FOR OFFICIAL USE ONLY

EAST AFRITAC (IMF)

Improving Cash Management in Kenya

Allan Gustafsson Mohan Joseph

March, 2009

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Table of Contents

I. Executive Summary................................................................................................................4

II. Introduction ...........................................................................................................................6 A. Terms-of-reference ................................................................................................................7 B. Execution of mission .............................................................................................................7

III. Elements of good cash management....................................................................................7

IV. Banking arrangements .........................................................................................................9 A. PRESENT SITUATION ..............................................................................................................9 B. PROPOSALS FOR IMPROVEMENT...........................................................................................13

V. IFMIS and cash management..............................................................................................16 A. PRESENT STATUS..................................................................................................................16 B. PLANS...................................................................................................................................17 C. IMPACT ON CASH MANAGEMENT .........................................................................................19

VI. Complementary reforms ....................................................................................................19

VII. Next Steps.........................................................................................................................20

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Abbreviations and Acronyms

AccGen Accountant General’s Department, MoF AIA Appropriations in Aid AIE Authority to Incur Expenditure BMD Budget Monitoring Department, MPND BSD Budget Supplies Department, MoF CAG Controller and Auditor General CBK Central Bank of Kenya CFS Consolidated Fund Services ERN Exchequer Release Notification GITS Government Information Technology Services, MoF GOK Government of Kenya IFMIS Integrated Financial Management Information System KCB Kenya Commercial Bank KRA Kenya Revenue Authority MFAD Monetary and Fiscal Affairs Department, MoF MoF Ministry of Finance MPND Ministry of Planning and National Development NBK National Bank of Kenya PFA Public Finance Administration PFM Public Financial Management PMG Paymaster General TSA Treasury Single Account

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I. EXECUTIVE SUMMARY

Cash management reforms in the Government of Kenya (GoK), which started in 2005, with assistance provided by East – AFRITAC (AFE), has been moderately successful. The reforms were aimed at establishing a Treasury Single Account with idle amounts of cash sitting in the Central Bank or commercial bank accounts swept back daily into a Treasury Funding Account at the Central Bank of Kenya (CBK). Because of legal constraints it has not been possible to implement such a mechanism. On the other hand, good progress has been made in strengthening central government cash flow planning.

Three main weaknesses remain in the Kenya public sector cash management:

• Substantial idle balances in government accounts in the CBK, commercial banks, and in donor accounts in commercial banks;

• Unnecessarily high costs of payment services;

• Lack of mechanisms and instruments to meet fluctuations in the Government’s aggregate cash needs;

Data provided by CBK on the balances in the different Government bank accounts in CBK show that while, the Government generally runs an overdraft (during the last six years fluctuating between Ksh. 0 and 15 billion, the net balance of all accounts is always positive and substantial. During these same six years the net balance has varied between 16 and 42 billion. During 2008, the average balance was Ksh.37.6 billion. At the same time, the Government has an outstanding internal debt on which it pays market interest rates. If the opportunity cost of the net balances in the Government accounts is calculated at 9 percent, which is the average interest rate of recent T-Bond and T-Bill issues, the opportunity cost of the net (idle) balances of the Government accounts in CBK amounted to some Ksh 3.4 Billion in 2008. The mission could not obtain complete information on all idle balances in government bank accounts in commercial banks. However, data that was provided for two of the banks indicate that these balances are substantial. In KCB and NBK alone the idle balances appear to hover around Ksh 20 billion. If an interest rate of 9 percent, the average of the returns on recent issues of T-Bills and T-Bond, is used, the effective yearly cost to Government amounts to some Ksh 1.8 Billion.

The greatest improvement in cash management – meaning the greatest reduction in the cost of providing liquidity to execute the Government’s expenditure programme – will come from reducing, and eventually eliminating these idle balances, in government accounts in the CBK and in the commercial banks.

The full roll-out of the IFMIS will be the main instrument to make this happen. After full roll-out, it will be possible to initiate nearly all payments from IFMIS and execute them by way of instructions issued to the CBK to pay directly to the payees account in a commercial bank. Funds for these payments could be drawn from a single Exchequer

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Account. There will thus be no need for ministerial accounts, neither in CBK nor in commercial banks1.

In the interim, i.e. until that time when all public institutions including in the districts are online to IFMIS, the Government should explore the possibility of organising government accounts in commercial banks into notional group accounts also known as notional cash pools. One sub-account in the group would hold the bulk transfers from the Exchequer Account while the other sub-accounts would be used for payments recorded as credits up to a credit limit established by Treasury. The government’s position vis-à-vis the bank would be the net of the negative and positive balances in all sub-accounts. This type of arrangement could, particularly when execution is uneven over time or over activities, as in the development budget, reduce the balances held in the commercial banks quite substantially.

At present all payment services provided by the commercial banks to the government are (with some minor exceptions) paid for through float. Commercial banks gain by investing the money in transit, while it is a cost to Government, as it has to borrow the corresponding amount in the market.2 Floats exist for to-flows and out-flows. It has not been possible, for the purpose of this mission, to estimate the full indirect cost to the government of these floats for lack of data on the outflows. However, just the yearly cost of the present arrangement by which revenue collections through the banks is transferred to CBK only every other day can be estimated at some Ksh 135 million. ( Pl see Table 1 on Page 9 ) In addition there will be floats within the banks as deposits made in outlying branches are transferred to the central KRA account in each of the three KRA partner banks.

It is not totally impossible, however, to estimate these costs, and the government should endeavour to do so and compare them with the likely total cost of fee-based remunerations. In this context, it should be noted that large corporate clients using the services of the same banks as the government, have moved to such models. It should also be noted that banks may be willing to absorb a loss in providing the actual payment service, provided that it is compensated by the auxiliary business generated by having government payments passing through the bank.

At present contractual matters pertaining to payments are for all practical purposes the responsibility of individual ministries and accounting officers. To achieve the best leverage vis-à-vis the banks, invitations to tender, negotiations, and eventual contracting for the provision of all banking services, should be centralised through the Treasury.

Fluctuations in the Government’s consolidated cash needs are today met through an overdraft facility in the central bank. Such an arrangement is not really desirable from a macroeconomic perspective, thus the present limit on the facility, and ought to be eliminated. The ultimate objective should be to develop an integrated debt and liquidity management function so that the consolidated government cash position can be brought to zero every day. This requires developing appropriate short-term market instruments such as repos, and mechanisms for trading in them. 1 Save perhaps for some petty cash accounts. 2 To be concrete: the banks can use the float to buy T-bills and T-bonds, the latest issue paying 12.5 percent.

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As pointed out above, the full roll-out of the IFMIS will bring with it substantial reductions in the cost of liquidity and is thus one of several reasons why it is very much in the interest of the Government’s to ensure that it is done quickly and successfully. This roll-out should also include the remaining core models, Public Sector Budgeting (or the Hyperion version of it), Accounts Receivable and Cash Management and eventually also Projects. The Cash Management module is important not only because of its automatic bank reconciliation functionality, but also because it can extract data from all modules to be used for cash forecasting, at whatever level of detail.

The major constraint to speedy and successful roll-out of the system to all remaining central MDAs and to the districts is probably the central implementation team. At present it consists of a mere thirteen, albeit competent, professionals. Some of the tasks can be outsourced but it is imperative that the government ensures that the central team is adequately staffed to be able to play the necessary strong co-ordinating role.

II. INTRODUCTION

East AFRITAC has since its inception provided technical and capacity building assistance to the Treasury of GoK, particularly to the Accountant General’s office, in the development of the cash management function. In July 2004, assistance was provided to design a cash flow planning system, and to review banking arrangements. In succeeding years, this assistance was followed by several capacity building efforts. Over this period a number of other reforms of public financial management have been implemented, notably the introduction of a revised budget classification and the gradual roll-out of an Integrated financial management system (IFMIS). The system captures approximately sixty percent of total budget appropriations. Donor project accounts are not captured in the IFMIS at present, however. The initial roll-out is limited to the General Ledger, Purchasing, and Accounts Payable modules. More background information on the IFMIS is provided in Section V of the report.

In regard to cash management, improvements have been hampered by legal constraints that have impeded the implementation of the proposals on banking arrangements elaborated in 2004.

On the other hand, good progress has been achieved in strengthening central government cash flow planning.3 Funds are released by the central government to districts and other service delivery levels, such as schools, in a reasonably timely manner. Commitment control is prescribed under the current legal framework, and is generally followed at the central government and district levels. The Treasury’s G-Pay is to be introduced shortly to enable line ministries to effect electronic payments directly to the bank accounts of suppliers of goods and services. The system is presently undergoing testing, after which it is expected to be initially pilot-run in a few ministries, pending full roll-out to all ministries. Its introduction will reduce significantly the usage of cheques by line ministries, facilitate bank reconciliation, reduce the problem of cheque floats, and eventually lead to the elimination of idle bank balances. It has also been decided by the authorities that from July 1, 2009, payment amounts 3 The draft PEFA Report of 2008 accords an A rating to cash flow planning.

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above Ksh 1 million will be effected through electronic payments, using the RTGS facility and not by cheques.

A. Terms-of-reference To take forward further reforms to cash management, AFE was requested to assist the authorities with a fresh review of banking arrangements and an evaluation of the cash-planning module of the IFMIS.

The tasks established for the mission were to: review the Government’s policy, strategy and progress in regard to implementing a Treasury Single Account; review public sector use and cost of banking services, including the use of auto-sweeps, and assess the potential for improving on the cost effectiveness of such services; review and propose improvements in the structure and flow of funds through the Government bank accounts in Central Bank of Kenya and its interface with the banking sector; provide a conceptual framework for quantifying the opportunity cost of idle bank balances and other non-optimal cash management arrangements; review the present and potential use of the cash-planning module of the IFMIS and propose a strategy forward.

B. Execution of mission The mission was carried out between March 2 and March 9, 2009 by Mr. Allan Gustafsson a member IMF’s Panel of Fiscal Experts, accompanied during the first three days by Mr. Mohan Joseph, Public Financial Management Advisor, IMF- East AFRITAC.

The key counterparts to the mission were Mr. Joseph Kinyua, Permanent Secretary to Treasury, Mr. Michael Gatimu, Accountant General and Mr. M.A. Ogolla Chief Accountant. Special thanks to Mr. Ogolla without whose deep knowledge of the subject and good support provided to this mission, this report would not have been possible.

A list of officials met by the mission is appended.

ELEMENTS OF GOOD CASH MANAGEMENT The ultimate objective of government cash management is to minimize the cost of liquidity necessary to execute the government’s expenditure programmes.

Good cash management requires efficient processes in a number of complementary areas:

Budgeting and budget execution

• An efficient budgeting process so that the execution of the budget can commence on the first day of the budget year, plus;

• Efficient processes to authorise agencies to incur expenditure in sync with their operational needs and within the constraints set by the yearly budget ceilings, in order to achieve as steady as possible execution of the consolidated budget during the fiscal year ;

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Revenue collection

• Taxation and other revenue collections organised in such a way, that it results in as steady as possible flow of revenues during the year;

Government borrowing

• Integrated management of long- and short-term borrowings so as to meet, in the most cost efficient manner, long-term financing needs, as well as, short-term liquidity requirements and fluctuations;

• The availability of appropriate instruments in the market (repos etc.) so as to be able to flexibly (=daily) adjust the government’s consolidated cash position;

Forecasting

• Good forecasting capabilities to facilitate government long, medium, and short-term borrowing;

National payments system

• Efficient payments system so as to minimize the actual, and systemic costs of payments;

Intra-government cash management

• Centralised cash management aimed at eliminating idle pools of cash sitting in the central bank, or in bank accounts in commercial bank;

• Appropriate procurement, contractual and remuneration models so as to minimize total explicit or hidden costs of the flow of cash through the banking system.

This report focuses on intra-government cash management and on forecasting but will if necessary and as appropriate comment on the other areas to the extent that they have a bearing on the focus areas.

The cost of intra-government cash management is a function not only of banking arrangements, but also depends on budget execution systems including the execution of payments. In the Kenyan context, it is very much influenced by the implementation of the IFMIS system.

The discussion that follows is therefore structured along these two lines. The first half of the report discusses existing banking arrangements, and concludes with recommendations on how banking arrangements can be developed in the long-run when the IFMIS is fully rolled out, and in the interim, awaiting full implementation. This section also contains a section on legal issues as there will be a need for changes to the PFM legal framework to facilitate changes in banking arrangements, and for the full potential benefits of IMFIS to be exploited.

The second half of the report focuses on the IFMIS: its present implementation status, plans, and constraints. It also contains an assessment of the usefulness of implementing the Cash Management module.

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III. BANKING ARRANGEMENTS

A. PRESENT SITUATION The costs of intra-government cash management are determined by the direct and indirect costs of transactions associated with the to- and outflows of cash and the opportunity cost of idle cash balances along the way. To-flow The following table shows the tax revenue to-flows to government, during the period July 2008 to February 2009.

Table 1 Collection of tax revenue through the banks

Category Ksh Monthly Revenue Collected DTD 180 378 438 376 CSD 119 579 052 465 RTD4 1 596 775 417 Total Revenue Collected by KRA 301 554 266 258 Less: Cash office collections DTD 47 491 134 907 Cash office collections RTD 860 576 384 Total Cash office Collections 48 351 711 291 Net Collections through Banks 253 202 554 967 Average monthly collection 31 650 319 371 Average cash in top account 1 507 158 065 Yearly implicit interest cost to government at 9% 135 644 226

Source: KRA

Three banks are used as conduits for tax payments: Kenya Commercial Bank, National Bank, and Cooperative Bank of Kenya. With all of them it has been agreed that the balance in the top account is swept to CBK every other day. That means that there is an average balance in the top accounts equal to one day’s collection. The opportunity cost of this calculated at the interest rate paid on overdraft in CBK is approximately Ksh 136 million a year.

In addition, there is money in internal transit from the time it has been deposited into one of the branch offices. Presuming that this transit time is another day, the total float would amount to 48 hours. The implicit yearly interest cost of this to the government calculated at the rate of 9 percent (the average rate for recent bond issues) is some Ksh.270 million. At the rate of the latest bond issue, 12.5 percent, the cost is some Ksh. 377 million..

4 DTD = Domestic Taxes Department, CSD = Customs Services Department, RTD = Road Transport Department

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In addition to the tax revenues collected by the Kenya Revenue Authority (KRA) there is non-tax revenues, some of it substantial, collected by other MDAs such as Immigration. Balances in the Central Bank The following table shows the balances in different government bank accounts, as of December 31st 2008.

Table 2 Balances in the Government bank accounts in CBK, December 2008

(in million Ksh.) PMGaccount 2536,03TreasuryFundingA/C 24441,48Tbondissues 1108,31T/billissues ‐Overdraft ‐15092,90Exchequer 6105,08Suspenseaccount 0,03Total 19098,03

Source: CBK

It is important to note that in the same month, government had an overdraft of Ksh 15 billion, while there were positive balances to the extent of Ksh.34 billion in other Government accounts. The Government currently pays nine percent interest on the overdraft, while its positive balances are un- remunerated.

This arrangement thus results in a budget outlay, which, in part, is compensated through the yearly “dividends” paid by CBK to the Government.

More important, however, is the opportunity cost of the net balances.

Table 3 below provides the average (nominal) net balances in these accounts for the six-year period 2003 – 2008. It would be seen from the Table, that 2008 is not an exception; the Government has consistent positive net balances in its accounts in CBK. At the same time, the Government holds a stock of internal debt on which it pays interest. This stock is greater than would be necessary if the Government were able to adjust its end-of-the day cash balance so that it is always zero. Applying a rate of 9 percent (the average rate paid on T-bonds and T-bills issued in recent times) to the average balance of 2008 implies that the (hidden) cost to Government of these positive balances in 2008 amounted to approximately Ksh 3.4 Billion. At the exchange rate prevailing on March 20th, 2009, the amount is approximately USD 42 million.

Table 3 Average net balances 2003 - 2008, Ksh Million

2003 2004 2005 2006 2007 2008Net 25562,81 16068,62 20787,10 34181,41 42059,40 37550,76

Source: CBK

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The graph below shows the variation of net balances over the year for these same accounts. The pattern in monthly fluctuations is not very clear, except for a tendency for the balances to peak in June. To fully explain these fluctuations and the lack of a clear pattern would require examining the different decisions which influenced these balances – decisions on release of funds to line ministries, and the issuance of T-bonds and T-bills. What the irregular pattern does suggest is that there is no well-established mechanism for projecting needs, releasing funds and issuing short term debt instruments. In other words, these decisions seem to be made in a rather ad hoc manner. Figure 1 Monthly net balances in Government accounts in CBK 2003 – 2008

Source: CBK What the graph does show is a weakness in the Government’s capacity to adjust liquidity in the short term so as to match the cash needed to execute the budget and/or to match the release of catch to available liquidity.5 Outflows As regards outflows, there is presently no uniform system of transferring funds and making payments. As regards payments by MDAs connected to the IFMIS, they will

5 The best solution is, of course to match liquidity to needs, rather than the opposite, as long as budgetary constraints are respected.

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shortly be made in the form of direct credits to bank accounts of suppliers, and to the bank accounts of employees.6

In respect of payments by and to entities not connected to IFMIS, accounting officers are presently free to select which banks to use, provided that the Accountant General approves it. There is no centralised procurement of payment and other banking services but some ministries have signed agreements with one or several banks. Ministry of Education, for example, has negotiated and signed MoUs with fourteen commercial banks in which educational establishments falling under the Ministry can hold banks accounts and through which payments are channelled.

Non-salary recurrent expenditure is paid out to the schools twice a year. Ministry of Education issues a global cheque to Standard Chartered Bank, which then re-distributes the money to the schools’ respective bank accounts in one of the fourteen banks. Presently 3 billion Ksh is transferred each time. In the MoUs between Ministry of Education and their partner banks, it is stipulated that the delay between the time the bulk cheque has been deposited with Standard Chartered and the time the money hits the individual bank accounts, must not exceed two days. It is unclear whether other ministries have entered into similar MoUs with other commercial banks engaged.

A common feature is that the banks do not charge any fees on transactions but also do not pay any interest on deposits. No use is made of autosweep, autocover or group account / cash pool facilities offered by commercial banks to their corporate clients. The potential for using such facilities to reduce the cost of cash is discussed further on in the paragraphs on interim arrangements in the section on proposals for improvement.

Idle balances in commercial banks All transfers to Ministry units operating in districts end up in bank accounts of commercial banks and all payments by these entities are made from these accounts. But the modalities in terms of the frequency of the transfers vary from ministry to ministry. Spending patterns are also likely to differ between ministries.

In the case of Ministry of Education, the half-yearly releases should in principle imply that the average balance in the account is Ksh.1.5 billion, which if using an interest rate of nine percent would amount to a yearly interest cost of Ksh 450 million. In practice the average balances are not of this magnitude. Much of the educational material has to be purchased at the beginning of the semester, thus the expenditure pattern is frontloaded. Furthermore, the materials are often delivered on credit. (This does not mean, however, that there are no unavoidable cash costs associated with this procedure. Credit is compensated through higher prices, which for this purpose should be treated as a cost of cash.)

Some data on the balances in two of the most important partner banks, the Kenya Commercial Bank and National Bank of Kenya were provided late in the mission. See table 4.

6 This form of payment was to have been in operation at the beginning of 2009 but due to delays in the supply of some equipment, it has been delayed.

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Table 4 Balances in KCB and NBK

Bank Date Ksh Kenya Commercial Bank 28/2/2009 13 399 478 938 National Bank of Kenya 1/1/2009 6 764 266 000 Yearly interest cost to Government at 9 % 1 814 737 044

Source: Treasury

If it is assumed that these figures correspond to the average balances over the year, opportunity cost of these balances amount to some Ksh 1.8 Billion.7

It should be remembered that, while the KCB and the NBK are two of the three largest commercial banks used by the Government, there are large number of other banks that are also used. Data from those banks were not available at the time of the mission. It has thus not been possible to estimate the total volume of idle cash balances in government accounts in commercial banks. With some effort that data can, however, be collected and the Government should do so.

B. PROPOSALS FOR IMPROVEMENT Idle balances The full roll-out of the IFMIS in terms of its institutional coverage as well as in terms of functionality will allow a dramatic improvement of government cash management. When all public institutions are on-line to the IFMIS, all payments can be executed as instructions to the Central Bank to pay directly into the bank accounts of the final recipients, be it a supplier, a government employee or a public institution for its petty cash needs. (The IFMIS and the roll-out of it is discussed in greater detail further below.)

In this situation there will no longer be a need for the present separate ministerial accounts in the CBK. All payments would be drawn directly on the Exchequer Account which would be a truly single treasury account.

There will thus be no idle cash balances sitting in ministerial repository accounts in CBK or in bank accounts in commercial banks.

The cost of the services of the commercial banks Presently the commercial banks providing payments services to the government gain from 1) the use of idle balances in government bank accounts, 2) the float on the transactions, and 3) auxiliary business generated by the contacts that tax payers, suppliers and government employees have with the government partner banks.

With the full implementation of direct payments generated in IFMIS and executed by CBK, the gains derived from using idle balances in government accounts will largely disappear.

7 This sum should not be added to sum in Table 1 as there would some overlapping and thus double counting.

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Remains the float and auxiliary business as potential sources of revenue. Floats have the advantage to commercial banks of not being very visible. That may, on the surface of it, also be seen as a positive thing by the government because funds do not have to be appropriated to cover the cost of these services. In reality this form of indirect payment may turn out to be considerably more expensive to the government than service fees, or some other appropriate basis.

It is worth noticing that corporate clients of the same banks that the government uses for payment services have opted for fee-based remuneration, rather than float. One of the banks informed the mission that the amount was Ksh 40 – 150 per transaction, the higher the number of transactions, lower the price.

For lack of data it has not been possible to make any estimation of the volume and thus the cost of the present float for outgoing payments.

The government should, however, endeavour to estimate these costs and compare them to different possible scenarios based on fee-based remunerations. When making such estimates it should be taken into consideration that banks may be willing to absorb a loss in providing the payment service, provided that it is made up by the auxiliary business generated by having government payments passing through the bank.

Improvements in the interim

Until the IFMIS is fully rolled out to the districts it will not be possible to fully eliminate idle balances in government accounts in commercial banks. The costs of these balances can be reduced, however, through centralised procurement of the services provided by the banks and by requesting that the banks that are used as conduits for government funds provide group account / cash pool services.

There are two types of group accounts: one type where funds in sub-accounts are physically swept to a top account and payment needs covered from that top account as required; and another type where balances – positive or negative – are left in their respective accounts, but interest is calculated on the net balance of the entire group.

It was the first type of structure that was suggested in East AFRITAC’s report of December 2004 for the Government’s accounts in CBK. The proposal was never implemented, because of a legal constraint: once the funds were released to an Accounting Officer, he is, per the present legislation, fully responsible for them and the money cannot be swept back to a top account by, in this case, the Accountant General.

The same legal constraint would apply to the first type of group account in a commercial bank, unless the law is amended, or replaced by the content of the PFA Bill,. A way around this problem would be to instead make use of the second type of group account.

The accounts of a ministry’s district entities would be set up as sub-accounts of the central ministry’s account in that particular bank. The sub-accounts would be set up as accounts with overdraft facilities.8 The overdraft limit would be set by the Exchequer

8 One possible legal snag may be that the provision in the present Government Financial Management Act, 2004 which states that “no bank shall allow a bank account for government purposes to be overdrawn”. However, if it is a group account that is seen as the actual account, and the others as memo accounts, it should be possible to legally justify such a setup.

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Release Notification (ERN); using the vocabulary of the PFA Bill. Funds would be transferred from the Exchequer to the one sub-account of the group, at appropriate intervals depending on the nature of the operations, so as ensure that net balance in the group account never falls below zero. The balance in all sub-accounts would at the end of the control period (defined by ERN or its equivalent) be set to zero through transfers from the top account. At years-end, any remaining balance in the latter would be returned to the Exchequer.

This type of arrangement could, particularly when execution is uneven over time or over activities as in the development budget, reduce the balances held in the commercial banks quite substantially.

To achieve the best leverage vis-à-vis the banks, the invitation to tender for and eventual contracting for the provision of banking services should be centralised to the Treasury. LEGAL AND PROCEDURAL ISSUES

The present PFM legal framework, in the ultimate instance, puts the onus of financial control on the control of the cash. The crucial step is the withdrawal of funds from the Exchequer Account (holding the Consolidated Fund). By whom this is authorised (the CAG) and under what conditions (an Act appropriating amounts) is regulated in sections 14 – 16 in the Government Financial Management Act, 2004.

The Public Finance Administration Bill, 2008 which has yet to be presented to Parliament changes that in a subtle way. The control chain proposed in the latter is: Parliament approving appropriations ⇒ CAG issuing a Grant of Credit9 ⇒ the Minister responsible for Finance issuing a warrant ⇒ Accountant General issuing an Exchequer Release Notification (ERN).

The important novelty in the proposal is the nature of the Exchequer Release Notification, which despite its name is a budgetary control rather than a cash control instrument. It “authorises an accounting officer responsible for an expenditure vote to incur expenditure on such expenditure vote up to the limits specified in the Exchequer Release Notification, and for the purpose and subject to the conditions contained in the Exchequer Release Notification”10.

Such a change of the PFM legal framework is necessary if, in future, payments are to be made directly from the IFMIS system by way of instructions to the CBK to pay directly to the final payee. It is obviously not feasible for the Accountant General to release funds (=cash) for every single payment, which, presumably would be necessary with the present legislation.

The Bill does not specify with what frequency ERNs are to be issued. That is an advantage because it allows the Accountant General to tailor releases in a way that encourages responsible behaviour by the MDAs. Those that execute their work

9 One may question the need and appropriateness of this step in the authorization chain. It would appear that the CAG’s role has an in-built conflict of interest, which is to audit what it has authorized at the budget execution stage. The government may wish to consider whether the CAG’s office should be associated in the authorization of payments process, or should it focus its attention with the audit function alone. 10 Section 23.(1)

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programme as planned without running up any arrears at the end of the year would gradually have ERNs issued for longer and longer periods; three months, six months, and eventually possibly for the entire year. The frequency of the ERNs can also be reduced as the Treasury together with CBK develops the mechanisms for adjusting liquidity through continuous operations in the market for short-term financial instruments.

As worded, it gives the Accountant General the authority to exercise extraordinary budgetary control. It cannot be called “cash rationing” as what is controlled is not the cash but the AIE, but the effect is the same. Such powers may be necessary to deal with sudden external shocks, but in normal, stable circumstances, the Accountant General could issue ERNs for a quarter, half a year or even a full year. Any necessary changes in the volume and distribution of public spending would be handled through the budget process by way of supplementary estimates. A presumption is of course that MDAs generally act responsibly and do not recklessly overspend at the beginning of the year using political blackmail to increase their appropriations for the latter part of the budget year. To contain that, the issue of ERNs could be tailored to the performance and demonstrated responsibility of different sectors and MDAs.

The nature of the ERN – being a budget rather than a cash control mechanism – also eliminates11 the legal impediment to putting in place a group account structure in which any balance in a sub-account is swept at regular interval (for example daily) to a top account and sub-accounts are automatically covered as necessary to meet ordered payments. With all MDAs connected to the IFMIS such a group account is not strictly necessary. All payments can be drawn directly on the central Exchequer Account. However, if not or until, all MDAs are connected, the proposed PFA Bill should eliminate the legal impediment to such a arrangements in commercial banks, which, as discussed above, would reduce idle balances and thus cash management costs.

IV. IFMIS AND CASH MANAGEMENT

The Kenyan Government, in 2003, initiated the implementation of a government-wide Integrated Financial Management Information System. The platform adopted is Oracle Financials, which has been slightly modified to meet procedural requirements specific to the Kenya public sector.

A. PRESENT STATUS System functionality and institutional and geographical coverage

Of the full suite of modules that make up Oracle Financials, three have so far been implemented: General Ledger, Accounts Payables and Purchasing.

These three modules have been rolled out to all central ministries and government bodies with the exception of Ministry of Defence, National Security Intelligence Agency and the Anti-corruption Commission. This coverage implies that some 90 percent of all central MDAs and approximately 60 percent of the budget is managed and accounted for through the system. Data from the manual cash books kept at institutions not linked up is

11 Presuming that the eventual PFA Act takes precedence over any other legislation that may contradict it.

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uploaded into the IFMIS in order to be able to produce consolidated government accounts. The current fiscal year 2008/9 will be the first year that these accounts will be produced from the IFMIS. Problems

As with any implementation of a major system like the IFMIS, the roll-out of Oracle Financials has not been without its snags. One major problematic area has been with connectivity. Initially the band-with was much too limited to support such a demanding application. With the installation of fibre-optics cables to connect the majority of central MDAs this problem has been reduced. Some installations, notably Ministry of Health however continue to suffer from frequent and long down-times, for reasons that have mostly been related to their respective local networks.

Security in terms of back-up facilities has been shaky but fortunately there has not been any major disaster. This problem is now being rectified with the setting up of an off-site back-up facility.

The system itself has experienced problems in a few report templates. And the fact that the entire suite of modules has not yet been rolled out, has limited the functionality of the system and the possibility of easily extracting from the system all information required for purposes of reporting.

Capacity building has been another problematic area. Training has not always been well synchronised with the roll-out of the system and capacity has thus been lost due to high attrition rates and people simply forgetting what they have learnt. The lack of operational manuals containing adequate information on the operation of the system has placed a lot of pressure on MDA staff, often to the detriment of their day-to-day work.

Notwithstanding the problems encountered, it is unquestionable that the introduction of IFMIS has led to major improvements to financial management. Most importantly perhaps, the reduction of pure manual work has allowed more time for analysis of accounting data.

B. PLANS Roll-out

The intention is to eventually roll out the IFMIS to all central MDAs and to all districts. The latter has become a much more challenging task with the proliferation of districts in recent times. The number of districts at present stands at 181 and rising, up from 71 at the beginning of 2007.

Implementation of new modules

As regards the other modules of the Oracle suite, the intention is to implement Accounts Receivables, the Public Sector Budgeting, the Cash Management and possibly the Project modules sometime during the next fiscal year beginning July 2009. The question whether the Public Sector Budgeting modules should be replaced by the more advanced Hyperion budgeting tool (acquired by Oracle and integrated into the OF suite) has not been fully settled.

Constraints

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The major constraint to speedy and successful roll-out of the system to all remaining central MDAs and to the districts is probably the capacity of the central implementation team.

At present it consists of a mere thirteen, albeit very competent, professionals. This team is required to manage the physical roll-out, responsible for testing and implementation of the new modules, manage the contracts with implementing partners, serve as a help-desk for existing installations, co-ordinate and partly provide training, and, for the time being, handle some operational tasks such as uploading and checking district cash-book data and producing reports.

The Government provides the financing for the implementation of the IFMIS. Funds has not been a constraint over the years and there is no indication that it will be.

Assessment

For the IFMIS, there is no way but forward. The Government already depends on it and the potential benefits when fully rolled out in terms of coverage and functionality are tremendous.

It is imperative that the Government ensures that the implementation capacity matches the task so that the system can be rolled out as quickly as possible. Some of the component tasks can be outsourced. Over time, the range of Oracle implementation partners in Kenya has grown and Oracle itself has increased its presence from a single representative when the project started to a team of 25 people today. The Treasury implementation team and Oracle have jointly worked out an action plan and an MoU is in the offing.

Notwithstanding this increased capacity of its private sector partner it behoves the Government to ensure that the Treasury team has the capacity to manage the whole process. And for the team it is imperative to decide what must be done by them, and what can be outsourced or assigned to other entities within the government.

The cash management module should definitely be implemented and rolled out at an early date. Its major and most immediate benefit will be automatic bank reconciliation. The other major functionality of the Cash Management module is the support it provides for cash forecasting. Such forecasting will be greatly facilitated when all or most payments are made through a single exchequer account. When that is reality, cash forecasting can be centralised to an integrated liquidity and debt management function, located as at present at CBK, or transferred fully to Treasury. Thanks to the law of large numbers and once the system of budgetary controls based on tailored AIEs is settled, it will probably be sufficient to collect, from the MDAs, information on exceptional payments, or on a major shifts in expenditure patterns.

A prerequisite for effective use of the forecasting functionality of the Cash Management Module, is that Accounts Receivables and the Public Sector Budgeting modules are implemented. This is because the basis of the forecasting functionality in the Cash Management module, is to extract and combine as appropriate data from the different modules, data which is then exported to other programmes for statistical analysis and forecasting.

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C. IMPACT ON CASH MANAGEMENT Elimination of idle balances

The most important effect on cash management of fully implementing IFMIS will be the possibility of eliminating most idle balances and most individual ministry bank accounts in commercial banks. Instead of the present system of releasing cash in a cascading manner – first to ministerial accounts in the CBK, then to central ministerial accounts in commercial banks and finally to accounts of individual institutions – all payments can be made directly from the central Exchequer account.

To avoid any doubt, it should be emphasised that payments from one central Exchequer account does not entail a centralisation of authority to make the payments. That would still rest with the Accounting Officer responsible for the appropriation vote to which the payment refers.

Improved cash planning

As already mentioned, the Cash Management module does include the functionality of creating templates for extracting data from all the modules of the Oracle Financials suite. This information can be extracted at a more or less detailed level, from the transaction or single budget line level of an individual government entity to aggregate information. This does not automatically mean that the forecasting of aggregates should be built from bottom- up thus putting a lot of demands on the lowest levels of the financial management hierarchy. More cost effective would be to use advanced statistical methods combined with exception reporting to generate aggregate forecasts.

V. COMPLEMENTARY REFORMS

Integrated debt and liquidity management

Executing payments from one single Exchequer Account will drastically reduce the total of idle balances in the system but it will not, by itself, totally eliminate them. Temporary cash balances in the CBK can be reduced so that on average the consolidated cash balance is zero, fluctuating between positive balances and an overdraft.

But such a situation is still not optimal because overdrafts are not desirable from a macroeconomic perspective, as they affect money supply, and should only be resorted to under extraordinary circumstances. The ultimate objective should be to develop an integrated debt and liquidity management function so that the consolidated government cash position can be brought to zero every day. This requires developing appropriate market instruments such as repos that can be used to adjust the government’s cash position on a daily basis.

Integration of external assistance

Substantial sums of idle cash are sitting in bank accounts set up as conduits for external funds to specific activities.

Once the IFMIS is fully implemented it should be possible to execute all foreign assisted projects. With time, when confidence in IFMIS has been established, it should also be possible to convince donors to channel their funds directly through the central Exchequer

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account, or if development partner legislation precludes that, via sub-accounts to the Exchequer Account, together treated as a cash pool.

VI. NEXT STEPS

The following matrix summarises suggestions for steps to be taken to improve cash management in the Kenya public sector. Some suggestions merely mirror plans and decisions already made by Treasury and the IFMIS team. The last column ticks off areas where AFRITAC could possibly provide assistance.

Area / Task Time frame AFRITAC 1. IFMIS

a) Strengthening of core IFMIS management team

2009

b) MoU signed with Oracle and other partnership issues sorted out

2009

c) Creation of a permanent training function to cater for roll-out and subsequent training needs

2009

d) AR, PSB, CM and Projects modules tested and installed

2010

e) Roll-out to all MDAs and districts 2010 2. PFA Bill

a) Review the Bill with the objective of better aligning it with the logic of IFMIS and centralised cash management, including the use of cash pools

2010 √

b) Prepare the bill for approval by Parliament 3. Contracting and remuneration model with

commercial banks

a) Calculate present cost of idle balances in government bank accounts

2009

b) Explore possibility of banks providing a notional cash pools with overdraft facilities for sub-accounts

2009

c) Design service contracts and negotiate service-based remunerations for payment services provided by commercial banks

2010 √

4. Liquidity forecasting a) Develop strategy and methodology for cash

forecasting 2010 √

b) Develop templates for extracting data for forecasting

2010

5. Integration of debt and central liquidity management

2011

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c) Widen the mandate of the Debt Management Office to include the management of the Government’s consolidated cash position

2011 √

d) Develop financial instruments and mechanisms for managing fluctuations in the Government’s cash needs

2011 √

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Appendix 1

List of people met during the mission :

Name Function Institution Mr. Joseph Kinyua Permanent Secretary MoF Mr. Michale Gatimu Accountant General MoF Mr. Kubai Khassiani Dy. Director BSD, MoF Mr. Mothemba Sr. Dy. Acc. Genl (

cash mgt.) MoF

Mrs. Nyakweba Sr. Dy. Acc. Genl. ((Districts )

MoF

Mrs. Kariuki Project Manager, IFMIS

MoF

Mr. Ogolla Chief Accountant MoF Mr. Willlis OKWALDO

Internal Auditor MoF

Jackson N. Kinyanjui Director, External Resource Department MoF

Mr. Alfayo Mogoka Internal Auditor IAD, MoF Mr. Thomas Njogi Sr. Accountant MoF Mr. Charles Kimwele Accountant MoF Dr. Hezron Nyangito Dy. Govcernor Centrral Bank of Kenya Mr.J.K. Tomno Director ( Banking

Services ) Central Bank of kenya

Mr. G..N. Nyaoma Director Central Bank of kenya Mrs. Nancy N. Kinyua Head, Accounts Unit Min. Of Education Mr. Festie N. Kamau Chief Accountant I Min . of Education Mr. George O. Haya Chief Accountant Min. of Education Mrs. Betty O. Achoch Principal Accountant Min. of Medical

Services Mr. Silvance Nono Head, Government &

Public Sector Banking Department

Co-operative Bank of Kenya

Mr. Jackson Kipkurgat Manager Co-operative Bank of Kenya

Mr. Jephther Opande Assistant Manager National Bank Mr. Mohamed Musa Corporate Relationship

Manager Kenya Commercial Bank

Mr. Allen Citta Regional Sales Oracle

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Manager Africa Ms. Carol S.W. Kinuthia

Territory Manager Public Sector

Oracle