Decentralization and MTEF

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Decentralization and MTEF

• By K. Migara O. De Silva
• Economist
• World Bank Institute
• August 20, 2004

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Decentralization and MTEF

• Plan of the Presentation
• Why MTEF? Concept Objective
• Linking with Intergovernmental Fiscal Reforms
• Establish policy priorities planning through
  evidence-based and consultative budget
  formulation process
• Discretionary powers to ministries and local
  governments
• Establish hard budget constraints
• Benefits of MTEF and some challenges

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Why MTEF Concept Objective

• MTEF provides the linking framework which
  allows expenditures to be driven by policy
  priorities and disciplined by budget realities
  (constraints).
• MTEF is a potential solution in countries where
  policy making, planning, and budgeting are in
  disarray and not property linked with one
  another. For this reason, MTEF has recently
  become a central element of many of the public
  expenditure reform (PEM) programs.
• MTEF includes a top-down resource envelop a
  bottom-up estimation of the current and
  medium-term costs of the existing policy and
  matching these costs with resources available in
  the annual budget process.
• Top-down resource envelop includes fiscal targets
  and estimates of revenues expenditures,
  governments financial obligations, and costly,
  medium-term programs such as civil service
  reforms (CSRs).

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Why MTEF Concept Objective

• Bottom-up estimation looks at sector policies and
  activities with an objective to optimizing
  intra-sectoral allocations.
• Stages of formulating a comprehensive MTEF
  include
• (a) developing a macro/fiscal framework which
  projects revenues expenditure in the
  medium-term
• (b) developing sectoral programs with cost
  estimates of activities, their objectives, and
  outputs
• (c) defining a sector-resource allocation
  strategy based on medium-term sector budget
  ceilings
• (d) preparing sectoral budgets and
• (e) political approval.

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Why MTEF Concept Objective

• Objectives of MTEF
• (1) greater macroeconomic balance which includes
  fiscal discipline attained through sound
  estimates of available resource envelop. These
  estimates are then used to make budgets that will
  fit within the envelop
• (2) improved inter intra-sectoral resource
  allocation
• (3) greater budgetary predictability for line
  ministries
• (4) efficient use of public funds/resources and
• (5) linking the MTEF to PRSP.
• In sum, MTEF will include three pillars (i)
  Projection of aggregate resource envelop, (ii)
  cost estimates of sectoral programs, and (iii)
  the political-administrative-institutional
  process which integrates the two

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Linking MTEF with Intergovernmental Fiscal Reforms

• Fiscal decentralization provides greater
  opportunities for establishing policy priorities
  planning through evidence-based and
  consultative budget formulation processes. When
  properly designed, it also improves efficient
  allocation of resources.
• By virtue of their proximity and ready access to
  local population, sub-national units such as
  Dzonkhags have superior information on local
  services and thus are better placed to respond to
  local demand for services and problems of service
  delivery and to match expenditure
  responsibilities with available revenue
  resources.
• Sub-national units could also raise local revenue
  and taxes more efficiently, finance local
  infrastructure, and effectively deal with the
  delivery of social services such as education,
  health services at the local level by
  developing monitoring mechanisms, performance
  benchmarks, private sector involvement, etc.
• Therefore, it is critical to provide sub-national
  governments both incentives and sufficient
  authority to manage revenue expenditure of
  their budget within a consistent and a
  comprehensive framework. They should also be
  able to predict with some certainty the amount of
  inter-governmental transfers (Bird, 2002, World
  Bank).
• Strengthening political decentralization at local
  levels such as Geog and Dzonkhag is another
  critical ingredient for the success of
  intergovernmental reforms.

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Linking MTEF with Intergovernmental Fiscal Reforms

• It is also important to transfer responsibilities
  to local units which are best positioned to make
  the desired changes. Example in Central
  America, decentralization of management
  responsibilities from central to provincial and
  local governments had little effect on primary
  education but when these responsibilities were
  transferred directly to the schools, education
  performance improved (WDR, 1999/2000)
• Quality of public services can also become worse
  when expenditure responsibilities are transferred
  to local government without introducing proper
  institutional mechanisms. Power may be simply
  transferred from national to local elites.
  Example Indias caste system - local
  participation depends on caste and poor have
  little or no voice. (also see Table 2, 3, and 5
  in the handout)
• Two basic principles of revenue assignment (I)
  Sub-national units should be allowed to finance
  locally-provided services (benefiting local
  residents) by using Own-source revenues (2)
  Where possible, sub-national revenue should be
  collected only from local residents in relation
  to the benefits they receive from local services
  (see also Table 1, 7 8 in the handout)
• The basic requirement for an effective and
  efficient sub-national government is to be able
  to match expenditure responsibilities with
  resources and revenue capacities with political
  accountability.

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Linking MTEF with Intergovernmental Fiscal Reforms

• Establishing Hard Budget Constraints
• Macroeconomic instability is caused by the
  inability to impose hard budget constraints.
  However, imposing hard budget constraints require
  political will (see also Table 9 and Exhibit 1 in
  the hand out).
• Argentina provides an important case in point on
  why hard budget constraints are important. Before
  1991, when Convertibility Plan was introduced,
  provinces were able to borrow large amounts from
  their own provincial banks which were later
  discounted to the central bank. In 1990, there
  were 20 provincial banks which provided more than
  60 of the credit to provincial governments.
  Central Bank had to lend large amounts of new
  rediscounts to prevent the collapse of a number
  of these banks.
• After 1991, with the introduction of the
  Convertibility Plan, the central bank was
  effectively transformed into a currency board
  which required it to maintain 100 reserve
  requirement. In 1992, central banks charter was
  revised, restricting it to take any new domestic
  assets and prohibiting the guarantee of bank
  deposits. (Dillinger Webb, World Bank, 1999).
  These institutional reforms imposed a hard budget
  constraint on provincial banks and helped the
  country avert macroeconomic crises in the 1990s.

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Linking MTEF with Intergovernmental Fiscal Reforms

• In Morocco, for instance, the government changed
  subsidy scheme for local government from one of
  budget-balancing, in which both capital and
  interest payment on loans increase transfer
  receipts, to a formulae-based equalization
  transfer which does not take into account the
  amount of borrowing done by local governments.
  Lenders were explicitly told that they should not
  count on financial bailouts (Richard Bird
  Francois Vaillancourt, 1998)
• There are instances where the central government
  bails out sub-national units when these units are
  too politically important to fail. In such
  situations, the central/provincial governments
  may keep the door to the treasury under lock
  and key to avoid any possibility of financial
  profligacy. In Canada for instance, provinces
  severely restrict local government borrowing and
  under no circumstances the local governments are
  allowed to borrow as they wish (Bird, 2002, World
  Bank).
• The main lesson to be derived from this
  discussion is that intergovernmental fiscal
  reforms should be carried out with the requisite
  institutional reforms and hard-budget
  constraints. For hard-budget constraints to be
  effective, there should be credible
  rules/procedures preventing bail-outs. In
  addition, there must be transparency - allowing
  full information to the creditors and residents,
  as well as full accountability.

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Linking MTEF with Intergovernmental Fiscal Reforms

• In the present context, institutions should
  provide proper incentives and reduce moral
  hazard. Sub-national borrowing is an important
  case in point. Since it is difficult to
  introduce formal bankruptcy procedures in the
  public sector, other institutional mechanisms may
  be introduced to limit sub-national borrowing.
  Politically important sub-national units may
  continue to borrow. Some constraints and
  procedures could be introduced such as
• Explicit prior approval requirement for regular
  and full information of sub-national borrowing to
  the public credible reviews and control systems
  monitoring and evaluation (both ex-ante and
  ex-post) clear and simple bankruptcy procedures,
  etc.
• Establishing explicit criteria for borrowing
  such as the system of traffic lights in
  Colombia where sub-national governments could
  borrow when debt is below a certain threshold but
  require explicit prior approval when debt levels
  are higher (Dillinger Webb, 1998) or
  Maastricht criteria for EU under which deficits
  and borrowing cannot exceed certain numerical
  limits (Bird, 2002). Similar mechanisms will
  limit recent foreign borrowing (Eurobonds) by
  some sub-national governments in Russia.
• Organizational reforms with proper incentives
  which discourage inefficiency and corruption.
  Ex recruitments based on merit promotions based
  on performance and not on seniority
• More formal role for citizens. Example
  introducing participatory budgeting where the
  public has a role to play at each crucial level
  of budget formulation. Example St. Petersburg
  City Government where citizens involvement in the
  budget formulation has been effective.

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Benefits of MTEF and Some Challenges

• Benefits
• More realistic budget framework and better
  alignment with policy priorities such as PRSP
• Greater opportunities to fund highest priorities
• More accurate reporting requirements such as
  reporting expenditures
• Greater transparency and ownership due to the
  involvement of and consultation with line
  ministries, local/regional government units such
  as Dzonkhags.
• Setting up Hard budget constraints and tighter
  sectoral ceilings
• Building institutional (rules/procedures, etc.)
  and organizational (agency) capacities at all key
  levels of budget formation.

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Benefits of MTEF and Some Challenges

• Some Challenges
• Creating an effective expenditure
  monitoring/tracking system at all levels of the
  government and especially at subnational
  governments.
• Implementation challenges due to lack of
  organizational and human resource capacity at all
  levels of government.
• Inability to prioritize sectoral/regional
  policies due to lack of political will.
• Lack of proper coordination within key
  policy-making budgetary units in the
  government.
• Lack of institutional capacity i. e., lack of
  appropriate laws, rules, and regulatory and
  monitoring procedures in place.