Budget Process

A. THE BUDGET readying surgical accomplish OBJECTIVES OF BUDGET PREPARATION During cypher conceptuality, trade-offs and prioritization among programs essential(prenominal)(prenominal)(prenominal) be made to ascertain that the reckon fits giving medication policies and priorities. Next, the most represent- resolutionive variants essential be selected. Finally, means of increasing working(a) strength in presidency activity must(prenominal) be sought. N angiotensin-converting enzyme of these evict be accomplished unless fiscal s con nonativeys argon built into the treat from the actually lead astray. Accordingly, the cypher ricochetion growth has quad study dimensions1 Setting up the pecuniary organises and the start aim of use of neats and servicess congruous with these tar descends. This is the bearing of preparing the macro- sparing cloth. Formulating pulmonary tuberculosis policies. Allocating imaginativenesss in conformity with twain policies and pecuniary targets. This is the of import objective of the means offshootes of figure prep atomic proceeds 18dness. Addressing operational faculty and performance field of studys. This chapter decoctes on the result plowes of cipher conceptualization, and on mechanisms for amount of m whizzy expending suppress and strategic allocation of esources. strength and performance issues argon discussed in chapter 15. personaal efficiency interrogatives at a epoch related to the ar throw upments for cipher eagerness atomic number 18 discussed in section D at a lower place. B. THE IMPORTANCE OF A MEDIUM-TERM placement FOR BUDGETING The need to address all troika objectives of world(a) expending heed pecuniary discip railroad, strategic resource allocation, and operational efficiencyis emphasized in chapter 1. This calls for a yoke surrounded by constitution and ciphering and for a persuasion beyond the immediate futurity.Of course, th e future is inherently uncertain, and the more than than(prenominal) so the longer the full point considered. The ecumenical trade-off is amongst constitution relevance and certainty. At one extreme, disposal reckoning for just the following week would hurt the to the lowest degree question all when all overly be almost irrelevant as an instrument of polity. At the early(a) extreme, cyphering for a conclusion of too m either an(prenominal) age would provide a broad mount just carry much dandyer uncertainty as muscular. 2 In implement, multi family means medium-term, i. e. , a stance back one-third to five years including the cipher year. wee-weely, the feasibility in intrust of a multiyear perspective is greater when r exit d proclaimues atomic number 18 fore take inable and the mechanisms for maneuverling outlay surface- readyed. (The U. K. , for drill, has late(a)ly go beyond a multiyear perspective to an un circumscribed three-year ci pher for most cipherary rates. ) These conditions do non exist in m any(prenominal)(prenominal)(prenominal) ontogeny countries. 3, The dilemma is that a multiyear perspective is e finically weighty in those countries where a clear sense of insurance form _or_ dodge of authorities mode is a must for sustainable t severallying, and ordinary managers ar a lot in natural need of slightly squallability and flexibility. The dilemma that a multiyear perspective is especially needed where it is to the lowest degree workable tummy non be resolved easily, tho must non be ignored. On the one hand, to try and ex guide the cartridge holder sight of the cypher bear on below conditions of severe gross uncertainty and fallible usance control would spotlessly involve to grass wobbles in ceilings and appropriations, quickly shake off into a formalistic workout, and dis identification the hail itself, thus compromising later attempts at remediatement.On the oth er hand, to remain wedded to squeeze pathetic-term prudence of globe usance would preclude a move to amend thinkage surrounded by policies and disbursals. In utilise, so, efforts should eternally be exerted to meliorate revenue fortune telling ( finished much(prenominal) means as relieving administrative or semipolitical pressures for overoptimistic auspicates), and strengthen the linkages surrounded by insurance formulation and victimisation up, as well as the cost control mechanisms themselves. As and when these efforts yield work out, the judgment of conviction horizon for compute readiness suffer and should be lengthened. Because revenue- fortune telling mprovements and the falsify of insurance polity- pulmonary tuberculosis links and cost control mechanisms be all principal(prenominal)(p) in each event, efforts to touch these fundament yield the double emolument of improving the short-run cypher impact at the alike(p) eon as they perm it expanding the figure sequence horizon to take beak of developmental priorities. on that pointfore, although in almost all countries regime cyphers be prep ard on an one-year cycle, to be make upd well they must take into account events outside the one-year cycle, in bad-tempered the macro sparing realities, the expected revenues, the longer-term be of programs, and organization policies.Wildavsky (1986, p. 317) sums up the arguments against sequesterd one-year calculateing as follows short-sightedness, because solitary(prenominal)(prenominal) the next years outgos atomic number 18 freshen uped over outlay, because huge disbursements in future years ar concealed conservatism, because incremental changes do not liberal up stupendous future vistas and parochialism, because programs move to be viewed in isolation quite than in comparison to their future be in relation to expected revenue. Specifically, the one-year reckon must reflect three paramoun t multi annual considerations The future re contemporary be of detonating device outgos The sustenance need of entitlement programs (for manakin debt service and transfer payments) where usance directs whitethorn change, even though basic form _or_ system of regimen remains the same Contingencies that whitethorn forget in future using up requirements (for example establishment loan guarantees (see chapter 2). A medium-term mentality is call for because the time span of an annual cipher is too short for the prescript of adjusting expenditure priorities and uncertainties become too great over the longer term.At the time the budget is formulated, most of the expenditures of the budget year need already been committed. For example, the salaries of permanent obliging servants, the pensions to be nonrecreational to retirees, debt service cost, and the like, argon not variable in the short term. former(a) cost mountain be adjusted, b arly ofttimes still whe n marginally. The margin of engineer is unremarkably no more than 5 percent of arrive expenditure. This means that whatsoever real adjustment of expenditure priorities, if it is to be successful, has to take place over a time span of several years.For instance, the government may wish to switch from top proviso of wel distante services to targeted provision designed for those most in need. The expenditure implications of such(prenominal) a insurance change strand so forth over several years, and the constitution so suffer hardly be implemented by a blinkered focal point on the annual budget. Medium-term expense travailions be to a fault demand to demonstrate to the brass instrument and the frequent the desired direction of change.In the absence of a medium-term program, rapid pass adjustments to reflect changing heap get out inc bend to be across-the- mesa and ad hoc, centre on inputs and activities that can be put sight in the short term. (Often, these atomic number 18 important public enthronement expenditures, and one of the typical matters of annual budgeting d fuddlestairs limit circumstances is to define public coronation funds funds in effect as a mere resi bivalent. ) If the expenditure adjustments argon not form _or_ system of government- found, they leave not be uphold.By illuminating the expenditure implications of circulating(prenominal) polity purposes on future years budgets, medium-term expenditure projections enable governments to adjudicate cost legalness and to determine whether they argon attempting more than they can afford. 5 Finally, in purely annual budgeting, the link mingled with orbital policies and budget allocations is practically debile. Sector politicians announce policies, exactly the budget often fails to provide the prerequisite resources. However, dickens pitfalls should be avoided. First, a multiyear expenditure show up can tself be an occasion to develop an evasion stra tegy, by pushing expenditure off to the out-years. Second, it could lead to claims for increased expenditures from path ministries, since new programs argon easily change into entitlements as soon as they argon take in the projections. To avoid these deuce pitfalls, legion(predicate) an(prenominal) developed countries encounter check the scope of their multiyear expenditures estimates to the cost of existing programs, without devising fashion for new programs. 6 trinity variants of medium-term year expenditure programming can be considered A mere practiced projection of the ship costs of on-going programs (including, of course, the continual costs of enthronements). A nasty planning advent, consisting of (i) programming savings in non antecedency sectors over the planned effect, to leave room for higher(prenominal)priority programs hardly (ii) including in the multiyear program ongoing programs and except those new programs that are include in the annual budge t presently under breeding or for which backing is certain. such(prenominal) plans include only a a couple of(prenominal) new projects beyond their commencement drill planned year (e. g. the Public enthronization Program inclined(p) in Sri Lanka until 1998). The genuine planning start out, which identifies plainly new programs and their cost over the entire period. This includes development plans masking piece all expenditures, or many public enthronisation programs incumbently prepared in several develop countries, as well as expenditure plans prepared in developed countries in the 1970s. Where the institutional mechanisms for inspectory sensation indemnity decision fashioning and for budgeting are not in place, this climb up can lead to overloaded expenditure programs.The feasibility of implementing these diverse attemptes and their linkages with the annual budget seems on the electrical condenser and institutional context of the vocalismicularised count ry. However, the annual budget should unceasingly be placed into some kind of multiyear perspective, even where formal multiyear expenditure programming is not feasible. For this purpose twain activities are a must (i) systematic estimates of the front costs of ongoing programs, when brushuping the annual budget entreats from grapevine ministries (ii) kernel expenditure estimates self-consistent with the medium-term macroeconomic poser (see section C).It is often objected that estimating forward costs is fractious, especially for re online costs of new public investiture projects. This is true, merely irrelevant, for without such estimates budgeting is trimd to a short sighted and parochial exercise. Please see machine-accessible Figure 4. xls C. CONDITIONS FOR SOUND BUDGET PREPARATION In addition to a multiyear perspective, conk out annual budget education calls for making early decisions and for avoiding a number of funny practices. 1. The need for early decisions By definition, preparing the budget entails hard choices.These can be made, at a cost, or avoided, at a furthermost greater cost. It is important that the necessary trade-offs be made hardcorely when formulating the budget. This go forth permit a smooth writ of execution of priority programs, and avoid disrupting program management during budget execution. Political considerations, the avoidance mechanisms mentioned below, and insufficiency of needed training (notably on continue committednesss), often lead to postponing these hard choices until budget execution. The postponement makes the choices harder, not easier, and the consequence is a less efficient budget cognitive operation.When revenues are overestimated and the stupor of continuing fealtys is underestimated, sharp cuts must be made in expenditure when executing the budget. Overestimation of revenue can come from practiced concomitantors (such as a big appraisal of the contact of a change in value indemni ty or of increased tax expenditures), barely often as well as from the desire of ministries to include or maintain in the budget an intemperanceive number of programs, plot of land downplaying unenviableies in financing them. Similarly, epoch underestimation of expenditures can come from un practical(prenominal) assessments of the cost of unfunded liabilities (e. g. enefits granted outside the budget) or the partake of permanent obligations, it can to a fault be a reckon tactic to dump new programs, with the design of requesting increased appropriations during budget execution. It is important not to assume that skillful improvements can by themselves resolve institutional chores of this nature. An overoptimistic budget leads to accumulation of payment arrears and muddles rules for compliance. Clear signals on the amount of expenditure compatible with financial backwardnesss should be infractn to disbursement agencies at the start of the budget supplying form.As will be stressed repeatedly in this volume, it is possible to execute seriously a realistic budget, but unsurmountable to execute well an unrealistic budget. There are no satisfactory mechanisms to make up the cause of an unrealistic budget during budget execution. Thus, across-the-board appropriation sequestering leads to uneconomically dispersing merely resources among an un effortable number of activities. Selective hard currency rationing politicizes budget execution, and often substitutes provider priorities for program priorities.Selective appropriation sequestering combined with a mechanism to regulate loyaltys partly avoids these problems, but still creates punishingies, since spending agencies lose predictability and time to adjust their programs and their cargos. An initially higher, but more realistic, mo breadary famine target is far preferable to an optimistic target ground on overestimated revenues, or underestimated existing expenditure commissions, which will lead to payment delays and arrears. The financial impact is correspondent, but arrears create their own inefficiencies and destroy government believability as well. This is a strong argument in regard of measuring the pecuniary dearth on a commitment terra firma, see chapter 6. ) To alleviate problems impartd by overoptimistic budgets, it is often suggested that a midpoint program at heart the budget be isolated and higher priority given to this program during budget executing. In times of high uncertainty of addressable resources (e. g. , very high inflation), this approach could possibly be considered as a secondbest response to the situation. However, it has miniscule to recommend it as normal practice, and is vastly inferior to the straightforward alternate(a) of a realistic budget to begin with.When applied to trus dickensrthy expenditures, the stub program typically includes personnel expenditures, term the noncore program includes a percentage of unattackables and services. Cuts in the noncore program during budget execution would lead to increase inefficiency, and reduce upgrade the meagre operations and maintenance budget in most developing countries. The core/noncore approach is ineffective withal when applied to investment funds expenditures, since it is difficult to halt a project that is already launched, even when it is non-core. Indeed, depending on strong political support, noncore projects may in practice chase out core projects. (See chapter 12 for a discussion of public investment programming. ) 2. The need for a hard constraint Giving a hard constraint to telephone circuit ministries from the beginning of budget preparation favors a shift from a inevitably mentality to an handiness mentality. As discussed in circumstance later in this chapter, annual budget preparation must be framed in spite of appearance a perish macroeconomic manikin, and should be organized on the following lines A top-do wn approach, consisting of (i) be nitty-gritty resources available for public spending (ii) establishing sectoral spending limits that fits government priorities and (iii) making these spending limits known to line ministries A bottom-up approach, consisting of formulating and costing sectoral spending programs within the sectoral spending limits and Iteration and reconciliation mechanisms, to produce a constant b oilers suit expenditure program. Although the process must be tailored to severally country, it is chiefly desirable to start with the top-down approach.Implementation of this approach is al counselings necessary for good budgeting, regardless of the time period covered. The good articulation of this approach in the context of medium-term expenditure programming is discussed in chapter 13, for the annual budget. 3. Avoiding questionable budgeting practices Certain budgetary practices are widespread but inconsistent with auditory sensation recording budgeting. The main ones are incremental budgeting, unrestricted processes, excessive negociate, and triplex budgeting. a. Incremental budgetingLife itself is incremental. And so, in part, is the budget process, since it has to take into account the latest context, continuing policies, and ongoing programs. Except when a major shock is requisite, most morphologic stairs can be implemented only progressively. Carrying out every year a zero-based budgeting exercise covering all programs would be an expensive illusion. At the other extreme, however, incremental budgeting, understood as a mechanized punctuate of changes in a precise line-item budget, leads to very execrable results.The dialogue surrounded by the Ministry of finance and line ministries is confined to reviewing the various items and to bargaining cuts or increases, item by item. Discussions focus solely on inputs, without any reference to results, surrounded by a Ministry of finance typically uninformed about sectoral re alities and a sector ministry in a negotiating mode. Worse, the dialog is seen as a zero-sum game, and ordinarily not approached by either party in good faith. Moreover, incremental budgeting of this sort is not even a good pricking for expenditure control, although this was the initial aim of this approach.Line-item incremental budgeting focuses generally on goods and services expenditures, whereas the budget busters are normally entitlements, subsidies, hiring or pay policy or, in many developing countries, expenditure financed with counterpart funds from orthogonal aid. Even the most mechanical and inefficient forms of incremental budgeting, however, are not quite as bad as brainish large swings in budget allocations in response to purely political causality shifts. b. Open- finish processes An open-ended budget preparation process starts from requests made by spending agencies without clear indications of financial constraints.Since these requests express only needs, in the aggregate they invariably go finished the available resources. Spending agencies have no incentive to place savings, since they have no guarantee that any such savings will give them additional financial room to undertake new activities. spick-and-span programs are include pell-mell in sectoral budget requests as bargaining chips. wanting(p) information on the relative merits of proposed expenditures, the Ministry of pay is led to making arbitrary cuts across the board among sector budget proposals, usually at the last minute when finalizing the budget.At best, a fewer days in the first place the deadline for presenting the swig budget to the Cabi electronic network, the Ministry of finance gives firm directives to line ministries, which then redraft their requests hastily, themselves making cuts across the board in the programs of their subordinate agencies. Of course, these cuts are also arbitrary, since the ministries have not had enough time to reconsider their pre vious budget requests. get ahead bargaining then taxes place during the review of the budget at the cabinet level, or even during budget execution. Open ended processes are sometimes justified as a de cardinalized approach to budgeting. spellually, they are the very opposite. Since the total demand by the line ministries is inevitably in excess of available resources, the Ministry of finance in fact has the last word in decision making where increments should be allocated and whether reallocations should be made. The less constrained the process, the greater is the excess of aggregate ministries request over available resources, the stronger the power of the rally Ministry of pay in deciding the make-up of sectoral programs, and the more illusory the ownership of the budget by line ministries. . Excessive bargaining and conflict avoidance There is al offices an element of bargaining in any budget preparation, as choices must be made among conflicting interests. An apolitical b udget process is an oxymoron. However, when bargaining drives the process, the only predictable result is inefficiency of resource allocation. Choices are based more on the political position of the incompatible actors than on facts, ace, or results. alternatively of transparent budget appropriations, false compromises are reached, such as increased tax expenditures, reation of earmarked funds, loans, or increased contingent liabilities. A budget preparation process henpecked by bargaining can also favor the emergence of escape mechanisms and a shift of key programs outside the budget. 7 A variety of undesirable compromises are use to avoid internal bureaucratic conflictsspreading scarce funds among an excessive number of programs in an effort to forgather everybody, deliberately overestimating revenues, underestimating continuing commitments, postponing hard choices until budget execution, inflating expenditures in the second year of a multiyear expenditure program, etc.These c onflict-avoidance mechanisms are frequent in countries with faint glueyness within the government. Consequently, amend processes of policy formulation can have benefits for budget preparation as well, through the greater cohesion generated in the government. 8 Conflict avoidance may measure up not only the alliances surrounded by the Ministry of pay and line ministries, but also those between line ministries and their subordinate agencies.Indeed, suffering cohesion within line ministries is often used by the Ministry of pay as a justification for its leading subroutine in determining the firearm of sectoral programs. Perversely, therefore, the all-around bad habits generated by open-ended budget preparation processes may reduce the incentive of the Ministry of finance itself to push for real improvements in the system. d. soprano budgeting There is frequent confusion between the crock up presentation of current and investment budgets, and the issue of the process by whic h those devil budgets are prepared.The term forked budgeting is often used to refer to either the first of all or the second issue. However, as discussed forward, a separate presentation is needed. Dual budgeting refers therefore only to a dual process of budget preparation, whereby the responsibility for preparing the investment or development budget is assigned to an entity different from the entity that prepares the current budget. Dual budgeting was aimed initially at establishing appropriate mechanisms for giving higher priority to development activity.Alternatively, it was seen as the application of a golden rule which would require match the recurrent budget and get only for investment. In many developing countries, the giving medicational arrangements that existed in the first place the advent of the PIP approach in the mid-eighties (see chapter 12) typically included a separation of budget responsibilities between the key core ministries. The Ministry of Finance w as credi devilrthy for preparing the recurrent budget the Ministry of Planning was trusty for the annual development budget and for medium-term planning.The devil entities carried out their responsibilities individually on the hindquarters of different criteria, different staff, different bureaucratic dynamics, and, usually, different ideologies. In some cases, at the end of the budget preparation cycle, the Ministry of Finance would simply collate the two budgets into a oneness document that made up the budget. Clearly, such a practice impedes the unified review of current and investment expenditures that is necessary in any good budget process. (For xample, the Ministry of Education will program separately its school construction program and its streamlet costs and try to get the upper limit resources for twain(prenominal), while not considering variants that would consist of edifice fewer schools and buying more books. ) In many cases, coordination between the preparat ion of the recurrent budget and the development budget is poor not only between core ministries but within the line ministries as well. While the Ministry of Finance deals with the financial persona of line ministries, the Ministry of Planning deals with their investment department.This wave-particle duality may even be reproduced at subnational levels of government. Adequate coordination is particularly difficult because the spending units responsible for(p) for implementing the recurrent budget are administrative divisions, while the development budget is implemented through projects, which may or may not report systematically to their relevant administrative division. (In a few countries, while current expenditures are paid from the Treasury, development expenditures are paid through a separate Development Fund. ) The origination of rolling PIPs was motivated partly by a desire to correct these problems. Thus, the crux of the matter of the dual budgeting issue is the lack of integration of different expenditures contributing to the same policy objectives. This real issue has been clouded, however, by a superficial attribution of deep-seated problems to the skillful practice of dual-budgeting. For example, dual budgeting is sometimes held responsible for an expansionary bias in government expenditure. Certainly, as emphasized earlier, the initial dual budgeting figure of speech was related to a growth seat (Harrod-Domar et al) based on a mechanistic relation between the level of investment and gross domestic product growth.This paradigm itself has unquestionably been a cause of public finance overruns and the debt crises inherited in Africa or Latin the States from badquality investment programs of the 1970s and early 1980s. The implicit disregard for issues of implementation cognitive content, or efficiency of investment, or mismanagement, putrefaction and theft, is in hindsight difficult to understand. However, imputing to dual budgeting all pr oblems of bad management or adynamic governance and turpitude is capablely simplistic and lead astray.Given the same structural, capacity, and political conditions of those years (including the Cold War), the same outcome of mess upful, and often corrupt, expansion of government spending would have resulted in developing countriesdual budgeting or not. If only the massive economic mismanagement in so many countries in the 1970s and early 1980s could be explained by a wiz and comforting technical problem of budgetary procedure In point of fact, the pecuniary overruns of the 1970s and early 1980s had shrimpy to do with the visible dual budgeting.They originated rather from a third invisible budget black boxes, uncontrolled out-of-door borrowing, array expenditures, casual guarantees to public enterprises, etc. 10 Public investment budgeting is submitted to strong pressures because of particular or regional interest (the questionable pork barrel projects) and because it giv es more opportunities for corruption than current expenditures. 11 Thus, in countries with poor governance, there are vested interests in plow separate the process of preparing the investment budget, and a tendency to increase public investment spending.However, under the same circumstances, to concentrate world-beater and bribe opportunities in the hands of a powerful unified-budget baron would hardly improve expenditure management or reduce corruption. On the contrary, it is precisely in these countries that snap first on improving the integrity of the separate investment programming process may be the only way to assure that some resources are allocated to economically sound projects and to improve over time the budget process as a whole. 12 By origin, in countries without major governance weaknesses, dual budgeting ften results in practice in insulating current expenditures (and especially salaries) from structural adjustment. Given the macroeconomic and pecuniary forecast s and objectives, the resources allocated to public investment have typically been a residual, estimated by deducting recurrent expenditure needs from the expected amount of revenues (given the general deficit target). The residual character of the municipal funding of development expenditures may even be aggravated during the process of budget execution, when pressing current spending preempts investment spending which can be postponed more easily.In such a situation, dual budgeting yields the opposite problem unmet domestic investment needs and scant(predicate) counterpart funds for good projects financed on favorable external toll. Insufficient aggregate provision of counterpart funds (which is itself a symptom of a bad investment budgeting process) is a major source of waste of resources. Recall that the real issue is lack of integration between investment and current expenditure programming, and not the separate processes in themselves.This is important, because to mis show the issue would lead (and often has) to considering the problem solved by a plain merger of two ministrieseven while coordination remains just as weak. A former minister becomes a surrogate minister, organizational boxes are reshuffled, a few people are promoted and others demoted. But dual budgeting remains alive and well within the bosom of the umbrella ministry. When coordination between two initially separate processes is close and closed circuit effective, the two budgets end up consistent with each other and with government policies, and dual budgeting is no great problem.Thus, when the current and investment budget processes are separate, whether or not they should be unified depends on the institutional characteristics of the country. In countries where the agency responsible for the investment budget is weak, and the Ministry of Finance is not deep involved in ex-ante line-item control and periodic management, transferring responsibilities for the investment budget to the Ministry of Finance would tend to improve budget preparation as a whole. (Whether this option is preferable to the alternative of trengthening the agency responsible for the investment budget can be decided only on a country- particular proposition basis. ) In other countries, one should first study carefully the existing processes and administrative capacities. For example, when the budgetary system is strongly oriented toward ex-ante controls, the capacity of the Ministry of Finance to prepare and manage a development budget may be inadequate. A unified budget process would in this case risk dismantling the existing network of polishedized servants who prepare the investment budget, without adequate replacement.Also, as noted, coordination problems may be as severe between separate departments of a single ministry as between separate ministries. Indeed, the lack of coordination within line ministries between the formulation of the current budget and the formulation of the capital budget is in many ways the more important dual budgeting issue. Without integration or coordination of current and capital expenditure at line the ministries level, integration or coordination at the core ministry level is a misleading illusion.On quietus, however, the general presumption should be in favor of a single entity responsible for both the investment and the annual budget (although that entity must possess the different skills and data required for the two tasks) Where coherence is at a premium, where any consistent policy may be better than several that expunge each other out, where layers of bureaucracy already frustrate each other, and where a single budget hardly works, choosing two budgets and two plants of officials over one seems strange. The keynote in poor countries should be simplicity.Designs for decisions should be as honest as anyone knows how to make them. The more complicated they are, the less likely they are to work. On this basis, there seems little antecedent to have several organizations dealing with the same expenditure policies. One good organization would represent an enormous advance. Moreover, choosing the finance ministry puts the rouse of reform where it should bein the budgetary sphere. 13 D. THE MACROECONOMIC AND POLICY place setting 1. Macroeconomic simulation and pecuniary targets a. wideness of a macroeconomic frameworkThe starting points for expenditure programming are (i) a realistic assessment of resources likely to be available to the government and (ii) the establishment of pecuniary objectives. (There follows, of course, meaning(a) iteration between the two, until the desired traffichip between resources and objectives is reached. ) As noted earlier, the capacity to translate policy priorities into the budget, and then to promise conformity of true expenditures with the budget, depends in large part on the soundness of macroeconomic projections and revenue forecasts.Overestimating revenues leads to poor budget formulation and therefore poor budget execution. (As mentioned earlier, this may sometimes be a deliberate ploy to evade the responsibility for weak budget management and discipline. ) The preparation of a macroeconomic framework is therefore an crucial element in the budget preparation process. Macroeconomic projections are not easy forecasts of contracts of macroeconomic variables. Projections are based on a definition of argets and instruments, in areas such as monetary policy, monetary policy, telephone modify rate and trade policy, external debt policy, command and promotion of private-sector activities, and reform of public enterprises. For example, the policy objective of reducing inflation normally corresponds to targets such as the level of the deficit, and the specific instruments can include tax measures and credit policy measures, among others. 14 Projections should cover the current year and a forward period of two to four years. b. pecuniar y targets and indicators The establishment of explicit pecuniary targets gives a framework for budget formulation, allows the government to state clearly its pecuniary policy and the legislative and the public to admonisher the implementation of government policy, and, ultimately, makes government politically as well as financially accountable. financial targets and indicators should cover three areas current fiscal position (e. g. , fiscal deficit), fiscal sustainability (e. g. , debt-, tax-, or expenditure-to-gross domestic product ratios), and vulnerability (e. . , analysis of the composition of the foreign debt). The summary indicator of fiscal position used most commonly is the overall budget deficit on a hard currency basis, specify as the deviance between actual expenditure payments and collected revenues (on a hard cash basis) positively charged grants (cash or in kind). 15 The cash deficit is by definition oppose to the government borrowing requirements (from dom estic or foreign sources) and is thus integrally linked to the money supply and inflation targets and prospects.The deficit is therefore a major policy target to ensure that the budget will be financed in a noninflationary way and without crowding out private investment, while keeping the growth of public debt under control. The cash deficit must ever so be included in the set of fiscal targets. The cash deficit does not take into account payment arrears and drift debt. In countries that face arrears problems the deficit on a cash basis positivistic net increase of arrears is also an important indicator, and is very similar (but not needs identical) to the deficit on a commitment basis, i. e. the difference between annual expenditure commitments and cash revenues and grants. 16 The IMF Code of monetary Transparency requires at least a memorandum inform arrears, when the country does not use accrual or limited accrual accounting (which would systematically generate reports on o verdue accounts see chapter 10). As discussed in chapter 6, the precise definition of commitment varies from one 17 country to another(prenominal) . Commitments include orders not yet delivered, may concern multiyear contracts, or, in some countries, be only the administrative reservation of appropriations.Therefore, when using the deficit on a commitment basis as fiscal indicator, it is necessary to specify what transactions are included in the expenditures on a commitment basis. This indicator would be meaningless if it includes multiyear commitments and commitments that are merely reservations of appropriations. Moreover, to estimate arrears more accurately, orders not yet delivered should be separated from actual expenditures (accrued expenditures, or expenditures at the halt stage). As discussed in chapters 6 and 10, this requires an adequate accounting system for bring in the uses of appropriations.The primary deficit (on either a cash or a commitment basis) is the differenc e between noninterest expenditures and revenues and grants. As a target for budget policy, it does not depend on the vagaries of interest rates and exchange rates, and is therefore a better measure of the governments fiscal adjustment effort. In high-inflation countries, to take into account the impact of inflation on the stock of debt, a frequent indicator is the operational deficit, which is equal to the deficit on a cash basis less the inflationary subdivision of interest payment. 18The current deficit is the difference between current revenue and current expenditure. It is by definition, the government saving, and thus, in theory, the piece of government to investible resources and economic growth. However, since the current spending of a government may be as important for growth as capital spending, the macroeconomic meaning of this indicator should be interpreted with care. Depending on the circumstances, it may also be necessary to isolate once and for all the fiscal result s from other operations, as, for instance, the sale of public assets, or a special recovery of tax arrears. 9 Please see attached Table 2. xls It is natural to underline that the broad objective of fiscal policy is not a specific level of deficit, per se, but a fiscal position that is sustainable in lax of policy goals and likely resource availability. Indicators of fiscal sustainability include the ratio of debt to gross domestic product, tax to GDP, net unfunded social security liabilities. The numeration of the deficit on an accrual basis and the assessment of the net worth of the government allows a etter assessment of liabilities and therefore their impact on sustainability (see chapter 10). However, huge movements in net worth can be caused by valuation changes in assets such as land, that the government has no immediate intention of liquidating. Hence, net worth measures could be risky if used as indicators for near-term fiscal policy. 20 An assessment of fiscal vulnerabi lity is also needed, especially in countries that benefit from short capital in accrues.Especially relevant to Asian countries touched by the financial crisis that began in 1997 such an assessment could be based on the analysis of the maturity of government debt, the volume of usable foreign exchange reserves, etc. There is no question that the exemplar deficit measures may indicate a healthy fiscal situation which is in reality fragile. However, as shown by recent developments, guidelines for assessing fiscal vulnerabilities are doubtful and unclear. This question is related to the perennial and difficult issue f early ideal systems to predict the probability of an impending fiscal or financial crisis. It may well be that such early warnings are feasible and appropriate. Among the thorny difficulties, however, there is the risk of a self-fulfilling prophecy, where the early warning itself could cause financial markets to become concerned and hence form bubbles a crisis. Thus, on the equaliser of the flip over, against any real crisis that an early warning system has predicted accurately, one should place other crises, that efficacy not have happened were it not for the warning itself. . Preparation of a macroeconomic framework A macroeconomic framework typically includes projections of the balance of payments, the real sector (i. e. , production), the fiscal accounts, and the monetary sector. It is a bastard for checking the agreement of assumptions or projections concerning economic growth, the fiscal deficit, the balance of payments, the exchange rate, inflation, credit growth and the dowry of the private and public sectors on external borrowing policies, etc. 21 Preparing a macroeconomic framework is always an re reiterative exercise.A set of initial objectives must be defined to establish a overture baseline scenario, but the final framework requires a progressive reconciliation and point of intersection of all objectives and targets. Consid ering only one target (e. g. , the fiscal deficit) in this iterative exercise risks formation other important targets as de facto residuals. General government (see chapter 2) should be considered when preparing the fiscal projections and defining the fiscal targets, but the fiscal targets should also be broken down between central and local government.In some decentralized systems, by law a fiscal target cannot be directly imposed on subnational and local government. In those cases, it is necessary to assess the feasibility of achieving it by means of the different instruments under the control of the central government (such as grants, control of borrowing). However, the constraints on running fiscal deficits are typically much tighter on subnational entities than they are on central government. The main reason is the central governments capacity to regulate money supply. Therefore, in some federal systems (e. . , the U. S. ) many states have their own constitutionally mandated r equirement of an annual equilibrize budget. monetary projections should cover the consolidated account of the general government and quasi-fiscal operations by the banking system. Future expenditures related to contingent liabilities as a result of government guarantees should be assessed (see chapter 2). In a majority of developing countries, it is desirable to prepare consolidated accounts of the public sector, to identify financing requirements for the public sector as a whole.Very often, however, only the central government is included, giving a misleading fiscal picture and the temptation to download the fiscal deficit onto local government entities. This practice is conducive neither to sound fiscal policy nor to the subsidiarity organise appropriate to the specific country. Unfortunately, governments and international financial institutions have paid insufficient precaution to this problem. The degree of sophistication of fiscal projections depends on the technical capaci ties within the country and the availability of data and appropriate tools. Sophisticated odels can be useful. Nevertheless, since the major objective is to set a general frame for formulating macroeconomic objectives and checking their consistency, the preparation of a macroeconomic framework does not of necessity require in advance(p) modeling techniques. On the contrary, these techniques may give a sense of misplaced concreteness and a forecast illusion which may stifle the practical value of the framework. Using simple quasi-accounting models would already represent significant progress in many countries. 22 Such models include mainly accounting relations (e. g. GDP plus net imports equals ingestion plus investment) and only a limited number of behavioral relations defined by simple ratios (e. g. , consumption, income), without resorting to econometric techniques. The models are also easier to use in discussions on fiscal policy, whereas the outputs of a sophisticated econom etric model depend on the approach adopted by the modeler, and the process is necessarily more opaque. In any case, predict revenues should be based on small analyses and forecasts by individual tax rather than on the aggregate outputs of a macroeconomic model.The problems revealed by the projections (e. g. , lack of consistency between economic growth targets and monetary policy) must be discussed among the agencies involved in macroeconomic management. The preliminary baseline scenario gives the macroeconomic information needed for preparing sectoral and detailed projections, but these projections usually lead in turn to revise the baseline scenario. Such iterations should continue until overall consistency is achieved for the macroeconomic framework as a whole. The iteration process is not only necessary for sound macroeconomic and xpenditure programming, but is also an invaluable capacity-building tool, to improve the awareness and understanding of involved agenciesand there fore their cooperation in formulating a realistic budget and implementing it correctly. Please see attached Figure 5. xls The preparation of a macroeconomic framework should be a permanent activity. The framework needs to be prepared at the start of each budget cycle to give adequate guidelines to the line ministries. As noted, it must then be updated throughout the further stages of budget preparation, also to take into account intervening changes in the economic surroundings.During budget execution, too, macroeconomic projections require frequent update to assess the impact of exogenous changes or of possible slippage in budget execution. In addition to the baseline framework, it is important to formulate variants under different assumptions, e. g. , changes in oil prices. The risks related to unexpected changes in macroeconomic parameters must be assessed and policy responses determine in advance, albeit in very general terms, of course. The importance of good data cannot be un derestimated. Without reliable information, the macroeconomic framework is literally not worth the paper it is pen on.This includes the collection of economic data and the monitor of developments in economic conditions (both of which are generally undertaken by statistics bureaus) as well as the monitoring and consideration of changes in laws and regulations that contact revenue, expenditure, financing and other financial operations of the government. 2. Aggregate expenditure estimates Typically, a macroeconomic framework is at a very aggregate level on the expenditure side, and shows total government wages, other goods and services, interest, total transfers, and capital expenditures (by source of financing).Assumptions and underlying policy objectives therefore concern the broad economic categories of expenditures, rather than the allocation of resources among sectors. Moreover, transfers or entitlements are not reviewed in sufficient detail and assumptions on future development s are not compared with continuing commitments. Thus, when elaborating a fiscal framework on the basis of the overall macroeconomic framework, estimates of the impact of the assumptions and the aggregate fiscal targets on the composition of expenditure, by sector or economic category, are required to assess whether the fiscal targets are realistic and sustainable, and to etermine the conditions to face-off these targets. Therefore, the preparation of aggregate expenditure estimates could suffice in assessing the sustainability of expenditure policy, and thus improve the budget preparation process (notably when defining expenditure ceilings for the various sectors). These estimates could cover (i) the forward costs of large investment projects (ii) projections for the more important entitlements and (iii) aggregate projections of other expenditures, by function and broad economic category.These estimates are less demanding in terms of capacity and institutional process than the for mal Medium-Term cost Framework (MTEF) described in chapter 13, but could be a step toward the implementation of a schoolwide MTEF. Indeed, this step is authorisation if some sectoral multiyear expenditure programming exercise is carried out (covering only investment or a few sectors), to embarrass contrast between the sectoral program and the macroeconomic framework, or the crowding out of expenditure in noncovered sectors or categories.Focusing only on technical issues while neglecting the fundamental question of the division of administrative responsibility inevitably produces a weak or inoperative macroeconomic framework. Some major considerations in this respect are discussed in chapter 5. 3. Consolidating the fiscal commitments a. fashioning the macroeconomic projections public While the iterative process leading to a realistic and consistent macroeconomic framework must remain confidential in many of its key aspects, when the framework is completed it must be made publi c.The legislature and the existence at large have a right to know clearly the government policy objective and targets, not only to increase transparency and accountability, but also to reach a consensus within civil society. While such a consensus may take additional time, and require difficult debates, it will also be an invaluable foundation for the robust and effective implementation of the policy and financial program. A good example is provided by the government of Hong Kong, china, which annexes its medium-term forecast to the annual budget speech (box 16 and annex VII). stroke 16Medium-Range accounts The Example of Hong Kong, China The Medium Range Forecast (MRF) is a projection of expenditure and revenue for the forecast period based on forecasting assumptions and budgetary criteria. To derive the MRF, a number of computer-based models that reflect a wide range of assumptions about the factors determining each of the components of governments revenue and expenditure were used. As summary is shown here, a fuller definition is in Annex VII. Assumptions relating to developing expenditure and revenue forecast over the mediumterm period are the following estimated cash flow of capital projects forecast completion dates of capital projects and their related recurrent consequences in terms of staffing and running costs estimated cash flow arising from new commitments resulting from policy initiatives the expected pattern of demand for individual services the trend in yield from individual revenue sources new revenue measures in 1998-1999 In addition to these assumptions, there are a number of criteria against which the results of forecasts are tested for overall acceptability in terms of budgetary policy Maintain adequate reserves in the long-termExpenditure growth should not scale the assumed trend growth in GDP Contain capital expenditure growth within overall expenditure guidelines Revenue projections reflect new measures introduced in thi s years budget To summarize, the MRF of Hong Kong is shown below (in $Hk beation) 1998-1999 Revenue 192,680 Expenditure 182,480 Surplus 10,200 congeries public expenditure 288,890 Gross domestic product 1,497,880 Growth in GDP (nominal) 12. 9 (real) 5. 0 Public expenditure as a percentage of GDP 19. 3 Forecast years 1999-2000 2000-2001 211,390 242,900 200,740 227,830 10,650 5,070 315,830 354,060 1,690,740 1,908,420 12. 9 12. 9 5. 0 5. 0 18. 7 18. 6 2001-2002 271,330 258,570 12,760 393,980 2,154,130 12. 9 5. 0 18. 3 reference point Medium Range Forecast of Hong Kong, The Internet, August 8, 1998. In some countries, government projections are submitted to a panel of nonsymbiotic and respected experts to ensure their reliability, while preserving the confidentiality required on a few rude(a) issues. In other countries, the projections are pass by the Auditor General (e. g. , the joined Kingdom and the Canadian province of Nova Scotia23).The liberty of the Auditor General adds cr edibility to the projections. However, any other form of participation of audit offices in the budget formulation process would be questionable. In any event, usage and alteration of forecasts would soon reduce the governments credibility and hence its influence. b. Binding fiscal targets? several(prenominal) countries have laws and rules that restrict the fiscal policy of government (fiscal rules). 24 For example, an earlier golden rule stipulated that public borrowing must not exceed investment (thus mandating a current budget balance or surplus).In some cases, the overall budget must be balanced by law (as in subnational government in federal countries). In the European Union, the Maastricht agreement stipulates specific fiscal convergence criteria, concerning both the ratio of the fiscal deficit to GDP and the debt/GDP ratio. (The former has been by far the more important criterion. ) One frequent criticism of such rules is that they favor fanciful accounting and encourage non transparent fiscal practices. When they are effectively enforced, nondiscretionary rules can also prevent governments from adjusting their budgets to the economic cycle. 5 Aside from the special case of European integration, one may generally consider that, in countries with fragile coalition governments, fragmented decision making, and legislative committees acting as a focus for periodic bargaining, setting up licitly binding targets may be appropriate. In other countries, however, binding targets could in effect predetermine the budget before its preparation even begins. 26 In contrast with an approach based on inflexible targets, other countries (e. g. , New Zealand) do not mandate specific fiscal targets, but refer to criteria such as provident levels and reasonable degrees.It is left to the government to specify the targets in a compute constitution Statement, which presents total revenues and expenses and projections for the next three years. This bidding is published at least three months before the budget is presented to Parliament, and is reviewed by a Parliament committee but not formally voted by Parliament. 27 Box 17 The New Zealand Fiscal responsibility Act Enacted in 1994, the New Zealand Fiscal Responsibility Act offers a comprehensive legal framework for formulation and conducting fiscal policy in general, and for incorporating a long-term orientation in the budget process in particular.While many OECD countries have similar practices in place, the Fiscal Responsibility Act is an example of these practices being enacted into law. The primary objective of the Fiscal Responsibility Act was to fasten sound fiscal policies and make it difficult for future governments to deviate from them. There are two provisions of the Act (i) a regime for setting fiscal objectives that focuses attendance on the long term and (ii) an massive system of fiscal reporting with rum mechanisms to ensure its credibility and integrity. The extensive reporting r equired by the act serves two purposes.First, it serves to monitor the consistency of the governments fiscal actions with its stated fiscal objectives. Second, it brings general transparency to government finances by mandating the disclosure of all relevant fiscal information in a well-timed(a) manner. The act requires two specialized reports the Fiscal Strategy Report and the PreElection Economic and Fiscal update. The Fiscal Strategy Report, which is presented to Parliament along with the budget, assesses the consistency of the policy framework contained in the budget with the short-term fiscal intentions and long-term fiscal objectives outlined in the calculate Policy Statement.The Pre-Election Economic and Fiscal Update contains the threeyear forecasts of all key economic and fiscal variables. Both reports contain two statements of responsibility, one by the Minister of Finance and one by the Secretary to the Treasury (a civil servant). These statements of responsibility aim t o clarify the roles of politicians and civil servants in producing reports and give a greater role to civil servants in producing them, thereby increasing the overall credibility of the reports. Source Budgeting for the future, OECD working paper, 1997.More important than specifying ex-ante targets and general criteria is to ensure that institutional arrangements and processes favor coherence among resource constraints, fiscal objectives, and expenditure programs. This broader issue involves the mechanisms for policy formulation, the budget preparation process, the role of the Ministry of Finance in budgeting, and the development of appropriate instruments for reviewing expenditures within a longer period than the annual budget. Box 18 A heartfelt Macroeconomic Coordination Practice The Gang of quadruplet in Siameseland The Thai system of budgeting is exceedingly centralized.It embodies a longstanding set of arrangements, rules, and procedures that unneurotic help exert discipl ine on aggregate fiscal management. It grants very little autonomy to line agencies over their budgets, and imposes weak accountability on them for their performance. The hallmark of the Thai budgeting system is aggregate fiscal discipline. A gang of four interacts to control the level of spending and thus the deficit the issue Economic and Social Development be on (NESDB), the Ministry of Finance (MOF), the Bank of Thailand (BOT), and the Bureau of the Budget (BOB) in the Prime Ministers Office.The gang of four is responsible for formulating the macroeconomic framework that serves as the basis for the aggregate expenditure ceiling. It also determines for the most part the ministerial ceilings. Prioritization is largely a function of the gang of four. It ensures that the budgetary requests of line agencies are consistent with the objectives of the five-year development plan. The gang of fours control over aggregate allocations to agencies and to expenditure categories implies that it exerts considerable leverage over priority setting.In Parliament, the Budget Scrutiny committee chaired by the Minister of Finance evaluates the governments proposal. Cabinet members can propose amendments to the governments proposal but seldom make significant changes in allocations to line agencies because of limited technical susceptibility to evaluate such proposals. Politicians can alter the allocation of line agencies. After a series of deliberations and negotiations, the committee submits the budget bill to Parliament. The Parliament almost always accepts the bill.Source Campos and Pradhan, budgetary institutions and expenditure outcomes, 1996. 4. Policy formulation a. vastness of policy formulation The budget preparation process is a powerful tool for coherence. The budget is both an instrument of economic and financial management and an implicit policy statement, as it sets relative levels of spending for different programs and activities. However, policy decision ma king is intricate and involves different actors in and outside the government.It is a technocratic illusion to embed all policy formulation within the budget process (as to some extent was the ambition of the PPBS see chapter 3). However, a coherent articulation should be sought between the policy agendum (which should take into account economic and fiscal realities) and the budget (which should accurately reflect the governments policy priorities). The budget process should both take into account policies already formulated and be the main instrument for making these policies explicit and operational. However, policies must be defined outside the pressure of the budget process. Making policy through the budget would lead to a focus only on short-term issues and thus to bad policy, since the policy debate would be invariably dominated by immediate financial considerations. (This is frequently the infelicitous outcome in developing countries with weak capacity faced with financial difficulties. ) In earlier times, medium-term development plans were intended as the instrument for setting up government strategy. However, these plans were rigid, invariant, and usually out of sync with financial realities.Paradoxically, therefore, they indirectly led in practice to the same dominance of short-term financial considerations. Organizational arrangements are discussed in chapter 5. b. The policy-budget link A bridge between the policy making process and the budget process is essential to make policy a breathing reality rather than a statement of wishes. For this purpose at least two clear rules must be established. 28 The resource implications of a policy change should be identified, even if very roughly, before a policy decision is taken.Any entity proposing new policies must quantify their effects on public expenditure, including the impact both on its own spending and on the spending of other government departments. The Ministry of Finance should be consulted in good time about all proposals involving expenditure before they go into ministerial committee or to the center of the government and certainly before any public announcements are made. in spite of appearance the budget formulation process, close cooperation between the Ministry of Finance and the center of government is required, at both the political and the technical level.The role of the center is to ensure that the budget is prepared along the lines defined to arbitrate or smooth over conflicts between the Ministry of Finance and line ministries and to assure that the relevant stakeholders are appropriately involved in the budget process. (This is a major challenge, which can only be mentioned here but requires care and commitment on a sustained basis. ) An interministerial committee is needed to tackle crosscutting issues and review especially sensitive issues.And, most importantly, each entity involved in the budget process must perform its own role in a responsible fashion, and be given the means and capacity to do so. c. Reaching out The importance of perceive Consultations can strengthen legislative exam of government strategy and the budget. Legislative hearings through committees and subcommittees, particularly outside the pressure environment of the annual budget, can provide an effective mechanism for consulting widely on the justness of policies (issues related to the role of the legislature are discussed in chapter 5) .The government should try to get feedb