1. Principles for Public Financial Management
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Principles for Public Financial Management
Asia-Pacific Finance and Development Institute
Shanghai, People’s Republic of China
1 June, 2018
Hans van Rijn
Principal Public Sector Management Specialist
East Asia Department, Asian Development Bank
Good morning ladies and gentlemen – my name is Hans van Rijn, and I’d like to start by saying that it is both an honour and a pleasure to be here today, and to discuss some insights on public financial management with you.
Since 2007, I have been working with various departments in the Asian Development Bank. For about 4 years, I worked with a team that looked after the governance and financial management aspects of ADB projects and programs, mostly in Nepal, India, Lao People’s Democratic Republic and Cambodia; then I moved to the Pacific Department and worked on e-Governance and PFM programs in countries like Solomon Islands, Timor Leste, Tonga, Fiji, Palau and the Federated States of Micronesia. Since 2 years I am in the office of the Director General of the Independent Evaluation Department
From 2003 – 2007, I worked as an advisor to the Ministry of Finance of Ghana (West-Africa), and from , I worked in Nepal, with both the Ministry of Finance and the National Planning Commission. In both countries, I worked with the government on both the strengthening of PFM systems and on fiscal decentralization reforms.
I started my career with a Dutch consultancy company, with PFM and PAR assignments in Kazakhstan, Kyrgyz, Pakistan and Viet Nam.
I graduated from the Free University in Amsterdam, with a degree in Public Administration and Public Finance.

2. Presentation Outline (morning)
Session 1(a) – Public Financial Management
Role of PFM In Macroeconomic Management and Fiscal Policy
Objectives of PFM
Key Characteristics of Prudent PFM
Key Principles For Strategic Budgeting
Budget Cycle Management
Session 1 (b) – PFM Assessment Approaches
In this presentation I will highlight some good practices in two areas: public financial management and the preparation of economic analyses, in particular for infrastructure projects
The presentation was prepared to be interactive and participatory: I would like to invite you to compare the more general overview of principles and practices with the actual situation in your country. And although we will have a dedicated Q&A session following the presentations, I will regularly ask for your inputs during the session too. And I have a list of names here, so I know who you are ….
I hope that’s fine with you?
In the first part, I will briefly discuss the importance of good quality PFM systems in the context of macroeconomic management and fiscal policy. Then we will move to a discussion of the various components of the budget cycle.
We will end the morning part of the presentation with a discussion of inter-governmental fiscal frameworks –
I am very happy to see that we have both officials from the Executive Yuan, national level government agencies and officials from local governments in the room today.
I should end by saying that we could probably spend a whole day discussing each slide of the presentation – unfortunately, we don’t have so muc time, so we have to be brief.

3. I. Role of Public Finance in Macroeconomic Management
Long term strategic vision for the economy
Learning from doing during implementation (targets, monitoring, feedback loops)
Transparency and accountability over policies, spending and results
Every government, regardless of its political orientation, needs resources – resources to pay the wages of civil servants, police officers and the army, and to
finance public utilities such as roads, for example. To finance these services, every government needs to collect resources from the economy. If a government
spends more resources than it is able to collect, it has to borrow to finance its deficit and it will build up debt. The focus of public finance is on a country’s
expenditure, revenues, deficit and debt and how these elements are linked.
As such, strong PFM systems are the backbone of prudent macroeconomic management.
Long term vision is a must to ensure self-sustaining sources of growth and employment – if your finances are nit sustainable, this will become a fallacy
Mistakes will be made, anywhere, so readiness to learn is key. This requires clarity on policies and targets, which can be monitored and fed back into the system – M&E are a crucial part of strong PFM systems
Transparency and accountability should be established as the basis for continued taxpayers’ trust in government – transparency and accountability are at the core of prudent PFM

4. II. What are the Objectives of Public Financial Management?
Fiscal discipline
Strategic resource allocation
Operational efficiency
Government must also match its expenditures with its income. This is called maintaining fiscal discipline. Maintaining fiscal discipline occurs at an aggregate level.
First, a government should know what its total available financial resources are (this is largely a technical exercise). This should be the starting point for the political process where it will be decided which individual ministry will get what.
It is important to emphasize from the outside that budget allocation decisions are POLITICAL decisions – budget allocations are never neutral and will always benefit some parts pf a population more than other parts. You can only spend money once, so a budget will always be the result of trade-offs between different options (say, building a road or investing in social safety nets).
And the same is true for the design of tax systems, needless to say.
The first objective of PFM focuses on the effective control of total revenue, total expenditure and government deficit/debt. Control of these totals is the first
purpose of every PFM system. Effective control over total revenues implies:
• realistic estimates of total government revenues (tax revenues and non-tax reveues
• ability to raise government revenues.
Effective control of total expenditure implies:
• realistic costing of expected expenditure
• ability to set a binding aggregate expenditure ceiling on total government expenditure as well as hard expenditure ceilings on individual spending
entities.
Effective control over deficit and debt implies:
• the capacity to set up a fiscal policy
• the ability to control (document and manage) both total revenues and total expenditure.
Expenditures should be based on investment priorities and on the effectiveness of government programs. This is referred to as strategic resource allocation. The decision making process leading to these allocations is, again, partly technical but predominantly political.
Allocative efficiency refers to the capacity to establish priorities within the budget, and to allocate resources in accordance with government priorities.
Allocating resources efficiently means shifting resources:
1. from old priorities in one sector to new priorities in another sector (shifting expenditure among ministries), for instance a transfer of budget from road
maintenance to primary education
2. from less effective programs/projects to more effective programs/projects within a sector (shifting expenditure within the
domain of one ministry), for instance a shift of resources from school buildings to teachers’ salaries.
Operational efficiency basically refers to value for money. Just like a business, a government should also aim to produce its goods and services as efficiently as possible, while at the same time maintaining high quality standards.
The key difference between a government and a business is that, in the end, business decision making is driven by one objective: profit maximization. Governments always struggle with multiple objectives: efficiency, equity, political viability, etc.

5. PFM objectives, budget management and macroeconomic and fiscal policy
Basic objectives
Levels of budget management
Type of objective
Aggregate Fiscal Discipline
Overall Expenditure Control
Strong role of the Ministry of Finance
Macroeconomic
Resource Allocation
Strategic areas (intersectoral)
Interministerial coordination
Within strategic areas
Programmes-Activities prioritisation
Allocative Efficiency
Policy Objectives
It is necessary to distinguish public financial management from public financial policy.
Public financial policy focuses on ‘what’ is to be done. What should be the level of government expenditure? What should be allocated to each sector? What
is the optimum level of taxation? What level of the fiscal deficit as percentage of the Gross Domestic Product (GDP) is acceptable?
Public financial management focuses on ‘how’ it is to be done. How to realise the desired level of government
expenditure? How to realise the desired reallocation of resources between sectors? How to achieve the optimum level of taxation? How to control the fiscal
deficit?
Public financial management is instrumental in nature. PFM is the whole complex of institutions, rules, regulations and processes that are in place to achieve policy
objectives. Public financial management and policy can be analysed separately, although the objectives (‘policy’) and the instruments (‘management’) to achieve
these objectives can be seen as two sides of the same coin. Assessing public financial management in a country can be done regardless of the country’s policy
choices, economic orientation or strategic priorities.
Operational Efficiency
Operations Service Delivery
Directorates, programmes, projects at the level of line managers
Operational Performance

6. Sustainable Fiscal Policy
Budget year T:
Budget years T +1,2,3:
Total revenues
Total expenditure
Budget deficit
Increase in costs
of total debt
Increase in total expenditure
Increase in budget deficit
Further increase in costs of total debt
Interest payments
The expenditure level that is required to implement the government’s medium-term policy agenda should fit within a macroeconomic and fiscal framework. This framework should include government objectives for two key variables:
• the fiscal position as indicated by the budget deficit, which is the difference between government revenues and government expenditure
• fiscal sustainability as indicated by the relative size of total debt.
This slide shows the relationship between these two variables. It shows that a budget deficit in any fiscal year results in an increase of the size of total debt. The size of total debt has, on its turn, consequences for the fiscal position in the forthcoming year through the requisite to pay the interest on total debt. A fiscal position is regarded as ‘non-sustainable’ if it results in such an increase of total debt that the forthcoming annual budgets cannot meet the resulting interest payments.

7. III. Main Characteristics of Good PFM
Comprehensive
Predictable
Accountable
Transparent
Clear, consistent, affordable
Political engagement
C – Important that Budget covers all public expenditure and revenues. Problem of off-budget aid is well known – lots of effort to get more on-budget. Expenditures off budget are of dubious legality since not part of expropriations act nor subject to oversight of PAC.
P – Strict timetable (process), what gets cut needs to be predictable (i.e. clear prioritisation, cash releases)
A – justification for the use of scarce resources
T – are resources used as planned and is this properly documented
C,C and A – failure to link policy, planning and budgeting may be the single most important factor contributing to poor budgeting outcomes in developing countries.
Political engagement – Politicians should operate within a formal budget process. In many developing countries this is not the case and we see very little contact between politicians and the formal budget process. Politicians/MPs try to meet narrow constituency demands rather than compare alternative uses of resources within overall revenue limits.
When related to the current Government’s Five-Point Policy Platform, you will note that 2 points are directly relevant for today’s discussion on public financial management: (1) the concern over inter-generational equity, and (2) increasing the transparency and efficacy of government institutions.

8. Underlying Problem: The Budget As A Common Property Resource
National budget is subject to the tragedy of the commons;
For every stakeholder, the incentive is to maximise spending rights, because the cost is paid by pooled resources
Detrimental to collective welfare
In the absence of clear rules, the budget process becomes a negotiation game: Minister A receives and indicative budget ceiling of 100, he will then ask for 150, but what he really wants is 120.

9. Mitigation Against Common Property Dilemma
The “Budget Institutions Solution”:
Formal commitment to a common fiscal policy and development strategy before negotiating individual shares
Therefore a “bounded” (restricted) negotiation strategy
Maximum transparency over the Fiscal Policy, the Strategy, the Budget & Results

10. Budget vs. Budget Process
Important distinction
Budget is a legal document
Budget process identifies the steps for preparation, implementation and monitoring of the document
The budget is the end-product of a politically and technically complicated process. To make a judgement on the soundness of PFM systems, assessing the budget document alone is not enough – what is more important is to assess the process that led to the preparation of the document.
So how can we summarize the different steps in that process?

11. Expenditure on activities
IV. From Policy to Outcomes:
The Budget Cycle
Economic Analysis!
Process
Product
Process
Product
Process
Product
Policy formulation
Policy statement
Budget compilation
Outcomes
Expenditure on activities
Budget
Revenue collection
PFM systems should allow a government to translate long- medium and short-term policy objectives into tangible goods and services.
This process must take place against an agreed timetable over the fiscal year – or fiscal calendar. It is also important to note that the different sub-processes are iterative in nature.
Finally, please note that each sub-process should result in a tangible product.

12. Why Use Economic Analysis (EA)?
Integrated framework/tool
Identify needed investments
Establish economic rationale
Assist in making choices
Assess economic benefits and costs, impact, and risks
Project economic analysis (EA) is a key tool to ensure that scarce resources are allocated efficiently, and investment brings benefits to a country and raises the welfare of its citizens.
EA assists in identifying needed investments, establish its economic rationale as well as help in making choices.
In a nutshell, project EA assess economic benefits and costs, its impact and impending risks.
For ADB operations, it is used to comply with the mandate of the ADB Charter and contribute to the broad objectives of poverty reduction, inclusive economic growth, environmental sustainability, and regional integration.

13. Dimensions of EA: Relevance
Country/sector analysis
What is the problem?
Why should Public Sector be involved?
Identifying:
Basic problems/needs
Underlying causes
Role of government
Relevance: doing the right things
These questions identify basic problems, binding constraints, solutions, and appropriate role of the government

14. Dimensions of EA: Responsiveness
Technical Options
Physical Constraints
Institutional &
Incentive Constraints
Non-Technical
Options
How should we be involved?
Many choices for taking actions
Responsiveness: doing them the right way
There is a menu of choices for taking action; one of them would be most appropriate to achieve agreed goals
Verify Demand/ Benefits
Ensure Least Cost Option is Selected
Compare Costs and Benefits

15. Differences between Economic & Financial Analyses
Perspective
Project entity or participants
Economy-wide, all members of society
Benefits and Costs
Financial flows – revenue minus costs
Welfare Changes – measured by costs savings, WTP
Project economic analysis and financial evaluation both involve the identification of project benefits and costs during the years in which they occur and converting all future cash flows to their present value using the technique of discounting. Both analyses generate net present value (NPV) and internal rate of return (IRR) indicators, termed economic NPV (ENPV) and economic IRR (EIRR) in the case of economic analysis and financial NPV (FNPV) and financial IRR (FIRR) in the case of financial evaluation.
The perspectives and objectives of the two analyses differ. Financial evaluation is carried out from the perspective of the project, and considers incremental cash flows (both revenues and costs) generated by the project. The purpose of financial evaluation is to assess the ability of the project to generate adequate incremental cash flows to recover its financial costs (capital and recurrent costs) without external support. On the other hand, economic analysis is carried out from the perspective of the entire economy, and it assesses overall impact of a project on the welfare of all the citizens of the country concerned. The purpose of project economic analysis is to assess whether a project is economically viable for the country.
The different perspectives and objectives between the two analyses mean that there are major differences in the specification and valuation of project benefits and costs. Financial evaluation is based on market prices that are actually paid or received by a project, and it focuses on financial values of project costs and benefits. Economic analysis uses economic prices, also called “shadow prices,” and it focuses on economic values of project costs and benefits. Deviations of financial values from economic values of project costs and benefits arise from two major sources: price distortions and nonmarketed impacts.

16. Linking Policy to Delivery
Long-Term Development Plan
MTFF / MTBF
The link between the broad statements in the Long Term Development Plan (LTDP) and actual service delivery is relatively weak in many developing countries.
To reduce the gap between strategic development objectives and actual service delivery, a functional budget process is a prerequisite.
Experience has shown that the translation of LTDPs into annual budgets has often been haphazard because the LTDPs are poorly focused and mean all thing to all people.
This, and unrealistic budgets that have been wish-lists of aspirations rather then a prioritised coherent set of feasible activities, has served to reduce the impact of a TWD of public expenditure compared to what could be achieved.
One solution is the introduction of three year rolling MTFF and MTBF
These provide a link between the more aspirational – but still prioritised – set of policies for poverty reduction and the hard decisions associated with an annual budget. In principle there should be a cascade down so that the resource allocations in the Budget approved by Parliament, reflect the indicative (non-binding) resource allocations of the MTBF, which in turn is consistent with the overall policies of the LTDP. In this way there is a clear link between policy and delivery.
Annual Budgets
Goods and Services

17. V. Strategic, Policy-Based Budgeting
Wide but structured participation in the budget process, within a carefully crafted time-table (“fiscal calendar”)
Comprehensive, multi-year perspective in fiscal planning, and budget management (minimize off- budget and quasi-fiscal activity)
Medium Term Fiscal Framework, Medium Term Budget Framework
Strategic planning is the first phase of the budget cycle. This phase should result in:
setting the government’s medium-term policy agenda
In many countries, the time horizon for such a strategic policy agenda coincides with the cycle of parliamentary elections.
2. matching the policy agenda with the country’s medium-term macroeconomic and fiscal framework.
The expenditure level that is required to implement the government’s medium-term policy agenda should fit within a macroeconomic and fiscal framework. This framework should include government objectives for two key variables:
• the fiscal position as indicated by the budget deficit, which is the difference between government revenues and government expenditure
• fiscal sustainability as indicated by the relative size of total debt.

18. Cabinet Decision on Ceilings based on agreed fiscal policy & strategy
V-a. A Structured Budget Calendar
Q1: REPORTING Spending statement; results reports
Q2: STRATEGIC PHASE Fiscal policy, strategy, ceilings
Q3: DETAILED PREPARATION Sector submissions (within ceilings), negotiation with MoF
Q4: APPROVAL
Cabinet legislature
Budget Circular No. 1
Budget Circular No. 2
Cabinet Decision on Ceilings based on agreed fiscal policy & strategy

19. V-b. Medium Term Fiscal Framework
Aggregate 3-5 year framework, covering the key aggregates of Central Government Financial Operations
Revenues, expenditures, planned deficit or surplus, levels of borrowing
Illustration: Table 2 in the IMF’s Article IV Consultations

20. IMF Article IV – Table 2

21. V-c. Medium Term Budget Framework
Breakdown, by agency / unit, of expected revenues and spending
Baseline scenario and new measures (possible changes in revenues and/or spending)
Latter especially relevant for windfall economies and/or economies vulnerable to exogenous shocks

22. Budget Classification System
Administrative Classification
Economic Classification
Functional Classification
Title
Chapter
Section
Article
Paragraph
Main Function
Function
Secondary Function
Ministry
Managing Unit
Main Classification
Subclassification
Suppl Information
Division
Group
Class
Agriculture & Forestry
DG for Agriculture
Expenses
Employee Compensation
Wages and Salaries in Cash
Economic Affairs
Agriculture, Forestry, Fisheries, Hunting
Agriculture
2 characters
1 character
3 characters
Page 7 of the IMF Technical Guidance Paper – for speaking notes (importance of BCS for the purpose of tracking specific expenditures, e.g., poverty reducing expenditures)
Sound BCS is also a necessary element in upholding transparency and accountability in the fiscal affairs of a country.
Economic classification categorises expenditure into economic categories, such as expenditure on wages/salaries, subsidies and capital expenditure. For international comparative purposes, the IMF has developed the GFS (Government Finance Statistics) economic classification scheme.
Functional classification categorises expenditure according to its purpose, such as education, social security, housing etc. It is independent of the government’s organisational structure. For international comparative purposes, the United Nations has developed the COFOG (Classification of the Functions of Government) functional classification scheme.
Administrative classification categorises expenditure according to administrative responsibilities. The government’s organisational structure (ministry, department or agency) constitutes the basis for this classification.

23. V. Strategic Planning
Setting the Government’s medium-term policy agenda (coherence of objectives!)
Accompanied by corresponding budget allocations
Within the boundaries set by the MTBF

24. VI. Effectiveness in Budget Execution
Good budget preparation (comprehensiveness, credibility)
Predictability and control (minimize leakages)
Accurate accounting, recording and reporting
External oversight (audit, public accounts committees)

25. VI-a. Controlled Budget Execution in Five Steps
Authorisation
Commitment
Verification
Payment authorization
Cash payment
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.
How does this work in Taipei?

26. VI. External Audit
The government’s financial 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. With the objective of issuing such a judgement, the SAI performs a ‘regularity audit’. In a regularity audit, two audit types with different objectives can be identified:
• Financial audit
This form of auditing makes an assessment of the financial statements. It seeks to determine the accuracy of the data contained in financial statements and reports. The purpose is to assess the assurance that these statements properly depict the financial activity and conditions of the audited entity.
• Compliance audit
This form of auditing aims to ensure the legal propriety of transactions. For individual transactions, it examines whether the appropriate authorisations and documents are present. This type of audit enables the auditor to identify any instances of illegal or improper transactions.

27. Expenditure on activities
From Policy to Outcomes:
The Budget Cycle
Process
Product
Process
Product
Process
Product
Policy formulation
Policy statement
Budget compilation
Outcomes
Expenditure on activities
Budget
Revenue collection
At this stage it might be good to go back to the earlier slide, depicting the various processes and outputs of the annual budget cycle, and quickly summarize the process as a whole.

28. References for Good Practices
Public Financial Management Open Budget Index