Public Expenditure and Financial Management Overview of Issues and Approaches

1. Public Expenditure and Financial ManagementOverview of Issues and Approaches Bill Dorotinsky, PREM public sector governance group PEAM Course May 2, 2006

2. Outline • Framework for Review • Approaches to PEM review • Budget Cycle • Formulation • Execution • PFM System • PFM Functions • Outcomes/Impact • Common Problems • Common Solutions • Measuring PFM Systems

3. Framework Three Objectives of Public Expenditure Management Systems • Macrofiscal discipline and stability • Support economic growth and stability (and reduce poverty) • Avoid public finance crises • Strategic allocation of resources • Match government policy with programs, objectives • And assure social safety nets, and promote growth • Technical efficiency • Getting the most from each zloty spent • And just delivering core services

4. Framework Basic principles of PEM • Comprehensiveness • include all revenue and expenditure, all agencies • Accuracy • record actual transactions and flows • Annuality • cover a defined period of time (e.g. one year budget, multi-year forecasts) • Authoritativeness • only spend as authorized by law • Transparency • information on spending is public, timely, understandable

5. What institutions to review? • Formal and Informal Rules • Laws and regulations • Constitutions , fiscal, budget, procurement, civil service, special funds, sector laws, public enterprises, mandatory spending • Process • Policy • Planning • Financial/resource management • Organizations and their roles • Information

6. Approaches to PEM Review • Cycle, Process • System • broad scope • organizations • Functions/tasks • Outcomes/Impact

7. Expenditure Management Cycle Financial management system boundaries Project Resource Annual budgets Medium term appraisal allocation Development, Planning plans, e.g. three recurrent and system year rolling plans revenue Expenditure Liquidity management review Public expenditure Institutions review Fund release procedure, e.g... warranting Accountability Expenditure Project monitoring control Audit system Post event Accounting for Monitoring review revenue and & controlling expenditure Reports and financial statements Source: Adapted from Integrated Financial Management.Michael Parry, International Management Consultants Limited.Training Workshop on Government Budgeting in Developing Countries. THE UNITED NATIONS. December 1997.

8. Budget Formulation • Issues are typically about • Process • Quality of Engagement

9. Process Issues • “Due process” • Fair hearing for proposals, requests within government • Coherence • Budget process is planning process • Planning within resource constraints • Indicative ceilings for budget offered early in the process • ‘hard budget constraint’ • Changing incentives • Comprehensiveness • Capital, all revenues and expenses • Civil society participation • ‘decentralized’ impact analysis • Legislative stage • In executive via white papers

10. Process (continued) • Proper decision sequence for coherent process • Macrofiscal, revenues, expenditures • Sectoral • Administrative/program/project • Accountability: Link resources with management responsibility • Schedule • Budget calendar issued • Sufficient time for sound proposals • Ministries • Budget office analysis • Legislative review • Two stage process

11. Quality Issues(improving process outcome) • Multi-year perspective • Setting multi-year policy objectives • Conservative economic, revenue forecast • Likely versus ‘hoped for’ • Benchmarked against non-governmental forecasts • Realistic expenditure forecast • Provision for recurring ‘unanticipated’ events • Contingency reserves – with clear rules for use • Indicative ceilings linked to second-year of prior budget forecast (policy) • Requests reconciled to prior year actuals, current year estimates • Two aggregate forecasts (advanced) • Proposed policy • Current services/policy • Capital and recurrent

12. Quality (continued) • Budget ownership • Early, frequent engagement of policy officials on structured decisions • Fiscal policy paper to kick-off process • Distinguish policy from recurrent revenue • Proposed revenue sources versus historical trends • No spending allowed against proposed unless they materialize (grants, tax revenue) • Communication • Clear signals of direction, markets and agencies • Prepare public for change – sustainable adjustment

13. Quality (continued) • Budget Information • Prior year actual, current year estimate, budget year +2, Staffing, Outputs • Classification: economic, administrative, functional, program • Requests distinguish between on-going, new spending; mandatory, discretionary • Decision papers • Basis for Minister of Finance, Gov’t decision • Pulls together academic, audit, performance, evaluation of prior years financial performance, other information

14. Why is budget execution important? Credibility of the Honduran Budget – In-year Deviations by Agency (percent of the executed over the approved budget)

15. What is budget execution? • Processes and institutions to implement the budget • Incentives – principle-agent problem • Reflects that budget is NOT only an accounting document • also a political document • Planning/steering device

16. Objectives of budget execution • Manage Spending and Revenues to budget • support choices of elected officials • allow budget to be planning and steering tool • promote macrofiscal discipline • Reduce opportunities for corruption • Enable program implementation • Assure resources flow to programs • allow budget to be aid to operational efficiency through spending unit advance planning, efficient administration • enable program managers to achieve objective

17. General Phases of Execution • Phase 1: Allocation • Phase 2: Ministry Spending Plans • link actions with finances; cash flow needs • Phase 3: Commitments • Phase 4: Verification • Phase 5: Liquidation of Financial Obligation

18. Phases of Execution Source: Integrated Financial Management.Michael Parry, International Management Consultants Limited.Training Workshop on Government Budgeting in Developing Countries. THE UNITED NATIONS. December 1997.

19. Budget and Policy Execution System in Hungary (1999) System

20. Public Finance Functions Core Functions Budget Execution Macroeconomic Forecasting Budget Formulation Fiscal Policy Revenue Administration Debt Management Treasury Procurement Policy Internal Audit Non-core Functions Lottery & Gambling Financial Asset Management Financial Market Regulation Financial Investigations Procurement Administration

21. Core Tasks and Organizations - internal control - program management - spending (commitments) - recording & reporting - payment orders - verification of receipt of goods/services - program/cash plans • - Macroforecasting • Fiscal Policy • Revenue administration • Debt Management Financial Management is Everyone’s Responsibility

22. Common PEM problems • Weak links between planning, policy, resource limits, and budgets • failure to achieve strategic objectives • abstract planning, unrelated to ways and means • Annual focus leads to suboptimal choices • Digging a hole; inability to climb out • Complacency today, unaware of crisis tomorrow • Separation between capital and recurrent budgets • Lower than expected returns to capital • Non-comprehensive budget • Using other means to support favored programs • Revenues not captured in budget • Taking piecemeal decisions without reference to over-all effect • Funds don’t reach intended beneficiaries • Budget executed differently than approved • Goods and services not delivered as planned

23. Common Reforms • MTEF • Treasury • IFMIS • Performance Budgeting • ‘Fragmentation’ • Procurement, Debt • New Public Management • Deconcentration, decentralization • Administrative & Civil Service

24. Measuring PFM Systems • Field of PFM has evolved recently, moving towards more assessment standardization • New set of PFM indicators to monitor quality of PFM system at high-level • See www.pefa.org • Recommended with approach to working with countries • Country-led reform agenda • Donor coordination around agenda • Shared information pool – common PEFA framework

25. PFM PEFA Indicators • Transparency of taxpayer obligations and liabilities • Effectiveness of taxpayer registration and assessment • Effectiveness of tax collection • Predictability of funds for commitment • Recording/management of cash, debt and guarantees • Effectiveness of payroll controls • Competition, value for money and controls in procurement • Effectiveness of internal controls • Effectiveness of internal audit • Orderliness in annual budget process • Multi-year perspective • Accounts reconciliation • Resources received by service delivery units • Quality and timeliness of in-year budget reports • Quality and timeliness of annual financial statements • External audit • Legislative scrutiny of budget • Legislative scrutiny of external audit reports Cross-cutting Indicators • Aggregate expenditure out-turn • Composition of expenditure out-turn • Aggregate revenue out-turn • payment arrears • Classification of the budget • Comprehensiveness of information • unreported government operations • Transparency of inter-governmental fiscal relations • Oversight of aggregate fiscal risk • Public access to key fiscal information

26. General References • SIGMA Policy Brief No. 1: Anatomy of the Expenditure Budget (1997) OECD • Managing Government Expenditure. Schiavo-Compo and Tommasi. Asian Development Bank. 1999 • Government Budgeting and Expenditure Controls, Theory and Practice. Premchand. IMF. 1993 • Public Expenditure Management. IMF. 1993. • Treasury Reference Model (Bank PE website) • A Contemporary Approach to Public Expenditure Management. Schick, Allen. World Bank Institute. 1999. • Public Expenditure Handbook. World Bank, 1998. • Managing Public Expenditure: A Reference Book for Transition Countries. Richard Allen and Daniel Tommasi, Eds. OECD. Paris, 2001. • Public Financial Management Performance Measurement Framework. PEFA. Washington, D.C. June 2005. • See www.pefa.org for PEFA Performance Measurement Framework

27. Application: Rules and Incentives • Budget Impasse • Executive-legislative relations • What rules might govern a budget impasse? • How might they effect incentives between the legislature and executive? • What might be important considerations for designing a rule?

28. Application Rules and Outcomes Source: World Bank – OECD budget procedures database athttp://ocde/dyndns.org/

29. Application Informal Rules Dominican Republic Budget Deviation, 1996-2000 Identifying sources of weakness for further investigation Identifying incentives at work Source: Dominican Republic PER 2003, background data

30. Application Dominican Republic Budget Deviation (ratio of executed to approved budget) Identifying trends for transparency Source: Dominican Republic PER 2003, background data

31. Above-the-waterline observation Exploringproblems 100 clinics, but only 70 operating WHY? Budget not comprehensive Budget fragmented Cash triage 10 built with donor funds, donor funds off-budget 10 built with domestic funds, capital budget separate 10 funded in budget, but no cash allocated to operate WHY? Weak budget law Too rigid budget execution Low public pay WHY? Donor ring-fencing for “accountability” Line ministry gets flexible resource pool Local staff seek higher PIU pay And what can be done about it?