MTEF/Top-down Budgeting for Korea Dong Yeon Kim The World Bank

1. MTEF/Top-down Budgetingfor KoreaDong Yeon KimThe World Bank

2. Table of Content • Introduction of MTEF • Korea’s MTEF Initiatives • Issues To Be Addressed • Implementation Strategy for Korea

3. Introduction of MTEF

4. Background of MTEF • Changing role of budgeting - from control (spending) to management (policy) • Increasing difficulty of maintaining fiscal soundness - slowed economic growth, built-in entitlement • Growing demand for public spending - aging population, education, social welfare • Demand for more democratized and transparent budgeting process

5. Objectives of MTEF • Integrating policy priorities into annual budget • Providing mid-term perspective (3-5 yrs) on expenditure plan • Enhancing operating efficiency • Strengthening feedback and accountability mechanism by performance management

6. MTEF Process (simplified) Updated cost estimate of existing policy/program Macro-economic forecasting Fiscal Target Total Expenditure Setting For multi years Sectoral Ceiling Setting for multi years Annual Budget Formulation New sectoral demand for t+2 (priority/cost) Sectoral Budget Preparation

7. International Trend (1) CBO: central budget office, MoF: different part of MoF/Treasury Source: OECD-World Bank Budget Practices and Procedures Database

8. International Trend (2) Source: OECD-World Bank Budget Practices and Procedures Database

9. Lessons from International Experiences • Integration of multi-year planning with annual budget - MTEF and annual budgeting is ‘one’ process • Honest/realistic macroeconomic forecasting • Separation of total budget from detailed program • Clarification of new roles of MOF/line ministries • Capacity building and incentives for MOF/line ministries • Development of feedback mechanism

10. Korea’s MTEF Initiative

11. Current Budgeting in Korea • Centralized, itemized budgeting • Heavy weight on bottom-up approach • MPB’s active involvement in program details • Lack of macro consideration and mid-term plan - institutional division between MPB and MoFE • Fiscal reform initiatives with mixed results

12. Budgeting Process in Korea

13. Track-record of linking budgeting with national planning • Economic Planning Board (EPB), 1961-1994: - planning and budgeting functions under one roof • Strong political support and leadership - monthly President’s visit to EPB - minister of EPB holds position of DPM (influence over line ministry for coordination) • In retrospect, MTEF exercise without calling it MTEF

14. Past Fiscal Reform Efforts in Korea • Strengthening linkage between formulation and execution • Bringing in incentive system for expenditure savings • Piloting performance-based budgeting • Introducing double-entry accounting system • Improving aggregate expenditure control • Introducing ex-ante evaluation system for major projects

15. Short-term Perspective with Bottom-up Approach - Yearly based revenues and expenditures - Weak linkage between national policy priorities and budgeting Future Fiscal Risk - Social welfare expenditure demands/rapidly aging population Inefficiency from Managerial Inflexibility - Limited autonomy to plan policy and implement budget Why MTEF?

16. Macro Forecasting & LTFP Sectoral & Ministerial Ceilings Fiscal Targeting & Budget Envelope Line Ministries’ Requests Review & Budget Document-tation MTEF Process in Korea (planed)` Updated Cost Estimate Cabinet Meeting

17. New Budget Process (1) • Stage I : Macro-economic Forecasting and Long-term Financial Management Planning - Macro-forecasting and review of national debt levels • Stage II : Fiscal Targeting and Budget Envelope - Set fiscal targets and policy, and total budget aggregate • Stage III : Sectoral and Ministerial Ceilings - Decide objectives, sectoral and ministerial expenditure limits

18. New Budget Process (2) • Stage IV: Cabinet Meetings • Agree on macro-forecasting, long-term plans, fiscal targeting, expenditure aggregates and sectoral ceilings • Stage V: Line Ministries’ Requests • Prepare budget proposal within guidelines • Stage VI: Review and Budget Documentation • Review line ministries’ requests for compliance with sectoral limits and policy priorities

19. Issues To Be Addressed

20. How to Build Macro Forecasting Capacity in MPB? • MPB plays a key role in macro forecasting for fiscal policy purpose - strong need to increase institutional capacity - consideration of social/political factors • Coordination mechanism with MoFE, BoK, public/private research institutes • Formula for conservative forecasting for budgeting - in Canada, add 0.5-1% to forecasted interest rates

21. How/Who Decide Total Budget & Sectoral Ceiling? (1) • Two stage approach: total envelope setting sectoral allocation • Total budget setting - macro/fiscal targets,social/political demands - new sectoral demands and updated costs estimates • Sectoral allocation - national policy priority - determined within total budget : zero-sum game

22. How/Who Decide Total Budget & Sectoral Ceiling? (2) • Final draft is prepared by MPB in consultation with the President • Send draft to cabinet meeting for consensus building - sectoral ceiling is not revealed until total decided - in Sweden, 2-3 days’ cabinet retreat • In case of disagreement, final decision is made by President “It is President who holds ultimate responsibility of budget”

23. Use of budget margin • Serves as a Bumper for 1) macro forecasting deviations 2) ‘inevitable’‘unexpected’ demand 3) President’s new initiatives under exceptional situations • Budget margin = total envelope – aggregate of sectoral ceiling * in Sweden, 3.33% in 1997, and 0.05% in 2003 • Unused margin to be used to accelerate debt payment

24. How much sectoral ceiling is binding? • In principle, no breach is allowed • Amendment allowed for substantial macroeconomic change (cost estimate basis) • Exception is explicitly identified ex-ante with MPB’s consent, through cabinet meeting 1) ministry makes trade-off within sectoral cap 2) trade-off between ministries within total budget 3) budget margin to be used

25. How Much Discretion Allowed for Line Ministries? • Sectoral priority discussed and agreed between MPB and line ministries • Line ministries prepare own budget request within provided ceiling & priority line • MPB’s monitoring and coordination mechanism • Incentive for efficient spending - allowed to carry-over certain % of savings to ministries

26. How to Build Incentive System? For MPB - Shift to higher level, macro decision-making by integrating national policy priorities with budgeting - Close interaction with President For Line Ministries - Budgetary Discretion to prioritize policies - Flexibility in implementing policy and executing budget

27. How to Ensure Line Ministries’ Accountability? (1) • Ministers hold ultimate responsibility over performance • MPB plays a watchdog • Performance management serves as a feedback mechanism for increased discretion • Linking budgeting with accounting system • Information system needs to be integrated between MPB, MOFE, line ministries, and NAB

28. How to Ensure Line Ministries’ Accountability? (2) • Performance Management System - utilized as information gathering and analysis - long-term, phased approach is desirable - need to adopt realistic short-term approach - pilot projects to introduce output-based indicator development and performance evaluation system - expand into all programs with outcome indicators

29. How to Improve Budget Structure and Scope ? • Need for strong budget basics and for simplified budgetary complexity • Complexity of budget structure • One General Account, 23 Special Accounts, 45 Funds, 2,000 appropriations, and 6,000 sub-accounts • Classification system emphasises input controls • Lacks transparency and is technically cumbersome

30. Implementation Strategy for Korea

31. Pre-conditions for Implementing MTEF • Strong political support • MPB’s willingness/commitment - clear understanding of MTEF and incentives - strong leadership within MPB • Line ministries’ compliance - proper incentives: discretion and policy prioritization • Capacity building for MPB and line ministries • Legal framework for new roles/responsibilities

32. Creating Enabling Environment for MTEF • Use MTEF as an instrument to alter status quo • Fiscal reform along with PS reform • Leadership and Capacity Building - champion of reform and creating core team - motivating self-development and capacity building • Performance oriented environment in government - e.g., regulation-free organizations

33. Implementation Strategy • Stage I : top-down approach (Big Bang Approach) - macroeconomic forecasting and fiscal target setting - setting total and sectoral ceiling prior to program details • Stage II : bottom-up approach (Gradual Approach) - line ministries’ discretion within sectoral ceiling and priority - allowing discretion on operating costs • Stage III :incorporation with performance management - well-functioning information system - performance information reflected in budgetary decision

34. “A budget is much more than a collection of numbers. A budget is a reflection of a nation’s priorities, its needs, and its promise.”