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

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

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

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

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

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

7. 7 Planning system Medium term plans, e.g. three year rolling plans Annual budgets Development, recurrent and revenue Fund release procedure, e.g... warranting Accounting for revenue and expenditure Public expenditure review Institutions Reports and financial statements Audit system Project monitoring Project appraisal Resource allocation Liquidity management Expenditure control Monitoring & controlling Post event review Accountability Expenditure review Financial management system boundaries 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. Expenditure Management Cycle

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

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

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

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

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

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

14. 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. 15 What is budget execution? Processes and institutions to implement the budget Processes and institutions to implement the budget Incentives – principle-agent problem Incentives – principle-agent problem Reflects that budget is NOT only an accounting document Reflects that budget is NOT only an accounting document also a political document also a political document Planning/steering device Planning/steering device

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

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

18. 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. 19 Budget and Policy Execution System in Hungary (1999) System

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

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

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

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

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

25. 25 PFM PEFA Indicators Budget Execution Accounting and Reporting External Audit and Oversight Budget Formulation 1.Aggregate expenditure out-turn 2.Composition of expenditure out-turn 3.Aggregate revenue out-turn 4.payment arrears 5.Classification of the budget 11.Orderliness in annual budget process 12.Multi-year perspective 13.Transparency of taxpayer obligations and liabilities 14.Effectiveness of taxpayer registration and assessment 15.Effectiveness of tax collection 16.Predictability of funds for commitment 17.Recording/management of cash, debt and guarantees 18.Effectiveness of payroll controls 19.Competition, value for money and controls in procurement 20.Effectiveness of internal controls 21.Effectiveness of internal audit 22.Accounts reconciliation 23.Resources received by service delivery units 24.Quality and timeliness of in-year budget reports 25.Quality and timeliness of annual financial statements 26.External audit 27.Legislative scrutiny of budget 28.Legislative scrutiny of external audit reports 6.Comprehensiveness of information 7.unreported government operations 8.Transparency of inter-governmental fiscal relations 9.Oversight of aggregate fiscal risk 10.Public access to key fiscal information Cross-cutting Indicators

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

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

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

29. 29 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 Application

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

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