Assessing the effectiveness of public financial management systems

Last week, the authorities in Gambia obtained a court order to freeze and place a temporary hold on all known assets and companies directly linked to former President Yahya Jammeh. Accordingly, they have seized 86 bank accounts and 131 properties linked to the former President who lives in exile in Equatorial Guinea. His lavish lifestyle includes ownership of a private jet, a mansion in the United States and a fleet of expensive cars. The new government has accused the former President of massive fraud involving the siphoning off public money during his 22-year rule, including the withdrawal of $50 million from the Central Bank between 2006 and 2016. This in addition to over $8 million he withdrew from a bank account of a Foundation he had established but the money was not used to fund any of the Foundation’s activities.

Over in South Africa, S&P and Fitch Ratings Ltd. last month reduced the country’s credit rating to junk status (BB+) amid concerns over policy continuity and political instability. The downgrade was due to the sacking nine Cabinet Ministers, including the Finance Minister who was replaced by someone with little financial experience. S&P was quoted as having stated that “political risks will remain elevated this year, and that policy shifts are likely, which could undermine fiscal and economic growth”. The new Minister and his deputy met with S&P last week in an attempt to avert a possible second downgrade. The Opposition parties have indicated that they would press ahead with a no-confidence vote against the President.

Today, we discuss a topic that is close to my heart. It is about public financial management and how its effectiveness can be assessed.

Public financial management explained

Public financial management (PFM) is concerned with fiscal policy, particularly on how levels of taxation and government expenditure affect macroeconomic stability and efficiency as well as economic growth. The central focus is on:

(a)           generating financial resources through taxation and other means;

(b)          allocating such resources in a manner consistent with policies and priorities set out in a strategic framework;

(c)           utilizing the resources in the most economical, efficient and effective manner to achieve expected outputs, outcomes and impact; and

(d)          periodic, full, timely and transparent reporting in all stages of the process.

According to the International Handbook on Public Financial Management, PFM is about designing and implementing well-crafted policies for the use of public funds with the central focus on budgeting for both revenue and expenditure. It is concerned with the laws, organisations, systems and procedures available to governments to secure and use resources effectively, efficiently and transparently. While PFM encompasses taxes and other government revenue, borrowing and debt management, its main focus is on expenditure management.

PFM has evolved as an academic discipline due mainly to the increased role of the state in the second half of the 20th century, and more recently because of the 2008 global financial crisis and the need to reinforce fiscal discipline. Several academic institutions and professional bodies offer special courses in PFM. The University of London has an MSc on the subject while the Harvard Kennedy School Executive Education Program, ACCA (UK) and the CPA (Canada) offer specialised training on the subject.

The available literature and various publications on PFM represent a distillation, codification and formalization of what is considered best practices. These were developed and refined over the years with the assistance of international funding agencies, such as the World Bank and the International Monetary Fund (IMF), especially in the context of developing countries. Such publications have been found to be extremely useful for countries that are still struggling to have their PFM systems brought in line with international standards. Even for those countries with sound PFM systems and procedures, there is a need to periodically assess such systems and procedures to ensure that they are in conformity with the latest developments in the field. Indeed, research has shown that many developed countries face issues that are similar to those of developing countries in implementing successful PFM reforms.

Needless to mention, sound PFM systems and practices provide the means for the prudent, accountable, and effective use of public monies. On the other hand, poor PFM systems often result in misallocations, corrupt behaviour, misappropriations, and waste of financial resources.

The practice of public financial management

From a practical standpoint, a PFM system involves the whole range of systems and procedures designed to ensure the efficient and effective delivery of a national budget in the context of a strategic framework that outlines priorities of the government over the medium term. Key elements include:

(a)           preparation and approval of a national budget in accordance with constitutional and legislative requirements after consultation with key stakeholders;

(b)          wide publication of the approved budget;

(c)           timely execution of the budget within the parameters set out in the budget documents, with appropriate embedded controls to ensure good value for money is achieved in the execution of programmes and activities;

(d)          accurate and timely recording of transactions using internationally recognized standards as well as up-to-date technologies;

(e)          periodic reporting on the execution of the budget; and

(f)           independent ex post evaluation and reporting to the Legislature and hence the public.

In each of the above stages, there must be a high degree of transparency to apprise citizens how their tax dollars are being spent.

Assessing the effectiveness of PFM

There are several tools that can be used to assess the effectiveness of a PFM system. The one that has gained wide acceptance over the last decade or so is the Public Expenditure and Financial Accountability (PEFA) Performance Measurement Framework, developed by the World Bank and the IMF, in conjunction with the EU, DFID and other bilateral donors. The PEFA Framework was initiated in 2001 and finalized in 2005. It was upgraded in 2011, then in 2016. As of 31 December 2015, over 500 PFM assessments have been undertaken at both national and sub-national levels in 149 countries.

According to the PEFA Secretariat, an open and orderly PFM system is one that enables:

(a)          effective controls of the budget totals and management of fiscal risks thereby contributing to maintaining aggregate fiscal discipline;

(b)          strategic allocation of resources involving planning and executing the budget in line with government priorities aimed at achieving policy objectives; and

(c)           the use of budgeted revenues to achieve the best levels of public services within available resources.

The PEFA framework identifies seven pillars of performance that are essential to achieving the above objectives. These are:

(i)            Budget reliability: The government budget must be realistic and is implemented as intended. This is measured by comparing actual revenues and expenditures with the original approved budget;

(ii)           Transparency of public finances: Information on PFM must be comprehensive, consistent, and accessible to users. This is achieved through comprehensive budget classification, transparency of all government revenue and expenditure including intergovernmental transfers, published information on service delivery performance and ready access to fiscal and budget documentation;

(iii)          Management of assets and liabilities: Effective management of assets and liabilities is necessary to ensure that public investments provide value for money, assets are recorded and managed, fiscal risks are identified, and debts and guarantees are prudently planned, approved, and monitored;

(iv)         Policy-based fiscal strategy and budgeting: The fiscal strategy and the budget must be prepared with due regard to government fiscal policies, strategic plans, and adequate macroeconomic and fiscal projections;

(v)          Predictability and control in budget execution: The budget should be implemented within a system of effective standards, processes, and internal controls, ensuring that resources are obtained and used as intended;

(vi)         Accounting and reporting: Accurate and reliable records must be maintained, and information is produced and disseminated at appropriate times to meet decision-making, management, and reporting needs; and

(vii)        External scrutiny and audit:  Public finances should be independently reviewed and there is external follow-up on the implementation of recommendations for improvement by the Executive.

Within each pillar, there are a number of performance indicators that are used to conduct the PEFA assessment. In total, there are 31 such indicators which are further disaggregated into 94 dimensions. For example, Pillar VII (external audit and scrutiny) has two performance indicators, namely external audit; and legislative scrutiny of audit reports. These are further broken down into eight dimensions – audit coverage and standards; submission of audit reports to the Legislature; external audit follow-up; Supreme Audit Institution independence; timing of audit report scrutiny; hearings on audit findings; recommendations on audit by the Legislature; and transparency and scrutiny of audit reports.

The performance of each indicator is measured on a scale from A to D. The highest score, A, is given if the evidence clearly demonstrates that an internationally-recognized level of good performance is achieved. The D score indicates that performance is below the basic level. Indicators with more than one dimension are scored according to either the lowest score amongst its dimensions or the average of its dimension scores. The results of the individual indicator assessments are used to provide an integrated assessment of the PFM system against the seven pillars. This integrated assessment facilitates an overall assessment of the likely impact of PFM performance on the three desired budgetary outcomes referred to above: aggregate fiscal discipline, strategic allocation of resources, and efficient service delivery.

The culmination of a PEFA assessment is a report that provides an overview of the PFM system and evidence-based measurement against 31 performance indicators. It also provides: (a) an assessment of the implications for overall system performance and desirable PFM outcomes; and (b) a foundation for reform planning, dialogue on strategy and priorities, and the monitoring of progress.

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