Module 1.2 Introduction to the Budget Cycle INTRODUCTION TO PUBLIC FINANCE MANAGEMENT Module 1.2 Introduction to the Budget Cycle

Module map 2.2 MTEF and performance budgeting 1.2 Budget Cycle Planning and budgeting 2.4 Budget Execution 1.1 Introduction 2.1 Macroeconomics of the Budget 4.1 Revenue Administration 3.1 Payroll, Procurement & IT 1.4 Budget Classification 4.3 Accounting & Reporting 4.2 Treasury Management 1.2 Budget Cycle 5.3 Assessing & Recapitulation 3.2 Internal Control & Audit 5.1 External Scrutiny & Oversight 2.2 MTEF and performance budgeting 1.3 The Budget and budget preparation

Module outline The six phases of the budget Cycle

Six Phases of the Budget Cycle Budget Execution Review Policy Strategic Planning External Audit Budget Preparation Ask: where are you in the budget cycle? Ask: what is the first phase / the start of the cycle (if any)? The budget plays a central role in the process of government, fulfilling economic, political, legal, and managerial functions. It is the tool through which government channels public expenditure towards those areas that make the greatest contribution towards achieving government objectives. The budget process will differ between countries, but most will have at least the six generic stages shown here: Phase 1 – Strategic planning: determine the strategic priorities Phase 2 – Budget preparation: mobilise and allocate resources Phase 3 – Budget execution: implement planned activities Phase 4 – Accounting and reporting: generate financial information on public expenditure Phase 5 – External audit: ensure the reliability of financial reports Phase 6 – Policy review: evaluate the results of public expenditure. Mention also what is meant with upstream (first phases of budget cycle) and downstream (later phases). Budget preparation processes are comparatively stronger than budget execution and oversight processes across all African countries. In PFM jargon, this is commonly presented as ‘upstream processes are stronger than downstream processes’. Matt Andrews, A stocktake on African PFM, 2010. Ask: How many years does it take to run one budget cycle? Accounting and reporting

Phase 1. Strategic Planning Translation of the medium-term economic and social policies into a medium-term programme of actions, taking into account available resources Macro-economic forecasting National Development Plan Set macro-fiscal policy Development of sector strategies Determining expenditure ceilings Costing / fiscal impact assessments Phase 1: Strategic Planning Phase Strategic planning (SP) is the translation of the economic and social policies of the Government into a programme of actions to be executed in a certain period (one year or a couple of years), taking into account the availability of resources. SP is based on (i) the economic and social policies of the Government (ii) an analysis of the results of budget implementation in previous years, and (iii) macro-economic projections. SP is the link between the Government’s policies, making the Medium Term Expenditure Framework and the annual budgets. SP sets priorities for public programs in view of the fiscal constraints (how to make use of the available resources) Strategic planning is the first phase of the budget cycle. This phase should result in: setting the government’s medium-term policy agenda matching the policy agenda with the country’s medium-term macroeconomic and fiscal framework. Setting the government’s strategic policy agenda A starting point for the budget cycle is identification of the medium-term policy agenda and assessment of the level of expenditure needed to effect this agenda. In many countries, the time horizon for such a strategic policy agenda coincides with the cycle of parliamentary elections. In developing countries the strategic policy agenda is generally formulated in the country’s Poverty Reduction Strategy Paper (PRSP) or a similar national development plan. PRSPs describe the country's structural and social policies and programmes over a three-year or longer time frame to promote broad-based growth and reduce poverty. The plans are prepared by recipient countries through a participatory process involving domestic stakeholders, as well as the donor community. The Ministry of Economic Planning (or Development) usually takes the lead in the preparation of the PRSP. In many countries, the World Bank has played a strong role in initiating PRSPs. In practice, realistic costing of the PRSP to assess the level of expenditure needed for its implementation is often insufficient. Consequently, in the execution of the PRSP, its policy objectives frequently appear to be too ambitious in financial terms. Policy development side: No analysis of previous implementation of policies Lack of costed sector strategies Strategies are developed without fiscal constraint (wish list) Macro-economic side: Too optimistic macro-economic assumptions and projections Inadequate institutional framework to make realistic macro-economic forecasts Setting priorities within fiscal constraint policy side fiscal side

Phase 2. Budget Preparation Budget preparation deals with the annual translation of strategic plans into the budget Responsibilities in budget preparation process are set out in a legal framework: constitution, organic budget law, financial decrees and regulations Approved budget is a law: deviations (virements, supplementary budgets) need to be approved Phase 2: Budget Preparation Phase Political instrument: Main political event of the year What is the framework within which budget decisions are made? Internationally accepted budget principles Fixed timelines controlled by legal and regulatory framework Rules set out in a legal framework that determine the responsibilities in budget preparation process (e.g. constitution, organic budget law, financial regulations). For rules see Potter & Diamond, p15. These rules provide a legal framework within which the annual budget law, which includes the revenue and expenditure estimates for a given year, is prepared, approved, executed and audited. Basic principles: Comprehensiveness - include all expenditure and revenues in the budget Accuracy and timeliness - record actual transactions and flows Annuality - cover a fixed period of time (i.e. fiscal year) with a clear budget calendar and process Credibility and realism - public funds should be spent as authorized by Parliament Transparency - information on expenditures and revenues is available on time and accessible

Phase 2: budget preparation Phase 2: Budget Preparation Phase What are the basic steps? 0. The first step in budget preparation should be the determination of a macroeconomic framework for the budget year (and ideally at least the next two years). The macroeconomic projections, prepared by a macroeconomic unit in the ministry of finance or elsewhere, should be agreed with the minister of finance. This allows the budget department within the ministry of finance to determine the global level of expenditure that can be afforded without adverse macroeconomic implications, given expected revenues and the level of deficit that can be safely financed. In a quite a few countries, there are fiscal rules in place that may limit total spending or recurrent spending (e.g., the "golden rule"). I. The second step should be the allocation of this global total among line ministries, leaving room for reserves (a separate planning and a contingency reserve as explained below) to be managed by the ministry of finance. II. The next step should be for the budget department to prepare a budget circular to give instructions to line ministries, with the indicative aggregate spending ceiling for each ministry, on how to prepare their estimates in a way that will be consistent with macro objectives. This circular will include information on the economic assumptions to be adopted on wage levels, the exchange rate and price levels (and preferably differentiated price levels for different economic categories of goods and services). III. Step four is the submission of bids by line ministries to the budget department. Once received there needs to be an effective "challenge" capacity within the budget department to test the costing of existing and any new policy proposals. IV. The next step comprises the negotiations, usually at official and then bilateral or collective ministerial level, leading finally to agreement. V. Finally, step six is Cabinet endorsement of the proposals for inclusion in the budget that will go to parliament. 7 7

Phase 3. Budget execution Revenue collection Taxes (direct/indirect) Excises Duties Non-tax revenues Donor funding Expenditures Control Payroll Procurement of goods/services Transfers / subsidies Liquidity management Short term (cash management) Medium / long term (debt management) Aim: achieve policy goals Phase 3: Budget Execution Phase Lack of Commitment control Main expenditure categories: Payroll Procurement: Fair and transparent open competition Service delivery Clear and fair process Institutional and legal arrangements in place, advertisement, criteria, appeal Technical features important Bureaucratic powers / corruption 8

Payment Authorisation by MoF or Fin. Dept. Phase 3: budget execution Control Authorisation by MoF or Fin. Dept. of LM Commitment to future payment Verification of delivery by spending dept: liability Payment Authorisation by MoF or Fin. Dept. Phase 3: Budget Execution Phase Authorisation After Parliament has approved the budget, line ministries are authorised to spend money. However, this authorisation is limited to: - budget items: money approved for one line item (e.g. public transportation) cannot be spent on other line items (e.g. building schools) unless there are specific rules that regulate such ‘virements’. - budget year: money that remains unspent in the authorised budget year cannot be carried forward to be spent in the next year unless there are specific rules that regulate such ‘carry-overs’. Flexibility in budget authorisation Many OECD countries tend to provide line ministries with more freedom to manage their expenditure, by broadening the description of budget items and permitting carry-overs. However, when the public financial management system of a country is not (yet) well-developed, such loosening of budget authorisation is generally not encouraged, in the interest of fiscal discipline. Commitment In the commitment stage, a future obligation is incurred. For example, by signing a contract, a ministry may be bound to purchase some goods. The gap between entering into a commitment and the associated cash payments varies across expenditure categories. For large capital goods (e.g. construction of a government building), the lag may be large and is likely to extend beyond the end of the fiscal year. The registration of commitments is, therefore, crucial for maintaining a precise overview of the available resources for new expenditure. Nevertheless, in some systems, commitments are not recorded on a timely basis. Verification The verification stage entails checking whether goods have been delivered or services have been rendered. This is to determine whether the bills that have been received should be recognised as a ‘liability’ of the public sector. Payment authorisation In this stage, the payment order is given. To prevent fraud, a division of responsibilities is a basic requirement. This means that the person who authorises the payment should never be the same as the one who ordered the supply/goods. Three systems for attributing responsibility for payment can be distinguished: - Commonwealth system: the responsibility for payment orders is decentralised towards spending ministries - Francophone system: the responsibility for payment orders is centralised in the Ministry of Finance - Latin American system: the responsibility for payment orders is centralised in the so-called ‘contraloría general’, which also exerts a pre-audit function on commitments. Cash payment The final stage concerns the actual cash payment. In some countries (mainly Francophone), payments take place through a ‘single account’ in a designated bank administered by the Ministry of Finance. In others, payments are conducted through the commercial banking system via bank accounts held in the name of individual line ministries. Cash Payment by Treasury or LM 9 9

Phase 4. Accounting and Reporting Accounting: maintaining basic records of government transactions and, thus, outturn expenditures Aim: monitor and control legal compliance with budget authorisations Chart of Accounts (CoA): coding framework for financial transactions Data: commitments and/or payments Phase 4: Accounting & Monitoring During the budget execution phase, the commitments and payments need to be monitored. This is done by ‘accounting’, which can be defined as the maintenance of basic records of government transactions. The primary aim of the accounting system is to deliver reliable information on the government’s financial position. Accordingly, accounting systems are also referred to as ‘financial management information systems’. The financial management information system is being used by line ministries as well as the Ministry of Finance, and should ideally be integrated. Phase 4 ends with the presentation of the government’s annual statement or financial report. The aim of this financial report is to inform Parliament on the results of the budget execution phase. On the basis of this document, Parliament can conclude whether the budget has been executed in accordance with the appropriations. At the heart of any fiscal and financial information system is the accounting system, which maintains the basic records of government transactions and, thus, outturn expenditures. The capacity of MoF to consolidate, analyze, and use this outturn expenditure information is also important to provide data for macroeconomic, fiscal and financial management. Existing accounting systems were set up to monitor and control the legal compliance of expenditures with authorized budget provisions. As such, they may be poorly suited to provide the financial information required for macroeconomic, fiscal, and financial management. In general the accounting system is not well suited to provide the financial information required for macroeconomic, fiscal and financial management because it requires further data analysis and consolidation. This is also a reason for many countries to integrate the accounting system into a Financial Management Information Systems (FMIS).

Phase 4: Accounting and Reporting Financial reporting In-year reporting – related to budget execution End of year report: Annual Financial Statement Revenues and expenditures Balance sheet (assets and liabilities) Phase 5: Reporting & Audit Phase Phase 4 ends with the government’s financial report. This report informs parliament on how the budget has been executed and the country’s financial position at the end of the fiscal year. To assure the reliability of the information included in the financial report, it must be accompanied by a statement from an external auditor. In most countries, the role of external auditor is fulfilled by the Supreme Audit Institution (SAI). The legal position of the SAI and its legal tasks vary across countries. A common feature of SAIs is their responsibility to issue a judgement concerning the quality of the information included in the financial statement to parliament.

Phase 5. External Audit Supreme Audit Institution (SAI) National institution responsible for external auditing of government’s annual financial report Key feature Independence from executive and legislative authorities by Constitution l Phase 5: External Audit Phase Phase 4 ends with the government’s financial report. This report informs parliament on how the budget has been executed and the country’s financial position at the end of the fiscal year. To assure the reliability of the information included in the financial report, it must be accompanied by a statement from an external auditor. In most countries, the role of external auditor is fulfilled by the Supreme Audit Institution (SAI). The legal position of the SAI and its legal tasks vary across countries. A common feature of SAIs is their responsibility to issue a judgement concerning the quality of the information included in the financial statement to parliament. 12 12

6. Policy Review Assessment of actual versus desired government policy outcomes Ex-post analysis of impact of government policy programs Adaptations of strategic policy mix based on outcomes of government policy effectiveness and efficiency in service delivery  Should be an integrated phase of budget cycle No common practice in developing countries Carried out on an ad hoc basis Frequently initiated by donor community (PER, PETS) Phase 6: Policy Review Phase The last phase of the budget cycle concentrates on the evaluation of government policies. Based on policy evaluation, a government can decide to alter its policies. Such policy changes need to be taken into account in the strategic planning stage of the next budget. Accordingly, policy review should be an integrated phase of the budget cycle. In many developing countries policy reviews are not carried out as an integrated phase of the budget cycle, but only on an ad hoc basis by way of Public Expenditure Reviews, Annual Progress Reviews of the PRSP and other reviews frequently initiated by the donor community. It is not necessary to evaluate all government policies in-depth each year. This would be too costly and add too little value. A more efficient approach is to schedule evaluation at intervals of various years. The planning and control of such an evaluation schedule forms part of the budget cycle.

Fiscal Year: Budget T-1 Reporting & Audit Policy Review Budget Execution Account. & Mon. Strat. Planning & Budget Prep. Budget T Reporting & Audit Policy Review Budget Execution Account. & Mon. Strat. Planning & Budget Prep. Budget T+1 Reporting & Audit Policy Review Budget Execution Account. & Mon. Strat. Planning & Budget Prep. Take for t (and T) the current year. t-2 t-1 t t+1 t+2 14 14

Budget Cycle Exercise Groups should each clear a complete Table top, ready for working Take all cards Lay out in three columns: Do stages first, then tasks, then stakeholders Be sure to put tasks in correct order Time: 30 min Stages Tasks Stakeholders