Report No. 26041-BY Belarus Strengthening Public Resource Management June 20, 2003 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank CURRENCY AND EQUIVALENT UNITS Currency Unit=Ruble (BYR) January 2002: US$l=BYR1,600 Government Fiscal Year January 1 - December 31 Weights and Measures Metric System ACRONYMS AND ABBREVIATIONS ABL Annual Budget Law BSL Budget System Law CEEs Central and Eastern European CIS Commonwealth of Independent States CPI Consumer Price Index CoM Council of Ministers EU European Union GDP Gross Domestic Product GFS Government Finance Statistics GNI Gross National Income IMF International Monetary Fund INTOSAI International Organization of Supreme Auditors JAP Joint Action Plan LGL Local Government Law MDG Millennium Development Goal MoE Ministry of Economy MoF Ministry of Finance NBB National Bank of Belarus OECD Organization for Economic Cooperation and Development PAYGO Pay as you go PPP Purchasing Power Parity Rbl Rube1 SAI Supreme Audit Institution SCC State Control Committee SOE State Owned Enterprise SPF Social Protection Fund UNDP United Nations Development Program USSR Union of Soviet Socialist Republics WDI World Development Indicators WDR World Development Report Vice President: Johannes F. Linn Country Director: Luca Barbone Sector Manager/ Deborah L. Wetzel ACKNOWLEDGEMENTS This report was prepared by a team including Deborah Wetzel (Team Leader), Luis- Alvaro-Sanchez (Consultant), Marina Bakanova, John Litwack (ECSPE), Jonathan Dunn (Consultant), Noel Hepworth (Consultant), Rita Hilton (ESSVP), Konstantin Senyut (ECCU2), Tom Richardson and Roman Zytek (IMF). I t draws o n background papers o n Fiscal Sustainability, Public Expenditure Management and preliminary work for a Country Financial Accountability Assessment. The team benefited from meetings and workshops with a Working Group to support the preparation o f Public Expenditure Review, chaired by the Deputy Minister o f Finance, Mr. Sverz. The draft report was discussed with the Government in January and March 2003. We are also grateful for access and discussions with a broad number o f officials in the Belamsian government. However, the World Bank i s solely responsible for content o f this report. Matt Davies (IMF) and William Dorotinsky (PRMPS) are peer reviewers. TABLE OF CONTENTS EXECUTIVE SUMMARY ......................................................................................... i CHAPTER I. INTRODUCTION .............................................................................. 1 CHAPTER I1. STRENGTHENING FISCAL SUSTAINABILITY ............ 5 The General Government Budget .................................................................................. 5 Extrabudgetary Funds. Quasi-Fiscal Activities and . . . . Contingent Liabilities................................................................................................ 9 Low Deficits and Debt Levels Mask Several Problems .............................................. 17 Issues in Medium-TermFiscal Sustainability .............................................................. 19 A Long-Term Problem with Immediate Consequences: The Pension System................................................................................................ 25 Recommendations for Addressing Fiscal Risks .......................................................... 28 . CHAPTER I11 BUDGETARY ALLOCATION AND ITS EFFECTIVENES S ........................................................................ 31 Introduction.................................................................................................................. 31 ‘Public’ Expenditures in the Economy ........................................................................ 31 The Allocation o f Budget Expenditures: Economic Classification ............................ 33 The Allocation o f Budget Expenditures: Functional Classification ........................... 42 Assessing Public Expenditures: Principles ................................................................. 45 Performance o f Social Expenditures ............................................................................ 46 Social Assistance and Social Security Expenditures ................................................... 48 Health ........................................................................................................................... 53 Education ..................................................................................................................... 56 Allocating Sector Expenditures: Summing Up ........................................................... 59 Priority Areas for Action ............................................................................................. 61 . CHAPTER I V THE INSTITUTIONS OF THE BUDGET PROCESS .............. 63 Introduction.................................................................................................................. 63 Public Expenditure Management Principles ................................................................ 63 . . Organization ................................................................................................................. 65 The Legal Framework and Accountability .................................................................. 65 Budget Coverage .......................................................................................................... 67 Budget Classification ................................................................................................... 68 Budget Preparation....................................................................................................... 69 Budget Approval .......................................................................................................... 78 Budget Execution......................................................................................................... 78 Auditing and Evaluation .............................................................................................. 87 Assessing Budgetary Outcomes ................................................................................... 91 Summary and Recommendations ................................................................................ 91 . CHAPTER V DEVELOPING AN ACTION PLAN ............................................. 95 LIST OF TABLES Table 1.1 Key Economic Indicators Table 2.1 Fiscal Indicators, 1999-2003 Table 2.2 General Government Revenues, 1999-2003 Table 2.3 Revenues and Expenditures o f Innovation Funds Table 2.4 Extrabudgetary Income o f Selected First Level Institutions, 2002 Table 2.5 Composition o f Social Expenditures o f Enterprises Table 2.6 Government Fiscal Risk Matrix Table 2.7 Government Expenditure Arrears Table 2.8 Belarus: Fiscal Indicators and Projections, 1999-2008 Table 3.1 Selected Countries’ General Government Expenditure Avg. 1998-2000: Economic Classification Table 3.2 General Government Expenditures: Economic Classification, 1999-200 1 Table 3.3 Subsidies and Transfers, 1999-2001 Table 3.4 Protected Expenditure Items, 1999-2001 Table 3.5 Selected Countries’ General Government Expenditure Avg. 1998-2000: Functional Classification Table 3.6 General Government Expenditure as a Share o f Total Expenditure Table 3.7 Transfers to the Population, as a share o f disposable resources Table 3.8 Expenditures per Student as % GDP per Capita, 1997 LIST OF FIGURES Figure 1.1 Private Sector Activity as a Share o f GDP, 1992 & 200 1 Figure 2.1 General Expenditure as a Share o f GDP, 1999 (percent) and GNI per capita (PPP) Figure 2.2 Domestic and Foreign Debt as Share o f GDP Figure 2.3 International Reserves and Exchange Rate Figure 2.4 Enterprise Profits and Market Value Figure 2.5 Inventories o f Finished Goods Figure 2.6 Pension Bill as Percentage o f the Economy’s Wage and Salary Bill Figure 2.7 Pension Bill as Percentage o f GDP Figure 3.1 Belarus and Russia: Real Average Monthly Wage, 1996-2001 Figure 3.2 Total Capital Investment by Major Source o f Financing Figure 3.3 Expenditures for Wages and Extra Charges on Wages in Health Figure 3.4 Expenditures for Wages and Extra Charges on Wages in Education Figure 4.1 Actual Consolidated Expenditures as Share o f Annual Budget Law and Revised Plan, 2001 LIST OF BOXES B o x 1.1 Implications o f the Russia-Belarus Union for Public Expenditure Reform B o x 2.1 Seigniorage and Inflation Tax Income in Belarus B o x 2.2 Social Protection Fund Finances in 2002-2003 B o x 3.1 Government Priorities for Capital Expenditure B o x 3.2 Millennium Development Goals in Belarus B o x 3.3 Targeting Social Assistance B o x 3.4 Health Expenditures and Output Measures B o x 4.1 Public Budgeting and Accountability B o x 4.2 International Experience with Covering Tax Expenditures and Contingent Liabilities B o x 4.3 State Programs B o x 4.4 Policy Prioritization and Sectoral Allocations B o x 4.5 Medium-Term Fiscal Frameworks B o x 4.6 Cash Management B o x 4.7 Guidelines for a Supreme Audit Institution EXECUTIVE SUMMARY 1. L i k e other transition countries in the region, Belarus has strived in the last decade to create effective fiscal institutions that are consistent with the creation o f a market economy. M u c h has been achieved. Belarus n o w possesses a three-tier state budgetary framework, a tax system based o n the value added, profit, and other market-based taxes, and a number o f basic institutions o f control over state expenditures. This includes a treasury system and state procurement regulations. The government i s also in the process o f drafting a budget code. The W o r l d Bank has cooperated with Belarus in supporting fiscal reform. The current Country Assistance Strategy continues to attach importance to this area, emphasizing the goals o f greater effectiveness, transparency, and accountability in the use o f public resources. This report, the first Public Expenditure Review o f Belarus, concentrates on these areas. I t will remain focused o n broad systemic questions rather than delve deeply into sectoral issues. 2. Despite some similarities, the Belarus experience in fiscal reform i s rather distinct from that o f other transition countries in the region. This reflects a different overall approach t o economic transition. M ost notably, t h e government continues t o p lay a much more active role in Belarus than in neighboring transition countries, which i s consistent with a relatively large state budget and other means o f state influence over resource allocation. In some cases, this m a y have alleviated problems in control over tax and budgetary processes that have plagued some other former Soviet countries in recent years. Comparatively high levels o f social spending have supported what appears to be a relatively strong social safety net in Belarus. 3. By a number o f common indicators, recent budgetary outcomes in Belarus compare favorably with many other transition countries. Tax collection has been comparatively good, despite high tax rates, and the explicit (cash-based) general budget deficit has been below 2 per cent o f GDP for several years. Relatively l o w foreign and domestic government indebtedness (10 per cent o f GDP) relieves what are considerable budgetary pressures for debt servicing in several other countries in the region. 4. Nevertheless, growing imbalances and other worrisome trends in state finance pose serious threats to macroeconomic stability and the future growth o f the Belarus economy. For the short term, sharp declines in the profitability and liquidity o f enterprises, administrative wage increases, and lower gas subsidies f r o m Russia have adversely affected the state budget, suggesting the necessity o f substantial downward adjustments in government expenditure obligations and programs. The l o w liquidity position o f the government has become a particular concern, especially as Russia i s n o w demanding that cash or cash equivalents replace existing barter arrangements for natural gas. Gross foreign reserves o f the National Bank equaled the equivalent o f only t w o to three weeks o f imports in 2002. At the same time, government deposits and pension reserves have been falling rapidly, while arrears to and from state budgets have been increasing. 5. Even separate from the short-term liquidity problems, current very high levels o f direct and indirect (quasi-fiscal) government expenditures in Belarus imply a huge burden o f taxation and other costly regulations for businesses, thereby placing Belarusian firms at a disadvantage relative to competing enterprises in Russia, Ukraine, and other transition economies. Combining the size o f explicit general govemment outlays with various quasi-fiscal expenditures associated with directed credits, price controls, extrabudgetary funds, energy cross subsidies, and obligatory direct finance o f social assets and other programs by enterprises, suggests a figure much higher than the 46% o f GDP accounted for by explicit budgetary expenditures. Furthermore, many o f these various instruments undergo continual adjustments in the direction o f extracting “excess” surpluses from more profitable firms to bail out struggling enterprises, thereby weakening incentives for restructuring and investment. As other countries o f the former Soviet U n i o n continue to grow and improve their business and investment climates, Belarus faces the imperative o f either following this example or continually losing ground to i t s main competitors, with dire consequences for growth and stability. Recent trends show an unmistakable deterioration i n the external c ompetitiveness o f Belarusian firms, and the government i s w e l l aware that a primary imperative o f economic policy must be to stop or reverse this deterioration 6. On the basis o f these considerations, Chapter I1 o f this report concludes that the overall level o f government fiscal and quasi-fiscal obligations i s too large to be consistent with the basic objectives o f macroeconomic stability and sustainable growth in Belarus. Despite this fact, the Belarusian government can b e encouraged that there i s much r o o m for improvement in the efficiency o f public expenditures. Comparable social and other state objectives can be achieved at less cost. Thus, the improvement o f budgetary institutions and policies can be a critical part o f an overall reform strategy that preserves a high priority for social policy in a manner that does n o t pose such a threat to growth, competitiveness, and macroeconomic stability. This Review identifies a number o f areas where important improvements can be made in the determination and management of state expenditures. This includes the legal framework and coverage o f the budget, budget preparation, budget approval, budget execution, and evaluation. Chapter I11 examines the topic o f effectiveness in budgetary allocation, while Chapter I V concentrates attention o n budgetary institutions. 7. A number of the problems emphasized in the subsequent chapters fall into four broad categories given below. These categories are all closely interrelated. 0 The complicated array o f extrabudgetary and quasi-fiscal sources o f state finance imposes substantial losses o n the economy. 0 Budgetary preparation and approval lacks focus, realism, and an appropriate balance o f political influence. The implementation o f the budget suffers from excessively weak legality, and allows for too much discretion in the allocation and re-allocation o f state expenditures. 11 0 The connection between state objectives and public expenditures i s often unclear or weak. Extrabudgetary Funds and Quasi-Fiscal Activities 8. State finance in Belarus extends far beyond the explicit consolidated budget. Among other important instruments o f explicit and implicit state finance are extrabudgetary funds, including “innovation funds” controlled by the ministries, directed credits through commercial banks, obligations o f enterprises to finance various programs directly, price subsidies, and the selected relaxation o f tax discipline. M u c h o f this finance has costs to the country over and above an equivalent budgetary outlay. The multiplicity o f sources o f finance under control o f various agencies hinders the ability o f the government either to determine rational allocations o f state resources or to monitor outcomes. Directed credit through the banking sector distorts incentives o f commercial banks, threatens their solvency, and places pressure on the National Bank for inflationary refinance. Price subsidies can b e associated with irrational consumption and wastefulness. Direct (quasi-fiscal) expenditure obligations o f enterprises, along with price subsidies, complicate the evaluation o f enterprise performance o n the basis o f indicators such as liquidity and profitability, and thereby hinder the development of markets and effective institutions o f bankruptcy. Off-budget state procurement does not appear subject to the same guidelines, standards, and monitoring as procurement for the explicit budget. 9. The inventory and consolidation o f most o f these sources o f explicit and implicit state finance i s therefore a critical task toward increasing the effectiveness and efficiency o f public finance in Belarus. Extrabudgetary funds should be brought into the state budget and administered through the state treasury. I n some areas, such as public utilities, the phasing out o f subsidies will take time, and may require comprehensive state programs, such as those providing budgetary assistance to poor households as compensation for higher energy prices. In the cases where quasi-fiscal subsidization cannot be eliminated in the short run, it i s s t i l l important that the government accounts for the costs o f these implicit outlays o n state finance in general. Directed credits from the banking sector should b e discontinued, and the National Bank should cease direct finance on the non-financial sector. T o the degree that commercial banks remain involved in s tate finance, t hey s hould b e financing the e xplicit b udget deficit at market rates. An inventory and consolidation o f all existing sources o f fiscal and quasi-fiscal spending, along with a full consideration o f contingent commitments such as loan guarantees, will reveal the true picture o f government finance in Belarus, and provide a foundation for prioritizing expenditure categories, eliminating redundancies, and bringing state financial obligations in line with the overall objectives o f macroeconomic stability and the realization o f key social objectives. I t will also reduce or eliminate inefficiencies and risks inherent in most off-budgetary state finance cited above. ... 111 Budgetary Preparation and Approval 10. The effectiveness o f public expenditure depends on institutions to ensure that resources are allocated in l i n e with government priorities (allocative efficiency) and that resources are used efficiently (technical efficiency o f the budget process). Some o f these institutions relate to the preparation and approval o f the annual budget. In Belarus, this process proceeds largely o n the basis o f inertia from the realizations o f previous years. The system h as evolved as a result o f t he amalgamation o f v arious historical initiatives, each o f which may have had its o w n individual justification. While budgetary processes in many other countries also exhibit a high degree o f inertia, the current situation in Belarus suggests that the government should take careful stock of, and prioritize, existing programs with the goal o f linking budgetary allocations closer to specific social objectives. Budgetary proposals in Belarus currently give little attention to the evaluation o f actual outcomes on the ground from various allocations. There i s no consistent practice o f phasing out programs or mandates that have already accomplished their objectives, or, alternatively, have shown little success in accomplishing their objectives. As shown in B o x 4.3, programs involving commitments o f state expenditures have accumulated in recent years to the point that their finance i s simply infeasible. This compromises the credibility and legality o f fiscal policy in general. The determination o f norms for budgetary allocations is also rather divorced from questions o f cost-effectiveness and incentives for cost reduction. 11. The usefulness o f a planned budget depends on the accuracy o f the underlying macroeconomic projections. In the case o f Belarus, such projections derive from indicators endorsed by the president as a set o f targets for which the government becomes legally responsible. These indicators correspond closely to a best case five- year development scenario associated with the program o f “Main Directions o f Social and Economic Development in Belarus.” T o the degree that these targets lack realism, the actual implemented budget will unavoidably deviate strongly from the plan, with significant costs to the efficiency o f budgetary management that are stressed throughout this Review. This has indeed been an important problem in Belarus. The projections underlying the budget should correspond not to a desired best case scenario, but to a realistic assessment o f what i s probable. The current high degree o f uncertainty over macroeconomic variables in Belarus, particularly inflation, also suggests that the budget should include at least broad guidelines for adjustments to different contingencies. This concerns, in particular, a procedure for increasing nominal expenditures in the event o f higher-than-expected inflation, and a plan for expenditure reduction should inflation fall below expectations. 12. The process o f budget preparation and approval in Belarus i s characterized by a very strong role o f the president, and a relatively weak role o f Parliament. The president determines underlying projections and then must approve the draft budget submitted by the government. U p o n approval, the budget i s sent for examination to Parliament. Parliamentary committees consider each element, and m a y press for extra funds to be allocated to particular activities as long as additional sources o f funding can be identified. Changes proposed by Parliament have only the status o f iv recommendations, however, that can be subsequently accepted or rejected by the president. Measures to increase the authority o f Parliament in the process o f budgetary approval m a y help to increase legality and commitment in the overall budgetary process. Implementation o f the Planned Budget 13. An u navoidable high d egree o f u ncertainty in a t ransition c ountry 1i k e Belarus makes budgetary adjustments necessary during the course o f the year. Nevertheless, efficiency in budgetary allocation depends greatly o n upholding at least some degree o f commitment to the planned budget. Assuming the problem o f approving a realistic budget can be solved, this i s an area where Belarus can potentially make substantial gains. Budgetary allocations in Belarus currently deviate quite strongly f r o m the plan, although the Belarus government does manage to achieve some degree o f commitment through the creation o f special protected budgetary categories. However, this practice by itself can also be associated with inefficiencies. In particular, spending units have a bias toward the use o f protected items in the budget, thus distorting the input m i x in the production o f desired outcomes. The political process by which protected categories are chosen also lacks a comprehensive view o f the opportunity costs o f implied reductions in various non-protected areas. 14. The losses from a lack o f commitment to the implementation o f the planned budget are substantial. In addition to a general fragmentation and lack o f control over outcomes, the absence o f commitment weakens incentives. If budgetary spending units and budgetary recipients expect that the state i s allocating resources solely o n the basis o f a day-to-day assessment o f current needs, incentives will become distorted from two points o f view. Firstly, there will be little incentive for spending units or recipients to economize in the use o f budget funds, as this will only lead to an expected reallocation o f resources to other areas. Second, significant time and effort will be wasted o n continually lobbying higher state bodies for more resources. 15. In the process o f budgetary preparation, the budget circular should provide ministries and other spending agencies with indicative ceilings for sectoral allocations as well as fiscal aggregates. L i n e ministries and spending units then need to be held responsible for achieving fiscal targets in l i n e with the budget law. Spending units should not be permitted t o exceed their budget allocations without the explicit oversight, coordination, and approval o f the Ministry o f Finance. Budgetary revisions should correspond to an explicit legal framework. The cash management system must ensure that budget implementation leads to a distribution o f actual spending in accordance with intersectoral policy priorities as specified in detail in the planned budget. Cash management should also support operational efficiency by providing an appropriate balance between autonomy for spending units, o n the one hand, and their accountability to the Ministry o f Finance, o n the other. 16. The relatively high degree o f state control in Belarus m a y have helped to maintain financial discipline in some cases relative to other transition countries. V Belarus has not suffered from budgetary arrears and the proliferation o f non-cash budgetary operations (offsets, bills o f exchange, e tc.) to the same degree that Russia and Ukraine did in the latter 1990s. Nevertheless, budgetary arrears have become steadily more problematic along with falling liquidity in 2002. Phasing out the quasi- fiscal activities o f the National Bank and commercial banks, as recommended in this Review, will also put pressure on liquidity. In this case, the Belarus government can profit from studying the negative experiences o f Russia and Ukraine, and thereby avoid the demonetization of budgetary operations. Commitment to the planned budget includes a commitment by the government to honor i t s own expenditure obligations. As already s tressed above, p rogress in t h e implementation o f s uch a c ommitment in Belarus necessitates a much higher degree o f realism in the planning o f budgetary expenditures and programs involving state finance. Objectives and Budgetary Outcomes 17. Strengthened institutions for budgetary preparation, approval, and implementation, combined with the consolidation o f state expenditures, will afford the Belarus government the opportunity to take stock o f existing expenditure programs and restructure them in line with social and other objectives. All categories o f public expenditure deserve scrutiny. The Belarus government currently devotes a higher share o f its resources to subsidies and capital expenditures than most other transition economies. W h i l e this may follow from greater state ownership, i t i s nevertheless important for the government to assess the actual returns from these outlays. The share o f expenditures on salaries and pensions has increased rapidly as a consequence o f recent wage policies. A s stressed in this Review, this has had difficult implications not only for the budget and the pension find, but for the competitiveness of the economy as a whole. Compared with international experience, the share o f outlays o n education and economic services appear relatively high, while spending o n health is relatively low. A careful assessment o f international experience and the specific situation in Belarus in these areas would be useful. 18. A b r i e f r eview o f k ey so cia1 expenditures ( social a ssistance, health, e ducation) suggest significant opportunities for improving the efficiency o f public expenditures. Both broadly and with respect to sectors, the expenditure system in Belarus lacks a clear statement of strategic goals. Once such goals are identified, the government needs to establish performance criteria that are related to the strategic objectives. Belarus already has an active program for the collection o f statistical data upon which i t can build. A next step would be for the government to take action to make connections between user preferences, input mix, and costs. An effective system must also embody incentives for policy makers and executing agencies to pursue efficiency and cost reduction. Finally, as the government begins to make strategic tradeoffs, i t will be imperative to communicate clearly to the population the underlying goals and progress toward their realization. 19. Belarus could also profit from a better capacity to monitor outcomes. The Ministries’ Department o f Inspection and Control and the State Control Committee vi (SSC) currently perform the audit and control activities in Belarus. At present, the audit functions conducted by both the internal control departments and the SCC are largely devoted to assessing financial compliance, i.e. verifying that spending units utilize public funds in accordance with appropriations and legal regulations. There i s no effort to evaluate the effectiveness o f management, the quality o f outputs or service delivery, cost effectiveness, or other aspects o f performance. Another shortcoming in this area i s the absence of an external audit agency that i s independent o f the government and reports directly to Parliament. Here, Belarus should draft a medium- term strategy for the establishment o f an independent audit institution following best international practice. Developing an Action Plan 20. The body o f this study focuses on k e y issues that underpin an effective budgetary process: fiscal discipline and sustainability; effective allocation o f resources and the technical efficiency of the budget process. I n each area, Belarus has made important progress and strides, but in each area there are important steps that need to be taken that could significantly improve the use o f public resources. 21. However, managing change and improvement in fiscal and public expenditure management i s a complex process that takes years o f work. It requires policymakers that are committed to the goals o f improved budgetary practices. I t also requires developing a strategy and managing the change properly. The starting point o f developing a strategy is to identify the objectives that one seeks to achieve. The second step i s to carry out a comprehensive and candid assessment o f the strengths and weaknesses o f the system currently in place. This study i s a first step in beginning this assessment. 22. A s important to achieving success, however, i s building a commitment to improving the use o f public resources, both within and outside o f the government. Changes w i l l t ake h old only if t here are champions within t h e g overnment. T h e t o p management o f the Ministry o f Finance must be actively engaged in the process and efforts should be centered in the Ministry o f Finance. T o design and implement the reforms, the Ministry o f Finance should work in close cooperation with line ministries, subnational governments and other k e y players. 23. Effective organizational arrangements are also necessary to implement change. Given the important a n d wide ranging n ature o f is u e s related t o p ublic e xpenditure reforms, three levels o f participants are needed: 0 A S teering Group, which c onsists o f high 1eve1 o fficials that provide general direction to the program o f change. Typically the steering group i s chaired by the Ministry o f Finance. I t i s also important to include in the Steering Group the heads o f key departments in the Ministry o f Finance and representatives o f ministries and Government agencies participating in the reforms. One o f the vii aims o f this group is to establish a consensus o n the key objectives that need to be addressed. A Core Unit that i s made responsible for overall management of the program o f activities. This unit i s most appropriately located within the Ministry o f Finance and need to have a very clear vision as to the goals and objectives to be reached. It should also be given the authority to develop a communications strategy and spread new practices or approaches through seminars, workshops and training activities. e Working groups should be created to develop and help implement specific reforms in particular areas. These groups often undertake the detailed day-to- day work o f developing and implementing needed changes. Such groups will be needed to fully develop the needed changes but also to assure that the proposed changes have full ownership o f the Belarusian government and people. 24. Chapter V presents recommendations for moving forward on reform as a point o f departure for discussion. While there are many recommendations for changes that could help to improve fiscal discipline, strengthen allocative effectiveness and improve the technical efficiency, w e present the most critical actions that are needed. e Improve realism in budgetary planning and the management o f state obligations. e Develop institutions to support commitment to budgetary implementation. e Expand the coverage o f the budget to account for most activities with fiscal impact. e Develop a framework for identifying, quantifying and addressing fiscal risks. e Develop a sustainable wage and compensation policy. e Streamline subsidies to the productive sectors. e Focus o n development o f sector strategies, one or two sectors at a time: identify objectives, determine performance measures and the links between inputs and positive outcomes. e Improve the short and medium term revenue and expenditure forecasting capacity e Put in place systematic rules for budget revision. 8 Introduce guidelines for the allocation o f resources in the event o f unexpected inflation, cash shortages, or surpluses. e Develop a concept o f accountability beyond the Ministry o f Finance and budget agencies - extend the concept o f accountability to the public. Make budget information easily accessible to the public. 25. Many other elements o f a potential action plan are implied by the recommendations o f Chapter V. The Belarus govemment has already been developing an Action Plan in 2003 that i s consistent with a number o f these recommendations. viii The Bank stands ready to continue discussions and cooperation with the Belarus govemment o n this Action Plan. ix BELARUS STRENGTHENING PUBLIC RESOURCE MANAGEMENT CHAPTER I.INTRODUCTION 1.1 Background. At its independence in 199 1, Belarus inherited a standard o f living and capital stock that were among the highest in the Former Soviet Union (FSU). At the same time, the Belarus economy was quite dependent on linkages with the other areas o f the FSU. I t obtained 90 percent o f its energy and 70 percent o f its raw materials from other countries o f the FSU, and these countries also accounted for virtually all Belarusian exports. This made Belarus very vulnerable to the significant disruptions in trade that occurred in the early 1990s. 1.2 Despite some initial reform steps, GDP declined sharply in the early 1990s, while inflation soared to over 700 percent in 1995. In 1994, the government o f newly elected President Lukashenko pursued a new economic strategy that focused o n the administrative mobilization o f resources to restore linkages in production and enforce greater d iscipline, while k eeping t h e v ast m ajority o f t he economy remaining within state hands. Since 1996, growth has been positive, although inflation has remained high (see Table 1.1). Table 1.1: Key Economic Indicators 1995 1996 1997 1998 1999 2000 2001 200 GDP growth (annual %) -10.4 2.8 11.4 8.4 3.4 5.8 4.7 4.7 Consumer prices (% change over previous period) 709.3 52.7 63.9 72.9 293.7 168.6 61.1 42.6 Gross fixed capital formation (% o f GDP) 24.7 21.1 25.2 25.9 26.3 25.2 22.7 21.2 Foreign direct investment, net (BOP, current USS) 14.7 104.5 349.5 200.9 443.2 118.6 95.5 227.4 Current account balance (% o f GDP) -4.4 -3.6 -6.1 -6.7 -1.6 -2.6 -2.3 -2.0 Real effective exchange rate index 100.0 102.5 82.9 96.4 96.5 96.5 102.5 103.2 Poverty incidence 38.4 38.6 32.1 33.0 46.7 41.9 28.9 30.5 1.3 The path o f transition chosen by Belarus since 1995 differs from the other countries in the region. Although some administrative controls have been reduced over time, including those o n the exchange rate and a number prices, the economy remains highly regulated and under predominant state control. Relatively l i t t l e restructuring appears to have occurred in either industry or agriculture and foreign direct investment remains quite l o w in spite o f a new Investment Code. A new Banking Code, introduced in July o f 2000, tightens prudential regulations, although banks remain largely state- owned and are subject to government imperatives for directed credits to the national economy. 1.4 In 1999, agreement was reached o n the Belarusian-Russian Union Treaty, which formalized Belarus’ deep economic links to Russia. This agreement has provided Belarus with substantial economic benefits, including very large energy subsidies and an open border providing easy access to Russian markets. Recently the two countries agreed that Belarusian goods would be transported within Russia at the domestic cost o f transport. Belarus and Russia have expressed the joint goal o f a monetary union and potentially deeper integration. However, such integration would have important implications for fiscal policy (See B o x 1.1) 1.5 As indicated above, one o f the most striking aspects o f the Belarusian approach i s the degree to which economic activity has been retained within the realm o f the state. I t i s estimated that private sector employment accounts for about 11 percent o f economic activity. In most other transition countries there has been a substantial shift o f activity away from the state sector and towards the private sector (See Figure 1.1). This has not been the case in Belarus. Figure 1.1: Private Sector Activity as a Share o f GDP, 1992 & 2001 90 80 70 -~ 60 1992 5 I 50 2001 & 40 0 30 20 10 Source: EBRD. 1.6 Such a large state role in the economic activity implies that the allocation o f public resources is particularly important for overall economic outcomes. Recent trends that have threatened the liquidity position and budgetary balance o f the government speak to the immediate necessity o f a more rational allocation o f public expenditures. Both growth and poverty reduction will be largely determined by the degree to which public resources are effectively used in the context o f overall state expenditure reduction. The Bank’s Country Assistance Strategy for 2002-2004 placed emphasis on the need to establish increased transparency and accountability in the use o f public resources. This Public Expenditure Review i s a step in understanding h o w public resources are used in Belarus. 2 Box 1.1: Implications of the Russia-Belarus Union for Public Expenditure Reform Prospects are unclear for economic and political unification o f Russia and Belarus. Following agreement on a Union Treaty in 1999, movement toward monetary unification accelerated in 2002 with the signing o f a “Joint Action Plan for Introduction o f a Single Currency in the Union State” (JAP). The JAP envisages a range o f macroeconomic and structural reforms, including harmonization o f tax and customs legislation, budgetary procedures (including a Budget Code consistent with the Russian model) and o f course monetary union. To support the integration process, the Central Bank o f Russia (CBR) provided a Ruble 4.5 billion credit to the NBB, conditioned on performance against an IMF-style monetary program. The Russian Ministry o f Finance also made available a budgetary credit line o f $100 million, also conditioned on reforms. Political developments in the second half o f 2002 made it difficult for outsiders to judge the likely next steps in this process, however. Current plans envisage a rapid move to a fixed peg and subsequent “ruble-ization.” Already, the NBB pursues a crawling band exchange rate arrangement vis-a-vis the ruble (though monetary policy i s de facto oriented on the dollar). Under the JAP, the Belarusian rubel i s to be pegged to the ruble in 2004, and the ruble i s t o be introduced in Belarus from January 1, 2005. The NBB and the C B R do not seem to have agreed on the administrative arrangements for managing monetary policy in this new ruble area, as well as on whether or not a new “Union currency” should be introduced in 2008. International experience with dollarization suggests that a hard peg and ruble-ization will have major implications for fiscal policy and require rapid structural reforms in Belarus.’ As the experience o f Argentina most recently confirms, a pegged exchange rate cannot long persist with loose fiscal policy. In Belarus, where the transition process has been gradual to avoid social dislocations, fiscal policy has traditionally been very loose, accommodated by monetary policy consistent with high inflation. If the rubel i s pegged to the ruble, Belarus will more or less immediately be required to run monetary policy consistent with the Russian level o f inflation, which in 2003 i s expected to be about 12 percent. T o move from 30-40 percent to almost single digit levels will require much tighter fiscal policy in Belarus. For example, direct NBB financing o f the budget deficit will have to be abolished. Any NBB credit to government will have to be limited to incidental financing arising from open market operations carried out exclusively on the secondary market at market interest rates. As a result, the housing construction program (the earmarked recipient o f these funds at present) will have to be scaled back and financed out o f non-earmarked sources. I f currency union i s under serious consideration (and even if it i s not), the PER team hopes the authorities will find this PER to be timely and useful. Belarus needs l o w inflation in order to attract investment and to grow at a rapid rate. But if a hard peg or ruble-ization are imminent, the level o f public expenditures in Belarus will very quickly need to be brought to a level consistent with sharply lower inflation. To achieve both high growth and l o w inflation, Belarus w i l l need to re-examine the role o f the state in the economy (moving many activities which government n o w performs t o the private sector), and improve the efficiency o f government spending. This i s precisely the objective o f the current public expenditure review. ‘See A. Berg and E. Borensztein, “The Pros and Cons o f Full Dollarization,” IMF Working Paper WP/OO150 (2000), available at h~:/!www.imf.orglextenial/vubs/cat/lon~res.cfm?sk=3~86.0. 3 1.7 The three goals that every budget system must strive to achieve are the following: i)t o maintain aggregate fiscal discipline, ii)to allocate resources effectively, in accord with government priorities, and i ii) to promote the efficient use o f budget resources. These three objectives are complementary and interdependent. Without aggregate fiscal discipline, it i s impossible to achieve effective prioritization and implementation. Strengthening intemal management systems to achieve efficiency i s not possible without a hard budget constraint. However, fiscal discipline in the context o f arbitrary resource allocation and inefficient operations i s also unlikely to be sustainable.' These objectives thus provide a framework for both assessing public resource management in Belarus and for thinking comprehensively about the steps that are needed to strengthen the system. 1.8 The study begins in Chapter I1 with an overview o f the fiscal picture in Belarus, and highlights current worrisome trends in the economy and state finance that necessitate state expenditure reductions. Chapter I11 addresses the allocation o f public resources and the implications both o f the allocation process and o f the allocations themselves. I t discusses specific sectoral issues to some extent, but does not go deeply into any given sector. I t s aim i s to assess the systemic issues in the allocation and prioritization o f resources that may prevent effective public service delivery. Chapter I V tums to the institutions o f budget process and management in order to identify ways in which budgetary management can be made more effective. This chapter draws o n work prepared for the Country Financial Accountability Assessment, as well as a separate background paper. Chapter V concludes the study with the development o f a set o f recommendations that may form the basis o f an Action Plan to be agreed with the Government. See Richard Allen and Daniel Tommasi , 2001. eds. Managing Public Expenditure: A Reference Book for Transition Countries. Paris: OECD, p. 19-20. 4 CHAPTER 11. STRENGTHENING FISCAL SUSTAINABILITY 2.1 Aggregate budgetary indicators in Belarus give a first impression o f fiscal stability. In recent years, Belarus has managed to keep the general government (cash- based) deficit under 2 per cent o f GDP, while debt and debt servicing obligations have remained quite low. These indicators t e l l far from a complete story, however, and mask serious risks to the government fiscal position and to macroeconomic stability in general. Some o f these risks have become more apparent in 2002, as a combination o f increased financial strains in many Belarusian firms, administrative wage increases, and lower gas subsidies from Russia adversely affected the liquidity position o f the government, creating the necessity o f substantial fiscal adjustments. Other risks derive from a plethora o f off-budget and quasi-fiscal expenditures o f the government that can be associated with economic distortions and inflationary pressures. This chapter begins with a snapshot o f fiscal aggregates, with the goal o f assessing the overall degree o f fiscal stability in Belarus. Problems and risks to fiscal sustainability in the short and longer t e r m are identified. A contraction in the size o f overall (explicit and implicit) state expenditures will most likely be necessary to ensure not only the soundness o f the fiscal position, but the sustainability o f growth and competitiveness o f the Belarus economy as a whole. The General Government Budget 2.2 Table 2 .1 p rovides b asic information o n expenditures, revenues a n d deficits o f the general government2 from 1999 through 2003 (budget). General government expenditures have been quite stable at about 46-47 percent o f GDP. Cash deficits have remained low, ranging from 0.1 percent o f GDP in 2000 to 1.9 percent in 2002, and a projected 1.1 percent in 2003. When the budgetary balance i s considered o n an accrual basis, i t increases to -3.1 percent o f GDP in 2001, and about -2.0 percent o f GDP in 2002. The bulk o f deficit financing has come from domestic sources (Table 2.1). N e t foreign financing and privatization receipts have been quite small until the exceptional sale in December 2002 o f the government stake in the o i l company, Slavneft. 2.3 Even confining attention only to the explicit budget given in Table 2.1, the overall level o f public expenditures in Belarus i s rather high by international standards. This i s shown in Figure 2.1, which graphs general government expenditures as shares o f GDP and gross national income per capita in 1999 for a variety o f countries. Among transition countries, Belarus has a relatively high level o f general expenditure, on par with Hungary and considerably higher than other countries with comparable income per capita. B elarus’ expenditure i n 1 999 w as a bout 10 p ercentage p oints o f G DP higher than in neighboring Russia and Ukraine. Given substantial debt-servicing in Russian and Ukraine, the difference in levels o f primary expenditures i s even greater. 2 General Government includes the consolidated republican and local budgets as w e l l as the Social Protection Fund, but does n o t include state-owned enterprises, quasi-fiscal deficits o r other contingent liabilities. 5 Table 2.1: Fiscal Indicators, 1999-2003 1999 2000 2001 2002 2003 Authorit. Actual Actual Actual Prel Proiect. f rubles) (In billions o 1.State (Republican and local) budget Revenue 1052 3173 5735 8209 10603 Expenditure (cash) 1143 3236 6023 8681 10945 o/w transfer to the SPF 8 8 5 80 143 Expenditure (accrual basis 21) ... ... 6237 8706 10945 Balance (cash) -90 -63 -289 -472 -373 Balance (accrual 21) ... ... -502 -497 -373 2. Social Protection Fund Revenue 326 1010 1984 3065 4403 o/w: transfers f r o m the Rep. Budget 8 8 5 80 143 Expenditure 297 962 2021 3071 4434 Balance (cash) 29 48 -37 -6 -31 3. General government Revenue 1370 4175 7714 11194 14863 Expenditure (cash) 1432 4190 8039 11673 15236 Expenditure (accrual basis 21) ... ... 8252 11698 15236 Balance (cash) -62 -15 -326 -479 -373 Balance (accrual 21) ... ... -539 -504 -373 Statistical discrepancy 3 58 -3 0 35 0 4. Financing (cash), o/w 65 73 296 514 373 Privatization 3 8 12 427 119 Foreign financing, net -9 -50 -20 29 41 Domestic financing, net 71 115 303 58 213 (In percent o f GDP) 1.State (Republican and local) budget Revenue 34.8 34.7 33.4 32.2 32.2 Expenditure (cash) 37.8 35.4 35.1 34.0 33.3 o/w transfer t o the SPF 0.3 0.1 0.0 0.3 0.4 Expenditure (accrual basis 2/) ... ... 36.3 34.1 33.3 Balance (cash) 0.0 0.0 -1.7 -1.9 -1.0 Balance (accrual 2/) ... ... -2.9 -1.9 -1.0 2. Social Protection Fund Revenue 10.8 11.1 11.6 12.0 13.4 o/w: transfers f r o m the Rep. Budget 0.3 0.1 0.0 0.3 0.4 Expenditure 9.8 10.5 11.8 12.0 13.5 Balance (cash) 1.0 0.5 -0.2 0.0 -0.1 3. General government Revenue 45.6 45.7 44.9 43.9 45.2 Expenditure (cash) 47.3 45.8 46.8 45.7 46.3 Expenditure (accrual basis 2/) ... ... 48.1 45.8 46.3 Balance (cash) -1.7 -0.1 -1.9 -1.9 -1.1 Balance (accrual 2 4 ... ... -3.1 -2.0 -1.1 Statistical discrepancy -0.1 -0.7 -0.2 0.1 0.0 4. Financing (cash), o/w 1.8 0.8 1.7 2.0 1.1 Privatization 0.1 0.1 0.1 1.7 0.4 Foreign financing, net -0.1 -0.5 0.1 0.1 0.1 Domestic financing, net 1.8 1.3 1.5 0.2 0.6 Memorandum items: Primary Balance (percent o f GDP) -1.4 0.7 -1.2 -1.3 -0.6 G D P (trillion o f rubels) 3.0 9.1 17.2 25.5 32.9 Changes in arrears 0.0 0.8 1.2 0.1 0.0 IStock o f arrears 0.1 1.1 1.8 1.3 1.51 Source: Ministry o f Finance, SPF, and IMF staff estimates. I/ State government revenues includes privatization receipts. 2/ Includes changes in arrears. 6 Figure 2.1: General Expenditure as a Share o f GDP, 1999 (percent) and GNI per capita (PPP) 65 - 60 i *Sweden Denmark * B (3 551 Austria *France r 0 Winland s 50 - +Belgium v) m ttaly . Belarus *Germany *Hungary Greecea Portugal Netherland Latvia Poland 0 w Slovenia > *Estonia *Czech ReD. 0~ *Spain 40 i Romania* *Iceland Bulgaria Slovak Rep. New *Canada ***Russia Ukrai?%huania *Ireland *United Kingdom Japan 35 - l Australia I 30 -----zILs1 0 5000 10000 15000 20000 25000 30000 35000 I GNI per capita in PPP 2.4 General revenues are also relatively high, averaging over 45 per cent o f GDP over the past three years. As seen in Table 2.2, the largest sources o f revenue in Belarus are indirect taxes --just over 40 percent o f revenue comes from taxes on goods and services and some 27 percent from VAT. The third largest source o f revenues, at about 17 percent o f total revenues, comes from various charges to special budgets. These include both republican budgetary funds (the Agricultural Support Fund, the Employment Fund, the Road Fund, the Nature Preservation Fund and Energy Conservation Fund) and local budgetary funds (the Road Fund, the Nature preservation Fund, the Fund for Support o f Pre-schools and the Housing Fund). Direct taxes provide a much smaller portion o f overall revenues -just under 10 percent each for personal income taxes and the profit tax. 7 2.5 Since 1999, there have been some changes in the shares o f major taxes in total revenues. The most significant i s the drop in the profit tax from 13.5 percent o f total revenues in 1999 to 7.8 percent in 2002. Excise taxes have also dropped from 9.5 percent o f total revenues in 1999 to 7.2 percent in 2002. N o n -tax revenues have fallen from 5.7 percent o f total revenues in 1999 to 4.7 percent o f revenues in 2002. In contrast, between 1999 and 2002, the share o f VAT in total revenues increased (by about 1.5 percentage points), as have revenues from the special budgets and property tax. Some o f the r i s k s inherent with these shifting patterns will be discussed below. 2.6 The cash deficit has been financed primarily by direct credits from the National Bank at interest rates w e l l below market levels. Combined with other substantial off-budget (quasi- fiscal) spending directed through the banking sector (see below), the implied monetary expansion has fuelled persistently highly inflation in Belarus. This inflation has also served to reduce the real value o f government debt. 2.7 As seen in Figure 2.2, Belarus overall level o f debt as a share o f GDP has fallen dramatically since 1994 and remains relatively l o w at just over 10 percent. At the end o f 2001, total domestic debt as a share o f GDP was 4.5 percent. Just over h a l f o f this debt i s formally owed to the National Bank o f Belarus. The other h a l f consists o f short-term securities and promissory notes. Foreign debt in 2001 fell to 7.1 percent o f GDP. Controls over foreign borrowing by the broadly defined public sector, including control over the issuance government guarantees for foreign debts o f enterprises (see below), have kept the explicit public foreign debt at a relatively low level in relation to GDP and government revenue. 2.8 In sum, relatively l o w explicit budget deficits over the past few years have kept financing requirements and government debt servicing costs at manageable levels. At the same time, deficit-finance, along with the quasi-fiscal activities o f the banking sector, have contributed to persistent high inflation in the country. Extrabudgetary Funds, Quasi-Fiscal Activities and Contingent Liabilities 2.9 While the snapshot o f the fiscal situation provided above covers the explicit general budget (Republican budget, local budgets and the Social Protection Fund), there exist a variety o f other important activities involving at least implicit government financial obligations. Thus, looking at the general budget can provide only a partial view o f the fiscal picture. Given data limitations, i t i s very difficult to provide a complete picture, but even adding the information that i s available can prove useful to understanding the overall fiscal balance and its sustainability. 2.10 Extrabudgetary Funds. In recent years B elarus h as m ade s ome s trides i n incorporating extrabudgetary funds into the budget. In 1998, five previous extrabudgetary funds were included as earmarked targeted budgetary funds. Nevertheless, a variety o f activities remain outside o f the formal budget. 9 Box 2.1: Seigniorage and Inflation Tax Income in Belarus With limited access to foreign financing, a poorly developed financial sector, and very limited privatization sales, the government has depended on the national bank for financing i t s deficits. In addition to national bank credits for deficit and off-budgetary finance, the government has made use of central bank profits for boosting fiscal revenues and recapitalizing state-owned commercial banks. The NBB direct profit transfers to the budget have been relatively low, averaging 0.2 percent o f GDP over 1998-2002, partly because the NBB has had to shoulder the responsibility for recapitalizing state- owned commercial banks (i.e., pay for what should be fiscal expenditure). Also, due to the NBB’s weak net foreign asset position, NBB profits from the placement o f excess reserves have been minimal. The 200 1-2003 Budget Laws contained explicit NBB Government deficit financing targets that were routinely exceeded when other budgeted sources o f financing did not materialize. In 2001, the NBB created an equivalent o f 1.2 percent o f GDP in high powered money to finance the government’s deficit. The original 2002 Budget Law required the NBB to provide the government with Rbl 152 billion in direct low-interest financing. The draft Budget Law amendments prepared in September 2002 added another Rbl 30 billion, for a total o f Rbl 183 billion (0.7 percent o f 2002 GDP) in direct NBB deficit financing in 2002. Although the use o f the NBB printing facilities to finance the deficit and cut the real value o f the government’s outstanding debt has been gradually slowing, in 2003, under the budget signed by the president and sent to Parliament, the NBB will be required to add another Rbl 152 billion (0.5 percent o f GDP) in high powered money to finance the projected 2003 deficit. (This financing i s earmarked for housing construction.) As the NBB’s foreign exchange position i s expected to remain very weak and its other assets comprise low interest earning claims on the Belarus government and weak banks, the Government’s projected receipts from NBB’s profits in 2003, at Rbl 10 billion, will be lower in nominal terms than the projected 2002 outcome o f Rbl 15.5 billion. Money emission related to national bank financing o f the government and (at least implicity) the national economy has helled high and unstable inflation, which has cut into the wealth o f the population and kept money demand weak. During 1998-2002, economic agents in Belarus held an equivalent o f only 22 percent o f GDP in various components o f broad money, and the ratio f e l l to 16 percent in 2001-02. However, foreign currency deposits accounted for over 50 percent o f the broad money and between 70 and 80 percent o f all time, savings and foreign currency deposits. If foreign currency cash holdings are added (estimated by some at $2 billion or Rbl 3.8 trillion at today’s exchange rate) to broad money, it becomes clear that rubels may have accounted for less than 25 percent o f all money stock in Belarus and foreign currency cash and deposits accounted for over 90 percent o f all savings balances. The very low demand for rubels make even small NBB emission for deficit finance have a significant impact on inflation. The inflation tax calculated as the reduction in real value o f base money due to inflation, i s estimated at 3.6 percent o f GDP during 1998-2001. Inflation tax ”receipts” were 5.1 percent o f GDP in 1998, and gradually fell to 2.5 percent o f GDP in 2001. 10 Figure 2.2: Domestic and Foreign D e b t as Share o f GDP 90 80 70 60 Total Domestic 50 Debt 40 -- Total Foreign 30 Debt 20 -- -Total Government Debt 10 0 Sources: Ministry o f Finance, NBB, IMF, and Bank staff estimates. 2.1 1 Among the largest remaining off-budget activities are the Innovation Funds controlled by individual ministries or other state bodies. Provision for the existence o f such funds i s stipulated by Article 41 o f the Annual Budget L a w for 2002. They are financed by levies at the rate o f up to 0.25 percent from the costs o f goods, works and services managed by legal entities (state- owned enterprises (SOEs) and other units with own-source income) subordinate to the Government o f the Republic o f Belarus. The Council o f Ministers o f the Republic o f Belarus i s granted the right to establish increased norms o f allocations to innovation funds for certain republican state bodies and other state organizations subordinated to the Government o f the Republic o f Belarus. The innovation taxes, in particular their variable rates, distort the allocation of resources and the composition o f final output. In 2001, revenues o f innovations funds accounted for 2.0% o f GDP. Expenditureswere at approximately the same level (Table 2.3). 2.12 Every year, the government works out a special document for regulating the generation and disbursement o f the Innovation Funds. Innovation Funds are particularly important for financing capital investments. Spending entities view the separation o f the Innovation Funds from the budget as a way to maintain a minimum level o f investments, as capital expenditures are typically among the first items sequestered from the budget in the case o f cash shortages. This helps explain the continued existence o f the Innovation Funds, despite the Ministry o f Finance’s support for their liquidation and the incorporation o f an equivalent l e v e l o f resources into the budget. This proposal i s strongly opposed by l i n e ministries and state organizations. 2.13 Other extrabudgetary items include funds o f subordinate budget institutions generated by various user fees and other types o f public receipts. Budget institutions are allowed to collect 11 and retain “own income” under a Cabinet o f Ministers Resolution that regulates paid services that they m a y deliver. These resources may be used up to 40 percent o n salary enhancements as w e l l as other expenditures. An IMF Fiscal Affairs Department study estimated that the aggregate amount o f such “own income” in 2001 was the equivalent o f 6 percent o f total public expenditure. W h i l e it has not been possible to obtain more recent data, Table 2.4 suggests that “own income” i s an important source of revenues to some ministries, especially education and forestry. In 2000, o w n income of the ministries listed below was 0.7 percent o f GDP. According to some sources, there also exists a substantial “President’s Fund” outside o f the formal budget, although the government denies i t s existence and i t s size cannot be assessed. Table 2.3: Revenues and Expenditures o f Innovation Funds (thousand rubels) 2 Ministry of architecture and construction 250.1 241.9 4,397.00 4,233.00 11,985.10 11,854.20 3 Ministry of communication 5,582.00 5,595.00 15,359.00 15,398.00 36,195.00 36,178.00 4 Ministry ofnansportation and transportation links 967.7 596.4 1,859.00 1,203.00 3,571.00 1,678.00 5 Minishy o f housing and communal services 23.6 20 77 62 165 133 6 Ministry of commerce 10.9 8.8 36.8 34 63 51.9 Concerns 7 Bellegprom 199.7 167.8 2,551.30 2,4 18.70 3,441.00 3,295.40 8 Belbiofam 130.2 128.5 70 1 685 1,938.90 1,928.00 9 Bellesbumprom 65 1.6 603.6 668.9 660.6 889.3 841.3 10 Belmestprom 25.9 23 165.2 159.9 427.9 411.9 11 Belneftechim 1,251.50 1,068.00 11,605.90 10,373.70 45,371.00 43,096.00 12 Belenergo 26,165.70 24,151.70 63,417.70 56,760.20 95,383.60 89,270.40 13 Beltopgaz 12,252.40 8,765.30 29,479.20 3 1,825.40 47,570.30 47,448.00 14 Belkoopsow 1,606.00 1,609. I O 4,376.20 4,368.40 7,199.30 7,140.40 15 Belresursy 17.6 5.7 37.9 7 71.1 34.8 16 Public enterprise Beltransgaz** 22,149.90 20,911.70 17 State aircraft committee 719.8 68 1.3 1,290.00 1,097.00 5,129.00 3,173.00 18 Belatusan railway 794 568.7 12,792.00 11:246.00 30,898.00 29,609.00 19 Public assosiation Belbyt** 84.3 83.5 20 transportation links 14.6 12.7 22.2 10.9 65.9 62.7 Total 59069 52630 173281 164934 354780 339189 2’ol Memo: GDP 3,026,064 3,026,064 9,133,776 9,133,776 17,173,230 17,173,230 Total Innovation FundsiGDP 2.0 1.7 1.9 1.8 2.1 * revenues include carry-over residuals, for the year 1999 - adjusted to denomination ** innovation funds weren’t formed I ource: Ministry o f Economy. 12 T a b l e 2.4: Extrabudgetary Income o f Selected First Level Institutions, 2002 (million rubels & percent) Extra- Financing from Extra-budgetary budgetary/Budget Ministryhnstitution Budget Income Financing (%) Science and Technology Committee 5010.4 332.7 6.2 Ministry o f Education 159979.2 132942.4 45.41 I Ministry o f Health 198562.0 19282.8 8.91 Ministry o f Forestry 71042.3 24060.2 25.3 Source: Ministry o f Finance. 2.14 Quasi-fiscal activities . Activities carried out at the government’s request, but not paid for from explicit budgetary resources, are often termed quasi-fiscal operations. Conceptually, they properly belong to the category o f public expenditure, and often imply social costs over and above an equivalent budgetary outlay. There are some activities that are routinely provided by the government outside o f the budget, and these activities should be included in a comprehensive analysis to give a clearer picture o f the true fiscal role o f the government in the economy. 2.15 In Belarus, public utilities, state enterprises and commercial banks routinely shoulder obligations related to implicit expenditures o f the government. For example, Belarusian banks are routinely “encouraged” to finance priority sectors and projects with soft credits (primarily in agriculture and housing construction). 0 n a number o f o ccasions, t h e NBB h as p erformed a recapitalization o f distressed banks out o f its o w n resources, thereby paying for what would normally be a fiscal obligation o f the government. The total quasi-fiscal cost o f low-cost lending to agriculture has been estimated at 2.3 percent o f GDP in 1999, while the quasi fiscal costs o f housing loans were estimated at 0.5 percent o f GDP in the same year. 2.16 Quasi-fiscal operations can be carried out under various disguises. For example, in 2002, the Belarusian government asked o i l distributors to donate fuel for the harvest campaign. Also, industrial and agriculture companies continue to finance a large share o f social assets (housing, utilities, schools), as inherited from the Soviet period, that should properly be the responsibility o f municipalities (Table 2.5). Periodic “subotniki” (working Saturdays) announced by the government provide local municipalities with close to free labor for one day to clean parks and carry out various small projects. The value o f the various social expenditures carried out by enterprises according to some kind o f government mandate has been estimated at about 2.0 to 3.0 percent o f GDP. 13 Table 2.5: Composition o f Social Expenditures o f Enterprises Excluding Banks and Small Non-state Organizations and Taking into Account Denomination in 2000 1998 1999 2000 200 1 BRB m %Total BRB m %Total BRB m %Total BRB m %Total Expenditures o f Social Development 12941 100.0 74583 100.0 201893 100.0 357608 100.0 Construction o f Facilities 3435 27.5 29121 39.0 62577 31.0 82724 23.1 Maintenance o f Facilities 8161 65.3 4 1982 56.3 128410 63.6 253870 71.0 Health, sports and social insui:ance 1813 14.5 988 1 13.2 31323 15.5 64720 18.1 Education 2016 16.1 11563 15.5 36737 18.2 67602 18.9 Culture 322 2.6 1711 2.3 6429 3.2 13947 3.9 Housing and utilities 4010 32.1 18827 25.2 53921 26.7 107601 30.1 incl. departmental housing 2681 21.5 14450 19.4 41112 20.4 83245 23.3 Special Events 895 7.2 3480 4.7 10906 5.4 21014 5.9 Health and sports 634 5.1 1469 2.0 4768 2.4 8574 2.4 Education and culture 261 2.1 201 1 2.7 6138 3.0 12440 3.5 Expenditures o f Social Development 1.8 2.5 2.2 2.1 as % GDP Sources: Belarus authorities and Bank staff estimates. 2.17 Before 2000, the use o f multiple exchange rates supported various quasi-fiscal measures that provided cheap foreign currency and imports to selected firms and organizations. Fortunately, the government succeeded in eliminating this practice through the subsequent unification o f the exchange rate. 2.18 Other subsidies. Other off-budget activities that have significant implications include various types o f implicit import subsidies, consumer subsidies, and producer subsidies. Implicit import subsidies come from Russia in the form o f l o w prices for natural gas. In 2001, Russia supplied natural gas to Belarus at a lower price than to other CIS importers, -on average $31 per 1,000 m a bout a third o f t he w o r l d m arket p rice o f about $ 103 p er 1,000 m 3. With annual imports o f about 17.3bn cubic meters in 2001, the resulting gross gas subsidy i s estimated at about 10 percent o f GDP Part o f this subsidy i s retained by the Belarusian energy company, as it distributes gas at a higher price than i t pays. 2.19 Despite some progress in liberalization and increases in regulated prices, selected price subsidies remain important in Belarus. For consumer goods, three main categories o f goods and services were s t i l l subject to controls in 2001: socially important goods, a l i s t o f goods under “ministerial price controls,” and goods produced by 25 strategic enterprises. 2.20 The government has made some progress in the reduction o f subsidies and cross-subsidies in utility pricing, but their levels remain high compared to most other transition countries. In January-December 2002 utility tariffs covered an estimated 37.1 percent o f the costs o f providing these services during the heating season and 3 1.1 percent during the summer season. Taking into account tariffs for gas and electricity during 2002, the cost coverage o f utilities by the population reached 39.6 percent in the heating season and 36.4 percent in the summer season. These subsidies are financed largely through cross-subsidization, i.e. by charging industrial consumers higher prices. The authorities estimated (and reported to the IMF) the value o f cross-subsidies in 14 the energy sector at (pre-2000 rubels) Rbl 24.6 trillion (3.6 percent o f GDP) in 1998, Rbl 114 trillion (3.9 percent of GDP) in 1999, and (post-2000 denomination rubels) Rbl 279 billion (3.1 percent of GDP) in 2000, and about 3 percent o f GDP in 2001. 2.2 1 Selected tax preferences and preferential customs treatment represent foregone revenue to the government, and can therefore also be treated conceptually as a type o f quasi-fiscal expenditure. In 2000, tax exemptions granted on the basis of individual decisions o f the president reached about 1 percent o f GDP, o f which customs duties were equivalent to 0.2 percent o f GDP and VAT exemptions to 0.1 percent o f GDP. These ad hoc exemptions do not include the more extensive privileges that are written into law and are estimated to amount to 2-3 percent o f GDP. 2.22 In addition to price subsidies and exemptions, the selected enforcement o f payment discipline i s another type o f quasi-fiscal activity. Domestic arrears o n payments for energy reached an estimated 14.2 percent o f GDP at end 2001, and this figure picked up to 17.3 per cent in the first nine months of 2002, before falling to 13.4 percent o f GDP at end 2002. Roughly h a l f o f energy arrears concern natural gas. Industrial enterprises are the largest debtors, followed by housing and communal services, and agricultural entities. The accumulation o f domestic arrears has also led to the build-up o f extemal energy arrears, despite the l o w prices paid o n energy imports. As o f October 1, 2002, these arrears amounted to Belarusian Rbl 493.3 bn or 2.7 percent o f GDP (Rbl322 bn or 1.3% GDP at end-2002). The Russian gas monopoly, Gazprom, has promised to enforce stricter payment discipline in years to come. 2.23 Contingent liabilities. In addition to the explicit and implicit costs that are discussed above, the Belarusian budget i s also subject to a range o f contingent liabilities. Contingent liabilities exist when the government i s subjected to an obligation should a particular event occur. The right hand column o f Table 2.6 sets out a variety o f possible contingent liabilities. For example, t h e government p rovides a v ariety o f guarantees t o support b 0th b anks and t h e business sector - should a given entity fail to meet i t s obligation, the state will be required to step in. More broadly the government faces a substantial contingent liability should the banking system fail to meet i t s obligations. Some o f these contingent liabilities and the risks they pose are discussed below. 2.24 The fiscal snapshot above illustrates that, while official data suggest that Belarus has a l o w deficit and relatively l o w debt ratios, the underlying fiscal position i s much more serious. W h e n one looks a little deeper into those items that remain off-budget, the extent o f quasi-fiscal deficits, and the level o f contingent liabilities, it becomes clear that Belarus i s in need o f significant fiscal adjustment. Indeed, although general government expenditure was just less than h a l f o f GDP in 2001, the considerations above suggest the true level o f government expenditures i s much higher. 15 Table 2.6: Government Fiscal €4 kMatrix Sources of Obligations Direct Liabilities (Obligations in Contingent Liabilities (Obligation $a any event) particular event occurs) Explicit -Sovereign debt ( loans -State guarantees for non-sovereign contracted and securities issued borrowing by and other obligations o f Government L i a b i l i t y as by central government) subnational governments and the public recognized by a l a w or contract and private sector -Expenditure composition (non- discretionary spending - Umbrella state guarantees for various types o f loans (mortgage loans, student -Expenditure legally binding in loans, agricultural loans, small business the long t e r m (civil service loans) salaries and pensions) - Trade and exchange rate guarantees issued by the state - State guarantees o n private investment - State insurance schemes (deposit insurance, income f r o m private pension funds, crop insurance, flood insurance) Implicit -Future public pensions (as - Default o f subnational government o r opposed to c i v i l service publidprivate entity o n non-guaranteed A moral obligation o f pensions)a debt‘obligations government that reflects public and interest group pressures -Social Security schemesa - Banking failure ( support beyond government insurance, if any) -Future health care financinga - Cleanup o f liabilities of entities being - Future recurrent costs o f public privatized investment projects -failure o f non-guaranteed pension fund, employment fund o r social security fund - Possibly negative net worth a n d o r default o f central bank and its obligations (foreign exchange contracts, currency defense, balance o f payments) (aIn this framework, these services fall in the category o f -Other calls for bailouts direct implicit liabilities if their provision i s n o t mandated by - Environmental recovery, disaster relief, law. If mandated by law, then military financing these services f a l l in the category o f direct explicit liabilities.) Source: Polackova, Hana, 1998, :ontingent Government Liabilities: A Hidden Risk for Fiscal Stability”, Policy Research Working Paper 1989, W o r l d Bank, Washington, D.C. 16 L o w Deficits and D e b t Levels Mask Several Problems 2.25 The l o w debt-to-GDP and interest payments-to-government revenue ratios set out above provide only very limited comfort to policy makers. In a very stable world, the fiscal stance o f the Belarus government m a y be deemed sustainable, at least in the short-term. However, as the economy i s subjected to internal and external shocks, the resulting change in the fiscal stance could be rendered unsustainable, and insolvency or default could result despite initial stability and the l o w debt level. 2.26 In the case of Belarus, the l o w debt ratios may be a s i g n o f economic fragility as much as one o f prudent macroeconomic management and financial ~trength.~ Although the absolute level o f government debt is l o w relative to GDP, the economic financing costs are not negligible.4 The debt servicing costs are bound to increase rapidly in the near term, as the government i s forced to pay high market interest rates in the domestic debt market and its access to inflationary central bank financing i s curtailed. 2.27 The public sector’s liquidity position i s precariously l o w and the liquidity position o f the banking sector i s very weak. The Belarusian government and the Belarus National Bank (NBB) have at their disposal only very limited resources to counter financial pressure or outright crisis. The central bank’s international reserves are extremely l o w (at just 2-3 weeks o f imports, compared to a desirable absolute minimum o f at least 3 months) (Figure 2.3); and the public enterprise sector is illiquid, as it cannot s e l l i t s output and often resorts to barter and runs tax arrears. The very weak and illiquid balance sheet o f the enterprise sector makes crisis even more likely, because it destabilizes the government’s revenues and undermines the government’s ability to pay i t s o w n debts. 2.28 Ministry o f Finance (MoF) treasury deposits in rubels and foreign currencies plummeted fiom Rbl 127 billion (US.$80 million) at the end o f 2001 to Rbl 84 billion (U.S. 45.9 million) o n July 3 1,2002. Deposits o f the government, i t s agencies and the budgetary and extrabudgetary funds all fell and remained extremely l o w by intemational standards. Total government deposits with the banking system covered less than two weeks o f general govemment expenditure, and tax and expenditure arrears have increased, although public sector wages and pensions continue to be paid more o f less o n time. The reserves of the Social Protection Fund (SPF) have declined f i o m about 82 percent of monthly outlays in January 2001 to just 6 percent in April 2002, despite a massive infusion of funds to the SPF from the central government budget in April-May.’ N o t surprisingly, the government i s systematically forced to accumulate payment arrears to public utilities for services to public institutions (Table 2.7). In recent months, teachers’ salaries and 3 In fact, the Belarusian internally imposed ceiling on foreign government debt stands at $2 billion, more than two times the current amount o f foreign debt. 4 In 2001, the interest expenses o n government debt amounted to 0.7 percent o f GDP. However, since the government has no access to foreign financing, it had to repay (on a net basis) an equivalent o f 0.1 percent o f GDP. In the first six months of 2002, the government had to divert for foreign debt amortization 0.4 percent o f GDP, even though it budgeted receiving 0.6 percent o f GDP in new foreign financing in 2002. After drawing down all its deposits carried over from 2001, the SPF received in April-May not only i t s entire annual budget allocation from the central government budget, but also a short-term loan. 17 pension payments were also running behind schedule. The accumulation o f payment arrears i s likely to create pressure for mutual offsets o f those against tax arrears. Thus far, the volume o f offset arrangements has been fairly small (about 5 percent o f government expenditures in most years). But as budget constraints are tightened (including following the planned currency union with Russia), there may be greater pressure to resort to netting and offsets. The experience o f Russia, Ukraine and other CIS countries suggests this should be avoided.6 Table 2.7. Government Expenditure Arrears (in billions o f rubels) 1-Ja 11-02 1-Apr-02 1-A ug-02 Total 312.6 407.2 404.4 olw: central gov. 129.9 120.0 120.0 local gov. 182.7 287.2 284.4 olw: Payment for goods and services 211.8 303.8 308.5 olw municipal services 114.0 187.8 185.4 Subsidies 34.7 37.6 39.4 Transfers to population 32.1 39.9 21.9 Capital goods 34.0 25.9 34.6 Source: Ministry o f Finance. 2.29 A new agreement with Russian gas supplier, Gazprom, promises to place a further strain on the liquidity o f the government. While more than 90 per cent o f all payments for Russian gas have been in the form o f barter, Gazprom i s demanding cash or cash equivalents in the future as a precondition for continuing to supply a substantial quantity o f natural gas (10.2 billion cubic meters) to Belarus at the subsidized internal Russianprice in 2003. 2.30 The Belarus government and i t s financial institutions have very limited access to international financial markets. Even access to domestic sources o f financing is extremely restricted. Also, though relatively small in relation to GDP and government revenues, Belarus government debt i s characterized by extremely short maturity. In this respect, Belarus remains extremely vulnerable to short-term volatilities in financial markets. For example, in Russia offsets undermined the Federal Government tax base, contributing to the 1998 crisis. ’After three unsuccessful auctions on April 16 and 23, when out o f a total nominal offer o f R b l 2 0 billion only Rbl 0.65 billion was sold, the Government had little choice but to resort to direct placements to sell Rbl 38.6 billion worth o f securities (nominal value) between April 23 and M a y 2. The largest placement, for Rbl 15.7 billion o n April 25, had a maturity o f just 18 days, and the two placements o n M a y 2 offered maturities o f 18 and 2 1 days. On M a y 13 the M o F apparently averted an imminent crisis by rolling over the maturing debt into three direct placements with maturities of 168, 218, and 225 days. The MoF’s quite desperate financing situation can also be explained by the withdrawal from the market o f the NBB. In late 2001, the NBB participated in most auctions. This practice has apparently been stopped, or at least suspended, during January-July 2002. 18 Figure 2.3. International Reserves and Exchange Rate Rbl/US$ Percent 2,100 - - 75 I tr. L U 1,800 U II ILII Y III~~UI ts, rhs) 1,500 - 1,200 1 900 - 600 1 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-0 1 Jan-02 May-02 Sep-02 Source; NBB, IMF Staff calculations. 2.31 At the same time, additional sources o f revenue are also quite limited. As seen above, the government already collects a significant share o f national income in taxes and fees and any further expansion o f tax receipts will be difficult to accomplish without risking difficulties in the enterprise sector and the spread o f tax evasion among households and the nascent private sector. The potential source o f additional revenues from privatization o f state enterprises is limited, as the estimated value o f gross assets in Belarus appears to have shrunk significantly in the past decade. Issues in Medium-Term Fiscal Sustainability 2.32 The difficult liquidity position o f the Belarus government, combined with the wider potential claims on the government that are currently unaccounted for in the official budget, suggest significant risks to the government’s fiscal position. The prospect o f lower gas subsidies from Russia, and the need to pay for Russian gas with cash equivalents promises to further complicate an already difficult situation. Government tax receipts are not expected to rise over the medium-term. On the contrary, the already enormous burden o f taxation and other regulations o n Belarusian f i r m s appears to be hindering their ability to compete with their counterparts in Russia, Ukraine, and other transition countries, further feeding into lower profits, liquidity, and, consequently, tax payments. On the expenditure side, assuming financing constraints continue to limit the deficit, the government’s commitment to achieve prescribed wage targets will further undermine capital and infrastructure spending, As shown in Table 2.8, the government’s wage policy will continue to crowd out public capital investment from 10.7 19 percent o f GDP in 1999 to 2.2 percent in 2008.8 A number o f other issues pose serious risks in the medium term. 2.33 Deteriorating enterprise profitability bodes ill for future revenues and the public sector’s net worth. The government’s policy o f real wage increases -- as outlined in the five year plan approved in 2001 (see Chapter 111)-- even if compensated by the growth o f utility tariffs a n d partial liberalization o f prices, could likely result in macroeconomic imbalances due to improper sequencing. Usually, the growth of labor and capital productivity due to microeconomic restructuring and market incentives result in improvement o f enterprise profitability, which then allows for an increase in compensation o f employees. The opposite sequencing could further undermine the profitability o f enterprises. 2.34 The profitability o f the enterprise sector in Belarus has recently declined notably (Figure 2.4). As Russia, Ukraine, and other transition countries continue to improve the climate in their countries for business and investment, and domestic production in these countries picks up, many Belarusian firms are finding it harder to compete. The profits o f enterprises as a share o f GDP declined to 10-1 1 percent of GDP in 2001, from above 30 percent o f GDP ten years ago, and continued to decline rapidly in the first quarter o f 2002. The stock o f inventories o f finished products rose from over 50 percent o f production in late 2000 to close to 70 percent in the first quarter o f 2002 (Figure 2.5); the number o f loss-making enterprises increased to 34 percent in the fourth quarter o f 2001 and a staggering 44.1 percent during the first quarter o f 2002, while the economy-wide profitability o f output f e l l to 5.1 percent in January 2002 before recovering somewhat to 7.4 percent for the entire first quarter o f 2002, down from 9.8 percent in the same period o f 2001, and 15.2 percent in 1999. The value o f losses amounted to an equivalent o f 2.2 percent o f GDP in 2001. The projections o f the medium-term horizon in Table 2.8 are based o n the general budget number and do not take into account the wide variety o f off-budget and quasi-fiscal activities discussed in the previous section. Creating a medium t e r m analysis that accurately captures all off-budget and quasi fiscal activities, i s beyond the scope o f this study. The collection o f systematic information and preparation o f a framework for incorporating these into budget accounts i s an important recommendation o f this study. 20 Figure 2.4. Enterprise profits and “market1’ value (In percent o f GDP) profits estimated “market value” of enterprises: discounted 3-month credit rate 28 - 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Source: Belarus authorities and staff estimates. 2.35 In addition, the depreciation o f enterprise capital reached over 60 percent and much o f the capital stock was obsolete and uncompetitive in international markets. Market-oriented reforms aimed at improving economic efficiency at the enterprise level will inevitably result in a growth o f loss-making enterprises as subsidization is phased out and harder budget constraints are put in place. 2.36 Enterprise debts are mounting. Although overall government debt as a share o f GDP remains relatively low, the balance sheet o f the broadly defined public sector i s very weak and rapidly deteriorating. Belarus state enterprises are not only less and less profitable, and more and more o f them actually lose money, but also their balance sheet net worth i s rapidly declining. According t o t h e o f f c i a l d ata, a s o f A pril 1, 2 002, t h e gross 1iabilities o f B elarus enterprises were valued at Rb19.4 trillion (close to 50 percent o f GDP). O f this amount, almost h a l f (Rbl 4.5 trillion) was overdue, o f which 67 percent was overdue by 3 months or more. Foreign liabilities o f Belarus enterprises amounted to Rbl 1.49 trillion (about 7.5 percent o f GDP) o n April 1, up from 1.39 o n January 1, 2002, o f which Rbl 847 billion was owed to Russian companies. The net liabilities to nonresidents (the difference between liabilities and claims o n nonresidents) amounted to Rbl 8 11.9 billion or about 4 percent o f GDP The rapid growth in debt, especially in the “overdue” debt category, i s very worrying, in particular given the very l o w level o f international reserves. 21 Figure 2.5 Inventories o f finished goods (In percent o f monthly industrial production) 7 60 - 0 1 1 2.37 Energy subsidies JFom Russia are not likely to last long. The Belarusian economy has benefited from significant indirect subsidies from Russia in the form o f relatively cheap gas supplies, and the ability to pay for its imports from Russia and some other CIS countries directly in i t s own exports through barter arrangements. Low-cost gas imports and barter payments relieved some o f the pressure from the government to increase direct and indirect subsidies to domestic producers and households. The agreements signed this past summer with Russia provided temporary relief in the form o f l o w prices for gas, as Belarus pays Russia's domestic price for gas imports from Gazprom (almost 2/3 o f imports o f gas). Tensions mounted in toward the end o f 2002, however, as payment arrears for natural gas continued to increase. Under new arrangements, Belarus will have to pay a higher price for gas consumed over a limit from Gazprom o f 10.2 billion kw in both 2002 and 2003. Furthermore, as a condition for continued subsidization, Gazprom i s demanding cash or cash equivalents and an end to non-payments. The progressive increase o f Russian domestic gas prices will also automatically carry over to Belarus. A rapid increase in Russia's domestic price paid by Belarus to the level o f US$50 per 1000 cubic meters, or about half the price in Western Europe would require an estimated 3.6 percent o f GDP in additional balance o f payments financing. A full deregulation that would bring the internal price o f gas to about $100 per 1000 cubic meters would likely trigger a massive economic crisis, as Belarus would need to spend more than 10 percent o f i t s GDP (or more than three times i t s today's cost) o n gas imports. 22 'c!? " 2 m N 2.38 Vulnerabilities in the banking system may grow. The rapidly declining competitiveness o f the corporate sector i s fully reflected in the Belarus banking sector. According to official data, non-performing loans in the banking sector accounted for at least 2 percent o f GDP in 2001. The planned improvement in bank loan classification methodology and the restructuring o f enterprises are l i k e l y to push this ratio much higher. Should non-performing bank assets double or triple --a quite likely scenario following economic opening to competitive pressures from Russia -- bank re-capitalization would put a significant burden on public finances in an environment o f high interest rates. The interest rate expenditure to cover the additional debt to restructure banks would inevitably crowd-out other public expenditure, such as social transfers and infrastructure investments. 2.39 The large share o f loss-making enterprises bodes i llfor the ability o f banks to collect debts, especially after the inflation rate declines sharply in response to policies oriented at economic stabilization and following the possible introduction o f the Russian ruble. Belarus banks also face a daunting task o f ensuring credible levels o f asset coverage for their foreign-currency denominate liabilities. 2.40 The government’s current action plan is unlikely to bring long-lasting results. I n response to the mounting problems in the enterprise sector that threaten medium-term fiscal sustainability, the government has prepared a Program to Improve the Financial Condition o f the Non-financial Enterprise Sector.’ Although the Program document provides a sound evaluation o f the major impediments to enterprise competitiveness, profitability, and general financial recovery, the Program’s goals and objectives, indicate that the authorities’ main objective i s not so much to improve the financial c ondition o f the enterprise sector, but rather, to “improve the financial- economic indicators o f the enterprises.” As a result, most measures are indicators-oriented. Specifically, the authorities seek improvements in the financial-economic indicators primarily through short-term, mostly administrative, measures, such as: (i) elimination o f over-normative inventories; (ii) reduction o f energy prices to selective, energy-intensive enterprises; (iii) settlement o f past-due obligations through a combination o f debt restructuring, offsets (in particular, vis-&vis the various levels o f the government), provision o f new credits to finance working capital needs; and (iv) implementing energy and raw materials-saving modem technologies and increasing the discipline during the implementation o f the various administrative norms and regulations to reduce the production and marketing costs. 2.41 The Program indicates that the authorities expect that most o f the immediate improvement in the “indicators” will come from cuts in taxes and fees, sales o f excess inventories (made possible by the extension o f the Council o f Ministers Resolution No. 259 to strengthen the position o f Belarus enterprises in the domestic market), debt restructuring, and new bank directed lending. 2.42 The Program, unfortunately, i s silent o n h o w to re-ignite “entrepreneurial development” and improve the “low level o f financial management and marketing,” or “administrative price regulations’’ (although, the l i s t o f goods and services subject to price controls i s to be gradually Adopted by the Council o f Ministers on April, 15, 2002 24 shortened over 2002-2003), despite the identification o f these as major causes o f the “grave financial condition o f enterprises” in the first section o f the Program. A Long-term Problem with Immediate Consequences: The Pension System 2.43 One area where the government i s facing a major fiscal challenge i s the state pension system. The Belarus pension system i s financed o n a pay-as-you-go (PAYGO) basis. Under the PAYGO system, social insurance taxes paid by current workers finance the benefits o f current retirees. In the past, before the government’s new wage policy came into force, the pension system’s cash flow remained positive and pension fund tax receipts were partly used to pay some other, non-pension, benefits, such as benefits for families with children. However, since 2001 the finances o f the system have come under strain. The sharp administrative wage increases put in place over the course o f 2001 pushed pensions higher, while undermining corporate cash flows, profitability, and the ability o f the corporate sector to make the required pension fund contributions. As a result, by the e n d o f the first quarter o f 2002, the Social Protection Fund (SPF) has exhausted its entire surplus that accumulated from previous years. 2.44 Deteriorating demographics and a shrinking labor force, similar to most other countries o f the region, combined with pension arrears and the use o f the pension fund for non-pension related benefits have been the primary source o f troubles for the pension system. The combination o f demographic and e conomic developments in the past decade have pushed the number o f w orkers supporting e ach p ensioner f r o m a bout 2.2 in 1 990 t o 1ess than 1.7 today. However, in the case o f Belarus, the severity o f the problem may increase significantly by the rapid increase in pension benefits that are linked to wage levels and the weakness o f the corporate sector overburdened with too many employees being protected by administrative guarantees o f employment and labor remuneration. 2.45 Notwithstanding the demographic factors, the SPF’s finances would have been in much better shape had i t not been for the rapid increase in the pension benefits vis-&vis labor income. The average pension in Belarus has risen from 32.5 percent o f the average wage and salary in 1994 to almost 42.8 percent in 2001, before declining to 41.6% in 2002. By 2001, the aggregate pension bill had risen to over 25% o f the average wage and salary bill (Figure 2.6). 2.46 N o t surprisingly, the combination o f demographic developments and the relatively strong growth in the average pension have imposed ever rising burden o n the SPF, public finances, and the economy. The estimated pension bill rose from 18.1 percent o f the economies estimated wage and salary bill in 1994 to 27 percent in the first quarter o f 2002. A s a share o f GDP, the pension bill jumped from just 5.6 percent in 1994 to 12.1 percent in the first quarter o f 2002 (Figure 2.7). 25 Figure 2.6. Pension Bill as Percentage o f the Economy’s Wage and Salary Bill 30 - 27 - 24 21 1 - 18 - Sources: Ministry o f Finance, IMF, and B a n k staff estimates. Figure 2.7. Pension Bill as Percentage o f GDP 9 - 8 - 7 - 6 4 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Sources: Ministry of Finance, IMF, and B a n k staff estimates. 2.47 The pressure o f the above factors on the daily cash flow o f the SPF had been fully evidenced by the rapid decline o f the SPF’s reserves in 2002, and the emergence o f periodic delays in pension payments, as discussed in more detail in Box 2.2. 26 Box 2.2: Social Protection Fund Finances in 2002-2003 Social Protection Fund (SPF) finances are being hurt by the increase in pensions benefits and by the growth of social tax arrears, both o f which were triggered by the administrative wage increases in 200 1.The SPF carried forward into the first quarter o f 2002 Rbl 46.7 billion in savings from the previous years. These accumulated balances held in interest earning deposits earned the SPF Rb12 billion in the first quarter. However, by the end o f the first quarter, the SPF reported a negative net cash position o f Rb129.3 billion, as i t s cash flow recorded a deficit o f Rbl 75.9 billion during the first three months o f 2002. SPF’s reserves amounted to 82 percent of monthly expenditures as o f January 1, 2001, 20 percent on January 1, 2002 and just 6 percent on April 1, 2002. SPF’s ability to make pension and benefit payments in 2002 was preserved only through two extraordinary measures: (1) An immediate infusion o f Rbl 76.5 (Rbl 66.5 billion in transfers and an Rbl 10 billion loan) from the Republican govemment budget and (2) a delay, until November 1, o f pension indexation. On the revenue side, social tax contribution arrears have increased to Rbl 118.5 billion on May 1,2002, or by Rbl30 billion during the first four months. It i s unlikely the corporate sector could have delivered all the contributions required by law following the administrative wage increases in 200 1 without resorting to borrowing. The govemment tried to rescue the SPF by requiring that all bank loans to enterprises for wage payments include adequate funding to cover the related social security contributions. On the expenditure side, the SPF finances were undermined in 2002 by a recalculation o f pension benefits in February that led to a 20 percent increase o f average monthly pensions. This added expenditures o f Rbl 34 billion per month (to a total o f Rbl 203 billion per month). The indexation r u l e s required pension benefits to be adjusted for average wage growth. But after nominal wages increased by 10 percent, the govemment was compelled to amend these rules. As a result, pension indexation was pushed back until November 1 despite the fact that CPI rose by 19.2 percent between end-January and end-October, and the frequency of indexation was moved to no more than four times a year. The authorities’ projections o f SPF flows in 2002 and their budget plans for 2003 are likely to be overly rosy for at least three reasons: 0 Strong revenue growth stems from the assumption that the high share o f the wage b i l l in the economy (at 39 percent in 2001, up from 32 percent in 1997) can be maintained in 2002 and 2003. In reality, the nominal wage growth needs to slow down significantly for the corporate sector to return to profitability. 0 I t i s unlikely that employers would be able to pay the full amount o f social taxes due on higher wages. Falling corporate profitability makes further growth in social tax arrears in the reminder o f 2002 and in 2003 almost certain. 0 Pension spending i s s t i l l overly tied to the growth in the average wage. Pensions s t i l l will be adjusted to wages, albeit more cautiously.. Therefore, any further wage growth will fuel growth in pensions. This will undermine both employment and the employers’ ability to pay payroll taxes. 0 Further gains in tax compliance will be difficult to accomplish. The ratio o f social tax revenues to theoretical tax liability (based on average employment, compensation, and 36 percent tax rate) has already increased from an estimated 80 percent in 1998-99 to about 85 percent in 2001, and may in fact be difficult to maintain. 27 Box 2.2: Social Protection Fund Finances in 2002-2003 (Continued) The authorities readily acknowledge in their 2003 SPF budget projections the growing gap between revenues and expenditure. The SPF projects that i t will need Rbl 261.8 billion in transfers from the Republican Budget to support i t s cash flow in 2003. However, at the same time, the SPF tax revenue projections for 2003 seem very optimistic. Tax revenues are expected to grow by 42 percent in nominal terms, a figure that i s somewhat high, given even the government’s own optimistic growth projection of 6 percent and inflation forecast of 18- 25 percent. IMF staff projects that in 2003 the SPF deficit could reach Rbl251 billion, or 0.8 percent o f GDP. Recommendations for Addressing Fiscal Risks 2.48 When Belarus’ full fiscal picture is taken into account, it is clear that the economy i s subject to significant fiscal risks. Some o f these exist as the result o f “sins o f omission” - activities that have a significant bearing on government activity and the budget, but are excluded from any sort o f formal presentation. Other items represent substantial vulnerabilities in the economy that ultimately may come to rest at the feet o f the Government. These include: severe weaknesses in the state enterprise sector, the potential for a significant reduction in the energy subsidies from Russia, deterioration in the health o f the banking system and mounting problems with the pension system. 2.49 While addressing these vulnerabilities will likely go well beyond the budget, it is critical for the government to recognize that the large role o f government and wide range o f quasi-fiscal activities carried out by the government are at the root o f the issues that have been identified in this chapter. Without addressing the size and nature o f government’s activities (both explicit and implicit) it is unlikely that these risks will be successfully addressed. The question to be addressed here is what measures either pertaining directly to the budget, or that have a significant impact on the budget, might be taken to address the risks in the system. They include the following: 2.50 Establish complete information on all $seal risks in a comprehensive Ji-amework, It is impossible to address fiscal risks if the government does not have a framework and clear picture o f the totality o f fiscal risks. This involves a number o f steps: Extend the coverage o f government accounts to include all government activities. This includes incorporation o f the power ministries currently not covered in the budget, Innovation Funds, “own funds o f ministries” and quasi fiscal deficits. M a n y o f the items are currently reported to the Ministry o f Finance or available to the NBB. N o t including them in the budget makes it impossible to get a complete picture o f the fiscal situation and fiscal risks. Benefits provided through tax exemptions and other allowances should also be included as an annex to the budget. Monitor and remove all tax exemptions provided by presidential decree. Monitor closely the operation o f tax free zones and limit their growth. 28 0 Develop a comprehensive framework for monitoring o f all aspects o f direct and contingent liabilities. This includes debt, debt guarantees, other types o f guarantees and the potential costs o f implicit liabilities such as the recapitalization o f the banking system. 0 Develop and publish a comprehensive balance sheet for the government, which measures the net worth o f the government as well as the state-owned enterprises. 2.5 1 The Government should carefully consider its financing, lending and guarantee practices. 0 Beginning with the 2003 fiscal year severely limit (ideally discontinue) the practice o f using NBB emission credits to finance government deficit, government programs (such as the housing program), or for recapitalizing the commercial banks. 0 Discontinue all government lending that i s denominated in currencies other than the rubel. 0 Review and discontinue the practice o f extending government guarantees on loans to enterprises, especially on loans in foreign currency. 0 Discontinue the policy o f directing banks to grant credits to enterprises. 0 Refrain from all nettindoffset arrangements. 2.52 Measures should be taken now to begin topreparefor the reduction in gas subsidies: 0 Accelerate the implementation o f the program for the elimination o f cross-subsidization. 0 Develop a unified methodology for determining utility tariffs (in particular for gas, electricity, and water) to all users at levels justified by the full production costs and market conditions. Discontinue the current practice o f granting selective price discounts to strategically important enterprises to boost their profitability. 2.53 Action should also be taken to support enterprises that are potentially viable: 0 Discontinue the practice o f requiring enterprises to contribute various resources (financial and in-kind) to the annual harvest and similar programs, as discussed in par.2.17). 0 Strengthen implementation o f bankruptcy procedures to ensure that nonviable enterprises do not interfere or compete for resources with firms that are financially healthy. 0 Accelerate privatization and eliminate all impediments to privatization, investment, and foreign capital flows, such as the “Golden Share.” 29 2.54 Addressing pension reform will also be key to Belarus ’ fiscal sustainability: 0 Re-evaluate the pension indexation rules to assure they are appropriate in the current economic climate. 0 Prepare a comprehensive reform program to limit the growth in the number o f pensioners and tighten conditions for eligibility, with the goal o f bringing the state pension system back t o equilibrium in the medium and long term. 0 Discontinue the use o f the pension system to fund unemployment and poverty-related benefits by developing a separate system to support the unemployed and poor. 2.55 These m easures a re wide r anging a n d influence a number o f k ey a reas in t h e e conomy (enterprises, the banking system, the pension system). I t i s also likely that they will impose costs that need to be taken into account in the Government’s overall program o f expenditures as well as changes with respect to the composition o f expenditures. Ultimately, for the Government to be effective it must manage these fiscal risks while at the same time reducing expenditures and making the most effective use o f the resources i t has at its disposal. Chapter I11 and I V provide more detail o n h o w to pursue these objectives. 30 CHAPTER 111. BUDGETARY ALLOCATION AND I T S EFFECTIVENESS Introduction 3.1 Belarus was one o f the wealthiest states o f the former Soviet Union. Now, i t faces the challenge o f using i t s wealth o f human resources and strategic position t o further advance the welfare o f its population. Given the extended role o f the state in the economy, meeting this challenge requires taking a hard look at both what the government does and what outcomes i t obtains for resources expended. The experience o f other transition economies, both positive and negative, stands in the background to provide Belarus with a valuable store o f lessons. Creating a culture o f critically analyzing the role for and efficacy o f public expenditures is the only way to streamline public expenditures - and consequently reduce the tax burden o n productive sectors. Belarus has in place much o f the administrative infrastructure that could, with marginal improvements, support such a culture o f systematically assessing the efficacy o f government action. ‘Public’ Expenditures in the Economy 3.2 In Belarus the scope o f government activity extends well beyond what i s measured in resource flows. Indeed, government activity in the Belarus economy extends far beyond the O E C D conception o f ‘public expenditure’. The Government retains pervasive control throughout all sectors o f the economy, be i t through ownership or direct regulation. Public sector enterprises produce almost 90 percent o f the national output. Ministries exercise control and oversight o f enterprises and ministerial decisions can affect enterprise-level decisions - e.g. o n output, investment, location, social assistance, etc. These controls can even cover private enterprise. Local governments also keep an eye o n the production and behavior o f enterprises under their jurisdiction, since enterprise performance affects tax revenues and hence local budgetary resources. The consequence - i s a system that does not support clearly tracking the relation between resources applied, outputs generated and outcomes achieved. Collection o f such performance o r assessment information i s a precondition for improving efficiency o f public expenditures - while continuing to pursue govemment policy objectives. 3.3 There is much to be accomplished in the reform o f the public sector and public expenditure even within a very gradual approach to reform. There are t w o important areas in which progress can be made. The first area relates to the definition o f the role o f the state in the economy, and the establishment o f a clear demarcation line between public sector activity and the rest o f the economy. This task is complicated by the fact that in Belarus the public sector owns a large percentage o f the productive capacity. Still, proper management requires separation o f the roles o f the state as regulator and as owner. An arms-length relationship needs to be established between the public and enterprise sector. Considerable work would need to be done to improve the governance o f the state enterprise sector, strengthen budget constraints, allow easier entry and exit, and provide greater independence and responsibility to enterprises. Removal o f price controls and elimination o f production guidelines (or “quotas”) would b e an important first step in this direction. 31 3.4 The second area refers to improving the effectiveness o f public expenditure in the areas that remain the direct responsibility o f the state. This requires: (a) aligning public expenditure with strategic development objectives, and (b) seeking the highest efficiency in the use o f public resources. The focus here would be improving the effectiveness o f public resource use in what are typically considered to be areas for public delivery o f services - e.g. social services, health, education. 3.5 The government i s conscious that there is a very direct trade-off involved: resources absorbed by the public sector proper are not available for use in modernizing the productive equipment o f the economy. Without such modernization, i t will be impossible to maintain competitiveness and profitability in productive sectors. This necessarily means that the government will have to rationalize programs and seek improved outcomes from the same relative (if not lower) levels o f public expenditures. What is needed n o w is t o translate this awareness into concrete commitments and results. 3.6 An initial step in this direction is to gain clear understanding o f both h o w the government has been allocating its resources and h o w resources have been applied to accomplish outcomes. This chapter seeks to do this given the available information." While there i s n o 'right' formula for the allocation o f resources across sectors in an economy -- since priority setting and resource allocation decisions are inherently political processes - countries tend to cluster into certain patterns o f government expenditure, based o n economic structure. This chapter compares the situation in Belarus with that o f other countries to better asses the current situation. In doing so, the chapter focuses o n social expenditures (Le. social assistance and protection, health and education) because o f their importance in Belarus. 3.7 In aggregate, social expenditures account for over 50 percent o f public sector expenditure. Improvements in the effectiveness o f social expenditure are important t o address some o f the most critical challenges o f transition, and also t o eventually lowering the fiscal burden o n the productive sectors. This Chapter draws upon on-going Bank work o n these sectors. The results show that there is significant room for improvement, highlighting actions that could be taken in the short-term. The analysis also shows that, although there i s a valuable stock o f information available, significant improvements are needed in the type, quality, use and dissemination o f information. Returns to such improvement efforts w o u l d include: greater government capacity to assess effectiveness o f public sector expenditures; a natural agenda for future reform efforts; and popular support for reform efforts necessary for enhancing efficiency o f public expenditures. 10 A recent report on Chernobyl, already completed and discussed with Government, sought a similar objective. Other previous Bank reports also have analyzed expenditure and presented recommendations. These include: Poverty Assessment (1996), Enterprise Reform (1997), Farm Sector Restructuring (2000), Health Policy Note (2002), and Chemobyl Review (2002) reports. 32 The Allocation o f Budget Expenditures: Economic Classification 3.8 The economic classification o f the budget focuses o n the economic impact o f particular expenditure. I t shows the balance between recurrent (or on-going expenditures) and investment expenditure, which affects a country's capital stock. Within recurrent expenditures, the appropriate balance must be struck between expenditures on wages, goods and services and transfers to others. There i s typically little flexibility with interest expenditures except through tighter management o f government debt. 3.9 Table 3.1 shows the economic classification o f general government expenditures for a variety o f countries or country groups for average expenditure between 1998-2000." As seen in Chapter 1 1, general government expenditure, which averaged 45.5 percent between 1998 and 2000 is high relative to most transition economies. The average for all the CEEs i s 40.9 percent. I t i s similar to the amount spent by the 15 EU countries and all o f the OECD, but almost 10 points o f GDP higher than the shares spent o n the OECD countries excluding Europe. 3.10 Current expenditures c onsist o f expenditures o n goods a n d s ervices (including wages), interest, and subsidies and transfers. At 36.6 percent o f GDP total current expenditures seem to be on par with the CEE average (36.4 percent) and a bit lower than the EU-15 or OECD countries. Relative to other countries, Belarus spends more o f its current resources on other purchases o f goods and services, as well as subsidies and current transfers, and considerably less on interest payments. 3.1 1 Wages.'2 While during the 1998-2000 period wages were not extraordinarily high as a share o f GDP, in recent years the government's policy o f increasing wages to reach specific dollar targets has raised their level to 9.4 percent o f GDP in 2001 (Table 3.2) which makes the Belarus wage bill one o f the highest in the CIS In addition the effect o f the wage increase has not been the same at different levels o f government. At the Republican level, wages and charges grew from 11.4 percent o f total Republican expenditures in 1999 to 17.4 percent in 2001. At the local level wages and charges grew from 30.2 percent o f total local expenditures in 1999 to 37.8 percent o f all expenditures in 2001. This increase in wages, a decision made at a higher level o f government, i s causing compression on all other categories o f spending at the local government level. I' In order to b e able to make comparisons the data used in Tables 3.1 i s drawn from the IMF Government Finance Statistics. Because o f differences in classification between the IMF system and the Belarusian government system their may b e some slight differences between data in these tables and others in this chapter. 12 F o r a detailed discussion o f wage policies and issues see the IMF, Selected Issues, Jan. 4 2002. Section 111. 33 Table 3.2: General Government Expenditures: Economic Classification, 1999-2001 47.6 46.0 46.8 100.0 100.0 36.8 37.0 39.2 77.4 80.6 83.7 17.2 17.3 18.7 36.2 37.6 39.8 7.3 7.6 9.4 15.4 16.6 20.1 9.9 9.7 9.3 20.9 21.0 19.8 0.6 1.4 0.7 1.4 3.1 1.6 0.4 0.6 0.4 0.9 1.3 0.9 0.0 0.1 0.1 0.1 0.2 0.2 0.2 0.1 0.2 0.4 0.3 0.4 18.9 18.9 19.8 39.8 41.2 42.3 0.3 0.1 0.0 0.6 0.2 0.1 10.7 8.3 6.5 22.4 18.2 13.9 6.9 6.5 5.3 14.5 14.1 11.3 3.8 1.9 1.2 7.9 4.1 2.6 0.1 0.6 1.1 0.2 1.2 2.4 21.8 14.6 14.6 100.0 100.0 100.0 14.7 6.8 7.6 67.7 77.4 77.4 6.6 2.7 3.3 30.1 36.3 40.1 2.5 4.2 4.3 11.4 14.2 17.4 4.1 0.8 0.7 18.7 22.0 22.8 0.6 0.6 0.4 2.9 4.4 3.8 0.4 0.1 0.1 1.9 3.2 2.2 0.0 0.1 0.2 0.2 0.4 0.5 0.2 6.7 6.3 0.8 0.7 1 .o 7.6 0.1 0.0 34.7 35.3 33.5 0.3 4.8 3.7 1.2 0.5 0.2 7.0 3.0 2.5 31.9 25.7 19.7 3.3 1.8 1.2 15.0 16.1 13.1 3.7 0.0 0.5 16.9 9.5 6.6 0.1 0.0 0.0 0.4 -0.1 2.9 16.0 11.9 12.8 100.0 100.0 100.0 12.3 10.3 11.0 76.7 71.9 79.2 10.6 4.9 6.1 66.3 62.2 67.9 4.8 5.4 4.9 30.2 29.8 37.8 5.8 0.6 0.0 36.1 32.4 30.1 0.0 1.9 1.8 0.0 3.5 0.1 1.7 0.0 0.0 10.4 11.3 11.3 0.0 3.5 2.8 0.0 0.0 0.0 3.7 3.4 2.8 23.3 21.1 17.3 3.6 0.1 0.0 22.6 20.7 17.3 0.1 0.6 0.6 0.6 0.4 -0.1 0.0 0.0 0.0 0.0 3.5 3.5 9.8 10.5 11.8 100.0 100.0 100.0 9.8 0.1 0.1 100.0 100.0 100.0 0.1 0.0 0.0 1.1 1.3 0.9 0.0 0.1 0.1 0.0 0.0 0.0 0.1 0.0 0.0 1.1 1.3 0.9 0.0 10.4 11.7 0.0 0.0 0.0 9.7 0.0 0.0 98.9 98.7 99.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 I 0.0 0.0 0.0 0.0 0.01 Source: M i n i s t r y o f Finance. 35 3.12 In the social and cultural sphere,13 wages are determined by a wage grid with variations in coefficients depending on agency and seniority. The grid consists o f 27 categories, with each category defined as a multiple o f the “first-grade wage”, ranging from 1 to 7,84.14 Changes in the first grade are determined by discretion and indexation, which automatically affect other grade wages. Since March 1, 2001, the structure o f wages in the “power ministries and state administration” i s determined separately. The Government’s Program o n the Socio Economic Development in Belarus for 2001- 2005 calls for an increase in wages from an average o f $100 per month in mid-2001 to $250 per month by end 2005. Average monthly wage in 2002 was $107. 3.13 In addition to the basic wage, various fringe benefits are available . Total monthly cash benefits may exceed the basic wage by a significant amount (75 percent) for some levels o f the wage grid. Such fringe benefits make it difficult to get accurate information o n the full extent o f employee compensation and may undermine transparency. Both wages and the benefits that go along with them are “protected” items. 3.14 There are a number concerns related to the rapid increase in wages in recent years. The sharp increase in wages has not been underpinned by increases in productivity. Wage increases have therefore put pressure o n the financial position o f enterprises, as reflected in shrinking profitability and concerns about increasing arrears that were discussed in Chapter 1 1. Sharp increases in wages relative to Belarus’ main competitors also do not bode well for competitiveness (see Figure 3.1) In addition, they serve to increase the fiscal pressure o f the budget. Figure 3.1: Belarus and Russia: Real Average Monthly Wage, 1996-2001 I 250 200 - 8 150 E I1 100 50 0 I 1 1996 1997 IS98 1999 2000 2001 Source: IMF l3 The social and cultural sphere includes budget sector and state administration workers, excluding the “power ministries” (defense, security, police, and associated organizations such as the border guards) and state administration. l4 According to the Belarus’ legislation, labor renumeration i s carried out on the basis o f hourly or/and monthly tariff rates. The rates are set in the collective agreements or by employer, and for budget organizations - by the Govemment. From January lst 2003 the tariff rate o f the first grade employees was set at BYR 25,000. Minimum wage i s used as a social guarantee o f the labor renumeration and was set at BYR 40,670 from January lst 2003. From March 1” 2002, some social allowances, ceilings on average wage for setting pensions for some categories, as well as taxes, fines and other payments are calculated using so-called “base rate”, set by the Government. 36 In order to compensate for rising wages, the Government has cut other forms o f expenditure, especially capital expenditure. Arrears with respect to wages and particularly the knock-on effect they have with respect to pensions are causing increasing problems. 3.15 Overall, the practice o f setting large, ad hoc wage increases based on a dollar wage target does not appear to reflect the best approach to wage policy for Belarus. Public wages need to be set in a systematic, transparent process that i s fiscally sustainable and will support efforts to maintain macro stability. A shift to wage changes in line with productivity growth i s essential. 3.16 Purchases o f other goods and sewices averaged 10 percent over 1998-2000, but f e l l slightly in 2001 to 9.3 percent o f GDP. This level i s above most o f the comparator countries in Table 3.1. These expenditures reflect the basic operating costs o f government and are often an item in which economies can be found. From the data in Table 3.2, it i s clear that local governments have significantly reduced expenditures o n other goods and services (from 36.1 percent o f total expenditures in 1999 to 30.1 percent in 2001), whereas for the Republican government they have increased in recent years ( from 18.7 percent o f total expenditures in 1999 to 22.8 percent). In order to preserve efficacy o f expenditures, it i s important to ensure that cuts are not focused o n key material inputs. This i s particularly true at the local level, which bears responsibility for delivery o f critical services. For example, purchases o f such goods as textbooks and medicines are essential to effective services. 3.17 Interest expenditures. As discussed in Chapter 1 1, interest expenditures are very l o w in Belarus relative to those o f other countries (Table 3.1). Most interest i s owed to the NBB and bondholders, and less to external lenders. Taking the l o w level o f interest expenditures into account suggests that public expenditure in Belarus i s even higher compared to other countries. For example, in Table 3.1, Hungary and the EU-15 average come closest to Belarus’ level o f expenditure. But both Hungary and the EU have much higher interest costs (7.1 and 4.2 percent o f GDP, respectively). Considering primary expenditures only (which exclude interest expenditures), suggests that Belarus level o f expenditure i s about 5 points o f GDP higher than all countries in the sample, and i s about 13 percentage points o f GDP higher than in Russia. This i s critical as Belarus approaches integration with Russia as the adjustment required for effective convergence will be substantial. 3.18 Subsidies and Other Current Transfers. Subsidies and other current transfers, averaged 18 percent o f GDP during 1998-2000 and increased to 20 percent o f GDP in 200 1. Such a level i s o n the high end o f intemational experience. Poland and Slovenia had average transfers during the same period that were about 20 percent o f GDP. EU countries averaged subsidies and transfers o f almost 18 percent o f GDP, whereas, that OECD countries excluding continental Europe had transfers and subsidies o f only 11.6 percent o f GDP. Russia’s subsidies are averaged 14.3 percent o f GDP, considerably less than those o f Belarus. 3.19 The bulk o f transfers and subsidies are paid out o f the Social Protection Fund (about 12 percent o f GDP in 2001) and the Republican budget (6.3 percent o f GDP in 2001). About a third o f Republican expenditure goes to this category. Transfers are made at the local level but the magnitude i s smaller (about 2 percent o f GDP and a tenth o f their overall budget). Allocations to transfers and subsidies have also been increasing in recent years. 37 Table 3.3: Subsidies and Transfers. 1999-2001 'otal Subsidies and Current Transfers 18.6 18.8 20.0 which: I f lepublican Budget 'otal Subsidies and Current Transfers 7.6 6.7 6.3 Subsidies 2.1 1.8 1.1 T o public enterprises and organizations 0.6 0.3 0.2 Losses o f enterprises and organizations 0.1 0.1 0.1 Other subsidies 1.4 1.4 0.8 Current Transfers 3.3 2.8 3.1 M u t u a l settlementswiother levelsof gov't. 0.2 0.1 0.2 Housing Construction(to local budgets) 0.1 0.1 0.1 Targeted transfers t o local budgets for maintenance 0.1 0.0 0.0 Support o f administrative and territorial units(loca1) 2.7 2.5 2.5 Transfers t o the Social Protection Fund 0.3 0.1 0.0 Transfers t o M i n s k for functions o f t h e capital 0.0 0.0 0.2 Transfers o n free meals o f schoolchildren 0.0 0.0 0.0 Transfers t o the Population 1.7 1.7 1.9 Pensions and benefits 0.6 0.7 1.0 Scholarships 0.2 0.1 0.2 Non-cash housing subsidies 0.0 0.0 0.0 Other transfers t o the population 0.9 0.9 0.7 Foreign Transfers 0.3 0.3 0.3 .oca1 Budget 'otal Subsidies and Current Transfers 1.7 1.9 1.8 Subsidies 4.3 4.2 4.1 T o public enterprises and organizations 2.1 1.6 1.5 Losses o f enterprises and organizations 1.o 1.o 0.9 Other subsidies 1.1 1.6 1.7 Current Transfers -3.3 -2.7 -3.1 M u t u a l settlementsw/other levelsof gov't. -0.2 -0.1 -0.2 Housing Construction(to local budgets) -0.1 -0.1 -0.1 Targeted transfers t o local budgets for maintenance -0.1 0.0 0.0 Support o f administrative and territorial units(loca1) -2.7 -2.5 -2.5 Transfers t o the Social Protection Fund 0.0 0.0 0.0 Transfers t o M i n s k for fbnctions o f t h e capital 0.0 0.0 -0.2 Transfers o n free meals o f schoolchildren 0.0 0.0 0.0 Transfers t o the Population 0.4 0.4 0.7 Pensions and benefits 0.0 0.0 0.0 Scholarships 0.0 0.0 0.0 Non-cash housing subsidies 0.0 0.0 0.0 Other transfers t o the population 0.4 0.4 0.7 iocial Protection Fund Subsidies and Current Transfers 9.7 10.4 11.8 ource: M i n i s t r y o f Finance a n d SPF. 38 3.20 The largest component of Republican subsidies and transfers (about 50 percent o f the total in 2001) goes to current transfers to other levels o f Government. This includes support o f the administrative and territorial units, mutual settlements with local governments, transfers for housing construction as well as for housing maintenance. In 2001, the City o f Minsk also received a transfer from the Republican government. Current transfers also include transfers to the Social Protection Fund. Transfers to the population are the next largest component o f Republican budgets transfers. These include pensions and benefits, scholarships and other transfers. O f a similar magnitude, are subsidies that the Republican budget provides to support public enterprises and organizations, as well as to cover their losses. “Other subsidies” are a significant portion o f this category. 3.21 While local budgets are the recipients o f significant current transfers from the Republican budget, they also provide significant subsidies in their o w n right. Indeed, the subsidies that they provide to public enterprises - for general support and to cover losses - are at least two times as large as those provided by the Republican level. “Other subsidies” are a significant portion o f local subsidies. Local governments also provide direct transfers to the population, although they are not large relative to subsidies. 3.22 Overall, current subsidies and transfers comprise a significant portion o f the government’s budget (42 percent o f consolidated general government expenditures in 200 1). Given their magnitude, it would be a sensible strategy for Belarus to undertake a detailed analysis o f the full range o f subsidies and transfers, identify those that are truly meeting objectives, and elaborate options for reducing and slimming down the balance that are only partially achieving objectives. As will be discussed below, i t i s important to ensure that subsidies and benefits are focused and well targeted - otherwise the government m a y be spending resources for , at best, limited economic effect. This i s particularly the case with respect to subsidies provided to loss-making enterprises and to public enterprises that are not able to operate o n commercial terms. There i s no economic rationale for continuing such expenditures. 3.23 Capital Expenditures: Relative to other countries, Belarus allocated a very high share o f i t s expenditures to capital investment during the 1998-2000 period (Table 3.1). The average for those three years was 9 percent of GDP, almost three times higher than that o f the EU, OECD, and a number o f other countries including Russia and Ukraine. However, in the past three years, there has been a precipitous decline in capital expenditures in Belarus, from 10.7 percent o f GDP in 1999 to 6.5percent in 2001 (from 22 percent o f total consolidated general expenditures to 14 percent). The adjustment appears to have taken place at both the Republican and local levels in response to increasing wage and transfer requirements. 3.24 Capital investment expenditure goes into construction and major repairs. Capital transfers constitute a range of allocations to other budgets, to public enterprises, to financial institutions and “other transfers.’’ Capital transfers also include an “overseas” component to cover purchases and reconstruction of properties, “other transfers” and “other costs”. What remains unclear from the presentation o f the budget i s the degree to which capital expenditures are truly focused strictly on investment, or whether they include a variety o f the accompanying expenditures o f projects such as wages of the workers and other current transfers that are tied to investment projects. The decline in investment m a y be more precipitous than aggregate data reveal. 39 3.25 Given the blurriness of borders between public and private in Belarus, assessing an appropriate level o f public sector investment is difficult. Typically transition countries reduce the share o f public investment as a share o f GDP. Centrally-planned economies were characterized by exceptionally high levels o f capital spending. After adjustment to initial transition shocks, an increase in total capital expenditures would be expected, with a shift in composition towards a robust public-private mix. Unfortunately, the data give n o evidence o f such a shift in Belarus. 3.26 The structure of total capital investments (public, private and those made by public enterprises) in Figure 3.2 suggests a number o f points First, the share o f government in financing investment i s s t i l l substantial, though decreasing. Second, the share o f foreign financing is extremely low. The official 2003 projection o f an increase in the share o f foreign financing to about 15% o f total capital investment i s based o n an extremely optimistic assumption o f foreign capital inflows o f $412m. Third, extrabudgetary innovation funds play an important role in financing investment. The share o f innovation funds in total capital investment in 2001 was higher than that o f the consolidated budget. Finally, the major contributors are enterprises and organizations. Given that the Belarusian economy i s still dominated by public enterprises, this implies both that public investments (in the broad sense) continue to prevail and are indeed much larger than suggested by the consolidated general budget. Figure 3.2: Total Capital Investment by Major Source o f Financing (percent o f total) Enterprices an( 100% organisations ( i n c l.bank loans) 80% Population 60% 0 Foreign 40% investments 20% Extrabudgetary innovati o n - .- 0% funds 2000 2001 2002 2003f Source: Ministry o f Economy. 3.27 Given the variety o f funding sources for what essentially constitutes public expenditure o n investment, a key question arises as to the process for allocating public investment resources to achieve greatest impact. Processes need to be put into place to ensure that investments made through the budget and through public entities are prioritized according to highest rate o f return. In addition, recurrent costs need to be separated out o f the investment budget, and included in the 40 current component of the budget. Effectiveness o f public capital expenditure will depend on the stringency o f analysis supporting the process for allocating these resources. Official estimates indicate Belarus needs US$37 billion o f investments during 2002-2010 to meet the targets envisaged in the Main Directions o f the Socio-Economic Development o f Belarus till 2010 and the Program o f Socio-Economic Development o f Belarus for 2001-2005 (Le. 5-year plan). Developments in the enterprise sector suggest that increases in investments by enterprises and organizations i s highly unlikely in the short-run, due to worsening financial positions. Under current circumstances, no significant foreign investments will enter Belarus. With increases in wages, subsidies, and transfers, resources available for investment will continue to be compressed. I t i s therefore especially critical to assure that the resources which are allocated to investment meet priority needs and are utilized effectively. Box 3.1: Government Priorities for Capital Expenditure There i s not a clear pattern o f strategic prioritization evident in the Government’s investment program. According to the Public Investment Program for 2002, capital investments are aimed at achieving the following objectives: 9 Continuation o f the construction of the republican social facilities financed from the Republican Budget in 2001; 9 Implementation of the activities within the framework of the program for minimization and mitigation of the Chemobyl impact and implementation of flood-control priority activities at flood-lands of the rivers Goryn and Pripyat; > Support to agricultural and industrial sectors in implementing government targeted programs on food supply, including initial development of individual farms; 9 Govemment’s participation in financing production facilities - mainly those related to export and import substitution and productions employing new and high technologies - through allocation of budget funds on a tender basis with the purpose of attracting the own and borrowed funds o f enterprises; 9 Addressing a number of the nationwide tasks including the tasks stipulated by the instructions of the President and the Government of the Republic of Belarus which cannot be funded from other sources. 3.28 Protected items. An additional aspect o f the economic classification must be taken into account: “protected items.’’ Protected items are expenditure categories that cannot be reduced in the event o f a short-fall in revenues. They include such items as wages and extra-charges, foodstuffs, pharmaceuticals and dressings, along with a variety o f transfers. Table 3.4 suggests that one third o f Republican budget expenditures, and 42 percent o f local expenditures, were devoted to protected items. It is important to make sure that key social goals are not subject to drastic cuts during periods o f revenue shortfalls. However, dedicating such a large share o f public resources to such a wide variety o f expenditures can potentially distort allocation o f resources. Ministries may well seek to maximize protected resources - as opposed to maximizing outcomes. Similarly, resources applied to protected items may not be used as efficiently as possible. Every effort should be made both to evaluate the effectiveness o f protected expenditures in meeting their objectives and to reduce protected expenditures to as l o w a level as possible (in absolute and percentage terms). 41 Table 3.4: Protected Expenditure Items, 1999-2001 Extra charges on wages and salaries 11619 35001 38071 112184 87808 259547 Foodstuffs 12044 27500 33670 75452 89505 134071 Pharmaceuticals and dressing 7802 25270 27365 68760 56111 105219 Transfers to the population 52678 12527 159777 36781 3 19305 128742 including: Pensions and benefits 19089 43 62638 167 168035 426 Scholarships 4743 930 13287 2673 3 1079 5714 Cashless housing subsidies 0 42 0 82 0 228 Other transfers to the population 28846 11511 83852 33859 120191 122374 Total budget expenditures 659296 591067 1723175 1786861 3246150 3350897 ]Percentage o f the arotected items in the total 22 36 27 35 32 42 I Source: Ministry o f Finance. The Allocation o f Budget Expenditures: Functional Classification 3.29 The functional classification o f public expenditure provides an indication o f the allocation o f expenditures across sectors. Table 3.5 shows the functional composition o f total general expenditure compared to other countries. Expenditures in several categories, such as general public services, defense, public order and safety and recreation and culture appear to be in line with those o f other countries. The composition o f Belarus’ expenditure stands out in a few ways. Expenditures o n education and particularly on economic services appear to be relatively high. Expenditure on education in 1998-2000 averaged 6.4 percent o f GDP relative to an average o f 5.1 percent in the CEEs and 5.3 percent and 5.5 percent o f GDP in the EU and OECD countries respectively. Expenditure o n economic services is w e l l above that o f other economies and is approximately twice that o f Russia and Ukraine. This reflects the government’s continued involvement in the productive sphere o f the economy, whereas other countries have significantly reduced such expenditures. l5 In order to make comparisons with other countries this table draws on the IMF, GFS database as well as other databases, therefore the categories used are not exactly those reflected in the Government’s functional presentation of its budget that w i l l be discussed below. 42 m d - w y v v i w m v * o - - r4Pjr.i- 3.30 T w o areas in which Belarus’ expenditure as a share o f GDP appear lower than other countries are in health and in social security and welfare. At 4.6 percent o f GDP, health expenditures are just under the average for CEEs and about 2 percentage points lower than expenditures in Europe and the OECD. They are, however, twice the expenditure o n h ealth s een i n Russia. T he government has s et a n ambitious t arget o f expenditure on health reaching 7.5 to 8 percent o f GDP by 2005. Such an increase would take Belarus’ public expenditure on health well above that o f most countries. Therefore while some increase could potentially be warranted, an increase o f the magnitude proposed b y t h e govemment’s program may not b e necessary. For social s ecurity a n d welfare, at 11.1 percent of GDP, Belarus’ expenditure o n in a middling range. The highest share o f GDP devoted to these expenditures i s in Poland at 19.2 percent o f GDP. The lowest i s at 9.1 percent o f GDP in Russia. 3.3 1 In a more detailed presentation o f the composition o f general public expenditure in the last few years, it becomes clear that as a share o f total expenditures, expenditure o n social security and welfare has increased from 26.6 percent in 1999 to 32.4 percent o f total expenditure in 2002 (Table 3.6). This is at least in part due to the knock-on effect o f the increase in wages o n social protection payments. The table also shows that expenditures o n economic services has also fallen as a share o f total expenditures. Table 3.6: General Government Expenditure as a Share o f Total Expenditure (percent) Defense 2.1 2.1 2.3 2.2 Education 13.0 13.4 13.8 14.9 Health 10.5 10.9 10.9 10.9 Social Policy & Welfare 26.6 28.3 31.4 32.4 Housing & Utilities 5.7 5.9 5.6 5.3 Industry 2.4 1.7 1.5 1.3 Agriculture 5.6 9.1 7.8 6.4 Infrastructure 7.2 6.5 6.2 5.9 Conservation 1.3 1.3 1.5 1.9 Culture 1.4 1.5 1.5 1.5 Economic Services 10.8 5 .O 4.1 5.1 Other 6.5 7.3 6.0 5.5 Total General Expenditure 100 100 100 100 Total General Expenditure 1,432 4,190 8,039 11,655 I(in billions o f rubles) Source: Ministry o f Finance, WB Staff calculations 3.32 I t i s clear from Table 3.6 that expenditures o n education, health, and social policy and welfare come to over 50 percent o f total general expenditures. They have increased from 50.1 percent o f the total in 1999 to 58.2 percent in 2002. 44 Assessing Public Expenditures: Principles 3.33 While comparative analysis o f economic and functional budgetary allocation i s useful for observing expenditure trends and patterns, it cannot answer the most significant question, which is performance-related. A r e the allocation and subsequent use of resources achieving desired outcomes for the least cost possible (Le. efficiently)? The question that clearly arises in Belarus is whether, given the large allocation o f resources that are provided to the social sectors, the government is achieving its objectives and providing services effectively. 3.34 Considerable progress has been made, over the last twenty years, in understanding how to analyze public budget processes and assess performance o f public sector expenditures. There is widely shared understanding, at this point, that governments are not restricted to traditional expost program evaluation (which i s very costly) in order to gauge whether public resources are achieving desired outcomes - and at the least cost possible. Current understanding i s based o n a clear set o f principles, that must be systematically applied in order to show results. This section reviews these principles, and the following section uses them to review social expenditures, based on the information currently available. 3.35 Strategic planning. In order to meaningfully assess performance, governments need to k n o w in very specific terms what results or outcomes they are trying to achieve - both in aggregate for the country, as well as in more detail in individual sectors. Formal articulation o f goals i s essential, typically requiring input from relevant constituencies. The question o f goals, as well as the question o f means o f achieving goals must both be asked. Once goals in terms o f outcomes are specified, the question regarding options for getting there - and the relative costs associated with different alternatives - drives decisions o n resource allocation. Taking the health sector as an example, the first-order question i s what are the goals in the health sector? The strategic objective might be to achieve or maintain a healthy population. I t i s not a meaningful objective to spend ‘x’ percent o f public resources o n public health, as it would be possible to devote substantial resources to the health sector, and not achieve the strategic objective - e.g. by not serving the neediest segment o f the population, by over-building hospitals and under-building clinics. 3.36 Performance measurement. A necessary complement to a strategy i s an adequate mechanism for collecting relevant performance information. In the ‘best case scenario’, this entails a robust set o f outcome indicators and performance measurement instruments for tracking progress - that are used throughout the public budgeting process. At a minimum, governments must specify h o w they will measure and track progress in meeting specified goals. For example, if the objective in the health sector i s to achieve a healthy population, outcome indicators such as life expectancy and malnutrition might be tracked. Alternatively, if the objective i s to maintain a healthy population, the incidence of infectious disease and maternal mortality might be used as outcome indicators. Definition o f selected outcome indicators must b e coupled with capacity to collect, verify and interpret data. 45 3.37 Connecting resource decisions with desired results. Having a goal, and even a set o f measures or ‘indicators,’ i s not enough. Outcome information must b e combined with resource use information, in order to allow meaningful performance assessment. If a country i s moving towards i t s health objective, but spending much more o n health than another country with equal progress, this is important performance information. A recent survey o f 27 OECD countries indicated that three-fourths o f them routinely show performance information in budget documentation. 3.38 Using performance information for allocation o f public resources implies knowledge - as opposed to conjecture - about the connection between application o f a marginal level o f resources, and a marginal level o f results. There are at least t w o subcomponents o f this process. First, appropriate measures o f cost must be available - i.e. governments need to know how much inputs cost, and what production options are available for combining inputs to produce a unit o f government output. Second, there must be capacity to gauge the relative contribution o f government outputs to the achievement o f desired results - i.e. the connection between o u w and outcome (or result). In the health sector, patient hospital days are outputs. Patient health is the outcome. Those managing public resources must be able to monitor the relation between levels o f resources expended and levels o f results achieved. This understanding i s the core o f the intensifyingintemational focus o n assessing development results. 3.39 The combination o f clear objectives, performance indicators and an understanding o f the l i n k s between expenditures and results, enables government to improve the allocation o f resources among competing objectives (e.g. health versus education versus transportation). However, in order for a government to really make best use o f performance information in allocating (and monitoring) public resources, certain pre- requisites must be in place, such as: adherence to the r u l e o f law, adherence to an agreed- upon budget, political commitment to effective resource use, accessibility o f transparent information, a functioning accounting system, as w e l l as developed capacity for audit and evaluation. Information o n the relation between resources and results i s always valuable. However, expectations about reform efforts to include performance information in allocation o f public resources need to b e tempered in countries without the basic prerequisites. Performance o f Social Expenditures 3.40 This section takes stock of components and impact o f social expenditure in Belarus. As seen above, social expenditures are currently running at about 60 percent o f total expenditures and a considerable portion o f GDP. This share i s larger if other non-budget expenditures are included. Social expenditures have been on the increase (as seen between 2001 and 2002 in Table 3.6). The picture that emerges by combining these data with sector outcomes i s that the country needs to sharpen the objectives o f social expenditure, and seek efficiencies in implementation, as currently these expenditures are highly dispersed and may mask inefficiencies. Belarus has not yet made the transition to a market economy, and the country i s likely to face additional tasks to protect the most 46 vulnerable in the future, which would imply higher levels o f public expenditures that the country can hardly afford. To prepare the country for the times to come, it would appear reasonable to streamline and sharpen the focus o f current social expenditure. 3.41 Poverty in Belarus. A simple way o f assessing the impact o f social expenditures i s to inquire about the poverty situation in a given country. The picture o n poverty in Belarus is ambiguous. - By I I international standards, poverty is Box 3.2: Millennium Development Goals in Belarus low, and the country appears to perfom strongly on the Statistics in Belarus reflect that several o f the key MDGs have largely been met. T h i s includes fulfilling targets under the 2nd, 3rd, 4'h and 5'h Millennium Development Goals goals, (see Box 3*2)* this may not Goal 1. Eradicate extreme poverty and hunger be a relevant standard, at least not Goal 2. Achieve universal primary education relevant to the government and Goal 3. Promote gender equality and empower women Goal 4. Reduce child mortality the popu1ation* I n the Goal 5. Improve matemal health government has set itself higher Goal 6. Combat HIV/AIDS, malaria and other diseases goals and criteria to evaluate the Goal 7. Ensure environmental sustainability However, there appears to be some deterioration in health Of the popu1ationy than indicators over time (life expectancy, diabetes). those that arise from international 3.42 By domestic standards, the poverty rate has been relatively high at least on an episodic basis. Thus, while in 1998, less than 2% o f the population fell under the international poverty line o f less than US$2 per day (WDR 2002), and the PPP value o f GNI was US$7,550 per capita, according to Belarusian criteria, 42% o f population f e l l under the poverty l i n e at some point over the course o f the year in 2000. In 2001, the poverty survey e stimated that o verall, 2 8.9% o f t he p opulation f e l l b elow t h e national minimum standard o f living (monthly average, disposable resources per family member). ' 3.43 Even if the poverty experienced i s only temporary and the domestic poverty threshold is too high, these numbers reflect substantial economic vulnerability in the population. That is, small changes in the levels o f income can drive a significant percentage o f the population below the poverty threshold. This level o f vulnerability is worrisome, given the economic challenges to which Belarus i s currently exposed. Further, there i s significant spatial variation in the poverty picture. For example, the 2001 figure o f national average o f population falling below the minimum standard o f living (Le. 28.9%) disaggregated between Minsk City and rural areas comes out to 13.0% and 33.6%, respectively. 3.44 Indicators of decreasing health o f the population, fertility, and relatively high incidences o f at least transitory poverty reflect an ample scope for effective Government action. In the present circumstances, it i s fair to ask why high levels o f current l6The significant disparity in rates between the two years i s l i k e l y to b e at least partially attributable to the wage and pension increase mandated at end- 2001. 47 expenditure have not yielded more visible reductions in economic vulnerability. T o better understand the relation between the relatively high incidence o f poverty and the current expenditure system, i t helps to examine various expenditure programs more closely. The objective i s not to understand sectors, but to understand the practical relation in Belarus between public sector resource allocations and outcomes achieved. Social Assistance and Social Security Expenditures 3.45 I t i s apparent through budget allocations that the Government o f Belarus places a high priority o n protecting incomes of, and social services for, the populace. What i s not clear i s whether there is congruence between the volume o f resources expended and the outcome achieved. Social assistance and social security expenditures in Belarus are financed inside and outside the budget. The Budget includes a chapter o n social policy and a large percentage o f the expenditures to mitigate the effects o f Chemobyl go f o r social benefits. Outside the consolidated Republican budget, there are the SPF, tax benefits mandated by law, and social expenditures carried out by enterprises. Overall this i s a highly extended system o f benefits. 3.46 The most striking characteristic o f the current system o f social protection i s that i t covers a broad percentage o f the population. The extensive system o f implicit and explicit benefits provides the majority o f the population with access to a wide range o f cash and in-kind ‘privileges’. The system includes about 300 types o f various benefits, applied to defined categories o f citizens at varying rates. The system i s archaic, opaque and inefficient - both in administration and outcome. Table 3.7 shows estimates o f the transfers to the population as a percentage o f disposable resources, using results from household surveys. These estimates show that in 1999 this ratio was roughly similar for all the income quintiles in the population. The situation continued to be virtually the same in 2001. The results from the household survey confirm the presumption that the overall system o f social assistance and protection is not w e l l targeted. T a b l e 3.7: Transfers to the Population, as a Share o f Disposable Resources (by income quintile o f population) Lowest Second Third Fourth Fifth 1999 2.1 2.5 2.5 2.6 2.0 I 2001 2.0 2.2 2.7 2.9 2.6 I Source: Minstat. 3.47 Other sources confirm this result. Over 4 m i l l i o n people (or more then 40% o f total population - and according to some estimates this share i s substantially higher, up to 90%) are recipients o f various benefits, subsidies and privileges. Estimation o f the costs o f privileges i s a complicated task, and a clear accounting i s simply not possible under current systems. Privileges - both direct and tax expenditure - are pervasive. Actual direct spending on the whole range o f privileges provided outside the budget appears to be on the order o f between 2% and 3% GDP. However, a full estimate would need to take into account additional costs: abuses and inefficiencies arising in connection with 48 providing the benefit, tendencies to over-consume the good, or under-supply it (or to worsen the quality o f good or service). 3.48 In 2001, on Box 3.3: Targeting Social Assistance average, “social benefits” (including Experience with reform o f social assistance and broader benefits (Le. pensions) represented privileges) in the Former Soviet and other Eastern European countries i s 25% o f average family instructive. cash income. The The challenge o f rationalizing social protection expenditures figure reached 35% in remains huge. For this, benefits must be adjusted to affordable rural areas. Aside levels and strictly limited to target groups, while aiming to from spatial biases, the minimize errors o f inclusion and exclusion. Even in these poorer distribution o f social economies, targeting o f cash benefits can be achieved through benefits (excluding several instruments, including through life-line tariffs, s e l f selection approaches, geographic and community targeting, as well as pensions) are clearly through indicators o f income or income proxies. De- not equitable - institutionalization in some instances, where family and community although there has support structures are intact, may also be beneficial. Ultimately, been some slight cost efficiency measures w i l l help but not overcome the problem of leveling of the under-finding, which must be redressed through reallocation of public funds. discrepancy over the past three years. Reform o f social protection schemes often provokes political opposition. Flattening o f social benefits, for example, i s often seen as unfair by those who have contributed more from their incomes to 3.49 N o t only i s the the consolidated fund, as Georgia’s recent experience has shown. present system Hence, managing the political opposition, and maintaining adequate untargeted, but the- support to politically sensitive schemes, i s a constraint that many well-to-do receive far governments in the region face. Governments w i l l need to more than the poor in strengthen technical capacity for actuarial forecasts o f pension expenditures and revenues, auditing o f pension funds, and analysis absolute terms. Hence, o f fund collection problems in order to reduce the risks o f faulty if the objective o f the design and weak implementation. social assistance has Taken from: A Decade o f Fiscal Transition (Asad A l a m & M a r k been to help the needy Sundberg, The World Bank, M a y 2002). See also Poverty Correlates on a priority basis, the and Indicator-Based Targeting in Eastern Europe and the Former Soviet present system i s not Union ( Christiaan Grootaert & Je anine Braithwaite, The World Bank, meeting that goal. July 1998) for more detailed discussion o f targeting. Intemational experience shows that social protection systems, in order to b e both financially viable and actually cushion the effects o f transition on poor households, must b e targeted to the most vulnerable groups, 3.50 Another characteristic o f the present system is the dispersion o f social privileges into m any p rograms a n d 1egal p rovisions. T his approach d istorts expenditure p attems and confounds the analysis o f public expenditure efficiency, because accounting o f these items i s not transparent. To improve transparency, it i s necessary to classify and group the privileges by type and then decide on the scope o f the privileges and the method o f targeting. Experience o f other transition economies shows that a broad range of n some cases although the overall privileges can be eliminated with very little difficulty. I 49 level o f benefits (and costs to the government) may be high, the privileges themselves represent a small amount for the individualshouseholds. 3.5 1 T w o tasks would then appear to be a priority: grouping o f privileges and targeting. The World Bank has been in dialogue with the government for several years o n the need to improve efficiency in the delivery o f assistance to the population. The Ministry o f Labor and Social Protection has piloted a program for targeting benefits (Unified Targeted Social Assistance Program pilot). N o system o f targeting i s perfect. There can be errors o f both inclusion and exclusion - covering too many or missing legitimate beneficiaries. However, as long as administrative overhead in the system i s not excessive, introduction o f any mechanism for moving away from universal coverage i s likely to reduce expenditure burden and substantially increase efficiency o f social assistance expenditures in Belarus. 3.52 Social expenditures o f enterprises. Most SOEs, and even some transfonned enterprises, have retained their social sphere (kindergartens, summer camps, polyclinics, etc.). Social expenditures o f enterprises fell only marginally - from 2.5% GDP in 1999 to 2.1% GDP in 2001 ( see also paragraph 2.17). Given the importance o f social assistance expenditures, the degree to which these expenditures are effective has a significant impact on overall government efficiency. Although the Belarusian Government started to transfer these expenditures from enterprises to the local governments, the process i s slow and far from complete. 3.53 Managing the social impact o f transition. In most o f transition economies (especially CEEs) the restructuring o f enterprises has generated increases in unemployment, in tum requiring an increase in public spending o n unemployment benefits and various active labor market schemes. Given the limited restructuring o f enterprises in Belarus, the share o f expenditures for unemployment benefits accounted for a negligible share o f total expenditures (less than 0.5%). Registered unemployment i s l o w (2.3% o f economically active population in 2001 and 3.0% as o f end- 2OO2).” 3.54 However, i t i s likely that Belarus will have to face such challenges in the future. SOEs restructuring may mean shedding o f excess labor and direct social expenditures. In order to avoid significant levels o f social dislocation, an orderly system for shifting delivery patterns o f social services would be required. The net result for the public budget would be a more transparent accounting for resources spent o n social policy expenditures. Unemployment benefits and related expenses would increase. 3.55 Tax Benefits. Direct benefits to individuals are only part o f the system. There are a range o f indirect or implicit benefits and privileges, that while not directly social assistance, do play a role in the unfocused nature o f the system. Tax exemptions and similar privileges include privileges and exemptions o n customs duties, tax exemptions 17 Even given the limited reform in the Belarusian economy, it i s possible that t h s figure understates actual unemployment. Individuals have little incentive t o register, as the procedure i s cumbersome and the level o f unemployment benefits i s low. F o r example, a n average size o f unemployment benefit per person accounted t o 6% o f average monthly wage in the economy in December 2001 and about 9% at end- 2002. 50 and privileges for legal entities and individuals, granting o f postponing for payments o f tax arrears to the budget (often, by Presidential Decree), granting o f tax credits, arrears o n budget loans. The cost o f these type o f privileges in 2001 accounted to Rbl415.5 bn, or 2.4% GDP. 3.56 There appears to be movement towards rationalizing the system o f privileges - largely because o f economic relations with Russia. T w o steps have recently been taken which imply some degree o f commitment to controlling the growth o f non-transparent social support transfers. First, Presidential Decree #207 from April 15‘h 2002 rules that financial support to individual enterprises will be provided through budget subsidies. Although this does not imply that there i s a move to increase efficiency in use o f public resources, i t does imply that compared to the granting o f individual tax exemptions and other privileges, the process likely to become more transparent. Second, Presidential Edict #11 from April 19‘h 2002 revokes individual privileges (tax, charges, customs duties) to legal entities and sole-traders. Revocation o f the individual privileges was a precondition for introduction o f Russian tariffs for energy resources and cargo transportation in Belarusian temtory (effective M a y 1,2002). However, the same Edict not only revokes individual privileges but also sets the conditions and procedures under which these individual privileges can be granted. Given the extensive dependence on privileges within the economic structure, it remains to b e seen how revocation will play out in practice. 3.57 Chernobyl Expenditures. Within the total estimated “direct” costs o f providing social privileges, the share o f privileges granted to the Chemobyl-affected population in total costs i s the highest - about 31% o f total in 2001. This i s followed by the costs o f subsidized rent and utilities tariffs (18.8%), free or discounted travel services (16.5%), privileges granted to interior services (12.7%), privileges in education sector (1 1.4%) and supply o f medicine free o f charge or at discounted price (7.2%). Although a special subset o f social assistance expenditures, the Chemobyl system o f benefits offers a good illustration o f the complexities and distortions prevailing in social expenditures in Belarus, as well as the degree to which the system can be made more effective by improved targeting. 3.58 The Chemobyl nuclear accident had dramatic human and ecological consequences for Belarus. I t also imposed a significant financial burden on the country. Although Chemobyl expenditures declined over the 1993-2001 period, in absolute and relative terms, they s t i l l take a substantial part o f public resources. The recently-prepared Chemobyl Study showed that budgetary resources spent on Chemobyl-related activities in general, and on providing various social privileges to Chemobyl-affected people has been used ineffectively. 51 3.59 Most o f C hemobyl expenditures are financed from t h e republican budget b y t a x revenues from the earmarked emergency payroll tax” (about 70% o f total expenditures) and by allocations from different lines o f republican and local budgets (such as “prevention and liquidation of emergency situations and natural calamities” (over 95% o f this budget line), budgets o f Ministries o f health and education, etc.). The share o f Chemobyl-related expenditures in total budget consolidated republican and local expenditures fell from 16% in 1993 to 6.1% in 2002. 3.60 The system o f social benefits and privileges granted for “Chemobyl victims” i s extremely complex. I t includes more than 160 types o f benefits with different levels o f entitlements depending on factors such as the degree o f exposure to radiation, disability, area o f residence, etc. In addition, i t also includes a wide range o f special privileges for various categories o f recipients. More than 20 categories o f benefits have less than 10 recipients. 3.61 Chemobyl expenditures fall into the following three major categories: (i) Capital expenditures (resettlement, housing construction, construction o f educational and health facilities in affected areas, etc.); (ii) Social expenditures (various benefits and privileges for Chemobyl victims envisaged by the special Law: health recuperation, free meals for children, free medicine, etc.); (iii)Expenditures for special targeted activities and programs (production o f clean food, research and information, decontamination o f environment, waste disposal, etc.). 3.62 Between 1994 and 2001 the mix o f resource distribution across these three major categories changed. The share o f capital expenditures fell from 56.4% to 18.4%, and the shares o f social expenditures and expenditures for special programs increased from 38.2% to 64.1% and from 5.4% to 17.5% respectively. For 2002 further reduction in the share o f capital expenditures i s planned - to 14.4%. In addition, marginal reduction in the share o f social expenditures i s planned (to 62.2%). There i s to be a corresponding increase in the share o f expenditures for special programs - t o 23.4%. 3.63 A review o f social protection measures for Chemobyl victims confirms that many entitlements are not related to actual impacts o f radiation o n health. Rather, they are primarily s ocio-economic in n ature. B enefits a re distributed even t o those w h o w ere exposed to l o w levels o f radiation, or who continue living in relatively mildly contaminated locations. This reality highlights a key source o f distortion and inefficiency in social expenditures in Belarus. M a n y o f the poor or most vulnerable receive no support, while others have access to multiple programs. In many, especially remote, areas, the poor may not be familiar with the scheme or do not receive any entitlements 18 The tax was set at 18% o f the payroll fund, but lately had been reduced t o 4%. In ABL 2002, it h a d been fbrther reduced t o 3.75%. This tax represents a burden o n enterprises, increasing their costs and hence worsening their competitiveness. 52 since transport costs might exceed the amount o f assistance. The net result is that significant expenditures are made - but the intended outcome i s not achieved. 3.64 Special Programs in the Chemobyl area cover various activities, and as noted above, consume an increasing share o f the total Chemobyl-related expenditures. The most important activities are special agricultural protective measures, removal of contaminated radioactive materials, burial o f waste, and research. In 2000 they accounted to 29%, 16.8% and l6.2%, respectively, o f total expenditures for special programs. In 2001, the major emphasis was o n special agricultural programs, which alone took over 80% o f total expenditures for special programs. While the programs are viewed by the government as important, and are based on extensive scientific research, there i s n o economic assessment o f the efficiency o f these programs. Given the increasing share o f resources devoted to these special agricultural programs, an efficiency analysis and monitoring are necessary o f existing programs, as well as appraisal o f new programs before their launching and implementation. 3.65 Belarus spends a considerable amount of resources o n social assistance and social security programs and experience suggests that these resources are not being used as effectively as they might. The wide dispersion o f programs both direct and indirect pursue just as wide a variety o f objectives, making i t hard to identify the overall objectives o f the various programs and their effectiveness. What i s clear i s that programs to date have not been terribly effective at reaching the poorest o f the population and, to the contrary, have been allocated to the benefit o f the broad range o f society. 3.66 In order to assure that the resources allocated to social assistance i s effectively used a few k e y steps are required: 0 Objectives o f the system o f social assistance and social protection must be identified. 0 Programs must be reduced and organized around meeting those objectives. Privileges must be reduced and assistance must be better targeted. 0 Efforts need to be made to measure and monitor outcomes o f the programs, in addition to the allocation o f resources. 0 Regular assessments are required o f programs to assure that they are meeting objectives and to understand the link between use o f resources and successful programs. 0 Resources should be focused o n those programs that are demonstrably meeting objectives. Health 3.67 Historically, the levels o f health care services publicly-delivered in Belarus have been w e l l above a ‘minimum b asket’. T he c ountry inherited a n extensive n etwork o f healthcare, and a population in relatively good health. However, a significant deterioration in health status has occurred. The population i s declining, avoidable mortality and morbidity are considered to b e high, there i s a high incidence o f 53 cardiovascular disease, and there are emergent epidemics o f TB and STD.19 The health status o f the population i s an issue o f great sensitivity in Belarus. There are three factors which contribute: self-perceptions associated with the reputation for quality o f life acquired during the Soviet years; the level o f public anxiety about health consequences o f the Chemobyl accident; and social perceptions of emerging epidemics (e.g. HIV/AIDS). The prevailing level of sensitivity makes it difficult to discuss delivery o f health services with an eye to streamlining costs and improving performance in the sector. 3.68 Delivery o f health services in Belarus has historically focused largely o n curative as opposed t o p reventive o r p rimary care, with responsibility distributed a cross 1oca1 a n d national levels. There was an extensive legacy network o f well over 5,000 medical installations - and over 150,000 trained doctors and nurses. However, there were, and remain, significant unevenness in spatial distribution o f medical professionals. The ratio was estimated at 1.3 per 1,000 population in some areas and 7 per 1,000 population in others. 3.69 The prevailing inefficiencies in the Box 3.4: Health Expenditures and Output system were highlighted in the 2001 Measures study - i.e. inadequate primary care base, failure to shift to cost-conscious clinical Per-patient health cost indicators in Belarus are decision-making, and insufficient effort relatively high compared to both OECD and CEE to translate international evidence into countries. Belarusian clinical protocols. Belarus has For example, the average length o f acute care high per-patient cost indicators (see B o x hospital stays in Belarus (1996/97) was 14.6. 3.4). While not surprising in a system The same indicator was 16.3 for Russia, but which i s almost exclusively supply- it was only 12.5 in Latvia, 10.3 and 10.4 in driven, it i s not a situation which Belarus Estonia and Poland (respectively), 9 in the can continue to afford. Czech Republic. It ranged between 5 and 8 for the EU. O Similarly, inpatient care admissions per 100 3.70 Belarus has fairly extensive data people (1998) were 28 for Belarus, 21 for Russia, with the EU average at 18. available on input costs and output units. These are employed in the norms that are Source: Belarus Health Policy Note, World used for sector budgeting. There i s no Bank, 2002 analysis available, however, that links expenditures and outcomes (i.e. performance data). At a more basic level, there are apparently no data that link expenditures and actual (as opposed to normative) outputs. This reflects absence of the habit o f assessing and more formally evaluating resource use. For example, the obvious question - ‘if health expenditures have remained stable as a share o f functional expenditures (Table 3.6, above) why are health outcomes (life expectancy, rate o f communicable disease infections) deteriorating?’ - has apparently not factored in to discussions on health sector budgets. l 9 See Belarus Health Policv Note (2002) for extensive treatment o f sectoral organization and performance issues. 54 3.71 At least a partial answer i s certainly embedded in economic classification o f sectoral expenditures. General public health expenditure, as a percent o f total general expenditures, was 10.5% in 1999, and 10.9% in 2001. While expenditures on health have remained stable, the required expenditures on wages have increased, thereby leaving less in the way o f resources to procure other necessary inputs (See Figure 3.3). Figure 3.3: Expenditures for Wages and Extra Charges on Wages in Health 60 .I..I.____ I I I 50 .. - . - - - ._ ... I . expenditures 1999 2000 2001 ~ 3.72 The level of expenditures translates into just under 5% o f GDP over the last three years. This level is below the government’s target o f 7.5% o f GDP (2005). However, the efficiency justification o f the Program’s target i s not self-evident. N o r does the target shed light o n the government’s strategy for prioritizing across the numerous health challenges facing the population - which would be important for developing a baseline against which to gauge future performance. Regardless o f prioritization within the sector, given findings o f the 2001 study, it i s probable that there would be greater health outcome returns to a focus o n improving efficiency o f resource use within the current allocation than to expansions in the envelope. 3.73 As in other sectors, budgets are set using norms, which has crowded out strategic planning and has l e f t weak incentives for efficiency in the system. Under Decree #1225 (8/10/00), a pilot effort to improve efficiency in delivery o f health services was initiated (in Vitebsk). The Vitebsk pilot was an important step, in that it was designed to improve incentives for efficient delivery o f health services. Its objectives were to test reform approaches in the areas of expanding primary health care (Le. outcome-focused) and reducing dependence o n line-item budgeting (incorporating service utility data in resource allocation). The pilot was to be expanded beyond Vitebsk after the first year. 3.74 It appears that the process o f identifying objectives, assessing performance and testing reform has begun in the health sector through the pilot. Further steps, as outlined in the Health Policy note, are required to improve the effectiveness o f health spending. I t will be particularly important to monitor the impact o f increased wages on service 55 delivery and the ability to secure the other necessary inputs for improving health outcomes. Education 3.75 I t is difficult to assess the quality o f education in Belarus. The completion level o f teachers i s high at all levels o f education. At the same time, there i s no evidence o f the quality o f their knowledge and effectiveness o f pedagogy (Le. outcome data). There i s no interpretable evidence o f the quality o f learning, compared to international standards, as the necessary standardized tests have not been administered in Belarus. 3.76 Belarus, 1ike o ther former S oviet republics and Central-East E uropean countries, traditionally benefited from very high standards in elementary education. The situation i s less favorable in the sphere o f secondary, tertiary and special education. There is much to be done to implement new education methods and equip classes with computers, especially in rural areas. Otherwise, the education gap between various groups o f population (urban-rural, low-income-high income families, etc.) will widen, with negative implications for the society and economy. 3.77 An increase in educational resources in transition economies does not necessarily translate into the creation o f new opportunities for all. Rather, i t could actually increase inequality, especially for those in rural areas, low-income families or those without “connections.” In some countries the educational gap among various youth groups has widened. Belarus needs to guarantee access to quality education (consistent with international standards) to avoid a widening o f the educational gap between Belarusians and their counterparts in OECD, which would have a very negative effect o n technological skills and the potential for economic growth. 3.78 Belarus inherited high levels o f literacy and enrolment from the USSR. In 1999, the UNDP education index2’ for Belarus was 0.92, which i s marginally higher than the Eastern European and the CIS average (0.91) and comparable to the OECD (0.94). However, in spite o f impressive historical indicators o f education outcomes, the educational system in Belarus i s facing tremendous challenges. They are pervasive, encompassing the system from providing a sustainable system o f facilities through training o f teachers through creating new curriculum to computerizing class-rooms. Restructuring is imperative, in order to provide the population with skills and knowledge essential for a modem market economy. 3.79 In spite o f the development o f a nominal private sector presence in education, the state retains the major role as educational services provider. The state (including through enterprises) i s virtually the sole producer o f primary education services. The same i s true for secondary education. Private sector involvement i s more substantial on tertiary level 2oThis i s one o f the three indices, o n w h i c h UNDP human development index (HDI) i s built. I t is based o n the adult literacy rate and the combined primary, secondary and tertiary gross enrolment ratio 56 o f education. As o f the 2000-2001 academic year, there were 57 (43 state and 14 private) higher educational establishments in Belarus. 3 .SO Education expenditures are financed both from Republican and local budgets. Higher and post-graduate education, as well as special programs, are financed from the Republican b udget. T he b ulk o f expenditures f o r p re-primary, p rimary and secondary education are financed from 1oca1 b udgets. S ome educational establishments have o ff- budget funds, raised from the provision o f paid services (there are 29 types o f such services offered by establishments o f the Ministry o f Education). 3.81 Public expenditures for education in Belarus accounted for 6.4% o f GDP in 1998- 2000 and increased in 2001, which as seen in Table 3.8 i s higher than many other countries. The new L a w on Education adopted in 2002 sets the target o f increase in public expenditures for education to the level o f 10% o f GDP. Notably, decision rules in use for allocation o f public resources within this envelope to various levels o f education services are unclear. 3.82 Data o n the breakdown o f the consolidated budget between the different levels o f education are not available. However, a notional sense o f Belarus’ relative efficiency in the use o f resources can be obtained by Table 3.8: Expenditures per Student using data from international sources as YOGDP per Capita, 1997 on expenditures per student, disaggregated by the level o f education Primary Secondary Tertia in different countries. I t i s not 45,8 28,6 17,7 possible to draw clear relations 835 13,s 17,6 between the rate o f expenditure and 29,6 16,7 service outcome across the various 13 20,8 33,7 levels. For example, given the data in 24,l 34,2 49,2 Table 3.8, i t i s obvious from that 21,9 26,2 43,s Belarus has a very high rate o f 15,8 28,6 2736 expenditures per student at primary 17,9 17,6 30,4 level. I t i s well above that for other 51,3 33,l countries listed. Because o f lack o f 27,8 41,9 performance data available, it i s 14,l 20,6 45,8 unfortunately not possible to make a 16,7 15,9 25,4 complementary comparison on the ISlovak Rep 21,8 9,7 29,3 dimension o f results. Source; WDI 2002, pp86-88. 3.83 Although there are likely to have been some changes since 1997, there i s n o reason to expect that there has been a dramatic reallocation o f the expenditures towards secondary and/or tertiary education. While there i s no intemationally accepted ‘guideline’ for distribution o f total public expenditures between different levels o f education, evidence i s widely accepted that there are greater initial positive extemalities associated with investments i n primary education ( Le. achieving universal 1iteracy and numeracy). From this perspective, the pattem o f expenditures i s not notable. However, given that Belarus (as most countries o f the region) has a highly literate and numerate 57 population - and a pressing need to retool for a modern economy - one would anticipate that the share of public resources being devoted to tertiary and higher education might be more akin to that o f countries committed to transition (e.g. Lithuania, Poland). 3.84 There i s clearly room for efficiency improvements in delivery o f education services. This is true on both the ‘hardware’ and ‘software’ sides. Student-teacher ratios, fixed costs, indicators o f performance as well as effectiveness o f capital stock and investments warrant attention. For example, based on data available for secondary schools, although the pupil-teacher ratio in Belarus is lower than in most other countries, this ratio fell further from 11.9 in 1992 to 10.1 in 2000 (from 15.1 to 12.2 in urban areas and from 7.5 to 6.9 in rural areas.) There may be room for this ratios t o increase through a reallocation o f resources.. Unfortunately, what is not evident from available data i s the interaction o f this factor with educational outcomes - i.e. are students learning, and learning what they need to know? 3.85 Another area o f concern is adequacy o f facilities. Current expenditures represent the bulk o f education expenditures, and their share in total education expenditures o f the consolidated budget increased from 90.6% in 1999 to 93.6% in 2001. I t i s set at 97.3% in 2002. This bias towards current expenditures - increasingly devoted to wages and associated extra charges (see Figure 3.4) - can hardly be viewed as sustainable. Over 50% o f current expenditures o n education were devoted to personnel costs in 1999. This figure has risen to over 70% in 2002. (Other important items o f current expenditures on education are utilities, foodstuffs and transfers to population - a l l part o f the privileges that are not means-tested.) Figure 3.4: Expenditures f o r Wages and Extra Charges on Wages in Education* I I 80 70 60 as % of total 50 expenditures 40 as % of current 30 expenditures ~ l 20 10 ~ 1999 2000 2001 2002” *Actual 1999-200 1, projected for 2002. 3.86 There is little logic evident in distribution o f the l o w level o f resources that are devoted to capital expenditures for education. Given the way that utilities are paid for in Belarus - through a system o f cross-subsidies from sectoral ministries and enterprises - quality o f capital stock (i.e. schools, classrooms) interacts substantially with fixed operating costs. Energy - and budgetary resources - are wasted in heating and lighting 58 poorly designed and maintained facilities. These resources could be used for more direct performance-related purposes, such as books and needed equipment. Given the intention o f the government to eliminate cross-subsidization, the burden o f utilities bills is expected to be ease. However, without elimination o f the inefficiency in the consumption o f utilities, this gain will be short-term. 3.87 Efforts are being made to address inefficiency at the school level. Based o n results o f a pilot in Brest, the Ministry o f Education is taking steps to rationalize the system o f facilities (e.g. consolidating some schools in rural areas).*' At the same time, the World Bank i s working with the govemment on a Social Retrofitting Project (which includes energy retrofitting in schools and medical facilities, as well as technical assistance and training aimed a t reduction o f energy consumption in Belarus' social infrastructure by utilizing up to date methods and equipment, by reviewing and revising energy-related standards, etc.). 3.88 While these measures are important, there are clearly some fundamental flaws in incentives in the system for distributing resources in the education sector that must be addressed. The Ministry o f Education reports great need in the basics for local level education - e.g. facility maintenance, curriculum development. At the same time there i s substantial new capital investment in elaborate facilities at the national university. W h i l e not conclusive in isolation, this dissonance provides one o f many pieces o f evidence that resources for education in Belarus are not yet being distributed with an eye towards performance o f public resources. Allocating Sector Expenditures: Summing Up 3.89 The b r i e f review o f social expenditures shows that there i s a wide range o f opportunities to improve the efficiency o f public expenditures, both in terms o f the allocation o f the resources across sectors as w e l l as application o f resources within sectors. It would appear that Belarus can achieve far greater progress towards strategic objectives (i.e. outcomes, results) for a given level o f resource outlays than it presently does. In order to move in this direction, the government must begin instilling a results focus and culture of performance assessment. Using the principles outlined at the beginning o f the chapter, specific areas for attention are summarized briefly below. 3.90 Strategic Objectives. The current system has evolved as a result o f the amalgamation o f various historical initiatives, each o f which m a y have had its o w n individual justification. The result, as this review clearly shows, i s that the public expenditure system in Belarus lacks a clear statement o f strategic goals. This i s true at both the aggregated national and sectoral levels. Recent reviews o f Chemobyl expenditures provide a good example o f the need to redefine expenditure objectives. This i s directly related to another essential shift in approach highlighted in recent reviews - i.e. the need to move from a benefit approach to an economic development approach in the affected areas. Work o n social assistance also shows that there i s not a clear statement o f 21 Thus, 179 schools in rural areas were closed during the 2000/2001 academic year. 59 objectives covering the multiplicity o f programs and initiatives. Likewise in health, there not clearly stated goals in terms o f outcomes, as opposed to intermediate inputs (i.e. number o f beds, hospital facilities, doctors) that are embodied by norms. Moreover, stakeholders are not customarily involved in developing sector strategies or action plans. 3.91 The government has substantial advice that has been made available to it over the past several years in terms o f options available for improving sectoral efficiency - in the enterprise sector, agriculture, health, social assistance, and Chemobyl. The challenge i s to make the strategic decisions, and carry through despite short-run costs (social, political or economic) that may arise. The practical path is for the government to revisit the ‘plan’, and develop a complement that identifies a very limited set o f outcomes for each sector. Once priorities are defined primarily in terms o f outcomes - reflected in a very limited set o f indicators - i t will be possible for the government to discuss, and follow through on, meaningful cross-sectoral allocations. 3.92 Performance Measurement. The lack o f clear strategic objectives has clearly hindered the development o f sectoral monitoring indicators and related performance information. The country needs to identify outcome measures related to strategic objectives-Le. performance indicators. But this in itself i s not enough. I t i s essential that the government begin: to collect relevant data o n the selected indicators; to develop a baseline against which to judge future performance; and to instill a culture and build capacity for assessing performance across sectors. 3.93 Belarus already has a very active program o f collecting statistics. A next step would be for the government to focus o n taking actions to make - and allocate resources based upon an understanding o f - connections between user preferences, input m i x and cost, and service performance. In addition to assessing the relevance o f sectoral statistics collected, the government should focus o n developing capacity to audit and verify performance data within sectors - both at the ministry and local levels. 3.94 The country, has an abundance o f information regarding expenditures that provides a point o f departure from which to build performance measurement systems. Hence, Belarus i s in an optimal position to begin using performance information in managing sectoral expenditures. This base o f information can b e immediately incorporated into the budget cycle, in a variety o f ways. Substantial retums stand to be captured by any effort, however modest, from relating user input and expenditure plans (at the planning stage) all the way through to assessing and evaluating actual public resource outlays and outcomes (at the execution and evaluation stages). 3.95 Connecting inputs and outputs. Perhaps the greatest handicap to developing a proper understanding o f the l i n k s between inputs and outputs is the use o f norms. Although norms are empirically developed, they do not represented a proper assessment of the relationship between inputs and outputs. The recently completed Chemobyl study made the point that often budgetary allocations are made following certain understanding o f their impact o n reducing radiation intake, but these assumptions are often not tested. 60 Also, although information available about costs, this information i s not use in the selection o f programs. 3.96 What incentives do policy-makers and executing units have for improving performance? While any economic transition meets with resistance from those with vested e conomic interests, o ver t h e m edium t o 1ong-term t h e e conomy a n d p opulation stand to benefit from a more balanced, transparent and strategic use o f resources. As the government begins to make strategic trade-offs, however, i t will be imperative f o r the government to communicate clearly with the population about goals - and progress towards those goals. Public sentiment typically serves as a k e y incentive for policy- makers. Thus, government has an incentive to articulate goals (the rationale behind them) - and transparently demonstrate progress towards those goals through use o f performance data. Developing an explicit communication strategy to share the logic and benefits o f reform with the public - as well as government and enterprise employees particularly - will be critical to success o f any reform. 3.97 At the level o f ministries and local levels, the government might wish to consider financial incentives. Ministries or local levels should be recognized for application o f performance information in resource allocation. For example, some small percentage o f budgetary resources could be reserved to an incentive fund to reward ministries with some nominal budgetary allocation (not for achieving results, just for adopting a results orientation). A lternatively, t h e C ouncil o f Ministers c ould provide 1imited managerial flexibility (freedom from narrowly specified personnel or other rules) to ministries in exchange for their being held accountable for results. Priority Areas for Action 3.98 This chapter has provided a broad overview o f the allocation o f expenditures and its e ffectiveness. A number o f p riorities f o r t h e g overnment’s attention c an b e drawn from the discussion. These include the following: 0 The government i s currently following a wage policy that i s likely to lead to a multitude o f problems. N o t only i s the rapid increase in the level o f wages putting financial pressure o n budget institutions and firms, it i s also quite likely to negatively affect the competitive position o f Belarus relative to its neighbors. Wage increases should be determined in a systematic way that is closely aligned with increases in productivity. They should not be based on a foreign currency target. Getting wages increases under control w i l l also allow for a more effective distribution of inputs in the delivery o f services. 0 Subsidies and transfers from a particularly large part o f the government’s expenditure. Subsidies to public enterprises and especially to loss making firms need to be phased out. Objectives need to be set for transfer programs and the number o f programs rationalized and more effectively grouped. Efforts to f these improve targeting are also critical for improving the effectiveness o expenditures. 61 0 Capital expenditures by the public sector are under pressure due to the rise in wages and in subsidies and transfers. Capital expenditure funded by public enterprises is likely to fall given the financial deterioration these enterprises face. A comprehensive mechanism for evaluating, prioritizing and allocating investment resources should be developed. I t should focus on investments that are critical to the public sector and that w i l l provide the highest social rate of return. 0 A good portion o f expenditures in the budget are protected. While i t i s important to assure that social needs will be met in the event that there are revenues shortfalls the current extent o f protected items in the budget appears excessive. The extent o f protected expenditures distorts the incentives o f budget institutions and reduces the flexibility o f budget management. A careful evaluation o f protected expenditures should be undertaken with an eye to reduce protection to those expenditures that are truly vital. 0 The review o f functional expenditures suggests that the amount o f resources dedicated to economic services may be excessive relative to the experience o f other countries. As Belarus moves forward o n its transformation to an economy integrated with the world, i t will be necessary to reduce the scope o f public sector involvement in economic activities that are not geared towards the provision o f public goods. Over time the involvement o f the public sector in the provision o f economic services should be considerably reduced. 0 The sectoral allocation o f expenditures in Belarus i s heavily oriented towards the social sectors. In principle, there i s n o “correct” sectoral allocation that applies to all countries. Rather what i s needed i s to focus on the effectiveness o f expenditures in terms o f the services delivered and outcome attained through an expenditure allocation. Belarus has until recently paid relatively little attention to the outcomes o f expenditure and virtually none to performance (i.e. assessment o f the effectiveness o f resources use). I n order to move forward in this important area, in each sector the government needs to: i) identifi strategic objectives; ii) develop a system for measuring performance; iii) connect resource allocations with desired outcomes; and iv) create incentives for policy makers to pursue the effective use o f resources. Only then will i t be possible to fully understand the trade-offs in resource allocation between sectors. 3.99 The combination o f clear objectives, performance indicators and an understanding o f the l i n k s between decisions and results, enables government to improve the allocation o f resources among competing ends. However, in order for a govemment to really make best use o f such an approach, certain pre-requisites must be in place, such as: adherence to the rule o f law, adherence to an agreed-upon budget, political commitment to effective resource use, accessibility o f transparent information, a functioning accounting system, as well as developed capacity for audit and evaluation. The fundamental institutions o f budget management are a prerequisite for both effective allocation o f resources and maintenance o f fiscal sustainability. The next chapter turns to a review o f these public budget institutions in Belarus. 62 CHAPTER IV. THE INSTITUTIONS OF THE BUDGET PROCESS Introduction 4.1 The emerging budgetary problems in Belarus have increasingly focused Government’s attention o n crisis management. The consequence has been to create a wedge between the budget as approved and as implemented. Although the government has succeeded in keeping the fiscal deficit under control on a cash basis, the uncertainty that has been introduced for spending agencies, transfer recipients, public employees and contractors i s having a large negative impact o n the budget institutions. At the heart o f the matter there appears to be developing an inconsistency between the capacity o f the productive system to g enerate revenues a n d the e xpenditure plans o f g overnment. The government i s conscious o f the urgency to address such misalignment. The challenge will be h o w address these problems systematically, so as to build up the institutions that sustain the budget process. 4.2 The world has accumulated abundant experience in improving the management o f public moneys over the last decades. These experiences show that budget reforms to improve the quality o f expenditure management take a long time and are best initiated as soon as possible. This experience also sheds light on the different options for institutional budgetary arrangements as well as the sequencing o f reforms. The experience o f the transition economies in this regard has its o w n peculiarities. The role, scope, and size o f the state has been significantly streamlined in these countries. The state has moved from being direct provider to regulator and overseer. N e w concepts, such as accountability and transparency have been introduced, and preliminary efforts have been made in some transition countries to create a tighter link between objectives, budgetary instruments and outcomes. The role o f the Treasury has been strengthened. However, most o f the transition countries operate to varying degrees with a mix o f old and new institutions. Belarus is n o exception. 4.3 This chapter reviews the existing budget processes and institutions in Belarus. The chapter begins with a presentation o f the normative principles o f public expenditure management. The rest o f the chapter looks at each o f these dimensions as n o w practiced in Belarus. Finally, the chapter closes with recommendations to accelerate improvements in the allocation and use o f public moneys. Public Expenditure Management Principles 4.4 Robust budget systems facilitate public expenditure management. Public expenditure management has three overarching and interrelated objectives, which are to ensure that: the government operates within resources reasonably available; resources are allocated across competing national priorities in a clear, deliberative and consistent manner; and once allocated, resources finance only effective and efficiently managed activities. Government budget processes -as w e l l as the budgets themselves - are essentially the tools for ensuring achievement o f the objectives o f public expenditure management. 63 4.5 Fiscal Discipline. As discussed in Chapter 1 1, establishing and maintaining aggregate fiscal discipline helps maintain a solid macroeconomic environment and sets the basis for a sustained rise in incomes. Governments, like households, must “live within their means.” Thus, fiscal deficits are necessarily short-term and the accumulated public sector debt must be kept within reasonable and sustainable limits. In developed market economies, the financial markets impose fiscal discipline. In other environments, countries will have depend more on administrative measures to exercise fiscal discipline. The budget process i s the mechanism through which a country both adheres to aggregate fiscal policy targets, identifies spending priorities and specifies h o w i t will achieve service objectives. 4.6 Allocating Resources Among Competing Ends. By definition, public budgets ration scarce resources across alternative competing uses. The process o f establishing strategic priorities and formulating a budget reflecting those priorities i s necessarily a political process, which has to be supported by a sound institutional underpinning. Such institutional underpinnings must include an effective process for managing the extent and form o f departmental bids and for allocating shares o f total funding across sectors, departments, and spending units. The objectives o f strategic prioritization are to encourage an allocation o f funds that both reflects well-defined government priorities and that channels funds to those programs providing the highest return o n the use o f public funds. Among the institutional features and enforcement mechanisms cited as supporting allocative efficiency are: 0 an effective medium-term fiscal framework that clearly outlines a government’s policy priorities and facilitates a multi-year horizon for financial planning and implementing structural change; 0 comprehensive budget coverage to ensure that tradeoffs between competing demands for funding can be fully considered and accurately assessed; 0 consistent and transparent criteria for assessing the full costs and benefits associated with alternative uses o f public funds (or at least one that explicitly identifies beneficiaries); and 0 a process for establishing policy priorities and compatible allocations that incorporates demand information across a variety o f stakeholders, but also provides an opportunity for top-down enforcement o f sectoral or departmental spending limits (envelopes). 4.7 Technical and Operational Eficiency. H o w to achieve and improve technical efficiency in public expenditure continues to debated. Still, modem approaches to public expenditure management highlight an appropriate balance between managerial autonomy and accountability in the spending agencies. The following are k e y points o f this approach: 0 clear definition o f measurable program outputs; 64 0 flexibility or autonomy on the part o f program managers, allowing for decentralized decision making to determine best inputs to produce expected outputs; 0 predictability in the level o f funding; 0 strict reporting and monitoring o f spending; 0 high quality audits; 0 merit-based recruitment; 0 competitive procurement; and, 0 involvement o f the end-users. Organization 4.8 The chapter i s organized around the key phases o f the budget cycle: preparation, approval, execution and audit and evaluation. Note, however, that the budget cycle phases overlap e.g. preparation o f the budget for coming years i s accomplished during execution o f the current year. Thus, although for analytical purposes, i t makes sense to discuss the phases separately, the various phases o f the budget process are inter-related and progress has to be made across the board. Good preparation i s needed for a successful implementation and a fair implementation o f the budget enhances the credibility o f the preparation process. I t is important to have this in mind, because responsibility for the stages o f the budget process lies with different agencies. A central authority i s needed then to guide the overall process. The experience o f countries with successful fiscal systems shows that a strong fiscal authority i s needed. That authority i s often the Ministry o f Finance. The Legal Framework and Accountability 4.9 The legal framework for, and extent o f coverage of, public budgets define the degree to which it i s possible to achieve effective public expenditure management. The effectiveness o f the legal framework, however, will depend o n appropriate enforcement. Hence, the s ingle m ost important o bjective o f an e ffective 1egal framework f o r p ublic budgets i s to provide for the accountability o f individuals with authority for managing public finances. In order to accomplish this, the prevailing legal framework must set a clear and predictable set o f roles and obligations for those involved in public budgeting - across all phases. Accountability can be encouraged internally and externally (Box 4.1). Internal accountability requires an appropriate balance o f powers across branches o f government as well as across and within government agencies. External accountability, to those outside o f the government structure, requires a high degree o f transparency in all fiscal matters and explicitly outlined arrangements for independent audit. 4.10 The existing legal framework in Belarus i s a combination o f old and new practices. This incomplete legal framework wrests effectiveness from the public budgeting process and prevents full accountability and transparency. The legal framework has to move from being an instrument that records and tracks expenditure to being the main instrument that translates policy objectives into concrete outcomes o n the ground. 65 Box 4.1: Public Budgetingand Accountability In the aggregate national context, there are at least four dimensions on which to assess accountability: financial, administrative, public and political. Robust public budgeting systemically addresses the first three dimensions. Financial accountability i s h l l y addressed through the process o f annual audits conduct according to internationally accepted accounting standards. Audits also at least partially address the issue of administrative accountability - as do evaluation, the structure o f civil service and administrative laws and controls. An important instrument for accountability i s transparency. Hence, public accountability - and efficient use o f resources - i s reinforced by ensuring access to information throughout budget cycles. Government policymakers and service providers need information on demand conditions (i.e. what services in what amounts the public wants) in order to best allocate resources. Similarly, the public - whether individuals, interest groups or private producers - need information on the shape, size and effectiveness o f government finances and programs in order to make rational economic decisions. 4.1 1 The legal framework for budget management in Belarus includes provisions in the Constitution, the Budget System L a w (BLS), the Annual Budget L a w (ABL), the L a w o n Local Government (LGL), and other laws including those governing budget classification, the banking sector, government debt and taxation. These laws address most dimensions o f budget process, but still they are incomplete, particularly in key areas o f transparency, such as audit. 4.12 The government has recognized that there i s a need to complete and streamline the legislative base for public budgeting and is presently considering formulation o f a comprehensive budget code. In doing so, the government faces a trade-off between making short-run improvements in current practice versus composing a ‘best case’ comprehensive budget code. Since changes are always skill intensive - at both technical and legislative levels - and there is a limited pool o f qualified staff available to address aggregate-level public budgeting issues, there is some concern that focusing reform efforts on preparation o f a comprehensive budget code might preclude making much- needed changes immediately. Nevertheless many countries, including Russia and Ukraine, have successfully amended and updated their budget process through the development o f a Budget Code. 4.13 In the interim between existing conditions and enactment o f new comprehensive budget legislation, prevailing legislation o n budget processes could productively be amended to: (i) require the Government to produce a public budget policy statement; (ii) reduce significantly the scope o f off-budget activities and clarify the legal status o f the republican level extra budgetary funds (Social Protection Fund) ; ( iii)expand access to information on fiscal performance to parliament and the public at large; and, (iv) establish a legal basis for an independent external audit agency reporting directly to Parliament. 66 Budget Coverage 4.14 The extent o f budget coverage - i.e. what i s included in the budget versus what i s handled through special funds or is ‘off budget’ - i s important for several reasons. First, it determines the degree to which the budget can function as a tool for maintaining aggregate fiscal discipline. Second, comprehensive budget coverage facilitates resource management and tracking and allows for the tradeoffs between competing demands for funding to b e assessed against consistent criteria. Third, comprehensiveness facilitates transparency and accountability. The scrutiny o f oversight agencies and the general public r educes t h e risk o f imprudent o r undisciplined u se o f p ublic funds. T o e xtend budget comprehensiveness, however, requires removal o f the financial incentives that encourage ministries, budget organizations and lower levels o f government to utilize off- budget funds. 4.15 .Chapter I1 has already identified the public expenditures not included in the budget. The Belarus government must decide either to drop expenditures not in the budget or incorporate them, even if only through the treasury. On the expenditure side, the power ministries should be brought into the budget and the corresponding resources managed through the treasury. Extrabudgetary funds should b e kept at a minimum. Those financed with contributions, like the Pension Fund, may be outside the budget, but they should follow strict accounting and transparency rules, and over time resources (certainly, revenues) should be managed through the treasury. 4.16 The streamlining and potential elimination o f Innovation Funds requires special attention. Today, they are part o f the government’s effort to direct investment to critical sectors o f the economy. I t would be best to replace the mechanism o f Innovation Funds by including the investments they support into the system o f capital grants, or for those allocated to commercial enterprises to strengthen the ability o f the financial sector to respond to investment needs. 4.17 The rules and incentive structures governing fee for services and non-tax revenues derived f r o m t h e entrepreneurial a ctivities o f m inistries s hould b e r eviewed t o remove perverse incentives that may complicate budget management and make difficult the implementation o f hard-budget constraints. The experience o f other transition countries show that spending units when facing a hard budget constraint seek altemative sources o f income to keep the level o f expenditures and postpone reform. This often leads to a distortion o f fee-for services, as the link i s lost between tariffs and costs and equity considerations are not taken into account. T o prevent this from happening, it necessary to enforce clear rules for the calculation o f the fee-for services and to include expected fee collection in the budget, without reducing other allocations proportionally (claw-back.) 4.18 The rules regarding non-tax revenues derived from entrepreneurial activity also provide perverse incentives. The present rule in Belarus i s that the surplus generated by entrepreneurial activities o f the ministry are to be deducted from the allocation to the respective ministry. Not surprisingly, according to the Ministry o f Finance, these activities do not show a surplus, meaning that the present rules induce ministries to use 67 all o f the resources available. This leads to the allocation o f public resources on non- priority expenditures. If spending agencies have the incentive to spend all o f the non-tax revenues under their control, the marginal social benefit o f the use o f these resources m a y be lower than in other activities in the public sector. 4.19 As seen in Chapter 1 1, quasi-fiscal expenditures continue to be present, especially with respect t o the banking system, directed credit and controlled interest rates. These expenditures not only do not go through the budget, but rarely are they carefully accounted for. A first step to address the issue o f quasi-fiscal activities i s to assure that there i s a full accounting o f those activities that have an implicit impact o n the budget so that the sum total o f their effect i s made clear. The second step, i s to eliminate price distortions and to explicitly include in the budget support for targeted groups that m a y need assistance based on their l o w levels o f income. Moreover, a broad effort i s needed to examine the extent o f the contingent liabilities in the Belarus economy and to streamline and tighten the rules that may directly or indirectly be extending public sector guarantees to activities carried out by spending agencies or enterprises outside the purview o f the budget authorities. This issue may b e particularly relevant in the case o f energy debt o f enterprises. 4.20 Lastly, o n the revenue side, there should a policy o f accounting for tax preferences. Tax preferences are in the end expenditure items and they should b e properly accounted for. Also, there should be a strict policy o f not issuing tax preferences, and if tax preferences are given, a proper costing should be made o f the impact o n the budget. Moreover, practices o f targeted exemptions by decree or by fiat are best discontinued (See B o x 4.2). 4.21 The government i s aware o f these problems and recognizes that improvements in the coverage o f the budget are necessary to allow sound fiscal management. Already in 1998 the budget consolidated five targeted funds previously excluded from the budget. In addition, reporting requirements have been strengthened for two o f the largest remaining off-budget funds (Social Protection Fund and Innovation Funds). In fact, since 1 January 2002, the Ministry o f Finance keeps record o f revenues and expenditures received from entrepreneurial activity by the establishments financed from the republican budget; Innovation Funds created by the Republican governing bodies and other state organizations; and the Social Protection Fund. While this information i s collected by the Ministry o f Finance i t i s not fully incorporated into budget planning and into the fiscal system more generally. While the government plans to extend coverage o f the treasury system to include all Republican budget organizations and local budgets i s a positive step, the “power ministries” (Defense and Internal Affairs) remain outside the treasury system, thus continuing to allow only a partial picture. Budget Classification 4.22 The main shift to a Government Finance System (“GFS”) -based system occurred, according to the Ministry o f Finance, in 1997. Thus, the budget analysis would generally be consistent with the GFS analysis. However there are issues that remain in the 68 transition to this system. With respect to the economic classification, much work needs t o be done t o assure that capital expenditure i s fully consistent with those expenditures only spent o n actual investment. The current costs that accompany investment should not be considered as part o f capital expenditure. The functional classification s t i l l uses a broad range o f categories that are not fully in line with GFS categories. Finally, the Belarusian budget continues t o treat privatization o f assets as a source o f revenue rather than as a financing item. Because privatization reflects a change in the assets and liabilities o f the governments and is typically a “one-off receipt” international practice i s t o treat revenues from privatization as a financing item. Box 4.2: International Experience with Covering Tax Expenditures and Contingent Liabilities In addition to direct expenditures, comprehensive budget coverage also necessitates reporting on tax expenditures, quasi-fiscal activities, contingent liabilities and other fiscal risks. Tax Expenditures A growing number o f countries now produce as part o f budget documentation an explicit l i s t o f tax expenditures, Le. legislation or regulations that entail a revenue loss due to the application o f a rate reduction or tax exemption for a specific taxpayer or group o f taxpayers. In France, the list o f tax expenditures i s classified in three different ways, including by the economic nature o f the tax, by the policy objective o f the tax expenditure (e.g. economic development, sectoral support, housing, social policy, or promotion o f savings), and by category o f beneficiary (e.g. households or enterprises). Other countries that produce a comparable listing o f individual tax expenditures include Australia, Austria, Belgium, Brazil, Finland, Germany, Greece, Korea, Portugal, Spain, Sweden and the United States. In Germany, tax expenditures are one component o f a broader “subsidy report” that includes all forms o f support whether they be through tax r e l i e f or direct expenditures. Regular reporting on subsidies, including tax expenditures, encourages ongoing analysis o f their effectiveness and assessment o f whether to continue utilizing such policy instruments. Fiscal Risks and Contingent Liabilities W h i l e revenue estimates and budget baselines, i.e. formal appropriations approved by the legislative body, should strive to incorporate comprehensive and accurate information regarding macroeconomic forecasts and the costs o f spending programs, even the most carefully formulated budgets face sources o f uncertainty. For this reason, some countries have taken the step o f incorporating into budget documentation a formal presentation o f risks around the budget baselines. In Greece, budget documentation includes an assessment of the fiscal impacts attributable to both variations in the macroeconomic outcomes relative to forecasts underlying budget baselines and the realization o f contingent liabilities, i.e. changes in either revenues or expenditures resulting from the occurrence o f specific events or legal decisions. In New Zealand, the legal framework governing public financial management requires the government to produce a listing and description o f individual contingent liabilities as well as policy risks, Le. changes in the amount o f revenue or expenditures resulting from Cabinet approval o f a new or modified policy. Each contingent liability or policy risk above a specific materiality level must be quantified unless the fiscal impact i s highly uncertain or if a sound argument can be made that public disclosure would compromise the government’s financial interests (e.g. in a commercial transaction or contract negotiation process). I Budget Preparation 4.23 Budget preparation encompasses the formulation and eventual presentation o f the budget by the chief executive t o the consideration o f the legislative branch. The process of budget preparation has to be framed within a precise timeline o f critical decision points (the calendar) and clear directions issued by the executivehudget office (budget circular.) 69 The preparation o f the budget itself involves input from individual government agencies (i.e. line agencies) as well as k e y budget institutions (i.e. Ministry o f Economy, budget office). Budget preparation concludes with executive acceptance o f a budget as ready for submission for legislative action. 4.24 T w o elements are k e y t o effective executive budget preparation: forecasting, and the procedures for the allocation o f resources among competing ends. First, reliable forecasting o f revenues and expenditures i s necessary. The revenue forecast i s particularly crucial, as i t sets the context for the expenditure allocation process by establishing the envelope within which expenditure allocations must fit. Second, clarity and reliability in roles and procedures spelled out in budget circulars and calendars, has a critical effect o n the quality o f budget proposed by the chief executive to the legislative body. If budgets do not materialize as expected, or if they are subject to arbitrary revisions, spending agencies will have little incentive to cooperate in improving preparation and work on evaluation. 4.25 Budget preparation requires priority attention today in Belarus on account of:(i) emerging budgetary arrears, meaning that a disconnect has appeared between budget preparatiodplanning and execution, and (ii) t h e very 1imited extent t o w h i c h e ffective results o n the ground are taken into account in budget preparation. 4.26 Budget Calendar & Budget Circular. The budget calendar and budget circular should define the responsibilities o f different actors in the budget process, specifying information to be included in budget requests, and establishing a timetable for producing an effective budget. The budget calendar deadlines must allow sufficient time for macroeconomic and revenue forecasting, priority setting by senior leadership in light o f resource constraints, translation o f policy priorities into indicative spending envelopes, preparation o f budget submissions by spending units, review o f these budget submissions, and consolidation o f a final draft budget document. The budget circular plays an important role in setting out the parameters to be used in the various stages o f the process covered by the calendar. 4.27 Public budgets in Belarus cover the calendar year. The deadline for the submission o f a completed draft budget by the President to the Parliament i s 1 October, and Parliament i s expected to approve the budget before the end o f the year. In recent years, budget circulars have been distributed to ministries and other organizations financed by the Republican budget toward the end o f June, and budget proposals submitted by spending agencies by the mid-July. This timeline left a relatively short period o f time for spending units to prepare their budget submissions. 4.28 Moreover, the existing timeline leaves roughly two months for review, negotiation, and reconciliation o f b udget submissions w ith finalized m acroeconomic and aggregate fiscal constraints, final approval by the CoM and Presidential Administration and preparation o f b udget documents. Negotiations over final allocations incorporated into the draft budget extend well into August and possibly September. Despite the lingering macroeconomic revisions and negotiations, the process has been successful in meeting 70 the 1 October deadline set by the Budget System L a w (BSL) for submission o f the draft budget by the President to the Parliament. 4.29 Notwithstanding the ability o f the government to meet budget preparation deadlines, the budget calendar can still be fine-tuned to best serve the budget preparation process. Ideally, the initial resource framework should be ready by March, the indicative ceilings by April, and the budget circular issued by May. This calendar would leave more time to spending agencies to present their proposals by June. Then, with a revised macro- framework, the final budget can be put together by August and b e presented to Parliament in September. However, with a high and variable inflation, i t i s more difficult to generate macroeconomic forecasts early o n and issue expenditure ceilings. Over the medium term, the effectiveness o f the budget calendar can h i t f u l l y be increased by taking a multi-year view o f the budget and sectoral allocations. 4.30 With regard to the budget circular, in addition to the current practice o f presenting k e y macroeconomic parameters, the MoF has expressed an interest in using the circular to provide ministries and other spending agencies with indicative figures for fiscal aggregates and s ectoral spending envelopes. T h i s w ould b e a v ery welcome initiative. However, the initiative will only be effective if the ceilings are effectively enforced 4.3 1 Additionally, the budget circular should require that spending units provide a breakdown o f spending according to standard GFS-type economic and functional classifications, as well as a breakdown o f spending between funding needed for the continuation o f existing activities and funding for new policies, where the latter includes both a change in level o f existing services and delivery o f new services. For effective cash-flow management, the M o F should also require spending units to provide an accurate monthly cash payment schedule, and notify them that significant deviations from the schedule submitted may incur penalties. Spending units should also be asked to identify sources o f savings either through efficiency gains in existing service delivery or through termination o f services where the social retum on public funding i s l o w relative to possible altemative programs. Finally, the circular should require that spending units begin the process o f defining measurable performance indicators and outputs associated with individual spending programs, along with explanation o f how those outputs relate to policy objectives. In a nutshell, the M o F and the M o E need to improve their information regarding spending needs and outcomes. 4.32 Forecasting. Reliable forecasts are needed to make informed policy prioritization and define expenditure ceilings for spending units in order to allow spending units to prepare reasonable spending plans (budget submissions). The basis o f good forecasting i s an accurate and consistent macroeconomic framework. Inconsistent macroeconomic scenarios increase the likelihood o f budget revisions and deteriorate the credibility o f the budget process. Such a framework should cover at least two to three years beyond the coming fiscal year, so as to provide policy makers with adequate information for strategic planning. Effective coordination and communication within govemment i s vital to assure consistency o f the macroeconomic and fiscal forecasts. Similarly, effective communication to the public regarding forecasts can play an important role, not only for 71 promoting accountability, but to allow for fully informed decision making by economic agents. 4.33 In Belarus, there i s already a tradition o f macroeconomic forecasting, primarily with the Ministry o f Economy and the agencies that provide essential inputs to economic policymaking. The MoE produces the five-year Socio-Economic Development Plan (SEDP), which establishes priority macroeconomic and fiscal targets, including rates o f real economic growth and annual inflation. 4.34 Revenue estimates for the budget are done within the M o F by the Revenue Department. Although the methodology i s detailed, the reliability o f the budget revenue forecasts has been less certain. This i s an important source o f risk for the budget execution today. Recently, revenues forecasts appear to have been overoptimistic and significant tax arrears exist at present. A s o f M a y they amounted to 208 billion rubels compared with 134 billion rubels at the beginning o f January 2002. 4.35 The main problem with revenue forecasting in Belarus today seems to be an inconsistent macroeconomic framework, which has consistently generated inflation above government targets. In addition, in some cases the sectoral data used for forecasting GDP also appear to be based more o n optimistic expectations on the part o f individual line ministries striving to achieve policy targets rather than a more realistic assessment o f production trends and demand. The M o F has to have the main responsibility for putting together the yearly macroeconomic scenario. Mid-term scenarios, out o f indicative planning and the responsibility o f MoE, have to be revised o n a continuous basis to reflect the evolving environment and to avoid wide discrepancies between the plan and outcomes. These revised scenarios should be the basis o f a more realistic mid-term macroeconomic forecasting in Belarus. 4.36 Spending Unit Proposals. All Ministries prepare budgets and a l l budgets are included in the national budget.22 The only exception are some functions o f the Ministry o f Internal Affairs that are paid for by local governments. Spending agencies prepare separate recurrent and capital budgets. 4.37 Preparation o f recurrent budgets combines two approaches: incrementalism and bottom up. The budget preparation approach i s incrementalist because a budget envelope for the coming year is based o n the expenditure o f the current year, adjusted by parameters such as inflation (built into the budget at Ministry o f Finance level), or any special programs that have been approved, and the impact o f any Decrees issued by the President (see B o x 4.3). At the same time, the budget preparation i s bottom up because i t is based on a set o f agreed norms that are used to calculate expenditure. Reportedly, the 22 Local budgets financed with revenue sharing are also prepared. These budgets are very important, since they account for a large percentage o f the public sector budget. L o c a l budget budgets tend to cover social expenditure-health, education, etc. Reportedly, during the process o f preparation there i s coordination between the local governments and the line ministries. However, local governments present their budgets directly to the MoF and defend them as well. Oblast budgets cover the budgets o f the rayons. 72 norms have been derived from statistical evidence and reflect existing technologies in the production o f government outputs. Based o n this information, preliminary figures are prepared by the Ministries, who are expected t o take into account the government’s priorities as set out in the budget circular. Naturally, at this stage Ministries a i m t o maximize their o w n allocation. This dual approach produces t w o sets o f budget expenditure estimates-one based o n an updated estimate o f the previous year’s allocation and another f r o m the bottom up and based o n norms. These t w o approaches are reconciled during consolidation. Box 4.3: State Programs State programs in Belarus are numerous and varied. As o f 2002, the l i s t included 108 presidential, state economic and social programs, and special programs plus 30 scientific and technical programs. Typically, sectors lobby for programs in order to get more funds and as a result, they do not typically reflect state priorities and availability o f public resources. They also are not presented with clear objectives and expected outcomes, a rationale for public expenditure, an assessment o f the amount and mix o f resources needed to achieve the objectives, and quantitative or qualitative indicators for assessing the program outcomes. From time to time Ministry o f Economy on the order from the Council o f Ministers conducts an inventory o f state programs. However, this procedure does not imply an evaluation o f the existing programs and working out recommendations for extension, phasing-out or redesigning the programs: the major purpose i s to compile the fill l i s t o f such programs with their brief description. Although there seems to be an understanding by M o F and M o E that more and more programs are transformed into unfunded mandates, no attempt has been undertaken t o estimate the costs associated with the implementation o f all o f the adopted programs in a sustainable way and to compare these costs with the availability o f public resources. Among the largest programs are the following: + Presidential Program “Children of Belarus”: BYR 739.84 bn during 2001-2005; + National Program “Mitigation of the Consequences of Chernobyl Nuclear Accident for 2001-2005 and up to 2010”: BYR 2177.88 bn during 2001-2005 and BYR 2422.66 bn during 2006-2010; + State Program “Conservation and Use o f Meliorated Land for 2001-2005”: BYR 153.39 bn during 2001-2005, including BYR 89.4 bn from republican budget; + f Belarus for 1997-2005”: BYR 181 180.1 bn in 1997 prices during 2001- State Program “Roads o 2005 + Housing Program (as approved in the “Program o f Socio-Economic Development o f the Republic of Belarus for 200 1-2005”)- commissioning o f 2500-3000 thousand sq. meters o f housing annually. 2001: BYR 110 bn o f the NBB long-term credits and BYR 14 bn subsidies from the Republican to Local Budgets, BYR 93.7 bn from local targeted budgetary housing-investment finds; 2002: BYR 132 bn o f the NBB credits and 17.4 bn subsidies from the Republican to Local Budgets and BYR 132.3 bn from local targeted budgetary housing-investment finds; 2003: BYR 140 bn o f the NBB long-term credits, BYR 21.2 bn subsidies from the Republican to Local Budgets and BYR 187.3 bn from local targeted budgetary housing-investment funds Such programs represent important government initiatives, but are not well integrated into the budgetary process. They appear to be separate from overall sectoral programs and the multitude o f programs suggests that financing for all these programs remains uncertain. The creation o f such programs also strains the budgetary process, by drawing resources away from other activities. Some activities, such as the housing program are financed directly from the central bank rather than being part o f and financed through the budget. Finally, it seems clear that the financing o f all such programs i s not feasible within a sound fiscal framework. 73 4.38 Several shortcomings stand out today in the preparation o f the public budget in Belarus. First, budgetary proposals and allocations do not seen to take account o f the effective outcomes on the ground. That is, as discussed in Chapter 1 11, allocations are not supported by a solid system o f assessing public expenditures - nor even by a more narrowly defined system o f traditional evaluation. Second, there i s not a concept o f improving efficiency embedded in the preparation o f the budget23, such as improving norms over time. Partly, this i s due to the fact that the spending agencies would not get to keep either all or part o f the gains from potential efficiency increases. Hence, there i s little incentive for spending agencies to improve efficiency. Third, the practice o f protected items, during execution and even preparation o f the budget, provides an incentive for spending agencies to emphasize the use o f protected items, and hence distorts the input m i x in the production o f desired outputs. This practice clearly has a very negative effect on efficiency. Fourth, there i s not a consistent practice o f phasing out programs or activities that have already accomplished their objectives. All o f the above lead to bloated requests for financing and to l o w efficacy o f public outcomes. The direction o f reform should combine binding sector envelopes and greater flexibility and accountability for the sector agencies in the preparation o f their 4.39 Consolidation. Consolidation o f initial submissions into an aggregate budget i s accomplished through an opaque process o f iterative negotiation or ‘reaching consensus’. The process amounts to one-to-one negotiation between the Ministries or the local governments and the MoF, based o n arguments o f previous spending patterns, bottom-up budget estimates based in norms, protected items, and new p r i o r i t i e ~ . ~ ’ Once the Ministry o f Finance concludes iterations with the various Ministries, the Council o f Ministers discusses and agrees o n the budget. The budget i s then submitted to the President for his approval. 4.40 Recently, given the limited public resources, the M o F has taken initiatives to streamline expenditures, for instance, by eliminating some privileges. I t i s noteworthy that the initiative i s taken by MoF, as this points out the limited incentives o f the spending agencies to initiate expenditure reform. In these circumstances, the spending agencies tend to play a passive role, seeking above all to protect their allocations in terms o f salaries and other priority expenditures, rather than focusing on improving performance and delivery. Since, i t i s spending agencies that have a more detailed knowledge o f the expenditure programs, the present approach o f expenditure reform i s 23 The usual definition o f the term ‘efficiency’ in Belarus i s that o f ‘spending in accordance w i t h the budget law’. Improving efficiency does not mean a greater ‘value for money’. 24 The information requested from spending agencies should identify all their expenditure programs, regardless o f the source o f financing. Each program should identify the expected outcome. Information o n changes o f existing programs or the identification o f new ones should be discussed as early as possible with MoF and before the budget i s submitted. 25 Reportedly, there i s continuous communication between the MoF and the spending ministries and agencies regarding budget needs. This continuous communication eases somewhat the strain placed by the short time available for consolidation, as pointed above. However, continuous communication does not substitute for a more structured consolidation process. 74 not likely to lead to the best outcomes. Hence, if Belarus wants to undertake an ambitious program o f streamlining expenditure and improving efficiency, a new institutional framework o f cooperation between the MoF, the M o E and the spending agencies i s necessary. Some successful experiments in this regard have already been undertaken in the health sector. 4.41 A k e y outcome o f the modern consolidation process should leave all parties relatively satisfied. The Ministries o f Finance and Economy should be c ertain that the proposed budget does not strain the macroeconomic situation o f the country. There should also be certainty in the government that the proposed budget meets national priorities. Spending ministries and agencies need to be satisfied that the process o f allocation i s fair and that they have the resources to meet the priorities that have been assigned to them. Also, they should have enough operating autonomy to align resources assigned and objectives. The way to address these requirements i s to implement a policy o f budget ceilings and to enforce it, with greater autonomy for spending agencies. In the process, spending norms should be revised. (See B o x 4.4 on best current practices.) 4.42 Capital Budgeting: A separate budget for major capital items exists. This budget i s controlled centrally even though it i s allocated over to individual ministries. The separate capital budget appears to be intended for major infrastructure projects. Upon examination, however, the capital budget does not seem to include a l l investment expenditures nor are all items included investments proper. Thus, some capital expenditures are often included within the individual ministry budgets and treated exactly the same as recurrent expenditures. Since the capital budget i s subject to the rules o f ‘protection’ applied by the Treasury and therefore spending included within this budget could be deferred, spending agencies m a y be trying to protect certain expenditures by moving them to the recurrent category. 4.43 On the other hand, the capital budget appears also to be used as a source o f funding for special purpose activities that would not normally be regarded as ‘capital purposes’ although some o f the expenditure could fall into the definition o f capital. In other words, i t was not being strictly used for capital investment purposes. Thus, there i s no overall capital budget in the conventional accounting sense and n o separate identification o f capital expenditures within the budgets o f individual Ministries. T o improve capital budgeting in Belarus, i t i s necessary that the capital budget b e developed to include all investment under implementation and that non-investment expenditures be taken out. 4.44 Also, i t i s essential that investment decisions be made within the context o f a medium-term framework. That framework should include a stage o f determining aggregate resources available for capital investments and a policy prioritization process to set the parameters for allocating funds across sectors in accordance with sectoral priorities and needs. The specific project proposals should be primarily the domain o f sectoral specialists in spending units, with MoE and MoF officials providing the necessary guidance regarding government priorities, budget constraints, informational requirements for proposals, critical analysis o f submissions from spending units and oversight during implementation o f approved projects. 75 Box 4.4: Policy Prioritization and Sectoral Allocations T w o critical aspects o f budget preparation are establishing a government’s commitment to well-defined and publicly stated fiscal policies and establishing a budget process that effectively allocates funding in accordance with policy priorities. The Fiscal Responsibility Act in New Zealand requires the government t o produce a Budget Policy Statement (BPS) each year no later than three months prior to the beginning o f the fiscal year. The practice has actually been to produce the BPS even earlier so that macroeconomic and fiscal forecasts presented in the document along with the statement o f sectoral policy priorities serve as parameters for budget formulation by spending agencies. The medium-term fiscal frameworks employed in Australia, Denmark, Germany, New Zealand, Sweden, the United Kingdom and other countries all provide examples o f a budget process that sets down indicative baselines or expenditure ceilings for spending units or sectors before those spending agencies formulate their annual budget proposals. There are several important contributions this has for sectoral prioritization. First, the indicative baselines or ceilings are concrete indicators o f the government’s intention to fund particular sectoral activities. Second, the “top down” indicative allocations give spending agencies both greater certainty o f funding levels and a clearer definition of budget constraints. This encourages spending units to carry out a more thorough internal prioritization o f sectoral programs and pursue efficiency gains in existing programs in order to finance new or high priority programs. Spending units do not have to fear losing funding to a “claw back” by a finance ministry. 4.45 Over time, it is advisable to consider jointly both capital and recurrent budgets. After all, both recurrent and capital budgets seek to meet joint objectives within a given sector. The historical practice in many countries, however, has been to have separate capital and investment budgets. In some cases, the capital budget i s entirely separate, produced and managed by a separate agency. In some countries, this reflects the impact o f a high level o f dependency on donor financing and the donors’ preferences or preconditions for control or oversight. This i s clearly not case o f Belarus. In other cases, as in many transition economies, the institutional separation o f capital and current budgets reflects the traditional organizational roles o f distinct central ministries (Le. the MoE and the MoF). Whatever the source o f the bifurcation, the lack o f integration can seriously undermine a government’s effort to formulate and implement a cohesive set o f policies incorporating an efficient level o f capital investment and combination o f current and capital spending. 4.46 Lastly, as seen from the data in Chapter 1 11, the capital budget i s treated as a residual item and subject to extreme compression, both in the initial formulation o f the budget and in subsequent interim budget revisions. A consequence o f the present institutional environment for capital budget could w e l l be the emergence o f a sizeable stock o f incomplete projects. This has already happened in other transition economies and i s beginning to emerge in Belarus. 4.47 Medium-Term Expenditure Framework. Best practice today in the budgeting o f public resources takes a multi-year approach (See B o x 4.5). Although the idea appears simple, proper implementation requires dealing with many o f the basic concerns that are identified in this review. Otherwise, current problems are simply transferred to a multi- 76 year framework. For instance, if it is n o w difficult to forecast next year’s revenues, it will be that m u c h more difficult to forecast them in the medium term. Likewise, in the absence o f a truly comprehensive budget, actors may find ways t o further elude budget control by developing even more complicated schemes over the medium term. Box 4.5: Medium-Term Fiscal Frameworks Many countries now use some variant of a medium-term framework for macroeconomic and fiscal forecasts to: promote aggregate fiscal discipline by explicitly accounting for outer year costs of both current and capital spending; focus the attention o f political leadership on strategic decision-making for sectoral policy prioritization; strengthen planning and implementation of multi-year structural changes in fiscal policies; and encourage greater technical efficiency by increasing the predictability of funding for spending units. In all cases, the medium-term fiscal estimates are updated annually, that is, they are “rolling” estimates. In Australia, forward estimates of budget baselines cover both the budget year and an additional three years. Cabinet and Department of Finance (DoF) consideration of annual budget proposals by the spending units (ministries) focuses on changes in the aggregate forward estimate o f indicative allocations for that spending unit. The DoF carefully scrutinizes any policy proposals from spending units that imply an increased allocation, and spending units may be constrained to financing any new spending initiatives out of cost savings in existing programs. In Denmark, annual budgeting begins with the application of macroeconomic forecasts to existing multi-year projections of spending. Medium-termbaselines adjusted for changes in key parameters such as inflation and wages act as spending ceilings for individual ministries when preparing annual budget proposals. Again, this allows for the political decision-makers and the MoF to focus negotiations with individual spending units on how to accommodate fiscal pressures of new spending proposals, either by increasing the indicative allocations or by requiring offsetting reductions in spending elsewhere within the sector’s budget allocation. In Germany, preparation of the annual budget begins with submission of a multi-year financial plan to Parliament. The financial plan i s the work of the Financial Planning Council with representation by all levels of government. The plan provides both an aggregate level of spending and a set of forty sectoral allocations. The sum of indicative allocations i s held below the projection of total spending in order to provide for a general planning reserve accommodating the additional costs o f new programs and unanticipated price increases for existing programs. In the United Kingdom, determination of aggregate spending over the medium-term i s subject to two constraints. First, there i s the “golden rule” that the government will borrow only to finance investment spending and not current spending. The second rule i s that the ratio o f net public debt to GDP be held at a stable and “prudent” level to ensure that the level of borrowing and investment be fiscally sustainable. As in other cases, medium-term baselines are provided to spending agencies, incorporatingupdated macroeconomic forecasts, and periodic program reviews every few years are used to provide in-depthassessment of the quality of public spending programs. To encourage greater technical efficiency by spending units, including both incentives for seeking cost savings and avoidance of year-end “spend-ups”, spending agencies are allowed to carry over unspent hnds from one year to the next. 77 Budget Approval 4.48 Budget approval practices vary greatly by country, but overall, the effectiveness o f the approval process i s dependent on: how the system i s organized for the task; the quality o f information available (Le. in budget draft and relevant documentation); the level o f staffing and support; clarity in defined role for the chief executive; and the extent and quality o f communication between the chief executive (or h i s h e r designate) and the legislative body. 4.49 In Belarus, the President submits a draft annual budget to the legislature. Parliamentary Committees consider each element, and may press for extra funds to be allocated to particular activities. However, in such situations, Parliament has to identify sources f o r t he additional funding. W here P arliament p roposes c hanges, t h e authority still remains with the President to decide whether to accept or reject Parliament’s advice. Once approved by Parliament and the President, the budget becomes law and imposes obligations o n each respective ministry. 4.50 The Parliament in Belarus plays a limited, but not totally passive role, in the budget approval process. The limited role o f Parliament i s due mainly to fact that the budget i s discussed at high degree o f aggregation. The information provided seems adequate, but since the budget i s not comprehensive, Parliament does not get a complete picture o f public expenditure. Moreover, the practice o f revising the budget throughout the year (in response to fluctuating resource expectations and cash position) combined with the exercise o f Presidential decree power, limit the influence and relevance o f the formal budget approval process. Given the relatively limited actual power o f Parliament to modify the draft budget, that leaves ample time for a legislative decision to be taken before the beginning o f the fiscal year o n 1 January. I t would b e advisable in Belarus to strengthen the role o f Parliament during the approval and revision process. There has to be a limit to the capacity o f the executive to change the budget. Budget Execution 4.51 The challenge i s to ensure that the budget i s implemented as approved, a n d that changes during the year (to cut, increase, or shift resources within spending categories) are introduced following a clear-cut due process. Thus, line ministries need to be held accountable for achieving agreed-upon fiscal targets if the budget i s to represent a meaningful constraint. M o r e specifically, aggregate fiscal discipline requires that spending units not be permitted to exceed their budget allocations. 4.52 The cash management system must ensure that budget implementation leads to a distribution o f actual spending in accordance with intersectoral policy priorities as specified in the detailed implementation budget. Also, cash management should support operational efficiency by providing an appropriate balance between autonomy for spending units, on the one hand, and their accountability to the M o F o n the other. In situations o f shortage o f resources, c ommitment control and cash management acquire 78 special relevance. In these circumstances, i t i s very likely that budgetary intentions are severely distorted during the implementation phase. . 4.53 A detailed budget. Parliament approves the budget along very broad spending categories and thus the M o F and the executive in general retain considerable discretion in the final allocation o f public funds. For execution, the Ministry o f Finance breaks down the approved budget into detailed lines for each item o f spending and for each part o f the spending Ministry responsible---activities are allocated over the actual spending agencies o f the Ministry, for example to a university or hospital. Within that, each line i s broken down into quarters to reflect the level o f spending expected to be incurred in that quarter. The arrangement for spending is that ministries cannot engage in spending above the limit allotted for the specific quarter. 4.54 The mechanics o f budgetary spending. U p o n allocation o f the detailed budget (broken down by line, agencies and time), a ministry i s able to commence issuing orders for services, works and equipment. For expenditures other than protected items (see below) and where the ordedcontract i s for the supply o f services, works and equipment, the Ministry i s not able to commit spending o f more than the quarter’s allocation even though it m a y enter into a contract for the whole year. The quarterly allocations are those specified by the Ministry o f Finance; there i s no separate quarterly cash allocation made by the Treasury. The Treasury makes the actual payment through a centralized payment system and also makes decisions about which items will be paid and which held up. The Treasury carries out an ex ante payments check and as part o f that process ensures that there i s provision in the budget for the spending. The Treasury also attempts to control the ceiling o f any contractual commitment to ensure that it can be funded within the budget. 4.55 Advances in treasury management. Treasury operations have been much improved in recent years. Systems o f reporting and control are now in place that permit the M o F to track the use o f funds, monitor arrears, and improve the f l o w o f funds to spending agencies. The expanded coverage o f spending units funded by the national budget appears t o b e c ontributing t o m ore e ffective tracking o f s pending a n d reporting t o t h e Ministry o f Finance. Treasury coverage was expanded in 2002 to include five previously off-budget targeted funds. Further extension to other off-budget funds i s envisioned, but i t u nclear a t p resent whether t h e t reasury s ystem w illalso b e e xpanded t o incorporate local budgets. 26 4.56 Book-keeping on expenditures and arrears. There have been significant advances in public expenditure book-keeping in Belarus. Each Ministry maintains its o w n bookkeeping system o n the basis o f the agreed chart o f accounts. I t therefore lines up with both the Treasury and budgetary systems. The Ministry o f Finance specifies the bookkeeping methodology. The bookkeeping system in some ministries is fully computerized and information i s available o n a daily basis. In other ministries the bookkeeping system may be partly manual and partly computerized. 26 A comprehensive r e v i e w o f treasury activities was undertaken on 2001 by a n IMF Mission. 79 4.57 The bookkeeping information i s used to control expenditure and to keep the central ministry a ware o f the levels o f spending by the different e stablishments for which the ministry i s responsible such as universities that have their o w n individual budgets (albeit as part o f the overall ministry budget). Thus, i f such an establishment i s not spending its budget, a ministry will get to know and will be able to seek explanations. The information contained in the ministry bookkeeping system i s also used as a comparator with the Treasury information and from such comparisons the ministry i s able to identify the extent o f payment arrears, at the levels o f ministerial agencies.27 Where bookkeeping systems are fully computerized, there i s a computer link with the Treasury that allows a daily analysis to be made. Generally i t appears that the same bookkeeping system i s used to provide information about ministry off-budget activities and the same bookkeeping staff i s used for this purpose. The only exception to this appears to b e for the Social Security Fund. 4.58 Commitment control c a n b e improved. M inistries keep records o f commitments and the Treasury i s informed o f these but not the Ministry o f Finance. However, the information provided to the Treasury m a y not be systematic and appears t o amount to an indication, when contracts are entered into, o f the whole amount o f the contract for the year even though the current application to spend i s for one quarter only. Poor commitment control and reporting m a y w e l l b e an additional reason for the emerging budget arrears. Clearly, Belarus needs to improve its system o f commitment control. 4.59 Cash-management under shortage offunds. Belarus has not been able to take a full advantage o f the advances made in treasury management. Optimistic revenue forecasts incorporated into the budget have contributed to cash shortages during budget implementation. Furthermore, strong political pressure to finance initiatives not included in the original budget have added to the imbalance o f available resources versus expenditure demands. The result has been a critical cash shortage and budget sequestration in which the allocation o f resources becomes a day-to-day management o f available funds directed to priority spending categories. While spending units may have a formal appropriation for a given amount o f funding and apportionments are made quarterly, spending units face a high degree o f uncertainty as to whether they will actually receive their full funding, inclusive o f unprotected items. The need to guarantee a m odicum o f fiscal d iscipline g ives t h e T reasury control o ver t h e u se o f c ash during budget execution, supplanting formally approved budget appropriations as the mechanism for allocating resources across priority programs. Thus, the Treasury takes a central role that derives from the fact that the present system in Belarus suffers from 28 serious deficiencies. 27 Where such arrears occur a Ministry i s able t o discuss with the Treasury what i s h e l d up and if necessary can appeal to the Council o f Ministers t o arbitrate. 28 In practice when spending starts, Ministries k n o w that because o f the cash difficulties o f the Government ‘protected’ items w i l l be p a i d but others could b e h e l d up. T h i s means in effect that it may n o t b e possible to provide full spending for the activities as envisaged in the budget. In particular, the Ministry o f Finance said that equipment spending tended t o occur in the last quarter because this provided a cushion if there were cash funding difficulties because equipment purchases were n o t ‘protected’ items. 80 4.60 This situation has developed partly as a result o f a budget preparation process that relies more o n past trends than o n emerging realities, unexpected expenditure mandates during implementation, and difficulties with tracking revenues month-to-month during the year. Hence, besides improvements in budget preparation and limiting executive discretion in altering the budget approved by parliament, as emphasized elsewhere, Belarus needs also to improve short-term revenue and expenditure forecasting. Forecasts should provide budget officials with a reasonably accurate projection o f the revenue stream on a monthly or quarterly basis, noting seasonal patterns for k e y sources or government income. Similarly, for expenditures, the M o F requires a reasonably accurate global picture o f cash needs on a month-to-month or quarterly basis. This would include a careful analysis o f past trends regarding the seasonality o f different types o f expenditures, assessment o f cash flow needs and, quite importantly, the provision o f monthly cash payment schedules by spending units as part o f their budget submissions. The MoF should establish appropriate incentives for spending units to keep their actual cash needs in line with projections, including negative sanctions for deviating widely from the schedule without suitable explanation o f circumstances beyond their control. (See B o x 4.6 o n cash-management practices.) 4.61 Protected items. To manage the cash shortage, the government has defined certain items o f expenditure as ‘protected’ such as salary and wage payments, food and what are defined as ‘essential’ items.29 ‘Protected’ for this purpose means that the expenditure i s given priority for payment and i s generally not held up if there i s a cash shortage. Protected items are allocated to separate budget lines. Control over employee costs i s particularly tight and ministries have to comply with pay norms that are laid down. Should a ministry wish to increase the number o f employees it would need to seek the specific approval o f the Ministry o f Finance. Despite these measures, the concept o f protected items introduces serious distortions in the structure, especially when the concept i s also used as part o f the budget preparation process. Moreover, as more items are moved to the protected category and budget funds grow scarcer, arrears may emerge even in protected items, such as wages. This appears to b e already happening. Such practices remove the relevance o f the concept o f “protected item” and point out that this approach is at best a temporary tool. This i s n o real replacement for good budgeting. 29 See Chapter 111, for a quantitative analysis o f the protected items. 81 Box 4.6: Cash Management Effective cash management i s critical during budget execution to avoid costly short-term borrowing, prevent the build-up o f arrears and avoid interruptions in the provision of basic goods and services. Generally, the system regulating planning, disbursement, use of cash by spending units, financial reporting and monitoring should support an appropriate balance o f fiscal control and managerial flexibility. Incentives play an important role in promoting responsible cash management by spending units. Examples kom various countries show how specific characteristics can contribute to these objectives. Over the past decade, the Philippines has implemented a series of reforms to its system of cash management in order to improve the ongoing alignment of disbursements and revenue collections. Reinforcing interagency linkages and communication, both through information technology and committee oversight, between the Department o f Budget and Management (DBM), Department of Finance (DoF), Bureau of the Treasury and Central Bank has been one important component o f reforms. The Simplified Fund Release System (SFRS) implemented in 1995 seeks to standardize the release of hnds across spending units, allow spending units greater flexibility within prescribed legal limits, reduce paperwork and other transactions costs, and strengthen monitoring instruments. The system also seeks to establish a formal process for coping with interim cash constraints, while protectinga degree of flexibility in resource allocation for spending units. Sweden has also taken measures to strengthen incentives for sound cash management by spending units. Annual appropriations are divided into monthly apportionments and deposited according to schedule into each unit’s interest bearing accounts. If balances are drawn down more slowly than scheduled, the spending unit retains the additional interest income accrued. Conversely, if spending exceeds the monthly apportionment, spending units must pay the interest costs to offset the government’s cost o f borrowing. Also, a carry-forward provision applies to both unspent balances and overspending. The provision allowing for the carry-forward of unspent hnds into the subsequent financial year removes incentives for end-of-year “spend-ups”, while also encouraging greater attention to efficiency gains, since spending units are entitled to retain any savings. Applying the carry-forward provision to excess spending encourages fiscal discipline to avoid commitment of the next year’s appropriation. Any features of cash management systems that contribute to overall fiscal discipline and a spending pattern in accordance resource availability and scheduled financial plans help to minimize the government’s costs of borrowing, an important objective of cash management. Technology permitting, another measure used in some countries, including New Zealand i s a nightly “electronic sweep” of government accounts into a single account so that interest income earned on the balance of funds held by government agencies accrues to a central account rather than to individual spending units. 4.62 Revising the Budget During Implementation. N o matter h o w w e l l prepared a budget might be, circumstances are almost certainly going t o arise that necessitate interim revisions. Such circumstances include macroeconomic developments deviating f r o m forecasts used t o formulate the budget, unanticipated program costs, new policy proposals and the realization o f contingent liabilities. And while the budget can and should incorporate some provisioning for these potential fiscal pressures, some revisions during the fiscal year are virtually inevitable. Therefore, it is important that the legal framework and administrative procedures support a formal process for interim budget revisions. Otherwise, agents lose the incentive t o do a good j o b in budget preparation, as they would have the option to still alter their allocations through the budget revision 82 process. These incentives take precious time away from focus on proper implementation and performance assessment. At the close o f the fiscal year, i t similarly complicates accountability in the use o f public resources. 4.63 Pressures for recent budget revisions have included unfavorable revenue outtums, increases in the cost o f existing programs due to inflation and interim policy initiatives such as wage increases. According to M o F officials, there are n o formal rules governing the process o f budget r e ~ i s i o n . ~ ' Recent experience actually suggests that revisions are more o ften m ade in a crisis-like e nvironment, where p olitical p ressure t o finance n ew policy initiatives even in the face o f revenue shortages has forced significant compression o f pre-existing budget appropriations. Moreover, due to the broad scope o f protected spending categories enshrined in the ABLYa relatively narrow range o f unprotected expenditures (e.g. capital investment, capital repairs and maintenance, and purchases o f goods and services), have had to absorb more extreme reductions. 31 4.64 General principles governing budget revisions include legal requirements that revisions above a certain amount or percentage require explicit approval by the legislative body. Conversely, the executive should have the authority to make relatively minor revisions including fiscally neutral transfers with program areas without prior approval from the legislature. In exceptional cases, when the revisions are significant and funds are needed urgently, the revision may need to be implemented prior to formal legislative approval. However, circumstances allowing for urgent action should be quite restrictive, and the executive should be required to submit a revised budget for legislative consideration and approval within a specified period o f time. If budget 'revisions entail a significant shift o f resources across sectors or programs, indicative o f a change in policy priorities, then the rationale for such changes must be thoroughly explained to the legislature and to the public. 4.65 One option utilized by some countries i s to establish a regular timing for periodic interim budget revisions. A mid-year budget baseline update i s an effective way o f accounting for the fiscal impacts o f evolving macroeconomic conditions, unanticipated program costs, new policy developments and the realization o f any contingent liabilities. I t also reduces pressures for an excessive number o f revisions over the course o f the fiscal year. As part o f a routine mid-year update, new round o f macroeconomic forecasts should be conducted and necessary fiscal adjustments can be made accordingly. 30 But, there i s an understood process in place for allowing variations. Budget variations are dealt with in the following manner. With the agreement o f the M i n i s t r y o f Finance, Ministries can shift spending between quarters. They can also agree changes t o budget lines provided a n increase in one line is offset by an equal reduction in another line. There i s little or n o possibility o f a change, w h i c h w o u l d require an amendment to the budget law, that is, to any i t e m specified in the budget l a w itself, w h i c h in effect i s at the level o f m a i n budget heads. 31 The lack o f predictability associated with the ad hoc application o f Presidential authority throughout the budget year undermines fiscal discipline as w e l l as effective program performance (Le. discrepancy between Presidential budget submitted t o Parliament and final for a given FY). I t also affects the quality o f the budget preparation process. 83 4.66 In Belarus, the annual budget i s subject to frequent and extensive revisions over the course o f the fiscal year. Figure 4.1 shows that relationship between the budget lines as approved in the budget and as finally implementedi s weak. Fiscal pressures have brought on budget sequestration in recent years, which in practical terms means that formal budget appropriations succumb to a daily or weekly reprioritization and reallocation o f available funds. In such circumstances, one could say the budget i s subject to constant revision with a very short time horizon, though both M o F budget managers and their counterparts in spending units may still look to initial budget appropriations as a sort o f guideline or justification for allocating sequestered funds. In particular, i t is o f great concern from the perspective o f fiscal transparency that a small group o f senior officials determine which spending units in the queue will receive a share o f available funds. 4.67 The three objectives o f budget management (aggregate fiscal discipline, allocative efficiency and operational efficiency) all call for a more transparent and balanced approach to interim budget revisions. For aggregate fiscal discipline, revisions must respect binding resource constraints and the risk o f rising budgetary arrears being incurred. N e w policy initiatives, whatever the source, must only be pursued if the resources are available to fund them, without forcing other spending units to incur arrears for programs subject to funding cuts. For allocative efficiency, the distribution o f any expenditure cuts should give due attention to established policy priorities and full, including medium and long-term, consequences o f imposing cuts o n selected categories o f spending (e.g. reduced support for capital investment). For operational efficiency, budget revisions must avoid detrimental and costly interruptions in service delivery, must consider risks o f not completing capital investment projects already underway, and must not undermine desirable efforts by spending units to engage in financial planning. 4.68 Rules to carry over expenditures to the next year. Where at the end o f the financial year there i s an under-spending on the budget caused by Treasury restrictions o n expenditure (as described above) then the under-spending can b e charged against the budget o f the following year, in the first month o f the next financial period. However, there i s no corresponding increase allowed in the next year’s budget. There i s also an arrangement, which allows for an overlap o f spending into the first part o f January that can be set against the budget of the previous year. If a Ministry i s for some reason i s unable to meet this deadline, after that the budget i s lost. Overspends have to be set against the next year. Underspends o n ‘own revenues’ can b e carried forward and Ministries are able to make their o w n decisions about this. 84 Figure 4.1: Actual Consolidated Expenditures as Share o f Annual Budget Law and Revised Plan, 2001 - . ~ l-l-..^-.-.- "_ ___^.l,,_____l__,- _"_ Total Expenditure 1 Republican Nat Consvn Fund 1 Repub Ii can A g r icult wal Fund i CAPITAL EXPENDITURES I Elections and referenda I Preventionof emergency situatiom &p as share busing and publicutilities Revised Ran ~ Market infrastructuredevelopment T r w p o r t r o w ma m 8 commci n 7 Conservalonof m 8nal re5 \nnual Budget - 13 .aw Agr c A u a sector I n d a r y power eng 8 constrwt on 1 ~cente JJd cal a*lmrlties Lav-enforcement awl s e c ~ t y N a om1 asfence Imernatlonal axl" t y Sratewmmstrat o n g l o c a ~ g o v t 0 20 40 60 80 100 120 140 160 Source: MinFin. 4.69 Accounting for fee-for services and off-budget expenditures. The ministries do maintain costing systems for services that are charged for. In the Ministry o f Education, there are 29 such services. The regulations about cost recovery are laid down by the Ministry o f Finance. The spending ministry estimates what the costs will be and then fix the level o f charge. The process allows for the making o f a profit defined according to the rules. The authority to fix the charge differs depending upon the type o f charge. For example, some charges can be agreed by the head o f an establishment, others need the approval o f the ministry and others need the approval o f the minister personally. The costing system is also used to compare actual costs against the estimated costs used to 85 calculate the charges. 32 In some ministries, as in for example Health and Education, o f f budget funds are important. The responsibility for the management o f the o f f budget funds l i e s with the establishment that generates the funds. Therefore those establishments maintain the detailed bookkeeping systems for such o f f budget funds. They also operate their own bank accounts and may have several such accounts. The head o f the establishment has authority to operate the bank accounts (which m a y include foreign currency accounts) but the Ministry o f Finance does receive information about the state o f those accounts. Where a profit i s made on the o f f budget activities, that profit remains with the establishment generating the profit, i.e. it i s not recycled for the benefit o f the service generally. 4.70 Procurement. The quality o f the procurement process for both capital investment projects and the supply o f other goods and services i s an important determinant o f the efficiency and effectiveness o f public spending. Procedures should allow an appropriate level o f discretionary authority to be vested with spending units for purchases below a defined level o f materiality. Moreover, spending units should also have a central role in managing contractual arrangements for purchases involving a more significant amount o f finds, but subject to closer monitoring and approval by the MoF. Procurement must satisfy standards o f transparency and tendering for contracts above an appropriate materiality level should be on a competitive basis. Still, spending agencies should take responsibility o f the pure technical aspect o f procurement. Contractual arrangements should be clear as to the rights and responsibilities o f different parties, including quality standards, the timing o f delivery, verification o f goods and services received, the amount and timing o f payments and legal recourse for resolution o f any disputes. 4.71 In Belarus, there are materiality levels that define where the authority to approve a given contract lies. For purchases up to 10 million Rbl in 1991 prices, local executives can approve a contract. For amounts between 10 and 20 million Rbl, sector ministries must approve the contract. And for amounts above 20 m i l l i o n Rbl, the C o M or govemment must approve the contract. However, in all cases, the MoE will be involved in authorizing the tender and contract. At present, tenders are mostly awarded to state enterprises. 4.72 The M o E assumes primary responsibility for monitoring procurement processes, particularly for capital investment projects. The M o E completes a monthly analysis o f capital spending, and the government prepares a quarterly report o n project implementation. Regional govemments must report to the M o E o n their use o f capital investment funds when projects are jointly financed with support from the Republican budget. 32 The definition o f cost used f o r this purpose was n o t investigated and n o one interviewed indicated that charges levied were used in any w a y to regulate demand. 86 4.73 However, g iven t he r eliance o f m any m inistries a n d t heir spending units o n o ff- budget funds for financing capital investment and other purchases o f goods and services, there i s concern regarding the scope o f reporting to the M o E and MoF. Reporting standards, assuming adequate enforcement and compliance, m a y be adequate for monitoring outlays finded directly b y the budget. However, there appears to be l i t t l e reporting t o central oversight agencies regarding the use o f off-budget funds, although this seems to have been changing in recent years. In the absence o f proper reporting on off-budget procurement, there are g enuine concerns about compliance w ith contractual standards as w e l l as whether resources are being allocated in line with policy priorities. Auditing and Evaluation 4.74 Audit i s a detailed review o f financial and spending practices. Audits offer opinions at a detailed level to confirm that that fiduciary controls have functioned appropriately, and that rules have been followed and there has been n o misuse o f funds. They also confirm that spending was accomplished as planned - or highlight causes and deviations from the plan. Effective auditing and evaluation processes play a vital role in the budget cycle, both in their ex-post examination o f budget execution to assure compliance with regulations and in the guidance they can provide for improving the efficiency and effectiveness o f program activities in the future. There are a variety o f different types o f audits and assessments. Systems in most countries include both internal and external audit processes, with the principal distinctions being the audience for which the audits are performed and the relationship o f the auditors to the agency being audited. 4.75 Traditionally, ‘audit’ focused on financial dimensions o f expenditure activity, and ‘evaluation’ focused o n the results o f expenditure (i.e. outcomes). Understanding o f ‘evaluation’ in budgeting has evolved substantially over the last twenty years, with the focus shifting heavily - b ut not exclusively - away from reliance o n formal extensive evaluation o f programs (essentially audits o f outcomes, after the fact) towards more pervasive and flexible use o f performance information throughout the budget cycle. There are no flawless systems, and experimentation continues around the world - supported by both conceptual and technological advances. Reforms have resulted in a wide variety o f approaches and terminology, leading to some blurring o f concepts - e.g. some governments use what they call “performance audits”, while others use “performance evaluation” and “performance measurement”. At base, there are n o w two tools available to policy makers interested in effective public expenditure management - i.e. performance information that can be used throughout the budget cycle to notionally gauge progress, and traditional evaluation which continues to b e an important tool for use after the fact in more precisely establishing causal linkages. 4.76 Another important categorization concerns the primary focus o f the audit and assessment processes. M o r e specifically, audits m a y focus on financial management and i t s compliance with established regulations and appropriations. Altematively, the process may focus on whether a given government department or program achieved predefined outputs in a cost effective manner. B o t h types o f assessments can provide valuable information for senior management internally within the department being audited, as 87 w e l l as for government agencies overseeing budget implementation. In addition, effective external audit processes can make an important contribution toward the goal o f strengthening accountability on the part o f public officials for the quality o f governance. 4.77 The quality o f the audits, and hence their potential for contributing to better public sector governance, depends o n the quality o f information available to those carrying out the audits, as well as the qualifications o f examiners themselves. In turn, the quality o f information for carrying out audits depends on the quality o f accounting and reporting systems used to produce information and the working relationship between examiners and those being examined. Auditors, both internal and external, must have fbll access to financial records and the full cooperation o f an organization’s management apparatus. Moreover, those carrying out the audit must have the requisite s k i l l s to know what to do with the financial information provided and to assess the decision-making process within the organization being audited. 4.78 Responsiveness o n the part o f departments can also be encouraged by making audit - along with performance and evaluation - results available to the public. Surprising as i t m a y seem, senior officials in some countries suggest that public release o f audit reports would somehow constitute a divulgence o f sensitive information or jeopardize performance o f their duties. On the contrary, the fundamental principal to recognize and reinforce i s that the resources used to provide government services are public resources and that every government organization must be held accountable to the public for how i t utilizes those resources. While the work o f the internal audit agency may justifiably remain confidential within the senior management o f executive agencies, the results o f the external audit processes should be readily available to the public. 4.79 Current Situation. I n Belarus, there are two principal entities involved in audit- type activities, one is comprised o f a network o f the internal control departments operating within ministries and the other i s the State Control Committee (SCC). The two reportedly coordinate their activities. Also, the advances made in accounting for expenditures are a good base for auditing and evaluation in Belarus. 4.80 Inspection and Control within Ministries. The Ministry Department o f Inspection and Control is responsible for the ‘control’ o f both the budget and the o f f budget funds o f the ministry and for ensuring that the procurement rules are properly followed. ‘Control’ for this purpose means ensuring that the funds are spent in accordance with the budget law. Departments o f Inspection and Control in most spending ministries have regional control arrangements as well as a central control responsibility. The Ministry Controller supervises the methodology o f the Ministry Regional Controllers who have a dual reporting responsibility, namely to the Ministry Controller and to the regional governor. The Ministry Controller receives reports from each region. The Ministry Controller also has direct relations with the Committee o f State Control and with the Ministry o f Finance. The Ministry Controller will contribute to State Control Committee inspections into a region. Some o f the key features o f the internal control are: 88 0 Control i s ‘ex post’ and is carried out on a sampling basis. The aim i s to cover each element o f Ministry activity at least every other year. 0 A report on the results o f the control activity i s made to the Ministry o f Finance on a quarterly basis and also to the Minister. The Ministry Controller reports directly to the Minister. 0 In addition to the control and inspection activities o f the Ministry’s own Department o f Inspection and Control, the State Control Committee (SCC) may also carry out i t s o w n inspections. 4.8 1 The SCC. The SCC has broader powers to investigate activities o f any public sector entity including all ministries, state-owned enterprises and local governments. I t also has the power to prosecute individuals and issue financial penalties for legal violations. The SSC reports directly to the president. The internal control departments also, until recently, r eported t o t h e p resident, b ut a recent change n o w h as t h e m r eporting t o the CoM. B o t h the internal control departments and the SCC have an organizational structure that includes departments at the national and local levels. I t appears, however, that the SCC maintains a stricter organizational independence o f its inspectors than do the internal control department inspectors serving within local administrations. 4.82 At present, the audit functions conducted by both the internal control departments and the SCC are largely devoted to assessing financial compliance, that is, that public funds are utilized by spending units in accordance with appropriations and legal regulations. There i s no effort to evaluate the effectiveness o f management, the quality o f outputs or service delivery, cost effectiveness or other aspects o f performance. Performance-based audits are not a part o f their organizational mission. The MoF’s internal control department cited staffing limitations, both number and technical capacity, as a constraint o n their ability to broaden the scope o f audit objectives beyond financial compliance. Moreover, opportunities to conduct performance-based audits and program evaluations are constrained by the lack o f explicit programmatic objectives and outputs for spending units. 4.83 While the combined efforts o f the internal control departments and the SSC may well provide a thorough basis for auditing financial compliance, there are two apparent shortcomings with regard to audit functions in Belarus. One i s the absence o f any performance-based audits that could provide an important contribution to improving cost- effectiveness and the quality of service delivery. The second critical shortcoming i s the absence o f an external audit agency independent o f the government and reporting directly to Parliament. Here, Belarus should draft a strategy to put in place over the medium term an independent audit institution along best international practice (See B o x 4.7). 89 Box 4.7: Guidelines for a Supreme Audit Institution At a 1999 meeting o f the Presidents o f central and eastern European Supreme Audit Institutions (SAIs) and the European Court o f Auditors, agreement was reached on a document listing the key characteristics for establishment and proper functioning o f a supreme audit institution. The document includes eleven separate recommendations, as follows: 1. The supreme audit institution should have a solid, stable and applicable legal base that i s laid down in the constitution and laws, complemented b y regulations, rules and procedures. 2. The supreme audit institution should have the functional, organizational, operational and financial independence required to fulfill i t s tasks objectively and effectively. 3. The supreme audit institution should have the powers and means, clearly stated in the constitution and laws, to audit all public resources and operations, regardless o f whether they are reflected in the national budget and regardless o f who receives or manages these public resources and operations. 4. The supreme audit institution should undertake the full scope o f government external auditing, covering both regularity and performance audits. 5. The supreme audit institution should be able to report freely and without restriction on the results of i t s work. Reports may be submitted to parliament and be made public. 6. The supreme audit institution should adapt to suit local conditions and formally adopt, promulgate and disseminate audit standards, compliant with I N T O S A I Auditing Standards, the European Implementing Guidelines for I N T O S A I Auditing Standards, and any relevant public sector auditing standards issued by the I F A C and accepted for application in the EU. Audit standards should be applied on a consistent and reliable basis to the work o f the SA1 to ensure that audit work i s o f an acceptable quality and competence. The SA1 should therefore develop audit manuals and detailed technical guides to help promote the practical use and achievement o f the standards. 7. The supreme audit institution should ensure that i t s human and financial resources are used in the most efficient way to secure effective exercise o f i t s mandate. T o this end, SA1 management will need to develop and institute appropriate policies and measures t o help guarantee that the SA1 i s competently organized to deliver high-quality and effective audit work. 8. The supreme audit institution should develop it s internal organization as a supportive structure for the proper conduct o f work related to the requirements o f the pre-accession period. 9. The supreme audit institution must ensure that i t s staff and competent, capable and committed to help guarantee that effective audit work i s produced in conformity with international standards and good European practices. 10. The supreme audit institution should develop the technical and professional proficiency o f i ts staff through education and training. 11 The supreme audit institution should focus on the development o f high quality, effective management (internal) control systems in audited entities. 90 Assessing Budgetary Outcomes 4.84 Chapter I11highlighted the limited attention that is given to outcomes evaluation in Belarus. I t also highlighted three areas that need work if improvement i s to be obtained in this area. Mainly, these are: (a) a clear strategic vision (both global and sectoral); (b) identification o f performance indicators to measure progress o f outputs in achieving outcomes corresponding to the strategic vision, and (c) an improved understanding o f the linkages between inputs and outputs, that is the technology o f producing public goods. These points set the basis for a long-term strategy, which can b e launched in full force once the basic concerns that have been identified in this report are addressed. Belarus can then focus on improving sector allocations and technical efficiency. Summary and Recommendations 4.85 This review o f budget institutions and management has identified areas where progress has been made and areas that need further work if B elarus i s to improve the efficiency o f its p ublic spending, m aintain fiscal d iscipline, a n d s ucceed i n it s goal o f reducing the social costs o f transition. There would seem to be two m a i n challenges today around which to focus improving in budget management today in Belarus. 0 First, there i s the need to address to problem o f budgetary arrears and the underlying causes: poor revenue forecasting, and discretionary mandate changes by the executive. Under the present circumstances, cash management becomes all important and at the end the main force driving budgetary allocations. The practice o f protected items introduces further distortions. These developments undermine the importance and credence o f the budget preparation process. Spending agencies seek to protect the allocations and the link between expenditures and national objectives i s lost. 0 Second, Belarus needs to improve the efficiency o f its expenditure, both in terms o f improving the alignment o f allocation o f the resources and the national developmental objectives and the effectiveness o f sector expenditures. Only then, can Belarus reduce somewhat the fiscal burden, while keeping to its commitment to provide for the least advantaged and build i t s human and social capital. Meeting these t w o c hallenges requires improvements in a 11 o f s tages o f t he b udgetary cycle as well as changes in the underlying legal framework. The main recommendations in each o f the stages o f the budgetary cycle are: Legal Framework In the context o f drafting a budget code, the Belarusian govemment should focus o n the revising the following elements o f the legal framework: 0 Require the govemment to produce a public budget policy statement; 91 0 Reduce significantly the scope o f off-budget activities and clarify the legal status of the republican level extra budgetary funs (Social Protection Fund) ; 0 Expand access to information on fiscal performance to parliament and the public at large; and, 0 establish a legal basis for an independent external audit agency reporting directly to P arliament. Restrict t h e issuance o f e xemptions a n d p rivileges a n d require a tax-expenditure budget; Budget Coverage The scope o f coverage o f the budget can be improved by including in the budget: 0 Innovation funds 0 Fee for services & off-budget activities 0 Tax expenditures 0 Contingent liabilities As suggested in Chapter 1 1, a comprehensive framework for identifying and measuring both quasi-fiscal deficits and contingent liabilities should be established, so as to help the Government better understand and address the fiscal risks that it faces. Budgetary Calendar and Budget Circular The budget circular could be amended to include, 0 Binding sector ceilings or envelopes along best practice lines; and 0 Require information from spending units that facilitates evaluation along altemative expenditure options-cost, cash, requirements, etc. Budgetary Preparation To improve budget planning, actions are needed o n several fronts, 0 Improvements in forecasting require: improving the overall consistency o f the macroeconomic framework and focusing o n likely outcomes (product growth, inflation, tax revenues, etc.) as opposed to government targets. The government should clearly differentiate between government targets or desired objectives, which may include mid-term objectives, and likely outcomes for the preparation for the next year’s budget. There should not be a penalty if parameters f o r the budget differ from targets or objectives. The M o F should be given a greater responsibility during in forecasting. A lso, greater attention should b e given t o short-term forecasting to fine tune cash-management and the operations o f the treasury. 0 An effort should be made to take account o f the budget outcomes in budget preparation. To achieve this objective, incentives should b e given to spending 92 agencies to improve efficiency, and to phase out obsolete programs. “Efficiency’ should be understood as a concept broader than ‘expenditure as in accordance with the budget law.’ Spending agencies should be allowed to keep part o f the gains made from efficiency increases, and use these resources to advance priority sector objectives; I t i s necessary to improve the transparency o f the budget negotiation process between spending agencies, MoF, MoE, and the Cabinet. This improvement will require a stricter use o f sector ceilings or envelopes and clearer rules for the allocation o f resources among competing ends. Although, sector ceilings are used today, their use does not follow best international practice. I t i s important that the actors in the budget process be satisfied that their allocation i s fair so as to avoid continued haggling for revisions, even during budget execution. Limiting executive discretion during execution bolsters the credibility o f the preparation process. All investments made with budgetary resources should be included in the capital budget and the non-investment expenditures should be taken out. A clear delineation should be established between the capital budget o f the public sector and the capital budget o f the enterprises. Over the medium t e r m one or more pilots can be conducted to consider together recurrent and capital budgets in meeting specific sector objectives. Pilots should also be considered to grant greater autonomy to the agencies in preparing and executing their budgets, along the lines o f the health sector expenditure in the Vitebsk region. Gradually, the government should develop sector strategies and explicitly identify expected outcomes. Work on Chemobyl, health, and social assistance provide a good basis to begin with. Correspondingly, the Government should start developing a system o f monitorable outcome indicators. Budgetary Execution 0 Improvements in budget planning and elimination o f unexpected revisions throughout the year should improve budget execution; e Greater clarity should be introduced for the allocation o f resources in situations o f cash scarcity; 0 The system o f commitment control and reporting should be improved-strict control on commitments should be to align expenditures with expected revenues during the year; 93 0 ’ Changes should be made to the procurement process to enhance competition. Also, monitoring o f procurement with non-budget funds should be improved. 0 All extrabudgetary funds, power ministries and local governments should eventually be brought into the treasury. Budget Audit 0 The whole legal, reporting, control and external review process should not be focused exclusively on whether or not expenditure follows the budget law; an attempt should be made to determine that resources are used well and not wasted. 0 The concept o f accountability o f the spending agencies should b e extended beyond the Ministry o f Finance and other government bodies. The public should be informed o f audit, performance and evaluation results, and mechanisms should be designed for i t s involvement; 0 There should also be a more active and direct involvement o f the Parliament in the oversight, performance assessment and evaluation o f public expenditure. Eventually, there should be a external control body reporting directly to Parliament; 0 Audit, either internal or external, should not be understood in the government and even the private sector as an ‘unnecessary expense’ by many managements with external audit being positively discouraged for some companies by the actions o f the government; 0 There should be increased awareness that improvements in the approach to audit, reporting and transparency are important in improving management efficiency in the use o f public funds. 94 CHAPTER V. DEVELOPING AN ACTION PLAN: RECOMMENDATIONS FOR ACHIEVING FISCAL SUSTAINABILITY AND IMPROVING BUDGETARY MANAGEMENT IN BELARUS. 5.1 The previous chapters have focused o n key issues that underpin an effective budgetary process: fiscal discipline and sustainability; effective allocation o f resources and the technical efficiency o f the budget process. In each area, Belarus has made important progress and strides, but in each area there are important steps that need to be taken that could significantly improve the use o f public resources. 5.2 Yet managing change and improvement in fiscal and public expenditure management i s a complex process that takes years to undertake. Indeed, the strongest o f systems are always in the process o f trying to improve themselves. This requires policymakers that are committed t o t h e goals o f improved b udgetary practices. I t also requires developing a strategy and managing the change properly. The starting point o f developing a strategy is to identify the objectives that one seeks to achieve. The second step i s to carry out a comprehensive and candid assessment o f the strengths and weaknesses o f the system currently in place. The previous chapters have attempted to begin this assessment. 5.3 Once the k e y measures have been identified, a phased action plan can be developed. Such an action plan should include the following elements33: 0 The overall goal o f the reforms and the specific objective o f each component; 0 A l i s t o f components; 0 A l i s t o f activities for preparing and implementing the reforms; the deadlines for completing these activities and the milestones for accomplishing k e y tasks; 0 Indicators to monitor the progress achieved; 0 The organizational arrangements to prepare changes and supervise implementation; and some notion o f the resources that will b e devoted to the reform in order to obtain the required inputs. 5.4 As important to achieving success, however, i s building a commitment to improving the use o f public resources, both within and outside o f the government. Changes will take hold only if there are champions within the government. The top management o f the Ministry o f Finance must be actively engaged in the process and efforts should be centered in the Ministry o f Finance. To design and implement the reforms, the Ministry o f Finance should work in close cooperation with l i n e ministries, subnational governments and other key players. 33 This and what follows draws on Allen and Tommasi (2001) Managing Public Expenditure - A Reference Book for Transition Economies. OECD. 95 5.5 Effective organizational arrangements are also necessary to implement change. Given the important and wide ranging nature o f issues related to public expenditure reforms, three levels o f participants are needed: 0 A Steering Group, which consists o f high level officials that provide general direction to the program o f change. Typically the steering group i s chaired by the Ministry o f Finance. I t i s also important to include in the Steering Group the heads o f key department in the Ministry o f Finance and representatives o f ministries and government agencies participating in the reforms. One o f the aims o f this group i s to establish a consensus on the k e y objectives that need to be addressed. 0 A Core Unit that is made responsible for overall management o f the program o f activities. This unit i s most appropriately located within the Ministry o f Finance and needs to have a very clear vision as to the goals and objectives to be reached. I t also be given the authority to spread new practices or approaches through seminars, workshops and training activities. 0 Working groups should be created to develop and help implement specific reforms in particular areas. These groups often undertake the detailed day-today work o f developing and implementing needed changes. Such groups will be needed to fully develop the needed changes, but also to develop a communication strategy and to assure that the proposed changes have full ownership o f the Belarusian government and people. 5.6 On the basis o f the analysis o f the previous chapters, this final section o f the report outlines suggested primary directions for economic policy in the short and medium term. We hope that these recommendations m a y prove useful to the Government in the elaboration o f an Action Plan for improving public resource management. This Action Plan should specify concrete steps for the short and medium term, together with the agency most likely responsible, and indicators for measuring performance in reaching the given objectives. .. 5.7 But before moving to the recommendations, it i s important to reiterate, what this study sees as the keys goals to be achieved for an effective budget system: 0 Maintaining Aggregate Fiscal Discipline. Assuring that the country lives within i t s means i s a fundamental objective for healthy budget management. In order to maintain its growth and competitiveness, Belarus must reduce the extent o f explicit and implicit fiscal activities. This can start by identifying expenditures that can be cut in the short term and including the complicated array o f extrabudgetary and quasi-fiscal activities into budget analysis. 0 Allocating resources to effectively meet government priorities. Effective allocation o f the Govemment’s resources implies that specific outcomes in line 96 with government priorities are attained. These outcomes must go beyond the financial fulfillment o f an expenditure plan. They must include the actual results o f service delivery ( in the form o f meeting sectoral objectives). The government must seek to create a better connection between public expenditures and state objectives. 0 Promoting the ef$cient use o f resources through sound budget processes. The rules by which resources are allocated, distributed, monitored, evaluated and audited play a critical role in assuring that resources are being well-used. The best methods o f allocation may be undermined by weak budget rules and budget management practices. I n Belarus, budgetary preparation and approval lacks focus and realism and the implementation o f the budget allows for too much discretion in the allocation and re-allocation o f state expenditures. 5.8 For effective budget management, a l l o f these objective must b e developed over time. To focus on one aspect, while ignoring the others, i s unlikely to lead to success. In this sense, efforts to improve the system must be comprehensive, so that all the complementary pieces for the system to work w e l l are in place. In what follows, " short run" is t o b e interpreted as a p eriod o f 1-2 years, w h i l e m edium term covers 3-4 years.. I)The imperative o f tax and expenditure reduction: 0 The size o f government in Belarus i s too large for the economy to meet the challenge o f growing competition o n world markets from producers in Russia and many other countries. While the explicit general government budget i s roughly 10 per cent more o f GDP than in Russia, for example, accounting for significant off-budgetary and quasi-fiscal expenditures would make this differential substantially higher. A significant overall reduction o f the tax burden o n Belarusian f i r m s i s needed, together with a program for achieving comparable reductions in state expenditures. 11) Measures aimed at achieving overall financial stability and discipline. a) Increase the sphere o f the budget to include significant expenditures that are currently off budget o r quasi-fiscal. 0 For the short term: Incorporate Innovation Funds into the budget with full separate classifications for current and capital expenditures. Introduce full accounting for all remaining off-budgetary sources o f state finance, including o w n funds o f ministries. Cease directed commercial credits and other political pressures on commercial banks to make loans or h o l d government debt. Continue reducing subsidies and cross-subsidies in energy, supplemented by budgetary support f o r p oorer families. T ake inventory o f a 11 o ther r emaining q uasi-fiscal sources o f finance. 97 0 For the medium term: Incorporate all extrabudgetary funds other than the Social Protection Fund into the government budget. Continue reducing quasi-fiscal sources o f finance according to established benchmarks. b) Calculate and reduce risks associated with contingent liabilities. 0 For the short and medium term: Identify the most important contingent liabilities for the government budget. Given an account o f these liabilities in the state budget, develop facilities to monitor contingent liabilities effectively and calculate the corresponding risks. Develop a strategy for controlling and reducing risks from government guarantees and other contingent liabilities. c) Eliminate individual tax exemptions. Reduce sharply other tax exemptions. 0 For the short term: Identify and evaluate existing tax exemptions. Eliminate tax exemptions granted on an individual basis. Develop a strategy to reduce remaining tax exemptions according to explicit targets. 0 For the medium term: Achieve reduction in the amount o f granted tax exemptions according to explicit targets. d) Improve and tighten conditions for financing the government budget deficit. 0 For the short term: Cease direct National Bank finance o f the budget deficit. Establish conditions for placing state securities o n the basis o f transparent competitive auctions. Fulfill all state debt obligations according to contract (no unilateral restructuring or rollovers). 0 For the medium term: Uphold commitment to these practices. e) Rationalize utility pricing 0 For the short and medium term: Continue the program for reducing indirect subsidies and cross-subsidies, while introducing a transparent methodology that relates utility prices to long-run marginal costs. Develop parallel program to compensate poorer households directly from the budget. f ) The creation o f an effective and sustainable pension system 0 For the short term: Identify the primary risks in the pension system. Cease the funding o f non-pension or insurance-related expenditures from the Social Protection Fund. Increase minimum pension age. Consider reform options to ensure effectiveness and sustainability o f the pension system. 0 For the medium term: Accelerate preparation o f the pension reform. 98 g) Improve cooperation between the Ministry of Finance and the Central Bank. 0 Promote a greater sharing o f economic information, data, perspectives, and projections. Create joint committees for the examination o f questions pertaining to macroeconomic policy o f concem to both the National Bank and the Ministry o f Finance (Government debt and guarantees, for example). 111) Measures aimed at strengthening the link between government objectives and expenditures. a) Develop effective methodology for regulating wages in the state sector. 0 For the short and medium-term: Work out an effective methodology for regulating and restraining wage growth in the state sector in a manner consistent with state objectives and the imperative o f reducing state expenditures. b) Develop sector strategies to link budgetary expenditures with state objectives. 0 For the short-term: Work out strategies in various sectors that assess and modify existing programs and expenditures with the underlying goal o f achieving specific government objectives. Introduce a more ambitious strategy, including a sector envelope approach to budgeting, in a pilot sector. 0 For the medium-term: Continue to develop and expand sector strategies. Spread the practice o f envelopes to other sectors. c) Improve practices of state-financed fixed capital investment. 0 For the short term: Develop clear criteria for the cost-benefit evaluation o f investment projects. Take inventory o f existing investment projects and their degree o f completion with the goal o f eliminating ineffective or non-financed programs. Clarify a proper division o f capital and current expenditures in the budget. 0 For the medium term: A full scale implementation o f the new approach to capital expenditure budgeting. d) Take full inventory o f state subsidies to the productive sector and ensure their steady reduction. 0 For the short term: Take inventory o f the quantities o f various direct and indirect subsidies given to producers, and develop a strategy to reduce subsidies over time according to well-defined benchmarks. 0 For the medium term: Realize the subsidy reduction program according to given benchmarks. 99 e) Limit the use of protected items in the budget. 0 For the short and medium term: Evaluate the opportunity costs associated with protected items in the budget and develop a strategy for their reduction, along with the introduction o f a more comprehensive system o f financial planning and commitment control. f ) Improve budgetary preparation 0 For the short and medium term: Base budgetary preparation o n more realistic and consistent economic projections. Develop increased capacity for such forecasting. Review the role o f budgetary organizations in budgetary preparation, with a view toward greater decentralization and accountability. IV) Measures aimed at increasing efficiency in the use o f budgetary resources. a) Improve the legal and normative base for budgetary preparation and execution. 0 For the short-term: Strengthen the legal foundation o f the planned budget by requiring the approval o f Parliament for substantial revisions. Draft and submit the Budget Code to Parliament. 0 For the medium-term: Implementation o f the Budget Code. Realize a greater commitment to upholding the planned budget. b) Increase the scope and effectiveness o f the state treasury. 0 For the short-term: Develop a program for the expansion o f the state treasury to include all ministerial revenues, funds, and accounts, including those o f the power ministries. Develop o f system o f short-term forecasting for more effective cash management and commitment control. 0 For the medium-term: Realize the expansion o f the treasury and more effective cash management and commitment control according to explicit targets. c) Internal and external monitoring and control. 0 For the short term: Demarcate responsibilities for internal controls between the SCC and Ministry o f Finance in a clear and precise fashion. Begin plans for introducing performance-based audits. Prepare for creation o f an external auditing agency. 0 For the medium term: Begin introducing performance-based audits. Progress in the creation o f an external auditing agency. 100