the Local Government Development Program

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BOX 3.3 Main Features ofLocal Development Grants under the Local Government Development Program

The main characteristics oflocal development grants under the LGDP are as follows:

They include a nonsectoral investment menu (discretionary) but incentives to spend at least 80 percent on national priority areas and reduce investments on non-service-oriented areas. A certain percentage (15 percent) may be used for investment servicing and monitoring costs, including retooling. A transparent formula based on two criteria—population size (85 percent) and land area (15 percent)—is included. Urban authorities get a higher per capita amount because ofthe perceived additional costs ofexpenditure assignments in urban areas. The allocation system distributes grants to all layers oflocal governments, which ensures that grant allocations reach the lower levels. Clear minimum conditions exist as fixed requirements ofeligibility to receive the grants. There is a direct link between the size ofthe grant allocation and the performance oflocal governments, measured by the use ofdefined and agreed transparent generic indicators ofadministrative performance and national (external) assessments oflocal government performance. This link provides strong incentives for local governments to improve their performance. A link exists between the local development grant and capacity-building grants in the sense that, iflocal governments fail to comply with the minmum conditions ofthe local development grant, they may still receive capacity-building grants to enable them to comply as soon as possible. The grants contain an incentive (through the performance measures) to enhance local governments’ own revenue-raising efforts. There is a local government cofunding requirement, which is 10 percent ofthe grant.

Source: Steffensen and Tidemand 2004.

Therefore,the aim is now to concentrate the disbursement ofequalization grant in fewer local governments to make the grant more useful.Initiatives are under way to increase the size ofthe grant.A review ofthe equalization grant was part ofthe review ofthe allocation criteria under the FDS.

Other transfers ofspecific interest Uganda has designed a number ofunique grants.One ofthe most interesting is the PAF monitoring grant,which sets aside funds for local government monitoring and accountability institutions such as the LGPACs and tender

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boards.These grants have had a positive role in support ofthe financial management and control system in local governments and have ensured funds for areas that were previously not fully prioritized and funded by them.Furthermore,as part ofthe new FDS procedures,local governments may spend 5 percent ofthe recurrent grants on monitoring and supervising projects to ensure proper planning,budgeting,maintenance,and follow-up. Finally,the grant system has been used to pilot various initiatives in some districts,which are rolled out later.An example is the nonsectoral grant under the Plan for the Modernisation ofAgriculture.

Other funding flows—on budget and offbudget On top ofthese formal,budgeted transfers,historically there have been numerous transfers to specific districts that are neither coordinated nor basedon a thorough analysis ofneeds and poverty concerns (Steffensen, Ssewankambo,Tidemand,and others 2002).Some districts have received development funds from the European Union,the Danish International Development Agency,the Netherlands Local Government Development Program,and the World Bank,on top ofother development grants,whereas other local governments have received much less donor funding for development (for an overview ofthese programs,see MoLG 2002,xxvii;Steffensen,van’t Land,and Ssewankambo 2002).Other investments in the districts are made by the central government and NGOs without being incorporated in the district budgets.A review in 2002 showed that U Sh 333 billion was budgeted for investments in local government services and infrastructure in FY 2001/02 (including a share ofroad maintenance).Only USh 145.5 billion (budget 2001/02) was transferred through the local government budgets and accounts in the form ofdevelopment grants.Numerous studies have documented the problems—in terms ofplanning,budgeting,budget execution,and accountability constraints—with these multiple funding channels and the lack of information and overview ofthe funds transferred to local governments.

Resolving these problems calls for a more coherent effort and mainstreamed system to ensure that transfers are done in an objective,fair, equitable,transparent,and budgeted manner.The means identified has been the LGDP-II,which provides a common basis for coordinated and harmonized transfers ofdevelopment funds to local governments.The LGDP-II is expected to play a strong role in streamlining these channels,in line with the folding in ofdonor support and sectoral grants to one coherent,on-budget, intergovernmental,fiscal transfer system.

Hence,most district support programs with investment funds have been mainstreamed and brought on budget with the commencement ofthe

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LGDP-II.The remaining programs with funds for investments ininfrastructure and service provision outside the budgetary system are theNorthern Uganda Social Action Fund,covering 18 districts and offering support ofUS$3 to US$4 per capita,and a few smaller district support programs.

Timeliness in Transfers

The predictability and timeliness oftransfers to local governments have been problematic,although the situation had improved until 2002/03,when the increase in defense spending led to cuts that disrupted certain programs and activities (Kragh and others 2003,pp.v and 106).However,most ofthe grants to the local governments have been largely preserved,because the PAF arrangement has provided a budget shield against major cuts—especially regarding the PAF development expenditures—and the entire system is relatively predictable.Grants released in FY 2002/03 totaled U Sh 657 billion against the budgeted U Sh 670 billion (Kragh and others 2003),and the grants on salary had an overall budget realization of98 percent.14 Some areas with shortfalls were the roads grants and district primary health care grants. Most grants have been at a level of90 to 100 percent ofthe budgeted amount in recent fiscal years,15 but the transfer installments are sometimes delayed during the fiscal year.

Studies ofthe financial management performance oflocal governments show that the delays in transfer offunds negatively affect performance in service delivery,especially as investments are delayed,leading to bottlenecks and problems with contractors and financial management.The reasons for the delays (which typically last one to four months) are many and complex,16 but they often emanate from the lack oflocal government capacity to provide timely reporting (under requirements that are very demanding) on the use offunds already provided and to absorb the cash within the time available.There are also cash-flow problems at the center,17 some caused by lack ofgovernment cofunding ofdonor development projects and the inefficient banking system.The delays are problematic for the execution ofall local government budgets,especially at the beginning and end ofthe financial year.The last installment oftransfers is typically submitted rather late in the financial year (June),thereby forcing local governments to use the funds very hurriedly or send the unused funds back to the MoFPED.

The design ofthe reporting and accountability system,with its requirements to submit more than 20 elaborated quarterly reports to the center and with various detailed modalities,has also been a major cause ofsome ofthese problems.This area is being tackled by the ongoing FDSimplementation,

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tostreamline,harmonize,and simplify all reporting modalities on the fiscal transfers.

Use ofGrants

A number offactors can improve the use oftransfers:strong supervision of local governments’use ofconditional grants,as well as monitoring,supervision,and review ofthe quarterly reporting ofgrant use,combined with comprehensive expenditure tracking surveys that identify problems and lead to mitigating initiatives (World Bank 2003).For example,an expenditure tracking study conducted in 1996 showed that only 2 percent ofpublic nonwage education spending reached schools in 1991,owing to theft and the use offunds by district councils for purposes other than those budgeted.In 1999,more than 90 percent ofthe intended funds reached the schools (Therkildsen n.d.,based on Ablo and Reinikka 1998 and Collier and Reinikka 2001).Other sectors have also improved,although not yet to the same extent.Studies ofthe use ofthe nonsectoral LGDP grants have also shown promising results,ifthe grants are linked to a reward and sanction system that is based on performance and addresses local governmentincentives to use funds in the key national target areas.

Allocation Criteria

Allocation criteria vary greatly by type ofgrant.Most grant allocation criteria and grant modalities were analyzed in a recent comprehensive study (2002–03) that was part ofthe FDS,with specific recommendations on criteria and weights to be applied for each grant (LGBC 2003).

The objective is to elaborate new criteria that promote sector policies, that can ensure more equity across the country and that are transparent, objective,needs based,simple,easily understood,and perceived as fair in their effect on distribution.Recommendations from a study team have been scrutinized,and a close dialogue and negotiations have been conducted between the sector ministries and the local governments,represented by their associations.Tentative agreements have been reached on the basic parameters and the transitional schemes (to prevent making some governments losers,the system will be phased in).The criteria are being fine-tuned,and the new criteria are expected to be introduced in FY2005/06.

So far,the new criteria for the sector-specific conditional grants are not linked to local government performance,revenue mobilization efforts,and

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other incentives.However,such links are being considered for the future system under the FDS.

Local Government Borrowing and Debt Traditionally,local government borrowing has been a minor revenue source. According to article 195 ofthe 1995 constitution,“Subject to the provisions of this Constitution and with the approval ofthe government,a local government may,for the carrying out ofits functions and services,borrow money or accept and use any grants or assistance as parliament shall prescribe.”

According to schedule 5,part VI,article 21 ofthe LGA (as amended in 2001),a local government may raise loans by way ofdebenture,issue of bonds,or any other method,in amounts not exceeding 25 percent oflocally generated revenue,provided that the local government council demonstrates ability to meets its statutory requirements.

Borrowing also needs the approval ofthe minister oflocal government ifthe amount to be borrowed exceeds 10 percent ofthe total amount the council is eligible to borrow.The auditor general must certify the books of accounts for the preceding year,the report must not be qualified,and the funds must be intended for investments in priority activities as identified by the whole council.Moreover,the executive committee ofthe local government must guarantee that repayment ofthe loan will not adversely affect the operations ofthe council and,in particular,that the council will be able to meet its statutory obligations,including payment ofsalaries.

Pending revenue receipts,the local government may obtain an advance ofmoney not exceeding 10 percent ofthe approved budget as a temporary loan or overdraft and as part ofthe amount to be borrowed to defray that expenditure (LGA,schedule 5,part VI,article 21).There are no restrictions concerning the source offunding.

The newly adopted (2003) Public Finance and Accountability Act contradicts these provisions:

Subject to the provisions ofthe Constitution,the authority to raise money by loan,to issue guarantees,and to accept grants for and on behalfofthe government shall vest solely in the minister [for finance] and no other person,public organisation,or local government council shall,without the prior approval of the minister,raise any loan or issue any guarantee,or take any other action, which may in any way either directly or indirectly result in a liability being incurred by government (part III,article 20).

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The minister for finance decides the terms and conditions.The act also stipulates strong control by the minister for finance,and all loans need prior approval.The issuing oflocal government bonds may be perceived to be covered by the new Public Finance and Accountability Act and also requires prior approval.In addition,the act prescribes strong involvement ofthe parliament;any loan terms and conditions—except for the treasury and monetary policy management purposes—need to be laid before parliament and approved by a resolution (article 20,paragraph 3).There is,therefore,a need to harmonize the legislative framework in this area.

In practice,local government borrowing is very limited and typically restricted.According to an overview by the MoFPED,the total owed to net nonbank creditors and local government bank loans was U Sh 1.222 million and U Sh 400 million,respectively,in 2001/02—less than 0.2 percent ofannual local government revenues and 2 percent ofannual local government own-source revenues (MoFPED 2003).Official borrowing is limited for several reasons:

The amount ofown-source revenues is relatively small,and local governments can borrow at most 25 percent ofthis amount. Because ofvarious financial flaws,local governments have problems qualifying for loans. The approval procedures are cumbersome. The financial market for local government borrowing is lacking. Generally,there is a lack oflocal government creditworthiness.

However,local governments’short-term overdrafts and arrears are significant.Although there are only limited official data and no aggregate consolidated overview,evidence suggests that short-term arrears are a severe problem for many local governments,one that needs to be addressed soon (Kragh and others 2003).A recent financial management study offour local governments revealed that they did not have any bank loans but had significant outstanding payments and credits.Although specific figures were not available,the four local governments estimated their arrears at U Sh 100 million to U Sh 300 million (20 to 40 percent ofannual own-source revenues) and some had outstanding arrears of10 to 20 percent oftheir total budget—similar to the amount ofown-source revenues for the entire year. Strategy appeared to be weak,and there was no apparent provision in their budgets for clearance ofarrears.Oversight ofoutstanding payments was also weak.Creditor registers and ledgers were sometimes missing and often consisted ofonly a simple list ofcreditors,typically not properly updated.