Report No. 17743-RO

RomaniaPublic Expenditure Review(In Two Parts) Part I: Public Sector Financial Management

June 26, 1998

Poverty Reduction and Economic Management Sector UnitEurope and Central Asia RegionThe World Bank

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY AND EQUIVALENT UNITSCurrency Unit = Leu

Period Average Exchange Rates(Lei per US dollar)

Jan-Apr1995 1996 1997 1998

2,033.3 3,084.2 7,167.9 8,277.8

ABBREVIATIONS AND ACRONYMS

EU European UnionGDP Gros Domestic ProductGDSFC General Directorate of State Financial ControlIMF International Monetary FundINTOSAI International Organization of Supreme Audit InstitutionsMOF Ministry of FinanceNBR National (Central) Bank of RomaniaOECD Organization for Economic Cooperation and DevelopmentRCA Romanian Court of Accounts (also called Romanian Court of Audit)SAI Supreme Audit InstitutionSIGMA Support for Improvement in Government and ManagementUK United KingdomUS United States

FISCAL YEARJanuary 1 - December 31

Vice President: Johannes F. LinnCountry Director: Christiaan J. Poortman (Acting)

Sector Director: Pradeep K. MitraSector Leaders: Frank J. Lysy and Sanjay Pradhan

Task Team Leader: Hassan Fazel

ROMANIAPUBLIC SECTOR FINANCL41 MANAGEMIENT

Table of Contents

I. INTRODUCTION AND SUUMMARY .............................. , .I

IH. BUDGET FORMULATION .2

MACROECONOMIC FRAMEWORK ................................ 2

STRATEGIC RESOURCE ALLOCATION .4

Fragmentation of the budget ............................... 5Inadequate information.6

PUBLIC INVESTMENT9

m. BUDGET EXECUTION.10MACROECONOMIC MANAGEMENT.10INST1TUTIONAL FRAMEWORK.12

Role of Ministry of Finance.12Role of spending ministries.12

EXECUTION OF THE BUDGET.13Problems of execution.13Monitoring execution.13

TREASURY SYSTEM.14DJEBT MANAGEMENT AND GUARANTEES.1 6

1V. FINANCIAL CONTROL.18

LEVELS OF FINANCIAL CONTROL..18COURT OF ACCOUNTS..20

Inst it utional framework .......... ,20Earlier findings..22Reforming the RCA..23Rnecommendations..24

V. NEXT STEPS..25 .............................................

THE NEED FOR A MORE COMPREHENSIVE REFORM APPROACH.25AN INTEGRATED REPORM~ PROGRAM.26

V I. LIST OFRECOMMENDATIONS ............................................ 7

ANNEX 1: COMMENTS ON TILE LAW ON PUBLIC FINANCE1...

ANNEX 2: SUGGESTED AMENDMENTS TO THIE LAW ON THE COURT OF ACCOUNTS..33

ANNEX 3: SPECIALFUN ........................................................... . 38

A NNEX 4: CONSOLIDATED GENERAL GOVERNMENT FINANCES ........................................................... . 40

This report is based on the findings of a World Bank ,mission which visited Romania from February 9 to21, 1998. The mission members were Peter Dean, Hassan Fazel, Allister Moon (ECSPE), Ruud Berndsen(Consultant) and Guido De Weerd (Consultant). Cornelia Giurescu (E.CCRO) joined the mission during its

stay in Bucharest.

I. INTRODUCTION AND SUMMARY

1. This report on public sector financial management in Romania, and a parallel oneon civil service reform, are products of a review of public sector expenditure andmanagement issues carried out by a World Bank mission during February 1998. Thepurpose of these reports is to advance the process of policy dialogue and reforms that,over time, would lead to: better definition of the role of the public sector in the emergingmarket economy, strong aggregate fiscal discipline, allocation of public resources inaccordance with the country's strategic priorities, and efficient provision of services.This process began with the country's own goal of strengthening developmentadministration, to which several partners, including the OECD, EU, IMF, the UK KnowHow Fund and the US Treasury, have made sustained contributions thus far.

2. As a result, public sector financial management has been improving in Romania.For instance, a treasury system and treasury single account have been established; budgetthinking is based on the sustainability of the deficit; budget data are presented in aconsolidated form and debt management systems are being upgraded. Further reforms areunder way or under consideration in: the macroeconomic budget framework -and reportingsystem; the classification of revenues and expenditures; results-oriented budgeting; andfmancial control. Serious constraints remain, however, in the country's budgetary,treasury and financial control systems and, above all, in the coordination of parallelreforms being pursued on different time scales.

3. The present report, therefore, focuses on the above-mentioned constraints. It dealsexclusively with issues in the management of the state budget. Local budget issues arenot addressed here as they are expected to be the subject of a separate exercise. Inreviewing the state budget process, the report examines budget formulation, budgetexecution and financial control. Section II concerns budget formulation and providesdiagnoses and recommendations relating to macroeconomic framework, strategicresource allocation and the public investment program. Section III is on budgetexecution, including issues and recommendations concerning macro-management, theinstitutional framework, the treasury system, and debt management and guarantees.Section IV looks at the country's four main levels of financial control in the public sector;the most important being the Romanian Court of Accounts. Earlier findings on the Courtof Accounts are referred to explicitly and recommendations on further reforms made.Finally, Section V suggests an interrelated set of reforms to address financialmanagement issues, and the report's recommendations are listed in Section VI.

2

II. BUDGET FORMULATION

MACROECONOMIC FRAMEWORK

4. Effective budget formulation must begin with preparation of a realisticmacroeconomic framework. The earliest preparation of spending proposals should beguided by a broad estimate of the aggregate resources within which such proposals mustfit. Such estimates need to be revised frequently, especially in Romania where furtherprogress is needed toward macroeconomic stabilization. It is important that themacroeconomic framework is estimated as closely as possible at the beginning of budgetpreparation and that the implications of the macroeconomic position for aggregateexpenditure and for sector expenditure ceilings are conveyed to managers in spendingagencies who will be responsible for budget preparation. Managers need to begin budgetpreparation with a realistic sense of feasible levels of expenditure targets, in order toavoid wasted effort in preparing proposals which cannot be financed. This results infrustration in spending agencies and a backlog of potential commitments whichcontribute to pressure to overspend the approved budget.

5. In Romania, the budget process does not begin from the macroeconomicframework. The first step in the formal budget process is the issue from the Ministry ofFinance of methodological norms. According to the public finance law, such norms are tobe issued in May, although in practice this occurs later. The norms provide a range ofdetailed instructions on budget preparation, but do not include either specific expenditureceilings for spending agencies, or more general guidance from the macroeconomicframework on aggregate expenditure projections, which would help managers to formrealistic expectations of available resources for their agencies over the budget period.

6. The public finance law does require the Ministry of Finance to provideexpenditure ceilings for line agencies later in the budget cycle. In principle, this shouldhappen in July, although again in practice there is often considerable delay. More seriousis the evidence that such ceilings are not based on an agreed macroeconomic framework.It also appears that even after Cabinet consideration of the frarnework, major adjustrnentsare made in key parameters which may negate previously communicated decisions onbudget strategy.

7. The budget cycle for 1998 illustrates this problem very clearly. While the formalsteps of budget preparation have been observed - issue of methodological norms,indication of expenditure ceilings, etc. - the macroeconomic framework has been placedin disarray by later decisions, such as the major cuts in income tax and profit tax and thesubsequent proposal to finance lunch vouchers. The fiscal implications of these decisions- several percentage points of GDP in each case - were sufficiently great to requirefundamental reworking of the macroeconomic framework if they were to beaccommodated within a viable budget strategy.

3

8. It may be that the difficulties of the 1998 budget are regarded as exceptional,relating to transitional instability generated by an underlying political realignment.However, the problem in budget process - a failure to make binding decisions on budgetstrategy at an early stage in the budget formulation - does not appear to be exceptional inrecent practice. Final approval of the budget has been deferred until well into the budgetyear in previous years (May in 1996, April in 1997). The evidence suggests a coreproblem in the process of decision making on budget strategy. In order to develop abudget process which begins from a realistic macroeconomic framework, several actionswill be needed.

9. Firstly, the Ministry of Finance will need to strengthen its capacity formacroeconomic planning and management, as most recent initiatives have begun to do.At present, the Ministry relies on work by the Council for Prognosis as the main source ofmacroeconomic projections. Given the need for the MOF to lead and coordinate thebudget process and the need for frequent review and refinement of the framework duringthe. course of budget formulation, it would be better if MOF had in-house capacity tocarry out such work. In view of the relatively limited availability of macroeconomicskills within Government, it might be sensible for such capacity to be built up by transferof existing staff from the Council for Prognosis.

10. In addition to strengthening in-house capacity for macro framework preparation, itis also necessary to improve the coordination between other agencies with a role inmacroeconomic planning and management. The mission was informed that the keyagencies in this field - MOF, NBR, the Council for Reform - meet to coordinate positionson the macro framework on a relatively ad hoc basis, often under pressure of preparationfor an IMF programming mission. Such coordination should be maintained at regularintervals throughout the year, permitting consolidation of the framework at the timerequired for initiation of budget preparation and subsequent adjustments to the frameworkin the later stages of the cycle.

11. In order to achieve binding decisions on budget strategy at a sufficiently earlystage in the budget cycle it is clearly necessary to ensure the commitment of all keypolicy makers. For this purpose, the Cabinet is normally the appropriate forum fordecision making regarding budget strategy. However, in a system in which Parliamenthas significant powers to amend the budget it is clearly very important to ensureconsultation with at least the Public Finance and Banking Committee from the earlieststages of budget preparation, including on basic parameters of macroeconomicfiamework.

12. The processes of decision making and consultation can be greatly facilitated byadoption of a rolling multi year framework as the basis for budget preparation. This isdesirable both for the macroeconomic framework and the broad sector resourceallocation, but development of such a framework should begin with extending the horizonof the macroeconomic analysis.

4

13. At present, the authorities express some understandable caution on developmentof multi year projections. Gaining credibility for such a framework would not be easy,given the high degree of volatility in macroeconomic performance in the recent past andthe uncertainty surrounding key elements of the fiscal program only one year ahead (suchas the significant dependence on privatization receipts and the assumption of rapidgrowth in non bank treasury bill borrowing). While this caution is entirely reasonable, itis important to recognize the role which a realistic multi year macro framework can playin geting expectations in line with reality, which itself can make an importantcontribution to reduction in fiscal volatility. Spending pressures which may merely bedeferred by successive one year austerity measures can be more readily subjected toradical reassessment if placed in the context of a realistic medium term outlook. TheGovernment should therefore not defer too long development of a multi year framework,beginning with the macroeconomic framework: broadly satisfactory macroeconomicperfornance in the current year would be an adequate base for beginning the next budgetcycle with a multi year approach.

In summary:

* MOF macroeconomic capacity should be strengthened along the most recentinitiatives, if necessary by transferring functions of the Commission for Forecastingas they relate to the macroeconomic framework for the budget, to MOF.

v MOF should produce its own macroeconomic framework for the budget which shouldbe continuously updated.

* The aggregate resource envelope for the budget should be announced earlierfollowing Cabinet endorsement of the macroeconomic framework.

* This framework should be prepared in close coordination with the National Bank ofRomania.

STRATEGIC RESOURCE ALLOCATION

14. Just as the budget process must begin from a sound macroeconomic framework,there is also a need to establish early in the budget cycle an overall budget strategy interms of broad expenditure allocations. These allocations need to be clearly linked to thepolicy goals which Government has developed for public expenditure. The significanceof strategic resource allocation is underscored by the size of annual governmentexpenditures, averaging around a third of GDP during 1995-97. (See Annex 4 for recentrevenue and expenditure data.)

15. There are several prima facie grounds for believing that this aspect of budgetprocess is not working very effectively in the Romanian system. Firstly, strategicresource allocation cannot function effectively if there is poor performance at the level ofaggregate fiscal discipline. As noted in the previous section, if the aggregate resourceenvelope is not established early in the budget cycle, on the basis of a strategic decisionwhich is allowed to bind subsequent fiscal decisions, it is difficult to allocate rationally

5

within the overall resource envelope. Secondly, the evidence from budget out-turns(discussed in more detail below) suggests that resource allocations incorporated in thebudget are substantially remade in the course of budget execution. This impliesweaknesses in budget execution, specifically the failure to impose hard budget constraintsfor major sub-components of expenditure. However, it also suggests the possibility ofweaknesses in the procedures for establishing broad sector allocations in budgetpreparation.

16. Apart from the lack of a stable budget strategy which has already been discussed,two main factors have been identified as contributing to weaknesses in strategic resourceallocation in Romania: fragmentation of the budget and inadequate information. Each ofthese factors is now discussed.

Fragmentation of the budget

17. Failing to bring all expenditure proposals clearly within the same fiamework,competing on a similar basis for limited funds, makes it difficult for policy makers tomake rational overall allocations. One the of the main problems in this area is thefragmentation of the budget arising from the establishment and operation of specialfunds.

18. The Public Finance law envisages special funds as a temporary phenomenon, tobe reviewed and probably eliminated following "gradual achievements in macrostabilization and economic and budgetary restructuring". The real reason for theirexistence appears to be protection for expenditure programs which might otherwise bethreatened. The operation of special funds entails earmarking of revenues for particularpurposes. In principle, special funds are subject to the same budget process of submissionof proposals and approval procedures as other areas of expenditure, but in practice, theMinistry of Finance recognizes that a major attraction of such arrangements for lineministries is that there is less risk of curtailment of expenditures within year and probablygreater likelihood of budget provisions being renewed automatically in subsequentbudgets.

19. Several special funds exist (see annex 3 for details). The funds for roads andtourism have recently been established. It is easier to justify the existing funds with asocial insurance function than it is for the other funds where the aim seems to have beento capture a revenue source, irrespective of other considerations. The criteria forestablishing funds is unclear. For instance, they could be established to enhanceaccountability, to handle quasi commercial activities, to promote cost recovery or toensure a close match between costs and revenues. Several funds have been establishedwhere there is no specific match between the scope of the funds and the responsibilitiesof particular agencies. In the case of the roads fund, it operates alongside other lineministry expenditure in the road sector. The result is fragmentation of the budget and ofaccountability relationships.

6

20. The rationale implied in the Public Finance law for protecting specific areas ofexpenditure in circumstances of fiscal uncertainty is not particularly cogent. In general,fragmentation of the budget through a proliferation of special funds is more likely tocreate fiscal uncertainty than provide protection against it. More specifically, the fundsfor border posts and tourism simply reflect a drive for capturing revenues and evading thefull rigours of competition for resources. There may be grounds for attempting to protectpriority areas of expenditure in budget execution, but establishing special funds is not thebest instrument for doing this, nor do the existing special funds represent the highestpriority candidates for such protection.

* MOF should review all special funds to assess the need for their continuation asspecial funds.

* Where no convincing reason exists for a special fund, MOF should ensure that it iswound up and its funding retumed to the budget.

* Government should adopt a strict policy of reducing the number of special funds andof preventing the formation of new funds.

Inadequate information

21. In order to make soundly based strategic choices, decision makers must haveadequate information. The mission identified three aspects of budgetary informationrequiring improvement: (1) the classification of revenues and expenditures, (2)information on programs and activities and (3) the goverrment accounting system. Thefirst two topics are discussed here, and the third is discussed in section three below.

Classfifcation of revenues and expenditures

22. Governments seek better budgetary classifications in order to generate meaningfulinformation for decision making. The information generated can be used for thefollowing types of analysis and decision:

macroeconomic analysis (revenues, expenditures, capital and recurrentexpenditures, borrowing, lending, -budget surplus or deficit),

making high level expenditure allocations (functional breakdown ofexpenditures),

making lower level expenditure allocations (institutional and lower levelbreakdown of expenditures),

achieving budgetary control (institutional and line item breakdown ofexpenditures),

monitoring performance (institutional, program, and line item breakdown ofrevenues and expenditures), and'

7

analysing costs (expenditures by program and cost centre).

To produce the required type of information a classification system has to meet severalcriteria. It must:

arrange the information in four main categories: by economic function (e.g.health, education); by budgetary institution (e.g. Ministry of Transport); byeconomic category (e.g. current revenues, capital expenditure, recurrentexpenditure, subsidy); and by detailed line item (e.g. tax revenues, salaries,utilities, communications). The fourth category is really a more detailed versionof the third,

construct the first three categories independently of each other so that eachcategory is exclusive of the others (i.e. no functional data within the economiccategory),

provide a logical means of codifying items within the classification system, and

meet the Government's needs for information while providing a feasible datasystem in terms of the degree of detail, length of coding block etc. implied.

23. The IMF has indicated the need for an improved classification scheme, inparticular for a more complete economic breakdown of expenditures and greaterconsistency in the division between the functional and economic categories . Morerecently SIGMA has begun a detailed review of the scheme. The current system does notmeet the above criteria in several respects2:

-within the category, material expenses, the range of sub categories is incomplete,

-transfers do not distinguish adequately between those made to persons (e.g.student grants) and those made to legal entities (capital transfers),

-an abbreviated version of the classification scheme is often used in the budgetdocument (see for instance the 1997 budget of the Ministry of Education in whichthree quarters of the expenditure is given under the three heads, primary,secondary and advanced education),and

-the functional and economic classifications overlap in some places.

Romania: improving public expenditure management, IMF, 1994, page l14.

2From correspondence with SIGMA.

8

24. The MOF, working with SIGMA, is giving high priority to an improvedclassification scheme, compatible with EU practice. This will permit the production ofmore useful public finance information and lead to better decisions.

Program budgeting

25. Currently, the government budget has a traditional format. It presents costs, butdoes not reflect the outputs which will be delivered, and it provides inadequateinformation on programs and cost centers at levels below that of ministry. Without thistype of information on costs, the underlying reasons for making budget allocationsremain opaque. Allocations appear to depend on historical factors such as last year?scosts rather than changes in policy and the demand for services.

26. Clearly, given the tight budget constraints faced by Romania, expenditure budgetsmust come under closer scrutiny. A major objective is for ministries to become moreefficient in their use of resources. To know about efficiency more information is neededon the services to be delivered and on those actually delivered. By relating this data tocosts, it would be possible to reduce the resources currently spent on low priorityobjectives, and to direct resources to higher priority objectives.

27. For this purpose, with the assistance of the US Treasury, Government is preparingto introduce "results budgeting". This system has had somewhat mixed success in themany countries in which it has been tried. Problems have included the uneven quality,reliability and relevance of performance measures; difficulties in identifying programcosts; difficulties in relating performance measures to cost figures; and failure to use theinformation in the budget process for the purposes for which it was produced.

28. Nevertheless, extending the use of performance measurement in the public sectoris a worthwhile exercise in itself, especially when it is accompanied by delegation ofpowers to those who actually manage resources as has occurred in Australia, NewZealand and the United Kingdom. Currently results budgeting is in its infancy inRomania. The fact that the current expenditure classification scheme does not identifyprograms and cost centres is a major challenge. The aim is to introduce the new approachfor the formulation of the budget for the year 2000, by which time changes to theclassification scheme will allow more meaningful data on costs to be generated.

29. In conclusion this budgetary reform places emphasis on a better identification ofprograms at the sub-ministry level, their objectives and costs. The work on measuringoutput is also important for the better management of spending agencies. There is a needto maintain realistic expectations about the short-term impact of this reform in improvingthe budget process.

9

PUBLIC INVESTMENT

30. The problem of weak links between expenditure proposals and a realistic budgetstrategy is particularly acute in the case of capital budgeting. A large stock exists ofinvestrnent proposals and ongoing projects which cannot be financed within anyrealistically estimated budget ceiling, either in the current year or probably for some yearsto come. The expenditure required to continue existing projects in many sectors exceedsthe resources available for capital expenditure. Existing projects are given priority overnew proposals in capital budgeting. Nevertheless, the pipeline of new investmentproposals continues to grow, despite very limited prospects for funding. Also, it does notappear that central agencies or line ministries review the existing portfolio to terminatepoorly performing or lower priority investmnents.

31. Matching a limited capital budget with a large array of capital spending proposalsis a problem in strategic choice for which Government is poorly equipped under presentinstitutional arrangements. Capacity to carry out adequate economic appraisal of newprojects is fairly limited across government. Within central agencies, the Ministry ofFinance carries out an assessment of investment proposals, but this appears to be confinedto technical feasibility and compliance with legal and administrative guidelines. Capacityfor economic appraisal of projects exists at the Council for Reform, which is appliedselectively, mainly to large individual projects.

32. The capital budget appears to involve a substantial amount of wasted effort in lineministries, where a large number of investment proposals are prepared which are unlikelyto be financed. Given the limited progress so far in strategic resource allocation, there islittle prospect that such proposals can be integrated with medium term sector expenditureplans.

33. In view of the unrealistically large stock of ongoing investment projects and newproposals, a rapid stocktaking exercise, based on broad sector reviews rather than detailedappraisal at the individual project level is advisable. The objective would be to sift theexisting portfolio for investments which are consistent with current views of the role ofGovernment, focusing strongly on the rationale for public provision rather than a detailedtraditional cost benefit analysis. The exercise should also aim to scale down investmentprograms in relation to what can be afforded.

34. As an ad hoc corrective measure, it is suggested that such a stocktaking exercisebe led from the central agencies, utilizing the capacity which exists in the Council forReform, but with MOF providing leadership. However, the exercise will requireGovernment to take a firn stand to assign a leadership mandate to the MOF, andrequiring line ministries and other sectoral agencies to collaborate closely in the work. Inthe longer term, line ministries should take the lead in such sector expenditure planning,with a central agency role confined to review and evaluation and coordination ofintersectoral allocation.

10

In summary:

* MOF should ensure in cooperation with the spending ministries that all capitalprojects of significant size are subject to economic appraisal.

. For the very largest capital projects MOF should carry out its own economicappraisals.

* For all project proposals of significant size the recurrent costs which will have to befimded on completion of the project should be estimated. MOF (and the relevant lineministries) should maintain records of these costs on a project by project basisincluding estimated coefficients of the capital/recurrent cost relationship so that therecurrent costs of capital projects can be estimated for budgetary purposes.

* To bring the existing stock of new proposals and ongoing projects to a more realisticlevel, MOF with relevant line ministries should carry out a review, aiming to sift outprojects where (1) the rationale for public provision is weak and no longer consistentwith current views of the role of Government; (2) the project is inconsistent withmedium term sector objectives and realistic expectations of future resourceavailability; (3) the project is known to have a poor rate of return.

* The unit for the co-ordination of public investment in the Council for Reform shouldbe transferred to MOF.

* Technical assistance should be given to selected spending ministries with large capitalproject portfolios to enable them to prepare project proposals more effectively.

III. BUDGET EXECUTION

MACROECONOMIC MANAGEMENT

35. In circumstances where macroeconomic stabilization is a recent and fragileachievement, it is likely that frequent budgetary corrections will be needed. While suchcorrections may be necessary, they can be highly disruptive for public expendituremanagement, reducing the planning horizon, undermining managers' accountability forbudget performance and often sharply reducing the efficiency of expenditure by distortionof its composition in ad hoc cuts. The procedures for monitoring macroeconomicperformance and deciding on any within year adjustment are therefore very importantelements of the overall budget management system.

36. It is clear that there has been significant within-year adjustment of the budget inrecent years. The overall deviation between the approved budget and the final out-turn atthe broadest level of functional classification is estimated at 20 % of the original budgetin 1996 and about 13 % in 1997. The disruption of the budget must have been higher stillat lower levels of aggregation. In 1997 the main adjustments were realized in two budgetrectifications: in 1996 there were more.

37. Given the damage that within year adjustments bf the budget can inflict onefficiency, it is important to ensure that such adjustnents do not occur more frequently

11

than is necessary. The adjustments which have occurred do not appear to have beennecessary responses to new developments, such as revenue shortfalls or othermacroeconomic shocks, but rather within year changes in policies and spending priorities.This points to serious problems in the process of strategic resource allocation.

38. First, the most important step in avoiding such within-year adjustments is to beginthe year with a prudent and realistic budget, consistent with a sound macroeconomicframework, as discussed above. This is vital to building aggregate fiscal discipline.Second, it is important to review budget performance regularly within year in the light ofprogress with macroeconomic objectives, in order to identify as quickly as possible theneed for corrections in expenditures and ensure that such corrections can be implementedas smoothly as possible with maximum forewarning to spending agencies. For thispurpose, it is essential to develop and regularly maintain a cash flow data and forecasts,identifying the net cash impact of all government operations, updated at least at monthlyfrequency and projected over the year ahead. The mission did not see such forecastsalthough it is understood that the Treasury department has begun work in this area. Anearlier IMF report (Diamond, et al Sept. 1994) made detailed recommendations for workin this area, which are still appropriate.

39. Cash flow forecast should be comprehensive in coverage of Government'sfinancial position including total revenue and expenditure, net borrowing and specialfumds. Good cash flow forecasting requires good data on actual cash flows and onspending intentions. This implies the passage of information from spending agencies toMinistry of Finance and in the opposite direction. The results of revisions to the cashflow forecasts should be communicated regularly to spending agencies, conveying notonly revised ceilings for agency spending where necessary, but also providing regularupdating on the broader framework. There should also be opportunity for feedback on theimplications of shortfalls in budget provision, as spending agencies adjust their ownforecasts to conform to the revised aggregate ceilings.

40. The implications of revised cash flow forecasts should be reviewed regularly withthe central bank. The understanding of the mission was that there are at present no regularmeetings to discuss Government's evolving cash flow requirements. In a situation wheresustained stabilization has yet to be achieved, it is likely that within year adjustments inaggregate expenditure and overall fiscal stance may be necessary to maintainmacroeconomic targets. Consensus needs to be maintained on at least a monthly basis onthe relative contribution expected from within year fiscal adjustment and actions of thecentral bank on monetary policy. The central bank needs to be regularly updated on thenet impact of fiscal operations, as part of wider consultations aiming at coordination offiscal and monetary policy.

In summary:* MOF should ensure that its cash flow forecasts for revenues and expenditures are

regularly updated during the budget year.

12

* MOF should record actual cash flows in relation to forecasts.* MOF should analyze the changing macroeconomic impact of the budget through

figures concerning its cash implementation and share this information with NBR.* An explicit link should be made between cash flow forecasts and borrowing

decisions.* MOF capacity should be enhanced to achieve these changes.

INSTITUTIONAL FRAMEWORK

Role of Ministry of Finance

41. The Ministry of Finance supervises the execution of the budget. It tries to ensurethat the target budget deficit is respected. When revenue collections do not meetexpectations and cash resources are depleted, it has to restrict expenditures to levelsbelow those established in the budget. It does this by establishing expenditure limits foreach spending agency each month.

42. The MOF has the job of assessing revenue performance from month to month andof considering changes in the government's cash position. Expenditure limits areestablished within the totals approved by Parliament in the budget. The information ispassed to the treasury which each month opens credits which represent ceilings for eachspending agency. At any point in time the total expenditures to date, together with newexpenditure requests, must be less than the cumulative credits issued for the year.

Role of spending ministries

43. On the 25th of every month the credit ordinators of ministries inform Ministry ofFinance of their expenditure needs for the forthcoming month. They do this on the basisof calculations of their own needs and calculations supplied to them by secondary andtertiary credit ordinators. Under normal circumstances the Ministry of Finance opens thecredits requested. But when necessary, it opens lower credits than have been applied for.Disappointed credit ordinators are pernitted to submit supplementary requests underthese circumstances. Once the credits are opened, credit ordinators can submit requestsfor payment. At present the amounts of blocked expenditure and of payment arrears arequite small. Thus the schedule of priority expenditures which includes remuneration ofemployees, pensions, medicines and child operations is not put into operation.

44. Requests for payment are standardized. They are presented at treasuries byprimary, secondary or tertiary ordinators. If they are correct, the treasury either transfersthe money to the payee electronically, or issues cash. Generally salaries and wages arepaid in cash which raises serious control issues. Some requests for payment have to beendorsed by the Court of Accounts before they can be paid.

13

45. Ministries keep their own accounts according to norms established by Ministry ofFinance. They record commitmnents and payments according to the chart of accounts.Secondary and tertiary credit ordinators are responsible for utilization of budgetaryallocations, revenue collection, the efficient use of money transferred from other funds,the integrity of assets with which they are entrusted, the organization and maintenance ofaccounting records and the submission of accounting reports (Law on Public Finance,Article 36).

EXECUTION OF THE BUDGET

Problems of execution

46. Since 1994 the main budget law has been delayed. In 1996 there were threebudget rectifications; in 1997 there were two. The combination of late enactment of themain budget law (in 1997 this occurred at the very end of April) and frequent revision,creates uncertainty and robs the budget process of meaning. Repetitive budgeting occursthroughout the year. Until the main budget is authorized, spending can be no more than itwas in the corresponding period of the previous year. Late enactment and frequentamendment therefore create the conditions for expenditure surges late in the budget year.For subordinate offices and local governments these delays are even more seriousbecause their budgets are known only after a further delay.

Monitoring execution

47. Spending ministries submit monthly and quarterly expenditure reports for whichthe reporting delays after the end of the relevant month are 15 and 25 days respectively.These reports, and reports of cash balances from the treasuries which are available daily(again with a small lag), enable Ministry of Finance to monitor budget execution.However the data received relates to the cash execution of the budget. Data onexpenditure commitments is recorded by ministries and their subordinated bodies but isnot reported to Ministry of Finance making it difficult for the central authorities toanticipate future cash needs. Thus there is a poor basis for cash flow forecasting.

48. The law on public finance 3 defines the powers of reallocation. Amountsallocated to a main authorized beneficiary (usually a ministry) cannot be reallocated toanother. But reallocations at below this level (within the budget of a main beneficiary)are permitted provided that neither the capital nor the personnel allocation is increased.Reallocations under other heads can be made by the main beneficiaries for their ownbudgets and for the budgets of subordinated units, but only starting with the third quarterof the year. This restriction to the third quarter and later, does not make sense given thegross delays in the budget calendar, and would not make much sense even if the budgettimetable were in fact honoured.

Comments on this law are given in annex 1.

14

49. End of the year accounts cannot be finalized unless formally approved byparliament in the form of a law. Accounts for the period 1991-1995 have now beenapproved. Accounts for fiscal 1996 and 1997 await approval. Such delays are excessive.Moreover the current fornat of the statement of budget execution is inadequate because itdoes not require full accountability for budget execution. An improved report wouldprovide more comprehensive information, including statements regarding cash flows andborrowings during the year, and cash balances and borrowings outstanding at the end ofthe year.

50. The compression of the budget execution period from 12 months to seven monthsresulting from dislocation of the budget timetable means that meaningful monitoring ofbudget results is not possible. The effects on the budgeted deficit are monitored. Butthere is not time for a more detailed mid-term review of ministry spending, with adverseconsequences for the quality of budget revisions.

51. Given the above, and bearing in mind the limited content of treasury reports,budget monitoring is weak in Romania. The following are therefore suggested:

* adhere to the established budget timetable so that the budget is approved before thebeginning of the budget year;

* rectify the budget only once during the year;* precede the rectification with a mid-term budget review. This will facilitate a system

of budget reporting which allows comparison between sums authorized and actuallyspent for each main budget beneficiary. Such a system can also be used for theannual statement of budget execution; -

* set up a system whereby ministries report their expenditure commitments--includingall arrears--to MOF;

* establish a system of cash flow forecasting on the basis of estimates of expenditureand revenue, cash balances and anticipated borrowing requirements. e

* use the cash flow forecasts for determining expenditure releases and for cash and debtmanagement.

* introduce an integrated financial management system to replace the current treasurysystem (see below).

TREASURY SYSTEM

52. Before independence the budget was executed via a range of banks and cashcontrol was weak because there was no treasury single account. The State Treasury wasestablished in 1992. It now maintains a single account at the National Bank of Romania.

53. The Treasury provides collection and payment functions for the following:revenue collecting departments, state budget institutions and their subordinated offices,special and extra-budgetary funds, local governments and the Ministry of Finance for

15

domestic borrowing and servicing external debt. The treasury system is thereforeextensive. It employs about 4,000 staff and has 289 sub-treasuries, besides the TreasuryDepartment in the Ministry of Finance. The system has the advantages of security (theState guarantees all financial operations made through treasuries), comprehensivenessand uniformity (the system applies to all special funds and local governments as well asto state budget institutions).

54. The institutions served by the treasury system must carry out their transactions viaa treasury where such a treasury exists. But the system is not complete and some bodiesare therefore without treasuries. They are permitted to carry out their transactions viacommercial banks. Treasuries are missing in four out of six districts of Bucharest andthere is no treasury for the Bucharest municipality. They are also missing at someprovincial locations. These gaps present problems of accounting, reporting, cashmanagement and control and expose the Government to risks given that the commercialbanking system is not entirely reliable.

55. Treasuries carry out transactions, account for them on the cash basis, record themaccording to a uniform chart of accounts and report the results at various intervals. Theyprovide systems for collections and disbursements. They do not provide systems forreceivables, payables, commitments or payrolls. Systems dealing with such matters aresaid to operate at the ministry and sub-ministry levels.

56. A treasury carrying out an expenditure transaction checks whether the proposedexpenditure is:

(a) within the authorized budget and the cash ceiling set by credit ordinators forthe budgetary institution.

(b) correctly requested in terms of its destination and category.

(c) supported by the signature of the credit ordinator and by other necessarydocumentary evidence.

57. The body for whom the payment is made, records the resultant transaction in itsown accounting records. The applications software for the above system is written inFoxPro. It enables relatively simple automated functions to be carried out in real time ata large number of locations according to uniform procedures. It also allows consolidatedstatements to be prepared each month, albeit with some delay and lack of control, due tomanual transfer of data.

58. The basic problem of the treasury system is lack of an integrated computer systemcovering all the relevant processes and participants.

-Ministry accounting is not fully integrated with treasury accounting.

16

-Therefore, as far as the treasury system is concerned, certain aspects of spending(commitments, payment orders, receivables, payables, payrolls) are either notrecorded at all or are only recorded in the treasury system when a cash transactiontakes place.

-The absence of the above data within an integrated financial management systemmeans that reports lack detail, timeliness and relevance. For instance cash flowforecasting is weak because data on expenditure commitments are kept by creditordinators and cannot be conveniently reported to Ministry of Finance bycomputer.

-Some data are processed manually. Manual transfer of data between systemscreates bottlenecks and delays, and permits errors.

-Budgeting and accounting are not integrated via a nationwide computer system.

-The sub-treasuries are not fully integrated with the Ministry of Finance andtherefore the consolidation of data presents difficulties.

-The visa of the Court of Accounts has to be given at the location of the creditordinator and cannot be given via direct access to computer records.

59. Given the above, a full scale reform of Government's fnancial management.systems is needed to provide a far higher degree of integration.

- The treasury system should be redesigned so as to provide spending agencies withmodem systems for managing commitments, payables, receivables and payrolls.

* A modem relational data base system should be installed covering all majorrecording, budgeting, accounting and reporting functions.

* Treasuries, spending agencies, Ministry of Finance and those responsible for issuingendorsements as a result of pre-audit should be linked via a network.

* The treasury system should be extended in Bucharest (to the four districts withouttreasuries and to the Bucharest municipality) and also to other locations so thatcommercial banks would no longer carry out treasury functions, and cashmanagement, control and reporting are improved.

DEBT MANAGEMENT AND GUARANTEES

60. Debt management is a shared responsibility. Ministry of Finance, through itsGeneral Directorate of Public Debt establishes policies and is responsible for overseeingtheir implementation. The National Bank of Romania and the House of Economy (theprincipal national savings bank) act as agents of the Ministry of Finance for managingexternal and internal debt respectively. Debt management is governed by the lawregarding public debt (1994) and by methodological norms issuied by the Ministry of

17

Finance in the same year. A new law on public debt has been drafted. It provides amodem legal framework for the management of debt and of government's guarantees.New borrowing and the issue of new guarantees are controlled by limits proposedannually by Government and approved by Parliament. The new public debt lawestablishes the important principle that Ministry of Finance is the only entity that canauthorize new borrowing and the issue of government guarantees.

61. Recent borrowing limits were arrived at in consultation with the IMF. They givea ceiling for borrowing and within it a separate ceiling for the issue of new guarantees.The ceilings were as follows:

1996 3.0 billion dollars of which 1.2 billion in guarantees1997 3.2 billion dollars of which 0.9 billion in guarantees1998 2.9 billion (provisional, and not yet split)

62.. For successful management of borrowing, data on estimated future cash flows areessential. Such data allow better decisions on the timing, amount and duration ofborrowing which have a big impact on the cost of borrowing. Cash flows ariseprincipally from budget revenues and expenditures, but also from debt maturities. A cashflow forecasting system monitors these flows in order to predict levels of liquidity orilliquidity at forward dates. Cash flow forecasting is said to take place in the Ministry ofFinance but it is doubtful that it is sufficiently developed. Particular problems are theincomplete nature of the treasury system, the lack of reporting on the expenditurecomnitments of ministries and their subordinate offices, and the inability to forecast debtservice and repayment flows except for short periods ahead.

63. Romania borrowed on the Eurobond market in June 1997. The credit rating givenby Standard and Poors is currently BB-. A succession of budget deficits has resulted inincreased indebtedness and increased debt service costs:

1992 1993 1994 1995 1996 1997Total public debt service as % of GDP 0.2 0.9 1.3 1.3 1.6 3.5............. .and as % of total expenditures 0.6 2.7 3.8 3.8 .4.7 10.7

The cost of honouring guarantees is also increasing steeply:

1995 1996 1997 1998 (est.)Budget cost of honouring government 23.3 45.8 126.7 166.3guarantees in recent years (in millionUS dollars).

64. Prior to the issue of a guarantee the creditworthiness of the borrower is carried outby the ExinmBank. An Interministerial Committee then decides on the merits of eachcase. On the recommendation of the committee Government issues the guarantee.

18

Government charges borrowers a premium when guaranteeing their debts. The proceedsare paid into a Risk Fund. But the assets of the fund do not cover the costs of servicingand honouring debts taken on by government as a result of defaults.

65. A continuation of difficult economic conditions in the enterprise sector and ofGovernment' s program of privatization provide an uncertain environment in which tocontrol these and related costs. State companies face liquidity problems and loansguaranteed by government are an obvious avenue. Nor is privatization necessarily apanacea, as many state companies require restructuring in order to be marketable. To theextent that their old debts are canceled, the immediate effect on the budget may not beevident. The recent vulnerability of credit ratings in Asia may have indirect relevance toRomania. To protect its rating and its ability to borrow, Romania needs to control itsborrowing. This implies the need for a smaller budget deficit and reduced newborrowings, and for conservative policies with regard to the issue of guarantees. Thecosts associated with borrowing and the issue of guarantees are increasing and in someresplects difficult to control. To achieve better control and management Governmentshould:

* adapt reporting systems covering revenues, expenditures, debt repayments andtreasury operations and on this basis introduce an improved cash flow forecastingsystem to support debt management.

* in the longer run, develop an integrated financial management system for moreeffectively achieving this result.

• provide NBR with more complete data on expected cash flows arising from thebudget.

- introduce modem database systems for debt management.* carry out simulations of future debt service costs and repayments based on alternative

borrowing scenarios.* introduce stricter criteria for assessing the creditworthiness of borrowers seeking state

guarantees.* reduce the risk to govermnent by refusing guarantees where there is significant doubt

about the borrower's capacity to service the loan.* ensure that the premiums charged to borrowers for state guarantees provide funds

sufficient to cover the cost of defaults.* enact the draft law on debt management.

IV. FINANCIAL CONTROL

LEVELS OF FINANCIAL CONTROL

66. Four levels of financial control exist in the Romanian public sector. These are: (a)the internal control units of state bodies; (b) the General Directorate of State FinancialControl (GDSFC) of MOF; (c) the Financial Guard under the Ministry of Finance and (d)the Court of Accounts.

19

67. According to the Constitution, the Court of Accounts is the supreme organ ofcontrol. It has extensive control powers and the right to issue methodological instructionsto the other organs of control. The management of GDSFC disputes this supremacy.Before 1992, the preventive control functions carried out by the Court of Accounts, werecarried out by GDSFC. The controls in question are referred to as preventive controls.They are enforced via pre audit and evidenced by endorsement without which atransaction cannot proceed. Selected transactions of credit ordinators have to beapproved and endorsed by the Court of Accounts before they can be carried out. This cancause delays. The Court of Accounts considers these to be minor; others do not. Preauditing by the Supreme Audit Institution can be found in other countries, as isacknowledged in the Lima Declaration of the International Organization of SupremeAudit Institutions. However it is increasingly recognized amongst OECD countries thatSAIs should move away from this type of audit and concentrate on post audit. Thus,amongst members of the European Union all SAIs carry out post audits, but only fivewere recently carrying out pre-audits (Belgium, Greece, Italy, Luxembourg and Portugal)and of these Italy is reported to have recently stopped.

68. The law goveming the internal control of state bodies of 1991 has been overtakenby the law on the Court of Accounts of 1992. Thus many of the provisions of the 1991law are out of date. This is the most important level on which to build in the long run.But currently state bodies suffer from under staffing and lack of the required skills forthis type of activity. The GDSFC carries out programmed inspections of state and localbodies. It has a staff of 90 at the centre and 890 spread throughout the country. It reportsannually on the infractions discovered, resources saved etc. The Financial Guard isgoverned by a law also of 1991. It is uniformed and armed and also has a mandatecovering the state sector. In practice much of its work is in the enterprise sector andconcerns non payment of amounts due to the state. The Financial Guard has 150 staff atthe centre and 1500 in the counties. In addition the Court of Accounts has 2,280 staffpositions. Thus financial control employs large numbers of public sector staff inRomania.

69. An important question facing Romania is the distribution of controls betweendifferent bodies within govermment. Modem systems tend to locate internal control at thelevel of each entity. The entity is responsible for its own controls and for compliancewith norms set by higher levels. This model is suitable for countries with mature systemsof public administration, experienced staff, reliable systems and adequate externalmonitoring. In less well-endowed countries to rely on internal controls is to runsignificant risks. Such countries need a halfway house between a highly centralisedsystem and one in which controls are delegated to the entity. Romania appears to be inthis category and for this reason in the foreseeable future spending agencies wouldrequire a form of pre-audit either by the Court of Accounts or the Ministry of Finance.But the aim would be to loosen these controls progressiv.ely, in relation to the growingcapacity of spending agencies to control their own affairs.

20

In summary:

* MOF should establish the new post of Financial Controller at all spending agencies.The financial controller, a senior staff member of MOF assisted by a small staff ofcontrollers, would exercise pre-audit functions instead of the Court of Accounts. Theaim would be to assist the spending agencies in ensuring adequate financial control.

* Over time and to the extent appropriate, pre-audit functions would be transferredprogressively to the spending agencies themselves.

COURT OF ACCOUNTS

Institutional framework

70. The Romanian Court of Accounts (RCA) was re-established by means of the Lawon the Organisation and Operation of the Court of Accounts (No. 94/1992), but has itshistorical origin as early as 1864. This law stipulates that:

"The Romanian Court of Accounts is the supreme body of financial control andjurisdiction in the financial domain and is attached to the Parliament of Romania Itexercises its functions independently and in keeping with the provisions of theConstitution and the other laws of the Country. "

71. It is clear that the RCA is a supreme audit institution with large competencies inthe field of public auditing. It also has extensive jurisdictional powers. It performs itstasks on its own initiative; only Parliament has the power to request an investigation bythe RCA.

The RCA performs its tasks by means of:

* preventive (ex-ante) control on the state budget, the state social security budget andthe special funds

* subsequent (ex-post) control on the execution accounts of the state budget, the statesocial security budget, the special funds, the local budgets, the treasury funds andthe State public debt.

72. Preventive control is legalistic: checking whether intended expenditure actions aremade according to law and other regulations. It leads to an official endorsement by theRCA of expenditure decisions of principal account executives (termed 'ordinators').Spending without the endorsement is illegal unless Government gives its explicitauthorization for the expenditure. The RCA must inform Parliament each month on suchcases. Not all of the expenditures need an endorsement of the RCA: only expendituresthat exceed 5 million lei are subject to preventive control. Above that, the RCA performsin practice a selective approach in discharging its preventive control.

21

73. Subsequent control is also primarily legalistic: it constitutes a regularity audit ofthe accounts presented by the competent management of public bodies. Moreover, in thecourse of these activities, the RCA must make an ex-post assessment of the necessity andopportunity of the budgetary decisions and furthermore must examine the quality of thefinancial management of the auditees, from a point of view of economy, efficiency andeffectiveness. Whether this permits the RCA to carry out performance audit is unclear.

74. Subsequent control leads to the discharge of managements by the RCA, possiblyafter a ruling of the Jurisdictional Board of the RCA. Such a ruling could requireamendment of the accounts (because the RCA considers the accounts or financial acts tobe incorrect). Through its Financial Public Prosecutor, the RCA has the power toprosecute administrators, managers, bookkeepers and other persons within the auditedbodies who are judged to have caused financial damage or committed financialinfringements in the execution their administrative responsibilities. The JurisdictionalBoard of the RCA has the authority both to judge and to decide (in first and last instance)on these cases, requesting payment of civil compensations and imposing fines on thepersons responsible. The decisions are called sentences. Criminal offences are notified tothe criminal prosecutor of the regular judiciary. The basis for the jurisdictional powerscan be found in Article 125 of the Romanian Constitution.

75. Ultimately the exercise of subsequent control leads to an Annual Report in whichthe RCA presents is major findings to Parliament. The report is to be printed in theOfficial Gazette. The RCA can also submit additional reports to Parliament in thedomains of its competence whenever it considers necessary. The RCA can evaluate theinternal finanical audit activities wihtin the audited bodies. It can give instructions for theinternal audit functions. It can ask for personis to be suspended from office. Until now, theRCA has not made use of this last competence.

76. It must be noted that preventive control is, in comparison to subsequent control,directed at a more limited field of auditees. The preventive control is aimed at thedecisions of 'ordinators' in the ministries and territorial-administrative bodies, the socialsecurity bodies and the bodies that administer the special funds. The subsequent controlconcerns central government institutions, local government institutions (counties,districts, communities), state companies and commercial companies in which the stateholds more than half of the capital. In the course of its audit activities, the RCA canobtain accounting evidence from commercial enterprises and natural persons that have afinancial relationship with the State (i.e., through grants, subsidies, concession contracts).

77. The activities of the RCA are performed through its office in the capital andthrough its regional offices. The staff for subsequent control is mainly located within thecentral government public institutions. The RCA has a staff of 2,300.

78. The Law on the Organisation and Operation of the Court of Accounts is at thismoment under revision. A new draft law is currently being discussed within thegovemment but has not yet been presented to Parliament.

22

79. It is clear that the RCA played an important role in the transition of the Romanianstate into a democratic republic, just after the change of regime in 1989. The RCA wasreestablished quickly to help Parliament safeguard the patrimony and revenues of thestate while other functions of the state were not yet in good working order. As reform hasbeen underway for several years now, this may in itself be an opportune time to updatethe law of 1992.

Earlier findings

80. In August of 1997, SIGMA presented a report on the f'unctioning of the RCA4.The main findings were as follows:

* The judicial decisions of the RCA cannot be appealed in the civil courts. This maybe in conflict with the constitutional right of citizens of free access to justice and,-more generally, with the rule of law.

* The judicial competencies of the RCA are very wide.* The law under which the RCA functions is rather complex in the sense that it is

difficult to comprehend and implement.* The preventive control may slow down the implementation of government policies.

The private sector regards this control as excessively formal.- The focus of preventive control is limited. The control risks concerning local

budgets and budgets of state-owned enterprises are more or less neglected.- There is uncertainty about the consequences of preventive control for the proper

execution of subsequent control (can the RCA object later in time to expenditureswhich carry its prior consent?).

* lThe RCA does not have proper tools to carry out its preventive control. In practicethis control is limited (commitments are not recorded; not every operation isaudited). This control may hinder the implementation of an appropriate budgetsystem by the Ministry of Finance.

* There is lack of co-ordination of control activities between different institutions(RCA, Ministry of Finance, line ministries).

* The subsequent control of the privatisation process may lead to a slowing down ofthis process because of the lack of clarity regarding the way in which the RCA mustproceed.

* There are differences of opinion on the audit of the budget of Parliament.* The forms of communication between the RCA and the government and its

administration, between the RCA and Parliament, and between the RCA and thepublic are not properly developed.

* Parliament does not have a special committee for dealing with the reports of -theRCA.

4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

4 Support for Improvements in Govemance and Management, a joint initiative of the OECD and thePHARE programme.

23

* The internal organisation of the RCA is rather complex.* The norms and standards that are used in audit activities do not comply with

recommendations of INTOSAI5 (e.g., with respect to documentation andreporting).

* The actions of the RCA and the absence of legal protection against its decisionsmake public sector managers unwilling to take personal responsibility for certaindecisions.

Reforming the RCA

81. The current state of financial control in the Romanian public sector must bejudged to be weak and incomplete.6 This may endanger the reform of the public sector ina broader sense. However the RCA is not well-positioned to improve the situation. Itsrelationships with the rest of government, Parliament and the private sector are more orless frayed. Thus the impact of the RCA on improved financial control is often negativein the sense of hindering decision-making via heavy external controls. The discussion ofwhat to do about this is confused by methodological issues and by differences of opinionwith respect to the most appropriate future institutional framework for financial control.Reforms in the RCA's legal mandate and responsibilities have to be seen in the context ofimproving financial controls in a more general sense, as already explained.

82. Clearly there is a need for greater transparency in the sense that Parliament andthe public need to obtain reasonable assurance that the execution of budgetary decisionsis in line with arnounts authorized. The processes of preparation, execution and closingof the budget provide a means of achieving transparency, particularly when the results arethe subject of independent audit reports. More informative audit reports containing theauditor's assessment of the reliability of the annual statement of budget execution inaccordance with relevant international and European audit standards would improvetransparency. Also if all reports of the RCA were made public at the time of submissionand not after the reports have been discussed by Parliament, there would be a further gainin transparency. Furthermore, a special combined committee of both houses ofParliament should be established in order to give appropriate attention to the reports ofthe RCA.

83. It is inappropriate for the RCA to have the authority to give directives to otherpublic bodies charged with control responsibilities. This is in order to avoid anyprejudice on the part of the RCA in the exercise of its subsequent control. However tofunction efficiently, the Supreme Audit Institution must be able to use the results of

5~~~~~~

Intemational Organisation of Supreme Audit Institutions.

6 See also the RCA report "Evaluation of the Activity of Financial Audit Bodies" (1997). This reportcomments on the scope and quality of audit activities-of the General Directorate of the State FinancialAudit, the Financial Guard and the General Inspection for Intemal Activity of the Ministry of Financeand of the control activities of fiscal bodies.

24

control and audit work performed by line ministries and other public bodies and for this itwould need access to their findings, given a certain level of quality.

84. In principle, judicial functions should be performed by the regular judiciary inorder to achieve a clear separation of powers. This principle should be implemented inRomania with regard to the prosecuting and sentencing powers of the RCA. It has beenfound in the Netherlands and elsewhere that a Court of Accounts is better without suchpowers. In principle, the RCA should give up such powers. Accordingly in the shortterm, the jurisdictional powers of the RCA should be restricted to decisions of firstinstance. This implies that there would be right of appeal against these decisions. Theright to appeal against the decisions of the RCA through the Supreme Court of Justice isunder discussion at this moment.

85. It is necessary for the RCA to inform Parliament and the Romanian publicsystematically on the economy, efficiency and effectiveness of public sectormanagement. With reference to INTOSAI standards, it is necessary that the RCA shouldbe invested with more explicit competencies to undertake performance audits of thefimctioning of public bodies.

86. The RCA should only concern itself with the privatisation process on a post-auditbasis. This means that it should not attempt to outguess those actively involved in theprivatisation process on matters such as the desirability of decisions to privatise or thecorrectness of take-over prices. The process and procedures for privatisation could besubject to the post audit of the RCA from a performance point of view, implying that:

-no judicial decisions are taken;

-the RCA reports after the process of privatisation is completed; and

-the RCA bases its audit on evidence made available by the public authorityresponsible for privatisation.

87. Although there have been intensive discussions between the RCA, the Ministry ofPrivatisation and the State Ownership Fund about the audit of privatisation, it remainsunclear how the RCA should proceed. The RCA itself holds the opinion that it should beable to perform an ex-post audit of privatisation processes in total but that it shouldrefrain from evaluating the opportunity of these processes (per letter No. 272 of 2 June,1998 from the RCA to the Minister of Privatisation).

Recommendations

88. A number of recommendations are presented below. It must be noted that theserecommendations suggest changes in the currept situation that can only be implementedin the long term. For implementing the suggestions made, a-more detailed and specialisedassessment of the necessary changes must be made in the context of a balanced model of

25

internal and external control/audit functions. Furthermore, a detailed plan for the co-ordination of the different steps to be taken in time must be presented. Such a planshould be established by the Government in close co-operation between all actorsinvolved, but certainly in accordance with the views of Parliament, the MOF, theMinistry of Justice and the RCA. This because of the complexity of different legislative,organisational and jurisdictional implications of the suggested changes. Accordingly, it isurged that careful attention be paid to changes of the current situation that have beensuggested by the RCA itself.

* The law governing the Court of Accounts should be amended in severalrespects.7

* All preventive control responsibilities (pre-audit) should be transferred fromthe Court to the General Directorate of State Financial Control of MOF andthe staff of the Court currently carrying out these functions should transfer toMOF to the extent that they are willing to do so.

* The Court should carry out only post-audits and its law should be amended toallow it to carry out audits of efficiency and effectiveness (performanceaudits).

* The Court should adopt modem audit standards similar to those used in well-developed Supreme Audit Institutions in Western Europe and elsewhere.

* The Court should regularly report its audit findings in public, irrespective ofwhether these findings have been debated by the legislature.

* The judicial decisions of the Court (including prosecution and the impositionof penalties) should be subject to superior judicial review.

* The Court should not carry out audits or controls of privately-ownedcompanies unless the equity share of the state exceeds 50%.

- The Court's audit of the privatization process should be exclusively post-audit.

* A small joint committee should be established by the two houses of thelegislature in the field of public accounts to consider the Court's reports and toreport to the two legislative chambers.

V. NEXT STEPS

THE NEED FOR A MORE COMPREHENSIVE REFORM APPROACH

89. Much has already been done to improve public sector financial management inRomania: a treasury system and treasury single account have been established; budgetthinking is based on the sustainability of the deficit; budget data are presented in aconsolidated form and debt management systems are being upgraded. There is alsoevidence of preparedness to make further reforms. Reforms are in process or underconsideration as follows: in the macroeconomic budget framework and reporting system;

Specific proposals for amending the law on the Court of Accounts are given in Annex 2.

26

in the classification of revenues and expenditures; in the area of results orientedbudgeting; and in the field of financial control.

90. At the same time serious constraints prevent more effective financialmanagement:

-the links between the macroeconomic framework, the budget and politicaldecisions are still weak.

-the political process upsets the budget timetable, which means that basic budgetprocesses (revision, execution, reporting, evaluation) cannot work properly.

-the statement of budget execution is not yet an effective accountabilitymechanism, to the extent that the process of compiling the statement is long and,once compiled it sits a long time in Parliament.

-the line agencies and the treasury use systems which render difficult the reportingand sharing of data amongst those in need of data for management purposes.

-cash flow data and forecasting are inadequately developed.

-financial controls are weak and inappropriately located.

91. The major problem with current reform efforts is that they are fragmented anduncoordinated. For instance, debt management cannot become fully effective until cashmanagement is improved. Cash managemenf waits for better cash forecasts but they arenot possible without better reporting of expenditure commitments. Financial controlactivities overlap. It would be unrealistic to expect all such inconsistencies to be resolvedgiven that parallel reforms occur on different time scales. Nevertheless a morecomprehensive process is required.

AN INTEGRATED REFORM PROGRAM

92. Reforms are needed in three major areas:

* fiscal planning (ensuring that aggregate public expenditure conforms tomacroeconomic realities).

* budgeting (achieving a better and more stable allocation of resources to sectors andprograms).

* resource utilization (improving the ability of the treasury system to provideinformation for decision-making; ensuring that the correct- balance is achieved

27

between ex ante and ex post controls; and establishing systems for reviewing costsand performance).

93. Necessary changes discussed in the above text, run across these three areas (e.g.the need for better cash flow forecasting, an improved classification of revenues andexpenditures, a more stable budgeting system, and the first two of these are already beingaddressed in separate initiatives). What has been lacking is an integrated and coordinatedapproach, without which it will be difficult to achieve significant improvements.

94. A comprehensive reform process would cover all three major areas identifiedabove. But to make progress, there are two requirements: recognition of the need foraction and acceptance of a comprehensive reform strategy. This report has identifiedareas where action is needed. The next step would be to formulate a specific program forcomprehensive reform. To reach that point, further fact-finding, discussion and planningwould be needed.

VI. LIST OF RECOMMENDATIONS

MACROECONOMIC FRAMEWORK

* MOF macroeconomic capacity should be strengthened along the recent initiatives, ifnecessary by transferring functions of the Commission for Forecasting as they relateto the macroeconomic framework for the budget, to MOF.

* MOF should produce its own macroeconomic framework for the budget which shouldbe continuously updated.

* The aggregate resource envelope for the budget should be announced earlierfollowing Cabinet endorsement of the macroeconomic framework.

3 This framework should be prepared in close coordination with National Bank ofRomania.

FRAGMENTATION OF THE BUDGET

* MOF should review all special funds to assess the need for their continuation asspecial funds.

* Where no convincing reason exists for a special fund, MOF should ensure that it iswound up and its funding returned to the budget.

* Government should adopt a strict policy of reducing the number of special funds andof preventing the formation of new funds.

BUDGETARY CLASSIFICATION SCHEME

* MOF should accelerate the program for reforming its scheme for classifying revenuesand expenditures.

28

* More important, it should adopt a scheme which responds to its own datarequirements, particularly as regards the identification of program costs and thedisclosure of more complete line item detail.

PROGRAM BUDGETING

* MOF should amend the expenditure classification scheme to allow betteridentification of the costs of programs and sub-programs.

* Technical assistance should be given to selected spending ministries to enable them tomove to budgets which are more program-oriented (i.e. identify objectives, costs andoutput measures).

PUBLIC INVESTMENT

* MOF should ensure in cooperation with the spending rrinistries that all capitalprojects of significant size are subject to economic appraisal.

* For the very largest capital projects MOF should carry out its own economicappraisals.

* For all project proposals of significant size the recurrent costs which will have to befunded on completion of the project should be estimated. MOF (and the relevant lineministries) should maintain records of these costs on a project by project basisincluding estimated coefficients of the capital/recurrent cost relationship so that therecurrent costs of capital projects can be estimated for budgetary purposes.

* To bring the existing stock of new proposals and ongoing projects to a more realisticlevel, MOF with relevant line ministries should carry out a review, aiming to sift outprojects where (1) the rationale for public provision is weak and no longer consistentwith current views of the role of Government; (2) the project is inconsistent withmedium term sector objectives and realistic expectations of future resourceavailability; (3) the project is known to have a poor rate of retum.

- The unit for the co-ordination of public investment of Govermnent of Romaniashould be transferred to MOF.

* Technical assistance should be given to selected spending ministries with large capitalproject portfolios to enable them to prepare project proposals more effectively.

MACROECONOMIC MANAGEMENT

* MOF should ensure that its cash flow forecasts for revenues and expenditures areregularly updated during the budget year.

* MOF should record actual cash flows in relation to forecasts.* MOF should analyze the changing macroeconomic impact of the budget through

figures concerning its cash implementation and share this information with NBR* An explicit link should be made between cash flow forecasts and borrowing

decisions.* MOF capacity should be enhanced to achieve these changes.

29

EXECUTION OF THE BUDGET

* adhere to the established budget timetable so that the budget is approved before thebeginning of the budget year.

* include in budgeted expenditure a reasonable allowance for inflation (not fullindexation, but reasonable estimates of the impact of inflation, for instance fromanticipated wage settlements during the budget year).

* rectify (revise) the budget only once during the year.* precede the rectification with a mid-term budget review.* set up a system whereby ministries report their expenditure commitments to Ministry

of Finance.* establish a system of cash flow forecasting on the basis of estimates of expenditure

and revenue, cash balances and anticipated borrowing requirements.* use the cash flow forecasts for determining expenditure releases and for cash and debt

management.* introduce a system of budget reporting which allows comparison between sums

authorized and actually spent for each main budget beneficiary, and use this systemfor the annual statement of budget execution.

* introduce an integrated financial management system to replace the current treasurysystem (see below).

TREASURY SYSTEM

* The treasury system should be redesigned -so as to provide spending agencies withmodem systems for managing commitments, payables, receivables and payrolls.

* A modem relational date base system should be installed covering all majorrecording, budgeting, accounting and reporting functions.

* Treasuries, spending agencies, Ministry of Finance and those responsible for issuingendorsements as a result of pre-audit should be linked via a network.

* The treasury system should be extended (in Bucharest to the four districts withouttreasuries and to the Bucharest municipality) but also to other locations so thatcommercial banks would no longer carry out treasury functions, and cashmanagement, control and reporting are improved.

DEBT MANAGEMENT AND GUARANTEES

* adapt reporting systems covering revenues, expenditures, debt repayments andtreasury operations and on this basis introduce an improved cash flow forecastingsystem to support debt management.

* in the longer run, develop an integrated financial management system for moreeffectively achieving this result.provide NBR with more complete data on expected cash flows arising from thebudget.

* introduce modem database systems for debt management.

30

* carry out simulations of future debt service costs and repayments based on alternativeborrowing scenarios.

* introduce stricter criteria for assessing the creditworthiness of borrowers seeking stateguarantees.

* reduce the risk to government by refusing guarantees where there is significant doubtabout the borrower's capacity to service the loan.

* ensure that the premiums charged to borrowers for state guarantees provide fundssufficient to cover the cost of defaults.

* enact the draft law on debt management.

LEVELS OF FINANCL41 CONTROL

* MOF should establish the new post of Financial Controller at all spending agencies.The financial controller, a senior staff member of MOF assisted by a small staff ofcontrollers, would exercise pre-audit functions instead of the Court of Accounts. Theaim would be to assist the spending agencies in ensuring adequate financial control.

3 Over time and to the extent appropriate, pre-audit functions would be transferredprogressively to the spending agencies themselves.

COURT OF ACCOUNTS

* The law governing the Court of Accounts should be amended in several respects.8

D All preventive control responsibilities (pre-audit) should be transferred from the Courtto the General Directorate of State Financial Control of MOF and the staff of theCourt currently carrying out these functions should transfer to MOF to the extent thatthey are willing to do so.

- The Court should carry out only post-audits and its law should be amended to allow itto carry out audits of efficiency and effectiveness (performance audits).

. The Court should adopt modem audit standards similar to those used in well-developed Supreme Audit Institutions in Western Europe and elsewhere. -

* The Court should regularly report its audit findings in public, irrespective of whetherthese findings have been debated by the legislature.

* The judicial decisions of the Court (including prosecution and the imposition ofpenalties) should be subject to superior judicial review.

* The Court should not carry out audits or controls of privately-owned companiesunless the equity share of the state exceeds 50%.

* The Court's audit of the privatization process should be exclusively post-audit.* A small joint committee should be established by the two houses of the legislature in

the field of public accounts to consider the Court's reports and to report to the twolegislative chambers.

Specific proposals for amending the law on the Court of Accounts are given in Annex 2.

31

ANNEX 1: COMMENTS ON THE LAW ON PUBLIC FINANCE

Basic principles. Certain basic principles need to be clearly stated: (a) that all publicrevenues flow into one consolidated fund (specific exceptions to this rule have to beclearly defined); (b) that the annual budget law authorizes for the budget year, both thecollection of taxes and the appropriation of funds from the consolidated fund to specificpurposes; and (c) that the Government proposes the budget, the legislature authorizes it,and the Ministry of Finance oversees its execution.

Financial authorization. The law does not define the requirements which should applyto the commitment of public funds: (a) that specific funds must have been appropriatedin the annual budget for that particular purpose. (b) that sufficient uncommittedbudgetary authority must exist to cover the intended expenditure. (c) that the expendituremust be covered by credits issued by the Ministry of Finance for incurring expenditure,and (d) that sufficient unused credits must exist to cover the proposed expenditures.Credit ordinators at all three levels (primary, secondary and tertiary) should be maderesponsible for ensuring that expenditure commitments do not exceed authorized limits.The information to be held by spending agencies necessary to achieve this result(information on budgets, credit limits, expenditure commitments and actual expendituresmade) should be specified.

Appropriations. The budgetary concept of "appropriation" should be adopted. A sum issaid to be appropriated, when a fully authorized budget allocates it to a particular use.Appropriation implies that the sum concerned cannot be applied to a use other than theone for which the appropriation was made. An appropriation gives legal authority toMOF to transfer the sum from the Government's general fund for that particular purpose.Normally appropriations also specify the budget organization which can use the money.

Budget reserves. In the case of an unexpected emergency, it is normal for theGovernment to have at its disposal a contingency fund. It is authorized to draw from thisfund under appropriate circumstances which should be defined. However, it also has toaccount for the money spent. The necessary procedures are not given in the law.

Accountability. For the circle of budgetary accountability to be complete, adequateprovision must exist for the body which originally authorized the budget (the legislature)to receive meaningful and reliable reports on its execution after the end of the budgetyear. This entails accounting reports which directly compare what was authorized withwhat was spent, and a report from an independent auditor certifying that the accountshave been correctly prepared and are otherwise reliable. Besides the informationdescribed in paragraph 3 above, the statement of budget execution should includestatements regarding cash flows and borrowings during the year, and cash balances andborrowings outstanding at the end of the year.

32

In order to review the execution of the budget the legislature usually delegates the task toa sub-committee which is empowered to call on the administration for clarifications andexplanations. The committee makes recommendations to Government regarding aspectsof execution which have been found to be unsatisfactory. Such a committee, often calleda Public Accounts Committee, does not exist in Romania and should be established.

Budget presentation. The rules for budget presentation are incomplete. They shouldinclude the following:

the annual budget (and its revisions) should be backed by adequate trend data onrevenues and expenditures to date (e.g. the expected out-turn of the current year,the budget results of years previous etc.), and

the budget should be accompanied by an economic report providing them