PUBLIC EXPENDITURE MANAGEMENT CHALLENGES IN ECA PRSP COUNTRIES Warsaw, Poland February 7-9, 2005 NOTES ON BUDGET REFORM EXPERIENCE ALBANIA

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1 PUBLIC EXPENDITURE MANAGEMENT CHALLENGES IN ECA PRSP COUNTRIES Warsaw, Poland February 7-9, 2005 NOTES ON BUDGET REFORM EXPERIENCE ALBANIA 1. What is the country s one most successful achievement in the PEM reform process, and what was the main factor contributing to that success? Perhaps the single most successful achievement to date in the PEM reform process has been the establishment and maintenance of fiscal stability over an extended period, as illustrated by Albania s key macroeconomic and fiscal indicators. This has been important in Albania s sequencing of PEM reforms which seeks three key levels of achievement: fiscal stability; strategic reallocation of resources; and economy, efficiency and effectiveness of expenditure. The establishment and maintenance of fiscal stability has made it possible to design and implement further PEM reforms based on the creation of a comprehensive and modern public finance system. In this regard, a Medium Term Budget Program (MTBP) was established in 2000, with the first full MTBP 1 cycle encompassing the years Since then the MTBP reforms have been consolidated and deepened. The tools for a strategic reallocation of resources have, therefore, largely been established and some strategic reallocation has already taken place. Much more work is required, however, before substantial further work can take place on strategic reallocation. In particular, this will require much clearer and more informative sector strategies under the framework of the National Strategy for Socio-Economic Development (NSSED). The NSSED Department is now commencing work on this as part of the Government s new Integrated Planning System. Detailed MTBP and budget preparation procedures have been developed to achieve economy, efficiency and effectiveness in public expenditure. These will be implemented from 2005 onwards as part of the Government s new Integrated Planning System. Transforming the budget formulation from an institutional presentation to a program presentation has also been an important achievement which has enabled the current reforms under the MTBP to go ahead. 1 Medium Term Expenditure Framework (MTEF).

2 Page 2 of What are the major problems that you have encountered in reforming (a) budget formulation and (b) budget execution and financial controls? (a) Budget Formulation Problems Producing reliable and realistic estimates of future resource availability to inform the establishment of MTBP expenditure ceilings, budget preparation ceilings and appropriations. Weaknesses in forecasting and unrealistic expectations of some components of the reforms process (e.g., revenue increases from improved administration) have meant that fiscal stability has often come at the price of revising down MTBP and budget preparation ceilings after line ministries have begun working with them. This has produced a credibility problem for the reform process. Line ministry capacities. Low capacity at the line ministry level has resulted in weaknesses in the preparation of MTBP and budget submissions. Line ministry expectations. The budget process in Albania over many years was incremental. This resulted in a situation where little attention was paid to budget preparation. Moreover, because line ministries were able to engage in substantial budget transfers during budget execution, there was little incentive to pay much attention to either MTBP or budget preparation. There is a great deal of unlearning to do before substantial successes will be recorded at the second and (particularly) the third levels of PEM achievement. This is being addressed partly through changes to the rules for budget transfers and through the establishment of detailed procedures for MTBF and budget preparation. Training to complement these new systems is also being carried out and a comprehensive training programme is planned. Role and status of the Budget Department in the Ministry of Finance. The Budget Department in the MoF has a low status compared with its responsibilities. As a result, it is difficult to attract and retain sufficient experienced and skilled staff to lead and manage the reform process. This is being addressed through proposals to raise its status to that of a General Directorate under the new Integrated Planning System. Confusion over the respective role of various policy, planning and budgeting tools in the PEM cycle. In addition to the MTBP, Albania has recently adopted a number of other policy/planning/budgeting tools, each of which has an important role to play in the PEM cycle. Until recently, there has been a degree of confusion over the relative role of each, however. This has resulted in line ministries being over-burdened with requests for (similar) information from central government institutions, thereby distracting their attention from and commitment to MTBP and budget preparation. This is being addressed through proposals for an Integrated Planning System which have been prepared over the last several months by a Technical Secretariat operating under the Council of Ministers and which have involved all of the key actors in the PEM system.

3 Page 3 of 33 (b) Budget Execution/Financial Control Problems A high volume of budget transfers. As noted above, a major reason for this has been the relatively poor attention that has gone into the budget formulation process from spending agencies. The ongoing PEM reforms are designed to address the underlying reasons for this. New rules for budget transfers have been instituted to address the effects. In-year expenditure cut-backs to maintain fiscal targets. As noted above, weak forecasting and unrealistic expectations of reforms result in the need for unplanned expenditure reductions to maintain fiscal targets. The effect of this should be mitigated once the new MTBP and budget preparation procedures (which link directly to outputs and policies) are operational (i.e. illustrating the opportunity costs of cutting back particular programmes rather than alternative programmes). Otherwise, the current stage of MTBP reforms, which accords greater importance to integrating macro-fiscal forecasts in the PEM process and which seeks earlier involvement of the Council of Ministers in the process, seeks to address the underlying problem. 3. What is the top priority not yet being addressed in your PEM reforms? What are your plans for addressing this priority? As noted above, a major problem in the PEM system over recent years has been the creation of a number of policy, planning and budgeting tools for which there has been a degree of confusion over the respective role each should play. This has resulted in them relating badly to one another and, to some extent, undermining one another. Perhaps the most important PEM initiative in Albania in recent years, therefore, has been the Government s decision to establish a Technical Secretariat (TS) to advise on the design of a new Integrated Planning System. At the heart of this system is the desire to create a proper legal basis for the future development of a modern public financial system based on international good practice. To achieve this, the Ministry of Finance in cooperation with DFID has been preparing a New Organic Budget Law (NOBL). Taking in consideration the importance of this law, the Ministry of Finance has prepared a draft Manual of Procedures for Public Financial Management. The procedures in this Manual describe in detail how key aspects of the NOBL would be implemented in practice and provide a range of actions that will be implemented as secondary legislation under the NOBL.

4 Page 4 of 33 NOTES ON BUDGET REFORM EXPERIENCE ARMENIA Prepared for presentation of: The Formation of the Medium-Term Planning Process of Public Expenditures and Introduction of Program Budgeting Elements in the Republic of Armenia Dear Colleagues, For more than 12 years after gaining independence and declaring its commitment to the achievement of acknowledged values in establishment and functioning of the state and civic society in the country, and its intention to be integrated to the world society, the Republic of Armenia has been gradually moving towards the targeted goals through implementation of reforms in the economy and society. Among the reforms in the economy those implemented in budget area have a particular role. Evidences of positive results of the reforms which have been already implemented are: institutionalizing of budgeting process, establishment of treasury, adjusting the state budget format to comply with the format close to international standards, improvement of budgeting efficiency through introduction of medium-term planning of public expenditures in the budgeting process, comprehensive review and analysis of budget expenditures of the past years, as well as introduction of competition-based public procurement. Results achieved by the country have been acknowledged by international organizations (IMF, World Bank, European Union). With the support of these organizations and also of such countries like the USA and UK Armenia continues implementation of reforms in budget area. One of the main trends in reforms being implemented by the country in budget area currently and to be implemented in the coming years is introduction of program budgeting elements in budgeting process. Since 2003 we have undertaken preparation activities to create required conditions for shifting from current method of budget planning, which is based on estimation of input to be used for implementation of the program, to the method based on the evaluation of results achieved while implementing the program. Therefore an Action Plan aimed at reforming budget area was developed in This actions plan considers that an effective framework of expenditures program is the basis both for successful budgeting and for identification and strengthening of the link between the Government policy and the budget. It should be noted that the Action Plan of reforms in budget area developed in 2003, in the part relevant to introduction of program budgeting elements in the budgeting process is based on the results of the Public Expenditure Review for , which was carried out with active and productive support of the World Bank. This study helped identify the shortcomings in the budgeting process and work out relevant proposals for improving it. Institutionalizing of the process of public expenditures medium-term planning, which had been proposed on the basis of results of the country s public expenditures study, had a big

5 Page 5 of 33 role in providing necessary background for adoption of the action plan on introducing program budgeting elements in the budgeting process through legislative strengthening of it in 2003 as an integral part of budgeting process. It should be stated that we have acquired sufficient experience in the country in the field of preparation of medium-term public expenditures frameworks. The process of medium-term planning started in 2000 and at the beginning it was limited to macro-level predictions. During the next years in the result of consequent actions to develop methodology of medium-term planning of public expenditures and improvements of organization and coordination of activities, we have managed to shift from pilot introduction of medium-term planning in 4 branches to medium-term planning of public expenditures in the whole economy. With the aim to coordinate medium-term planning of expenditures and quickly solve issues arising in the process, the Prime-Minister s Decree was issued, according to which a Supreme Council was established for developing medium-term expenditures frameworks and a Task Force - for coordinating development activities of medium-term expenditures frameworks. The Supreme Council consists of high officials in the head of public administration of finance and economy, social area, defense, tax and customs services, and the Central Bank. The National Assembly members recommended by the represented parties may also participate in the work of the Supreme Council. The Supreme Council is led by the Prime- Minister. The Supreme Council is in charge of strategic guidance and control over the whole process of development of public expenditures medium-term frameworks. The Task Force which coordinates activities of development of medium-term expenditures frameworks consists of officials at the level of head deputies of public administration of finance and economy, social area, and tax service. Donor organizations representatives may also participate in the work of the Task Force. The Task Force is led by the Deputy Minister of RA Finance and Economy. The Task Force in charge of coordination is responsible for providing current guidance and organization of activities for development of public expenditures medium-term frameworks both in separate branches and in general, and for current control of the work progress. The process of development of medium-term expenditures framework begins with the Prime-Minister s Decree issuing the start of budgeting process for the next year and it lasts not less than 6 months in average. The same Decree of the Prime-Minister specifies the schedule of activities to be implemented in the scope of the process of development of medium-term expenditures framework, and the public administration bodies responsible for implementation of the specific activities. Particularly, the Ministry of Finance and Economy is responsible for development of methodological instructions and for provision of the Task Force in charge of coordination (and with the agreement of the latter of Supreme Council) with the proposals regarding the main principles, indicators, and restrictions which can be used as the basis for development of medium-term expenditures framework, for conclusions on drafts of branch medium-term expenditures frameworks, submitted by line ministries, for preparation of the final option of medium-term expenditures framework draft and submission of it to the Government for review. Line ministries are responsible for development of branch medium-term expenditures frameworks in compliance with the methodological instructions

6 Page 6 of 33 and for submission of them to the Ministry of Finance and Economy within the time determined by the Prime-Minister s Decree. According to the Law, the Government shall approve the Medium-Term Expenditures Framework by June 20 of the given year and publish it by July 1. Development of the state budget draft for the next year starts from the date of approval by the Government of the Medium-Term Expenditures Framework and is built-in its provisions. Moreover, according to the Law, when submitting the state budget draft for the next year to the National Assembly, the Government is obliged to inform the National Assembly about deviations of the state budget draft from the Medium-Term Expenditures Framework and give adequate explanations regarding the reasons of those deviations. It should be mentioned that while introducing the process of public expenditures medium-term planning, the Government faced the necessity to organize training courses on preparation of public expenditures medium-term programs for the relevant specialist of the public administration bodies, which have been carried out by the Training Center of the Ministry of Finance and Economy with a direct support of the USA Treasury and DFID. In the result of introduction of the process of public expenditures medium-term planning, transparency and predictability of public expenditures planning increased both for the public administration bodies and for the broad levels of the society, it became possible to identify at an early stage the state policy priorities for the next three years, to compare them with the principles, priorities, and goals of the long-term policy of the state (currently it is Poverty Reduction Strategy). The level of line ministries independence in formulation of branch policy and identification of its priorities relatively increased. Introduction of the process of medium-term planning of public expenditures enabled to evaluate in general the expected medium-term results of the proposed state policy in different branches as well as the degree to which the proposed activities are provided with human, material, and financial resources (naturally, the level of responsibility of the line ministries for the results of programs they implement also increased). Ultimately the Medium-Term Expenditures Framework became the basis for preparation of the annual state budget draft for the next year. Preparation nowadays to start introduction of program budgeting elements in the budgeting process is the logical continuation of the process of increasing transparency, predictability and reasonability of public expenditures and expected results at the level of individual programs. Particularly, the action plan of reforming budget area provides for review by all the state authorities of the structure of expenditures programs implemented by them, so that eventually to have logically and functionally interrelated group of services rendered by these authorities to the society (population, other authorities, internally in the state authorities) during the process of functioning. The aim of the aforementioned action plan is to provide the Government, National Assembly, and the society as a whole with useful information about the services rendered at the account of allocated budget resources and the results achieved due to implementation of these services. The revision of the structure of expenditures programs implemented by the state authorities and financial assessment of the expenditures programs in terms of services to the society would also

7 Page 7 of 33 provide with useful information regarding the cost of the services and their adequacy to the results of the services rendered. Currently 4 ministries of social area of the country are involved in the reform (Ministry of Labor and Social Issues, Ministry of Education and Science, Ministry of Health, and Ministry of Culture). Later, on the basis of analysis, generalization, and formalization of the experience gained due to functioning of the ministries under the new conditions of budgeting, we intend to introduce this experience in all the agencies of the state administration of the country. Like in case of introducing medium-term planning, in this case also training of the background knowledge and methodology of program budgeting, especially at this stage of reforms training of skills of revising the framework of current programs and their reformation seems to be of utmost importance for the specialists of public administration bodies. Information regarding the cost of services provided at the account of budget resources allocated by the society and their adequacy to the results achieved due to implementation of these services will help to more reasonably assess probable consequences of decisions made for implementation of specific policy and expenditures programs in the framework of the policy, thus enabling to make reasonable decisions for directing limited budget resources to those areas and to implementation of those activities, which would promote the best achievement of political targets. Increase of importance of the given reforms implementation as compared to the past is conditioned by implementation by the Government of the Poverty Reduction Strategy and increase of political in their basis requirements to ensure transparency of compliance between the activities carried out by the Government in the scope of its programs, results achieved due to implementation of the programs, and the Government reporting to the society. It is evident that the factors mentioned above prove again the imperative necessity of reforms currently being carried out in budget area, and we are determined to successively and purposefully continue implementation of those reforms. I appreciate your attention very much. FURTHER NOTES ON BUDGET REFORM EXPERIENCE ARMENIA 1. What is the major achievement in the reform process of public expenditure management in your country and key factor for attaining it? An important achievement in the reform process of RoA public expenditure management is: the move to long-term strategic planning; the overall institutionalization of the budgetary process; the increase in the level of inclusion and consolidation of state budget receipts and expenditures in the budget; the introduction of medium-term expenditure planning; budget classification in conformity with international standards; a modern Treasury

8 Page 8 of 33 system; and the introduction of a procurement system for the needs of the state and communities. A key factor for attaining the mentioned results is combining the political will for implementing reforms and professional competencies of the staff involved in reforms. 2. What are the main problems encountered in the reform process (budget formulation or budget execution and financial supervision)? Problems arose in the budgetary reform process from the need to establish bases for long-term strategic planning for the country s development, and to build capacity for the public administration system in the areas of policy development and implementation under the budgetary process. Particularly in formulating policy priorities and objectives, strengthening the links between the adopted policy and budget, introducing an internal audit system in state and local government bodies (particularly, in determining the scope of audit, clarifying the relationships between audit bodies, staff training), and improving the reporting system for state non commercial organizations that are outside the Treasury system. 3. What top priority issue has not been included in the public expenditure management reform yet? What are your plans to address the issue? The following have not been included in public expenditure management reforms yet: Universal introduction of program budgeting which is planned to be implemented from 2007 (taking into account the experience of pilot activities for introducing it in individual ministries). Development of a strategy for capacity building activities for local self-governance system in the area of implementation of the budgetary process (which is planned to be developed in the coming years). RoA public sector accounting system and Second Generation Treasury Reforms (it is planned to be implemented by 2009), the issue of moving from an accounting system in place in the RoA public sector from Soviet times to a system conforming to international accounting standards. Introduction of a financial management information system in the public sector (for automation/computerized management of financial information flows between the treasury system, state and local self-government bodies, and institutions under their authority). During the coming three years it is planned to introduce an internal audit system in the RoA public sector in conformity with the best international practice (according to the strategy paper for the development of that sector adopted by RoA Government). Introduction of an e-procurement system for state needs (procurement planning, organization of procurement including electronic competitions, presentation of reports on procurement and supervision).

9 Page 9 of 33 NOTES ON BUDGET REFORM EXPERIENCE AZERBAIJAN Prepared as speech of Deputy Minister of Finance, Mr. A. Bayramov Seminar on Public Management Expenditure Tasks in Europe and Central Asia Region (Poverty Reduction Strategy) Warsaw Background Azerbaijan Republic was established on May 28, Day of Independence October 18, 1991 Territory 86,6 thousand square km. Population ,0 thousands Capital Baku Joined UNO March 2, 1992 Joined CIS September 19, 1995 Joined Parliament Assembly of European Union January 17, 2001 Ladies and Gentlemen, During last 13 years of national independence Azerbaijan passed through a difficult path of democratic renewal. There was an urgent need to solve the problem of securing full independence and its consolidation, transition to market economy, establishment of political and social stability, building-up democratic system of political power and its compliance with world standards. In the transition period the Gross Domestic Product was decreasing by 20-25%, inflation made up 1800%, budget deficit to GDP ratio constituted 15%, the gold and currency savings were on zero level. The Government has undertaken significant steps aimed at strengthening of legislative base, stimulating development of market economy, achievement of macroeconomic stability. Accordingly, new legislation and regulations, such as Law on Budget System, Tax Code, Labour Code, Civil Code, Law on Land Reform, Law on Privatization of State Property, Law on Securities, Law on Joint-stock Companies, Law on Protection of

10 Page 10 of 33 Investment, Law on Currency Stabilization, Law on Banks and Banking Activity, Law on Bankruptcy and tens of various legislative documents were adopted. Also a new budget classification was developed, the procedures of state budget elaboration and execution process, with detailed list of all functions and responsibilities of each participating organization was approved. Significant steps on enhancement of transparency of fiscal and monetary policies were undertaken. The execution of these measures proceeded from the Law of Budget system, adopted in This Law was the first to reflect the budget system of Azerbaijan: mid-term budget forecasts, endorsement by Parliament of all budget components on all levels (division, subdivision and paragraph), interbudgetary relations; the publication of budgetary materials in mass media means, the state budget project evaluation by Chamber of Accounts and etc. is planned. In line with state budget project also the project of consolidated budget, which is one more criterion of budget transparency, will also be submitted to the Parliament of the republic. On of the main conditions of transparency is publication of materials related to state budget (besides the law draft, a large number of documents is published, like mid-term conception of social-economic growth, principal directions of budgetary-tax policy, public investment policy). It stipulates the awareness of most social groups with the budget and the active participation of population and NGO-s. Once successfully implemented, the fiscal and monetary policy has played a significant role in continuation of structural reforms pace in economics, increase of foreign investments in leading economic fields, fuel-energy sector, industry, construction and land sector, enhancement of social protection of population. Taking into consideration the importance of proper utilization of oil revenues, the government has worked-out and adopted the long-term strategy of oil revenues management, which presents a real consumption level of oil revenues with time course and their direction to the development of non-oil sector. The government also pays great attention to securing the oversight of state financial discipline, keeping financial accounting and providing accountability of state budget execution, expedient and economical distribution of funds. One of the important measures was establishment of a treasury system, stipulating the implementation of all revenues and expenses of state budget and non-budgetary funds, credit transactions under the Treasury.

11 Page 11 of 33 For the present time automatic and computer-based performance of treasury system is being developed. This will allow managing and executing financial control of funds in real time regime, taking urgent actions for efficient use of budgetary funds. The Government of our Republic is closely cooperating with financial institutions like International Monetary Fund, World Bank, Bank for Economic Development and a number of other international institutions. They have participated in development of many projects for legislative-regulatory documents, which are very important for securing transparency of fiscal and monetary sectors; strengthening of financial discipline in public utilities sector and including indirect subsidies of fuel-energy sector in consolidated budget. Besides the aforesaid measures, privatization, deepening of structural reforms, liberalization of prices were introduced in the republic; the government started paying particular attention to private sector, entrepreneurship, giving priority to regional economic development, decrease of taxes through expansion of tax base sphere, significant reforms in banking were realized, the securities market expanded, foreign investors were attracted into economy of the country, and a number of other measures contributing to the restoration of state economy and were a great incentive to its development. Due to severization of monetary policy, particularly, the liquidation of practice of financing budget deficit at the expense of central bank credits, and also stabilization of situation on monetary and currency market by the beginning of 1995, the inflation processes in Azerbaijan were completely eliminated. One of the important achievements of recent years is a banking system, which is stable, developing and has modern infrastructure. One of the most developed elements of banking infrastructure is online functioning Interbank System of Electronic Payments (RTGS). Development of this system caused root changes in payment relations and payment culture in our country. Payment turnover, especially payments in budget sector, increased several times. Starting from 2001 all budget payments are made automatically, online. Competition environment was created for banks servicing accounts of central treasury. Forecasts show, that in future years annual increase of money supply will make 30-40%. In order to introduce effective sterilization and extra liquidity mechanisms, National Bank and Ministry of Finance make joint efforts aimed at development of securities market. In 5 recent years increase of GDP and GDP per capita made 75.5%. State budget revenues and expenditures increased 2.4 times in 5 recent years. In 5 recent years social expenditure of state budget increased 1.3 times. The salaries of budgetary employees increased by 3.1 times, pension and allowances by 2.3 times, expenditures for purchase of medicines, food expenditures by 4.7 times, expenses for acquisition of main funds by 5.5 times.

12 Page 12 of 33 In line with the achievements, there is need to eradicate a few objective and subjective factors. Today the economic activities of the republic impose a negative impact on expenses designated for refugees and IDSs. In 2005 more than 4.3% of state budget expenditures (US$87 mln.) will be allotted on their needs. We confront a number of important challenges: solving the problem of programmed utilization of budgetary funds; improving the system of salaries of budgetary organizations; improving the social conditions of pensioners and low-income families, to enhance targeting of supplements to pensions, accelerate the introduction of targeted child benefits; achieving best regulation of energy tariffs and 100% collection of public utilities fees and, thus move away from indirect subsidies to energy sector; reforming the health system, enhance the role of medical insurance; improving the management system, improve performance indicators, eliminate or merge units with duplicating functions, decrease complexity of administration system; enhancing the budget role in improvement of interbudgetary relations aimed at regional economic development; and reducing the number of IDPs living in poverty, contribute to return of IDPs to homes and help them to achieve economic independence. Thank you for attention!

13 Page 13 of 33 NOTES ON BUDGET REFORM EXPERIENCE GEORGIA Georgia s most successful achievement in PEM process In 2003 the new Budget Systems Law has been developed and it became effective on January 1, The law replaces a procedure which was fragmented and informal. The new law gives for the first time a comprehensive framework of the roles and responsibilities of the Ministry of Finance and the spending agencies in the budget process. Under this new law the Ministry of Finance is responsible for this integrated budget preparation process. The key innovation of the new budget system law is a better structured budget preparation process. The law requires a two stage prioritization process: first the key directions are determined, and then spending agencies present their detailed budget requests within the associated budget ceilings One of the effects of the Budget Systems Law is that the so-called protected tems are eliminated and now all budget items have equal priority. This also changes the sequestration mechanism. Budget performance will be reviewed by Parliament on quarterly basis and on proposal of the Government all budget items can be adjusted, and not only the non-protected ones. A further change on budget procedures related to the use of targeted programmes. These are omitted in the new law. In previous budgets, targeted programmes were initially filtered by the Ministry of Economy, independent of the ceilings to the spending agencies, and only reconciled with spending agencies ceilings at a late stage of the budget preparation. As a result, budget preparation was not a unified process and key policy priorities were related to the resource envelop only late in the process. The preparation process for the 2005 Budget follows already the time table stipulated in the Budget Systems Law, in spite of the fact that the process has been affected by the events in November 2003 and the subsequent Presidential and Parliamentary elections. Major problems encountered in the reform process The largest problems are related to the spending agencies, especially their limited capacity, which results in suboptimal budget proposals and in late submissions of budgets to the Ministry of Finance.

14 Page 14 of 33 Top priority in PEM reforms Overall, in Georgia the budget cycle has conceptually been developed, but in several areas implementation and entrenchment needs further attention. Particularly weak is the link between strategic planning and budget preparation. This link entails two main stages: setting of overall fiscal targets and sectoral ceilings, based on the overall government priorities, macroeconomic forecasts and fiscal policy; and allocating resources to strategic priorities within these sectoral ceilings. Despite some fragments of progress, there is still a critical lack of strategic and longterm thinking, especially at sector level. Furthermore, there is no mechanism in place to translate strategic priorities into financially justified plans of actions. Therefore, the Ministry of Finance has made introduction of the Medium Term Expenditure Framework its priority. The Budget Systems Law already requires the government to develop a medium-term outlook, especially to prepare the Medium-term Macroeconomic Framework, Medium-term Fiscal Forecast and Basic Directions for Budget and Tax Policy for the budget year and for the year following the budget year. Also, the 2005 Budget Instructions contain for the first time a Form, requesting the spending agencies to submit information about their activities/programmes, including description of activity/programme objectives and performance indicators. The Ministry of Finance has developed a comprehensive approach to design and implement the MTEF, taken into account the needs of the country and building upon the existing system of budget preparation. The overall plan is presented in the attached table. According to this plan, the focus will bed simultaneously in three areas: (i) improvement of macro-economic and fiscal forecasting; (ii) analysis of cross-cutting expenditure issues; and (iii) development of sector strategies and expenditure plans. As already indicated above, the capacity of planning and budgeting at the spending agencies is in general weak and therefore, MoF has opted for two levels of engagement in developing the sector analysis for the MTEF: Tier 1 agencies which would prepare sector expenditure strategies. hese would comprise those ministries that are strongly submitted to the MTEF exercise and which have technical assistance to support the development sector expenditure strategies. The Plan proposed that this group should comprise health, education, agriculture and finance, and possibly one or more of energy, justice, internal affairs and defence. Tier 2 agencies comprising the remaining ministries for which more rudimentary costings and prioritisation would be undertaken.

15 Page 15 of 33 Suggested MTEF Preparation Timetable and Stages December January February March April May June Macro-Fiscal Framework Review macro-fiscal policy objectives and macroeconomic outlook. Review revenue policy and administration reforms measures. Project inflows of external financing (budget support and project). Debt strategy and sustainability analysis, debt servicing projections. Macro-Fiscal Framework Projections Update macro-fiscal forecasts. Public expenditure resource framework projections. Finalise mid-term fiscal table. Preparation of MTEF Inception Memorandum (setting out: key public finance issues to be addressed in the forthcoming MTEF, scope of the MTEF analysis, timetable for MTEF preparation. It can also include the preliminary macroeconomic outlook/framework and preliminary resource ceilings,) Finalise Basic Directions document and submit to Cabinet/President President submits Basic Directions to Parliament Comments from Finance and Budget Committee of Parliament Approval of MTEF Inception Memorandum by MTEF Task Force Analysis of Cross-Cutting Expenditure Issues Analyse expenditure trends, identify policy issues. Cross-country comparisons and identification of policy issues Analyse selected expenditure policy, allocation and management issues. Analyse inter-budgetary resource allocation trends and issues. Cabinet Approval of MTEF Document Sector Expenditure Analysis and Plans Summary analysis of priority sector programme reform actions. Public spending implications of reform actions. Detailed strategic expenditure plans for pilot sectors. Analyse inter-sectoral resource allocation issues and priorities. Finalisation of Expenditure Review and Analysis Incorporate 2004 budget outturns into cross-cutting and sector analyses. Review/finalise technical notes and strategic sector expenditure plans. Develop detailed sector resource ceilings broken down between central (by ministry), social fund and local budgets. Prepare and finalise MTEF document and sector and ministry resource ceilings. Submit to Cabinet. Preliminary Steps Analysis and Preparation of the Main MTEF Elements Finalising the MTEF Document MoF Issues Budget Circular and Distributes MTEF Document

16 Page 16 of 33 NOTES ON BUDGET REFORM EXPERIENCE KOSOVO 1. What is the country s/territory's one most successful achievement in the PEM reform process, and what was the main factor contributing to that success? There are several achievements in the Public Expenditure Management, especially we need to mention the: functionality and transfer of responsibilities to the Ministry of Economy and Finance; law on Managing Public Finances and Responsibilities; creation of the Consolidated Budget Department at the MFE; certification of municipalities on Financial Management; and organization of work and responsibilities at the Budget Department, (Division of work and responsibilities according to the Spending Agencies). Therefore the biggest achievement was to create a unique and transparent budget process for all the organizations of the Consolidated Budget, according to international practices. Monitoring of budget spending electronically through Free Balance has increased the speed and the functionality of work in monitoring public expenditure reports in the consolidated Budget 2. What are the major problems that you have encountered in reforming (a) budget formulation and (b) budget execution and financial controls? Budget formulation insufficient funds; low capacity and lack of training in budget organizations; double standards between PISG and Reserved areas; inconsistencies between planned and actual expenditures; and frequent moves of budget and finance officials to other sectors. Budget execution and financial controls hiring controls, lack of coordination between the payments unit at the Ministry of Public Services and Treasury; non-efficient evaluations of government programs; and inconsistencies between planned and actual expenditures.

17 Page 17 of What is the top priority not yet being addressed in your PEM reforms? What are your plans for addressing this priority? strategic plan (that will include the main goals of the government); additional instructions in identifying priorities of budget expenditures to develop sectoral strategies of spending agencies; more liquidity in the Kosovo consolidated Fund; fiscal discipline, accountability and transparency; budget appropriations to be on yearly basis and cash-based; simplified budget process in: (a) budget formulation, and (b) budget decisions; support from possible donors to be managed within the budget process of Kosovo; reports from spending agencies on the execution of planned programs; and full integration of the public enterprises in the budget process. Addressing this priority is not a responsibility of the MFE and will need harmonization with the SRSG.

18 Page 18 of 33 NOTES ON BUDGET REFORM EXPERIENCE KYRGYZ REPUBLIC 1. Achievements of the Public Expenditure Management Reform The most successful achievement of the Public Expenditure Management Reform in the Kyrgyz Republic was development and implementation of the methodology for the Midterm Budget Framework (MTBF). Implementation of this instrument made the budget an active tool of the economy policy and facilitated to better plan resources to carry out sectoral policy by spending agencies in the mid-term period. A new version of the Law on Budget Principals of the Kyrgyz Republic was developed to support this instrument. The Law (#78) was adopted on June 11, In accordance with the new version, Governmental Budget Commission was formed. In 2004 its functions were transferred to the Economy Policy Council under the Government of the Kyrgyz Republic. To ensure compliance with the strategic policy documents new methodology for the program-based budgeting was implemented. To better assess budget resources, institutional basis for Public Investment Program was established in the Ministry of Finance, PIP indices were integrated into the Republican budget and special means of budget institutions were incorporated into the budget. In the course of the implementation of the MTBF methodology, budget classification was expanded and adjusted. An integral part of the budget reforming was delimitation of the responsibilities between different levels of government and improvement of the system of intergovernmental relations, i.e. between republican and local budgets. To ensure budgeting predictability and transparency, the Ministry of Finance of the Kyrgyz Republic improves the methodology on a regular basis and updates the format of the MTBF. 2. Main problems related to budget preparation and execution and financial control The main problems of the budget reform can be summed up as follows: It is required to improve the quality of the program-based budget preparation and to better use program principals in the course of the budget execution, i.e., to ensure interrelation between the resources allocated by the budget institutions and performance results, and their compliance with the goals set for an agency and goals of NPRS/CDF. It should be noted that cost assessment of CDF/NPRS measures, to finance which it is anticipated to allocate budget assignments, is hampered by lack of expertise to determine

19 Page 19 of 33 future expenditures by line ministries and agencies, lack of program prioritization and resource savings at the expense of low-prioritized programs and further re-allocation of funds on highly-prioritized programs. It is important to prioritize goals and objectives set by the strategic programs and spending programs of the budget agencies. Effective use of public budget resources is also hampered by the revenue cyclic fluctuations as a result of poor resource management (resources concentrated in the state budget). Audit system both internal and external is not capable to adjust management decisions during budget execution and to optimize public spending process and, respectively, provide public services. The main challenge of today is to implement financial decentralization policy aimed at improvement of the quality of the services, increase of the effectiveness and transparency of the public spending. It is also required to re-delimitate and specify revenue and spending responsibilities between intergovernmental entities and local self-governing agencies, improve the system of inter-budget transfers, elaborate sub-laws on implementation of the National Decentralization Strategy of the Kyrgyz Republic. 3. Priorities that have not been yet considered within the framework of the Public Expenditure Management Reform. Plans towards implementation of these priorities. A key priority of the Public Expenditure Management Reform is to improve mechanisms for mid-term budget framework (MTBF). The goal is to link MTBF and CDF/NPRS, integrate MTBF into annual budget cycle, go over from annual budgeting to budget planning aimed at mid-term tasks and prioritized resource allocation. To achieve the above-stated goal it is required to: (i) fully implement budget format and execution at republican and local levels; (ii) finance programs aimed at measurable results; and (iii) elaborate simple and informative indicators to monitor performance of the spending agencies. To improve MTBF methodology it is envisaged to integrate current and investment expenditures into the budget. It is intended to improve the format of the consolidated budget, which integrates all elements of public expenditures and sets a basis for the strategic budgeting. This requires development of the institutional procedures ensuring joint planning and monitoring of the current sectoral and development spending, standardization of budgeting procedures and capital expenditure classification, which are financed out of the internal and external sources, evaluation of costs related to post-project expenditures and their incorporation into MTBF. One of the steps towards MTBF improvement is to elaborate methodology and regulatory framework for the financial decentralization. Within that framework it is intended to improve mechanisms of the intergovernmental relations to stimulate local budget growth and effectiveness of spending.

20 Page 20 of 33 NOTES ON BUDGET REFORM EXPERIENCE MOLDOVA 1. What is the greatest country achievement in public expenditure management reform and what major factor impacted this progress? The most successful country achievement in public expenditure management reform consisted in rehabilitation of macro-finance stability since 2001 and strengthening aggregate fiscal discipline. After a prolonged period of budget imbalances, as a result of tight budget policy, the budget cash deficit reduced from 10% GDP in 1997 to 1% surplus in At the same time, the negative trend in budget arrears accumulation was firmly reversed. These achievements resulted from a broad range of factors, including systematic efforts in public expenditure management reforms during the last 10 years. In 1996, a new law on budget system and budget process was adopted and a basis was laid for the budget system reform. A new budget classification corresponding to international standards was developed. Introduction of Treasury system which started its active functioning in 1998 was another important reform stage. Budget execution through Treasury made it possible to increase transparency in budget execution and to introduce elements of commitment controls. Since 2001, Treasury system has been covering public finances at both the Central government level and the local governments. To date Treasury system is able to register budget cash operations and produce operational reports, keeping under control the existing contracts on the government procurement. Another important reform stage was consolidation of budget formulation process initiated after 2000 in the context of preparations for introduction of medium-term budget planning as an integral phase of the budget process. That made it possible for the government to get more comprehensive view on available resources and to manage them more effectively. This also increased budget transparency. The subsequent work to introduce medium-term budget planning simulated strategic nature of resource allocation in mediumterm perspective in accordance with the government fiscal policy targeting the priority programs and made it possible to improve efficiency of budget spending. Budget cycle from budget preparation till Parliamentary adoption of the budget execution report extended from 12 to 17 months and became more logical and comprehensive.

21 Page 21 of What significant challenges did you experience during the reforms of (a) Budget formulation process, and (b) Budget execution process and financial accounting system? For a long time a serious obstacle for the reforms in management of public finances was high macro-financial instability at initial stage of transition period which was enhanced by financial crisis of Prolonged GDP decline during the first half of the 90s was accompanied by accumulation of substantial national debt, which by 1998 exceeded 60% of GDP. The economic problems were compounded by high political instability and frequent changes in the government. After the 1998 crisis, immediate adjustment in budget expenditures as a share of GDP became needed. As a result of increased share of budget spending for national debt servicing, the government was extremely limited in its ability to implement social policies and maintain the level and quality of public service delivery; financing of any new reforms became very difficult. The country also faced strict limitation in access to external sources of budget deficit financing. Fragmentation resulted from multiple extra-budgetary funds and other elements of budget system-- not integrated into the budget until recently can be considered as an internal problem of the budget system complicating the reforms. Weakly developed analytical skills of ministries and budget institutions in identification of measures targeted at more effective use of allocated resources and prioritization of spending remain to be a significant limitation. This fact slows down the process of expansion of the work on strategic sector expenditure planning and budgets guided by programs and results. Resulting from imperfect technology and low quality of Treasury supply and maintenance, the quality and delayed budget reporting do not meet the requirements and do not allow for efficient analysis of the budget execution and timely decision making. Commitment controls are complicated and imperfect, difficulties in cash management and challenges in ensuring regular and predictable financing for budget execution persist. 3. What is the main priority which has not been implemented during the reform of public finances in your country? How this problem is to be solved? For today, further consolidation of public finance management system based on strict and accurate rules of high transparency and responsibility is a priority. Targeted at these priorities and in accordance with the Economic Growth and Poverty Reduction Strategy, modernization is planned based on introduction of integrated information system.