Development Assistance and Fiscal Management

1. Development Assistance and Fiscal Management Peter S Heller SAIS November 23, 2009

2. Issues to cover • Macro and Micro facts of life: • Divergence between goals vs reality: WHY • Issues confronting Ministers of Finance and sectoral ministers • PFM reforms that can contribute to better management and performance of aid • P.S. Economists use TOO much econo-speak jargon: don’t hesitate to ask for clarification!!!!!

3. Goals vs. Reality • Donor objectives • Full real resource transfer occurs • That aid fully augments total spending on targeted program of assistance • The Reality • Real resource transfer blocked or results in crowding out of other government or private investment outlays • Governments do find ways of substituting across programs and sectors • Households equally reallocate spending in response to aid flows • Aid creates moral hazard effects re revenue mobilization, program priorities etc

4. The macroeconomic realities • Start with recognition that countries obviously differ enormously in terms of their stability, security, and governance capacity: and aid must deal with these differences in the political and economic environment • Aid can be a very significant share of GDP and government budgets

5. Real resource transfer may be difficult to achieve • Full resource transfer needs to be matched by increased current account deficit • But is the real exchange rate compatible? • Facilitating the transfer harder since much of aid flows not directed at releasing bottlenecks in nontraded goods sector, but rather at donor priorities • Is the private sector crowded out? • Even more challenging when macro situation is tight (as in current recession): incentives for flexibility in use of forex enhanced

6. Inevitable substitutions: no surprise! • A reality both at household, sectoral and national levels • Aid relaxes budget constraints for some programs but not for others--inevitable shift from ex ante allocations • But aid will nevertheless shift realized budget priorities: are these genuinely owned by recipients? Compatible with development needs or government priorities? • May also preempt future fiscal space--the HIV/AIDS entitlement issue • May lead to creation of contingent liabilities in the form of PPPs

7. Aid creates moral hazard effects • Empirical results suggest revenue mobilization may be adversely affected • Intuition suggests that political economy challenges of revenue mobilization not easily confronted in the presence of large aid flows • What incentives created for sectoral agencies in responding to donor priorities? Hard to resist all those rents and indirect modes of compensation

8. Ministers of Finance (MOF) must confront the vagaries of aid flows: volatile! Unpredictable! Commitments are not long-term! • Aid highly volatile relative to domestic revenues (recent IMF study): more significant, the higher the share of aid in a budget; • Aid characterized by short-term surges • Aid volatility creates incentives for building up reserves; identifying priority spending in the event of aid shortfalls • Unpredictability creates challenges in day to day budgeting in weak PFM environment; enhances cash rationing; biases against nonwage inputs • Lack of long-term donor commitments: encourages either caution by responsible MOFs or excessive risk taking by others: Can you ensure that a program is sustainable?

9. MOF may find aid priorities differ from that of Government • How to respond to a lack of compatibility in priorities between donors and govt? • At MOF level, do you significantly adjust budget shares allocated to different sectors? Or do these adjust more slowly, despite donor aid priorities? • Generally, it’s at the sectoral level where the tradeoffs and compromises are faced; the MOF is unlikely to be aware of most of these decisions

10. MOF must worry about how to ensure long-term sustainability of government programs • Is there capacity for adopting effectively a medium-term fiscal framework? Only limited number of LICs meaningfully use a MTFF • Large magnitude of aid relative to GDP underscores challenge of ultimate phasing- down from excessive dependence? • How to embed greater flexibility in programs? Avoid lock-in effects; again, the challenge of anti-retroviral programs as an example

11. Finally, MOF wants to ensure aid-financed programs are effective! • Achieving effectiveness in the use of budgetary resources: the fact of available aid resources doesn’t guarantee ability to implement programs well • Increased aid flows may create difficulties in absorption and implementation • May confront bottlenecks in availability of skilled manpower/absorptive capacity limitations; internal brain drain issues; distortion of wage scales • Increase in number of donors creates coordination challenges, despite Paris and Rome declarations

12. Key priorities for Public Financial Reform in context of higher aid flows • Ensure MOF has adequate control over fiscal aggregates • Ensure process of budget preparation is comprehensive and coherent and integrated with priorities-setting process of national plan • Establish budget classification for administrative and economic categories • Ensure basic accounting system to process receipts and payment transactions, record information and produce timely fiscal reports reconciled with banking data • Ensure reasonable cash flow planning and control of spending at key points of spending chain and commitment stage • Establish simple system for recording donor aid commitments and disbursements

13. What donors can do to facilitate strengthened PFM-1 • Encourage institutional arrangements that promote effective communications between MOF, MOPlanning, and other agencies in planning and disbursement of aid • Provide realistic projections of donor disbursements • Resist earmarking aid for specific purposes • Provide full information on actual aid disbursements, whether in cash, in kind or direct reimbursement to suppliers • Ensure that once funds are disbursed, accounting and banking records are expeditiously reconciled, and ideally integrated with govt treasury system • Foster transparency in reporting of aid disbursements