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Public Financial Management in a Decentralized Context

Materials at : http://www-wbweb.worldbank.org/prem/premcompass/know_learn/psgo.htm

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Public Financial Management in a Decentralized Context

Common themes faced by local governments in Indonesia and Peru

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Overview

Key features of decentralization in Indonesia and Peru

What’s wrong with local financial management ?

Cleaning up procurement ?

Concerns on Transparency and Accountability

Falling into bad habits-local level debt in Peru..

How has the Bank responded—some challenges and opportunities

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Indonesia Facts & Figures

Big Bang Decentralization 2001: Laws 22 and 25 in 1999 on Decentralization and Fiscal relations and Law 34 on Regional Taxes in 2000

Expenditure responsibilities for public service delivery decentralized to localities

Laws revised 2004: Some political claw-back. E.g. Ministry of Home Affairs must approve provincial budgets (ex-ante)

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Indonesia Facts & Figures

32% of overall budget is SN expenditures

440 local governments, average budget of $32.8 million, population of 470,000, on average spend 34% of budget on development expenditures

IG system of fiscal transfers is based on equalizing grant (DAU), shared revenues and taxes and capital grant

Domestic borrowing limited, foreign borrowing needs approval by Ministry of Finance (borrowing less than one half of one percent of GDP)

Own source revenues limited but have doubled in past 4 years

Data show trend of budget surplus

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Indonesia Sub-nationals at a glance1999-2002

Local Government Revenue

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

1997 1998 1999 2001 2002

Bln

s o

f R

up

iah Other Rev

Grants

Shared Rev

Ow n-Source

Local Government Expenditure

0

20,000

40,000

60,000

80,000

100,000

1997 1998 1999 2001 2002

Bln

s o

f R

up

iah

Other

Trd & Trns

Oth Rt

Staff

Local Government Surplus and Reserves

-2,000

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1997 1998 1999 2001 2002

Bln

s o

f R

up

iah

Deficit/Surplus

End-of-Period Reserves

Sub-National Borrowing, 1978-2001

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Disbursed Due Paid Arrears Outstanding

Bln

s o

f R

up

iah

Province-BUMDProvKab/Kota-BUMDKab/Kota

Dependency on IG transfer Majority of spending goes to staff

Poor budget forecasting No incentives to pay back

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Peru Facts & Figures

Elected regional governments, 2002Two guiding principles in the Basic Law of Decentralization 2002: Fiscal Neutrality and Phased-In DecentralizationSafeguards to protect fiscal responsibility and hard budget constraints Major weaknesses: labor, procurement, accounting, budgeting, M&E and financial management.

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Peru Facts & Figures

14 % (2002); 25 % (2003); 23% (2004) of overall budget is SN expenditures1800 highly unequal local governments 25 regional governments with no tax revenues of their ownPeru has no horizontal equalization or compensation policy Domestic borrowing limited according to standard indicators of borrowing capacity.

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Peru Sub-nationals at a glance1999-2004

Municipalities: Transfers/Income Ratio

Regional: Transfers/Income Ratio, 2003-2004 Regional Revenues, 1999-2002

Own revenues Transfers Capital Income

Structure and Evolution of Local Governments’Income 2001 – 2003

(Millions of Nuevos Soles)

Source: Boletín de Transparencia Fiscal – Informe Especial –MEF – EEFF - CPN.

Regional Revenues, 1999-2002

0

1020

30

4050

60

70

8090

100

1999 2000 2001 2002

Central Government Transfers Other Income

Transfers/Income Ratio, 2003-2004

91.0%

92.0%

93.0%

94.0%

95.0%

96.0%

97.0%

2003 2004, Jan-Jun

Transfers/Income Transfers/Income w /o privatization resources

Transfers/Income Ratio, 1998-2003

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

1998 1999 2000 2001 2002 2003

Transfers/Income

Transfers/Total Income (incl. Cap)

Transfers+RP/Income

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What’s wrong with local financial management (LFM)?

Indonesia

FM diagnostic survey of selected local governments show some common problems.

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LFM Issues - Indonesia

Planning and Budgeting

Five year plan lacks targets, priorities or hard budget constraint

Many bank accounts for technical departments, not all revenue reported

Though communities participate in planning activities—disconnect between plans and budgets

Budget realization varies from 80-95%, budgets amended at least once a year, own revenues exceed targets

Some districts use different expenditure classifications not consistent with GFS classification - difficult to account for costs

Districts use multiple bank accounts for different sources of revenue

Districts starting to use performance based budgeting – can’t distinguish salaries versus goods and services

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LFM Issues - Indonesia

Institutional and Legal• Few districts have appropriate and comprehensive local legislation or institutional arrangements in place for FM

Budget Execution and Monitoring• Lengthy bureaucratic process—many steps for disbursement of funds • Do not make monthly or quarterly cash forecasts—resulting in delays in payments• No verification of revenues collected • Because of multiple accounts - don’t know their cash position

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LFM Issues-Indonesia

Revenue and Asset ManagementLots of random and nuisance taxes-limited transparency Revenue forecasts based on previous year with % increase No analysis of revenue potential No consolidated information on regional assets, lack national guidelines and legislation Not all revenues reported

Debt and Contingent LiabilitiesFew formal records on debt -usually for local water company

No procedures for monitoring contingent liabilities

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LFM issues-Indonesia Internal and External Audit

Internal auditor limited capacity and skills-only reports to executive, covers 5% of budget at most Confusion over institutional roles in internal and external audits: five agencies involved (district, province and 2 national agencies as internal auditors plus a national external auditor)

Accounting and Reporting

Accounting all cash based and on single entry basis Confusion over accounting standards because of Home Affairs guidelines not entirely consistent with Govt. Account Standards. Accounting classification inconsistent with central guidelines.Weaknesses in internal controls over regional treasury operations.

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LFM Issues - Indonesia

Legislative OversightLegislature limited capacity to review draft budget or review performance

Human Resources and CapacityLack of adequate staff—limited analytical ability No requirement for certification

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LFM Issues - Peru

    Institutional and legal

All levels of Government required to follow standard accounting and reporting practices on the basis of Integrated Financial Management System (SIAF).

By now all regional governments and more than 900 municipalities have basic SIAF modules installed.

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LFM Issues - Peru

     Planning and Budgeting

• Though communities participate in planning and budgeting activities—disconnect between plans and budgets or between budgets and available resources

• Budgets often ignore prior liabilities• Budgets follow “functional-institutional”

classification, with specification of projects that are funded through earmarked transfers.

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LFM Issues - Peru

     Budget Execution and Monitoring

High level of discretion for treasury (disbursement) decisions at regional and local levels Delays in payments are frequentFloating debt accumulates from year to year Local governments often resort to banking system for tax revenue payments and short term (liquidity) borrowing

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LFM Issues - Peru

     Revenue and Asset Management

High level of discretion for treasury (disbursement) decisions at regional and local levels

Proliferation of random and nuisance fees at local level

Revenue forecasts based on previous year with % increase

No analysis of revenue potential

Inventory of public assets is being completed.

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LFM Issues - Peru

     Debt and Contingent Liabilities

High level of discretion for treasury (disbursement) decisions at regional and local levels Few formal records on debt Unregistered/unprovisioned debt are common practicesNo procedures for monitoring floating or contingent liabilitiesLack of standardized accounting practices weakens debt indicators contained in Fiscal Responsibility and Fiscal Decentralization Laws

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LFM Issues - Peru

Internal and External Audit• Weak internal controls. Local council is subservient to the mayor. City managers are in weak position;•External auditor (Contraloría) limited capacity, low (and late) coverage of subnational governments;

Accounting and Reporting• Accounting is generally cash based; •Advances with standardized rules and reporting to the Contaduría (Gen. Accounting Office); •Weaknesses in internal controls over regional treasury operations.

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LFM Issues - Peru

Legislative or Central Executive Oversight•No oversight by Legislature•M&E system being established at Ministry of Finance. Will take 2-3 years before it applies to SN

Human Resources and Capacity•Lack of adequate staff—limited analytical ability•Labor laws over-protect stability, thereby forcing subnational governments to duplicate payroll•Certification requirements will be applied shortly.

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Cleaning Up Procurement! Common Problems in Indonesia

Institutions weak not familiar with national procurement laws and processes:Don’t use standard bidding documentsNo mechanism to handle procurement complaintsDisclosure limitedLimited staff capacity and not certified in procurement

Commonly seen deficiencies:Pre-qualification of contractors (have to belong to a local business association-leads to bid fixing and collusion) Lack of public disclosure on the processUse of restricted bidders (based on locality)Delays and lack of timeliness in contracting Direct contracting-limited tendering, often use local district agencies rather than third-party

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Cleaning Up Procurement! Common Problems in Peru

Institutions weak not familiar with national procurement laws and processes:Don’t use standard bidding documentsNo mechanism to handle procurement complaintsDisclosure limitedLimited staff capacity and not certified in procurement

Main deficiencies in implementing procurement law appear to be due to:Lack of public disclosure on the processUse of restricted bidders (based on locality)Weak linkages between procurement commitments, liabilities, budget provisions, actual disbursements and medium term fiscal planningPoor enforcement and sanctioning mechanismsProviders and contractors protect themselves from arrears and non-payments through over-pricing and multiple contracting with one administrationDirect contracting-limited tendering, often use local district agencies.

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Transparency and Accountability Concerns - Indonesia

Local Budget allocation decisions not transparency—though in theory have bottom-up planning process Budget documents difficult to read and usually not accessible Limited public consultation on draft local laws or budget process-though required by law Limited information on how local government expenditures or performance rates with others i.e. benchmarking of service Limited transparency on procurement and audit findings District heads prepare annual accountability speech for parliament—needs to be accepted for budget to be approved Villages receive limited funds for small infrastructure projects—though increasingly LGs decentralizing % of budget to village and sub-district for local planning and execution of infra projects

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Transparency and Accountability Concerns - Peru

Budget documents difficult to read and usually not accessibleFrustration with participatory planning and budgetingLimited use of naming and blaming. Central Government Fiscal M&E system is just being introducedLimited transparency on procurement and audit findingsContaduría Pública gives clearance for budget execution, yet it is just now in the process of strengthening accounting and control mechanismsNew legal requirements for medium term fiscal targets are just being regulated

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Falling into bad habits: local level debt in Peru !

Debt stock figures show a significant increase during the last 5 years. Preliminary research suggests that unregistered debt is significant. Debt is highly concentrated. (40% of total debt is explained by 20 municipalities out of 1829).The debt/income ratios suggest that most of these municipalities may have structural problems.A significant number of municipalities do not comply with Fiscal Responsibility and Transparency Law numeric rules.A high share of liabilities is related to labor debt, however the net wage bill is always disbursed. The structure of the liabilities in the balance reflects a great increase in long term debt. 67.3% of the debt is under current liabilities.Contingent and floating debt represent 13% of total registered debt.

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Local level debt in Peru - DIAGNOSIS

Growing and highly concentrated municipal debt. Negative externalities affect service delivery.High portion of liabilities associated with labor debt. Link with management – lack of liquidity difficult reforms.Government needs to redesign fiscal rules. A more extensive set of indicators are needed to fully identify the sustainability of municipalities.Debt recording has to be strengthen. The introduction of SIAF-GL is going to solve only part of the problem.Field visits show evidence of links between debt problems, management, legal framework, civil service regime, transparency issues, political cycle, weak capacity to enforce laws, low capacity to generate revenues.

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Local level debt in Peru

Source: CPN – EEFF and Executed Budget 1998-20031/ 97% if only municipalities that presented financial statements over the six years of the sample are considered.

Municipal Debt Stock 1998 – 2003 (Millions of Nuevos Soles)

Municipal Debt Stock(% of GDP and NFPS current income)

Source: CPN – EEFF, BCRP.

1,426

1,835

3,2372,933

2,588

2,124

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

1998 1999 2000 2001 2002 2003

0.9% 1.1% 1.1% 1.4% 1.5% 1.5%

7.2%7.7%

9.6%10.3% 10.3%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1998 1999 2000 2001 2002 2003

% Municipal debt / GDPI % Municipal Debt/ NFPS current income

5.4%

Suppliers and

contractors

26%

Employees and

pensions

11%

Labor taxes and contributions

23%

Social benefits

13%

Banks

27%

Sample: Registered debt by Creditor - 2003

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1998 1,999 2000 2,001 2002 2,003

Provision of Social BenefitsOther LiabilitiesBank OverdraftAccounts payableLong Term Debt

Debt by Balance Sheet accounts

Suppliers and

contractors

26%

Employees and

pensions

11%

Labor taxes and contributions

23%

Social benefits

13%

Banks

27%

Sample: Registered debt by Creditor - 2003

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1998 1,999 2000 2,001 2002 2,003

Provision of Social BenefitsOther LiabilitiesBank OverdraftAccounts payableLong Term Debt

Debt by Balance Sheet accounts

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Local level debt in Peru-Recommendations

Differentiated treatmentSeparate the stock from the flowsJoint plan of administrative controls, institutional reinforcement, revenue goals, primary results and repayment schedule. Voluntary adjustment – Incentives.Pilot plan – Set a good example.

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How the Bank has responded in Indonesia: challenges and opportunities

Challenge

How to reorganize and work with 400 plus SNGs with weak capacity, unfamiliar with the Bank, poor fiduciary environment and incomplete decentralization policy framework

Strategic organization

Indonesia CAS FY2004-2007, cross-cutting focus on SNGs through “multi-sector” local government platform group-estimated lending $400-600 million over current CAS

Coordinated policy advice dialogue and analysis through dedicated decentralization team

Capacity Building

Coordinated capacity building program through WBI and partnership with other donors (DFID, Dutch)

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Indonesia: Responses and Opportunities

Sub-national Lens on Country Diagnostic Work

Country Diagnostic

PER, CFAA, CPAR include sub-national component

Cross-sectoral Reform Loans

Series of sub-national local governance reform projects with “reform minded” districts and cities targeting capacity building, TA in procurement, FM, budget transparency and accountability, and improving local investment climate Series of sectoral projects which build in governance reform at local level

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How the Bank has responded in Peru: challenges

Challenges

(i) to put in place legal and regulatory framework that sends effective signals to SNGs in terms of fiscal discipline and expenditure efficiency, and

(ii) to support an institutional-focused fiscal adjustment package for over-indebted municipalities.

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How the Bank has responded in Peru: responses and opportunities

Internal organization   Peru CAS update (Board presentation – Dec. 2004), cross-sector focus on

Decentralization Processes, including strengthening of the three levels of government

    Coordinated policy advice dialogue and analysis Cross-sectoral reform loans    Series of decentralization-focused Programmatic SALs and TALs focused on fiscal

(DECSAL), social and competitiveness. TA focused on accounting, FM, budget transparency and accountability, M&E, asset management and improving local investment climate 

Strategy on Capacity Building

    Coordination with donor community, CAF and the IADB

 Sub-national lens on Country Diagnostic Work    Country Diagnostic work PER, ESW (Municipal Debt situation), other also has sub-

national component