Extending Budgeting to the Medium Term: From Fiscal Forecasts to Programmatic MTEFs

1. Extending Budgeting to the Medium Term:From Fiscal Forecasts to Programmatic MTEFs International Monetary Fund Fiscal Affairs Department Holger van Eden ASIAN REGIONAL SEMINAR: PROMOTING FISCAL SUSTAINABILITY Kuala Lumpur, February 28 - March 2, 2011

2. Outline • Why Medium-Term Budgeting? • The typical development path • When is a framework really a framework? • The constituent parts of an MTEF • Have MTEFs delivered on their promise? • Why is Medium-Term Budgeting so hard? • Prerequisites for introducing MTEFs • How to make MTEFs work – For Discussion!

3. The promise of medium-term budgeting • Improved aggregate fiscal discipline through estimation of realistic medium-term resource envelopes and setting of aggregate and sectoral ceilings • More effective fiscal policy; improved planning and execution ofstimulus and exit strategies by identifying fiscal space and possible/required policy measures over medium-term • Linkage of budget to long-term fiscal targets • Enhanced strategic prioritization by linking budget to strategic planning and sectoral priorities, and building in decision-phase on new expenditure priorities in budget cycle • Increased planning certainty for budget managers • Increased fiscal policy transparency and accountability • If linked with development of program budgeting – programmatic MTEF - >>> linkage to expenditure outputs and outcomes, improved policy impact of the budget, shift from administrative to managerial culture, improved expenditure efficiency

4. What is a medium-term [fiscal/ budget/ expenditure] framework? Amedium-term framework is a technical and institutional mechanism for setting multi-year objectives for [fiscal aggregates/budget expenditure/programs and outcomes] and ensuring that they are respected in budget formulation, approval and execution

5. Usual development path for medium-term budgeting (Phase I) • Fiscal outlook: macroeconomic forecast +top-down estimates of fiscal aggregates; debt sustainability analysis • Multi-year budget estimates: bottom-up estimates of budget items (often using very simple parameters) • Medium term fiscal framework (MTFF): involves cabinet decision on fiscal aggregates over the medium-term; agreement on major policy direction; uses high-level economic presentation >>> sometimes MTFF is achieved, sometimes immediate jump to step 4

6. Usual development path for medium-term budgeting (Phase 2) • Forward estimates: incorporation in budget estimates of existing and agreed policies. Implies development of baseline methodology + multi-year baseline estimates. Starts top-down with economic classification, can gradually incorporate bottom-up estimates aligned with budget classification. • Medium term budgetary framework (MTBF/or partial MTEF):cabinet decision-making on aggregate and line ministry spending ceiling over the medium term, reconciliation with forward estimates; decision-making over medium-term cutbacks, new initiatives, fiscal space >>> sometimes MTBF is achieved, sometimes immediate jump to step 6

7. Usual development path for medium-term frameworks (Phase 3) • Linking policy to medium term budget:Development of programmatic budget classification, linkage of sectoral strategies and policy initiatives to medium term budgeting. Not constrained yet by expenditure ceilings. • Full MTEF or Programmatic MTEF: Involves cabinet decisions on sectoral expenditure ceilings, fiscal space, policy priorities and expenditure programs (and their outputs and outcomes) over the medium term. >>> Without cabinet decision making, medium term budgeting remains a technical exercise with limited impact on the budget >>> mostly countries do not progress to multi-year appropriations

8. When is a medium-term framework really a framework? • Decision on multi-year fiscal targets/expenditure ceilings by Cabinet (and possibly by legislature) • Targets/ceilings are enforced in budget preparation (linkage to the budget) • Out-years of the MTFF/MTEF are rolled over; starting point for next MTFF/MTEF • Framework presents main allocative decisions that need to be made to reconcile baseline with ceilings (reconciliation for MTFF much less detailed then for MTBF and MTEF) >>Many countries have fiscal or budgetary outlooks rather than frameworks >>Fiscal and budgetary outlooks are useful by themselves to inform on (required) direction of government spending >>> a framework obviously has much greater benefits!

9. Key Design Elements of MTEFs • Linkage to fiscal objectives/targets/rules • Comprehensiveness • Unit of planning and control (Aggregate, Ministry, Economic/Line item, Program) • Time horizon: budget year + 2,3 or 4 years • Forecasts/Baselines vs. Ceilings • Introduction of strategic decision-making phase in budget process • Clear identification of fiscal space and new policy initiatives (and their costs over the medium term); • Rolling vs. Fixed (in any case one should not every year start from scratch) • Real vs. Nominal Baselines/Ceilings • Planning and/or contingency reserve • Performance orientation

10. Different countries have different models

11. Strategic Phase in MTEF should involve Cabinet and Legislature Cabinet • Does Cabinet endorse fiscal targets, and aggregate and line ministry expenditures ceilings for the medium term? • Are main cutbacks and new policies identified, costed and agreed upon? • Is an MTFF or MTEF document agreed upon • Do expenditure ceilings survive in the later budget process • Is the MTEF rolled-over in the next year, starting from last year’s decision-making Parliament • Does parliament debate the MTFF or MTEF document • Does parliament approve aggregate and sectoral ceilings • Does parliament vote on budget in two steps (aggregate envelope and then detailed expenditure plans) • Do budget amendments respect MTEF ceilings?

12. WB Interim assessment of MTEFs

13. Evidence from PEFA • Medium term focus is now prevalent in many countries • Annual budget credibility is increasing • Lack of reconciliation in rolling over budgets • Poor integration of capital and recurrent • But… • Classification (still dominated by economic) • Excessive detail in outer years • Comprehensiveness lacking • Execution often does not follow budget

14. Why MTEF is difficult to implement (1) • Political environment not ready to deal with budgetary decisions over the medium term – political time horizon often even shorter than one year • Institutional separation between MTFF/MTEF preparation and budget process • Lack of capacity in fiscal and macro forecasting; • Inappropriate design: • (1) no two-step budget process; • (2) no reconciliation in top-down/bottom-up; • (3) no recalibration of MTFF/MTEF at budget time; • (4) no roll-over of out-year figures /yearly restart of MTEF • Countries jump to MTEF while MTFF not functioning

15. Why MTEF is difficult to implement (2) • Coverage of MTFF/MTEF (and budget) is not comprehensive >>> EBFs, quasi-fiscal activities are excluded >>>aggregate control not realized • Expenditure ceilings set in strategic phase are systematically not enforced • Expenditure commitments are not controlled • Budget execution does not follow original budget given cash constraints/in-year changes to budget >>> these issues relate not only to MTEF but also to annual budget process >>>without a sound, credible annual budget process, an MTEF will not fulfill a useful role

16. Prerequisites for introducing MTEF • Reasonable level of macroeconomic stability • Adequate macro, fiscal and debt data, and projection skills/capacity to create realistic macrofiscal framework • Basic PFM process are functioning: • Credible budget preparation • Adequate fiscal reporting • Competent cash planning • Reliable budget implementation • Core strategic planning, fiscal and budgetary policy capacity in finance ministry/central agencies • Commitment from Cabinet and Parliament • Capacity to enforce hard budget constraint at sector/ministry level (systems capacity and political will) • Executive commitment to a more transparent budget process • Capacity in sector policy analysis and expenditure planning

17. Some suggestion to strengthen the use of MTEFs - I • Diagnose existing budget processes >>>PEFA, ROSC, PE(I)R, CFAA to identify weaknesses • Ensure PFM basics are in place • Develop MTFF first, ensure forecasting and policy making capacity of MF unit • Integrate MTEF unit into DG Budget; stand-alone units (even if positioned next to Minister) can be ignored • Ensure political and managerial support for multi-year perspective and decision making • Limit the time horizon; for emerging market and developing countries a 4-5 year horizon is much too long • Keep program budgeting component simple

18. Some suggestion to strengthen the use of MTEFs - II • Produce a MTEF decision-document, separate from budget, and split budget preparation process in two phases • Have Cabinet vote on the fiscal targets, expenditure ceilings, and main policy measures >>> send to Parliament for information or approval to enhance accountability • Reconcile MTEF with previous year’s out-years, i.e. ensure roll-over • Enhance fiscal reporting/transparency to increase political accountability for MTEF • Consider fiscal rule(s) as potential anchor of MTFF/MTEF to ensure fiscal sustainability and stability

19. Thank You!