3. PUBLIC FINANCIAL MANAGEMENT

Despite the substantial progress made towards reforming and strengthening its public financial management (PFM) systems, Albania still has a long way to go in achieving operational efficiency and value for money in the use of its public resources. The objective of establishing a more predictable and policy-led budget process has only been partially achieved, with the MTBP and budget planning processes not providing yet an effective vehicle for linking resource allocations to strategic policy and program priorities. Significant weaknesses also remain in budget execution, notably in the cash management and procurement processes. In addition to substantial reallocation and underexecution during the implementation process over the past years, these weaknesses have undercut the Government’s efforts to consolidate the budget as a predictable tool for policy implementation and have seriously undermined the integrity of the budget and the efficiency of public spending. In addition, while audit and parliamentary oversight arrangements are fairly sound in design, their effectiveness is severely limited by capacity constraints.

The challenges facing Albania in developing its PFM systems over the medium term will be the following: (i) to establish a single framework through the implementation of the Integrated Planning System for national and sectoral priority setting that takes into account public resource constraints and that strengthens policy formulation and coordination; (ii) to ensure stronger political engagement in the development of the Medium-Term Budget Program (MTBP) in order to bring about a more policy-led budget process; (iii) to improve the efficiency and accountability of the budget execution process including the Treasury and cash management systems and public procurement operations; (iv) to address the critical staffing and capacity constraints in the Ministry of Finance (MoF) and the line ministries that continue to affect all elements of the PFM system; and (v) to build greater external accountability into Parliament and civil society in the budget planning and management processes.

A. INTRODUCTION

3.1 Albania currently faces key challenges at the public financial management level. It must reconcile the two objectives of maintaining macroeconomic and fiscal stability, and also meeting significant socioeconomic demands. It also needs to balance various new emerging horizontal responsibilities arising from its commitment under the Stabilization and Association Agreement with the EU, the decentralization process and broader public sector and civil service reform.

3.2 Notwithstanding the recent progress, weaknesses in public financial management (PFM) systems remain a key institutional constraint that is undermining the efficiency of public expenditures. The 2001 Public Expenditure and Institutional Review (PEIR) provided an in-depth analysis of the budgetary planning process and the associated institutional arrangements. The PEIR found an urgent need to strengthen institutional capacities and enforce greater accountability across the public sector. It argued that the Government should use the introduction of its Medium-Term Budget Program (MTBP)55 as a central initiative around which to achieve improvements in its PFM performance.

3.3 The analysis undertaken for the current PEIR indicates that successive governments have faced difficulties and delays in implementing PFM reforms. As noted in other chapters, the performance of public spending across a number of sectors remains poor. Spending patterns have been slow to adjust to

55 The term used for Albania’s medium-term expenditure framework.

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new policy and program priorities. Over-optimistic revenue forecasting has resulted in significant in-year budget cutbacks in some years. Substantial inefficiencies persist in the delivery of a number of public programs. Weaknesses in budget execution and procurement continue to undermine the integrity of the budget. There also remain significant limitations in accountability.

3.4 This chapter reviews the development of PFM systems and processes for the period 2001-2005 and evaluates their performance. It begins with a summary of the progress made in implementing the recommendations of the last PEIR (Section B) and goes on to provide a more detailed assessment of the key elements of the PFM system (Section C). Drawing on this assessment, it argues that improved PFM outcomes will require the Government to address weaknesses in the institutional framework for PFM and to take more effective action towards tackling capacity constraints (Section D). The final section provides a summary of the key conclusions and recommendations (Section E).

B. RECENT PROGRESS IN IMPLEMENTING PFM REFORM

3.5 Since 2001 a series of measures has been implemented with the aim of strengthening PFM systems. These measures have included: (i) a progressive deepening of the medium-term budget planning reforms that were initiated in 2000; (ii) the introduction of a program classification to facilitate a more strategic approach to resource allocation within the spending agencies; (iii) initial steps in a number of a ministries to cost major policies under the NSSED; (iv) the modernization and computerization of the Treasury system; and (v) the design and introduction of an Integrated Planning System (IPS) – (see below). Albania’s development partners56 have provided considerable support for the implementation of these measures.

3.6 Progress is evidenced by the actions taken towards implementing the recommendations made in the 2001 PEIR. A joint World Bank-MoF review notes that action has been initiated on almost 90 percent of these recommendations. However, two-thirds of the recommendations have yet to be fully implemented, indicating, the continuing challenges that the Government faces in implementing its PFM reform agenda. Steadier progress has been made with the modernization of the Treasury system. The key salient features of progress made to date and the remaining challenges are as follows:

• Budget preparation. New economic and program budget classifications have been implemented since 2003. At the sector level, the MTBP process has been rolled out to cover 10 sector ministries. However, there continue to be difficulties in aligning the MTBP sector proposals with the NSSED. Recurrent costs arising from investment projects are still not being adequately considered in the budget planning process and little progress has been made in integrating the planning of recurrent and capital expenditures. Capacities for budget planning and analysis in both the MoF and the line ministries remain very limited. The Organic Budget Law (OBL) has not yet been revised to reflect the MTBP reforms.

• Budget execution. Good progress has been made towards the implementation of Treasury computerisation, in the direct recording of tax receipts into the Treasury and in developing the Treasury General Ledger. By the end of 2006, the central Treasury system will be computerised with a GFS compatible budget classification and chart of accounts adopted. However, the coverage and quality of budget reporting remains weak, particularly the reporting of expenditures on externally financed projects, as the majority of grant financed investment projects are still not recorded in the government accounts.

56 Including the DFID, European Commission, UNDP, USAID and World Bank.

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• Budget analysis and evaluation. A budget policy analysis section has been established within the Budget General Directorate of the Ministry of Finance (MoF), although its capacities remain overstretched. A Department for Budget Analysis has been established in the Parliamentary Secretariat to provide analytical support to the Economy and Finance Committee. However, there is no systematic training program for budget analysts working across the civil service.

• Improvement of broader financial management systems. Good progress has been made towards establishing an internal audit function across government and a supporting training program. There remain fundamental weaknesses in procurement practices. Although the quality and timeliness of external audit reports have improved, the follow-up on audit findings remains limited. Fiduciary risks remain significant.

• Institutional incentives for strategic prioritization and program design. The necessary institutional demands and incentives to support the more strategic approach to budget planning have made little progress until recently. In the past, the Council of Ministers and the MoF have not placed sufficient demands on the line ministries to ensure meaningful compliance with the requirements of the MTBP process. It has also taken substantially longer than anticipated to establish the analytical capacities within the MoF that are required for the MTBP. The introduction of the IPS in late 2005 and establishment of a Public Investment Management Department at the MoF reflect greater emphasis on strategic planning and prioritization.

3.7 With hindsight, it is clear that the 2001 PEIR was optimistic about the time required to implement far-reaching PFM reforms in a situation of limited institutional capacities. The implementation of budget planning and management reforms under the MTBP initiative has taken substantially longer than anticipated and has been constrained by the difficulties faced in strengthening capacities in the General Budget Directorate and relevant budget and planning departments in the line ministries. Political engagement in the MTBP process has also been less than anticipated.

C. THE PFM SYSTEM: PERFORMANCE AND CHALLENGES

3.8 Positive PFM outcomes depend on all stages of the PFM system operating in a harmonized and effective manner (Figure 3.1). Equally important, although external to the PFM system, is for the effective processes for strategic and sectoral policy review and development to be in place in order to guide macro-fiscal management and the allocation of public resources. The design and review of strategies and sectoral policies informs medium-term resource allocation decisions, or what is called “strategic budgeting.” The annual budget is then prepared, executed, monitored and audited based on the decisions taken in these stages—with the entire cycle focused on ensuring the disciplined allocation of annual budgetary resources to the Government’s policy goals. The significance of strategic planning and budgeting is emphasized and realized only when plans are monitored and audited and the findings fed back into the planning process.

Strategic and Sectoral Policy Review and Development

3.9 Since 2000 the Government has designed a number of policy frameworks for national and sectoral priority-setting. These frameworks have include the following: (i) the National Strategy for Socio-Economic Development (NSSED), which was adopted in 2001 and aims to bring income levels and living standards in Albania closer to those of its neighboring countries; (ii) the EU Integration Strategy, which sets out measures necessary to prepare Albania for eventual accession to the EU; (iii) the anti-corruption strategy; (iv) the three-year Government action plan; and (v) over 20 sector level strategies. Processes for monitoring the implementation of these initiatives have also been put in place.

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Figure 3.1: Key Elements of the PFM System

Source: World Bank staff.

3.10 However, Albania has not yet been able to develop a true policy orientation in the budget. Albania’s policy and programming systems have remained fragmented and disconnected from the budget process, specifically, as follows:

• Overlapping and fragmented policy frameworks have failed to provide clear and manageable vision and direction for public policy design and implementation. Each of the policy frameworks has included a detailed set of activities, deadlines and indicators, but without clear cost implications. The net effect has been an extraordinary volume of policy commitments many of which are fiscally unaffordable (Table 3.1).

• Separate planning and management arrangements have been established for the different strategic initiatives. This has placed excessive demands on often limited capacities within the sector ministries. Sector policies and plans have been presented piecemeal and sometimes disconnected from these broader strategic initiatives.

• Institutional responsibilities have been uncoordinated. The MoF is responsible for NSSED, the Ministry of European Integration for the EU Action Plan and the Council of Ministers for the three-year Government Action Plan and Anti-Corruption Strategy. The capacity within the Council to exercise effective coordination and management of the Government’s overall policy and framework was insufficient.

Table 3.1: Strategic Policy Frameworks – an Excessive Number of Overlapping Commitments

Framework Time-Frame

No. of Objectives/Actions/Measures

and Indicators NSSED 2003-03 882 priority actions EU Integration Strategy

2002-05 182 objectives, 415 measures

Anti-Corruption Strategy

2003-04 118 measures, 275 indicators

3-Year Government Action Plan

2003-05 Approximately 700 items

Source: IPS Inception Report.

2. Macro-Fiscal Management

3. Strategic Budgeting

4. Budget Preparation

Resource Management

5. Budget Execution 6. Procurement Management

7. Internal Audit

8 . Accounting and Reporting

9. External Account - ability and

Transparency

1. Strategic and Sectoral Policy Review and Development

PFM System

47

• Efforts to link policy and program development to resource allocation and management through the MTBP have achieved only limited success. Strategies and plans have been developed without adequately taking into account the fiscal resource constraints. New policy priorities have not been sufficiently driven down into the budget planning process.

3.11 As a result, the links between strategic policy review and development and the PFM system have not been sufficiently robust. The challenge that Albania now faces is to create a more unified and robust overall policy framework that is consistent with the fiscal realities and that provides clear and consistent priorities for public resource allocation. This reform should be part and parcel of a broader institutional reform aiming at strengthening policy formulation and coordination across government.

3.12 Recognizing the need to achieve more effective coordination of the policy development, resource allocation and program management processes across government, the Government committed itself in November 2005 to the introduction of an Integrated Planning System (IPS). Specifically, the IPS aims to reduce the fragmentation and duplication that has been associated with policy development and financial planning in Albania, and the Government started with the transfer of responsibility for coordination of the NSSED to the Council of Ministers. The IPS has therefore been built around two main processes:

• The National Strategy for Development and Integration (NSDI), which will provide a single comprehensive strategy covering all sectors. The NSDI will replace the NSSED and will include the European and NATO integration initiatives in order to provide a single comprehensive government program.

• The MTBP, which will be more closely, linked to the national policy processes of the NSDI. Line ministries will be required to elaborate their medium-term expenditure plans so as to deliver their policy objectives and goals within each ministry’s expenditure plan.

3.13 Implementation of the IPS will be undertaken as a phased process. The initial focus during 2006 will be on establishing the central structures and developing the basic IPS methodologies and processes. The latter will be extended to all ministries during 2007 and further broadened and deepened in subsequent years.

3.14 The IPS emphasizes the need for a stronger political engagement in the policy and budgeting processes. Under the IPS the Government will approve the initial MTBP macroeconomic framework and resource ceilings as well as the MTBP submissions from each ministry together with its wider integrated plan. Two inter-ministerial committees will oversee the implementation of the IPS: (i) a strategic planning committee chaired by the Prime Minister that will be responsible for policy development and implementation; and (ii) a Government Modernization Committee chaired by the Deputy Prime Minister responsible for the ensuring the upgrading of processes and capacities across government. A new Department of Strategy and Donor Coordination (DSDC) located within the Council of Ministers will be responsible for coordinating the IPS across government and for the preparation and monitoring of the NSDI. Implementation will be the responsibility of individual ministries and agencies.

3.15 The IPS also presents an integrated planning calendar that sets out the major requirements and deadlines for all core policy and financial planning processes. The calendar, which will be issued at the beginning of each year, will thus provide for a single consolidated policy development, program development and budgeting process. As such, it is intended to streamline and reduce overlap in the planning and budgeting processes, thus enabling the Government to make more effective and efficient use of its limited capacities in these areas.

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3.16 A key requirement for the implementation of the IPS is to establish a much closer working relationship among the Council of Ministers, the MoF and the Ministry of European Integration, each of which will be represented on an IPS Working Group. In the line ministries a single Standing Committee on Strategy, Budgeting and Integration will be established to oversee and monitor all core policy and financial planning processes.

3.17 Even with this phased approach, the IPS represents an ambitious initiative that will require a strong and sustained political commitment if it is to succeed. Successful implementation of the IPS should help to consolidate the policy planning process in Albania and enable it to be more effectively linked to the MTBP. It should also facilitate the success of reforms at the sector level by better linking policies to budget plans. The IPS should also provide a mechanism for identifying the problems and capacity constraints that affect the planning and budgeting system and bringing these to the attention of the Government. Its implementation will also depend on rapidly establishing the required technical and management capacities within the DSDC and in achieving effective coordination and collaboration between the DSDC and the General Directorate of Budget.

Macro-Fiscal Management

3.18 Since 2001, Albania has improved its macro-fiscal management. The fiscal deficit was reduced from 7.95 percent of GDP in 2001 to 3.4 percent in 2005, while the domestically financed deficit fell from 5.3 percent of GDP to 2.8 percent over the same period. The overall fiscal performance has remained within the targets set under the PRGF program.

3.19 However, the tendency to overestimate domestic revenue performance has undermined the macro-fiscal management, although recently there have been significant improvements in the accuracy of revenue forecasts. Between 2002 and 2005, domestic revenue collections averaged 4.4 percent less than the budgeted levels. As a result of the shortfall in domestic revenues, the discretionary spending budgets have had to be cut significantly. These cuts have generally fallen most heavily on operations and maintenance allocations and domestically financed project spending. In 2004 the shortfall in domestic revenues was largely offset by receipts from the privatization of the Savings Bank, which had not been included in the original budget. For the 2005 budget, a more prudent approach to revenue forecasting was followed and is reflected in the narrowing of the gap between forecast and actual revenues to 0.8 percent. There have been particular difficulties in forecasting the disbursement and expenditure levels of externally financed projects (see Chapter 4).

3.20 The capacities for macroeconomic and fiscal forecasting within the MoF remain limited and their strengthening should be a top priority for the MoF. The input-output based macroeconomic forecasting model in the Macroeconomic Analysis and Forecasting Department does not yet provide an adequate framework for developing accurate and disaggregated revenue and expenditure projections for budget preparation.57 There are also concerns about the complexity of the model and its reliance, in the absence of available data from Albania, on input-output coefficients derived from other countries. Priority should be given to: (i) the review and improvement of the existing macroeconomic forecasting model; (ii) the development of a better elaborated fiscal forecasting module; and (iii) the strengthening of human resource capacities within the Macroeconomic Analysis and Forecasting Department.

3.21 Medium-term fiscal forecasts should include alternative high, medium and low growth scenarios. However, the forecasts adopted for the MTBP should be relatively conservative in order to reduce the risk of expenditure allocations having to be revised downwards at a later date (Box 3.1). The introduction of a “planning reserve” in the original MTBP resource ceilings would also reduce the risk of having to cut-back on the MTBP ceilings when the annual budget is finalized.

57 The model was designed primarily to project GDP with revenue forecasts directly linked to GDP forecasts.

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Box 3.1: Conservatism in MTBP and Budget Forecasting In many countries it is the practice for the finance ministry to adopt a relatively conservative fiscal framework in order to maintain fiscal sustainability against uncertain macroeconomic conditions.

In Canada, the Department of Finance uses as its starting point the average forecasts made by independent economic forecasters. It then adds 50-100 basis points (0.5 percent-1.0 percent) to the average private sector forecasts for interest rates and runs its own econometric model to develop a more conservative scenario. As a further buffer, a significant planning reserve has been introduced that can only be used to compensate for forecasting errors and cannot be used for new policy and spending initiatives.

In Sweden, an independent research institute, the National Institute for Economic Research, conducts a comprehensive, macroeconomic modelling exercise for the coming three-year period. Based on the results, the Swedish MoF prepares its own forecast for the coming year for three scenarios based on its own simplified model and then chooses the most conservative of these projections as the basis for its fiscal planning. The MoF regularly runs its own model four to five times every year in order to update the macro-fiscal framework.

In United Kingdom, two different macro forecasts are prepared: one for budgeting purposes, announced by the Chancellor of the Exchequer (the finance minister) and often relatively conservative, and the other for normative purposes that is announced on behalf of the Treasury (finance ministry) and made by career public officials. The Treasury also surveys and monitors macroeconomic forecasts that are prepared by around 20 private and public institutes. However, while considering these forecasts, the Treasury does not apply any strict formula for developing its own projection.

In United States, formal econometric models are not used in preparing forecasts of key economic variables for use in the President's budget. Instead, professional economists in the Office of Management and Budget, the Treasury, and the Council of Economic Advisors (the “troika”) focus on projecting trends for six key variables. They also use as benchmarks forecasts provided by several academic and research organizations, as well as estimates from international organizations. The use of these alternative estimates places constraints on the extent to which politicians are tempted to adopt unrealistic scenarios in order to provide for additional budgetary spending. The forecast is updated every six months.

Strategic Budgeting

3.22 In introducing the MTBP a key objective was to move away from traditional incremental budgeting practices and adopt a more policy-led approach to the allocation of public resources. From the outset the MTBP document included a series of expenditure strategies that sought to link sector level policies to resource allocations. The number of sector ministries for which strategies have been prepared has gradually increased from 4 in 2001-03 MTBP to 10 in the draft 2006-08 MTBP.58

3.23 However, in practice, there have been considerable difficulties in realizing significant progress towards developing a more strategically oriented budget. This can be attributed to a number of factors:

• The analysis of the budgetary implications of national policies and strategies such as the NSSED has been unrealistic and focused on incremental costs rather than on the scope for utilizing existing resources more effectively. As a result, the linkage between priorities and resource allocation has been unclear, with many of the measures included in the NSSED proving to be unaffordable.

58 Owing to the change in Government following the 2005 elections, the 2006-08 MTBP was not submitted for Council of Ministers approval.

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• Inter-sectoral priorities and resource allocation proposals developed for the MTBP have not been sufficiently reviewed by the decision-makers and the Council of Ministers. The review and discussion of resource ceilings at an inter-ministerial workshop and with the Council prior to the issuance of the budget call circular has been limited. Little cross-reference to the strategic priorities identified in the MTBP has been made when the annual budget has been presented to the Council of Ministers and Parliament. The budget debate has thus failed to focus on the consistency of the proposed resource allocations with MTBP and government policies.

• Resource allocation has continued to be rigid and incremental with little indication that resource allocations, have adjusted significantly to reflect strategic policy directions and priorities. For example, there has been no clear trend in expenditure outturns to indicate that resource allocations have reflected the priority given under the NSSED to programs in the education, health and transport sectors (Figure 3.2).

3.24 The envisaged revision and updates of sectoral strategies under the IPS59 should lead to the development of a simple and prioritized set of key policy and program priorities with relevant cost estimates to guide the resource allocations. Concurrently, the MTBP process should be enhanced in order to strengthen its strategic focus. This will require the following: (i) a more rigorous analysis of alternative public spending demands and priorities as a basis for proposing sector and ministry resource ceilings; (ii) an in-depth presentation to and review by the Council of Ministers of the key budget choices and resource ceilings proposals; and (iii) the significant divergences from the MTBP resource ceilings to the Council of Ministers and Council’s agreement to them before the draft budget is finalized. Line ministries should be required to specify the proposed efficiency savings and new spending proposals that are needed to ensure better alignment of their public spending with sector level policy and program priorities.

Budget Preparation

3.25 The MTBP does not yet provide a predictable medium-term resource framework within which ministries can plan and prioritize their annual budgets. It is also questionable whether there have been significant improvements in budget predictability or in the quality of budget submissions. Spending agency resource ceilings have been changed significantly in the updating of the MTBP (Box 3.2 and Table 3.2). Such experience is common at the early stages of the introduction of medium-term budgeting when macroeconomic and fiscal forecasts are rudimentary, and when there may be an inadequate understanding of the public expenditure implications of strategic policy and program

59 Under the IPS calendar, the DSDC is managing the revision and preparation of sectoral and horizontal strategies.

Figure 3.2: Expenditure by Function (Actual), 2000-04

0 .0 %

5.0 %

10 .0 %

15.0 %

2 0 .0 %

2 5.0 %

3 0 .0 %

Public Orderand Safety

Educat ion Health SocialSecurity &Welfare

Housing &CommunityAmenit ies

Agriculture,Forestry

etc.

Transport &Comms

20002001200220032004

% o

f Tot

al E

xpen

ditu

re

Source: MoF

Source: MoF.

51

priorities. However, in the next stages of MTBP development it will be important to place greater emphasis on the outer years of the framework.60 3.26 Budget submissions from key line ministries have continued to exceed the ceilings set in the preceding MTBP. Allocations in the subsequent annual budget have sometimes differed from the MTBP ceilings by a significant margin. An analysis of the 2005 budget for the eight largest ministries showed that in two ministries allocations differed by more than 7 percent (Table 3.2). These divergences can be explained by: (i) inadequate analysis in the setting of the original ceilings, which failed to consider the impact of commitments already announced such as those relating to pay levels; (ii) insufficient consultation with line ministries in the setting of resource ceilings; and (iii) the impact of adjustments resulting from the updating of the macro-fiscal framework. This emphasizes the fact that a more rigorous and participatory approach to determining resource ceilings is required to provide greater certainty that they can be honored and to reduce the likelihood of the need for subsequent cutbacks as the budget is finalized. It also emphasizes the importance of more active political engagement in the finalization of the resource ceilings so that the ceilings have credibility and are respected during budget preparation. 3.27 The introduction of a simple budget program classification has improved the policy orientation of budget preparation. The MoF recognizes the need to further develop this initiative by elaborating more clearly program objectives, activities, and costing, and by specifying simple output indicators that can be used for program monitoring. The program classification itself is now being developed to sub-program, and eventually activity levels.61 However, capacity limitations emphasize the need to take a realistic approach to further elaboration and towards more fully fledged performance budgeting (Box 3.3).

60 As the MTBP design and monitoring process at line ministries’ level improves over the next 2-3 year period, reallocations should be minimized because of a more stable basis for planning and budgeting. The requirements that all requests for fund transfers/reallocations should undergo the same procedures for identification (justification) of expenditure as those applied during the Expenditure and Investment Planning phase of the MTBP should lead to a gradual reduction in requests for re-allocations. Similarly, the introduction of the new procedures for Public Investment Projects is also likely to have the same effect. The institutionalization of these procedures, is awaiting the approval of the new Organic Budget Law and its related regulation on the Basic Guidelines for the Planning and Execution of the State Budget, as well as the approval of the new Procedures for Public Investment Projects. 61 The use of program classification has been improved in the context of the preparation of the 2007-2009 MTBP, and allowed a revision and reformulation of the objectives and outputs of many of the line ministries’ programs.

Table 3.2: Budget Allocations for 2005 Compared to Resource Ceilings of Selected Ministries

Resource Ceiling Budget Variance

Lek million Lek

million % Agriculture & Food 6.6 6.6 -0.8% Territorial Adjustment & Tourism 11.9 11.0 -7.7% Transport & Communications 15.8 14.6 -7.8% Education & Science 25.7 25.4 -0.8% Health 18.4 18.5 0.2% Public Order 12.0 11.6 -3.2% Defense 11.1 11.5 3.6% Labor & Social Protection 27.4 27.9 2.1% Source: MoF.

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Ministry of Education and Science

0

5

10

15

20

25

30

35

40

2004 2005 2006 2007 2008

2004-06 MTBP 2005-07 MTBP 2006-08 MTBP

Lek

billi

on

Ministry of Health

0

5

10

15

20

25

30

2004 2005 2006 2007 2008

2004-06 MTBP 2005-07 MTBP 2006-08 MTBP

Lek

billi

on

Ministry of Transport and Communications

Box 3.2: MTBP Outer Year Allocations: Credible Basis for Expenditure Planning

MTBP allocations for three major ministries for the period 2004-08 indicate that the outer year allocations do not give an accurate indication of likely future funding levels. As yet, the MTBP does not provide a reliable framework for medium-term budget planning at the sector and ministry level. In each case the outer year allocations have proved unduly optimistic and have been reduced as the MTBP has been subsequently updated:

• In education, the level of reductions has been smallest, but even here the 2006 ceiling in the 2006-08 MTBP was some 12 percent below the level projected two years earlier under the 2004-06 MTBP.

• In health, the differences have been much greater, with the 2006 ceiling from the 2006-8 MTBP being 30 percent below the level projected in the 2004-06 MTBP. However, the difference is much smaller at only 6 percent compared with the second year of the 2005-07 MTBP.

• In transport and communications, the downward revisions were even greater, with the 2006 ceiling from the 2006-08 MTBP being less than 50 percent of the level projected in the 2004-06 MTBP.

There are several reasons for the substantial downward revisions that have occurred as the MTBP has been updated. In part, they have been due to overoptimistic forecasting of revenues and financing, particularly in the earlier MTBPs. In the case of health they have also reflected a lack of capacity to implement planned reforms in the sector. In transport, key factors have been the uncertainty over the likely levels of external financing, and the tendency to treat domestic capital spending, which is particularly significant in the sector, as a residual in the budget planning process.

However, the analysis suggests that outer year projections may become realistic as the forecasting of the overall resource framework improves, and as the budget planning reforms introduced under the MTBP begin to take effect.

Sources: MoF and World Bank Staff calculations.

0

5

10

15

20

25

30

2004 2005 2006 2007 2008

2004-06 MTBP 2005-07 MTBP 2006-08 MTBP

Lek

billi

on

53

Box 3.3: Program Budgeting: Concept and Practice Program budgeting (PB) is a concept under which budget proposals are linked to government objectives using a program and activity based structure. PB has been applied in different ways in a number of countries.

a. Program budgeting as a means of improving managerial performance (Australia, 1984). A new version of PB, inspired by contemporary concepts of public expenditure management, purges budgeting of controls on line items such as personnel, supplies, travel expenses, and reorients the budgeting process towards the results to be accomplished within the available resources. In this sense, PB becomes the opposite of line-item budgeting. This “managerial” approach allows the designation of organizational units as programs, particularly at the lower levels of the program structure. In Australia, administrative expenditure was consolidated within a single appropriation for all operating costs, and managers were accorded substantial freedom in shifting resources to preferred uses while the program structure was introduced for targeting and reporting on performance and evaluating programs. However, it was concluded that although budgets were formally presented in program terms, resource management continued to be on an organizational basis, and that for PB to achieve its expected benefit it is necessary for deeper level system changes to take place. Thus, programs should become a central focus for strategic resource management and policy decision-making.

b. Program budgeting as a planning process (Brazil). Some countries began to utilize PB as a way to inject more strategy into budgeting and greater fiscal constraint into planning. It is expected that PB can result in budgeting becoming a more strategic (and less incremental) process thereby forcing government to regroup its activities with similar objectives under one program, especially when this is combined within an MTEF. In Brazil, a four-year plan is prepared during the first year of each new government. The plan is a comprehensive statement of the activities and expenditures scheduled for the next four years. It is divided into around 385 programs, a small number of which are designated as national priorities. Each program is assigned a manager who is responsible for promoting its objectives and coordinating relevant organizational units. The Constitution requires that the annual budget be consistent with the plan. To further integrate planning and budgeting, the Government has designated a manager for each of its many programs. However, program managers tend to be weak, especially when several organizational units share responsibility for a single program and many program managers do not control resources. In spite of these inadequacies, Brazil has shown how PB can facilitate the strategic planning process.

Source: “Conceptual Understanding of Program Budget” (Allen Schick), part of a series of publications for the Korean Program Budgeting Reform Program.

3.28 Programming for investment and maintenance remains a key weakness of the budget preparation process. Domestically financed projects are subject to very limited appraisal with funding allocations approved annually rather than against total costs. A significant proportion of externally financed public investment remains outside of the budget. There is no systematic approach to ensure adequate provision to cover the downstream maintenance costs of public investment projects. Both domestically financed public investment and operations and maintenance spending are treated as residuals within the budget planning process, with the result that allocations are subject to considerable variation from year to year while also being vulnerable to in year cutbacks. These issues are discussed in further detail in Chapter 4.

3.29 The current weaknesses in budget planning are recognized by the MoF and are being addressed with support from various development partners.62 Recent changes aimed at strengthening and better integrating the MTBP and budget planning processes changes provide for the following:

• Increased political engagement at key stages of the MTBP and budget planning process.

62 The project “Strengthening Public Expenditure Management” is financed by the DFID, SIDA and the Netherlands.

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• A greater emphasis on developing the initial macroeconomic forecast and spending agency ceilings which are to be approved by the Council of Ministers prior to the start of MTBP and budget preparation in March.

• The introduction of more detailed MTBP planning procedures involving (i) program policy review, and (ii) program expenditure and investment planning. MTBP submissions to the level of program and article are to be submitted to the MoF by the end of May.

• Preparation of the MTBP document in June and its approval by the Council of Ministers. Following Council approval, the MTBP will be submitted to Parliament for information purposes.

• The issuing of the Budget Instruction and final MTBP expenditure ceilings in July.

• The re-organization of the General Budget Directorate, through the establishment of the Directorate of Analysis, Policy and Medium Term Budget Programming and the Directorate of Public Investment Management.

3.30 While these procedures are consistent with international good practice, it will be important to ensure that they do not become overly complex. A key requirement is to avoid duplication in the tasks between the MTBP phase of the budget cycle and the subsequent preparation of the annual budget and Financial Plan.63 The success and sustainability of the procedures as currently elaborated require significant capacity building within the MoF and the line ministries, which should constitute a top priority of the Government’s reform agenda in the foreseeable future.

Budget Execution

3.31 Notwithstanding recent improvements, budget execution is still subject to considerable uncertainty due to in-year changes in funding allocations. Budget execution processes need to ensure the predictable, timely and transparent flow of resources to deliver public services efficiently. This applies to the management of budget aggregates, to the management of expenditures against budget allocations, to cash flow management, and to the operations of procurement systems. In several instances this has not yet materialized.

3.32 The overestimation of externally financed public investment and the problems in recording grant financed project expenditure have contributed to consistently lower levels of aggregate outturns. This shortfall increased from 3.0 percent in 2000 to 9.9 percent in 2004, before falling back to 8 percent in 2005. If externally financed project expenditures are excluded then the variance is reduced to 5.2 percent in 2004 and 3.5 percent in 2005 (Figure 3.3). At the level of the spending agency, the variance between actual and budgeted expenditure is much greater. In 2004, actual expenditure in 11 out of 52 agencies exceeded the original budgeted allocations by more than 10 percent, while in 10 agencies expenditure fell short of the originally budgeted allocation by more than 20 percent. 63 The annual Financial Plan is an implementation plan prepared after the budget is approved.

Figure 3.3: Percent Deviation between Budget and Actual Spending at the Aggregate Level, 2000-04

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2000 2001 2002 2003 2004

Total Expenditure Total Expenditure less externally f inanced projects

Source: MoF.

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3.33 Cash and budget planning procedures allow spending agencies to make significant changes to expenditure allocations compared with their previously negotiated budgets. The MoF provides spending agencies with a four-month expenditure allotment against which to prepare detailed two-month expenditure plans.64 Significant changes from what was negotiated during the budget preparation can be introduced through these expenditure plans. The MoF tends not to raise objections as long as the total aggregate expenditure and the expenditure by program are within the approved budget. This has resulted in a very high level of virements in recent years, over 23,000 annually.65 In some ministries the volume of public spending affected by virements has amounted to more than 30 percent. This high number brings into question the credibility of the original budget planning process. For example, in the case of domestically financed public investment projects spending agencies have been able to change the portfolio of project investments within a program during budget execution (Box 3.4).66

Box 3.4: Virements: An Indicator of Poor Budgeting or Flexibility in Budget Management? Frequent virement during budget execution is indicative of weaknesses in budget management. However, it is not easy to determine whether this reflects poor budget preparation or weaknesses in budget execution:

• Budget preparation may in itself be unrealistic or may be undertaken with insufficient accuracy with the virement process used to create a de facto revised budget. This brings into question the validity of the original budget planning process and suggests fundamental weaknesses in PFM. Such a situation is likely to persist if it is relatively easy to make virement adjustments during budget execution.

• Budgets may also be prepared to a level of detail that impedes management flexibility in service delivery. In such cases virements between line items may be necessary to enable managers to ensure that public services are delivered efficiently. The fundamental issue here is one of approving budgets at too great a level of detail.

• Budgets may be prepared in a realistic way that allows program managers adequate flexibility, yet substantial amounts of spending are still redirected through virement. If so, this is a clear indication of weaknesses in the management and execution of budget programs. Of particular concern are cases where virements occur between programs and sub-programs, since this reflects changes in the purpose of spending.

In the case of Albania, it appears that unrealistic budget preparation is the primary reason for the high frequency and amount of virement. The tight compliance control system during execution also makes line ministries apply for unnecessary approval from the MoF even for small changes.

3.34 Constrained cash releases, lack of proficiency in cash management, weak procurement planning and restrictive procurement procedures are seriously undermining the efficiency of spending, most notably capital investment. The concentration of spending during the final quarter of the year reflects weak resource management and is most pronounced for investment spending (Figure 3.4 and 3.5).

64 In 2006, the MoF issues a budget release on a monthly basis but it argues that the amount now closely reflects the actual request from the line ministries while the previous two-month allocation was rather a mechanical even distribution over the 12 months. 65 Since 2005, this number has been reduced (12766 in 2005) as a result of providing line ministries with more flexibility for reallocating up to 5 percent of an investment and recurrent expenditures within a program without prior approval of the MoF. Moreover, re-allocations are now handled by the Treasury Department and not by the Budget Department anymore and are done on a monthly aggregate basis as opposed to a daily transaction basis, providing greater flexibility in expenditure execution to line ministries. 66 No project level discussions take place before the budget is presented, but the appropriation is at the program level. The MoF and line ministries go through another negotiation process to prepare the annual Financing/Implementation Plan during January and February for project level discussion.

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• The conservative setting of cash release allocations by the MoF during the first part of the fiscal year restraints is primarily driven by the objective of meeting revenue targets. Revenue collections during the first quarter are lower than during subsequent quarters.

• The MoF does not currently undertake active short-term borrowing to mitigate in-year revenue fluctuations. The absence of commitment control renders cash management difficult and does not provide the MoF with a full picture of its cash flow demands. In the event that revenues fall short of planned levels, the MoF is forced to resort to cash rationing and budget cut-backs during the latter part of the year, resulting in a few cases of the deferment of payments to contractors and suppliers until the following fiscal year. While the MoF’s relatively tight cash management has contributed to fiscal consolidation, it has severely undermined the credibility of the budget (Box 3.5).

• The single year procurement regulation67 results in a concentration of outlays in the second half of the year. As a result of this rule, tendering commences after the beginning of the fiscal year with the contracted expenditure having to be completed by the end of the year. Accordingly, most of the expenditures against procurement contracts tend to occur during the second half of the year. This particularly affects capital expenditures. In 2004, some 45 percent of capital expenditure was incurred during the last three months of the year (Figure 3.4 and 3.5). This has an adverse impact on the efficiency of public spending, resulting in higher costs as contractors and suppliers are unable to spread their activities throughout the year. It also contributes to a short-term planning outlook that undermines recent initiatives to plan expenditures and public investment within a medium-term context.

67 The MoF has recently permitted full value procurement contracts for roads projects that cover the full period of project implementation rather than being limited to a single year. The extension of the use of multi-annual procurement planning will necessitate however the revision of the Law on Public Procurement.

Box 3.5: Principles of Good Cash Management The principal components of a good cash management system include:

• An annual cash plan that sets out projected cash inflows and outflows month by month. Past revenue and expenditure patterns, debt servicing forecasts, the timing of external borrowing and grant receipts, and planned spending profiles of major capital projects can all help to establish a realistic annual cash plan.

• A rolling three-month cash management projection that is updated each month on a rolling basis in the light of actual revenues and expenditures. When the three-month projections indicate that there may not be enough cash to cover expenditures in one or more of the coming months, actions can be initiated to delay expenditure commitments, accelerate revenue collection or undertake additional short-term borrowing.

• A monthly operational cash plan that is updated at least weekly and includes a daily or weekly forecast of cash outflows and inflows. It provides the basis for dealing with unanticipated day-to-day and week-to-week cash shortfalls in a least cost way.

Source: Guidelines for Public Expenditure Management, IMF, 1999.

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3.35 The use of the Reserve Fund has often departed from its allowed objectives. The budget includes a relatively large allocation for its reserve fund. In 2003 and 2004, this amounted to 2.6 percent of total appropriations. However, the use of these resources has departed from the general principle of such funds in providing a buffer against unexpected events such as natural disasters or sudden price shocks (Box 3.6). For example, in 2003 allocations were made from the reserve fund to cover outstanding arrears from budgetary institutions to KESH and to fund unplanned operational and investment expenditure. The State Supreme Audit report on the implementation of the 2003 budget noted that such expenditure fell outside of the criteria for allocations from the reserve fund.

3.36 The challenge facing the Government over the medium term will be to strengthen budget execution procedures in order to ensure greater predictability and accountability in budget execution. This will require the following:

• Greater predictability in the release of funds against allocations in the annual budget. The in-year funding release process should be expanded to cover a period of three to four months and to better reflect the requirements of budget implementation. With greater predictability in funding releases, spending agencies should be required to manage the implementation of their programs against the annual budget implementation plan rather than against their two monthly funding releases as happens at present.

• Improvements in cash planning and management, including the introduction of commitment

control. Better macro management and monitoring of the budget should make it easier to manage short-term borrowing to smooth over in-year revenue fluctuations. Consolidation of the numerous government bank accounts would permit better use of the available cash resources.

• Clearer rules and guidance on reallocation procedures in order to ensure that the integrity of the budget approved by Parliament is maintained. Line ministries should be provided with an appropriate level of discretion to reallocate resources between spending items where this can facilitate more effective and efficient budget management. In the case of the public investment projects, resources should be allocated and managed against the total estimated costs of the project.68 The MoF should appraise reallocation requests in terms of whether they facilitate the efficient and timely realization of program outputs and objectives.

68 See Public Investment Management, Chapter 4.

Figure 3.4: Monthly Total Expenditure (000 of lek), 1999-2005

Figure 3.5: Current and Capital Spending, 2004

0

5000

10000

15000

20000

25000

30000

35000

1 2 3 4 5 6 7 8 9 10 11 12

1999 2000 2001 2002 2003 2004 2005

Source: MoF.

0.0

5.0

10.0

15.0

20.0

25.0

Jan Feb M ar Apr M ay Jun Jul Aug Sep Oct Nov Dec

M ont h

Current (excl. interest) Capital

Lek

billi

on

Source: MoF.

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• The establishment of clear criteria for the use of the reserve fund. The use of the reserve

fund should be bound by a provision in the OBL and strictly limited to emergencies and macroeconomic shocks that could not be foreseen during budget preparation. Any unused resources at the end of the year should be returned or used to reduce government borrowing.

• The extension of full value procurement to other ministries but with a simple review

safeguards in place. The experience of the pilot ministries indicates that full value procurement results in more timely and cost-effective implementation of public investment projects. However, all multi-year procurement contracts should include provision for a progress review, both to facilitate cash planning and to ensure that implementation remains compliant with the terms and conditions of the contract. The Public Procurement Agency should ensure that staff in contracting agencies are provided with adequate training opportunities covering both procurement procedures and contract management.

Box 3.6: Reserve and Contingency Funds: Principle and Practice Article 21 of Albania’s Organic Budget Law (OBL) states that the “the State Budget will include a Reserve Fund to meet unforeseen expenditures” which “cannot be more than 3 percent of total appropriations.” It further states that “expenditures may only be made from this Reserve after proposal by the Minister for Finance and approval by the Council of Ministers” and obligates the Minister to “periodically report to Parliament on details of expenditure from the Reserve.” However, the Law does not specify limitations on the uses of the Reserve Fund and in recent years it has been used to meet expenditures that should have been foreseen. As such, there is a danger that the Reserve Fund becomes a means of circumventing the normal budgeting procedures, thereby undermining the integrity of the budget process. In Mongolia the Law on Government Reserve Fund and Contingency Recovery Fund that was drafted in 2003 addresses this issue. The law spells out the purposes for which the Reserve Fund may be used and details the requirements for requesting, approving and reporting on allocations made from the Fund. It also sets out sanctions to be applied in cases where these requirements are breached. Article 4.1 Funding for the following measures shall be made from the Government Reserve Fund • Measures for eliminating or reducing damages or losses caused by nation and region wide natural disaster

(drought, water and flood, sand and snow storm that cause damage or loss to industry or the economy, dzud1/, earthquake, soil layer removal, explosion of volcano, etc,).

• Measures for preventing, curing the disease case, seizing its spread, and setting up restriction zones when suspect on publicly harmful disease with high human and livestock loss is discovered.

• Measures for stopping and eliminating damages or losses caused by large industrial accidents, or forest and steppe fires that might cause serious danger to the air, rail and public transports; electricity, heating and water supply engineering network; health and life of the population and the whole economy.

• Projects or measures not listed in the approved budget, but necessary to be funded during the given fiscal year.

Article 4.2. The Contingency Recovery Fund shall be used when budget revenue shortage, or substantial increase in budget expenditure is caused by the following conditions: • Sudden decline of world market prices of the Mongolian main export products from the budgeted level; • Limitation on agriculture originated raw material export due to natural disaster, extreme infectious diseases,

and set up of restriction zones; • Sudden change in the currency exchange rate on the international financial market; • Serious budget deficit caused by decisive decline of domestic industry and service production due to force

majeure or other contingency factors. 1/dzud is a Mongolian term for a complex of natural phenomena that deprive livestock of access to pasture and results in massive livestock mortality.

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Procurement Management 3.37 Public procurement management practices reduce the competitiveness and probity of the procurement process and result in significantly increased costs. The overriding objectives of a national public procurement system are to deliver economy and efficiency in the use of public funds while adhering to the fundamental principles of non-discrimination and equal treatment, due process, access to information and transparency. Joint work undertaken under the CFAU and the PEIR found that the requirement that all procurement tendering against budget funds had to be completed by July 31 of the year69 has unnecessarily restricted the procurement process and has led to an overuse of direct procurement in order to get around this restriction.70 Bid evaluation is limited and invariably results in the contract being awarded to the lowest priced bid rather than the lowest evaluated bid. Inadequate contract supervision results in the supply of poor quality goods and services. Evidence from the roads sector suggests that unit costs are significantly higher, often by more than one-third, on domestically funded projects than on World Bank financed projects following international tendering procedures (Chapter 10).

3.38 Corruption continues to be rife within the public procurement system. The CFA confirms that, as with the assessment of the CPAR 2001, a good procurement law is still being undermined by poor application and no enforcement. Lack of clarity over the status and role of the Public Procurement Agency (PPA), and the continued prevalence of uncompetitive procurement methods, are key institutional weaknesses that have resulted in poor value for money and the prevalence of corruption.

3.39 There has been only a limited increase in the use of open tendering, from 31 percent of contracts in 2003 to 38 percent in 2005. The remaining procurement (around 60 percent of contracts) is mostly conducted through restricted tendering and requests for quotations. The lack of improvement in this area is echoed by the feedback received from suppliers, which suggests that they continue to have limited confidence in the procurement process, namely, because of unfair competition. In the BEEPS survey 2005, the proportion of firms saying that bribery is frequent to obtain government contracts has risen from about 32 percent in 2002 to about 41 percent in 2005 (Figure 3.6).

Internal Audit

3.40 Internal audit functions are still quite limited, with the emphasis on ex ante control rather than on systems audit and recommendations to management. While good progress has been made, the establishment of a modern internal audit function is still at an early stage of development. A Law on Internal Audit was passed in 2003 and the Government adopted a new policy on Public Internal Financial Control in March 2005. Implementation of the policy is being supported by the EU and is focused on creating a cadre of internal auditors familiar with modern audit practices. Internal Audit Units have been established in the larger budgetary institutions. The Internal Audit Unit in the MoF presents an annual report to the Council of Ministers on audits performed and the main findings and recommendations.

69 October 31 for funds approved under the Supplementary Budget. 70 This requirement, introduced under Decision No 675 of 20 December 2002, was revoked in early 2006.

Figure 3.6: Percent of Firms Saying Unofficial Payments are Frequent, Albania and

Comparators, 2002, 2005

0%

10%

20%

30%

40%

50%

Alb SEE ECA

20022005

Source: BEEPS.

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Nonetheless, there is too much focus on compliance rather than on systems audit and procedures for follow-up on audit reports are not harmonized.71

3.41 The Government should proceed with the introduction of a comprehensive requirement for key internal controls to be applied in all spending agencies based on the proposals made in the Public Internal Financial Control Policy Paper adopted in March 2005. This should include the linking of the nominal roll and payroll databases, the introduction of commitment control, and the implementation of internal audit procedures. Updated written procedures for financial control and for responding to internal audit recommendations should be developed and implemented. There is a substantial requirement for training in modern internal audit practice.72

Accounting and Reporting73

3.42 Public finance accounting and reporting currently comprises two systems that rely on different data sources, with the result that the figures cannot be easily reconciled.74

• The Treasury system from which is generated the annual income and expenditure statements that are laid before Parliament. The system is currently cash based and is used to manage budget execution, record receipts and payments and to reconcile bank balances through the central Treasury and Treasury district offices.

• The spending agency accounting system, which manages the collection of own revenues, the

incurring of expenditure, and the authorizing of payments, and from which accrual accounts are maintained covering all government assets, liabilities, funds and transactions. The system does not use standardized software and is not subject to management by a single agency. As a result, the data are less accurate and cannot easily be reconciled with data from the Treasury system.

3.43 Over the medium term the Government should adopt a set of harmonized accounting standards and policies that can provide the basis for the introduction of new accounting practices, including commitment accounting, and that rely on the data generated through the Treasury system. However, the wider introduction of accrual accounting should be approached cautiously and linked to the strengthening of capacities, particularly in district Treasury offices.

3.44 There is no procedure for recording within the Treasury system the receipt of in-kind resources received, particularly those relating to grant-financed public investment projects. At the spending agency level there is considerable variance in the comprehensiveness and quality of the information available and provided to the MoF on such receipts. The MoF should therefore develop and implement a standardized central reporting mechanism for in-kind resources that can be applied by all spending agencies. One possibility would be by requiring the co-signing of all grant agreements by the Minister of Finance.

71 The revisions of the Law on Internal Audit and the Internal Audit Procedures Manual are expected to be finalized within 2006. 72 Ongoing trainings are being undertaken in order to further build capacities, and will include a certification program for Auditors in the Public sector. Continuous updating and modernization of these trainings is needed. 73 For a more detailed discussion of accounting and reporting, refer to “Albania: Country Fiduciary Assessment Update”, The World Bank, 2006. 74The implementation of the computerized treasury system will resolve this problem starting from January 2007.

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3.45 The format and presentation of budget reports requires significant improvement. Summary information on the program objectives and key performance indictors should be introduced into the budget documentation in order to provide a basis against which to monitor implementation. Budget reports should also include a column to keep track of adjustments in allocations made during the year.

External Auditing and Accountability75

3.46 While oversight arrangements are fairly sound in design, their effectiveness is severely limited by capacity constraints. These will have to be addressed over the medium and long term by increasing the numbers and in-service training of financial management personnel.

3.47 The coverage and quality of the annual audit of the state budget prepared by the Supreme State Audit (SSA) has shown gradual improvement, but there continues to be insufficient follow-up on its findings and recommendations by the budgetary institutions. Audit reports from the SSA are submitted to Parliament in October of every year. These cover all central government entities and generally adhere to international audit standards, focusing on material and systemic issues. The SSA recorded an improvement in the follow-up of its recommendations from approximately 50 percent in 2003 to 70 percent in 2004. However, many budget institutions fail to respond to the recommendations within the statutory 20 day period, although improvement has occurred during the last two years. The quality of the responses received is reported to be limited.

3.48 Despite recent initiatives, Parliamentary oversight of the budget and public expenditure remains weak. Scrutiny of the budget by Parliament remains limited, mainly because it lacks the technical competences and time to asses the budget proposals submitted by the Executive. Under the current OBL, Parliament is allowed only 45 days within which to review and pass the budget, but Parliament lacks the technical staff to undertake the in-depth analysis to inform decision-making. In response, Parliament has proposed amending of the OBL to allow more time for its review of the budget. A Budget Analysis Unit was also established by Parliament in 2005, although it has yet to develop sufficient technical capacity.

3.49 The challenge for the medium-term will be to establish a more meaningful and strategic engagement of Parliament and civil society in PFM issues. This will require improvements in the presentation of information on the Government’s fiscal and expenditure plans, on the use of resources and on the performance of public programs. It will need to be backed up with the strengthening of capacities for budget analysis within the Parliamentary Secretariat. The MoF should develop a communications strategy aimed at facilitating this wider accountability.

D. STRENGTHENING THE INSTITUTIONAL FRAMEWORK AND CAPACITIES FOR PFM

3.50 The slow progress in reforming institutional structures and in addressing persistent capacity constraints across the PFM system has seriously impeded the implementation of PFM reforms. The MoF continues to face critical shortages of professional staff, while in line ministries there has been only very limited progress towards strengthening the policy, planning and budgeting functions. A revised OBL that incorporates the requirements of recent PFM reforms, including the MTBP, has still to be presented to Parliament. Improved PFM outcomes will depend on greater urgency being given to addressing these institutional and capacity limitations.

75 For a more detailed discussion of auditing and accountability, refer to “Albania: Country Fiduciary Assessment Update,” The World Bank, 2006.

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Legislative Framework

3.51 The existing OBL does not support a contestable strategic budgeting process. While the OBL provides a general framework that can accommodate the MTBP process and timetable, it does not elaborate further the requirements of a strategic budgeting process in terms of specifying budget policy objectives and priorities as the basis for determining inter-sectoral and intra-sectoral resource allocations. It also places no requirement for monitoring the performance of programs financed by the budget against these objectives. Similarly, the Treasury Regulations have become outdated and are no longer compatible with the new business practices being introduced under the program for Treasury modernization. The MoF has initiated a process of revision of the OBL, primarily to better reflect the requirements of the MTBP process.

3.52 In revising the OBL, the MoF should avoid setting out the MTBP and annual budget cycle in excessive detail, to the extent that subsequent changes would necessitate revision of the primary legislation. Instead, the OBL should specify the overall framework and key events in the budget calendar, leaving the more detailed timetable to subsidiary regulations and guidelines.76 Once the new legislation and regulations are in place, the MoF will need to ensure that training is provided to all budget users on their requirements and provisions.

Ministry of Finance Organization and Capacities

3.53 The previous PEIR emphasized the central importance of strengthening institutional capacities in the MoF, and this has been reflected in the reorganization of key departments within the Ministry. Since 2001 the status of the Budget Directorate has been upgraded to that of a General Directorate. The role of the Macroeconomic Analysis and Forecasting Department within the MTBP process has also been strengthened. At the end of 2005, the responsibility for public investment management was transferred to the MoF and it is expected that responsibility for the administration of external assistance will be similarly transferred during 2006. The internal structure of the General Directorate of Budget has evolved to take account of the requirements of the MTBP process and the recently transferred responsibility for public investment with the creation of new departments for budget policy and analysis, and public investment management. Front-line contact with the spending agencies for both budgets planning and budget execution is the responsibility of sector desks in the Budget Management Department. The Treasury Directorate has also been upgraded to a General Directorate.

3.54 However, these changes have yet to be reflected in significant strengthening of human resource capacities. Few of the staff in the General Directorate of Budget is capable of analyzing Ministry budget proposals from a policy perspective, with many budget officers lacking the technical skills and experience to support the more policy-oriented approach to budgeting being introduced under the MTBP. The General Directorate continues to face difficulties in retraining its most capable staff. In the case of the General Directorate of Treasury which has recently been restructured, the successful introduction and sustainability of the modernized Treasury system will require considerable strengthening of the capacities in MoF headquarters as well as the training of staff in the line ministries and District Treasury Offices. Capacity building for the cash management through a sufficient number of highly trained and professional staff is also critical.

3.55 The capacity of the MoF for monitoring and assessing expenditures at the local level is also very weak and needs to be considerably strengthened. Improved reporting of local government revenues and expenditures to central government line ministries and the MoF should be a top priority.

76 The draft of a new OBL that was prepared in 2003 was overly detailed and specified. It is understood that the MoF is now developing a draft that includes a simplified budget calendar.

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3.56 An immediate challenge facing the MoF is to establish a stronger management framework that addresses all of the major processes within the PFM cycle. This will require improved coordination between departments within the MoF and a more integrated approach to the development and implementation of systems reforms and capacity building. It will also require the MoF to take an effective lead in supporting the development of PFM functions in line ministries. The MoF should establish a PFM Reform and Development Committee to oversee this agenda. This Committee, which should be chaired at the Deputy Minister level, should include senior MoF management together with representatives of other key stakeholders, including the Council of Ministers and the major line ministries.

Policy, Planning and Budgeting Functions in Line Ministries

3.57 In the line ministries there has been a disconnect between policy, planning and budgeting functions that has significantly undermined efforts to introduce a more strategic approach to budget planning under the MTBP. Budget and finance staffs, who have the lead responsibility for the preparation of the MTBP and budget submissions, have frequently been unfamiliar with key reform initiatives in the sector and their implications for budget planning. As a result, ministry budgets have been slow to reflect planned changes in policy directions. Policy development and program planning and management have been fragmented with duplication and overlap in the institutional arrangements for sector strategies and key national initiatives such as NSSED and EU Integration. As a result, priorities have often become confused with excessive demands placed on the limited capacities for policy and program development in line ministries. This fragmentation has been identified by line ministries as a major factor adversely affecting their performance.

3.58 Strengthening the policy, planning and budgeting functions in line ministries will require action to be taken on three main fronts. First, as it is proposed under the IPS, each ministry should establish a single management framework in the form of a Standing Committee on Strategy, Budgeting and Integration. This committee should be chaired by a Deputy Minister and should include all senior management in the ministry. Second, the tasks of policy planning and management, budget planning and management, and program monitoring should be brought within a single integrated department in each line ministry.77 This would reduce the separation that currently exists between these activities. Third, the Council of Ministers and the MoF will need to provide advice, training and backstopping to line ministries on the organization and development of these functions. A key requirement will be to develop a small group of well-trained policy and budget analysts in each of the major line ministries.

E. SUMMARY OF CONCLUSIONS AND RECOMMENDATIONS

3.59 Albania has made progress towards reforming and strengthening its PFM systems. However, the preceding analysis has shown that the MTBP and budget planning processes do not yet provide an effective vehicle for linking resource allocations to strategic policy and program priorities. Significant weaknesses also remain in the budget execution processes which seriously undermine the integrity of the budget. There remains a need for more effective political engagement in the budget process.

3.60 With many of the PFM reform actions identified in the 2001 PEIR still to be completed, it will be important that Albania sustains and intensifies its PFM reform process. Broadly, these requirements can be grouped into five main areas:

77 This is a proposal under the IPS which envisages the establishment of a General Directorate for Strategic Planning and Budgeting in each line ministry.

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Developing and consolidating through the IPS a single strategic framework for national priority and sectoral policy setting that takes due account of public resource constraints. This will require:

o Moving ahead with the development of the National Strategy for Development and Integration (NSDI) to provide a single comprehensive strategy covering all sectors.

o Making the MTBP the platform for analyzing the expenditure implications of the NSDI. o Preparing and evaluating strategic and sectoral plans against a realistic fiscal resource

constraint. o Integrating and strengthening the capacities for policy analysis, program development

and budget planning in the major sector ministries.

Aligning strategic budgeting and budget planning processes to the realisation of strategic and sectoral policy priorities. This will require the following:

o Government approval of the initial macroeconomic framework, strategic medium-term spending priorities and MTBP resource ceilings at the outset of the MTBP preparation.

o Review and further development of the macro-fiscal forecasting model, focusing on the MoF’s main requirement for more detailed and better justified fiscal forecasts.

o A greater focus on the outer year MTBP resource ceilings to enable them to provide a realistic and credible basis for medium-term budget planning at the sector and agency level.

o Further development of the program-based budget classification in order to provide for more explicit linkage between the sector strategies and the budget.

o An expanded training program for MoF and line ministry staff on the new MTBP and budget planning procedures.

Fixing budget execution first, to ensure that resource management procedures support the implementation and integrity of the approved budget. This will require the following:

o Cash management and budget releases should be better matched to the requirements for the timely implementation of the annual budget implementation plan.

o Spending agencies should plan and manage the implementation of their budgets against their annual budget implementation plan rather than against cash releases.

o Full value multi-year procurement should be implemented, particularly for capital investment projects.

o Clear and transparent procedures should be developed for virement and revision of annual budgets that: (i) are consistent with maintaining the integrity of the annual budget, and (ii) provide budget users with appropriate flexibility in managing the implementation of their budgets.

o Internal audit and control should be modernized and strengthened based on the measures set out in the recent policy paper on Public Internal Financial Control; and

o The on going modernization of the Treasury system, including linkage with payroll module should be completed.

Strengthening the institutional framework and capacities for PFM. Key priorities are the following:

o Finalization and approval of: (i) the new OBL; and (ii) updated Treasury regulations. o Strengthening of the linkage between policy development and the budget planning,

processes requiring: (i) close collaboration between the DSDC and General Directorate of Budget in the implementation of the IPS initiative; (ii) establishment in the line ministries of a Standing Committee on Strategy, Budgeting and Integration; and (iii) the bringing of the responsibility of line ministries for sector level policy, program and budget planning within a single central department.

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o Establishment of a PFM reform and development committee or working group chaired by the MoF to actively engage all stakeholders in coordinating the implementation of the PFM reform agenda under the IPS.

o Development and implementation of a strategy for addressing capacity constraints across the PFM system.

Building greater external accountability. Achieving a stronger and more informed engagement of Parliament and civil society in PFM issues will require the following:

o Allowing additional time for discussion of the budget in Parliament by allowing for a timely processing of the MTBP.

o Strengthening the Budget Analysis Unit that has been established in the Parliamentary Secretariat.

o Ensuring more timely follow-up on external audit report queries and recommendations. o Improving the presentation of information on fiscal management and public spending

plans and outcomes so that it is more readily accessible to civil society.