4. ASSESSMENT OF PUBLIC EXPENDITURE MANAGEMENT: INSTITUTIONAL DIMENSION

A. Overview

4.1 The effective translation of government expenditures into expenditure outcomes depends critically on institutional arrangements through affecting incentives that govern the size, allocation, and use of budgetary resources. Institutional arrangements influence the quality of the outcomes on three levels: (i) aggregate fiscal discipline; (ii) resource allocation and use based on strategic priorities (allocative efficiency); and (iii) efficiency and effectiveness of programs and service delivery (technical or operational efficiency).1 Institutional arrangements alone, however, may not necessarily have any effect. For such arrangements to be binding, the mechanisms that make adherence to these rules transparent and that hold the government and its ministries accountable for bad performance are necessary. Transparency and accountability mechanisms impose implicit costs on politicians and bureaucrats for violating rules and thus can make their commitment to the rules credible. This chapter examines the effectiveness of public expenditure management applying this analytical framework.

4.2 To better assess the budgetary process in Cambodia, it is essential to understand the current fiscal system which was adopted with the Organic Budget Law in December 1993. Under the current system, provincial governments do not have revenue-expenditure decision making authority. They merely act as agents or implementing bodies of the central government. Prior to the introduction of the 1994 budgetary reforms, although tax and expenditure policies were determined by the central government, the provinces were empowered to collect revenues and the center depended on the transfers from the provinces to meet its expenditure requirements. The unification of the budget in 1994 swung the pendulum completely in the opposite direction, from a rather anarchic to a highly centralized system of public finance.

4.3 In the current system, the revenue collection was completely centralized and the provinces were transformed into mere administrative units disbursing expenditures as delegated by the relevant line ministries of the central government. The Organic Budget Law stipulates that the ministers and heads of relevant public agencies are the principal fiscal officers of the state budget, responsible for their relevant line ministries and departments both at the center and in the jurisdiction of the provinces; the ministers confer on the provincial governors the function of deputy financial officers of the state budget and also delegate the responsibility for executing some expenditure functions. The recently approved Provincial Budget Management Law, however, recognizes provinces as independent budgeting entities and devolves some limited revenue and expenditure powers (see Box 4.5, later in this chapter). 4.4 Budget institutions and processes in Cambodia have made a remarkable contribution to macroeconomic control. In the late 1980s, unsustainable large budget deficits funded by new money creation contributed to galloping inflation. This peaked at 150 percent in 1991 and continued at high levels until 1994, before decreasing markedly to single digits during 1995-97 with the adoption of the Organic Budget Law and the subsequent reforms aimed at improving budget management. Under the Law, the government’s annual fiscal program is detailed in the national budget, which must be prepared by the Ministry of Economy and Finance (MEF) in association with other line ministries and passed by the National Assembly. The Law lays down the timetable for completing the various steps involved in the budget preparation to ensure that the budget for the year is approved prior to the beginning of every financial year. The Law provides for a single unified national budget consolidating all the fiscal functions of both central and provincial governments, establishing the authority of the central Treasury

1 Ed Campos and Sanjay Pradhan, “Budgetary Institutions and Expenditure Outcomes,” September 1996; “The Public Expenditure Management Handbook”, June 1998.

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over all revenue collected, and ensuring a priori as well as ex post control over government expenditure by the Treasury. By adhering to fiscal discipline underpinned by the Law and the subsequent efforts2, authorities have succeeded in reining in the current budget deficit. Thus, from the perspective of expenditure control, Cambodian budget processes have been performing effectively.

4.5 Budget institutions and processes in Cambodia, however, have been very detrimental to allocative and technical efficiency, which is discussed in the following sections. The fundamental problem is that the Cambodian budgetary process has sacrificed too much in terms of allocative and technical efficiency to maintain aggregate fiscal discipline. Thus, the challenge for budgeting in Cambodia is to enhance the allocative and technical efficiency of the budget process without compromising the high level of aggregate expenditure control which is being achieved by current highly centralized budgeting practices. This involves improving the current unnecessarily large trade-off between the aggregate fiscal discipline on the one hand and the allocative and technical efficiency on the other. In fact, in the longer run there is evidence that improving allocation and operational performance can support improved fiscal discipline. The issues relating to improving the unnecessarily large trade-off are the central concern of this chapter.

B. Linking Planning, Policy, and Budgeting

4.6 Closely linking planning, policy, and budgeting is one of the most important factors contributing to desirable budgetary outcomes. The Five-Year Socio-economic Development Plan (SEDP) of Cambodia (1996-2000) sets out the developmental objectives and strategies for the medium term and makes an indicative allocation of investment pattern in the economy. This has to be translated into concrete expenditure programs in the annual budgets. Over the last four years, some important progress has been made in linking the plan with the annual budget through three-year rolling PIPs; nevertheless, the linkage between the medium term plan and the annual budget remains weak.

4.7 The Ministry of Planning (MOP) prepared the First Five-Year SEDP and subsequently three PIPs. The third PIP (1998-2000) makes a significant advance in strengthening the institutional capacity to prioritize inter-sectoral and intra-sectoral investments to meet the sectoral targets indicated in the SEDP. It also links the three-year rolling plan on investment with the investment outlay in the annual budget for 1998 in some important respects. First, greater coordination between the MEF and the MOP in the preparation of the PIP and the budget has helped to forge a better technical linkage between the planning and the budgeting of investment outlay. In particular, the PIP process was initiated by a joint circular issued by the MEF and the MOP which set out the objectives, guidelines, and timetable for the preparation of the PIP and which stated the policy that henceforth only those projects included in the PIP would be financed by the national budget. Second, the setting up of a formal inter-ministerial steering committee--consisting of high ranking officials from the MOP, MEF, CDC, and NBC, and chaired by the MOP--aids considerably in coordinating the functions of policy and investment planning, budgeting, and aid coordination. The steering committee is responsible for setting the overall investment ceiling and sectoral allocation priorities in keeping with the objectives of the SEDP. Third, there has been improvement in the appraisal and prioritization of projects. Prioritization in the PIP is to be based on sectoral priority, absorptive capacity, domestic resource availability, and implementation capacity.2 The MEF has made significant efforts despite difficult political situation. In particular, the MEF have

issued numerous reports on the occasions of the preparation of the budget and the reporting of its implementation. These reports have made a broad analysis of the fiscal situation focusing on the lack of discipline in fiscal management and the failure in implementing proper management process. These reports are usually sent to the Council of Ministers and the National Assembly. They are regularly published in the Budget Book and the MEF Economic and Financial Review (quarterly). Their recommendations are translated into laws, regulations, decisions of MEF and/or administrative circulars. For details of fiscal reform efforts during the last four years, see 45 Months at the Ministry of Economy and Finance by H.E. Keat Chhon, June 1998.

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4.8 In spite of efforts to improve the efficacy of the institutional and procedural framework, the government’s ability to determine inter-sectoral and intra-sectoral resource allocation remains weak. Consequently, linkages among the indicative sectoral allocations in the SEDP, programmed allocation in the PIP, and the annual budget allocation remain tenuous. The most important reason for this is that, with virtually no public savings, the government is not in a position to balance its investments so as to steer them to meet priorities according to the medium term plan. Thus, the government can hardly afford to give up externally funded investments, irrespective of sectoral priority or the impact on poverty reduction.

4.9 A critical institutional weakness is the absence of a proper system of monitoring. There is no system in place to see whether the actual disbursement of assistance to these sectors and sub-sectors has, in fact, occurred. When actual investment allocation is not monitored, it is difficult to direct future expenditures or the disbursement of external assistance to meet the plan targets. The task of monitoring is not confined to realizing investment targets. It also encompasses examining the achievement of the physical targets laid down. The assessment of additional investment requirements can be made only after the achievements of both financial and physical targets have been monitored. The government recognizes this problem and a system for monitoring the PIP is to be established under the Public Investment Management System (PIMS), which is intended to ensure the coherence and complementarity of the separate capital budgeting activities.

C. Budget Preparation

4.10 Budget preparation in Cambodia takes place in several elaborate stages (see Box 4.1). Despite this elaborate system, although some progress has been made in involving other ministries and agencies (especially the Ministry of Health), in practice the MEF largely dominates the entire budget preparation process (with the notable exception of the Ministries of Defense and Interior). The involvement of strategic agencies such as the CDC, the MOP, and the NBC is still limited. Although every line ministry has to prepare its budget allocation on the basis of the expenditure ceiling provided, the financial officers--officials of the MEF attached to line ministries--play the lead role. The involvement of the provinces is even smaller. The preparation of the budget by different provincial departments is carried out under the guidance of the financial officials deputized to the province by the MEF. While this arrangement is due largely to the weak capacity of other agencies as well as the need to exercise strict fiscal discipline, it brings out problems of incentives and accountability.

Box 4.1: The Budget Preparation Process in Cambodia

The first stage (beginning in June of the preceding year) is the establishment of the macroeconomic framework of the budget. This involves an MEF review of the macroeconomic constraints on the broad budget aggregates and their implications for overall budget balances. Forecasts of GDP growth and associated tax and other revenues (based on outcomes for the current year to date) are prepared by the MEF. Revenue forecasts determine the room for domestically financed budget spending. The second stage of budget preparation begins the policymaking process at the MEF. Initially, this focuses on the revenue side. Available funds are reviewed against broad spending objectives, and the scope for revenue augmentation is examined. Any options for reducing spending on major items to free up funds for new priorities is also discussed in general terms at this stage.

Once the availability of resources for domestically funded spending is determined, the third stage in budget preparation is to begin the prioritizing of these funds between the key sectors. This involves a first draft of the composition of the budget by broad strategic sectors, designed to maximize allocative efficiency. This draft sets ceilings for recurrent and investment expenditure by ministry and by major expenditure chapters of the budget. These indicative shares are based on the priority themes identified by the government for that particular budget (for example, the 1997 budget increased sector shares for education and health). The proposed broad sector shares are then approved by the Council of Ministers. With the sectoral architecture of the budget established, the fourth stage of the budget process

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begins, which involves translating the sector shares set by the MEF and Council of Ministers into the detailed spending programs for each line ministry. This process begins with a technical circular from the MEF to line ministries in July of the year preceding the budget which outlines the broad strategy and priorities for the coming budget. Against this background, the budget circular asks each ministry to present detailed bids for funding for both the central administration and the provincial departments of the ministry. The preparation of detailed estimates for the receipts side of the budget proceeds in parallel with this process.

In parallel, line ministry bids for funding are prepared during July and the first part of August for an August 15 deadline at the MEF. Ministry bids for different budget lines are heavily based on historical budgeting. The outlays in the last budget become the bids in the next budget. However, the process is more complex for ministries such as Education and Health which deliver programs through provincial and district offices. The MEF receives line ministry spending proposals by August 15 in the year preceding the budget. Then, the reconciliation of the top down and bottom up phases follow. The fifth stage, taking place in the second half of August, involves the technical analysis of line ministry budget proposals by the MEF, which checks compliance with priorities in the medium term plan, accuracy of costings, and consistency with initial ministry ceilings. The starting point for this MEF examination of line ministry bids is the budget currently under way. This is adjusted for technical parameters -- the actual use of budgeted funds by agencies and movements in wages and prices. The result is the budget for 1996 (for example) on the parameter base of 1997. Line ministers’ budget proposals for 1997 are then compared with this benchmark to identify adjustments, extensions, and new programs incorporated in their bids for 1997.

The sixth stage, during September, involves the resolution of conflicts between funds earmarked by the MEF for each ministry and funds sought by the ministry. This involves meetings between the MEF and line ministry officials. Where a disagreement cannot be resolved by officials, it may be raised to the level of the Minister of Economy and Finance and the line ministers. Upward and downward adjustments of ministry funding can also be made to ensure that proposals that can be fitted within one ministry’s envelope are not less cost effective than proposals which cannot be squeezed into the envelope of other ministries. In the seventh stage, final issues and disputes are resolved during October at the prime ministerial level. The draft budget that emerges is then submitted to the Council of Ministers for approval. With the details of the budget determined, the eighth stage is to prepare the budget bill. The bill is submitted to the National Assembly, and is subject to committee discussion and a plenary session. Following signature by the President of the National Assembly, the budget law is promulgated by the King. Finally, in the ninth stage the MEF issues a Praka to line ministries outlining the funds budgeted for them. Line ministries in turn distribute funds internally to their operational units on various decision rules.

4.11 Treatment of the capital component of the budget is different from recurrent expenditures. Most of capital budget is donor funded. Proposals for capital investments which appear in the budget originate from line ministry agreements with individual donors about funding for specific projects in their respective sector. However, the prioritization of capital spending options for inclusion in the budget takes place separately from the prioritization process applying to recurrent expenditures. It operates through the preparation of a PIP. While some progress has been made through the PIP process, the linkage between decision making on the investment and recurrent budgets is weak. This linkage needs to be strengthened through a more integrated approach.

D. Budget Execution

4.12 Highly Centralized Budget Execution. Budget execution is very highly centralized, with the MEF approving the individual spending decisions of line ministries to an extent that has few parallels. In some cases, three authorizations are required from the Minister of Economy and Finance--for entering obligations, for accepting tender, and for releasing cash. The running costs of line agencies are prescribed in Chapter 11 of the budget by the MEF in fine detail. Virement processes involving MEF approval are required to switch funds between, for example, electricity and telephone, inhibiting cost effective program management. Expenditure approval processes in the provinces are even more complex. A single expenditure action can involve approvals from the responsible line ministry, the Department of Financial Affairs at the MEF, the provincial governor, and the provincial treasury. Expenditures are subject to complex central controls intended to tightly control the evolution of the budget deficit through the course of the year. This highly centralized approach to budget execution ensures a high level of

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expenditure discipline. However, these controls make proactive management of programs by line agencies extremely difficult and also significantly reduce the allocative and technical efficiency of the budget process, as these complex processes absorb large amounts of resources, reduce budget flexibility, and focus senior officials on processing paper.

4.13 Monthly Cash Allocation of the Budget. Owing to the uncertainty of government receipts from month to month and the ad hoc (and often unwarranted) injection of new spending priorities (in particular in defense and security) into the budget process, budget execution is dominated by a monthly cash allocation process (Figure 4.1). At the beginning of each month, expenditure allocation to different spending ministries and agencies is carried out by a committee composed of the Budget, Tax, Financial Affairs, and Treasury Departments of the MEF, on the basis of the stock of

Figure 4.1: Monthly Distribution of Revenues and Expenditures in Cambodia, 1997

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Treasury balances and the expected revenues during the month. On this basis, a Praka of the monthly expenditure plan is issued by the MEF. This prioritizes the access each line ministry will have to the cash expected to be available during the month.

4.14 Financial Controller System. The process of authorization, however, is a long and complex one. Financial controllers employed by the MEF and assigned to line ministries, provinces, and municipalities play a central role in this process (see Box 4.2). Financial controllers undertake a pre-audit of each expenditure proposal by line ministries. This audit is based on expense, consistency with budget allocation, accuracy of costing, availability of funds, compliance with budget laws and regulations, consistency with budget intent, and quality of supporting documentation.

Box 4.2: Financial Controller System

The process of centralization was strengthened with the introduction of a system of financial control through a sub-decree in 1995, implemented beginning in mid-1996. Following this sub-decree, 50 financial controllers were appointed by the MEF and trained under a USAID program. Under this system, there is a chief financial controller for each line ministry and several deputy and assistant controllers, depending on the size of the budget of the line ministry. The functions of the chief financial controller could be similar to that of a chief financial officer of a line ministry. However, the controllers are located in the MEF and report to the Director of Financial Affairs. The system remains largely a function that pre-audits all expenditure commitments made by the line ministries.

The sub-decree allows the financial controller to authorize all expenditures up to CR 20 million and certain recurrent expenditures such as salaries on an annual basis. Following the July 1997 events and the financial crisis faced by the government, however, all expenditure commitments other than salaries and wages now require the approval of the Minister of Economy and Finance. As a result, the financial controllers are being used to process individual expenditure commitments for approval by the Minister of Economy and Finance. The financial controllers remain largely ineffective in the financial management of the ministerial expenditure programs for which they are responsible given their preoccupation with processing commitment requests for the approval of the Minister of Economy and Finance, as well as their lack involvement in the work of the finance and accounting departments of line ministries.

If these officers could be integrated with the line ministries within a decentralized accounting and financial management framework, they could play a significant role in the management of the line ministries. Proper control of expenditure commitment is important, but financial management does not stop there. Strategic financial management requires allocating resources to priority needs, evaluating the cost effectiveness of services, and obtaining value for money. These activities become even more important in view of the resource constraints

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currently faced by the government. The financial controllers, supported by adequate financial management systems, should be able to exercise better management of revenues, recurrent expenditures, and capital expenditures.

4.15 Since virtually all line agency expenditures must be approved by the relevant MEF financial controllers, these officials play a key role in ensuring that line agencies observe the letter of the budget. They also provide a control point for monitoring the level of spending commitments incurred by agencies. Other roles include reporting on budget implementation and providing advice on line agency spending proposals for the next year’s budget. Payment orders issued by the financial controllers in response to a purchasing activity which they approve are cleared through the MEF. This is a highly centralized process which currently involves approval by the Minister of Economy and Finance himself of relatively small and routine outlays proposals. Notification of MEF approval is then given to the national or provincial Treasury, authorizing the Treasury to make a direct payment to the external supplier. Substantial delays are involved as well as uncertainty about whether funding will be approved.

4.16 If cash flow problems arise during the course of the month, three types of adjustments are made in order to prevent an unplanned increase in the budget deficit. First, the monthly cash allocation by the MEF to individual ministries is reduced in relation to that contained in the budget appropriation. Second, payment authorizations are withheld by financial controllers, which restricts line agencies from spending their full monthly cash allocation (a pre-audit control). Third, where payment has been authorized by the financial controller and the transaction has been undertaken by the line agency, funds may not be immediately released by the national or provincial Treasury to the external supplier of goods and services.

4.17 "Serial spending" occurs in Cambodia owing to the introduction of new spending decisions in each monthly cash allocation. Ten percent of each month’s cash allocation is set aside for new political decisions in regard to spending. These decisions relate mostly to defense and security. The monthly cash allocation process does take account, to some extent, of the claims of the competing ministries, and involves a form of ad hoc reprioritizing in the face of unforeseen cashflow constraints. However, reprioritizing is undertaken without the same transparency and review mechanisms that characterize the budget preparation phase, thus reducing the allocative efficiency of the budget process. More serious is the effect on the technical efficiency of budget execution of ad hoc monthly revision of the budget. The operational inefficiencies created by the highly centralized system of cash allocation to line ministries relate particularly to the tendency for cash release to be irregular and unpredictable. Funding release tends to be concentrated toward the end of the year. Thus, operational units of the line ministries are uncertain about how long each cash allocation will last, which distorts the manner in which they determine their own spending priorities. For example, while the Ministry of Public Works and Transport would like to spend on road repairs when the road conditions are bad after the monsoon, they cannot undertake these repairs until the end of the year. Lack of resources to finance the projects on a continuous basis can also result in time and cost overruns. In addition, there exists a practice of informally borrowing from local money lenders at exorbitant rates of interest to meet immediate expenditure obligations and repay the money when the liquidity position improves. 4.18 The monthly allocation practices during budget execution, often resulting from unwarranted political intervention, raises questions about the value of the elaborate processes associated with budget preparation. It is clearly demonstrated by Table 3.6 in Chapter 3 which shows significant discrepancies between the outcome and budgeted non-wage O&M expenditures, hugely in favor of defense and security at the expense of economic and social services. It also points to the importance of developing capacity for reliable and honest monthly revenue projection.

4.19 Leakage of Funds. A further reason why ministerial and provincial departments effectively fail to receive their budgeted allocation is associated with the informal diversion of funds released to

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individual agencies for uses unrelated to the agency program ("leakages" of funds). In the course of accessing their monthly cash allocations, ministries and provinces encounter informal arrangements for deductions from authorized funding at various approval points. These leakages fall into two categories: the diverted funds are used for other programs, informally reprioritizing budget outlays at the margin, and compromising the allocative efficiency of the budget; and the diverted funds supplement the personal income of those processing the payments (outright corruption), resulting in technical inefficiency owing to the higher than necessary budget cost of achieving given program deliverables. Box 4.3 presents the anecdotal evidence of such leakages.

Box 4.3: Anecdotal Evidence of Leakage of Funds

Anecdotal evidence suggests that “leakage” is particularly high during the course of processing cash allocations by the provincial treasuries (possibly as much as 15 percent of funds being disbursed to an individual ministry leak to other uses), with further leakages of possibly 5 percent at the provincial finance department office (in the course of issuing payment approvals) and possibly 1 percent at the provincial office. 1 Additional leakages may occur further down the line in the form of “commissions” by district officials. Further leakages arise owing to the delegation held by the provincial governor for the release of line ministry funds to ministry operatives in the province. This results in the practice by provincial governors of siphoning off funds intended for the regional activities of a particular ministry for their own purposes and programs, with the provincial ministry officials being obliged to sign for funds which they do not in fact receive. The propensity of provincial governors to skim funds from programs in this way reflects, in part, the lack of provincial revenue measures available to the governors.1 Based on information collected from provincial health departments in 1997.

E. Budget Monitoring and Reporting

4.20 The government has taken several steps to improve financial management and public accountability. A series of laws, decrees, directives, and accounting circulars has been put in place to provide the regulatory framework for sound financial management. In addition to the financial controller system described in Box 4.2, specialized units have been established in each line ministry to strengthen procurement. A budget reporting system, called TOFE, provides monthly macro-level information. These measures have improved budget management and accountability for public funds compared with the pre-1993 era.

4.21 Nevertheless, budget monitoring and reporting remain weak. The government’s efforts to increase transparency and accountability in the public sector have yet to bring about the expected outcomes, owing to weaknesses in implementation and lack of a proper accounting and auditing system and sound financial management at the line agencies. The severe limitations of the accounting and auditing systems are detrimental to technical efficiency, because they create an environment that is conducive to widespread leakages. There is an urgent need to establish a standard accounting system for line agencies, which would provide greater transparency of transactions and would help curb leakages. Linked with this is the need to establish audit capability, both internal and external, for line agencies.4.22 Accounting. The current accounting system is modeled on the pre-War French government system. The Treasury maintains accounts under double-entry accounting principles, with a modified cash basis accounting. This system requires that accounts be maintained on a cash basis but that they include certain commitments at year end under certain rules. Owing to the cash shortage, however, even the cash basis accounting system is not properly maintained. The expenditure commitments and the corresponding cash payments are occasionally in arrears. The Treasury then issues payment orders to creditors which are not immediately cashable by contractors and suppliers. The creditors in turn discount these payment orders with taxpayers who can use them to settle tax dues. It is not clear how these transactions are reflected in Treasury account books.

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4.23 The Treasury accounts are maintained by chapters of expenditure such as wage expenditure, non-wage expenditure, and capital expenditure. Revenues are better analyzed by tax and non-tax revenues and their sub-components. This system of accounting facilitates producing the monthly financial statement (TOFE). This is used for month-to-month budgeting versus reporting actual revenue, expenditure, and financing sources. The functions of line ministry accounting departments primarily relate to processing applications for approval of commitments to the MEF financial controllers.

4.24 Procurement. Following the issue of the Decree on Public Procurement in 1995, procurement units were established in all line ministries and provinces to undertake public bidding to procure goods, services, and civil works. In addition, a central Procurement Unit was established in the MEF to undertake all procurement contracts in excess of CR 20 million (approximately US$5,100). Notwithstanding this law and the very low threshold for public bidding, only about 14 percent of total non-wage expenditure in 1997 was procured through the MEF Public Bidding Office. This low volume of public bidding results from the inability of the MEF Public Bidding Unit to impose the legal requirements, owing to pressure from the ministers and the circumvention of bidding regulations through the breakdown of bids into smaller parcels. The law remains largely ineffective and the transparency of the procurement process is questionable. At times, after the announcement of public bids, contracts have been awarded outside of the bidding process through political interference.

4.25 One reason for the ineffective implementation of the procurement procedures could be the very low threshold set for centralized procurement. As centralized bidding takes time and the line ministries lose control, there is no incentive for line ministries to comply strictly with the rules. It would be better to give more flexibility to ministry procurement units and strictly enforce rules through post audits by the MEF procurement staff.

4.26 Auditing. There is no proper internal or external audit in place. As discussed above, financial controllers perform the pre-audit function. The current audit requirements are based on a Decree issued in 1984. The Decree explicitly exempts the Defense and Interior Ministries from audit unless it is authorized by the Prime Minister. A draft Audit Law is under consideration to establish an independent Auditor General’s Office reporting to the National Assembly. When the Audit Law and the relevant decrees under discussion are approved in current form, the laws would establish the basis for a modern auditing function. Both external and internal auditing can be useful only if audit findings are properly addressed and reported deficiencies are corrected. In this context, establishing a modern accounting function and training staff is critical. The Law on Accountability of Public Managers under consideration would also contribute to enhancing the accountability of budget with fines, disciplinary actions, and charges under the penal code for the mismanagement of public managers.

F. Recommendations

4.27 Given the history of fiscal and macroeconomic instability, it is clearly undesirable to introduce changes to budget processes which might weaken the current effective management of the budget deficit. However, considerable scope exists for improved allocative and technical efficiency of the budget process consistent with the present high levels of fiscal discipline. This relates particularly to the institutions and processes involved in budget execution. Because of the weak technical capacity at the central and provincial levels, this section focuses on the pragmatic removal of impediments to effective budget operation. Toward this end, it provides a strategy for reform in the form of six key directions and, under each direction, makes concrete recommendations with indications of sequencing. The six key directions for reform are:

Ensuring political commitment to an authoritative budget process Establishing responsibility for performance at the level of spending units Rationalizing the roles of the central and provincial administrations Developing financial participation schemes (user charging) Improving the allocative and technical efficiency of donor funding

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Strengthening the Public Investment Management System.

4.28 The top priority is for the government to respect the budgetary process, because if the government does not abide by its own budget rules and procedures (which has often been the case in Cambodia), there is little point in making efforts in designing budget reforms. In this regard, reducing unwarranted political interference in the budgetary process should be considered as the prerequisite for any budget reforms. Another prerequisite is to improve the managerial and accounting and reporting capacities at the spending units. This is especially so if responsibility for performance at the level of spending units is to be established--which is the key to improving the trade-off between fiscal discipline and allocative and operational efficiency--without unacceptable loss of financial control.

1. Ensuring Political Commitment to an Authoritative Budget Process 4.29 Ensuring predictability of the budget through political commitment to an authoritative budget process is the top priority. This reform would be a necessary condition for credible efforts towards improving management of expenditures at the sectoral level.

4.30 Recommendations: Ad hoc spending decisions taken outside the budget preparation context--which occur

because of newly identified political priorities-- should be minimized. Where new spending measures are proposed during the course of the year, they should not

exceed the reserve budgeted for this purpose. Where this is not achievable, the request for new spending from the Prime Minister's Office

should also specify the savings option from which the funding will be drawn, and the affected line ministries should be informed of the revision of their budget estimates.

2. Establishing Responsibility for Performance at the Level of Spending Units

4.31 Devolving Management and Financial Freedoms. The foremost medium-term direction for change is to increase responsibility for effective program performance at the program agency level. This would entail empowering program agencies and functional units to manage their programs with minimal interference rather than processing unpredictable levels of funding through multiple external approval processes. The aim is to reduce the pre-audit of individual disbursement activities by the MEF and replace it with a post-audit of expenditures from MEF approved expenditure plans. To give greater freedom to line agencies to determine the way in which they spend money in response to their knowledge of program environment, the government needs to extend the scope for lump sum program allocations rather than detailed line allocations. This would be a gradual process, as developing a program basis for budgeting requires good financial management skills within line agencies, so that envelopes of funds for particular programs are not diverted to less productive uses.4.32 Therefore, the devolution of management freedoms through program-based budget allocations should be conditional upon progress in capacity building in the spending units and hence confined to pilot programs rather than to broad-based changes for some time to come. A pilot approach was introduced in 1996 in the form of the Accelerated District Development (ADD) System (Box 4.4). 3 This system provides more efficient and flexible funding for hospitals and health centers in a small number of districts on the basis of: appropriating of a separate envelope of funds (on a program basis) for each district selected for participation, rather than having the district’s funding drawn from separate ministry-wide line items for numerous individual categories of running costs (to which individual districts have uncertain access); and providing more streamlined funding arrangements that bypass the provincial governor and associated leakages.3 ADD is not a program budget in a strict sense, among others, as it does not include wages. It is more of

cost center budgeting, with a program component.

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Box 4.4: Accelerated District Development System (ADD)

The ADD is a cash advance system (introduced in June 1996) designed to give program managers greater certainty in regard to the level of budget funds available to them and greater flexibility in the use of these funds. It provides funds for referral hospitals and health centers in (currently) 22 ADD districts. The ADD’s main feature is that operating costs (excluding wages) are budgeted as a single envelope (Chapter 13). This gives program managers discretion in the use of funds for some 24 purposes, such as patient food, emergency patient transport, furniture, maintenance of buildings, and vehicle running costs. Part or all of the operating costs in ADD districts comes from the Accounting and Finance Department of the Ministry of Health (MoH) rather than from the provincial Treasury. This eliminates pre-audit and provides greater certainty and stability of funding. However, the release of funds through the year is still subject to Treasury restrictions and does not ensure regular cash release and budget certainty.

The scheme operates as follows: (i) the MoH receives a cash advance from the MEF, which is charged against the MoH Chapter 13 allocation and becomes an imprest account; (ii) this is distributed to ADD districts on the basis of their budget allocation; and (iii) allocations are reimbursed by the MEF via a payment order signed by the MEF and given to the Treasury, reimbursing the imprest account. To ensure accountability, the imprest account is reimbursed by the MEF only after ADD districts submit invoices to the MoH indicating proof of expenditure, together with a summary of spending against each budget line by the ADD district. These invoices are checked by the MoH and the financial controller for the MoH at the MEF. If everything is correct, a payment order to the Treasury is signed by the MEF and the imprest account is reimbursed and charged against the MoH Chapter 13 allocation. The MoH can then make a further distribution to the ADD districts. The districts have the freedom to spend the Chapter 13 budget according to their district’s needs. However, the MEF is encouraging them to give priority to health-specific expenses--such as patient food and repair of medical equipment--over administrative expenses that are less directly related to health, such as furniture and maintenance.

4.33 The piloting of program budgeting through the ADD is an important step toward a better trade-off between fiscal control and the allocative/technical efficiency of the budget process. It sacrifices little in the way of fiscal control while offering a more streamlined and cost-effective use of funds by functional units. While strong central control of the total monthly cash release ensures continued fiscal discipline, spending decisions made closer to the program delivery level can respond more sensitively to priorities than can funding that is determined prescriptively from the center. Preliminary indications to date are that this is operating successfully.

4.34 Recommendations: An evaluation of the effectiveness of the ADD in its 22 districts is needed. Depending on the findings, a unit needs to be established in the MEF for: addressing

problems in introducing the ADD in the existing 22 districts; planning for the extension of ADD to other districts; identifying other agencies in which program budgeting might also be piloted.

Depending on the results of the evaluation, a trial of a similar program-based scheme should be planned in other agencies (with MoEYS an early priority).

4.35 Improving the Financial Management of Program Staff. Before introducing more devolved budgeting, good financial management skills within line agencies needs to be established. There are at least three pre-conditions for this: (i) the establishment of basic financial reporting systems in line ministries which indicate the purposes for which funds are used within each functional unit within the agency; (ii) a commitment by functional units to spend non-mandated funds so as to maximize program outcomes rather than the personal or managerial interests of the unit; and (iii) a commitment on the part of senior line ministry management to actively monitor the use of funds by functional units under their control and a willingness to redirect funds between units in response to ineffective use of funds.

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4.36 An initial step is to improve transparency and accountability through establishing standardized accounting procedures for line agencies. For this purpose, the accounting systems of the major line ministries should be reviewed to highlight the improvements needed before program budgets are used more widely. Following this, the MEF should develop accounting standards for line ministries so that an integrated financial information system could interface Treasury general ledger accounts with the line ministry general ledger accounts. Establishing a proper audit system with an independent Auditor General's Office is also critical. 4.37 Recommendation: The MEF needs to establish a financial management improvement team to help agencies introduce ministry-wide accounting systems for reporting, analyzing, and benchmarking resource use by each of their functional units. The unit would work initially with the most innovative of the large agencies (MoH). 4.38 Accounting for Deliverables. If financial decision making is to be devolved, the responsibility for program performance needs to be clearly assigned to the program units. This requires the identification of the outcomes for which they are responsible. The government needs to ensure that budget estimates of payments to line ministries are accompanied by statements of the deliverables expected from the ministry. The Health and (to some extent) Education Ministries are moving toward clearer identification of program outputs, because their budget bids are based on bottom up estimates of service that provide functional units and unit cost formulas for their operation. Over the medium term, rigorous activity-based budget bids along these lines need to be encouraged, as they would pinpoint areas in which operating costs are unacceptably high in relation to outputs and would reveal areas in which some flexibility is desirable in budget allocations and increase the cost effectiveness of budget outlays as a whole.

4.39 Recommendation: The MEF needs to prepare a timetable for introducing activity-based budget bids by line agencies over a five-year period. This could involve penalties where funding bids are inadequately supported by costing information. Assistance needs to be made available to line agencies from the proposed MEF financial management improvement team for the development of activity-based budget bids.

4.40 Improving Technical Skills in Line Agencies. A critical issue for devolving responsibility is whether line agencies have the technical capacity to undertake financial and management planning functions. The current situation is such that the need to build a financial management skill base in program ministries is urgent. One possible solution to this problem would be to create a technical specialist grade within the public sector for financial and policy analysts, with a wage structure closer to private sector payments for similar skills. Formal training in financial and program management skills would also help develop a suitable environment for greater prioritization of resource use within agencies. Equally important is that capacity building at the project management level needs to be more systematic and programmed.

4.41 Recommendation: Consideration needs to be given to the establishment of a technical specialist grade in the government service with wages more closely related to comparable technical positions in the private sector.

3. Rationalizing the Roles of the Central and Provincial Administrations

4.42 Program delivery at the provincial level involves too many players. And spending actions can be modified or delayed at many points, which can result in excessive uncertainty, delay, and leakage of funds. A particular issue is that the large number of government agencies involved increases the siphoning off of funds because of the payment of commissions at each stage of authorization. In

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addition, provincial governors redirect funds intended for line ministry functional units. The number of individuals and agencies involved in the approval process also results in an inability to assign responsibility for shortcomings in the operation of line ministry functional units.

4.43 Thus, a priority in budget process reform is the separation of the funding processes for provincial units of line ministries from clearance mechanisms involving the provincial governor. This is currently being tried successfully with ADD. A parallel reform, the Provincial Budget Management Law, gradually in phases would give provincial governors their own sources of revenue for undertaking the local programs which they identify while also gradually terminating the provincial governors’ role in channeling line ministry funds to their regional operations (Box 4.5). This would increase the control over cash allocations that can be exercised by the provincial departments of the line ministries, district offices, and managers of operational units, and would reduce the power of provincial governors in regard to cash disbursement.

Box 4.5: Provincial Budget Management Law

For administrative purposes, Cambodia is divided into provinces, districts, communes, and villages. There are 21 provinces in Cambodia. The country follows a unified budgetary concept in which the tax and expenditure powers were centralized with the adoption of the Organic Budget Law in December 1993 . The provinces do not have powers to raise taxes, fees, or use charges and they execute expenditure programs on behalf of the central government merely as its agencies.

Under this Law, provincial governors and city mayors must prepare and implement their budgets and are responsible for the maintenance and upkeep of the public assets transferred to them. The Law assigns certain local expenditure functions, such as maintenance of street lighting, fire fighting, public parks, water supply, drainage, sewerage, garbage disposal, roads, and parks to the provinces/cities, which are also required to meet their own employee payrolls and to devolve grants to districts, communes, and villages. To meet these expenses, the Law assigns certain minor taxes, for example, land taxes, registration fees and patent fees, vehicle taxes, and non-tax revenues such as user charges on electricity and water supplied to local residents and fees for the occupation/use of public property (markets, parking lots, etc.). These revenues will be supplemented by central grants to ensure that no province or city has a deficit budget.

The Law is expected to be implemented in phases. Initially, the Law is to be applied to Phnom Penh, Siem Reap, and Battambang. It would be extended to other provinces as the administrative capacity develops. Full application of the Law would require detailed working out of the framework for the local levy of taxes and non-tax revenues as well as a methodology for making transfers which is objective, equitable, and transparent and at the same time contains incentives for better fiscal management at the provincial level. The degree of decentralization advanced by the new law, however, would be limited. In the proposed arrangement, the expenditure share of the provinces remains broadly the same. Nor do provinces have appreciably greater flexibility in regard to revenues, since the revenues assigned to them contribute less than 2 percent of total tax revenues and about 1.5 percent of total revenues. Nevertheless, the proposal would provide better incentives to provincial governments for providing services. Enabling the provinces to raise revenues to meet a part of their expenditures (although marginal) enhances flexibility, provides greater incentives, and improves accountability.

4.44 It should be borne in mind, however, that the development of a transparent and objective transfer system devoid of disincentives to fiscal management is a challenge. Moreover, as the expenditure control system at the provincial level is weak, developing the provincial financial management capacity, including an independent audit system to ensure that funds are utilized efficiently and for their intended purposes, is critical to the decentralization of expenditures.

4.45 Recommendations: A priority should be given to separating the roles of the line ministries and provincial

governors in the disbursement of budget funds.

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In parallel, the financial management skills of the regional units of line ministries should be upgraded within each line ministry.

4. Developing Financial Participation Schemes (User Charging)

4.46 The Cambodian budget system is characterized by a variety of arrangements for user charging by service delivery agencies. Some arrangements are officially sanctioned, such as fees for logging and fishing rights, while others are unofficial, such as fees for school examinations or health services. Ministries vary greatly in the degree to which they acknowledge the existence of user charges. For example, the MoH is open about their existence but the MoEYS is reluctant to acknowledge them. At face value, extrabudgetary funding is inconsistent with the budget law and prevents the overall prioritization of the use of funds available to the government. Informal user charging also places part of the financing of public sector goods and services outside the system of financial transparency and accountability. In addition, there are likely to be adverse income distribution effects where the less well-off are unable to purchase a service. However, user charging does contribute to greater allocative efficiency between the public and private sectors, since the level of consumption of publicly provided goods and services is connected to the resource cost of their provision. User charging also helps overcome deficiencies in central revenue collection. However, the schemes should meet minimum standards of efficiency, equity, and transparency. 4.47 Recommendations:

The existence of financial participation (user charging) schemes should be acknowledged as a significant budget tool, and the incidence and terms of such arrangements should be progressively documented over time

A set of guidelines should be developed by the MEF on the circumstances in which user charging is appropriate, the appropriate basis for determining charges, and the handling of associated equity issues.

5. Improving the Allocative and Technical Efficiency of Donor Funding

4.48 Much room exists for improving the allocative and technical efficiency of donor funding . The current situation is such that much donor assistance bypasses the budget and involves direct funding of project contractors. This reflects lack of donor confidence in line ministry capacity to identify, design, and implement projects. Magnifying the problem is the weak coordination at the sectoral level. There are no formal groups involving multilateral and bilateral aid agencies in any sector. On the other hand, NGOs are better organized, with the Cooperation Committee for Cambodia (CCC) facilitating consultation among its members and with the government.

4.49 While such an approach to aid may have been to some extent unavoidable, it has resulted in a fractionalized public sector effort with little central organization and control and with a number of adverse side effects such as: (i) the absence of strong government ownership of many projects; (ii) piecemeal efforts by aid agencies toward sectoral issues and institution building; (iii) weak coordination among donor programs; (iv) a proliferation of different procurement, disbursement, auditing, and progress monitoring activities among agencies; and (v) the creation of special project units, staffed by expatriates or by nationals with “topped up” salaries, with adverse impacts on institution building.

4.50 Capacity Building. To improve the efficiency of donor funding, the government needs to improve technical, financial, and managerial capacities in line ministries to achieve better project implementation. Improved project implementation would encourage donors to increasingly work through the existing public administration. The government also needs to improve project identification, design, and costing in line ministries. Tighter quality standards for project proposals from line ministries could then be introduced by the MoP and the CDC when admitting line ministry proposals to the PIP.

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The government would then be in a better position to negotiate with donors by presenting better prepared options.

4.51 Aid Coordination. In parallel, the government needs to move toward better aid coordination. A promising way would be the Sector Wide Approach (SWAP). SWAPs would involve the creation of sector working groups with representation from the MEF, CDC, MOP, relevant line ministries, donor agencies, and NGOs. Such groups would provide the forum for exchanges between aid agencies and the central and line ministries and could help plan sectoral strategies, coordinate donor activities, monitor sectoral progress, and address implementation problems. Under SWAPs, the responsibility for sector development is shared collectively by donors and the government. While SWAPs will involve considerable efforts on the part of the government and donors, this approach would link donor funded capital spending more closely with the priorities identified in the SEDP. It would be important that SWAPs should not create a new central clearance mechanism for investment proposals, which would increase bureaucracy and lead to delays in getting individual projects under way.

4.52 Donors' Role. To effectively complement the government's efforts, donors need to play a significant role. Donors need to provide well-coordinated technical assistance and training to strengthen the line ministry's capacity in a more systematic and programmed manner. Ad hoc approaches to capacity building would make the proposed budget reforms more difficult to implement. Donors also need to move toward better aid coordination, such as through a SWAP. The effective subordination of donor activities to mutually negotiated sector-wide strategies would be not be easy and there would be problems of agreement among individual donors regarding responsibility for specific inputs or outcomes. However, while SWAPs give donors less freedom in selecting the individual projects they wish to fund, it give greater involvement in developing (along with the Cambodian government) the overall priorities and strategy for each of the key sectors. Furthermore, a SWAP would move toward common management arrangements and could lead to more coordinated donor involvement in sector development which would help strengthen the weak institutional capacity in line ministries.

4.53 Recommendations: The preparation for a SWAP needs to be initiated in the health sector, as the MoH has a

better capacity for this; in addition, coordination between the MoH and donors is relatively close (e.g., regular monthly meetings).

A number of system-wide issues, such as managerial decentralization, reforms in accounting and budgeting systems, and changes in staffing incentives should be addressed for a SWAP to be adopted effectively.

6. Strengthening the Public Investment Management System

4.54 Capital budgeting is composed of five stages: (i) identification of the development framework; (ii) project identification; (iii) investment programming; (iv) investment budgeting; and (v) investment monitoring. These stages involve a number of agencies such as the CDC, MOP, MEF, and line ministries. The Public Investment Management System (PIMS), introduced in March 1998 by the CDC, is intended to ensure the coherence and complementarity of the separate capital budgeting activities of each of these agencies. In particular, PIMS draws the activities undertaken by the MOP and MEF during the preparation of the PIP and the annual budget into a coordinated management framework. The major weaknesses in the chain of PIMS sub-systems include inadequate investment appraisal at the line ministry level, insufficiently robust cost estimates in the PIP for transmission directly into the annual capital budget, and shortcomings in the monitoring of project execution by line ministries. The major

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benefit from PIMS would be the focusing of resources on these three weak links in the capital budgeting chain and the acceleration of their repair.

4.55 The PIMS master plan would work effectively only when these shortcomings are resolved. In particular, a more formal interface between the PIP and the budget requires better and more detailed programming by the MOP of cash flows associated with each project. This would enable the MEF to include in the budget a more accurate schedule of counterpart payments than at present. Preparation in the PIP of budget quality splits for annual capital spending by project has a further important advantage. It is closely linked to the use of the “out-year” estimates of spending for each project as a nascent set of forward estimates or a starting point for an eventual medium term expenditure framework (MTEF), which would help link policy, planning, and budgeting more closely and consistently.

4.56 Recommendations: An urgent need is for the line ministry's capacity in monitoring the implementation of the

PIP to be strengthened. Over the medium term, the development of PIMS needs to be extended beyond a broad

framework for linking capital budgeting institutions, to become a vehicle for developing concrete strategies aimed at overcoming the current weak links in the operation of the capital budgeting cycle

. G. Conclusion

4.57 There exists significant potential for enhancing the allocative and operational efficiency without undermining the current high level of aggregate fiscal discipline. To realize this potential, the foremost priority is to respect the budgetary process, minimizing unwarranted political interventions. Another priority is to improve the managerial and accounting and reporting capacities at the spending units, in particular because responsibility for performance at the level of spending units must to be established without losing financial control.

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