PUBLIC EXPENDITURE IN THE CIS -7

Transcription

1 PUBLIC EXPENDITURE IN THE CIS -7 Mary Betley, Mokoro, UK The paper was prepared for the Lucerne Conference of the CIS-7 Initiative, January 20-22, 2003 The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations or to members of its Board of Executive Directors and the countries they represent. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgement on the legal status of any territory or the endorsement or acceptance of such boundaries.

2 Contents Executive Summary... iv 1. Introduction CIS7 Public Expenditure Context... 2 Introduction... 2 Overview of Public Expenditure Context in the CIS Overview of Fiscal Adjustment Experiences and Public Expenditure Management of the CIS Analysis of Budget Trends in CIS Introduction...12 CIS7 Budgetary Allocations by Sector and Economic Classifications...12 Targeting Budgets to Govenrment Policies...17 Institutional Constraints to Better Targeting of Expenditures - CIS Effectiveness of Budgetary Outcomes in CIS Introduction...24 Comparative Analysis of Budget Deviations...24 Impact of Budget Execution Systems on Good Budgetary Outcomes Future Directions for Public Expenditure Management Reform...31 Introduction...31 Future Reform Directions...32 Annex A Assessment of CIS7 Against Code of Good Practices on Fiscal Transparency...37 Annex B Statistical Appendix...41 Bibliography...50 ii

3 List of Tables Table 2.1: Public Expenditure Levels in CIS Table 3.1: Comparison of Per Capita Planned Spending By Sector (Function), Table 4.1: Comparison of Planned and Actual Budgetary Outcomes By Sector (Function), Table 4.2: Deviations in Economic Items between Original Budget & Actual Outturns for CIS7..28 List of Figures Figure 2.1: Public Spending & Per Capita Income in European/Central Asian Countries, Figure 2.2: Adjustment in Public Spending, Selected CIS, Figure 3.1: Planned Spending by Sector, Figure 3.2: Total Budgetary Spending, Figure 3.3: Bu dgetary Spending on Social Services, Figure 3.4: Budgetary Spending by Economic Item, Figure 3.5: Operations and Maintenance Budgetary Spending, Figure 3.6: Moldova: Breakdown of General Government Expenditure by Type, Figure 4.1: Georgia: Sectoral Budget Deviations, List of Boxes Box 2.1: Overview of Public Expenditure Systems in CIS Box 2.2: Overview of Reforms in Public Expenditure Systems, CIS7, Box 3.1: Expenditure Implications of Medium-Term Policy Measures, Kyrgyz Republic...19 Box 3.2: The Problem with Norms...21 Box 4.1: Kyrgyz Republic: Budget Deviations Largest Budget Users (2001)...27 iii

4 Abbreviations and Acronyms CEE CIS7 ECA FMIS GDP GFS IMF iprsp KR MTBF OECD PEM PER PIP PRGF PRSP SISF WB Central and Eastern European region Commonwealth of Independent States -7 (Armenia, Azerbaijan, Georgia, Kyrgyz Republic, Moldova, Tajikistan, Uzbekistan) Eastern Europe and Central Asia region Financial Management Information System Gross Domestic Product Government Finance Statistics (IMF) International Monetary Fund Interim Poverty Reduction Strategy Paper Kyrgyz Republic Medium Term Budget Framework Organisation of Economic Co-operation and Development Public Expenditure Management Public Expend iture Review Public Investment Programme Poverty Reduction and Growth Facility (IMF programme) Poverty Reduction Strategy Paper Social Insurance State Fund (Armenia) World Bank

5 Executive Summary 1. The CIS7 were amongst the poorest and least developed of the republics in the former Soviet Union. Following independence, as a result of the collapse of traditional markets, disruptions in trade and transport routes, the loss of budget subsidies and civil war, these countries suffered huge economic losses, resulting in economic declines by 20-60% of their GDPs by the mid-1990s. Following the extent of these economic shocks, economic recovery began in the mid -1990s, with positive growth rates recorded, particularly in countries not invo lved in continuing civil conflicts. The recovery in these countries was interrupted by the Russian crisis of 1998, but recovery of the Russian economy enabled growth rates in the CIS7 to begin to pick up again in Nonetheless, real output was still as low as 36% (for Georgia) of pre-independence levels by Substantial fiscal adjustment took place within the context of stabilisation programmes instituted by CIS7 governments in the early to mid-1990s. Fiscal adjustment involved redefining the role of government (away being the direct producer of goods and services to providing social benefits, investing in and maintaining economic infrastructure and providing a legislative and regulatory framework for private sector activity) and instituting significant cuts in the level of government spending as well as increasing revenue mobilisation. 3. Aggregate spending as a share of GDP was reduced, in many cases to very low levels (Figure 1). Subsidies to enterprises and capital investment were reduced sharply declined, whilst transfers to the population, in the form of social benefits, increased in importance. Nonetheless, implicit subsidies to enterprises and the public remain, particularly in energy. Figure 1: Adjustment in Public Spending, Selected CIS, Tajikistan Georgia Azerbaijan Armenia Kyrgyz Republic US dollars Share of GDP Moldova Russia Ukraine Percent 4. The consequences of this sharp fiscal adjustment on the CIS7 include: Low per capita incomes, greater poverty and higher inequality. Poverty in most CIS7 countries has risen to the point where those living under the (official) poverty line are as high as 80% of the total population in Tajikistan. Increasing debt burden, particularly in Georgia, Kyrgyz Republic and Tajikistan. The former two have reached agreements with the Paris Club on debt restructuring. Nonetheless, excessive fiscal deficits and large debt burdens result in high debt servicing costs, which reduce the amount of discretion budgetary resources able to be used for the provision of essential public services. v

6 Low social sector public spending by international standards and in comparison with countries in Eastern Europe and Central Asia. Assessment of Budgetary Allocations 5. Per capita spending by CIS7 governments range from less than US$25 for Tajikistan to nearly $140 for Azerbaijan (Figure 2). In terms of GDP, public expenditure ranges from 15% to 33% (Figure 3). Average public expenditure in the CIS7 in relation to GDP (at 22.6%) is below the average for the CIS and countries in Eastern Europe and Central Asia but similar to levels for Latin America and East Asia. 1 Generally, public spending as a share of national income rises with increases in per capita GDP. Therefore it is not surprising to find that the majority of the CIS7 have relatively low public expenditure shares. Some countries, particularly Kyrgyz Republic, Moldova, and Uzbekistan, have public expenditure levels which are higher than would be expected from an analysis of spending and income in Eastern Europe and Central Asia 2 ; in these countries, one also tends to find a relatively higher fiscal deficit. Figure 2: Per Capita Public Expenditure across CIS7 (2000) Azerbaijan Armenia Georgia Moldova Kyrgyz Republic Uzbekistan Tajikistan US$ 1 While conceptually it is difficult to ascertain whether a particular level of spending is adequate or not, international comparisons with countries within the same region and countries with similar per-capita income levels can provide a useful point of reference. However, it is important that, when making comparisons amongst countries, comparative countries are pursuing broadly similar policy directions. 2 See Figure 1.1 in the draft version of Public Expenditure Review: Fiscal Policies for Growth and Poverty Reduction, World Bank, vi

7 Figure 3: Public Spending as Share of GDP % of GDP 35 Per Capita GDP (US$) Public Spending/GDP Per capita GDP Armenia Azerbaijan Georgia Kyrgyz Republic Moldova Tajikistan Uzbekistan 6. In all CIS7, fiscal adjustments have been felt more strongly on health and education, with the level of public expenditures suffering most in these sectors (Figure 4). This is having an adverse impact on the poor, particularly their access to these services. Given that in many CIS7 health and education represent the bulk of resources managed by local governments, there is also the need to ensure appropriate coordination between social sector reforms and adjustments to inter-governmental finance. Figure 4: Budgetary Spending on Social Services, % of Total Budget Armenia Azerbaijan Georgia Kyrgyz Republic Moldova Tajikistan Uzbekistan 7. The structure of budgets for the majority of CIS7 is distorted and inhibits the implementation of sectoral reform. Wages, transfers to the population, and debt-servicing represent the majority of expenditures, displacing funds necessary for adequate operations and maintenance. Increasing debt servicing payments have an adverse impact on the availability of discretionary expenditures for the provision of key public services, such as social services. 8. The budget preparation process should cover all government expenditures, ensure consistency of budgeted expenditures with a realistic medium-term macro-fiscal framework, and prioritise spending according to Government policies and its reform programme. However, up to one-third of total public expenditures in the CIS7 are outside of the budget prioritisation process, including extra-budgetary funds, externally -financed project expenditures, and quasi-fiscal deficits. vii

8 9. Expenditure allocations tend to be based largely on the updating of allocations from previous budgets, rather than on explicit prioritisations. The under-funding of services and the lack of expenditure prioritisation have led to expenditure compression during budget execution and have delayed the adjustment of the composition of spending to the priorities of a market economy. Assessment of Budgetary Outcomes 10. Sound expenditure management requires the budget to be implemented as planned, with transparent and efficient adjustment to new developments during the year. However, the analysis in this paper shows that differences between budget plans and actual budgetary outcomes further distort Governments intentions to link budgets to policies. 11. Actual outcomes differ significantly from budget plans, both overall and between sectors (Figure 5). Some countries, particularly Georgia, suffer from budget volatility more than others. The analysis also showed that Governments do successfully protect protected economic items (e.g. wages) from budget cuts. Social sectors are often victims of significant budgetary cuts when revenues are less than expected. By contrast, actual expenditures on defence and public security remain relatively close to their budget plans. Figure 5: Deviation between Budget Plans and Actual Expenditures, % % Difference from Budget Plan -5% -10% -15% -20% Armenia Georgia Kyrgyz Republic Moldova 12. Poor budgetary outcomes, compared with budget plans, are the result of: Macroeconomic shocks, leading to reductions in expected budget revenues and thereby requiring cuts in budget expenditures to meet agreed deficit targets. The effect of such shocks was illustrated by the Russian crisis of Unrealistic, often politically driven, revenue projections, which inevitably require expenditure cuts during the year. Volatile revenue flows, both of domestic revenue (due to political and governance factors) and receipt of foreign donor financing. Poor cash flow management, which results in unpredictable cash releases. This lead to cashrationing expenditures. Institutional weaknesses in budget planning such that planned budgets are not credible and do not provide an adequate framework for strategic allocation of public resources. In the absence of a strategic framework, governments concentrate on protecting certain budget items as a way of reducing the build -up of arrears on these items; however, arrears can be built up instead on non-protected items. viii

9 Budget control systems are not fully effective in cash management, as evidenced by cash rationing and the build -up of payment arrears. They lack capacity to generate timely, comprehensive and reliable fiscal data. Improving Public Expenditure Management 13. Governments in the CIS7 have been relatively more successful in strengthening fiscal discipline than in ensuring that public expenditures conform to strategic priorities and are efficiently utilised. Expenditure allocation decisions across and within sectors do not yet reflect Government priorities. Expenditure cuts necessitated by shortfalls in revenue and increasing debt service payments are made across-the-board, falling most heavily on unprotected items. Within the social sectors, inadequate attention is paid to the relative contribution and effectiveness of different programmes in terms of alleviating poverty, with social protection expenditures which target the poor and primary education and health care receiving insufficient priority and shares of the budget allocations. 14. Future public expenditure reforms in the CIS7 should involve phasing out remaining subsidies, particularly in the energy sector, and increasing overall allocations for, and the efficiency of use of expenditures in, social sector programmes, focussed on appropriate targeting and poverty reduction. The efficiency of overall government spending and its targeting towards Government priority areas should be improved. 15. The establishment of appropriate institutional arrangements for sound expenditure management is a key component of the fiscal reform effort for the CIS7. In particular, effective systems for public expenditure management play a central role in the realisation of national poverty reduction strategies. National poverty reduction strategies are dependent for their success on effective public expenditure planning and management; at the same time, good public expenditure management should provide the resource framework to guide the preparation and implementation of poverty reduction strategies. 16. There is a need to ensure that the budget preparation process improves the link with Governments policies and captures Governments actual public spending intentions. The majority of the institutional weaknesses on budgetary planning highlighted the need for a more strategic approach to public expenditure planning which is forward looking and links overall medium-term budgetary resource allocations with sector policies and planned expenditure programmes. A number of governments in the region are introducing (Armenia, Kyrgyz Republic and Moldova), or planning to introduce (Azerbaijan, Georgia, Tajikistan, and Uzbekistan), a strategic phase to the budget in the form of a medium-term budget framework (MTBF). If introduced appropriately, this would address issues of the current short -term nature of budget decision -making, budget comprehensiveness, budget transparency, and the current absence of a mechanism to link budgets to the Government s reform programme. 17. At the same time, Ministries of Finance should ensure that expenditure plans and sector ministry prioritisation of expenditures are executed without excessive variations. Key recommendations for improving budget outcomes and ensuring that the budget that is approved is implemented in practice include: Improve the quality of revenue estimation as the basis for more realistic expenditure allocations. Work to improve cash planning skills for staff involved in cash management. Based on realistic monthly and quarterly cash plans for budget execution as prepared by the Ministry of Finance, sector ministries should be required to prioritise their monthly discretionary expenditures within the available cash limits. Improve control of commitments made by budgetary institutions to avoid payment arrears. All sector ministries and budgetary institutions should be required to register their commitments above a certain level. Improve the analytical content of financial management information provided to policymakers. ix

10 1. Introduction 1.1 All CIS7 countries underwent a very difficult economic transition during the 1990s, with GDP contracting sharply; in the most dramatic case, Georgia s GDP dropped by 80% between 1991 and The majority of this transition was borne by the public sector, with public expend itures declining by an average of nearly 90% in dollar terms over the decade as governments cut public expenditures, particularly investment, eliminated subsidies and in general substantially downsized the government sector. Accompanying this drop in economic output has been a significant rise in poverty in all of the CIS Hence, in comparison with other Eastern European and Central Asian countries, the countries comprising the CIS7 are characterised by low revenues and public spending in relation to GDP, relatively low per capita GDP, relatively higher levels of donor financing on concessional terms, and particularly sharp fiscal adjustment. 1.3 Growth and poverty reduction efforts in the CIS7 depend crucially on sound management of scarce public resources. In an effort to improve the effectiveness of their much-reduced levels of public expenditures, several CIS7 governments have begun restructuring their public expenditure management systems, including changes to budget legislation, the presentation and coverage of its budget, budget preparation processes, Treasury system and overall budget execution, procurement system and internal and external audit systems. 1.4 Despite these reforms, efficient public expenditure outcomes remain constrained by: (i) inter-secto ral budget allocations which are inconsistent with stated policy priorities; (ii) intra -sectoral budget allocations which are derived from input-based norms and thus do not meet policy reform requirements; (iii) inappropriate input mix, particularly between salaries and operations and maintenance expenditures; (iv) significant in -year, often ad hoc, changes to budgets; (v) budget outturns that differ significantly both from stated policy priorities and budget plans; and (vi) the build -up of expenditure arrears. Poor budgetary outcomes can be traced to a large degree to weaknesses in the institutional framework for public expenditure management, exacerbated by difficult economic conditions and poor governance. 1.5 This paper provides a comprehensive analysis of public expenditures across the CIS7, both planned and actual outturns. It reviews how well the governments of the CIS7 allocate their scarce budgetary resources in relation to government policy priorities, as well as how effective are these governments in executing their plans. Specifically, the analysis and assessment of public expenditures in the CIS7 in this paper covers: 3 a discussion of the public expenditure context for the CIS7 (Section 2); analyses of how well budget plans conform to Government policy priorities and the consequences of weak linkages (Section 3); analyses of how close actual budgetary outcomes are to planned expenditures and institutional reasons for significant differences (Section 4); and future reform directions for the CIS7 (Section 5). 1.6 Two annexes contain, respectively, an assessment of the CIS7 against the Code of Good Practices on Fiscal Transparency (Annex A) and a Statistical Appendix (Annex B). 3 This paper will not address issues concerning revenue generation, tax policy, accounting systems, internal and external audit and procurement, as these are either being addressed in other papers or beyond the scope of the paper. 1

11 2. CIS7 Public Expenditure Context Introduction 2.1 The paper begins with an examination of the public expenditure context of the CIS7 countries. It provides background data on the aggregate level of public expenditure for each of the CIS7 and an overview of the characteristics of the public expenditure management systems in these countries. Overview of Public Expenditure Context in the CIS7 2.2 An analysis of public expenditure spending across the CIS7 reveals a wide disparity in expenditures in relation to national income (Table 2.1 and Figure 2.1). Public spending as a share of GDP ranges from around 15% in Tajikistan to 33% in Uzbekistan, with the average across the CIS7 standing at around 25% in In per capita terms, public expenditure levels range from just under US$25 in Tajikistan to nearly US$150 in Armenia. In relation to national income, Moldova, Uzbekistan and to a lesser extent Kyrgyz Republic have relatively higher public expenditure levels than the other CIS7. These differences may be mainly attributed to: (i) difficulties in revenue collections (Georgia and Tajikistan); (ii) differences in the degree of overall spending in excluded categories, such as externally-financed project expenditures, and in the degree of inclusion of extra-budgetary fund expenditures and local budgets; and (iii) the slower rate of implementation of economic reform, which would tend to be associated with a larger quantity of budget subsidies to public -sector enterprises. Table 2.1: Public Expenditure Levels in CIS7 1 % of GDP Armenia Azerbaijan Georgia N/a Kyrgyz Republic Moldova Tajikistan Uzbekistan Per Capita US$ Armenia Azerbaijan Georgia N/a Kyrgyz Republic Moldova Tajikistan Uzbekistan Notes: Source: 1. Data exclude external project expenditure (except KR) and public enterprises. Data include: Armenia consolidated accounts of Republican, and local budgets; Azerbaijan all levels of government except municipalities and all extra-budgetary funds, including Oil Fund; Georgia consolidated state, municipality and extra-budgetary funds; KR consolidated state, municipalities and extra budgetary funds; Moldova consolidated state, municipality and extra-budgetary funds; Tajikistan excludes budgetary transfers to extra-budgetary funds; Uzbekistan includes extra-budgetary funds but excludes local budgets. 2. Data are distorted by the fact that official population figures until 2001 did not exclude those who had emigrated. 3. Data include externally-financed Public Investment Programme. IMF, World Bank, EBRD 2

12 Figure 2.1: Public Spending and Per Capita Income in Selected European and Central Asian Countries, Total expenditure (as share of GDP) KR KR Tajikistan 12 Bosnia Belarus Bulgaria Uzbekistan Yugoslavia Moldova Ukraine Russia Romania Macedonia Albania Armenia Azerbaijan Georgia Kazakhstan GNI per capita Athlas method (current US$) Sources: IMF; World Development Indicators, World Bank staff calculations. 2.3 As CIS7 countries have restructured their economies, the share of public expenditure in national income has fallen over time 5. This was in response to the much smaller resource framework resulting from the strict macro adjustment undertaken by these countries. As they squeezed their spending in order to fit within the much reduced budget envelope, budget expenditures have fallen dramatically: price subsidies and subsidies to state-owned enterprises have been reduced or eliminated, large public sector investment programmes, particularly in the infrastructure sectors, have been slashed, a contraction in the public sector through privatisation and the beginnings of a reduction in wider public sector employment, with reforms e.g. in the health sector, and the provision of some services, e.g. pre -school education 6, has been eliminated. At the same time, wages and operating costs 7 have declined significantly in real terms, in line with the contraction of overall public sector revenues. 2.4 Accompanying the dramatic drop-off in public resource availability has been a fundamental change in the role of the government sector in the CIS7 since independence. The role of the state sector, and thus the aim of public expenditure, has changed from one of providing all economic and social services to that of: (i) ensuring an appropriate legislative and regulatory framework for economic activity, particularly by the private sector; (ii) providing an enabling environment (e.g. through reducing unnecessary bureaucratic impediments) to facilitate a vibrant private sector to develop; and (iii) either contracting or being the direct service provider in areas in which the market fails to produce the right level of services at a socially acceptable price (e.g. pub lic health services). 2.5 The average decrease in public spending in the CIS was around 23.1 percent of GDP during the 1990s. 8 The largest reductions in expenditure as a share of GDP took place in Tajikistan, Georgia, Azerbaijan, and Armenia (Figure 2.2). 9 4 Taken from draft Kyrgyz Republic, Public Expenditure Reform: Fiscal Policies for Growth and Poverty Reduction, The blip in the share of public expenditure in GDP in 1998 and 1999 in many of the CIS7 reflects the effect of the Russian crisis in 1998 and the consequential drop in economic growth rates. 6 Although much pre-school education was provided by state-owned enterprises and was thus not part of budgetary expenditure. 7 With the exception of utility payments. 8 See Asad Alam and Mark Sundberg, A Decade of Fiscal Transition, World Bank, May The initial level of expenditure is approximated at 45 percent of GDP, as the data for the selected set of countries are not quite comparable. See Sanjeev Gupta, Luc Leruth, Luiz de Mello, and Shamit Chakavarti, Transition Economies: How Appropriate Is the Size and Scope of Government?, IMF Working Paper,

13 Tajikistan Figure 2.2: Adjustment in Public Spending, Selected CIS, Georgia Azerbaijan Armenia Kyrgyz Republic US dollars Share of GDP Moldova Russia Ukraine Percent Note: The change in the spending/gdp ratio is measured as the difference between the 2000 and 1991 levels. The change in dollar spending is measured as the ratio of 2000 and 1991 spending in U.S. dollars. 10 Overview of Fiscal Adjustment Experiences and Public Expenditure Management of the CIS Box 2.1 compares the CIS7 countries in terms of characteristics of their public expenditure systems. 10 Sources: Recent Economic Developments, IMF; World Development Indicators, and World Bank staff calculations (see Kyrgyz Republic Public Expenditure Review: Fiscal Policies for Growth and Poverty Reduction, Draft, World Bank, 2002). 11 Some of the information in the following paragraphs is based on analyses from recent draft Public Expenditure Reviews conducted by the World Bank. 4

14 Box 2.1: Overview of Public Expenditure Systems in CIS7 Public Expenditure Data Public expenditure 3 (2001) US$ mn per capita (US$) as % of GDP Armenia Azerbaijan Georgia Kyrgyz Republic Moldova Tajikistan Uzbekistan % 1, % Revenues as % of GDP (2001) 15.2% 20.5% 18.0% 15.0% 23.0% 12.9% 30.0% Local gov t expend as % of total gov t exp 6.3% 17.6% 33.0% % % % of external finance in total public expend 17.1% % 25.4% Features of Budget System Budget year Jan-Dec Jan -Dec Jan-Dec Jan-Dec Jan-Dec Jan -Dec Jan-Dec Structure of budget Consolidated = Central+local+Social Insurance Fund Major players in budget preparation Principal legislation governing public expenditure Government/executive body in charge of supervising public expenditure management Ministry of Finance and Economy, (sector ministries) Law on the Budgetary System (1997) + separate Treasury Law (2001) Consolidated = Central + local + EBFs (Social Protection Fund, State Oil Fund) Ministry of Finance, Ministry of Economic Development, (sector ministries) Budget System Law (2002) % 2 Consolidated = Central+local+ EBFs (Pension Fund, Employment Fund, and Road Fund) Ministry of Finance, sector ministries Organic Budget Law % Consolidated= State (Republican + local) + Social Fund; muncip and ear-marked funds separate Ministry of Finance, sector ministries Law on the Principles of the Budget (covers Treasury), 1997 Collegio Cabinet Cabinet Government s Economic Policy Committee Notes: 1. Includes transfers from Central Government. 2. Data refer to 2000 outturns. 3. Includes expenditures of state budget, municipalities, and extra-budgetary funds. Excludes external-financed Public Investment Programme % Public Fiscal Expenditures = Consolidated + State Social Insurance Fund Ministry of Finance, Ministry of Economy, sector ministries Law on the Budgetary System (1996) % Consolidated = Central+local+Soc Protect ion Fund+Road Fund Ministry of Finance, Ministry of Economy sector ministries Law of the Principles of the Budget Structure and Budget Process (1997) 1, % Consolidated = Central + local + EBFs Ministry of Finance, Ministry of Macroeconomics and Statistics, (sector ministries) Law on the Budgetary System (2000) Cabinet Cabinet Cabinet, Oliy Majlis

15 Armenia Fiscal adjustment 2.7 The extent of Armenia s fiscal adjustment was in the middle range for the CIS7. The drop in public expenditure as a share of GDP was just over 20% between 1991 and 2000, compared to 30% for Tajikistan and around 15% for Moldova. In real terms, expenditures fell to around one-third of its 1991 level. This resulted from a simultaneous decline both in real output (more than 50%) and in the relative size of the Government. By 2000, the economy had stabilised, with stable exchange rates, a manageable level of external public debt, and reductions in the level of energy-related subsidies. Currently, total public expenditures represent around 30% of GDP. 2.8 Compared to other countries in the region, Armenia has a lower than average incidence of tax expenditures (both tax arrears and exemptions). It has also been less affected by uncontrolled growth of contingent public liabilities, including off-budget quasi-public borrowing. Non-cash payment schemes are not widespread (as they are in the Kyrgyz Republic, for example). However, the fiscal situation is vulnerable to swings in revenue collections, with the situation in deteriorating, following the domestic political crisis and the Russian financial crisis. Improvements in revenue collection are important to maintain fiscal stability and reduce arrears. 2.9 The consolidated fiscal deficit has been reduced in recent years but has fluctuated between 5 and 8% of GDP over the past 5 years. Recent improvements in tax collections (due to strengthened tax administration and changes to the tax code) would need to be sustained to keep the fiscal deficit down to its medium-term level of around 3.5% of GDP. Nonetheless, with an official GDP per capita of around US$700, approximately 55% of Armenia s population is below the poverty line. Features of public expenditure management system 2.10 The budgetary system of the Republic of Armenia consists of the Central Government, local governments and the Social Insurance State Fund (SISF) 12 (known collectively as the consolidated budget). The legislative basis of the budgetary process comprises the Law on the Budgetary System adopted in 1997 and the Treasury Law adopted in The majority of consolidated fiscal transactions is concentrated in the Central Government budget (accounting for around 65% of total expenditures). Local governments have limited revenue capacity 13 ; thus the share of local governments expenditure in the structure of consolidated expenditure is very small. External finance is particularly important in supporting public investment. Azerbaijan Fiscal adjustment 2.11 Expenditure cuts were much more dramatic in Azerbaijan than for other CIS countries, with public expenditure more than halving in relation to GDP and currently representing approximately 22% of GDP. Stabilisation was achieved through a stringent fiscal control program, supported by restrictive monetary policies, together with structural reforms designed to accelerate the progress toward a marketdriven economy. Macroeconomic stability has been restored and maintained despite some external shocks, such as the Russian financial crisis in 1998 and the large drops in oil prices in 1998 and Overall growth has been restored, with the economy growing at an annual average of more than 7 percent over the period On the fiscal side, the share of public investment in GDP fell sharply as did the share of health and education in GDP. Overall public expenditures showed a decline of more than 2 percent of GDP from 1995 onward. Revenue collections have increased as a share of GDP in recent years, but they continue to 12 In 1998 the Pension and Employment Fund was renamed the Social Insurance State Fund. 13 By law, only land tax and property tax revenues are recorded as revenue for the local governments. 6

16 be relatively low for the region as a whole; compared to the CIS7, however, they appear relatively high. Significant quasi-fiscal deficits in the energy sector (estimated at 14% of GDP on average between 1998 and 2001, mainly on electricity and water. Accompanying the sharp fiscal adjustment has been an increase in poverty. With a per capita GDP of just under US$700, the poverty rate is estimated at 50% in 2001 and extreme poverty at 17 percent. Features of public expenditure management system 2.13 Based on the new Budget System Law adopted in 2002, the Consolidated Budget consists of: (i) the State Budget (comprising the Central Government Budget including the State Fund for Protection of Forests and Reforestation, the State Fund for the Protection of Nature, and State Support for Entrepreneurs); (ii) Local Government Budgets and Nakchivan Autonomous Republic; and (iii) Extra- Budgetary Funds (Social Protection Fund and the State Oil Fund). Municipalities are funded separately. The State Budget is dominated by the Central Budget, which accounts for 71% of total state budgetary expenditure. Georgia Fiscal adjustment 2.14 Georgia s current public expend iture level (18.5% of GDP in 2001) is one of the lowest in the CIS. Public spending levels as a share of GDP fell by a significant amount (nearly 30%) between 1991 and 2000 and was one of the highest contractions in the CIS7 (lower only than in Tajikistan). Between 1991 and 1994, output had fallen by nearly 80 percent and government finances had broken down. The dramatic drop in incomes and the ensuing collapse in government social services led to a rapid emergence of poverty in Georgia after independence. Whilst substantial fiscal adjustment has taken place under Georgia s stabilisation program, launched in the mid-1990s and, primarily relying on expenditure cuts, fiscal sustainability has yet to be established. The Government has been unable to meet its revenue and expenditure targets and large arrears (notably on wages and pensions) have accumulated over the years. Public expenditures for maintenance and rehabilitation of basic infrastructure are negligible and those in the social sectors are among the lowest in the region. On the other hand, an increasing share of fiscal revenue is being devoted to service Georgia s large external debt. Consequently, successful Paris Club external debt restructuring followed the build-up of overall debt levels to 54% of GDP and debt servicing obligations to 28% of exports by the beginning of Georgia suffers from a relatively low revenue/gdp ratio (one of the lowest in the CIS7), particularly due to poor custom duty collections as a result of unsecured borders and areas of conflict. New revenue measures have been introduced to try to improve revenue collections, and indeed, its recent levels of revenue collections, at 15.9% of GDP in 2001, have improved considerably since 1995 and currently the country s performance is close to most CIS Georgia has been able to restore and sustain economic growth and price stability since However, at around US$600, Georgia s per-capita income is still less than 40 percent of what it was at independence. While the incidence of poverty is relatively low (23 percent of the population in 2000), it is estimated that 60 percent of the population are at risk of falling into poverty. In addition, health sector outcomes have deteriorated sharply over the past decade, while there are signs that the quality of education is rapidly declining. Moreover, the poor have suffered the most from inadequate access to social services and from crippling basic infrastructure. Features of public expenditure management system 2.17 Georgia s consolidated government budget comprises: central government, extra -budgetary funds (the pension fund, employment fund, and road fund), and local governments. In 2001, the state budget accounted for 67% of total general government spending, whilst central government accounted for 46%, with 20% for extra-budgetary funds and 33% for local government expenditures. The share of local governments has increased significantly since 1996 when it accounted for only 17% of total Government expenditures; currently, local govern ments account for 30% of public spending and are particularly 7

17 important for delivery of basic social services. There are also off-budget expenditures, known as special resources, mostly related to service fees paid to public institutions (e.g., in tertiary education). These resources do not pass through the budget, but were reported for the first time in the 2002 budget, for information purposes. These special resources account for around 2% of GDP. Kyrgyz Republic Fiscal adjustment 2.18 Public spending levels in US dollar terms fell by more than 90% between 1991 and 2000, representing one of the largest drops in the CIS7, following Tajikistan and similar to Moldova. Per capita expenditure has fallen annually since After independence, the country s GDP dropped drastically to 48 percent of its initial level by However, the Kyrgyz Republic moved early on to adopt institutions compatible with a market economy, and international donors supported these efforts with grants and loans. Consequently, expenditures dropped far less as a percentage of GDP than did revenues, which resulted in high fiscal deficits. The structure of expenditures changed in the process, with a significant increase in public investment, financed mostly by donors and geared to transportation and infrastructure. At the same time, subsidies to enterprises were sharply curtailed. The 1998 Russian crisis slowed an incipient economic recovery and the government had to undertake a drastic fiscal adjustment, which reduced expenditures from 34 percent of GDP in 1998 to 26 percent in Over the same period, the fiscal deficit was halved to 5 percent of GDP. This adjustment and tight monetary policies helped to stabilise prices and improve the macroeconomic environment, leading to economic growth rates of 5% in each of 2000 and Nevertheless, the country is still among the poorest in the world, with a per capita income of US$308 in A reduction in the PIP and Paris Club debt relief (reduction in debt servicing from US$101 million to 5.6 million) have improved the sustainability of public finances. Size of PIP is expected to be reduced from 7.1% of GDP in 2000 to 3% in Consequently, debt service payments as a % of both revenues and exports are expected to decrease after Features of public expenditure management system 2.20 The Law on the Principles of the Budget provides the overall legal framework for budgeting in the Kyrgyz Republic. It sets out the Consolidated Budget as inclusive of the State Budget (the Republican Budget and oblast and rayon budgets), as well as the Social Fund, the Public Investment Programme, the intergovernmental irrigation agreements, and a number of ear-marked funds, including a Road Fund. A system of shared and assigned taxes, together with transfers from the Republican Budget, provide the finance for local government services, including the provision of basic health and education services. A Treasury system was established in 1996, making the Kyrgyz Republic the first country within the CIS to have a functioning manual Treasury. External agencies are an important source of finance for supporting public investment. Moldova Fiscal adjustment 2.21 One of the deepest and most prolonged GDP declines among the transition economies (a cumulative decline of 65 percent between 1990 and 2000) has turned Moldova into one of the poorest countries in Europe, with more than half of the population living in absolute poverty. Social indicators have deteriorated. Along with Tajikistan, Moldova is amongst the poorest of the CIS7, with an estimated 80% of the population living on less than US$1 per day. A number of factors contributed to the poor transition outcomes experienced: unfavorable initial conditions and shocks at the outset of the transition; 14 The level of public expenditure would have been as high as 42 percent of GDP in 2001 if quasi-fiscal expenditure, off-budget transactions and extrabudgetary funds were taken into account. Similarly the fiscal deficit in 2001 would have been 4 percent of GDP higher than the consolidated deficit of the State budget, the Social Fund, and the PIP (i.e., 9 percent of GDP in total), and this is only on the account of quasi-fiscal activities in the power sector. 8

18 the poor quality of governance over the period; a partial and stop-and-go approach to reforms by Moldova s ten governments over this period; a precarious fiscal position resulting from soft fiscal policy until 1998; and a vulnerability to external shocks, culminating in the massive external shock from the 1998 regional fiscal crisis, which resulted in the need for deep and painful fiscal retrenchment Nonetheless, in GDP terms, Moldova suffered one of the lowest levels of contractions in public expenditure following independence of all the CIS7, although in dollar terms it suffered more than many of its fellow republics. At around 30% of GDP, Moldova s general government expenditures is amongst the highest as a share of national income within the CIS7 (Uzbekistan is the highest). The consolidated fiscal deficit has remained at between 4 and 6% of GDP since High external debt levels are a significant problem, with debt servicing amounting to around US$200 million in Features of public expenditure management system 2.23 Fiscal reforms are still at their early stages. Governed by the Law on the Budgetary System promulgated in 1996, Moldova s budget system consists of the State (central) Budget, local budgets and the State Social Insurance Fund. The combined State and Local Budgets comprise the Consolidated Budget. Local budgetary expenditures (including transfers from the Central Government) constitute around 25% of total State budgetary allocations. A Central Treasury has been established, efforts continue to strengthen revenue administration and collection, and attempts to launch a far-reaching fiscal decentralisation reform have been initiated. Other reforms include the introduction of a new budget classification system (conforming to GFS standards) in 1997 to strengthen the targeting and monitoring of public expenditures, and the adoption of a Law on Local Public Finance (2000) Off-budget funds, including those earmarked by specific taxes or fees corresponding to their end uses (road fund, ecology fund, and text book fund) and special funds established by budget institutions, which are financed by the extra-budgetary resources of the state budget that originated from official user charges and fees, accounted for approximately 5% of total expenditures and 3% of GDP in These resources are shown in the Budget documents. Tajikistan Fiscal adjustment 2.25 With a GDP level of US$161 per capita, Tajikistan remains the poorest of the CIS7; an estimated 83% live below the poverty line. It suffered the largest reduction in expenditure during the 1990s of any of the CIS7, measured both in dollars and as a share of GDP. Spending as a share of GDP fell by nearly 30% between 1991 and 2000, from 45% to just over 15%. The collapse in spending measured in dollar terms (a reduction of nearly 100%) was the result of civil unrest. This has had consequences on access of the poor to social services Tajikistan has the lowest revenue/gdp ratio of any of the CIS7. At the same time, high external debt restricts access to foreign investment. Fiscal sustainability and the large debt burden remain the Government s key concerns. Approximately 50% of government revenues are tied to debt service obligations. The consolidated deficit (excluding foreign-financed PIP) has remained at less than 4% of GDP since Features of public expenditure management system 2.27 The legislative basis of the budget process is governed by the Law of the Principles of the Budget Structure and Budget Process, which was promulgated in May The consolidated budget system comprises the budgets of different levels of Government (the Republic, oblasts, rayons, municipalities, and local jaomats) as well as the budgets of the Social Protection Fund and the Road Fund. Through shared and assigned taxes, each level of Government has its own revenues sources and nominal budgetary independence (with the right to modify spending plans within and across sectors), which is undermined by their reliance on transfers from the central (Republican) budget. Local gove rnments are responsible for the majority of State budgetary financing for social sector spending. However, as a result of budget shortages 9

19 (revenues account for the lowest share of GDP of all CIS7 countries), local administrations are only able to finance protected items and thus have little flexibility to affect expenditure patterns. Uzbekistan Fiscal adjustment 2.28 Uzbekistan enjoyed the smallest decline in output following independence of all of the CIS countries, owing in part to the government s ability to find new markets for its main exports of cotton and gold. With the absence of an official poverty line, the Government s proxy is those with a per capita income which is at least 1.5 times lower than the official minimum monthly wage (US$17 at the offic ial exchange rate). On this measure, approximately 14% are defined as needing social assistance. The consolidated budget deficit (excluding the PIP) has remained below 4% of GDP since The economy is not market -based, and restrictions on interest rates and exchange rates cause economic distortions. Full currency convertability is planned during Significant levels of foreign debt due to sharp deterioration in the trade balance have resulted in a high debt service burden. At 34% of GDP, current levels of public expenditure are higher than in any other CIS7 country. Relatively high levels of expenditures are spent on defence, relative to social sector spending. Limited fiscal reforms have taken place, trailing other CIS7 countries. Main reform has been the introduction of modern budget systems legislation (2000). Whilst a revised economic classification system was introduced at the end of 1999, the functional classification is not based on the GFS, making international comparisons difficult. Features of public expenditure management system 2.29 The basic legislative framework consists of the Organic Budget Law. The Consolidated Budget consists of the Central Budget, local budgets and Extra-budgetary Funds. Extra-budgetary funds included in the Consolidated Budget include: the Pension Fund, the Employment Fund, the Privatisation Fund and the Road Fund. With the exception of transfers of privatisation proceeds to finance the Central Budget, these extra -budgetary funds usually keep their resources independent of the Central Budget. Fiscal Reforms 2.30 The reform of public sector management in a number of transitional countries has been approached initially through support for reform of budget and expenditure management processes. Typically, these operations have involved three main elements: (i) the establishment of a treasury function; (ii) the reform of budget procedures; and (iii) the introduction of more strategic expenditure planning processes, involving the establishment of a realistic macroeconomic framework for the budget and the elaboration of sector expenditure strategies and reform proposals. Examples of this approach include the introduction of medium-term budget frameworks (MTBFs) in Kyrgyzstan and Moldova. Under this approach, the demand for reform of government structures and organisation arises out of the implementation of public expenditure reforms. However, experience also suggests that reform of public administration and reform public expenditure management need to be explicitly linked, if the wider process of public sector management reform is not to become stalled Reforms undertaken across the CIS7 include (Box 2.2): the introduction of a longer Budget calendar, one which gives sector ministries longer to prepare their submissions, and the Ministry of Finance more time to consider sector ministries proposals. the introduction of more comprehensive Budget presentation, including the consolidated budget picture and showing budgets by sector ministries so that appropriations may be made according to the administrative classification; Budget classification, including introducing an economic and functional classification based on the GFS and an administrative classification; 10