Annex_9_-_Report_on_the_Technical_Review_of_the_MTEF.pdf

USAID Partnerships for Development – Technical Review of MTEF Process 1

PARTNERSHIPS FOR

DEVELOPMENT

A TECHNICAL REVIEW ON THE MTEF PROCESS IN

KOSOVO

December 23, 2014 This report was produced for review by the United States Agency for International Development. It was prepared by USAID Partnerships for Development implemented by Chemonics International, Prime Contractor, and Crimson Capital Corp. and Policy and Management Consulting Group, Subcontractors.

CONTENTS

1. INTRODUCTION

2. THE MEDIUM TERM EXPENDITURE FRAMEWORK – KOSOVO BACKGROUND

3. LEGAL BASIS AND THE ASSESSMENT OF CURRENT PRACTICES

3.1 Legal framework

3.2 The Budget Cycle

4. KEY AREAS FOR IMPROVEMENT

4.1 Policy Priorities and Budget Planning

4.2 Macro-Fiscal Forecasts

4.2.1 Revenue forecasts

4.3 Data Quality and Classification Issues

5. FROM A BUDGET CYCLE TO AN MTEF PROCESS

6. RECOMMENDATIONS

1. INTRODUCTION

This note summarizes the findings of the review of medium term expenditure framework (MTEF) planning process in Kosovo. The purpose of this review was to identify weaknesses related to current MTEF planning practices and to propose recommendations to the Government of Kosovo (GoK) on improving the process and content of future MTEFs. The recommendations presented in this note can serve to GoK as a tool to increase medium term budget planning effectiveness, and improve governance by enhancing transparency and accountability. Using this note, GoK can also better utilize and coordinate available donor support to step up efforts for improving medium term fiscal planning.

The main finding of this report suggests that promoting the understanding of the MTEF as a concept that represents a planning process, and not merely a budget document, and hence fully integrating the budget cycle within the MTEF cycle, is the key to future improvements. Other specific shortcomings identified with this review, and the respective recommendations, are elaborated in sections below.

It should be noted that for any improvements to be made, there is a need for the high level decision makers to support the civil service in implementing required improvement measures.

This note is organized into 7 sections. After the introduction, the second section provides the background to MTEF development in Kosovo. The third section presents a situation analysis of the current approach. The legal and institutional framework and the current budget cycle are also described. As part of section four, the report describes the key MTEF areas reviewed in this exercise and an assessment of how these need to improve. The fifth section summarizes how an improved MTEF process would be implemented and describes recommended changes to the budget cycle. Section six presents the specific recommendations for the Government of Kosovo to consider.

2. THE MEDIUM TERM EXPENDITURE FRAMEWORK – KOSOVO

BACKGROUND

Governments undertake activities that span well beyond a single budget year, and have multiyear fiscal implications. Decision makers need to assess policy affordability and effectiveness for at least two years ahead of the current budget year to achieve policy consistency and reach long-term policy objectives. In addition, planning over the medium term increases predictability and enhances transparency of fiscal policy. Ultimately, it improves governance, and focuses expenditure on strategic objectives rather than ad-hoc initiatives.

In Kosovo, multiyear fiscal planning started with the adoption of the Medium Term Expenditure Framework in 20051. While the first MTEF was mostly table-based with no government-level policy content, the next versions improved considerably, with the one presented in the Donor Conference for Kosovo in 2008 (MTEF 2009-2011) highly valued by all stakeholders, including the donor community. However, in later years, producing the MTEF was seen more as a legal obligation and not necessarily as a policy and spending document to guide the allocation of public funds.

1 MTEF 2006-2008, accessed through MoF archives

When the GoK first adopted the MTEF, it was seen more of as a process which would enable the implementation of policies with multiyear fiscal implications without endangering overall fiscal stability (spending more than the available resources). The MTEF was also developed to serve as a roadmap for linking donor aid to a financing gap, defined as the difference between the necessary level of public spending and the level of financing available through the budget. For example, on July 11th 2008, at the Kosovo Donors’ Conference, aid commitments targeted the financing gap identified with the 2009-2011 MTEF. The association of the MTEF with donor aid allocation created the need to have a document which provides a list of aid “requests”. Thus, since its inception, the MTEF was largely perceived as a document rather than a process.

From 2005 to 2008, the MTEF was used to plan medium term expenditure at the level of “sectorial priorities.” This meant that GoK would prioritize among different areas of policy –termed sectors– and then develop a fiscal plan for the distribution of expenditure among each sector. However, the definition of a sector was not standardized, meaning that the presentation of expenditure by sector varied between different MTEFs. Moreover, it was not clear whether a sector referred to a group of economic activities or to group of government functions. Thus, in addition to being perceived only as a document, the consistency of the MTEF over year grew weaker because it was hard to track how priorities changed between sectors, or within each sector.

Since 2010, the preparation process of the MTEF, as a document, became very similar to the annual budget planning process, and three year expenditure ceilings, instead of sector ceilings, are now presented for each budget organization. This has constrained the role of the MTEF to a tool for the allocation of financial input based on budget organizations’ needs.

Before 2010, the MTEF planning process was centered at the Ministry of Finance, which at that time received extensive technical assistance. This ministry still continues to play the key role in preparing and submitting the MTEF, but coordination responsibilities are now more widely shared with line ministries and the Strategic Planning Office at the Prime Minister’s Office; which emerged as a new key stakeholder in the policy coordination process in 2010.

3. LEGAL BASIS AND THE ASSESSMENT OF CURRENT

PRACTICES

3.1 Legal framework

The preparation of the MTEF is described in detail under Section IV of the LPFMA2 “Preparation and Contents of the Proposed Annual Budget of the Republic of Kosovo.” Article 19.1 of the LPFMA defines in detail the requirements for the preparation of the MTEF, and sets the deadline for the approval of the finalized document by the Government - April 30th. This legal reference to the MTEF presupposes from the onset that it is a document which initiates the annual budget preparation process.

The current MTEF document comprises of four parts:

a) A statement of Government policy priorities

2 Law on Public Financial Management and Accountability (LPFMA, 03/L-048) http://gzk.rks-gov.net/ActDetail.aspx?ActID=2524

b) A three year forecast of the economic performance, revenue, and overall expenditure – the so called macro-fiscal forecast

c) Three year expenditure programs for each budget organization, including their mission statements, objectives, and performance measurement indicators

d) A presentation of the level of inter-governmental transfers, with central government grants to municipalities

A description of the legal basis for the preparation of these four parts and an assessment of the compliance of current practice to the legal requirements is presented below.

Statement of Policy Priorities: The legal basis for the preparation of a statement of policy priorities stems of Article 19.1(b) of the LPFMA, which states that the MTEF should contain a priority statement which “directs” budget resource allocations. However, further instructions on the form or the content of this statement are absent in the law. Articles 5.2 and 6.1 implicitly assign all responsibility for the technical preparation of the MTEF to the Budget Department and the Economic Public Policy Department at the Ministry of Finance.

The legal basis for the preparation of policy priorities as per current practice is defined in the Government Regulation of Rules and Procedure3 (GRP). Article 46.1 of this regulation defines a “statement of priorities” as a “policy framework” that shall precede the preparation of the MTEF.

Moreover, Article 46.2 of GRP specifies that the responsibility for the preparation of the statement of priorities lies with the Strategic Planning Office (SPO) within the Prime Minister’s Office.

None of this relevant legislation provides specific instruction on whether this policy priority statement should be a standalone document, published and approved by the Government before the Line Ministries and the Ministry of Finance start to plan expenditure, or only as a part that is integrated within the MTEF. Nor does the legislation clearly define responsibilities for preparation of the policy priority statement.

In summary, the current legal framework does not provide for a fixed deadline, clear instructions, and a division of responsibilities among different Government bodies, to enable a better integration of the policy planning component within the MTEF.

Medium Term Macro-Fiscal Forecasts: Article 19.1 of the LPFMA, describes in detail the requirements for the preparation of medium term macroeconomic and fiscal forecasts in the MTEF.

The LPFMA, provides sufficient instruction to support a coherent planning process for this part of the MTEF. However, in contrast to Treasury financial rules, there are no further sublegal acts, such as administrative instructions or internal regulations, that provide further technical instruction as to how revenues should be classified for budget tables, what principles should guide revenue forecasts, or which level of the Government should forecast revenues collected by municipalities in the medium term.

Current planning practices follow legal instructions, with one exception. The LPFMA requires that subsequent forecasts are consistent with each other - Article 19.1(d) - and that differences are transparently explained. In practice, however, MTEF estimates are not compared with those of the previous years.

3 http://gzk.rks-gov.net/ActDetail.aspx?ActID=8639#

Three Year Expenditure Program: The third part of the current MTEF presents central budget organizations’ tentative expenditure plans. In addition, within this third part, central budget organizations present their missions, objectives, and, starting with the 2014-2016 MTEF, key performance indicators, which are currently in their early stage of development. However, based on the LPFMA, Article 19.1(m), there is no requirement for the presentation of such detailed information with the MTEF. On the contrary, this information is part of the requirements for the annual budget documentation defined with Article 21.1(l) of the LPFMA.

Article 21.1 also requires a “short-term and medium-term fiscal strategy” to be part of the proposed annual budget. In addition, Article 20.8 of the LPFMA requires that a more formal link is established between the annual budget and the MTEF, by stating that the Minister of Finance has to submit to the Government an updated MTEF together with the budget proposal. However, the Law does not specify whether the entire MTEF document should be up-dated, or just the forecast of revenue and expenditure.

In practice, the presentation of the MTEF ceilings in the first budget circular represents the only link between the MTEF and the annual budget process. The annual budget proposal that is sent to the Government contains updated expenditure forecasts for two outer years alongside the next year’s budget proposal, as per Article 21.1, and the understanding at MoF is that this presentation automatically satisfies the requirements of Article 20.8 to present a medium-term fiscal strategy.

In conclusion, there are legal requirements relating to the annual budget process that are currently being applied in the preparation of the MTEF. Considering that the legally defined deadlines assign significantly more time to the preparation of the budget, overburdening the MTEF preparation process with additional tasks brings the quality of the input presented in its third part into question.

Moreover, the legal requirements for the preparation of the annual budget repeat many of the requirements for the preparation of the MTEF. This provides a clear indication that a better integration of the two processes would increase planning efficiency.

Inter-governmental transfers: The MTEF should present the level of Central Government grants for each municipality, as per Article 19.1(l). In practice, the fourth part of the MTEF, titled “The Municipal MTEF,” presents not only the grants, but also the forecasts of own source revenues for each municipality. Municipalities prepare their own Medium Term Budget Frameworks (MTBF) which have no basis in legislation. It is not clear from the LPFMA who is responsible for the forecasts of property tax revenues and the projection of own source revenues in the medium term.

Article 19 of the LPFMA presents only two obligations related to municipal budgets: the MoF should provide the municipalities their share of the total budget deficit, and inform in time the municipalities on the level of financing they will receive from the central level. Neither the LPFMA nor the Law on Local Government Finance4 (LLGF) clarify who formulates the medium term forecast for revenues collected by municipalities: the Ministry or the municipalities.

In addition to the legal requirements that define the MTEF preparation process (and its four components elaborated above), there are two other issues that need to be emphasized in relation to the current legal foundations for medium term fiscal planning.

The provisions defined in Article 44.4 of the LPFMA require budget organizations to present a “Declaration of Results” when they submit their audited financial statements to the MoF. This declaration should provide an analysis of how much budget organizations have achieved the

4 http://gzk.rks-gov.net/ActDetail.aspx?ActID=2525 objectives they have stated in the annual budget. However, such a provision is not implemented in practice, and as a result, the budget planning process, and subsequently the MTEF, does not take into account, at least not formally, any performance measurement input.

Finally, the LPFMA is a law that gives very detailed instruction on how public bodies should plan and run their finances. In the everyday operations of public institutions, it essentially serves as a financial manual. Thus, it is very important that it can be easily referenced, and well understood by all its users. However, the basic law has been amended three times to date, and, due to Assembly practices, the basic law and its amendments are not formally consolidated in a single document that is accessible by all users. In addition, in the course of its amendment, the law contains errors related to references in parts of the basic law which have not been amended. For example, Article 21.1 was reordered with the 2010 amendment, but the reference to this article in Article 44.4 has remained unchanged. In addition, the basic law and two of the amendments were originally written in English.

Without judging the translation into Albanian, continuous adaptation of the language in Albanian is highly important to make the law more comprehensible.

3.2 The Budget Cycle

Figure 1, below, outlines the most important stages of the current budget cycle. Observing current planning practices, the cycle is divided in three stages: the MTEF preparation, the preparation of the budget proposal, and the approval of the budget.

As depicted, the MTEF preparation process ends with the publication of the MTEF, on April 30th of each year. At this first stage of the budget cycle, the greatest responsibility lies with the MoF (the Budget Department and the Economic Public Policy Department), the Prime Minister’s Office (Strategic Planning Office), and the Line Ministries. The role of the PM’s Office in the MTEF process ends with the preparation of the Statement of Priorities which, as will be discussed in the next section, has limited impact over the allocation of funds during the second part of the budget cycle – the budget proposal preparation. While the Government Regulation of Rules and Procedures states that the Statement of Priorities should precede the MTEF, the preparation process of these two documents is usually implemented simultaneously, rather than sequentially.

During the first stage the MOF and the OPM coordinate amongst each other informally. The MoF sends preliminary forecasts of revenues and expenditures to the Strategic Planning Office around February, and the SPO sends the draft of the Statement of Priorities to the MoF for comments in March. Since 2013, this cooperation has been somewhat formalized at the technical level with the establishment of the Strategic Steering Group, which comprises of MoF and OPM civil service representatives and is headed by one political advisor of the Prime Minister. The aim of this group is to foster better cooperation among different government bodies involved in the preparation of the Statement of Government Priorities. Nonetheless, the involvement of a higher political level in the process of preparing the MTEF before its approval in the Government is still limited, and requires further development.

Once approved on the 30th of April and going forward into the second stage, the MTEF serves as the basis for the formulation of the budget ceilings for the first budget circular, but it has very little impact on what will be actually budgeted for over the next two years. From the issuance of the first budget circular, the preparation of the annual budget proposal proceeds as a separate process with weak linkage to the MTEF. Macro-fiscal forecasts are updated for the annual budget document, but no clear reference to the previous MTEF forecasts are presented. It is important to note that due to this division of the two processes, the budget hearings are primarily focused on the annual budget requests, and the primary responsibility for organizing and processing the conclusions of these hearings falls with the Budget Department at MoF.

This separation and weak linkage between the policy priorities and other strategic elements of the MTEF to the annual budget process has led to a situation where the MTEF is merely a ‘document’ approved at 30th of April which provides budget ceilings. It is not a continuous rolling process and there is no discussion of the budget over the medium term from the point at which the MTEF is finalized on April 30th until February the following year.

Figure 1: MTEF as part of the Budget Preparation Cycle

Source: Law on Public Financial Management, Government Regulation of Rules and Procedure, Partnerships for Development Project Staff observations of current practice

4. KEY AREAS FOR IMPROVEMENT

Medium term fiscal planning is a successful process only if there are clearly defined policy objectives which guide expenditure planning, and if sound annual budgeting is in place to inform and support the extension of the planning horizon. If a government is unable to formulate and respect a simple input driven5 annual budget, then, as economist Salvatore Shciavo-Campo puts it6, the extension of the planning horizon and its linkage to policy objectives will produce “elaborate facades of fiscal reform at high transaction cost, without improving budgetary outcomes.” The adoption of a medium term approach to fiscal planning should not shift focus, nor try to conceal lack of focus, from basic budgeting practices, i.e. realistic and transparent representation of financial obligations, conservative projection of revenue, or the ability to respect budget allocations without frequently deviating from the original budget throughout the year.

Thus, any improvement of the MTEF process should ensure robust annual budgeting practices, including best practice and transparency in developing fiscal forecasts. It should exemplify the best way of integrating annual budgeting practices within a three year horizon and providing a linkage to long term national policy priorities.

4.1 Policy Priorities and Budget Planning

A successful MTEF process requires a statement of policy priorities that can be clearly translated into a guide for resource allocation over the medium term. Policy based fiscal planning, where “policy priorities drive funding, not the other way around,7” requires the establishment of a mechanism which enables the translation of policy priorities into instructions for budget allocation decisions. To develop such a mechanism in Kosovo, the budget preparation process, on one hand, and the policy prioritization process, on the other, need to be modified.

The development of a policy based MTEF process starts with sound annual budgeting practices. In the context of developing a more policy oriented fiscal planning process in Kosovo, further development of program classification and functional classification into the budgeting system is one of the most important practices that would enable the translation of policies into instructions for budget allocation.

Currently, the program classification in the budgeting system resembles an administrative sub-classification. For example, if the administrative (budget organization) classification is the Ministry of Agriculture, examples of a program classification include the Agency for Agricultural Development, or the Kosovo Agricultural Institute. To adopt a more policy oriented approach to planning, program classification needs to reflect the activities that are undertaken to achieve policy objectives

– for example, “support for land fertilization.”

The adoption of functional classification in planning the budget also needs further improvement.

Currently, functional classification is adopted for reporting purposes, and the Ministry of Finance is carrying out activities to promote the adoption of functional classification in the budget preparation

5 A budget that is primarily based on planning the budget of each budget organization by line item, i.e. wages, utilities, equipment, etc.

6 See Shciavo-Campo, Salvatore. 2009. “Potemkin Villages: ‘The’ Medium-Term Expenditure Framework in Developing Countries”. Public Financial Publications, Inc.

7 ENV/EPOC/EAP/REPIN(2009)2 http://www.oecd.org/env/outreach/42942138.pdf stage, both at the central and at the local level of government. This practice is particularly important if equivalent, or very similar, classification is used to define policy areas or sectors, during the policy prioritization process, because it enables policy priorities to be mapped to broad budget allocations.

In order to create a mechanism for translating policy priorities into instructions for budget allocations over the medium term, policy priorities need to be consistent over and beyond the medium term. Prioritization of policies needs to be quantifiable through specific objectives to the extent that it provides a clear signal as to which budget requests (defined through activities/programs) need to be satisfied before others. Ideally, broad national priorities provide the signal for the prioritization of broad appropriations among different government functions, while medium term policy objectives provide the signal on which activities should be funded before others.

The current list of policy objectives in the current statement of policy priorities (SPP) is over-abundant. The definition of the four priorities, with around 17 policy objectives, for the SPP 2015- 2017 entails an all-encompassing range of policy areas, reflecting poor prioritization. Moreover, a standardized definition of policy areas or “sectors”, which would be similar to the classification of the functions of the Government in the budget and the MTEF process, is absent from the current statement of priorities.

The formulation of policy objectives in the current statement is not followed with any measurable indicators. The absence of such indicators leads to a reformulation of either existing or new objectives without any reference to the performance related to the achievement of previous objectives.

The SIGMA assessment8 for 2013 finds that while the legal framework is generally suitable for supporting medium term planning, MTEF implementation has not been able to provide a platform for policy based resource allocation. The report cautions that extensive focus on the annual budget inhibits the “development of [a] more strategic fiscal management” system.

Finally, in order to have a functioning mechanism for translating policy priorities into budget allocation decisions, it is highly important that the statement of priorities is continuously used as an anchor of policy direction during the budget negotiations between the Ministry of Finance and other budget organizations. Currently, the statement of priorities does not have a marked role in the negotiations that are carried out between the MoF and other budget organizations throughout budget hearings.

8 http://www.sigmaweb.org/publications/KosovoAssessment_2013.pdf

Decide on spending ceilings between Government functions

Decide which activity/program to fund first

Pr io ri tiz ed P ol ic y A re as

Medium Term Policy Objectives

4.2 Macro-Fiscal Forecasts

Sound, transparent and objective medium term fiscal planning is key to fiscal discipline and long-term stability. Since 2009, the LPFMA was amended three times to include measures which aim to ensure greater fiscal sustainability in Kosovo:

1) The requirement that mid-year revisions to the budget law cannot alter the level of deficit planned with the original budget (Article 25.5 of the LPFMA)

2) The requirement that any new law or an amendment to existing laws is submitted to the MoF for a fiscal impact assessment prior to its approval by the Government (Article 26 of the LPFMA)

3) The establishment of an Emergency Liquidity Assistance Fund with the Central Bank of Kosovo (Article 18.5 of the LPFMA)

4) The introduction of a fiscal rule which limits the level of General Government budget deficit at 2% of the forecasted Gross Domestic Product (Article 22.A of the LPFMA)

With the adoption of the fourth measure - a fiscal rule which limits the level of expenditure based on the GDP forecast and budget revenues – the quality of forecasts has gained a greater role in preserving fiscal sustainability.

However, forecasts need to be more realistic and evidence based. An unrealistic revenue and/or expenditure forecast may result in the Government adopting policies which are not affordable over the medium term. This may result with the Government either raising more debt, likely at a higher cost, or abandoning some policies altogether in order to cut expenditure and balance the budget.

While over the past years the Government has maintained its fiscal discipline with a number of measures on both sides (revenues and expenditures), going forward, it is highly important to enhance evidence-based forecasting of revenues and expenditures to avoid the risks of running high deficits.

4.2.1 Revenue forecasts

Since 2012, the actual budget revenues seem to have been below those forecasted through the MTEF and Budget. This suggests that going forward, more caution is required in forecasting revenue, since this projection is used as the basis for allocating budget expenditure.

For the revenue forecast, the MoF uses a methodology which is primarily based on national accounts and other aggregate economic data. Namely, a macroeconomic model follows various variables that monitor the health of the economy, and at the same time provides indications on what direction the economic activities (the tax bases), upon which taxes are levied, will move. This means that the forecast of revenue is broadly based on the expected direction of change of the overall economy (assuming no change on tax policy). However, in addition to using the projections for the performance of the economy as a basis for revenue forecasting, in some cases revenue projections are also driven by the pressing needs for more government spending and the assumptions for a marked improvement in the performance of TAK and Customs, mainly taking into account measures to reduce the tax gap9 (the example of 2014 and 2015 projections). The inclusion of such elements in revenue projections, without clear and measurable actions to be taken to reduce the informality, 9 The difference between what can be collected if there was no tax evasion and what is actually being collected may result in unrealistic expectations for budget revenues, which in turn leads to higher budget spending and consequently higher deficits.

A transparent analysis of the precision of the forecasts from year to year is very important for making them more realistic. Article 19.1 (d and e) of the LPFMA requires that the most recent MTEF should contain a table summarizing all changes compared to the current annual budget and the two outer fiscal years. Currently, the MTEF forecasts are compared to the current year’s budget forecast, but changes between different outer years’ forecasts are not fully explained (i.e. the revenue and expenditure forecast for year 2015 made in 2012 to the revenue and expenditure forecast for 2015 made in 2013.)

The inclusion of assumptions about additional revenues coming from a narrowing tax gap without clearly indicating the measures to be taken weakens the credibility of forecasts, beyond an acceptable margin of error that comes from model based forecasts. Moreover, differences between forecasts made in one year to the forecasts made in another year should be transparently disclosed.

Currently, MoF measures the performance of Customs and the Tax Administration in terms of the ability of these agencies to collect revenue at the level of the budget forecasts. In turn, budget forecasts are internalized by TAK and Customs as monthly revenue collection targets. The common term that is used to describe this forecast-based target is “the revenue plan,” which collection agencies either “meet” or “don’t meet.”

In principle, if revenue forecasts are realistic and appropriately updated, and if they are followed with a robust assessment of the tax gap, then they can provide information on whether current revenue collection is in line with an expected compliance rate.

Nevertheless, if there are data quality issues related to the forecasts of tax base itself, and if there is no robust assessment of the tax gap, then forecasts should be used with caution both in organizing and in evaluating the work of the collection agencies. The role of these agencies is to administer/implement the tax legislation, and encourage taxpayer compliance (which does not depend on them only). As such, their performance should be evaluated based on the efficacy of administering taxes, not solely on the level of revenues collected.

Performance measurement metrics, and the work of the collection agencies, should be focused on a plan that makes compliance with tax obligations easy and simple, and not on a “revenue plan” which agencies strive to meet at any cost. Focus on highly pressurized revenue targets may lead to practices which are not in line with efficient and transparent tax administration.

4.3 Data Quality and Classification Issues

A consistent forecast of economic variables, and consequently of revenues and expenditures, is conditional upon timely and reliable economic and fiscal statistics. Data input for the formulation of revenue forecasts comes from the Kosovo Statistics Agency (KSA) and the Central Bank (CB), on one hand, and the Treasury Department, the Tax Administration, and Customs, on the other hand.

KSA publishes national accounts data once a year and with a 9 month lag (very recently they also started with quarterly GDP data, with a target publication lag of three months). It publishes labor force survey results twice a year, with a lag of over 6 months, while consumption price statistics are the only ones to be published on a monthly basis. KSA also publishes the Household Budget Survey and the Structural Business Survey results once a year, with an undefined publication time lag.

The frequency, and more importantly the lag, with which national accounts are published limits their usage for fiscal planning. Moreover, little information is given on the methodology used to compile the national accounts, and different KSA data are not consistent. Private consumption, for example, which is calculated for the national accounts, is significantly different from the estimated household consumption based on the Household Budget Survey. In fact, these two estimates should be the same.

In general, timeliness and consistency of data produced by the KSA requires improvement to enable the preparation of better quality of fiscal forecasts

The Central Bank publishes data on the balance of payments (including imports and exports of services, remittances, foreign direct investment) as well as financial sector data (loans, deposits, interest rates, non-performing loans rates, etc.) between one and three months after the end of the period. This data is adequate to support the preparation of forecasts.

Data for actual revenues is obtained from the Kosovo Financial Management Information System (KFMIS), which consolidates data on both tax and non-tax revenue from all Government bodies that collect revenue. The frequency of the data is adequate as it can be accessed by the MoF on a daily basis. However, there are a number of pressing issues that are related to the quality of current revenue data used for the preparation of MTEF forecasts:

• TAK and Customs currently report to the KFMIS the collection of tax arrears, as well as accumulated interest and penalties pertaining to a particular type of tax, as regular tax revenue. Thus, MoF forecasts are formulated treating collection of tax arrears, and income from interest and penalties, as regular tax revenue

• Property tax revenue data reported to KFMIS provides information on the inflow of cash related to this type of tax, but it does not provide any division between the inflow that resulted from interest and penalties, on one hand, and the amount resulting from tax paid, on the other hand. Also the MTEF, the Budget and Financial reports, all group property tax as an own-source revenue, and do not classify it with other tax revenues. The exclusion of property tax from other tax revenue does not reflect the total tax base in Kosovo.

• Tax revenue is not reported by type of tax, in line with Government Financial Statistics (GFS) Manual classification10 in the budget tables. And, although the Chart of Accounts that is prepared by the Treasury Department entails a classification that follows GFS standards, summary tables provide only information on revenue by type of tax in the footnotes.

• Non-tax revenue is also only reported by administrative classification, meaning the level of government that collects it, and not by type of fee or charge that it represents.

The improvement of the quality of data used as input to prepare the forecasts, as well as a transparent and standardized classification of forecasts (and actuals), is an important area that needs to be addressed to increase the quality of macro-fiscal forecasts in the MTEF process.

10 https://www.imf.org/external/pubs/ft/gfs/manual/

5. FROM A BUDGET CYCLE TO AN MTEF PROCESS

The promotion of MTEF as an overarching strategic fiscal planning process requires the evolution of fiscal planning practices - which are currently centered on the annual budget preparation cycle -towards an MTEF cycle (a cycle for the preparation of three year expenditure plans based on policy objectives). This requires more substantial involvement of the higher political level in order for the MTEF process to result in tangible policy decisions that are reflected in the annual budgets.

In order to shift the focus of fiscal planning from the annual budget towards a policy driven MTEF, the MTEF process should end with a three year budget program, which incorporates the annual budget proposal that is submitted to the Parliament.

This report recommends that the MTEF process should comprise of three stages, resulting in three documents, which should all be approved by the Government:

• the statement of policy objectives,

• the medium term fiscal plan, and

• the medium term budget program.

A high level government committee – like the Government Fiscal and Budget Issues Committee (FBIC) which is already established but inactive, or a similar body with clear scope of work - should provide political guidance during all three stages of the MTEF process, ensuring political engagement is maintained both prior and after the Government approval of the documents.

From January to March, the process should focus on preparation of preliminary macro-fiscal forecasts and the formulation of policy objectives (the statement of policy objectives). The latter part of the process is not clearly identified as a stage of the current MTEF process, and it is prepared rather independently. Going forward, the focus should be placed on formulating medium-term specific and measurable policy objectives within prioritized policy areas, which could derive from a longer term strategy, if such a document is adopted by Government.

These policy objectives would then feed into the second and the third stage of MTEF, the medium-term fiscal plan and the medium-term budget program. There can be no automatic mechanism to translate policy objectives into budget ceilings. Rather, clear political signals are required to ensure that the structure of the expenditure follows policy intentions, and the role of high level government committee should be to provide these signals.

The statement of policy objectives should be a separate document and approved by Government as such, which contains a policy matrix which is then attached to the next document of the MTEF, the medium term fiscal plan.

By end-April, the Government should prepare a general medium term fiscal plan. This next stage of the MTEF cycle should be focused on offering a more analytical assessment of the available resources over the medium term, including a robust forecast of revenues by types and a more thorough assessment of fiscal risks. It should not strive to provide ceilings for each budget organization. Rather, it should give an orientation of spending per different sector (policy area).

The allocation of expenditure between different policy areas does not only involve the allocation of additional revenues. Particularly when there is no additional revenue available, this mechanism calls for the reallocation of existing funds from one policy area to another. Such decisions require higher involvement of the political level, and the involvement of a committee similar to FBIC would ensure the political ownership.

The LPFMA, Article 19.1.m. requires the MTEF to present estimated expenditure ceilings for every budget organization that is not a municipality or an independent agency. The medium-term fiscal plan, as opposed to the current, more detailed, MTEF document, should focus on setting minimum ceilings that guarantee undisturbed provision of public services, while at the same time and identifying a total undistributed amount that can be allocated to budget organizations during the development of the annual budget and the three year budget program.

Starting in May, the entire process should be focused on developing a three year budget program in parallel with the development of the annual budget proposal. At this stage of the process, the first budget circular should provide tentative ceilings per each budget organization, including a distribution of additional funding or cuts based on sector ceilings as per the fiscal plan developed at the end of April. Again the role of the FBIC (or a similar body) should be to oversee the first tentative allocation of expenditure by budget organizations, based on a government approved fiscal plan which provides ceilings by sector. From there on, the process should focus on budget organizations, which receive the circular and start developing their three year budget programs, where the first year constitutes their proposal for the annual budget. These programs include the development of policy objectives and key performance measurement indicators, which should broadly derive from the first part of MTEF – the statement of policy objectives.

This final stage of the MTEF process should then culminate with the discussions on the proposed plans during the budget hearings. The key concept here is that all discussions on the annual budget proposal should be linked to the three-year budget program, which not only includes estimates for expenditure in the two outer years, but also presents qualitative planning components such as KPMI and budget organization’s plans to reach national policy objectives. During these hearings, the declaration of results, as per Article 44 of the LPFMA, should also be a criterion for discussion.

The negotiations during budget hearings should incorporate active involvement of all stakeholders, not only the MoF Budget Department. They should be carried out between the MoF and the other representatives of the Strategic Steering Group, on one side, and other budget organizations, on the other side.

After the conclusion of these discussions, a three year budget program is approved together with the annual budget proposal. In this manner, the budget proposal, then, becomes indispensable from the MTEF process. No budget circulars should be sent out after the budget hearings. Rather, all budget requests should be based on agreements between MoF and BOs based on the hearings, thus increasing the importance of these hearings. The budget proposal should finalized after a final review of the Fiscal and Budgetary Issues Committee.

With the preparation of a three year budget program, as the final stage of the MTEF process, becomes essentially the preparation stage for the annual budget proposal, in a well-developed three year planning horizon, and in accordance with Article 21 of the LPFMA. More importantly, the budget proposal results from discussions that include more policy considerations.

Figure 2 presents a proposed process incorporating the improvements discussed in the previous paragraphs.

Figure 1: Proposed Planning Cycle

6. RECOMMENDATIONS

With a view to improving medium term planning practices in accordance with the vision described in section 5, the following recommendations are presented for consideration to the Government of Kosovo:

1) Implement the MTEF process in three stages: a) policy formulation; b) preparation of a general fiscal plan; c) and the preparation of a three year budget program, which becomes part of the budget as per Article 21.1 of the

LPFMA

2) Provide an MTEF calendar that highlights the strategic component of fiscal planning – namely separating the Statement of Priorities. In this regard, the Government can amend the Regulation of Rules and Procedure to:

a. define a fixed deadline and the format of the Statement of Priorities, and

b. specify the mechanism for translating policy objectives into three year budget allocation plans

c. incorporate the declaration of results (as per Article 44 of the LPFMA) in the MTEF process

3) The Ministry of Finance should Prepare a medium-term budgeting handbook that provides practical information of the MTEF as a process to promote a better understanding of the LPFMA requirements

4) The Ministry of Finance should support the adoption of functional classification and program classification in the planning stage, to enable expenditure planning based on the objectives of expenditure initiatives

5) Stated policy objectives prepared by the SPO should be defined in a measurable manner, and include measurement indicators for their evaluation. Both the 2008- 2010 and the 2009-2011 MTEFs contain a policy matrix which could be used again, with measurement indicators added next to expected output, already presented in those matrices

6) Budget Hearings, which are primarily focused the annual budget, should be utilized as a platform to link policy objectives to budget allocations in the medium term, thus fully merging the medium term planning process with the annual budget process. The discussions between Government stakeholders throughout the budget hearings should revolve around three year expenditure plans, and take the statement of policy objectives as a guide to filtering essential from non-essential expenditure.

The declaration of results (as per Article 44 of the LPFMA) should be also utilized during the budget hearing

7) Any forecast related to reduced informality should be quantified, linked with specific actions and transparently disclosed. A thorough tax gap analysis, accordingly updated, should provide the basis for any argument related to additional revenue resulting from reduced informality

8) Forecasts should be transparently compared across years, and based on a documented and regularly updated methodology. The responsibility for forecasting municipal level revenues needs to be clarified.

9) Classification of revenue and expenditure, in general, should adhere to IMF’s Government Financial Statistics 2014 Manual11. In particular,

a. The Tax Administration should provide a separate classification of current year’s tax revenue, tax arrears, penalties, and interest

b. Property tax revenue should be separated from non-tax revenue and clearly reported and forecasted as a direct tax. Classifying property tax within non-tax revenue prevents Government focusing on how property tax revenues will be improved from the base of current low compliance rate of 44%. Fees should be set on a cost recovery basis without any focus on universal increase or decrease.

c. The MTEF documentation should transparently present the stock of internal and external public debt that is being planned in the medium term

10) The Government should step up its support for a more timely preparation of economic and labor statistics prepared by the Kosovo Statistics Agency

11) The Government Fiscal and Budgetary Issues Committee should be modified and activated to provide enhanced political commitment to strategic planning

11 Page 49 and 63 of GFS 2001 Manual, https://www.imf.org/external/pubs/ft/gfs/manual/pdf/ch5.pdf, https://www.imf.org/external/pubs/ft/gfs/manual/pdf/ch6.pdf

U.S. Agency for International Development Mission in Kosovo

Ismail Qemali Street, No. 1

Pristina, Kosovo 10130 Tel: +381 (0) 38 243 673 Fax: +381 (0) 38 249 493

4.3 Data Quality and Classification Issues