Policy Note 83079 September 2013 PUBLIC FINANCIAL MANAGEMENT REFORMS More Efficient Public Expenditure for Strong and Inclusive Growth Significance Cambodia has achieved impressive economic growth, with an average annual GDP growth rate of 8.1 percent over the period 2000-10, and a dramatic reduction in poverty from 53.0 percent in 2004 to 20.5 percent in 2011. Notwithstanding these achievements, further progress is needed to raise living standards of those living just above the national poverty line, and help the more than 2 million people who are still poor. The critical challenge ahead for Cambodia is to ensure sustained high growth without social exclusion. Sustained strong inclusive growth will require both public investment in physical infrastructure and human capital (including health and education), and assuring equal access to quality public services. The need for increased investment, coupled with the expected decline in Overseas Development Aid (ODA), will mean greater dependence on domestic revenues. This will require improved standards in the ways in which the Royal Government of Cambodia manages its public finances. Increasing fiscal space by reducing tax exemptions and improving collection should provide larger allocations. This is one side of improved public financial management (PFM). In addition, on the expenditure side, this should be accompanied by more efficient and effective spending, together with more transparent rule-based governance. Improving both aspects of PFM will promote strong, inclusive growth and better quality services for citizens. However, revenues (excluding grants) are lower in Background Cambodia than in other low-income countries (Figure 1), due in large part to generous tax exemptions and incentives, In 2011, the World Bank, in cooperation with the Government and widespread tax evasion. The foregone revenue incurred and development partners, conducted an Integrated by the Government’s tax holiday on companies’ profits Fiduciary Assessment and Public Expenditure Review represents more than 2 percent of GDP. These tax (IFAPER). The IFAPER analyzed the structure and exemptions, together with those from paying customs duty efficiency of government spending in Cambodia, with and excise and other tax incentives, represent a fiscal space an emphasis on agriculture, education and health. This that could be enlarged to enable more public investment anal y si s wa s su p p l e me n te d by a re vi e w of p ub lic that is critical to sustaining strong and inclusive growth. financial management (PFM). The key motivation of the IFAPER and the objective of its Figure 1. Revenues excluding grants are lower recommendations are to support sustained strong growth in Cambodia than in other low-income countries (in percent of GDP in 2008) in income and employment, to help reduce poverty, and to ensure fiscal sustainability in Cambodia. This note 40 summarizes some of the key findings of the IFAPER and 35 sets out its main conclusions and recommendations to the 30 RGC, taking into account developments since publication in 25 November 2011. 20 15 10 Revenue 5 0 RGC’s revenue has increased substantially , and is Cambodia Low-income ASEAN East Asia OECD forecasted to reach 14.2 percent of GDP in 2013, up from 13.1 percent in 2010, reflecting the Government’s Source: World Development Indicators, the World Bank commitment to enhanced revenue collection. 1 Policy Note Public Financial Management Reforms agricultural growth. The analysis confirms that government Public Spending spending has rightly focused on the provision of public goods and services, which have high rates of returns, rather Public spending in Cambodia to date has been substantial, than on subsidies. There is, however, good potential for is comparable to other countries with similar per-capita further efficiency gains on resources spent. income, and has contributed significantly to positive development outcomes. There is also little difference Cambodia has no policy-induced distor tions in in the composition of Cambodia’s spending relative to agriculture. However, a complex set of structural comparable countries (Figure 2), although Cambodia is constraints have hampered the effectiveness and lagging behind on three of the nine MDGs. efficiency of public expenditures. These include a lack of continuity in public funding, especially for Operation and Figure 2. General government spending is in line with that in countries with simmilar per-capita income Maintenance (O&M) costs, for extension services, and for (in percent of GDP, 2008 and 2009) agricultural research. Deeper institutional issues that could limit the long-term effectiveness of these expenditures 30.0 Cambodia1/ Kenya also need to be addressed. Other challenges include an 25.0 Burkina Faso Ghana excessive focus on rehabilitating primar y irrigation 20.0 Benin infrastructure and a neglect of secondary and tertiary Mali Cambodia (2009) systems; a neglect of maintenance of irrigation and rural 15.0 Lao PDR Bangladesh Cambodia (2008) roads; and the slow pace of development of new 10.0 technologies for rural roads. 5.0 The Government could get better value for money by 0.0 reallocating spending within the existing envelope 450 500 550 600 650 700 750 800 on agriculture. In the short term, more resources for Source: World Development Indicators agricultural research, extension services and secondary Note: 1/ Overall public spending for 2009 irrigation canals, and smaller allocations for strategy and planning, are among the recommendations for the There is room for improvement, in terms of both authorities to consider. Researching mitigation and allocations and efficiency in spending. Such improvements adaptation measures will help prepare Cambodia for climate would make more funds available for priority areas without change. An extension of funds within the existing budget increasing the overall level of spending relative to GDP. This envelope, or larger allocations from donor grant resources, is illustrated in the following examples of public spending in to secondary canals and associated infrastructure will agriculture, education, and health. also bring substantial benefits. Over the medium term, the authorities are invited to consider the economic viability of new technologies for rural road rehabilitation and Agriculture Spending maintenance. Agriculture is a Government priority, as one of the core sources of economic growth and export earnings. Health Spending Although from a low base, government spending on agriculture has risen from 1.3 percent of GDP in 2007 to Cambodia has achieved remarkable health gains over 1.5 percent in 2009, mainly through significant increases in the past decade. Overall spending on health increased, outlays on irrigation and rural roads (in this note, spending but out-of-pocket spending outlays still predominate, on agriculture includes outlays on agriculture, rural roads, placing a burden on the poor and making catastrophic care and water resources). This period of rising public spending too expensive for people of most income levels. on agriculture overlapped with relatively high annual growth rates of agricultural output. Although insufficient time has While spending more on certain categories of elapsed to assess with confidence whether there is a causal healthcare could help improve health outcomes, it relationship between the level of public spending and is crucial that any such allocations be accompanied agricultural growth in Cambodia, available evidence by measures to increase the efficiency of existing suggests that public expenditures, along with spending and be funded, at least in the medium term, improvements in the policy environment, may indeed by savings within the sector. First, the efficiency of have had a significant impact in boosting and sustaining expenditures on healthcare could be enhanced by more 2 Policy Note Public Financial Management Reforms efficient purchasing, particularly for pharmaceuticals, of the Ministry of Education, Youth and Sports also needs medical equipment, and supplies. Savings could exceed to be strengthened to process data for decisions related US$50 million a year, or one-third of government health to policy planning and implementation. In particular, spending—the equivalent of 0.4 percent of GDP. Second, monitoring of the Educational Strategic Plan needs budget allocations for central departments, hospitals, and to provide an opportunity to revise policy actions on provinces should be based on transparent formulas and the basis of the level of achievements. Educational clearly agreed outputs. Third, mechanisms for budgeting quality, as measured by student assessment, needs to be and expenditure tracking should be strengthened at mainstreamed and scaled up from the current operational district and facility levels. Fourth, the shift project-based approach to provide a solid metric on which toward semi-autonomous service delivery arrangements for to base decisions and evaluate whether public resources hospitals and some health districts should be accompanied are being well spent. by measures to limit increases in user fees and to establish appropriate financing arrangements to ensure quality and continued access by the poor and near-poor. Improving the Foundation of PFM Savings from increased efficiency, together with Education Spending potential revenues from enlarged fiscal space, could provide more substantial spending for development Cambodia has achieved substantial progress in outcomes. However, this will require improvements in improving access to primary and tertiary education. the ways the Government manages its public finances. The emphasis now needs to be on improving access to The RGC has committed to enhanced PFM by adopting a early childhood education and secondary education, and public financial management reform program (PFMRP) and raising the quality of outcomes. As in other fields, education has achieved solid progress since 2004. This is reflected in, in Cambodia remains highly dependent on development among other things, improved budget credibility, enhanced partner support. Even with extensive external aid, however, revenue collection, and key technical upgrades. However, overall government spending is still only as large as progress has yet to match the Government’s ambitions and spending by households, placing a large burden on targets. segments of the population. Deeper achievements from PFMRP require better Government spending on education is in line with integration of public administration, decentralization, targets, but is lower relative to GDP than in countries and public finance management reform. The allocation with comparable per-capita GDP. Before considering of responsibilit y for ser vice deliver y and resource increases in overall spending on education, the authorities management is linked to staffing, and to how the whole are invited to consider the potential savings from the large civil service is organized. Delays in comprehensive civil decline in enrollment in recent years. Such savings would service and institutional reform directly influence progress be reaped only if the authorities can reallocate resources in PFM, and put at risk the sustainability of many hard-earned from schools and districts with declining enrollment. A gains. Assigning and devolving functions will better align small part of these savings—about 0.1 percent of GDP— responsibilities and sources of funding, and will help could be used to allocate sufficient funds to increase the improve the efficiency and effectiveness of service delivery. availability of textbooks. Some of these savings, or additional development-partner support, could provide additional The Government can benefit from better alignment resources for student scholarships. of strategic planning, budget preparation, and aid coordination. Development-partner support for public The framework of planning and budgeting works well spending is substantial (at about 40 percent of overall in education in general. There is scope for improving public spending), but is poorly coordinated. As a result, it the sub-program for providing school operating budgets. is less impact than intended. The recommendations for While devolving more responsibility, the authorities should enhanced PFM are presented below. The cost implications work to ensure that governance issues are adequately of the recommendations in agriculture, health, education addressed so that outcomes are improved. The capacity and PFM are shown in the final box. 3 Policy Note Public Financial Management Reforms Recommendations In summary, the IFAPER report presents the following key messages to strength public financial management: •  Increasing fiscal space through reducing tax exemptions, tightening collection, and restructuring existing spending should offer room for larger allocations to areas crucial for sustaining strong and inclusive growth. This includes infrastructure, adequate funding for rehabilitation and maintenance of existing capital spending, research and extension in agriculture, textbooks and guidebooks in education. •  Improving the quality, coverage and classification of items in the government budget is crucial for designing, executing and monitoring government policy and strengthening accountability. The authorities could benefit from bringing all government spending on budget, including disbursements on development-partner-financed projects, development-partner-financed technical cooperation and development-partner top-ups of civil service wages. Agreement is needed on the expenditure reports on development-partner-supported projects prepared using the Government’s chart of accounts (COA), which will enable their better integration into the budget. •  There needs to be better alignment between the budget, strategic planning and development-partner support. Sector strategies need to be designed with full cooperation between development partners and the Government. Achieving these goals will require improved collaboration among development partners to overcome existing fragmentation and heightened government leadership. •  Advancing reforms of PFM is crucial for ensuring public money is spent effectively and budgets, responsibilities, and rewards are better aligned. •  PFM reforms need to be better integrated with reforms of the public administration and decentralization and deconcentration. The allocation of responsibility for service delivery and resource management is linked to wage levels, staffing and the internal organization of the Government. •  The functioning of Cambodia’s processes for managing and spending public money needs to be set in the broader context of the manner in which the overall public sector operates. Substantial progress has been achieved in developing the foundations for an effective state. But several issues constrain the Government’s ability to deliver core services and all available studies point to persistent high levels of corruption. •  Establishing more effective, transparent and rule-based governance remains at the heart of Cambodia’s development challenge (and at the center of the World Bank’s support for the country’s future). Progress in improving public finances is critically dependent on progress in enhancing transparency, accountability, and participation. Cost Implications of Main Recommendations Main recommendation Fiscal impact per year Notes Agriculture Overall: broadly neutral Reallocation of spending Allocate more resources for research, extension and within existing envelopes secondary irrigation canals: less for strategy and planning. Health Overall: cuts spending Equivalent to one-third of Improve the efficiency of purchasing pharmaceuticals and medical supplies. Saves 0.4% GDP health outlays Increase outlays on health equity funds Spends 0.01 – 0.05% GDP Education Overall: broadly neutral Possible increase in Free space from the 12.5 percent drop in primary enrollment Saves 0.02 GDP development-partner Spend more on early shildhood education, scholarships Spends 0.05 GDP support and student textbooks Public Financial Management Overall: increases revenue Potential of achieving Reduce tax exemptions Saves 0.6% GDP 6-7% GDP The World Bank Office For further information, Funding for the PFM trust fund from the please contact: AusAid, EU, and Swedish SIDA is gratefully No. 113 Norodom Blvd. Phnom Penh - Cambodia acknowledged. Tel: (855 23) 861 300 Leah April Fax: (855 23) 861 301/302 Senior Public Sector Management Specialist Visit our website: (lapril@worldbank.org) http://www.worldbank.org/cambodia Linna Ky This note reflects the views of the authors and not Team Assistant Phnom Penh necessarily those of the World Bank and the donors. (lky@worldbank.org)