for reform.
A flawed fiscal compact: rethinking the NFC and the federal-provincial contract
The current fiscal framework, established under the 7th National Finance Commission (NFC) Award in 2010, allocates 57.5 percent of federal revenues to the provinces. While this arrangement was intended to strengthen provincial autonomy following the 18th Amendment, its promise is fading fifteen years on. Provinces have become heavily dependent on federal transfers, contributing only about 1 percent to the national tax-to-GDP ratio, while the federal government remains responsible for over 90% of revenue collection and all debt servicing.
This imbalance has severely strained the federal budget, limiting its ability to invest in national priorities such as defence, infrastructure, and climate resilience. Meanwhile, provinces now bear the bulk of expenditures in critical sectors like health, education, and local development—but lack the fiscal tools and revenue authority to sustainably finance them. This mismatch is further exacerbated by IMF-imposed provincial primary surplus targets, which compel provinces to cut back on development spending to support federal deficit reduction efforts, even as their own service delivery obligations expand.
The absence of integrated planning and data-sharing mechanisms between federal and provincial governments further compounds inefficiencies and leads to duplication of spending, particularly in overlapping service delivery sectors such asocial protection, health and education.
A disjointed fiscal federation
Despite constitutional devolution under the 18th Amendment, economic policymaking continues to be overly centralized. Key domains—such as excise duties on tobacco, electricity pricing, and mineral royalties—remain firmly within federal control, limiting provinces' ability to capitalize on their unique comparative advantages.
For instance, KP produces 78 percent of Pakistan's tobacco—yet cannot set meaningful fiscal policies due to federal dominance over excise taxation. While the federal government earns over PKR 550 billion from tobacco excise, KP receives only 14.62 percent of the divisible pool, and its own provincial excise efforts are mired in legal challenges and regulatory overlaps.
Despite its potential in green energy, minerals, tourism, and agriculture, KP remains confined by institutional and regulatory barriers:
It cannot issue provincial bonds or access international finance without federal approval.
It lacks control over transmission infrastructure and energy regulation.
It has no dedicated investment authority for its diaspora, despite contributing nearly one-third of Pakistan's remittances.
Visa restrictions and negative media portrayals deter investors, despite an impressive tourism safety record.
Unfair electricity pricing: the green energy dilemma
If provinces were empowered to lead their own energy policies, Khyber Pakhtunkhwa (KP) could help power half the country.
With a hydropower potential exceeding 30,000 MW—of which 5,626 MW is already being generated from major projects like Tarbela, Warsak, and Gomal Zam—KP has a unique comparative advantage in clean, affordable energy. The province produces electricity at an average cost of PKR 7–8 per unit. Yet, paradoxically, it is forced to buy this electricity back from the national grid at exorbitant rates of PKR 65–72 per unit due to centralized pricing, rigid federal regulation by NEPRA, and prohibitive wheeling charges imposed by entities like NTDC and PESCO.
This structural inefficiency discourages both public and private investment in local energy solutions. KP's attempts to sell surplus electricity directly to industries through bilateral wheeling arrangements have repeatedly stalled due to wheeling charges as high as PKR 27 per unit—rendering such transactions commercially unviable. More than 20 hydropower projects are currently under development, including Pehur, Ranolia, and DaralKhwar, but without timely federal approvals and grid access, many risk becoming stranded assets.
The province has taken proactive steps to unlock its energy potential: hosting investor roadshows, crafting investment-friendly policies, and reaching out to the private sector. However, without federal alignment on transmission access, pricing, and regulatory autonomy, these efforts have limited impact.
The consequences are serious. KP—despite its resource abundance—remains energy-poor. Industries face high electricity costs, household bills continue to rise, and potential job creation and economic growth are stifled. Households consume 56% of electricity in KP, followed by industries (24%) and commercial/government use, yet all segments bear the brunt of inflated tariffs driven by inefficiencies in the national system.
Further compounding the issue is the prolonged delay in Net Hydel Profit (NHP) payments owed to KP by the federal government. These funds could have been reinvested to expand the province's renewable energy base and reduce dependency on expensive imports.
The paradox is stark: a province rich in green energy is shackled by a centralized framework that neither rewards efficiency nor promotes equity. Unleashing KP's energy potential—by decentralizing authority, rationalizing wheeling charges, and ensuring timely NHP payments—could lower national energy costs, enhance industrial competitiveness, and drive sustainable economic growth both within the province and across Pakistan.
Natural resources and neglected rights
Khyber Pakhtunkhwa is not just an energy province — it's a national resource powerhouse. It contributes 52 percent of Pakistan's crude oil, 13 percent of natural gas, and 46 percent of LPG production. Its mining and quarrying sector grew by over 14 percent last year, driven by coal, oil, gas, and mineral extraction. Yet, despite this output, KP has little control over how these resources are priced, taxed, or managed.
Federal constraints prevent KP from monetizing its share of oil and gas. Direct sales are restricted, provincial transmission capacity is limited, and key decisions—such as issuing exploration licenses—remain under federal control. This leaves KP dependent on federal disbursements, which are frequently delayed or contested, undermining fiscal stability and planning.
The province's rich mineral and forest wealth also remains underutilized. KP holds 45% of Pakistan's forest cover and contributes more than half of the country's carbon sink, yet it receives no economic benefit—no carbon credits, no fiscal incentives, and no meaningful recognition for its environmental stewardship. Similarly, while the 18th Amendment devolved several sectors, others like tobacco remain under federal control. KP produces 78% of Pakistan's tobacco, but has no regulatory authority or revenue autonomy over it.
In a functional federation, such contributions would be rewarded and leveraged. In Pakistan, they are often overlooked—leaving KP with vast resources but limited returns.
Trade: a strategic gateway left closed
Khyber Pakhtunkhwa's geography makes it a natural trade gateway to Afghanistan, Central Asia, and western China. Yet its strategic position remains underutilized. Ten out of twelve border terminals with Afghanistan remain non-operational, while KP is excluded from federal trade negotiations and infrastructure planning that directly affect its economic future.
Local producers struggle to scale exports due to outdated logistics, non-tariff barriers, and inconsistent security protocols. The lack of provincial authority over trade and transport policy has choked KP's export potential and stifled regional trade integration.
Despite its potential to become Pakistan's northern trade hub, KP is sidelined from economic diplomacy and denied the autonomy to pursue cross-border commerce. Until trade facilitation is devolved and provincial voices are included in national planning, the province's gateway advantage will remain blocked.
Tourism: a powerhouse constrained
Tourism is one of KP's most dynamic and fastest-growing sectors. The province attracted over 20 million domestic and 5,400 international visitors in 2024, contributing significantly to job creation and the services economy. With 45% of Pakistan's forests, dramatic mountain ranges, and rich cultural heritage, KP has all the ingredients of a global tourism destination.
Yet this potential is held back by federal bottlenecks. Restrictive visa policies, mandatory NOCs for foreign tourists and investors, and the absence of national-level support for destination branding continue to constrain growth. Despite KP's strong safety record and improved infrastructure, outdated narratives in international and national media further dampen its appeal.
There is also no institutional framework to channel remittances into tourism development. KP's diaspora contributes nearly one-third of the country's remittances, but the lack of a dedicated provincial investment authority means that capital remains untapped.
To unlock KP's tourism economy, the province needs federal cooperation on visa liberalization, international promotion, and the establishment of a diaspora investment window.
(To be continued)
Copyright Business Recorder, 2025
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