Public Expenditure and Public Expenditure and Financial ManagementFinancial ManagementOverview of Issues and Overview of Issues and

ApproachesApproaches

Bill Dorotinsky, Bill Dorotinsky,

PREM public sector PREM public sector

governance groupgovernance group PEAM CourseMay 2, 2006

22

OutlineOutline

Framework for ReviewFramework for Review Approaches to PEM reviewApproaches to PEM review

Budget CycleBudget Cycle FormulationFormulation ExecutionExecution

PFM SystemPFM System PFM FunctionsPFM Functions Outcomes/ImpactOutcomes/Impact

Common ProblemsCommon Problems Common SolutionsCommon Solutions Measuring PFM SystemsMeasuring PFM Systems

33

Three Objectives of Public Three Objectives of Public Expenditure Management SystemsExpenditure Management Systems

Macrofiscal discipline and stabilityMacrofiscal discipline and stability Support economic growth and stability (and reduce Support economic growth and stability (and reduce

poverty)poverty) Avoid public finance crisesAvoid public finance crises

Strategic allocation of resourcesStrategic allocation of resources Match government policy with programs, objectivesMatch government policy with programs, objectives

And assure social safety nets, and promote growthAnd assure social safety nets, and promote growth Technical efficiencyTechnical efficiency

Getting the most from each zloty spentGetting the most from each zloty spent And just delivering core servicesAnd just delivering core services

Framework

44

Basic principles of PEMBasic principles of PEM

ComprehensivenessComprehensiveness include all revenue and expenditure, all agenciesinclude all revenue and expenditure, all agencies

AccuracyAccuracy record actual transactions and flowsrecord actual transactions and flows

  AnnualityAnnuality cover a defined period of time (e.g. one year budget, cover a defined period of time (e.g. one year budget,

multi-year forecasts)multi-year forecasts) AuthoritativenessAuthoritativeness

only spend as authorized by lawonly spend as authorized by law TransparencyTransparency

information on spending is public, timely, understandableinformation on spending is public, timely, understandable

Framework

55

What institutions to What institutions to review?review?

Formal and Informal RulesFormal and Informal Rules Laws and regulationsLaws and regulations

Constitutions , fiscal, budget, procurement, civil Constitutions , fiscal, budget, procurement, civil service, special funds, sector laws, public service, special funds, sector laws, public enterprises, mandatory spendingenterprises, mandatory spending

ProcessProcess PolicyPolicy PlanningPlanning Financial/resource managementFinancial/resource management

Organizations and their rolesOrganizations and their roles InformationInformation

66

Approaches to PEM ReviewApproaches to PEM Review

Cycle, ProcessCycle, Process SystemSystem

broad scopebroad scope organizationsorganizations

Functions/tasksFunctions/tasks Outcomes/ImpactOutcomes/Impact

77

Planningsystem

Medium termplans, e.g. three

year rolling plans

Annual budgetsDevelopment,recurrent and

revenue

Fund releaseprocedure, e.g...

warranting

Accounting forrevenue andexpenditure

Public expenditurereview Institutions

Reports andfinancial statements

Audit system

Project monitoring

Projectappraisal

Resourceallocation

Liquidity

managem

ent

Expen

ditur

e

contr

ol

Monitoring

& controlling

Post eventreview

Accountability

Expenditurereview

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 CycleExpenditure Management Cycle

88

Budget FormulationBudget Formulation

Issues are typically aboutIssues are typically about ProcessProcess Quality of EngagementQuality of Engagement

99

Process IssuesProcess Issues ““Due process”Due process”

Fair hearing for proposals, requests within governmentFair hearing for proposals, requests within government CoherenceCoherence

Budget process is planning processBudget process is planning process Planning within resource constraintsPlanning within resource constraints

Indicative ceilings for budget offered early in the processIndicative ceilings for budget offered early in the process ‘‘hard budget constraint’hard budget constraint’

Changing incentivesChanging incentives ComprehensivenessComprehensiveness

Capital, all revenues and expensesCapital, all revenues and expenses Civil society participationCivil society participation

‘‘decentralized’ impact analysisdecentralized’ impact analysis Legislative stageLegislative stage In executive via white papersIn executive via white papers

1010

Process (continued)Process (continued) Proper decision sequence for coherent Proper decision sequence for coherent

processprocess Macrofiscal, revenues, expendituresMacrofiscal, revenues, expenditures SectoralSectoral Administrative/program/projectAdministrative/program/project

Accountability: Link resources with management responsibilityAccountability: Link resources with management responsibility

ScheduleSchedule Budget calendar issuedBudget calendar issued Sufficient time for sound proposalsSufficient time for sound proposals

MinistriesMinistries Budget office analysisBudget office analysis Legislative reviewLegislative review

Two stage processTwo stage process

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Quality IssuesQuality Issues (improving process outcome)(improving process outcome)

Multi-year perspectiveMulti-year perspective Setting multi-year policy objectivesSetting multi-year policy objectives Conservative economic, revenue forecastConservative economic, revenue forecast

Likely versus ‘hoped for’Likely versus ‘hoped for’ Benchmarked against non-governmental forecastsBenchmarked against non-governmental forecasts

Realistic expenditure forecastRealistic expenditure forecast Provision for recurring ‘unanticipated’ eventsProvision for recurring ‘unanticipated’ events

Contingency reserves – with clear rules for useContingency reserves – with clear rules for use Indicative ceilings linked to second-year of prior budget forecast Indicative ceilings linked to second-year of prior budget forecast

(policy)(policy) Requests reconciled to prior year actuals, current year estimatesRequests reconciled to prior year actuals, current year estimates

Two aggregate forecasts (advanced)Two aggregate forecasts (advanced) Proposed policyProposed policy Current services/policyCurrent services/policy

Capital and recurrentCapital and recurrent

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Quality (continued)Quality (continued) Budget ownershipBudget ownership

Early, frequent engagement of policy officials on Early, frequent engagement of policy officials on structured decisionsstructured decisions

Fiscal policy paper to kick-off processFiscal policy paper to kick-off process Distinguish policy from recurrent revenueDistinguish policy from recurrent revenue

Proposed revenue sources versus historical trendsProposed revenue sources versus historical trends No spending allowed against proposed unless they No spending allowed against proposed unless they

materialize (grants, tax revenue)materialize (grants, tax revenue) CommunicationCommunication

Clear signals of direction, markets and agenciesClear signals of direction, markets and agencies Prepare public for change – sustainable Prepare public for change – sustainable

adjustmentadjustment

1313

Quality (continued)Quality (continued)

Budget InformationBudget Information Prior year actual, current year estimate, budget year Prior year actual, current year estimate, budget year

+2, Staffing, Outputs+2, Staffing, Outputs Classification: economic, administrative, functional, Classification: economic, administrative, functional,

programprogram Requests distinguish between on-going, new Requests distinguish between on-going, new

spending; mandatory, discretionaryspending; mandatory, discretionary

Decision papersDecision papers Basis for Minister of Finance, Gov’t decisionBasis for Minister of Finance, Gov’t decision Pulls together academic, audit, performance, Pulls together academic, audit, performance,

evaluation of prior years financial performance, other evaluation of prior years financial performance, other informationinformation

1414

Why is budget execution Why is budget execution important?important?

0.0

50.0

100.0

150.0

200.0

250.0

300.0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Credibility of the Honduran Budget – In-year Deviations by Agency (percent of the executed over the approved budget)

1515

What is budget execution?What is budget execution?

Processes and institutions to Processes and institutions to implement the budgetimplement the budget

Incentives – principle-agent problemIncentives – principle-agent problem Reflects that budget is NOT only an Reflects that budget is NOT only an

accounting documentaccounting document also a political documentalso a political document Planning/steering devicePlanning/steering device

1616

Objectives of budget Objectives of budget executionexecution Manage Spending and Revenues to budgetManage Spending and Revenues to budget

support choices of elected officialssupport choices of elected officials allow budget to be planning and steering toolallow budget to be planning and steering tool promote macrofiscal disciplinepromote macrofiscal discipline Reduce opportunities for corruptionReduce opportunities for corruption

Enable program implementationEnable program implementation Assure resources flow to programsAssure resources flow to programs allow budget to be aid to operational efficiency through allow budget to be aid to operational efficiency through

spending unit advance planning, efficient administrationspending unit advance planning, efficient administration enable program managers to achieve objectiveenable program managers to achieve objective

1717

General Phases of ExecutionGeneral Phases of Execution

Phase 1: AllocationPhase 1: Allocation Phase 2: Ministry Spending PlansPhase 2: Ministry Spending Plans

link actions with finances; cash flow link actions with finances; cash flow needsneeds

Phase 3: CommitmentsPhase 3: Commitments Phase 4: VerificationPhase 4: Verification Phase 5: Liquidation of Financial Phase 5: Liquidation of Financial

Obligation Obligation

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Supplemen-tary budgets

Budgettransfers

(virements)

Purchaseorderissued

Invoicefrom

supplierPayment

Mediumterm

financialplan

Expenditurewarranted

Annualbudget

Time

Financial planning and budget systemFund control

systemCommitmentaccounting

Accrualaccounting Cash accounting

Phases of ExecutionPhases 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.

1919

Budget and Policy Execution System in Hungary Budget and Policy Execution System in Hungary (1999)(1999)

System

2020

Public Finance FunctionsPublic Finance Functions

MacroeconomicForecasting

Budget Formulation

Budget Execution

TreasuryRevenue Administration

Debt Management

Financial Market

RegulationProcurement

Administration

Internal Audit

Financial Asset Management

Financial Investigations

Lottery & Gambling

Fiscal Policy

Core Functions

Non-core Functions

ProcurementPolicy

2121

- Macroforecasting- Fiscal Policy- Revenue administration- Debt Management

Core Tasks and Core Tasks and OrganizationsOrganizations

Ministry of Finance

Treasury

SpendingMinistry

Spending Unit

- Budget Allocations- Supplemental Budgets- Virements- In-year monitoring and correction

- Warrants (cash allocations)- Cash Flow Management (forecasting, planning, sequestration)- debt management- financial asset management- accounting (policy, system management, chart of accounts)- make payments- collect revenues- account management and reconciliation- Central Bank relations

- 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

2222

Common PEM problemsCommon PEM problems Weak links between planning, policy, resource limits, and budgetsWeak links between planning, policy, resource limits, and budgets

failure to achieve strategic objectivesfailure to achieve strategic objectives abstract planning, unrelated to ways and meansabstract planning, unrelated to ways and means

Annual focus leads to suboptimal choicesAnnual focus leads to suboptimal choices Digging a hole; inability to climb outDigging a hole; inability to climb out Complacency today, unaware of crisis tomorrowComplacency today, unaware of crisis tomorrow

Separation between capital and recurrent budgetsSeparation between capital and recurrent budgets Lower than expected returns to capitalLower than expected returns to capital

Non-comprehensive budgetNon-comprehensive budget Using other means to support favored programsUsing other means to support favored programs Revenues not captured in budgetRevenues not captured in budget

Taking piecemeal decisions without reference to over-all effectTaking piecemeal decisions without reference to over-all effect Funds don’t reach intended beneficiariesFunds don’t reach intended beneficiaries

Budget executed differently than approvedBudget executed differently than approved Goods and services not delivered as plannedGoods and services not delivered as planned

2323

Common ReformsCommon Reforms MTEFMTEF TreasuryTreasury

IFMISIFMIS Performance BudgetingPerformance Budgeting ‘‘Fragmentation’Fragmentation’

Procurement, DebtProcurement, Debt New Public ManagementNew Public Management Deconcentration, decentralizationDeconcentration, decentralization Administrative & Civil ServiceAdministrative & Civil Service

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Measuring PFM SystemsMeasuring PFM Systems

Field of PFM has evolved recently, moving Field of PFM has evolved recently, moving towards more assessment standardizationtowards more assessment standardization

New set of PFM indicators to monitor New set of PFM indicators to monitor quality of PFM system at high-levelquality of PFM system at high-level See See www.pefa.orgwww.pefa.org

Recommended with approach to working Recommended with approach to working with countrieswith countries Country-led reform agendaCountry-led reform agenda Donor coordination around agendaDonor coordination around agenda Shared information pool – common PEFA Shared information pool – common PEFA

frameworkframework

2525

PFM PEFA IndicatorsPFM PEFA Indicators

Budget Execution

Accounting and Reporting

Budget Formulation

External Audit and Oversight

1. Aggregate expenditure out-turn2. Composition of expenditure out-turn3. 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 collection16. Predictability of funds for commitment17. Recording/management of cash, debt

and guarantees18. Effectiveness of payroll controls

19. Competition, value for money and controls in procurement

20. Effectiveness of internal controls21. 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 information7. unreported government operations8. Transparency of inter-governmental fiscal relations9. Oversight of aggregate fiscal risk10. Public access to key fiscal information

Cross-cutting Indicators

2626

General ReferencesGeneral References SIGMA Policy Brief No. 1: Anatomy of the Expenditure Budget (1997) SIGMA Policy Brief No. 1: Anatomy of the Expenditure Budget (1997)

OECDOECD Managing Government ExpenditureManaging Government Expenditure. Schiavo-Compo and Tommasi. . Schiavo-Compo and Tommasi.

Asian Development Bank. 1999Asian Development Bank. 1999 Government Budgeting and Expenditure Controls, Theory and PracticeGovernment Budgeting and Expenditure Controls, Theory and Practice. .

Premchand. IMF. 1993Premchand. IMF. 1993 Public Expenditure ManagementPublic Expenditure Management. IMF. 1993. . IMF. 1993. Treasury Reference Model (Bank PE website)Treasury Reference Model (Bank PE website) A Contemporary Approach to Public Expenditure ManagementA Contemporary Approach to Public Expenditure Management. Schick, . Schick,

Allen. World Bank Institute. 1999. Allen. World Bank Institute. 1999. Public Expenditure HandbookPublic Expenditure Handbook. World Bank, 1998.. World Bank, 1998. Managing Public Expenditure: A Reference Book for Transition Managing Public Expenditure: A Reference Book for Transition

CountriesCountries. Richard Allen and Daniel Tommasi, Eds. OECD. Paris, 2001.. Richard Allen and Daniel Tommasi, Eds. OECD. Paris, 2001. Public Financial Management Performance Measurement FrameworkPublic Financial Management Performance Measurement Framework. .

PEFA. Washington, D.C. June 2005.PEFA. Washington, D.C. June 2005.

See See www.pefa.orgwww.pefa.org for PEFA Performance Measurement Framework for PEFA Performance Measurement Framework

2727

Application: Rules and Application: Rules and IncentivesIncentives

Budget ImpasseBudget Impasse Executive-legislative relationsExecutive-legislative relations

What rules might govern a budget What rules might govern a budget impasse?impasse?

How might they effect incentives How might they effect incentives between the legislature and executive?between the legislature and executive?

What might be important What might be important considerations for designing a rule?considerations for designing a rule?

2828

Rules and OutcomesRules and Outcomes

Table 2: Provisions for spending in the event no budget is enacted prior to the fiscal year, by system of government Non-OECD OECD Presidential

(8) Parliamentary

(5) Presidential

(3) Parliamentary

(23) Executive’s budget takes effect

38 % 20 % - 17 %

Previous year’s budget takes effect

50 % 80 % - 26 %

Legislature must vote other measures

- - 33 % 39 %

Executive falls, new elections held

- - - 4 %

Other (including no provisions)

12 % - 66 % 13 %

Source: World Bank – OECD budget procedures database at http://ocde/dyndns.org/

Application

2929

Informal RulesInformal RulesDominican Republic Budget Deviation, 1996-2000

Identifying sources of weakness for further investigation

Identifying incentives at work

0%

100%

200%

300%

400%

500%

600%

Congreso

Nac

ional

Presi

denci

a

Fuerza

s Arm

adas

Relac

iones

Ext

erio

res

Finan

zas

Deporte

s

Trab

ajo

Agricultu

ra

Indust

ria y

Com

erci

o

Turis

mo

Poder J

udicia

l

Junta

Cen

tral E

lect

oral

Source: Dominican Republic PER 2003, background data

Application

3030

Dominican RepublicDominican Republic

1979-86 1987-96 1997-2000Partido del Presidente PRD PRSC PLDPresidencia de la República 2.09 7.35 2.53 Interior y Policía 1.06 1.00 1.06 Fuerzas Armadas 1.06 0.86 0.97 Finanzas 1.94 0.54 1.06 Secretaría de Estado de Educación y Cultura 0.96 0.86 0.95 Salud Pública 0.87 0.68 0.78 Agricultura 0.82 0.35 0.76 Obras Públicas 0.98 0.44 0.88 Otros 1.19 1.13 1.08

Budget Deviation (ratio of executed to approved budget)

Identifying trends for transparency

Source: Dominican Republic PER 2003, background data

Application

3131

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 execution Low public pay

WHY?

WHY?

And what can be done about it?

ExploringExploringproblemsproblems