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

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

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

International Trend (1) CBO: central budget office, MoF: different part of MoF/Treasury Source: OECD-World Bank Budget Practices and Procedures Database Coverage of MTEF Responsibility of economic assumption Multi-year cost estimate for new spending Sweden 3 yrsMoF * All spending item Norway varyingMoF * No UK 5 yrs CBO All spending item Australia 4 yrsCBO All spending item NZ 2 yrsMoF * All spending item USA N/A All spending item

International Trend (2) Source: OECD-World Bank Budget Practices and Procedures Database Basis of setting spending limit for ministries Final decision on ministries’ spending Arrangement in congress to establish total budget before individual item Sweden MTEF Prime Minister Yes Norway N/ACabinetYes UK MTEFMoFNo Australia MTEFCabinetNo NZ MTEFCabinetNo USA Suggestion only PresidentYes

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

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), : - 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 Why MTEF? 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

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

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

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

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. ”