Devolution and economic resilience in Nepal

• Fiscal devolution has significantly enhanced the economic resilience of Nepal’s rural and semi-urban municipalities. • Internal revenues have contributed less to economic resilience than government spending and intergovernmental transfers. • Conditional transfers, primarily allocated for infrastructure, have been critical to local economic resilience. • Investment, rather than autonomy, has been the key factor driving subnational economic resilience in Nepal. This article examines the impact of three key components of devolution —government expenditure, internal revenue, and both conditional and unconditional transfers— on the economic resilience of Nepal’s local governments during and after the Covid-19 pandemic. Bridging the gap between the devolution and resilience literature, it focuses on Nepal, a country that embarked on an ambitious devolution journey, transitioning to a Federal Democratic Republic following the monarchy’s overthrow in 2008. This transition was institutionalised through the 2015 constitution, which established a three-tier system of government. The analysis reveals that, following fiscal devolution in 2017/18, local government expenditures and intergovernmental transfers significantly enhanced the resilience of rural and semi-urban municipalities. However, internal revenue collection has played a limited role in this process. In a country with low local-level capacity, conditional transfers —primarily allocated for infrastructure and services— have been crucial for local economic resilience, whereas unconditional transfers have not demonstrated the same impact. The findings suggest that greater investment, rather than autonomy, has been the primary driver of subnational economic resilience in Nepal.