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 group PEAM Course January 13, 2004

2. Outline • Framework for Review • Approaches to PEM review • What is reviewed? • Common Problems • Common Solutions • Getting the basics right

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 matter? • Laws and regulations • Fiscal, budget, procurement, civil service • Process • Policy • Planning • Financial/resource management • Organizations

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 and Policy Execution System in Hungary (1999)

9. 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

10. 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

11. Credibility of the Honduran Budget – In-year Deviations by Agency(percent of the executed over the approved budget)

12. Common PEM problems • Weak links between 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

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

14. What is an MTEF? • Conceptual framework for thinking about public finance systems • ties together multiple technical reforms • gives paradigm for understanding import of technical reforms • teaching tool • Process, not only components of public expenditure systems • process of government decision-making • developing a “public interest” in decision-makers • Multi-year emphasis • creating a learning system • Emphasizing policy • steering versus rowing for senior officials, organizations • linking policy, inputs, outputs, objectives • Effort to change paradigm of actors in system

15. Core elements of an MTEF • Multi-year fiscal envelope • Setting broad policy priorities (sectors) • Setting multi-year sector ceilings • Sector budgets prepared under constraints • Strategy, policy and objectives under constraints • Delivering resources as budgeted

16. Budget Management Comprehensiveness 1. Composition of the budget entity Benchmark Description 2. Limitations to use of off-budget transactions 3. Reliability of budget as guide to outturn 4. Data on donor financing Meets GFS definition of general government Formulation Classification Extra (or off) budget expenditure is not substantial 5. Classification of budget transactions Level and composition of outturn is "quite close" to budget 6. Identification of poverty-reducing expenditure Both capital and current donor funded expenditures included Projection Functional and/or program information provided 7. Quality of multi-year expenditure projections Identified through use of classification system Internal Control (e.g., a virtual poverty fund) 8. Level of payment arrears 9. Quality of internal audit Execution Projections are integrated into budget formulation 10. Use of tracking surveys Reconciliation 11. Quality of fiscal/banking data reconciliation Low-level of arrears accumulated Internal audit function (whether effective or not) Reporting Tracking used on regular basis 12. Timeliness of internal budget reports Reconciliation of fiscal and monetary data carried out Reporting 13. Classification used for budget tracking on routine basis Final Audited Accounts 14. Timeliness of accounts closure Monthly expenditure reports provided within four weeks of 15. Timeliness of final audited accounts end of month Timely functional reporting derived from classification system Accounts closed within two months of year end Audited accounts presented to legislature within one year HIPC expenditure tracking assessment’s 15 indicators, benchmarks of PEM system capabilities

17. Relative need for upgrading PEM Systems 15 Agreed Assessment (8) Number of Benchmarks met Bolivia (5) Cameroon (4) Ethiopia (6) Gambia, The (5) Ghana (1) Guinea (5) Madagascar (7) Malawi (7) Mauritania (7) Mozambique (5) Nicaragua (5) Niger (3) Sao Tome & Principe (4) Senegal (4) Zambia (3) 9 Benin (8) Burkina Faso (9) Chad (8) Guyana (8) Honduras (8) Mali (8) Rwanda (8) Tanzania (8) Uganda (9) Substantial Upgrading Required Little Upgrading Required Some Upgrading Required Source: “Actions to Strengthen the Tracking of Poverty Related Public Spending in Heavily Indebted Poor Countries (HIPCs), World Bank and IMF, March 22, 2002. See http://www.worldbank.org/hipc/hipc-review/tracking.pdf

18. The results indicated the need to improve basic aspects of PEM systems (Percent of countries not meeting each benchmark) 100% Note: Based on 24 countries’ Final Assessments 90% 80% 70% 60% 50% 40% Timely functional reporting from class system Audited accounts to legislature within 1 year Meets GFS definition of general government Projections integrated into budg. formulation Quality of internal audit (effective or not) Accounts closed within two months of y/e 30% Fiscal & monetary data reconciled Extra (off) budget expend. Pov. Red. Exp. Identified 20% Data on donor financing Classification of budget Low level of arrears Regular tracking Month reports Outturn close? 10% 0% Benchmark number: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Formulation Execution Reporting Source: “Actions to Strengthen the Tracking of Poverty Related Public Spending in Heavily Indebted Poor Countries (HIPCs), World Bank and IMF, March 22, 2002. See http://www.worldbank.org/hipc/hipc-review/tracking.pdf

19. Comparison of selected PEM indicators for ECA PRSP countries and HIPCs • A recent draft study by the Bank’s Europe and Central Asia (ECA) region, entitled “BUDGET MANAGEMENT AND PRSP in ECA PRSP COUNTRIES” (June 2003), employed an instrument similar to the HIPC expenditure tracking assessment. The instrument was applied in 11* ECA countries. Many indicators in the ECA study are sufficiently different to prevent comparison with the HIPC expenditure tracking results, but four can be compared: • Comprehensiveness of the budget. Budget reporting follows GFS. No ECA countries met the benchmark, compared to 10 percent of HIPCs. Budget comprehensiveness challenges are a particular legacy of the former socialist countries, with the public sector still being defined in many countries. • Multi-year forecasts integrated into the budget process. Ten percent of ECA countries met the benchmark, compared to 18 percent of HIPCs. Relatively more emphasis has been placed in ECA countries on budget execution during the 1990’s, and budget formulation, including medium-term forecasts and MTEFs, are a more recent phenomenon. • Internal audit effectiveness. None of the ECA countries met the benchmark, compared to about 12 percent of HIPCs. Even though internal audit has generally been neglected in Africa, the function nominally existed. For ECA countries, the socialist heritage did not include internal audit functions. • Audited accounts presented to the legislature. Fifty-five percent of ECA countries met the benchmark, compared to 17 percent of HIPCs. ECA countries, as noted above, have placed relatively greater emphasis on budget execution, including auditing and reporting, in the 1990’s, and this is reflected in the results. HIPCs in Africa have focused more on budget formulation (MTEFs) rather than budget reporting. • HIPC countries generally scored better than ECA PRSP countries, and these reflect the differing initial conditions, capacity for reform, and differing PEM reform emphasis in the regions. • * Albania, Armenia, Azerbaijan, Bosnia, Georgia, Kyrgyz Republic, Serbia, Macedonia, Moldova, Montenegro, and Tajikistan. Serbia and Montenegro form one country, but are reported separately in the ECA study due to significant differences between the two Republics PEM systems and capacity.

20. HIPC Assessment Conclusions • Execution and reporting relatively weaker • Institutional reforms • require continuous engagement and monitoring: not one-off • Country commitment also fundamental • Unless some of these addressed, other PEM reforms will have limited impact • With limited policy space for reform, important to focus on a few key areas, rather than laundry list

21. 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. • “Tracking of Poverty-Reducing Public Spending in Heavily Indebted Poor Countries,” Revision 1, March 28, 2001, SM/01/16, and World Bank, March 30, 2001, IDA/SECM2001-0052/1 • “Actions to Strengthen the Tracking of Poverty-Reducing Public Spending in Heavily Indebted Poor Countries,” Revision 2, March 21, 2002, SM/02/30, and World Bank, March 22, 2002, IDA/SECM2002-30/2 • “Update on Implementation of Action Plans to Strengthen Capacity of HIPCs to Track Poverty-Reducing Spending,” March 11, 2003, SM/03/90; World Bank, March 13, 2003, IDA/R2003-0043. All HIPC Papers available at: http://www-wbweb.worldbank.org/prem/prmps/expenditure/hipc.htm