A study on budget formulation by TINEPAL

A STUDY ON

BUDGET FORMULATION PROCESS OF THE GOVERNMENT OF NEPAL

A Study on Budget Formulation Process of the Government of Nepal

Chapter I

Report : A Study on Budget Formulation Process of the Government of Nepal

Research Consultant : Mr. Madhab Ghimire, Lead Researcher Mr. Khem Prasad Dahal, Researcher Mr. Dilli Prakash Ghimire, Researcher (The Molung Foundation)

Published : Kathmandu, November, 2015

Publisher : Transparency International - Nepal (TI Nepal) Chhakkubakku Marga, New Baneshwor Kathmandu, Nepal Phone: 977-1-4475062, 4475112 Email: trans@tinepal.org Website: www.tinepal.org FB/Twitter: tinepal Hotline: 1660 01 22211

Support : Royal Norwegian Embassy, Kathmandu, Nepal Copyright : Transparency International - Nepal (A National Chapter accredited by Transparency International) All Rights Reserved. ISBN : 978-9937-8679-9-3

The views and opinions expressed in the report do not necessarily correspond with those of Transparency International - Nepal

II A Study on Budget Formulation Process of the Government of Nepal

Preface There are some fundamental issues associated with public finance in Nepal, especially budget formulation and implementation. The budget formulation process reveals random changes in the public budget without adequate logic or implementation plan. Additionally, the lateral entry of administrative and political programmes expose inconsistencies in current public finance. Nepal needs to narrow the gap between allocation and actual spending in the annual budget. Both top-down and bottom-up approaches must balance interests of the country and its stakeholders â&#x20AC;&#x201C; citizens, businesses, government, parliament and donors. Abrupt political promises and commitments should not heavily influence the National Exchequer. Current capacity, skill, knowledge, attitude and innovation in public finance must be enhanced. Tools such as Medium Term Expenditure Framework (MTEF) and Minimum Conditions and

Performance Measures (MCPM) have to be aligned with Five Year plans of the Government. TI Nepal believes that this study provides an in-depth diagnosis of the budgetary processes and recommends pragmatic solutions. This study also complements our earlier publication - The Management of Funds in Local Bodies. We acknowledge the effort of the Research Team of the Molung Foundation led by Mr. Madhab Prasad Ghimire. Also we express our gratitude to the Royal Norwegian Embassy for funding this study. Our indebtness to those who supported this research in one way or another. Bharat Bahadur Thapa President

A Study on Budget Formulation Process of the Government of Nepal

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Chapter I

IV A Study on Budget Formulation Process of the Government of Nepal

Executive Summary The budget formulation process is a key activity of modern government. Budget is a financial instrument to implement government plans and programs to achieve socio-economic objectives of the government. Budget in Nepal is classified as recurrent, capital and finance. The recurrent budget comprises major headings of expenses such as consumption, office operations, grants and subsidies, services and production expenses, contingency and interest payment on domestic and foreign loan. The term capital expenditure is capital transfer, capital formation, and the finance is defined as investment in share and loan in corporations and the financial institutions, repayment of principal of domestic and foreign loan. The National Planning Commission (NPC) draws up the size of recurrent and capital expenditure in conformity with policies, programs and priorities laid down in the periodic national plan considering factors such as implementation capacity, the revenue projection, and availability of foreign grant and the extent of external and domestic borrowing. The Resource Committee (RC) which is chaired by the Vice Chairman (VC) of NPC decides on the budget ceiling for the next fiscal year (FY). In consultation with the Ministry of Finance (MoF), NPC sets out the priority and policy goals with respect to plans and programs for the forthcoming fiscal year and provides guidelines to the Line Ministries (LMs). MoF issues circular for budget formulation with budget ceiling to the LMs. The budget formulation process is not only the process of budget preparation; it is also the process of implementation. It should be noted that for the last several years, government budget was dominated by the recurrent budget and the capacity to spend the capital budget was weak. The aggregate fiscal discipline, allocation efficiency, and operational efficiency are complementary tasks in modern budget formulation. A well developed budget should serve these three objectives. The more typical approach may be to emphasize aggregate fiscal discipline because it is vital to political interest and financial stability. The second is operational efficiency which is compared with contemporary orientation of private and public sector management. It entails a fundamental reconsideration of the role of central budget formulation agencies. In the context of Nepal these three fiscal disciplines, allocative

efficiency, operational efficiency and equity are very important. The study has tried to analyze the aggregate fiscal discipline, allocative efficiency and operational and equitable efficiency. Indeed there are norms and guidelines which emphasize before any investment is to be made on any project; the project needs to be feasible from an economic, financial and technical points of view. The Financial Procedure Act clearly indicates that once a project is found feasible, detailed plans needs to be drawn up. Such a feasible project should be included in the government expenditure plan. Similarly, the government has standard monitoring and evaluation formats and time bound reviewing process. Monitoring and evaluation of development projects are carried out at different levels and has become ritual only without valuable feedback to the budget formulation process. A failure to spend capital budget on time, points to the failure to deliver goods and services to the general public. To address the problems associated with public financial management (PFM), many studies have been initiated by the government and the donor agencies. Independent non-governmental organizations like Transparency International (TIN) Nepal, initiated this study on PFM. In Nepal the budget formulation starts from the macro economic analysis. In macroeconomic analysis, the economic indicators of last year and four monthsâ&#x20AC;&#x2122; financial performance of the current fiscal year are studied in detail and the macroeconomic projection for the upcoming fiscal year is prepared. The RC prepares the total budget ceiling which is based on various indicators. Nepal uses both the top - down and the bottom-up approaches in budget formulation. The central government budget is prepared using the top-down approach. The cabinet approves the budget ceiling for the next fiscal year on the recommendation of NPC. NPC issues guidelines for the budget formulation with budget ceiling to the LMs. MoF issues circular downwards for the budget preparation within the limit of ceiling and guidelines. The next approach is bottomup approach, which starts from the ward level. Budget formulation at local level reveals that the process is

A Study on Budget Formulation Process of the Government of Nepal

participatory. User committees mobilize local resources and implement projects on a cost sharing basis. There is top-down and bottom- up approach parallel at the local level budget formulation process.

Chapter I

It is observed and analyzed that the amount of total budget is increasing in successive fiscal years. The spending of recurrent budget has increased. At the same time, the spending capacity of capital budget has decreased. It reveals that in our context operational efficiency is weak. For the purpose of analysis the gap between allocation and actual expenditure of capital budget, the study targeted 5 ministries: Ministry of Physical Infrastructure and Transport (MoPIT), Ministry of Education (MoE), Ministry of Irrigation (MoI), Ministry of Federal Affairs and Local Development (MoFALD) and Ministry of Health and Population ( MoHP). The Team analyzed the strengths and weaknesses, the opportunities and threats of the prevailing budget formulation process. The Government had initiated PFM reforms. The legal and institutional mechanisms were well designed and established. Many positive achievements have been observed .The up-to-date and readily available information are disseminated on a regular basis. The peopleâ&#x20AC;&#x2122;s participation in budget formulation is constitutionally ensured and peopleâ&#x20AC;&#x2122;s awareness of the need, practices and available resources is impressive. In spite of these achievements, the Team found gaps in the implementation process. The Team after consultations and meetings with stakeholders and study of the literature and observations found some problems in budget formulation and the implementation process. At the local level, budget ceiling is not received on time. As a result, delays in budget formulation are experienced. At the line agency level, budget forms are filled only. There are only formalities to participate in workshops. Lists of projects are compiled as there is no technical capacity to formulate financially viable project/projects. It is also noted that local level institutions have no resource estimation capacity as well. In principle the budget formulation process is meant to be bottom-up that reflects local needs and priorities in budgetary allocation but in practice the budget formulation process is top-down. Often local level programs proposed through local participation are inadequately funded. There is low level of interlink between local priorities and budget allocation. At the local level, there are frequent changes in political

VI A Study on Budget Formulation Process of the Government of Nepal

party representatives. The party at the local level does not appoint a representative on a permanent basis to attend Village Development Committee (VDC) meetings. This disrupts priority setting and results in delays in budget formulation. It also observed that civil society has not been able to analyze the problems and orient the participants accordingly on the basis of their analytical findings. The overall capacity of civil society is not at the expected level. In budget implementation, the first installment of the allocated budget should be released to DDC within the first trimester. But in practice there is delay in releasing the fund. There is weak institutional and technical capacity of the VDC and the municipalities. The people at the local level cannot express their needs. The setting of priorities is very poor due to shortage of skilled human resources. There is a provision of providing technical assistance from the district level but there is constraint, due to heavy workload and limited technical manpower. At the ward level, need assessment is not carried out but a listing of new projects creates a new basket of projects. Also feasibility study is not carried out. In many cases, the political party or their workers influence the user committees. DDCs are aware of irregularities so they only reimburse the fund of the project run by user committees. These committees in many places complete the formalities as the local contractor works on behalf of the user committees. Representatives at the local level and civil society groups are engaged in listing projects and sharing resources through user groups. The old organizational structure of DDC and VDC is in operation. The annual budget of local government is expanding each year. At the VDC, the operation is handled by a single junior staff, but the annual budget, including the funds for social security is huge. There is no accountant in the VDCs. The VDCs secretaries, discharge the duty of a financial officer. It leads to weak financial management in VDCs. There is a provision of monitoring and supervision of the performance of VDCs by DDCs but it is not functioning. There is a process of reviewing the progress of implementation but due to resources crunch it is rarely practiced. In DDC, the Office of the Auditor General (OAG) conducts final audit. But in the VDC the audit is conducted by a registered auditor appointed by the DDCs. The internal audit of VDCs should be conducted by DDCs on a regular basis. The Municipalities may create a position of an

internal auditor, or outsource the services of internal auditing. In practice, the internal auditing function is given least priority. It leaves a gray area for financial discipline. At the central level, problems exists in the present budget ceiling system, arising from many factors, among them: the approach of setting overall budget ceiling, incomplete coverage of government operation, the high level of re-budgeting through virement (transfer of allocated budget amount from one budget head to another), and off treasury expenditure such as revenue expenditure and foreign grant funded projects. The present budget ceiling is ad hoc and incremental. The budget request from Line Ministries (LMs) generally exceeds the budget ceiling. At the time of budget discussion, project wise negotiation takes place. The reduction in budget request to accommodate within ceiling sometimes crosses the limits of project prioritization. The key identification of central level budget includes expenditure prioritization. More than 80% of the capital expenditure budget is classified under P1 (priority one). Rest of the project expenditures are under P2 and P3 (priority two and three). Consequently, even the projects which deliver results with considerable delays are also funded in the annual plan. Once a project is included in the red book, it continues to receive funds in successive years. The budget formulation process which should be guided by social and economic objectives is driven more by political objectives. The capital budget is heavily over programmed because of political pressure. The donor agencies are eager to show their programs within the budget plan. But the major portion of the foreign grant is spent directly. Such spending is also out of the purview of the OAG. The revenue expenditure, without disclosure of how much is spent on tax exemption is in practice. Another gray area is allocation of a huge amount in contingency fund, making it less transparent as such fund is reallocated for off budget expenditure. In the process of implementation, project approval is delayed. It is reported that it takes two to three months to approve projects for the year. The budget implementation starts after the approval of the programme by the NPC. The procurement act requires formulation of an effective procurement plan. The offices feel it as a burden. It is very scientific, but the traditional mindset of officials does not allow it to be practiced in a proper manner.

The budget has provisions of grants to some departments and entities. The grant is transferred to other entities. The account of other entities or NGOâ&#x20AC;&#x2122;s is not audited by the OAG. Thus there seems a dilution of accountability. The LMs can reallocate their budget within the same category. This gives opportunity to play by political motives, weakening the accountability and credibility of the budget. The planning divisions of ministries are weak in terms of physical facilities, infrastructure and human resources. The field offices lack technical capacity and are overloaded with projects. The feasibility study and the cost benefit analysis are felt to be time consuming. The procurement procedures are started late, due to delays in the preparation of documents, estimation and design of the project. In many cases, low bidding also causes delay in implementation. The low bidding and cartels is hampering construction on time. The capital expenditure at the last trimester is now a regular occurrence. The Treasury Single Account (TSA) system is effective in cash management and timely reporting but in the absence of a clear mandate to carry out preaudit function, it has no effective, internal operational control. One of the indicators of openness of budget is the pre budget statement. In our context pre budget statement is prepared and submitted to the finance committee of the Legislative-Parliament but it is not formally published. Another indicator is citizen budget, there is no citizen budget in our context. The budget proposal is made available to the public but the enacted budget is highly technical. Based on key findings as well as observations of central level, the study team has made the following recommendations: Ensure all expenditure coverage in budget ceiling. The off treasury expenditure should also be covered within budget ceiling. n Prepare the budget ceiling in line with national development strategy, development priority, and institutional capacity in place of ad hoc instrumentalism. n Develop criteria for project screening to avoid unnecessary inclusion of scattered projects and inflated budget. n Make the budget comprehensive by including details of revenue expenditure and other off budget expenses. n Make the expenditure prioritization more realistic, based on specific criteria. Develop clear criteria

A Study on Budget Formulation Process of the Government of Nepal

VII

for prioritization of recurrent budgets such as grants, subsidies and transfer payments. Increase political understanding and commitment in budget formulation in line with social and economic objectives of the government. Ensure the size of the budget is consistent with the resources available and institutional capacity. Increase effectiveness of MTEF. Include donor agencies grants’ in budget and channel it through the treasury. Take into consideration the past performance of projects in budget formulation Use sensitivity analysis to forecast economic indicators. Cover all expenditures in annual budget. Ensure provision of a budget announcement date at least two months before the end of the fiscal year. It should be inserted in the constitution to avoid delay in budget preparation. Ensure project approval in time to reduce delay in project implementation. Keep mandatory provision of feasibility study of a proposed project , costing more than a designated amount before allocating resources at both the local and central level. Prepare a detailed action plan for each and every project. Prepare a procurement plan based on the prevailing price and make provisions for price changes in the plan to avoid delays in procurement of goods and services. Prepare procurement document beforehand to save time. Prepare well defined guidelines for project implementation. Ensure adequate allocation of capital budget and strengthen the implementation capacity of capital projects. Develop project performance tracking indicators and effective mechanism to avoid delays in project implementation and ensure timely correction of constraints and the problems experienced during implementation to avoid expenditure delay in capital budget. Make project monitoring more effective and practical. Enhance the capacity of planning divisions of each ministry. Increase physical facilities of planning division. Start providing pre budget statement, promoting citizen budget and make it available to the public in simple language.

Chapter I n n

n n n n n n

n n

n n n n

VIII A Study on Budget Formulation Process of the Government of Nepal

n Provide enacted budget in simple language to ensure openness and transparency of budget formulation and implementation. Based on the findings and key learning as well as observations at the local level, the study team has made the following recommendations: n Ensure timely information on budget ceiling of grants to local level. n Practice resource estimation or prepare a “resource envelope” for each local body. n Develop MTEF for local bodies. n Prepare local budget ceiling considering local resources for each year at the local level. n Ensure budget formulation process be bottom-up in place of current practice. n Follow budget formulation calendar. n Determine the meeting point of budget formulation process of local level and central level. n Review the Minimum Conditions and Performance Measures system as a basis of grant allocation for local bodies. n Make the budget comprehensive, transparent and equity based.(MCPM). n Make local level planning process participatory. Prepare local level project priorities and guidelines to make local investment cost effective. n Strengthen planning and technical capacity in local level. n Ensure timely release of grant to local bodies. n Provide technical assistance to implement projects in local level. n Review user committees’ functions. n Prepare project preparation and implementation guidelines for local bodies. n Restructure human resources and organizational structure of the local bodies. There should be an accountant and a sub overseer to handle budget and project in each VDC. n Prepare a plan for capacity building of local level. n Develop monitoring and supervision mechanism in local level. n Develop regular reporting system and social audit in local level. n Develop monitoring guidelines for local level. n Develop project performance tracking indicators and effective mechanism to avoid delay in project implementation and to correct expenditure delay in the capital budget. n Make project monitoring effective and practical. n Make scientific and practical arrangement of internal audit.

n Ensure final audit to be conducted by the OAG (Supreme Audit Institution of Nepal). n Publish the Audit Report and make it available to the local people. n Finalize and implement the â&#x20AC;&#x153;budget management and fiscal responsibility bill.â&#x20AC;? In conclusion, one of the main objectives of the government is to provide goods and services to the public. All reforms are targeted towards improving service delivery. Alongside these reform measures and their contributions to effectiveness of the state and sustained macroeconomic stability, budget implementation should be a priority. The budget formulation process should have optimum use of available resources for the

betterment of the people. The timely budget formulation and its implementation saves time and money. Delays in budget implementation results in cost and time overruns of projects. It deprives the people from getting the expected benefit. The low capacity of spending capital budget is the product of many factors: absence of proper knowledge of procurement law, lack of risk taking capacity, dissatisfaction with job, long and cumbersome legal framework and unnecessary political interference. In order to ensure timely, systematic formulation and implementation of the budget, the government has drafted a budget management and fiscal responsibility bill which needs to be enacted as soon as possible.

A Study on Budget Formulation Process of the Government of Nepal

Chapter I

X A Study on Budget Formulation Process of the Government of Nepal

Table of Contents Preface Executive Summary Acronyms/Abbreviations

III V XIII

Chapters

Page no.

Chapter I: Introduction 1.1 Background 1.2 Objectives 1.3 Methodology 1.4 Logical Framework 1.5 Time Frame

1-3 1 2 2 3 3

1.6 Limitations of the Study 1.7 Research Team

3 3

Chapter II: Literature Review

5-9

Chapter III: Budget Formulation Practices in Nepal 3.1 Current Practice 3.2 Budget Formulation Calendar (Central and Local level) 3.3 PEFA Concept in Budget Formulation (Central level) 3.4 Role of Different Agencies in Budget Formulation: The Top-down Approach 3.5 The Role of Different Agencies in Formulating Budget of Local Bodies 3.6 PEFA Evaluation of Budget Formulation at Local Level 3.7 Classification of Expenditures 3.8 Budget Implementation and Control

11-17 11 11 13 14 14 16 16 16

Chapter IV: Analysis of Current Practices in Budget Formulation 4.1 Budget Ceiling Assessment 4.2 Current Budget Formulation Approaches 4.3 Budget Discipline 4.4 Budget Allocation and Actual Expenditure Trend 4.5 Sector-Wise Gap Analysis 4.6 Budget Monitoring 4.7 Medium Term Expenditure Framework (MTEF) and Challenges 4.8 Best Practices of Budget Formulation for Transparency 4.9 The Status of the Application of Best Practices in Nepal 4.10 Decentralization and Local Participation in Practice 4.11 Project Priority and Need Assessment 4.12 Transparency, Accountability and Integrity in Nepalese Budget Formulation 4.13 SWOT Analysis

19-38 19 19 20 20 26 29 30 31 33 34 34 35 36

A Study on Budget Formulation Process of the Government of Nepal

Chapter V: Findings 5.1 Problems (Local Level) 5.2 Problems (Central Level)

Chapter I

39-41 39 40

Chapter VI: Recommendations and Conclusion 6.1 Recommendations: Central Level 6.2 Recommendations: Local Level 6.3 Conclusion

43-45 43 44 44

References

List of Key Informants

XII A Study on Budget Formulation Process of the Government of Nepal

Acronyms/Abbreviations CBOs

Community Based Organizations

CFAA

Country Financial Accountability Assessment

CPAR

Country Procurement Assessment Report

DDC

District Development Committee

DDF

District Development Fund

DEO

District Education Office

DEP

District Education Plan

DNGO

District Non-Governmental Organization

DTCO

District Treasury-Comptroller Office

FCGO

Finance Comptroller-General Office

FPA

Financial Procedure Act

Fiscal Year

GDP

Gross Domestic Product

LMBIS

Line Ministries Budget Information System

LMs

Line Ministries

LSGA

Local Self Governance Act 2055

MOF

Ministry of Finance

MOFALD

Ministry of Federal Affairs and Local Development

MTEF

Medium Term Expenditure Framework

NGOs

Non-Government Organizations

NPC

National Planning Commission

OECD

Organization for Economic Cooperation and Development

PEFA

Public Expenditure and Financial Accountability

PERC

Public Expenditure Review Commission

PFM

Public Financial Management

PPA

Public Procurement Act

Resource Committee

SWOT

Strengths, Weaknesses, Opportunities and Threats

TIN

Transparency International Nepal

TSA

Treasury Single Account

USA

United States of America

Vice-Chairman

VDC

Village Development Committee A Study on Budget Formulation Process of the Government of Nepal

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Chapter I

XIV A Study on Budget Formulation Process of the Government of Nepal

Chapter I

Introduction 1.1 Background The budget of the government is a financial instrument to implement government plans and programs to achieve socio-economic objectives. In its narrowest and traditional sense, public financial management was concerned with how the government manages the budget which included formulation, approval and execution of the revenue and expenditure policy. In modern times financial management has broadened its focus from a narrowly defined budget to all aspects of managing public resources (debt management, revenue and expenditure and foreign aid management in developing countries). Public financial management is a system aimed at collecting, compiling information, process and rules that can help support fiscal policy making as well. It provides an instrument for implementation of financial decision. The major objectives of public finance management are maintaining sustainable fiscal position, effective allocation of resources and efficient delivery of goods and services to the public. Budget proposal includes both revenue and expenditure and the ways and means to meet the budget deficit. Budget in Nepal is classified as recurrent, capital budget and finance budget. The recurrent budget comprises major headings of expenses such as: consumption, office operation, grants and subsidies, services and production expenses, contingency and interest payment on domestic and foreign loan. The term capital expenditure is capital transfer, capital formation, and finance is defined as investments in shares and loans in corporations and financial institutions, repayment of principal of domestic and foreign loan. The National Planning Commission (NPC) works on the size of recurrent, and capital expenditure, keeping in consideration the policies, programs and priorities laid down in the national periodic plan, emerging needs and resource availability. Both the ceiling on recurrent and capital expenditure is decided by the Resource Committee (RC) which is chaired by the Vice Chairman (VC) of NPC. NPC sets out the priority and policy goals with respect to annual plans and programs for the forthcoming fiscal year and provides guidelines to the concerned Line Ministry (LM) and Ministry of Finance (MoF) for budget formulation. It should be noted that for the last several years, the government budget was dominated by the recurrent budget and the capacity to spend the capital budget was

weak. It is reported that in the last four years (2010/112013/14) on average, 87 percent of the recurrent budget was spent each fiscal year, while only 79 percent of the capital budget was spent during the same period. The actual budget expenditure is about 86 percent of the total allocation. The foreign aid disbursement was 75 percent of the allocation and the foreign grant was 88 percent, whereas the foreign loan disbursement was 57 percent. Since 2002, there has been no elections at the local level (VDCs, Municipalities and DDCs). There is an All Party Mechanism to oversee local development works. Political representatives from different parties are supposed to run local bodies. However, due to differences in views and interpretations the mechanism has failed to work in many places. This has badly affected the smooth functioning of VDC secretaries, Executive Officers of Municipalities and Local Development Officers of the District Development Committee. This has had a negative impact on budget formulation at the local level. At this level, the size of the budget and implementation status of District Development Committees (DDCs) is not compiled and reported. Local Self Governance Act, 2055(LSGA) specifies that the Ministry of Federal Affairs and Local Development (MoFALD) should compile the internal resources mobilized by DDCs, but this provision is not implemented. Hence the status of public spending and resources mobilized by the government, through the central level and DDCs is not consolidated. The budget cycle includes policy formulation, preparation of a macroeconomic framework and annual plan formulation, legislation, implementation, monitoring and auditing. The most important component is the size of the total budget. Each year, NPC in consultation with MoF, provides budget ceiling and issues guidelines for annual projects/programs selection and the guidelines for budget formulation. Sectoral Ministries formulate annual plans and programs based on these guidelines. Planning process starts almost eight months before the start of the new fiscal year. Indeed, there are government norms that before any investment are made on any project; the project needs to be feasible from an economic, financial and technical A Study on Budget Formulation Process of the Government of Nepal

point of view. Once the project is found feasible, a detailed plan is drawn up and the project is included in the government expenditure plan. It is found that the number of projects included in the annual expenditure plan (Red Book) was on average 450 in the last ten years but it has increased to 496 in 2013/14. A large number of projects included in the budget, is allocated without strictly following the norms and guidelines. It also shows the weaknesses of the bureaucracy to draw up feasible projects on a timely basis to include in the budget. As a result, budget formulation has become an ad hoc exercise. The implementation of the budget has suffered which has resulted in poor capital budget expenditure.

Chapter I

Similarly, the government has standard monitoring and evaluation formats and time bound reviewing process. The monitoring and evaluation of development projects are carried out at different levels and has become ritual only without valuable feedback to the budget formulation process. Nevertheless, the growth in activity in the public sector seems greater than the degree of impact. It is the outcome of internal and external factors. In developing countries transparency and access to information opportunities are lacking for the general public. It is because, transparency is poor, especially in countries that are aid dependent like ours. However, in recent time there has been an improvement in transparency in many countries due to many factors. These factors are opportunities arising from changes in government, social and political pressures, pressures from development partners and dissatisfaction of the public. The strategic review presents an analysis of the trends, gaps and opportunities in the budget formulation process. Transparency and accountability are not means but are ends in themselves. Budget transparency is necessary but it is not sufficient for accountability. The study has focused on the demand side initiatives, particularly Non Government Organizations (NGOs) that raise their voice for transparency and accountability in the budget formulation process. The study enables us to suggest specific initiatives that can enhance the process of reform in the budget formulation. In our context, there is public dissatisfaction with under spending of capital budget. The under spending of the capital budget, points to the failure to deliver goods and

2 A Study on Budget Formulation Process of the Government of Nepal

services to the public within the proposed time frame. To address the problem of Public Financial Management (PFM) many studies have been initiated by the government and donor agencies. Independent nongovernmental organizations like Transparency International Nepal (TIN), Freedom Forum, Nepal initiated a study on PFM, which is important during this interim transitional period of governance. The interim constitution with the lag in promulgation of a new constitution is very crucial and critical. The main objective of this study is to understand the budget formulation process at the central level and to find out the problems, causes and impact of budget formulation in the absence of elected officials at the local level.

1.2. Objectives The overall objective of the study is to examine the strengths and weaknesses of budget formulation and implementation and to recommend reforms in budget formulation. The major objectives of the study are: n To assess budget ceiling, n To asses budget allocation, n To assess the process of budget discussion at the Line Ministries (LMs), MoF and NPC, n To find gaps in budget allocation and actual spending, n To find gaps in budget implementation (Transparency, Accountability and Integrity), n To asses budget monitoring system. The study focuses on these objectives. Budget request, allocation and the approved budget are the areas covered by the study. Budget formulation is the process from policy making to implementation.

1.3 Methodology A qualitative methodology was used to study the issues in budget formulation in Nepal. The team gathered information through literature review, government documents and previous reports. The team also undertook focus group discussions. The study stakeholders were planning and budget division chiefs of LMs, MoF and NPC. Information were collated through secondary sources, cross checked and verified with the Financial Comptroller-General Office (FCGO).

1.4 Logical Framework S.N.

Objectives

Activities

Related Agencies

Expected Result

To asses budget ceiling procedure

Document collection and discussion with stakeholders

NPC, MoF,

Examine budget ceiling process

To asses budget request procedure

Focus group discussions

NPC, MoF, FCGO, LMs

Budget request process will be studied.

To assess process of budget discussions in Ministries and NPC

Discussions with stakeholders

NPC, MoF, LM

Study the criteria of budget finalization

To examine gaps in budget implementation (Transparency, Accountability and Integrity).

Comparison between allocation and actual spending

LMs and FCGO

Gap findings

To asses budget monitoring system

Review the monitoring system of budget implementation

MoF, LMs

Review monitoring mechanisms

Remarks

1.5 Time Frame

1.7 Research Team

The study is expected to be completed within 3 months.

The study was carried out by Molung Foundation. The research team was led by Mr. Madhab Prasad Ghimire, other members were Mr. Khem Prasad Dahal, and Mr. Dilli Prakash Ghimire. They all have expertise in their respective fields.

1.6 Limitations of the Study The study is based on secondary data. It is limited to the budget formulation process of the central government and DDCs.

A Study on Budget Formulation Process of the Government of Nepal

Chapter I

4 A Study on Budget Formulation Process of the Government of Nepal

Chapter II

Literature Review On budget and budget formulation, there are many studies and reports. This study has also reviewed books and previous reports on financial management in Nepal. C.E. Bastable in his book has stated that the term budget has come to mean the financial arrangement of a given period, with the usual implication that they have been submitted to the legislature for approval. In the Nepalese context, there are many studies and reports on central level and the local budget formulation. Nepal started the process of decentralization, first through the Local Self-Governance Act (LSGA), which was enacted in 1999. The Interim Constitution 2007 emphasized local self-governance as a pillar in the state structure. Basic changes on self-governance and local development gave an opportunity to improve efficiency of service delivery and empower citizens. However, these opportunities have not translated into better use of available resources and better understanding of the budget formulation process. In this context, the World Bank piloted an innovative study in 2011, “Budget Transparency Initiative (BTI)”. The study analyzed and disclosed the reality of budget formulation at the local level. After studying three districts: Kaski, Dolakha and Nawalparasi, the report concluded that there was the dominance of a top-down approach in budget formulation. Some weaknesses, such as lack of cost benefit analysis, delay in the communication of ceiling and guidelines and the release of budget were clearly underlined in that report. The goal of the pilot initiative was to introduce transparency into the budget process in order to reduce waste and control corruption and by actively engaging citizens and soliciting their feedback, foster demand for disclosure of financial information. The BTI reviewed the national and sub-national budgeting process and institutional framework. It stated that the MoF, NPC lead the annual budget formulation process with the involvement of sector ministries, a few civil society organizations and other experts. The RC is responsible for estimating total resources. Based on this, the MoF and NPC determine annual expenditure ceiling for sector ministries. The sector ministries, within the limit of the ceiling, allocate the respective expenditure ceiling to the departments and field offices. The NPC and MoF receive programs/projects with detailed budget heads on recurrent and capital expenditure usually exceeding

the initial ceiling. They finalize annual allocations based on negotiations at the time of budget discussion taking into account, past expenditure and internal and external funding. However, the adjustment process continues as new projects are added till the budget approval stage. The report stated that at the sub-national level (local level); NPC sets the overall district ceiling. As per the budget guideline, Village Development Committees (VDCs) are involved in the budget cycle. Annual plans and annual budgets are finalized in VDC council meetings which comprise of local representatives of political parties and members of civil society. The VDCs compile and send them to Ilaka workshop, an intermediary body created for development purposes. DDC organizes the Ilaka level workshop in which technical experts and civil society representatives are invited. The outcome of the workshop is submitted to the DDC which in turn submits the annual plan and budget request to the DDC council. After the approval by the council, it finally reaches the central level budget allocation process. The Budget Manual of the state of Indiana USA has stated that the preparation of local budget is more than projecting receipts and disbursements for a given year. The budget provides a financial plan for the local government, the fiscal body, and the tax payers. It also identifies operating costs considered essential to the successful operation of local government. It implies that budgeting must be something more than compiling an annual estimation report to be approved. In an indirect way, every budget provides some statement of community goal. The budget reflects the elected representative’s philosophy of local government too. The budget document is in one sense a cycle of budget formulation process. It is a continuous process. Because of this fact, it is not only a document but also an effective policy instrument. The department provides a budget calendar to the local government giving timeline for circulation and adoption of budget formulation procedure. The budget calendar is the schedule of events. In addition, there are established schedules for periodic reporting of budget execution. (Adapted from “Local Government Budget Preparation City and Town”, David Burgess Academy in the Public Service, Georgetown University, Graduate School, Washington DC).

A Study on Budget Formulation Process of the Government of Nepal

The Organization for Economic Cooperation and Development (OECD) Journal on budgeting has stated that aggregate fiscal discipline, allocative efficiency, and operational efficiency are complementary tasks in modern budget formulation process. A well developed budget formulation process should serve all three objectives. Moreover, accomplishing one of these tasks, advances the others as well. In practice, the three roles may get in one another’s way. They require different types of information; work orientation and skill. Getting all three at a time may be costly. The more typical approach may be to emphasize on aggregate fiscal discipline, because it is vital to political interest and financial stability. The second is operational efficiency. It is compared with contemporary orientation of private and public sector management. It entails a fundamental reconsideration of the role of central budget formulation agencies, which naturally leads to slow budget allocation and reform. It should be noted that over the long run the greatest pay off of reform is likely to be in improved program allocation.1

Chapter I

The Interim Constitution of Nepal 2007 has made provision of local self governance. The governance will be based on decentralization and devolution of authority in order to promote the participation of the people to the maximum extent possible. The system of governance should be such that it is conducive to the exercise of sovereignty by the people even at the local level, deliver services to the people at the local level, leading to institutional development of democracy. For this purpose, the constitution has provisions for participation of local representatives of political parties with representation in the Constitution Assembly. The constitution has stated that there shall be mobilization and allocation of revenues between the Central government and the localself governance bodies as provided by law in order to make the local-self governance bodies accountable. For identification of projects, budget formulation and implementation with a view to strengthening local self-governance bodies for local development. For this special attention shall be accorded to those classes and communities who are backward socially and economically with a view to ensuring a balanced and equitable development of the country. In the context of budget formulation, LSGA has stated that the VDC should initiate the formulation of the annual plan immediately after receiving the guidelines and prior estimation of resources from DDC and other concerned agencies by mid-November of each year. Even the VDC has to provide guidelines on selection of projects and formulation of budget to the different Wards for formulation of services and development program for

Alen Schick, “Changing Role of the Central Budget Office”

6 A Study on Budget Formulation Process of the Government of Nepal

the forthcoming year. List of Projects are compiled from ward committees which is the entry point as envisaged in the Act. The VDC has to prepare a resource map and carry out feasibility of the projects. The projects should be selected on the basis of feasibility and resource map. VDC has to maintain coordination with government agencies and NGOs and Community Based Organizations (CBOs) in formulating budget. There are several acts that are aimed at improving the system of governance. The aforesaid Local Self-Governance Act, 1999 is a comprehensive Act to regulate the operations of the local bodies. The Act has detailed provisions on the budget formulation and implementation at local level. The Act has granted the power to accommodate the activities to be carried out by the district level line agency offices and NGOs in annual integrated district development plan. The Act requires timely monitoring and supervision of the project implemented by local bodies and by members of the DDCs. The Council has the power to review the progress of the projects and to improve poor or nonperformance in delivering public service to the people. The Audit Report of the DDC’s should be presented to the Council for review. The accounts committee, formed by District Development Council, has the power to supervise projects and direct the concerned officials. However, these provisions are not implemented in the absence of elected representatives in local bodies. The World Bank report on operational risk assessment of public finance management reform in Nepal has concluded that budget formulation is formally well governed by detailed guidelines and procedures but these are not always adhered to in practice. The budget manual specifies a clear annual budget calendar, but there is often delay through each stage of budget formulation process resulting in late submission of budget request. According to a worldwide survey conducted by the OECD, Nepal lags behind most countries on every key deadline of the budget calendar. The practice in Nepal is that the phases encroach on one another and create overlapping pattern of simultaneous and disconnected activities. In practice there is no hard deadline of inclusion of new capital projects. In addition, expenditure ceiling set by MoF have yet to become a credible instrument, which undermines efforts to link budget allocation to policy priorities. Likewise the budget implementation in Nepal faces a number of challenges which are among others, the bunching of project expenditure towards the end of the fiscal year. The process especially of capital projects remains highly centralized and bureaucratic. Even after the budget is approved, the project approval process takes an additional three to four months due

to cumbersome procedure and complex procurement process. Reallocation (virement-transfer of allocated amount from one budget head to the other) rules are too flexible throughout the year. It should be noted that the MoF has the authority to transfer funds upto 10 percent of the total allocated fund to the Ministry in the contingency fund of the MoF and reallocate contingency amount. This ensures flexibility but weakens the credibility of the budget formulation process. The Financial Procedure Act 2055 (FPA) has stipulated that the MoF is responsible for preparing or causing to prepare budget and development programs to be carried out in the next fiscal year. The concerned account officer is responsible to submit to the MoF, periodic work description, estimate of income and expenditure and the statement of budget sanction spent by the office and subordinate office pursuant to sub clause (2) Article 93 of the Constitution and progress made according to the target. The foreign aid composition also should be included and a separate statement of the portion of foreign aid should be submitted along with the budget. The Financial Procedure Act, 2055 B.S. (1999) which is a legal requirement regulating the financial procedure of the government. It contains legal provisions to improve the transparency of government expenditures. The Act has provisions to improve the budget formulation process, sanction and spending of budget and maintaining books of accounts, records and arrangements for internal control and auditing. The Good Governance Act, 2008 is another milestone in the reform process. The Act aims to improve public administration so that governance is accountable, transparent, inclusive and participatory. On the provision of authority to control or withhold budget, the FPA has stated that the MoF may, in view of economic conditions and resource availability of the country, fully or partially withhold or control the appropriated amount, as required, other than the amount chargeable on the consolidated fund. The annual report of Public Procurement Monitoring Office 2014 has clearly stated the weakness in the implementation of Public Procurement Act (PPA) and Rules thereto. All public offices which fall within the definition, has to follow the procurement procedures laid down in the Act and elaborated in the rules. Any decision contrary to the procedures is illegal and is subject to rejection. There is the legacy of old legal framework and practices of previous laws and the lack of knowledge of new Public Procurement Act and Rules. The PPA has made provision for the preparation of annual procurement plans and multi-year master plan for the procurement exceeding Rs. 100 million for each public office. The public offices are required to submit plans for budget allocation. But such procurement plans have not been

prepared, updated and followed. There is provision of cost estimation and updating it, for the amount exceeding Rs. 25,000. There is cost estimation without information of market price. The public construction should not be started without the arrangement of land acquisition and construction site. But there are evidences of budget allocation for construction without fixing the site. There is provision of preparation of Tender documents but sufficient attention has not been paid while preparing such documents. There is a general practice to call tender notice before preparing tender documents to save time but the documents prepared later are incomplete too. The law has made provision for preparation of standing list of the suppliers for each year with the purpose of ensuring fair competition. But the suppliers syndicate has made it difficult to ensure this. There is the provision for an evaluation committee for evaluating each tender document but the forming of a committee for the whole year is the prevailing practice. Evaluation of economic, technical and business aspects of the tender is hardly practiced. The estimate prepared by responsible person should be reviewed by the Review Committee, which is provisioned for the purpose of checks and balance and for the sake of transparency. This always results in extra work and the contractor demands price adjustment and variations. There is the provision of project review for transparency purposes. In many cases, the offices have signed an agreement without the review of the tender process. The Act has a provision of integrity of contractor and official but it is silent on punishment for breach of integrity. In special condition, there is the provision of direct procurement. In many cases, offices avoid the regular procurement process and use this contingency purchase provision at the last moment. Freedom Forum, Nepal has published an Open Budget Survey, characterizing Nepal as the least open in budget formulation and data openness. On Open Budget Survey, Nepal scored 45 out of 100. It is below average in comparison with neighboring countries. The budget survey report clearly states that the budget formulation practice in Nepal lacks the pre-budget statement and citizen budget. In that survey India and Sri Lanka scored 67 each. The scores for Bangladesh, Pakistan, Nepal and Afghanistan were 48, 38, 45 and 21 respectively. Freedom Forum has published a report on a pilot study of transparency of foreign aid in Nepal. The report clearly states that the aid practice in Nepal is not as transparent as in other countries. After making a number of observations the report concludes that none of the agencies provided complete budgetary information and most of the agencies failed in their claim that they are transparent and accountable. Freedom Forumâ&#x20AC;&#x2122;s documents stated that there are three kinds of foreign aid expenditure: some are on budget and on treasury, some are on budget and off treasury and

A Study on Budget Formulation Process of the Government of Nepal

some are off budget and off treasury. The Freedom Forum has further mentioned that the political situation of the country is fragile. It is because the country is undergoing political transition following a decade of violence and insurgency that ended in 2006. Since the introduction of democracy, more than 20 governments exercised executive power. However, political instability has been the hallmark of the country. The first Constituent Assembly, failed to bring consensus in the draft constitution and a second election was held. The second Constitutional Assembly, is attempting to forge consensus. The second Constitutional Assembly, is now responsible for creating the environment to promulgate the new constitution for political stability in the country. The report further quoted the World Bank’s report and stated that the conflict and prolonged transition have contributed to erosion of the effectiveness of some state institutions. In this context, governance is weak and due to more focus on the drafting of the constitution, governance as an issue is not a top priority for politicians. Local institutions are responsible to participate in budget formulation, development and delivery of public services, but have functioned without elected representatives for over a decade. The local bodies are administered by an informal all party coalition formed by political parties without ensuring accountability. There is an absence of an opposition to discuss budget and other issues. Thus there are serious concerns on the budget governance and on programs as well. Due to the absence of elected local body, Nepal ranks low, in its level of democracy. In 2012 Democracy Index, Nepal scored 4.16 out of 10 resulting in country ranking of 111. This score was based on electoral process and performance, on political culture and other democratic indicators. The index on transparency is also not satisfactory. All political parties have agreed on the need for transparency and accountability in the governance system. Political parties are not transparent on their own activities. Parties do not disclose donations, income and expenditures or publish audited financial statements.

Chapter I

“A Study on Anti-corruption Intervention in Nepal: Gaps in Policy and Practices and Possible Collective Interventions” by development partners, was published in January 2015, by the Royal Norwegian Embassy. Dr Bimal P Koirala, Kedar Khadka and Yasoda Timilsina conducted the study on behalf of the School of Banking, Business Research and Development (SBBR). After a number of observations, the report stated that the legacy of corruption in Nepal derives from rent seeking behavior, inherited from a state controlled economy before 1990. After the democratic movement, the transition phase of governance was based on political compromise, rather than the rule of law. The lack of political commitment, fiduciary risks arising from allocation of resources and change from 8 A Study on Budget Formulation Process of the Government of Nepal

project to sector/program funding by development partners has created gray areas for misappropriation. From the beginning of the budget allocation, certain projects provide incentives for corruption. In general, projects entered through political pressure leave grounds for corruption. The budget allocated for such projects are intended for political and financial gain for pressure groups. The anticorruption study recommended three types of intervention: short-term, medium-term and long-term to control different types of corruption. In the medium-term, the report specifically recommended to bring total government budget along with local bodies (DDCs/VDCs Municipalities) under the purview of the OAG. This study is especially concerned with this medium-term recommendation . The World Bank has made recommendations on its policy notes for the development of Nepal. The policy note lays out a strategic vision for Nepal’s development. It is based on 3”I”s model of growth. The three “I”s model are : Investment, Infrastructure and Inclusion. On its policy note, the World Bank recommended strategic policies for 10 sectors. The vision states that investment is the bedrock of sustainable development but in Nepal, the state, firms, individual households are under invested. There are infrastructure barriers for access to opportunities. To unlock this, as well as, to expand access service to the public, infrastructure is critical. Nepal is under-connected and under-powered. Growth alone will not deliver to the growing inequality and poverty reduction, unless the growth model addresses the issue of inclusiveness. The note concludes that the overall development challenges for Nepal are to promote faster, sustainable and inclusive growth. Mr. Udaya Panta has pointed out that inadequate “budget implementation and poor work performance have been key weaknesses in Nepal.” This results in delays in the implementation of capital projects and the slow pace of capital expenditure. The performance in delivery have improved but there are problems and gaps in the budget provided for projects but not ready for takeoff. There is a time lag between seeking donors and approving the budget. He pointed out that the reason for slow progress of project implementation and low capital expenditure can be attributed to not segregating projects that are approved and ready for implementation, and projects that are not ready for implementation. The line ministries submit their “wish list” in the budget request. That results in a distorted expenditure trend by showing lower utilization of funds. There are some projects quickly approved and implemented and are included in the budget formulation through political pressure. The present practice does not allow for a more efficient budget formulation in the line ministries.

Mr. Bhanu Prasad Acharya in his article, â&#x20AC;&#x153;How Budget Reforms Link to Development Outcomesâ&#x20AC;?, (PEFA Journal, 2013) states that Nepal has made significant progress in budgetary process and public accountability after the restoration of democracy. After the democratic movement, several new policy measures were introduced with success, without proper institutional arrangements. Due to frequent changes of government, the capacity of the central government to create new institutions and implement reforms has weakened. Since 2000, there has been no election at the local level that has severely weakened the public financial management

and accountability mechanism at the local level. The review of the literature strongly indicates, serious lags in the financial development of Nepal. Budget formulation is intricately related with the overall development of the country. The formulation and implementation of the budget is carried out to meet the development goals of the government. The success of implementation depends on good governance. There is an interrelation between budget formulation and good governance and the overall development of the country.

A Study on Budget Formulation Process of the Government of Nepal

Chapter I

10 A Study on Budget Formulation Process of the Government of Nepal

Chapter III

Budget Formulation Practice in Nepal 3.1 Current Practice The Interim Constitution of Nepal has laid down that the Finance Minister prepare and submit the budget to the Parliament. The fiscal year starts in mid July and the process of budget formulation for the next fiscal year starts in Mid-November of the current fiscal year. Budget formulation is divided between NPC which manages development policy, annual plans and programs and the three year budget expenditure projection to be incorporated in the Medium Term Expenditure Framework (MTEF) and MoF which formulates annual recurrent expenditure, capital expenditure and the finance expenditure budget. Line ministries find it burdensome to prepare MTEF over their normal responsibility of preparing the line item budget, particularly in the context of a lack of reasonable predictability of resources over multi-year expenditure. The budget formulation starts from a macro-economic analysis which is completed by the MoF. In macroeconomic analysis, the economic indicators of last year and the four month financial achievement are studied and the macro-economic projections for the upcoming fiscal year are prepared. The RC decides on the ceiling of government expenditure, expected revenue collection, foreign aid and public borrowings for the upcoming fiscal year. This is usually done in mid-November. The

projection of ceiling is based on various indicators which are as follows: a) The projected economic growth rate and past achievement. b) The projected resource requirement for the implementation of the MTEF and budget needs to achieve projected economic growth rate. The foreign aid commitment for ongoing and new projects and the governmentâ&#x20AC;&#x2122;s obligation on meeting counterpart funds as required under bilateral and multilateral agreements are also taken into account. c) The physical and financial performance is also a basis for the consideration of the ceiling. It is also underlined that the NPC, before the announcement of the sectoral ceiling, starts consultation with selected LMs on plans, priorities and major activities, problems and constraints for the next fiscal year. The consultation lasts for ten days in case of infrastructure projects. The objective of this initiative is to make the budget formulation transparent and take into account the LMs emerging needs and changes in time. It is expected to make the budget formulation process more objective and realistic.

3.2 Budget Formulation Calendar (Central and Local level) SN

Activities

Agency

Fixed month

Preparation of Macroeconomic frame work n Project prioritsation in line with periodic plans n Revenue estimation

NPC, MoF, Cabinet LMs

Oct /Nov. (2nd week Kartik)

n Preparation of ceiling and submission to Resource Committee

NPC/MOF

Oct/Nov (3rd week of Kartik

n Decision on Budget ceiling

RC/NPC/ Cabinet

Nov. (2nd week of Marg)

n Preparation of Budget guidelines

NPC/MoF

Nov. (2nd week of Marg)

n Release of ministry and sector wise budget ceiling, guidelines circular

NPC/MoF/LM

Nov/Dec (4th week of Marg)

Submit budget and programs n Fill and submit budget forms n Submit to Departments

District level offices Dec/Jan (1st week of Magh)

A Study on Budget Formulation Process of the Government of Nepal

Activities

Agency

n Compilation Chapter I of budget forms and preparation of

Fixed month

Departments

Jan (4 week of Magh)

Discussions in respective LMs

LM/Departments

Jan/Feb

n Formulation of budget by LMs and submission to MoF

LMs

Feb/March (3rd week of Falgun)

Discussion on budget and programs n Policy discussions on District and Central level programs and budget

NPC, MoF, LM

March/April (4th week of Falgun -3rd week of Chaitra)

n Item wise discussions on recurrent and capital expenditure

LMs/ MoF

April/May (2nd week of Baisak)

n Preparation of Preliminary Draft Budget

MoF

June (3rd week of Baisak

Finalize budget and submit to cabinet n Finance Minister presents budget to the Legislative parliament n Budget approval by parliament

MoF MoF

June (4th week of Jestha) Mid July (Asad last)

parliament

September (Bhadra)

Budget authorization n Approval of trimester program n Authorization issued to field offices

Finance secretary

Mid July within 3 days, July/Aug

Departmental Budget and submission to Ministry

NPC/LMs

The 14-step planning and budget formulation process at the Local level. SN

Activities

Agency

Month

Receive budget ceiling and directives

District level line agencies

Sept. 3rd week

Review of guidelines

Line agencies/DDC

Sept/OCT (1st week of Kartik)

Pre-planning preparation workshop

DDC, Line Agencies, VDC secretary and DNGO

Oct/Nov Marga 1st week

VDC/Municipality meeting

DDC, VDC and Sector Line Offices

November last

Community-level project planning

Ward people/ NGOS Consumers/Ward members

November

Ward Committee meeting for project discussion

Ward members, Ward level Citizen forum/ Citizen Awareness body/representative of political parties, consumer committees

Dec. 3rd week

VDC/Municipality meeting

VDC/ Municipality Line offices

Jan. first week

Village/ Municipality Council meeting

Council members

Jan. 2nd week

Area (Ilaka)-level planning workshop

VDCs/MUN. representative of political parties/Line offices DNGOs

Feb. 2nd week

Sectoral planning meeting

DDC/Line agencies Offices

Feb. 3rd week

Integrated plan formulation meeting

DDC/VDC, MPs, line office and DNGOs

Feb. 3rd week

DDC meeting

DDC members

Mar.1st week

District Council approval

DDC council members

Mar. 2nd week

Implementation of DDC plan

NPC, MoFALD, LM, MoF, DDC

Mid July

12 A Study on Budget Formulation Process of the Government of Nepal

The cabinet approves the Budget Guidelines and budget ceiling prepared by the RC. NPC sends Macro and Sectoral Guidelines and ceiling to the LMs. Likewise the respective LMs send guidelines and ceilings to departments and agencies. The department sends ceilings and guidelines to the field offices. These budget guidelines and ceilings are targeted to control excessive budget request and direct them to formulate plans and programs in light of the availability of the budget. The budget formulation process starts from the bottom or the field offices and the budget request moves step by step to the parent Ministries. Ministries need to determine priorities of the various expenditure items before submitting budget request to NPC and MoF through Line Ministry Budget Information System (LMBIS). After receiving the budget request, NPC and MoF follow budget discussion calendar. Discussions at NPC is concentrated on policies, plans, programs and priorities of the LMs and the amount requested for each budget head. The detail head wise (line item budget) discussion takes place at the MoF. Budget division of MoF begins a series of hearings with each LMs and agency. The budget officials review each budget item requesting additional supporting documents for the justification of the requested amount of budget. This budget discussion takes place from April to mid June. MoF finalizes the draft budget and submits it to the cabinet for approval usually on the afternoon before submitting it to the legislative parliament on the prescheduled date and time. While submitting the budget proposal the finance minister outlines the fiscal and monetary policies of the government, projects to be implemented in the next fiscal year, size of resource mobilization and the sources to meet the budget deficit. The Finance Committee of the Parliament deliberates on the budget in detail. The Finance Committee with its comments and suggestions on proposed revenue and expenditure proposals sends it back to parliament and the parliament approves the Finance Bill, Appropriation Bill and the Public Debt bill. The Speaker of the Parliament forwards these bills to the President for approval.

3.3 PEFA concept in Budget formulation (Central Level) Public Expenditure & Financial Accountability (PEFA) highlights the four objectives of budget formulation : a. Credibility of Budget: The budget should be objective, realistic and doable. b. Comprehensiveness and transparency: The budget and fiscal risk oversight should be comprehensive. Fiscal and budget information should be accessible to the public.

c. Policy based budgeting: The budget should be prepared with due regard to government policy. d. Predictability and control in budget implementation: The budget should be implemented in an orderly and predictable manner. Arrangements should be made for the exercise of control and stewardship in the use of public funds. The role of PEFA in Nepal is to assess the effectiveness of public expenditure and financial accountability against the predetermined indicators. In the past, the Government of Nepal has introduced various initiatives in the area of financial reforms. These initiatives involve policymaking in different areas of public finance and annual budget, plans and programs. After the restoration of multiparty democracy in 1990, the government launched various economic reform programs. The reform program included, inter alia, reforms in Public Financial Management (PFM) system. Most of the PFM reform assessment were initiated during the insurgency such as: Public Expenditure Review Commission (PERC) 2000, Country Financial Accountability Assessment (CFAA) 2002, Medium Term Expenditure Framework (MTEF) 2002, Country Procurement Assessment Report (CPAR) 2002. Gap Analysis of Public Sector Accounting Auditing 2007, Public Procurement Act 2007, PFM Strengthening 2010 and Improving Budget Execution, Fiscal Reporting Cash Management 2012 were other examples of government initiatives. The most significant initiative was PEFA assessment conducted in 2007 covering fiscal year 2005/06. The assessment based on indicators showed that the credibility of the budget had declined. The actual expenditure is considerably less than the allocated capital expenditure and the expenditure outside the budget framework has increased. These indicators characterized policy based budgeting with poor expenditure management. Likewise there were weaknesses in budget implementation, which are reflected in delays in procurement and disbursement leading to time and cost overruns. The accounting and reporting indicators show problems in reconciliation. Nepalâ&#x20AC;&#x2122;s weak governance rating is found in PEFA assessment in 2008. It found significant gaps in PFM system. Out of 31 indicators, only 1 scored an A (in budget Credibility) and only 3 scored B. Similarly only 2 scored B in Budget comprehensiveness and transparency. The rest were rated C (8 indicators) C+ (9 indicators) D+ (7 indicators) and D (3 three indicators). PEFA assessments pointed out some major weaknesses in budget classification, transparency of intergovernmental fiscal relations, overlooking of fiscal risk in public entities, and extent of unreported and off budget government operation. The decline in credibility of the budget reflects the distrust among institutions,

A Study on Budget Formulation Process of the Government of Nepal

weak capacity to formulate expenditure plan, higher amount of budget request without proper exercise on the viability of a project.

Chapter I

3.4 Role of Agencies in Budget Formulation: The top-down approach Budget formulation at the central level are mainly a topdown approach. The agencies involved in formulating central level budget are given below: National Planning Commission: NPC, in close and active participation with the MoF and the LMs, prepares MTEF, policy guidelines for plans and programs and their priorities and the budget ceiling for the next Fiscal Year. It disseminates budget ceiling and guidelines to the LMs. Ministry of Finance: The budget ceiling and guidelines are sent to the LMs through NPC. Principally the budget ceiling is disseminated through ministerial channel up to the field level office. The field offices within the ceiling and guidelines prepare their budget request and send it back through the same channel. Such requests are compiled and sent to MoF. MoF holds series of discussions and finalizes a detailed expenditure plan, submits it to the cabinet through the Minister of Finance before submission to Legislative Parliament. Line Ministries: LMs participate in preparation of budget ceiling and guideline in NPC. Each line ministry receives a budget ceiling with guidelines and sends it to the departments and field offices through departments. LMs compile the budget request received from Departments and after holding interdepartmental consultation, forward the proposed detailed expenditure budget to NPC and MoF. Departments: Each department sends budget ceiling and guidelines to field offices for budget request. Field offices submit budget request to the concerned departments within the ceiling and the guidelines. Departments after holding series of discussions compile the budget request and submit it to the concerned LMs. District offices: District offices of Line Ministries receive ceiling and budget guidelines through Departments and prepare budget request and submit it to the concerned Department. Field offices hold district wise plan and budget workshops before submitting the request. Development Partners (indirect): Development Partners are indirectly involved in budget formulation. They are interested to include donor funded projects in the budget. The amounts are generally included on the line item budget but a portion of expenditure is 14 A Study on Budget Formulation Process of the Government of Nepal

off treasury. This practice has led to an increment of the volume of audit arrears. Cabinet: Cabinet is directly involved in policy formulation and implementation. Budget ceiling and guidelines are approved by the cabinet. Finalized budget is approved to submit to the Legislature parliament in the form of the budget speech of Minister of Finance and the finance bill, appropriation bill and the public debt bill are presented along with the budget speech on a prescheduled date and time. Legislature Parliament and Finance Committee: Legislative Parliament members discuss on the principles underlined in the budget and authorize the government to spend budget up to a specified percent of the proposed budget expenditure. The budget proposal is forwarded to the Parliamentary Finance Committee for detail discussions. The committee submits it along with its recommendations and suggestions again to the parliament and parliament approves it and submits it to the President for final approval. Office of President: The presidentâ&#x20AC;&#x2122;s seal is fixed on the Appropriation Bill, the Finance Bill and the Public Debt Bill, which takes the legal form.

3.5 The Role of agencies in formulating Budget of Local Bodies The bottom-up process Local-Self Governance Act has provisioned the procedure of formulating an integrated annual district development plan. The LMs field level offices implementing the devolved programs and NGOs working in the district level should be incorporated in the DDC annual plan. The approach in formulating a budget funded by internal resources of the local bodies and unconditional block grant from the central government is a bottom up approach. In case of devolved activities implemented by the field offices of the LMs and the programs funded under the conditional grant both a top- down and a bottom-up approach is used in parallel. The bottom-up budget formulation (Local Level) process and the agencies involved are given below: Budget ceiling of grants for all districts is fixed by the NPC and sent to MoFALD which then communicates through the internet to all DDCs. DDC, Municipality and VDCs receive grants with or without conditions. District Development Committee: DDC receives budget ceiling and guidelines from NPC and communicates it to VDC and Municipalities. VDCs and Municipalities formulate budget within the ceiling and the guidelines. The entry points of projects are ward level. The list of projects of VDCs and Municipalities are prepared at the

ward level and discussed in ward level meetings of Citizen Forum and Citizen Awareness Center of the same ward. The VDC and Municipal office compiles and discuss in their council and send the proposal to DDC. DDC holds Ilaka level planning workshop, sectoral planning meeting and integrated plan formulation meeting. DDC in its part compiles the Budget request of VDC/ Municipality and submits it to the DDC council for approval. DDC Council: The DDC council finally approves the budget with local resources and government grant. Projects with local resources are approved by the concerned council. The projects of government grants are also approved after the finalization of the central level budget. The budget implementation process starts after the completion of budget formulation. The 14 steps budget and planning process at local level as stated in LSGA are given in the box below: 1. Receive budget ceiling and directives 2. Review of guidelines 3. Pre-planning preparation workshop 4. VDC/Municipality meeting

Basis of grant allocation from the centre to DDCs a

Area covered

15%

size and composition of population

15%

cost

35%

population below the poverty line

35%

The percentage differs on the basis of area covered, size and composition of population, cost of the projects, and the population below the poverty line. If the area covered is less, the amount of grant automatically becomes less. At the same time, if the size of the population is small, the amount of grant also becomes small. The distance from the market is shown in the cost indicator. If cost of the material is high the amount of grant becomes large. Another criteria to allocate grants to DDC is the population below the poverty line. If the population below the poverty line is higher, the amount of grant becomes large. These criteria for grant allocation are transparent and scientific. Basis of grant allocation from the centre to VDCs

5. Community-level project planning

unconditional block grant of Rs 1500000

6. Ward Committee meeting

size and composition of population

75%

7. VDC/Municipality meeting

geographical area

10%

classification

15%

8. Village/Municipal Council meeting 9. Area (Ilaka)-level planning workshop 10. Sectoral planning meeting 11. Integrated plan formulation meeting 12. DDC meeting 13. District Council approval 14. Implementation of DDC plan

Ministry of Federal Affairs and Local Development MoFALD receives the program and budget request from the DDCs. Projects which are expected to be funded by central grant, are submitted in a budget format. MoFALD discusses it in NPC and the MoF. The budget is finalized after the approval of Legislative Parliament. MoFALD disburses the central grant to the DDCs/ VDCs /Municipalities on the following basis:

There are basis of grant allocation to VDCs. There is unconditional block grant to each VDC. The additional grant depends on the size and composition of the population, geographical area and other classification of VDCs. There is another basis that is MCPM. The percentage differs on the basis of MCPM. If the minimum condition of performance is poor, the percentage of grant is reduced. Basis of grant allocation from the centre to Municipalities a

size and composition of population

60%

Infrastructure indicators

25%

Mobilization of internal revenue

15% Sources: MoFALD

A Study on Budget Formulation Process of the Government of Nepal

The size and composition of the population infrastructure and mobilization of internal revenues are the criteria for grant allocation to Municipalities. The weightage are given in the table above. If the minimum conditions of performance are not fulfilled, grants are reduced.

Chapter I

3.6 PEFA Evaluation of Budget formulation at Local level PEFA conducted an assessment of PFM status at the local level. The sample outcomes were negative and raised serious concerns. No local bodies were rated A. Only 33% were rated B, 50% rated C and 17% rated D. The assessment showed weaknesses such as : ineffective internal audit, overpayment without supporting document, above limit administrative expenses, weakness in procurement, weak inventory management and expenditures without approval. Without elected representatives, district or VDC councils are nonexistent, so the budget formulation lacks public participation. Internal audit is problematic as government grant has increased but the government has not provided the services of an accountant and the secretary of the VDC is overworked. There is poor reporting and monitoring system. MoFALD approved a Fiduciary Risk Reduction Action plan in 2012. The plan was carried out to correct the weaknesses and strengthen the positive aspects on the basis of experience gained during the implementation of the Local Governance and Community Development Program (LGCDP) phase I. The phase I was designed for capacity building of PFM at local level and institutionalization of demand side mechanism. The action plan was expected to fill â&#x20AC;&#x153;sub- national gapâ&#x20AC;? in PFM reforms.

3.7 Classification of Expenditures The Government of Nepal has followed the Government Financial Statistics (GFS) classification, adopted from the International Monetary Fund, in the expenditure and revenue classification. Government expenditures are classified in three categories namely: recurrent, capital and finance. The expenses incurred to run the daily activities of the government fall under recurrent expenditures. The expenses incurred to acquire additional assets of the government falls under capital expenditure. The expenditures incurred to repay loans, investments in financial institutions (loan/share) fall under finance expenditure. This is the first level classification of expenditure. A two digit grant number is assigned to constitutional bodies, ministries and secretariat equivalent to such ministries/commissions. These numbers are known as grant indication. These indications are 95 in number. There are 12 service wise and sector wise classifications of budget under sectoral numbers. There 16 A Study on Budget Formulation Process of the Government of Nepal

are sub-sectoral numbers. There are 4 categories of foreign grants (11. 12. 13. 14.) and three categories of foreign loans (21, 22, and 23). The district level also has the same provision but the indication number differs as per category. In development programs, there are current expenditures and capital expenditures of both central level and district level. For the purpose of allocation and reporting, expenditure headings are classified under recurrent and capital also. Under the recurrent expenditure, there are consumption, such as salary, allowances, travel expenses, dress, food, medicine, pension, training. Similarly there are office operating expenses, grants (transfer) - grants with condition and without conditions to local bodies. There are services and production expenses. Others are repayment of principal, payments of interest and tax returns. All these expenditures are classified into twelve heads and other subheadings in each heading. The capital expenditures are also classified in capital transfer (purchases of land, building,) creation of capital, (furniture, vehicles, machinery, construction of building and civil construction), maintenance of capital, and study and technical consultancy services. In capital expenditure there is investment heading, capital grants (grants to corporations, unconditional and conditional grants to local body, social service unconditional and with condition contingency. Altogether, there are 9 capital expenditure headings. These classifications and indications are to facilitate budget formulation, implementation and reporting. In the government budget, the programs are grouped in P1, P2, and P3 categories. The program indicated as P1 is assured the earmarked fund to implement program and in case of programs indicated as P3, MoF may curtail the budget and instruct LMs accordingly in case of resource crunch. All donor funded projects are categorized as P1 projects.

3.8 Budget Implementation and Control The Treasury Single Account system (TSA) is one of the milestones in budget implementation system in Nepal. After the approval of the annual budget, MoF issues the authorization to implement the budget, along with the instruction on implementation of certain expenditure heads to the secretaries of LMs. FPA has provisioned that the secretary of the LMs (Chief Accounting Officer) are responsible to implement the budget and provide services and have their accounts audited by the Auditor General of Nepal. The secretary issues authorization of budget implementation to the implementing offices. The Authorization letter is also forwarded to District Treasury and Comptrollerâ&#x20AC;&#x2122;s Office (DTCO) to disburse the budget upon request of implementing unit on time. DTCO records, the authorized signature and name and

designation of Line Officers and enter into the computer software. The computer software is designed with a provision of internal check and internal control in budget disbursement. The respective offices complete the legal formality of sending a request to DTCOs to issue a cheque in the name of concerned party. Upon receipt of such request , DTCO issues the cheque against the payment request after completing the process of checking, designed for internal control. TSA has been rolled out across the country for better cash management. With the implementation of this system, almost 13717 bank accounts have been consolidated into 467 bank accounts. DTCOs of 75 districts are connected online with FCGO to enable real time and digital transmission of all field level transaction information to FCGO. FCGO publishes ministry wise and district wise monthly income and expenditure reports and budgetary position on its website. The total

income and expenditure status is available in computer display in FCGO and at DTCO office in each district on a daily basis. The financial information that the FCGO generates is used for budget formulation, bimonthly monitoring of projects and midyear evaluation. Another oversight agency is the Office of the Auditor General (OAG). There are two key governance issues on the control side: auditing financial performance and budget expenditure. The OAG has the sole responsibility to carry out financial and performance audit. The annual report produced by the OAG has sufficient audit information which enables the public to monitor whether public money is spent on right activities with due process. Thus the OAG report is the key document to provide feedback to the government on its financial performance.

A Study on Budget Formulation Process of the Government of Nepal

Chapter I

18 A Study on Budget Formulation Process of the Government of Nepal

Chapter IV

Analysis of Current Practices in Budget Formulation 4.1 Budget Ceiling Assessment The periodic planâ&#x20AC;&#x2122;s projected economic growth and the performance of the economy are assessed in an analysis paper prepared by MoF. While determining ceiling, NPC takes into consideration the MTEF and budget needs as adjusted on the basis of the projected economic growth rate. The major determining factors are: foreign aid, commitment for ongoing and new projects and the governmentâ&#x20AC;&#x2122;s obligation on meeting counterpart funds. The physical and financial performance is also a basis for the determination of ceiling but more emphasis is given on the financial information that is generated quickly. NPC has taken initiatives to consult with the LMs on plans, priorities and major activities for the next fiscal year. It is expected to make the budget formulation more objective, realistic and focused on result based activities. The entry point of projects should be the ward level for local level budget and district level activities for central level budget but in practice projects are injected laterally in the NPC and LMs even at the time of finalization of the budget. Budget ceiling is incremental. It is not based on the needs of the people and economic and social objective of the government. Once a project enters into the budget expenditure book or red book, it is carried over for years and budgeted over a long time. This practice blocks the limited resources in the name of new projects and the essential project lacks necessary amount of funds to complete it on time. An example is noted here, as mentioned in OAG Report 2013. The total estimated project cost of Rs. 2150 million for the Dodha River embankment in Kanchanpur district but the average annual allocation was Rs. 30 million only. A simple calculation for completion of the project allocation at this amount, shows that the project will be completed in 72 years. It

is a unrealistic allocation. Such kinds of budget ceiling and allocation are not realistic. The project document has set the target of about 12 years to complete the project which in itself is a long period. There are many examples of this kind, which are nothing, but scattering of scarce resources in the name of development. This example and other similar cases reveal that the budget ceiling in a large number of budget heads is not realistic. It is still an ad hoc exercise. On the one hand, the ceiling does not cover the local level projects funded from the local level resources, on the other hand, it does not take into account off budget expenditure directly implemented by development partners. Moreover, the NPC and MoF have allocated funds without questioning the efficacy and viability of the projects, receiving funds over the years. This definitely demonstrates the weaknesses in the allocative efficiency of the government.

4.2 Current budget formulation approaches The Government of Nepal is using both the top-down and the bottom-up approaches in budget formulation. The central governmentâ&#x20AC;&#x2122;s budget is prepared using a topdown approach. The ceiling and guidelines are prepared by NPC and MoF and approved by the cabinet and is sent downwards for budget preparation within the limit of ceiling and guidelines. The next approach is bottom-up approach which starts from the joint meeting of citizen forum, users committees and representatives of local political parties at the local level. Budget formulation at the local level reveals that the process is participatory and user committees mobilize local resources and small projects are implemented on a cost sharing basis.

A Study on Budget Formulation Process of the Government of Nepal

Top Down approach- Central Level

Chapter I NPC Line Ministries

Departments

District Offices

MoF

Bottom Up Approachâ&#x20AC;&#x201D;Local Level Ward level users committees, Political Parties, citizenâ&#x20AC;&#x2122;s forum

Ilaka level meeting

Municipalities/VDC Council, DDC, NGOs, CBOs

This diagram shows the present approaches of budget formulation in Nepal. As mentioned above there are two approaches which are parallel in practice. At the local level it seems bottom up and at central level it is top-down. Budget formulation process can neither be fully bottom-up nor top-down. In practice, the central level budget is dominated by a top-down approach. The local level budget formulation process seems bottom-up but it is parallel in nature. There is top-down as well as bottom-up approach at the local level. The budget ceiling is sent through parent ministries and departments but the projects are selected within the ceiling from the bottom. It is necessary to link the center and local level through budget ceiling and guidelines. Local level projects are prepared within the ceiling. If the projects are essential they can send a separate list outside the ceiling framework to the parent Ministries. The process has the advantage of peopleâ&#x20AC;&#x2122;s participation and opportunity to reflect local needs and priorities, but in practice it has become an exercise on listing projects. The list is drawn up without references to the district plan, program and priorities, so it has become a yearly ritual at the local bodies.

4.3 Budget Discipline For an analysis of budget discipline, the study reviewed the reports of the Auditor-General of Nepal. The reports has clearly described that the budget discipline is very weak. There are evidences of over expenditure in some budget heads. The Financial Procedure Rules 35(2) of 2064 B.S. states that the expenditure should be in line 20 A Study on Budget Formulation Process of the Government of Nepal

VDC/Municipal councils

District Council

DDC

Five Sectoral Committees

with the concerned head. But in most cases, the total over expenditure is huge. The parameter of budget discipline is virement (transfer from one budget head to another). Article 8.1 of Financial Procedure Act 2055 and Financial Procedure Rule 2064 (40) clearly specifies the limit of virement (10 % of the budget). There are a number of cases which reveal that the MoF has approved virement exceeding the limit which is against the budget principle. Another indicator shows that budget has been transferred to another budget head, despite the fact that the expenditure incurred in the same head is negative. There is no timely demand for reimbursement in case of foreign aided projects. There is a general tendency to allocate a huge amount of the budget in the name of contingency and miscellaneous and allocate it at the discretion of MoF in any budget head. There is a general practice of on-treasury and off-budget expenditure. There is revenue expenditure (tax exemption partially or fully) in each financial year and a huge amount is not shown in the budget. There is the practice of non budgetary expenditure. MoF allocates a huge amount in contingency and miscellaneous heads and during the financial year, particularly at the last trimester, such funds are largely reallocated to the off-budgetary expenditure in any project or budget heads.

4.4 Budget allocation and actual expenditure trend The budget formulation process is not only the process of budget preparation; it is also the process of implementation. The team observed the budget

formulation process to analyze the shortcomings and strengths of the current practice of budget formulation of Nepal. The budget allocation and expenditure is increasing each year. The spending capacity of public money in recurrent expenditure has increased, at the same time the capacity of spending capital budget

has weakened. The following table shows the budget allocation and actual spending of capital and recurrent budget. As such, there is a huge gap in each financial year. For the purpose of analysis the study team selected total figures of four years:

Table 1. Total Budget Allocation and Actual Spending (Amount Rs Billions) Category

FY 2010/11 Allocation

FY 2011/12

Actual

Allocation

FY 2012/13

Actual

Allocation

FY 2013/14

Actual

Allocation

Actual

Expenditure

337.90

295.36

384.90

339.17

424.83

358.64

517.24

435.05

Recurrent

190.32

170.30

266.61

243.46

299.01

247.46

353.42

303.53

Capital

129.54

107.85

72.61

51.39

66.14

54.60

85.10

66.70

Finance

18.04

17.22

45.68

44.32

59.68

56.58

78.72

64.83

Source: Financial Comptroller-Generalâ&#x20AC;&#x2122;s Office

The above table reveals that the gap between the allocated and the actual expenditure of the recurrent budget of FY 2010/011, 2011/12, 2012/13 and 2013/14 were 10.52%, 8.68%, 17.24% and 14.12% respectively. The position of the capital expenditure shows a similar trend but the gap is wider than the recurrent expenditure gap. The gap between the allocated and the actual expenditure of the capital expenditure for the FY 2010/11, 011/12, 12/13 and 13/14 are 16.74%, 29.22%, 17.44% and 21.7% respectively.

percent gap in 2013/14. The other point to be noted is that the total allocation of the capital expenditure has declined from 2010/11. The Government has a tendency to over program the budget and include a large number of projects without strictly following the norms and guidelines of the government. The number of projects under the budget heads was 734 in 2003/04, which declined to 536 when MTEF was introduced in 2004/05. It is reported that during the decade the number of projects on average was 450 but the number increased from 456 in 2013/14 to 496 in 2014/15.

The trend shows that there was a gap of almost 15 percent (on average) in total budget and actual spending. In case of capital expenditure, it was as much as a 22

The gap between total allocation and actual expenditure, recurrent expenditure, financing and revenue in the budget is shown in a simple graph below:

Fig. 1.a. Gap between Allocation and Actual of Total Expenditure

The above figure reveals that there is a gap between the total allocated amount and total actual spending of three years. In the year 2010/11, the gap is small but from

2011/12 it has widened. The gap has been widening in each succeeding year.

A Study on Budget Formulation Process of the Government of Nepal

Fig.1.b. Gap between Allocation and Actual Recurrent Expenditure

Chapter I

The figure above shows that there is a gap between allocation of total recurrent budget and actual spending too. In the year 2010/11, the gap seems small, however,

it started increasing by 2011/12. The gap has continued to increase in each succeeding year.

Fig.1.c. Gap between Allocation and Actual Capital Expenditure

The above diagram reveals that there is a gap between allocation and actual spending of capital budget. The release of funds at the last trimester, itself, is not a good practice in the budget formulation process. In total, the gap had narrowed in the year 2010/11 and 2011/12, to some extent, however, it started widening

from the succeeding year. This has ultimately resulted in decrease spending in capital projects. The total capital expenditure reveals the spending capacity of the country. The reasons may be different, however, it is a wellunderstood fact, that our bureaucracy does not possess the capacity to spend within the allocated time frame.

Fig.1.d. Gap between Allocation and Actual Financing Expenditure

22 A Study on Budget Formulation Process of the Government of Nepal

The above figure indicates a gap in financing expenditures too. The financing expenditures are precisely calculated and allocated. It also shows a gap since the year 2012/13. In the year 2010/11 and 2011/12 the finance spending is more or less equal to allocation, however, since 2012/13 the gap between allocation and actual spending started widening.

Compared to the underspending trend in expenditure, the performance in revenue mobilisation is satisfactory. As illustrated by the following table, the gap is insignificant. In 2012/13, the government succeeded in mobilising more revenue than the estimated amount, by 6.4%.

Table 2. Total Estimated Revenue and Actual Revenue (Amount Rs Billions) FY 2010/11

FY 2011/12

FY 2012/13

Estimation Actual Gap% Estimation Actual Gap% Estimation Revenue

216.6

199.8

7.9

245.1

244.4

0.7

289.6

FY 2013/14

Actual Gap% Estimation Actual Gap% 296.0

-6.4

360.6

357.2

3.4

Source: FCGO

In the year 2010/11, the revenue target was NRs 216.6 billion, the actual revenue realized was NRs 199.8 billion, with a gap of 7.9% only. Similarly the revenue estimated for 2011/12 was NRs. 245.1 billion while the actual revenue realized was NRs. 244.4 billion, with a gap of 0.7%. Likewise, the revenue target for the financial

year 2012/13 was NRs. 289.6 billion, while the actual revenue realized was NRs. 296.0 billion exceeding the target by 6.4 percent. The revenue target for the fiscal year 2013/14 was NRs. 360.6 billion; the actual revenue realization was NRs. 357.2 billion resulting in a gap of 3.4%.

Fig.2 Gap between Revenue Estimation and Actual

The above diagram shows that revenue realization is better than the capital expenditure. It shows that revenue estimation and actual realization are equal with each other. In some years revenue realization has exceeded the estimated amount.

Foreign Aid In Nepal, the capital budget is dominated by foreign aid. The rate of disbursement of foreign aid generally affects the rate of capital expenditure. In other words, less capital expenditure means, less utilization of foreign aid.

Table 3. Total Foreign Aid Allocation and Actual Spending (Amount Rs Billions) Category Foreign Aid

FY 2010/11 Allocation

FY 2011/12

Actual

Allocation

FY 2012/13

Actual

Allocation

Actual

FY 2013/14 Allocation

Actual

Total

87.57

58.00

99.78

51.89

72.83

47.20

123.24

65.61

Grant

65.34

45.92

70.13

40.81

46.99

35.23

69.54

43.66

Foreign Loan

22.23

12.08

29.65

11.08

25.84

11.97

43.70

21.95

Source: Financial Comptroller-Generalâ&#x20AC;&#x2122;s Office

A Study on Budget Formulation Process of the Government of Nepal

The table above reveals that the gap between the allocated and actual spending amount of foreign aid is glaringly wide. The gap is from 34% to 48%. The gaps in FY 2010/011, 2011/12, 2012/13 and 2013/14 were 33.7%, 48.0%, 35.2%, 47.0 % respectively. It seems that donors are eager to include the foreign aid program in the budget but would like to use the fund off treasury. It should be noted that the gap between the allocation and actual expenditure in foreign loan is more than the gap in the grant component. It reflects that the capacity of the government to implement projects is very weak.

Chapter I

There are certain norms in aid effectiveness. In this context, there are certain international declarations. The Paris Declaration 2005, Accra Declaration 2008, Busan Declaration 2011 on aid effectiveness has brought consensus on five principles for aid effectiveness. These are: alignment, ownership, harmonization, managing for results and mutual accountability. These international declarations have brought changes in the aid structure from projects to programs. Foreign donors are raising serious concerns about the fiduciary risk arising from the lack of coordinated action and transparency in allocation and operation by the government. Nepal is suffering from post conflict challenges. Governance is based on political compromises, rather than the rule of law, in the post-conflict transition. This has resulted in poor performance in foreign aid utilization. On average 20 to 25% of government budget is contributed by foreign aid over the years. The capital

expenditure is dominated by foreign aid. Foreign aid plays an important role in Nepal by financing most of the development projects. The main sectors receiving external support are: education 15%, health 13%, local development 12%, and road 11% (based on budget of FY 2013/14). In practice, all donors prioritized their aid effectiveness principle in their respective aid policy/strategy. As far as the attitude towards aid effectiveness is concerned, commitments vary significantly within donors. Foreign Aid plays a key role in Nepalâ&#x20AC;&#x2122;s socio-economic development. About 40 development partners are providing aid to Nepal. They emphasize commitment, institution, coordination and effectiveness. However, in practice, they need to align aid with the governmentâ&#x20AC;&#x2122;s national plan and country system. At present, about 71% of total aid is channeled through the government system (on budget), the rest is spent by the donors (off budget). That means, a large amount of foreign grants is spent in the form of technical assistance, direct payments, commodity grants and turnkey projects that are financed and procured abroad bypassing the budget formulation process and creating issues of transparency and accountability. Foreign aid spent in the form of budgetary support gives flexibility to the government but the plethora of conditionality attached to aid hinders the utilization of aid. Donor driven reform agenda, which has merits per se, needs to be critically scrutinized on the basis of ground reality and in the light of lessons learnt from the previous project/policy implementation experience.

Fig. 3.a. Gap Analysis of Total Foreign Aid

The above diagram shows that the gap between total foreign aid allocation and actual spending is widening each year. In comparison with the financial year

24 A Study on Budget Formulation Process of the Government of Nepal

2010/11 the gap increased in FY 2011/12. However it decreased slightly in FY 2012/13. In FY 2013/14 it started widening.

Fig. 3.b. Gap Analysis of Foreign Aid (Grant)

Figure 3b reveals the difference between grant allocation and actual realization. In comparison with the FY 2010/11 the gap between allocation and actual realization widened

in the FY 2011/12, however, it narrowed slightly in 2012/13 but started increasing in 2013/14.

Fig. 3.c. Gap Analysis of Foreign Aid (Loan)

Figure 3c reveals that the situation with foreign loan is also the same as with grants, In comparison to the gap for FY 2010/11, the 2011/12 gap is wider, however, in the FY 2012/13 it decreased slightly but started increasing by 2013/14 resulting in less spending in the capital budget. The diagrams on foreign grants and loan above reveal the gaps of allocation and actual spending for each year. In the year 2012/13, the gap of grant allocation and actual spending narrowed to some extent, but started widening by the next year. At the same time, the position of gap in allocation and actual spending of loan was also widening.

Nepal is dependent on foreign aid so this gap results in less capital expenditure. Foreign grants and loans have provided an important source of funds for government projects since the 1950s. In 2010/11 external aid consisted 29 percent of total government budget. Donor support represents more than 50 percent of capital expenditures and 12 percent of recurrent expenditures. This shows the dependency on foreign grants and loans. Foreign aid amounts to a higher proportion of government budget and the dependence on foreign aid in implementing capital projects and some social sector projects are very much pronounced. The availability of

A Study on Budget Formulation Process of the Government of Nepal

foreign aid and its predictability needs to be ensured for smooth implementation of upcoming projects. For this, the government needs to be serious in augmenting the implementation capacity of the government and accepting conditionality which the government is in a position of successfully implementing it.

Chapter I

4.5 Sector Wise Gap Analysis For the purpose of analysis of the gap between allocation and actual expenditure of capital budget, the study targeted 5 ministries: Ministry of Physical Infrastructure and Transport (MoPIT), Ministry of Education (MoE), Ministry of Irrigation (MoI), Ministry of Federal Affairs and Local Development (MoFALD) and Ministry of Health and Population( MoHP).

Table 4: Budget Allocation and Actual Expenditure of Selected Ministries for the FY 2010/11 to 2012/13 (Rs In millions)

FY 2010/11 Ministry

Ministry of Physical Infrastructure and Transport2 Ministry of Education

Ministry of Irrigation Ministry of Federal Affairs and Local Development Ministry of Health and Population

FY 2011/12

FY 2012/13

% of actual % of actual % of actual Expenditure expenditure Allocation Actual expenditure Allocation Actual Allocation Actual expenditure Head to to allocation to allocation allocation

Recurrent

2131 1602

75.2

9219 6657

72.2

3258 3247

99.6

Capital

35065 25883

73.8

34575 25882

74.8

27341 22215

81.2

Total

37196 27485

73.9

43794 32539

74.3

30599 25462

83.2

Recurrent

51896 48736

93.9

63627 61914

97.3

63249 62291

98.5

Capital

5931 6251

105.4

Total

57827 54987

95.1

Recurrent

824

655

79.5

Capital

7983 7212

Total

292

139

47.6

63919 62053

97.1

875

843

96.3

90.3

9153 8255

8807 7867

89.3

Recurrent

14569 12737

Capital

182

139

76.1

63431 62430

98.4

777

752

96.7

90.2

10471 9463

90.4

10028 9098

90.7

11248 10215

90.8

87.4

37051 31443

84.8

32497 30283

93.2

27272 24784

90.8

7449 3599

48.3

4247 3453

81.3

Total

41841 37521

89.6

44500 35042

78.7

36744 33736

91.8

Recurrent

17054 13737

80.5

20360 16970

83.3

17071 16288

95.4

Capital

6759 4438

65.6

4574 3270

71.5

3169 2761

87.1

Total

23813 18175

76.3

24934 20240

81.2

20240 19049

94.1

Source: Financial Comptroller-General Office

The table above reveals that actual capital expenditure is less than allocated amount for all the five ministries. The figure shows that MoPIT has spent only 73.8% of its capital budget in 2010/011. In the year 2011/12, it spent 74.8%. Similarly, in 2012/13 the expenditure was 81.2%. It is improving each year. The MoE spent about 95 % in the three year period in its recurrent expenditure. However, capital expenditure was erratic in three years. In 2010/11, it overspent its capital budget. In the year 2011/12, it spent only 47.6% of its capital

budget. Similarly, it spent 76.1% of the allocated capital budget in the year 2012/13. It should be noted that the MoE has dominantly a recurrent budget. The MoI which spends 90 percent of the budget in capital expenditure, spent on average, about 91% of the allocated capital budget in the three years. The MoFALD presents an interesting picture in its expenditure pattern. In 2010/11, the capital budget was

The erstwhile Ministry of Physical Planning and Works was restructured and divided into two ministries namely Ministry of Urban Development and Ministry of Physical Infrastructure and Transport in the year 2012/13. This affects the expenditure of the ministry of physical infrastructure and transport.

26 A Study on Budget Formulation Process of the Government of Nepal

66 percent of the total budget and in the next two years, the capital budget was only 10 percent of the budget. The gap on the capital budget was erratic.

2011/12. The ministry spent 87.1% of its capital budget in 2012/13. In the total budget, expenditure shows some improvement.

The MoHP spent 65.6% of the capital budget in 2010/11. Similarly, capital spending reached 71.5% in

The facts and figures are presented in the simple graph below:

Fig. 4.a. Gap between Allocation and Actual Expenditure of the Ministry of Physical Infrastructure and Transport

The diagram above shows that the total amount of budget allocation decreased in the year 2012/13. It is due to the separation of the Ministry of Physical Planning and Works into two ministries namely the Ministry of Infrastructure and Transport and the Ministry of Urban Development. Still the gap between allocation and actual

spending has not decreased. In comparison with the budget allocation and actual spending for FY 2010/11 the allocation and actual spending for 2011/12 slightly increased in the Ministry of Physical Infrastructure and Transport; however, the gap was reduced in FY 2012/13.

Fig.4.b Gap between Allocation and Actual Expenditure of Ministry of Education

Figure 4b shows the gap between allocation and actual spending of the Ministry of Education. The budget allocation increased in each year, in comparison with

FY 2010/11, the gap reduced in the succeeding years, however, the gap is still considerable.

A Study on Budget Formulation Process of the Government of Nepal

Fig. 4.c Gap between Allocation and Actual Expenditure of Ministry of Irrigation

Chapter I

The above figure 4c indicates that the allocation for irrigation increased in each succeeding year, however, the gap between allocation and actual spending was

the same. In comparison with the previous year or FY 2010/11, the gap was almost the same for the succeeding two years.

Fig. 4.d Gap between Allocation and Actual Expenditure of the Ministry of Local Development

The above diagram 4d. indicates that the gap between budget allocation and actual spending for 2011/12 was very wide, in comparison with FY 2010/11, however

28 A Study on Budget Formulation Process of the Government of Nepal

it narrowed in 2012/13, however, the gap still exists in allocation and actual spending of Ministry of Federal Affairs and Local Development.

Fig. 4.e Gap between Allocation and Actual Expenditure of the Ministry of Health and Population

The above figure 4.e. shows a large gap in 2010/11, the gap remained till 2011/12, however, it was corrected to some extent in year 2012/13.The gap has narrowed but still exists. The Team noted the following, while visiting the sectoral ministries and the district offices: As far as public financing of education is concerned, the Government has been allocating a large amount to this sector. Of the total allocated budget, 80% goes for salaries of primary and secondary schools, 9% for higher education, 4% for technical education and 3% for others. Due to the lack of a minimum required budget, 40% of the schools are functioning below the minimum required standard. Despite the huge spending, education is perceived to be one of the underperforming sectors. The District Education officer spends most of its time in non-core functions, instead of giving time to core functions, such as improving the quality of education, infrastructure improvement, etc. Over the years, public funding for schools has increased in real terms, which is indicative of the governmentâ&#x20AC;&#x2122;s priority to this sector. A large amount is released in the last trimester, particularly in the last month of the year. The schools are then able to pay salaries of the teachers, only after four months and not on a monthly basis. Teachers have to wait for a long time to get their salary. The system of reconciliation of funds released and received is not effective. Financial management at schools is reported to be very poor. Financial records are not kept properly. It is reported that at the primary school the head teacher acts as an accountant. The capital grant for the school is spent through direct purchases. Few schools conduct regular public audit. Financial monitoring of schools is virtually non-existent. There is no opportunity for career development of teachers, any teacher can become the head of the school. This practice is also responsible for diluting accountability.

In the health sector, the total health budget seems insufficient. There are more than 2000 health related activities at the local level but there is no costing. Budget is formulated at the departmental level and it is based on an incremental system. For universal coverage, a budget of $ 33 per head is necessary, but the present budget cannot cover this. The budgetary process is not practiced below the departmental level. Recurrent expenditure is spent almost a hundred percent, while the capital expenditures is spent at the end of the year. These sectors are representatives only but the gap between allocation and actual expenditures is high in all ministries. The practice of spending the capital budget at the end of the last trimester is common in all line ministries. Despite the flood of reforms of the government in financial management, the study team observed that the implementation has not been effective so far. There is still the incremental ceiling determination and budget allocation in practice. The analysis is based on data and figures made available from FCGO. The overall situation of spending is not encouraging. All ministries and departments suffer from the practice of starting project implementation late. This delays capital expenditure ultimately.

4.6 Budget Monitoring The budget expenditure of the previous year should be monitored while formulating the budget of the coming year. The Auditor Generalâ&#x20AC;&#x2122;s report clearly underlined that the analysis of the budget allocated for capital spending for fiscal year 2070/071, showed that out of 231 budget heads, there was no spending in 36 budget heads. This indicates that there is no monitoring system. From 36 budget heads, the amount of 6 budget heads, was transferred and spent on other projects. The report states that in some cases, the budget authorization was issued in the last month of the fiscal year and the amount spent in that year. There are several evidences of spending A Study on Budget Formulation Process of the Government of Nepal

capital budget in the last trimester. In FY 2070/071, out of a total capital expenditure of Rs. 6669 crore, Rs. 2498 crore (37.46%) was spent in the last month of the last trimester. In the previous year, the scenario was the same. Thus, the trend of spending the capital budget in the last trimester is high.

shows a lack of seriousness to learn from past mistakes and a lack of willingness to incorporate the solutions in the next cycle.

At the central level, there is a monitoring division in each LMs and MoF but monitoring activities are not effective. The MoF is the focal agency that releases the budget and monitors implementation through different ministries and agencies. The budget implementation is monitored at the central level through the line ministries budget division and departments. The MoF has direct connection with donor agencies. It also has direct connection with NPC and the central bank. At the local level, the monitoring mechanism is weak and nonfunctional. Monthly reports are prepared for monitoring of physical and financial performance. The concerned departments monitor district level and LMs monitor the departments or regional level budget implementation. A half yearly evaluation is conducted in each ministry and a special evaluation meeting is held in the MoF. All evaluations are routine work. In spite of these monitoring and evaluation practices the capital expenditures are still not satisfactory. One of the reasons we observed is that there is the absence of a procurement plan and delays in implementation of such plans on time. The monitoring mechanism was established to correct problems and report the weaknesses as a feedback to help formulate the next budget. The frequent repetition of the problems

The Medium Term Expenditure Framework was introduced to meet the following objectives:

Chapter I

4.7. Medium Term Expenditure Framework (MTEF) and Challenges

i. to integrate the objectives, plans and priorities and budget allocation ii. to release the budget on the basis of performanceboth physical and financial ii. to establish a result based monitoring system and follow the system rigorously The institutionalization of MTEF has not been effective in Nepal in establishing coordination between planning and budgeting. A practice has been carried out to submit updated MTEF before parliament. But there is the need to improve the quality of the MTEF process. The PEFA assessment indicated a high fiduciary risk environment in Nepal. The financial system is designed well but unevenly implemented. It has a reasonable control framework. Despite all these, there are gaps between control framework and implementation, because large fiscal activities remain outside of budgetary scope. MTEF as a rolling budget model is adopted as follows:

3 Year Medium Term Budget Rolling Estimates Budget Year 1 Budget to Actuals

Economic Changes

Multiple Year

Budget Year 2

Commitments

Budget to actuals

Capital-Recurrent

Multiple Year Commitments Capital-Recurrent

Rolling Estimates Economic Changes Budget Year 1 Budget to Actuals Multiple year Commitments Capital-Recurrent

(Adopted from the best practice website) 30 A Study on Budget Formulation Process of the Government of Nepal

There are three pillars of MTEF. They are: project priority, unit costing, result linked to output. The team consulted some stakeholders and found out that the priority is also sometimes overlooked while preparing the budget. One year, a project, is classified as P1 and the same project is classified as P2 and vice-versa. For the purposes of unit costing, a feasibility study is conducted. But in many cases, discount rates are not calculated. In mega projects, a feasibility is conducted and the rate of return calculated to international standards but at the local level this is not done. The results based on output are not achieved at the local level. The outcome of the plan is not projected and monitoring is also weak. Result focused programs are not performing as per expectation, due to lack of coordination between concerned institutions.

4.8 Best Practices of Budget Formulation for Transparency

There are challenges to effective implementation of MTEF. Some of these are given below:

Budget reports

Accounting: It is a universal fact that poor accounting processes and poor implementation data lead to poor planning. For the success of any financial management reform of the accounting process should be clear and scientific. The double entry system of accounting is the best system. Economic stability: There are challenges of uncertainty in terms of trade, commodity price, earnings, as well as the predictability of foreign aid in a situation of economic instability. Thus, economic stability is necessary for the success of MTEF. For economic stability, political stability is essential. Since 1995, Nepal has been facing political instability resulting in economic instability. Off-Budget: Generally, donor funding, revenue expenditure and government enterprise budget can be â&#x20AC;&#x153;Off-Budgetâ&#x20AC;? where the government is unaware of the full revenue and expenditure, which is the main tool for effective planning. There are other items of expenditure which are off the budget such as revenue expenditure. Over loading: The preparation for a three year rolling budget takes a long time. Starting too many works at once, in a short span of time overloads human capacity and prevents progress on reforms. Political will: The macroeconomic analysis or performance measures reflect the willingness or unwillingness of policy change. To make MTEF successful and the budget formulation effective, political will is necessary. Fiscal sustainability: The MTEF focuses only on medium terms perspective, which makes the process not attuned to long term issues.

Transparency, openness of policy, policy formulation and implementation are key elements of good governance. The budget is the single most important policy document of the government. Budget transparency is defined as the full disclosure of all relevant fiscal information in timely and systematic documents. OECD has designed best practice tools for all member countries. These practices are only reference tools for budget formulation in order to increase budget transparency. The best practices were designed with the experience of different practices of member countries. There are three areas of best practices. They are:

Budget is a key policy document. It should be comprehensive, so that the necessary tradeoff between different policy options can be assessed. It should be submitted to parliament, in no case less than three months prior to the beginning of the fiscal year. It should be approved prior to the start of the fiscal year. The budget should include a medium term perspective, illustrating how revenue and expenditure will develop at least for the upcoming two years. There should be a pre budget report (economic survey) which serves to encourage debate on the budget and to create appropriate expectations in the budget for the coming year. Monthly reports are necessary to monitor budget implementation. Such reports should be released within four weeks of the end of the month. The midyear reports are necessary to get an update on the implementation and to assess outcome of the budget. The year end report is the governmentâ&#x20AC;&#x2122;s key accountability document. It should be audited by the Auditor General. A preelection report illustrates the general state of government finance before the election. The feasibility of producing this depends on constitutional provisions. Long term reports assess the long term sustainability of current government policy. It should be published at least every five years. It should assess the budgetary impact on the economy and society. Specific disclosures Any deviation from the forecast of economic assumptions, underlined in the budget is a risk to the government. Therefore, all economic assumptions should be disclosed. The assumption about economic growth, the composition of GDP, rate of employment, the current account, inflation rate and interest rate (monetary policy) show the present situation. A sensitivity analysis should be done. At the same time, tax expenditure should be shown separately because it is the cost of revenue. Financial liabilities and assets should be A Study on Budget Formulation Process of the Government of Nepal

disclosed in mid-year and annual reports. Similarly, monthly borrowing activities should be disclosed in monthly reports and it should be classified by currency denomination and maturity profile of the debt. Financial assets also should be disclosed with classification as per major type. Non financial assets including real estate and property should be disclosed. At the same time, employee pension obligations should be disclosed in the mid-year and annual report. And lastly significant contingent liabilities should be disclosed.

Chapter I

Integrity, control and accountability The budget should mention a summary of accounting policy. These should describe the basis of accounting applied in preparing reports. If changes are required the reasons should be disclosed. A robust system of internal financial control should be in place to assure integrity. Each report should contain a statement of responsibility by the Minister of Finance and senior officials responsible for preparing the report. The year end report should be audited by the supreme audit authority. There should be an oversight agency

like the supreme audit body. All documents and process of expenditures should be scrutinized by that supreme body. The supreme body should be autonomous to examine all transactions of the public purse. The constitutional body should look after integrity and accountability. The public should be wary about the accountability of the officials. The budget control is carried out by the Financial Comptroller Generalâ&#x20AC;&#x2122;s Office. The budget is a public document. It should contain a statement of accountability. The controlling agency should examine the integrity using these indicators. The financial control mechanism should be built in the system of accountability that will help to develop integrity. For this purpose, all financial reports should be scrutinized by parliament. These reports should be made available publicly through the internet, free of cost. Best practices of government budget formulation cycle are presented below:

Government Budget Formulation Cycle Integration of Economic, Policy, Budget and Performance 1

Microeconomic framework

Financial Framework

Results

8 Budget Execution

Policy 2

Analysis

Government Objectives

Performance Framework Budget Plan

1. Economic model helps determine revenue expectation in financial framework 2. That provides constraints on government objectives 3. Economic realities drive policy considerations 4. Government objectives 5. And, the selection of measurements 6. That drives analysis of programs and activities 7. Used to develop the budget plan 8. That is adjusted during budget execution based on changing conditions 9. With output and outcome results that change the economic conditions and show what is working and what is not working

(Adopted from best practices website)

An economic model helps to determine the revenue target within a financial framework and which helps to remove constraints on government objectives. Economic realities often drive policy considerations. It supports the objectives of the government and the selection of measures to be undertaken. These provide analysis of programs and activities. The results of these analysis helps develop the budget plan and are

32 A Study on Budget Formulation Process of the Government of Nepal

based on changing conditions which is adjusted during budget implementation. It shows what is working and what is not, to achieve economic and social objectives. In the end, outputs and outcomes are measured and this results in changes in the economic condition of the country. These all are golden rules of best practices. We can examine our situation compared with the best practices.

4.9 The status of application of best practices in Nepal The budget formulation practice started in Nepal in 1952. It is a long practice in the perspective of development administration. The budget formulation process of Nepal

has passed through many reform initiatives. However, budget formulation still lacks important aspects of reform and of important tools prescribed by OECD. The following comparison shows our budget formulation practice:

OECD Best practice tools

Application status

Remarks

Reports 1

Executive budget proposal

Submitted to parliament

Published

Pre-budget statement

There is a pre budget statement

Citizen Budget

There is no citizen budget in practice

Enacted budget

Implemented

Published

Pre-budget survey

Economic survey is published

Published

Timely monthly reporting

Monthly reports are prepared

Tax expenditure(tax exemption) separate report

Such reports are not prepared separately

Revenue expenditure (cost of tax collection) separate report

No such report is produced.

Mid-year reports

Such mid-year reports are prepared

Year end reports

Are prepared and audited

Pre-election budget report

It is not prepared

Long term report ( five year)

It is not prepared

Timely submission to parliament in no case in less than 3 months before the beginning of FY approved prior to the start of the year.

It is submitted to parliament 3 to 7 days before the end of FY and approved 1 to 2 months later

Not published

No legal provision

Specific Disclosure 14

Disclosure of Economic assumptions

All assumptions are disclosed

Sensitivity analysis

Such analysis are not done.

Tax expenditure are shown separately

Shown in the finance bill as rate of exemption on different goods.

Disclosure of non-financial assets such as real estate

Are not disclosed

Integrity, control and accountability 18

Summary of accounting policy

It is given in Auditor-General's report

Internal financial control for integrity

Internal audit is in practice but it is not effective in all areas. Occasionally the parliament committee members visit large projects.

Statement of responsibility in all reports

No such statement

Year-end report should be audited

It is audited each year.

Report not published.

Published

A Study on Budget Formulation Process of the Government of Nepal

The above table reveals that many practices need to be corrected in the coming years. At the same time, it shows our position, clearly indicating where we are. As far as the reporting system is concerned, there are three reports which we lack in our context. With specific disclosure, the budget formulation process is totally lacking in this standard. In integrity, control and accountability there are certain norms which the budget formulation process of Nepal lacks. There are gray areas, by diluting accountability; such as releasing money by government agencies to NGO or user committees. The budget formulation is a continuous process. The budget preparation of one year ends and from that point on budget implementation starts. At the same point of time, the process of the next budget formulation starts along with the implementation of the present budget. The budget formulation with local participation is a must for local bodies. The participation of the legislature is very important for national budget formulation process.

Chapter I

The budget mentions a summary of government policy, but it lacks an accounting policy. The basis applied in accounting for preparing reports are not mentioned in the budget documents. If changes are required in the budget, reasons should be disclosed. To assure integrity, a dynamic system of internal financial control should be in place. Each published report should contain a statement of responsibility by the minister of finance and senior officials responsible for preparing the report. The yearend financial statements is audited by the Auditor-General of Nepal (the supreme audit body). OAG as supreme oversight agency should perform its duties as underlined in the law. All documents and process of expenditures should be scrutinized by the Auditor General. The supreme body should be autonomous to examine all types’ of transactions of public money. The performance audit is still in an infancy and there is still dominance of the traditional audit system. The constitutional body should look after the integrity, accountability and reporting systems. The public should be wary about accountability of the officials. The budget control is done by the FCGO. The budget itself is a public document. It should contain statement of accountability.

4.10 Decentralization and Local Participation in Practice Local participation and decentralization are jargons used in budget formulation frequently in different reports. The real picture is different. The collection of the project list is made by decentralization process; however project finalization is done through top-down process. People’s participation is also poor. For each local level 34 A Study on Budget Formulation Process of the Government of Nepal

projects 20% of the budget cost is expected through local participation. There is no costing of ward level projects. The commitments of local participation are only assumptions. In remote VDCs 20% of 15 lakhs is 3 lakhs and if they get the constituent assembly member’s fund, the amount of participation becomes 23 lakhs. It becomes impossible to spend with people’s financial contribution at the local level projects. The people’s financial contribution is on paper only. The contractors adjust the participation amount in their bidding and show the amount as a share of people’s participation. It is the starting point of corruption. Mostly the contractor is interested in road construction. Such projects provide incentives for corruption than other service sectors. On both the education and health sectors the situation is not satisfactory. In reports, we come across projects in: school improvement programs, free books, Tiffin and scholarship. As an example, the election of the school management committee in Dhanusha where shooting took place, was not for the improvement of the school, but of the incentives behind it. Likewise other events of conflict between doctors and medical representatives at Jeetpur Bara indicates the situation in the health sector; the purchases of essential medicine have been divided among the center, regions and districts hospital. Some medicinal drugs are procured and supplied at the local consumption centers. Most essential drugs, takes time in transportation and dispatch from the stores which results in the expiration date of medicines. MCPM is a very important tool to monitor and evaluate projects or performance of local bodies. As projects are administered by a team, reducing the budget on the basis of MCPM means the incapacity of the people which punishes the institution and ultimately the local people. It is discriminatory too. The same criteria do not apply at the central level.

4.11 Project Priority and Need Assessment As a flavour of development at the local level, most of the wards are interested to construct roads. The investment on a road for a road is useless, if there are no transportation facilities. Yet it is very important, that each village be connected with a road network. There should be transportation facilities too. The construction of a road without such facilities, is a misuse of resources. Still, local political representatives and users are interested in constructing roads. The road projects are selected without an environmental impact assessment which causes landslide and deforestation. The study team met with various individuals at the local level and discussed on budget formulation principles and practices. The common voice of all officials was that the main problems are in the entry point of projects. The selection of projects lacks need assessment. At

the same time there is no costing of projects in both central level and local level. Projects enter the pipeline either through the pressure of bureaucrats or politicians without the base line survey, feasibility study and costing. The discussion on ceiling, budget and programs at the planning commission is only ritual. The team observed the following: n Collection of lists of annual projects is not based on need assessment or feasibility study. n There is an absence of cost estimation at the time of budget formulation and the performance audit is still in its infancy and there is dominance by the traditional audit system. At the local level, internal audit is very weak. n Budget is formulated for a large number of projects on an incremental basis as compared with the previous yearâ&#x20AC;&#x2122;s actual expenditure. n There is no relation between the needs of the people and the budget formulation process resulting in less than desirable outputs or no outputs. n For infrastructure projects there is a gap between the allocated budget and actual spending, but there is demand for additional budget for projects outside the expenditure framework. n There is no environmental impact assessment study for local level projects. The construction of roads in each ward without concern for environmental damage and landslides is mostly attributed to it each year. n At the central level there are criteria for project prioritization. The budget is allocated according to this priority. Thus the central level budget includes expenditure prioritization. More than 80% of capital expenditure budget are classified under P1. It is not meaningful to keep most of the projects in P1. If 80% projects are kept in P1, there is the possibility of misuse of funds. Rest of the project expenditures are prioritized under P2 and P3. Consequently, even the projects which deliver results are also funded in the annual plan. The areas of service delivery also get continued funding whereas essential areas lack funds. Once a project is included in the expenditure head, it continues to be funded in successive years. n At the same time, recurrent expenditures are not fully prioritized. Only recurrent expenditures of ministries are prioritized under P1. The basis of prioritization of grants, subsidies and transfer payments are not clearly defined. n At the central level, there are numerous infrastructure projects but there is a gap between the allocated budget and actual spending

for each project. However, there is demand for additional budget for projects outside the expenditure framework.

4.12 Transparency, Integrity and Accountability in Nepalese Budget Formulation Transparency and integrity are the tools to control misuse of public purse. Accountability is at the heart of budget discipline. In the Nepalese context, secretary is accountable to spend as specified by law. Hence, the MoF, provides a letter of authorization to the LMs which gives authorization to departmental heads and budget implementing officers. The chain of accountability is maintained in a good system. But in practice, budget of any head, can be transferred to development committees and grants are provided to local NGOs. This practice dilutes accountability and hinders transparency. There are unspecified projects, in which budgets are allocated and projects are prepared in the last trimester. The budget, therefore, cannot be spent and it is provided as a grant to development committees. Such agencies provide funds to NGOs to hide spending. There is a large amount in the contingency fund in the MoF; mostly the amount is transferred to different budget heads and subheadings. This practice of hiding transfers raises the question of transparency in budget formulation. Transfer of grant is another loophole in budget implementation. In some cases, capital budget is allocated in such a way to keep it in unspecified projects, such as participatory projects, grants, and other hidden heads. Such amounts are in the budget but at the end of the financial year, the projects are specified and the amount is spent at the discretion of the concerned ministry. Sometimes, the amount is approved in the name of certain public enterprises and organizations and distributed to local NGOs. This practice always dilutes accountability and transparency. From the budget formulation stage, the project incentive becomes active and the question of integrity arises at each stage. The incentives may be political and financial. An example from the Ministry of Youth and Sports The Ministry of Youth and Sports, allocated large amount of grants to the Sports Council. The council kept a required amount and then transferred the rest to different organizations, such as: football association, cricket association and boxing association. The OAG has no mandate to audit such organizationsâ&#x20AC;&#x2122; financial transactions. These activities challenge accountability and transparency. Such types of budget transfer from one agency to another, lessens accountability and leaves gray areas for corruption.

A Study on Budget Formulation Process of the Government of Nepal

It is only an example. Such practices occur in different ministries too. The team observed that it is a general practice of ministries to release project budget at the last quarter of the financial year. Generally, projects are approved on the recommendation of political workers within the constituency of the concerned ministry and legislature.

Chapter I

Here is another example, from the Kantipur magazine. The magazine states that MoFALD started distributing projects in the name of participatory one. "Ministry of Federal Affairs and Local Development started distributing projects to political workers amounting to Rs 600 million, provisioned for people participatory projects". â&#x20AC;&#x201D;Kantipur, Chaitra 5/2071

This is just another example, there are many such cases. The contingency budget of MoF is also the fund for such pocket projects. There is no need of budgetary provisions of allocating. The amount is provided at the recommendation of members of legislature or politically connected individuals or on the discretion of MoF. At the local level, lack of elected bodies for a long time has further affected transparency and openness of financial activities. When, financial information is not disclosed, transparency and accountability become a far cry. Local governance is the closest agency to serve the people. At present, representatives of all parties in local bodies are severely criticized for non-disclosure of information and unaccountability by these representatives. It is widely realized, that greater transparency in many areas of public life including budget formulation leads to greater public participation in the decision making process on resources and better public service delivery. Nepalâ&#x20AC;&#x2122;s social, economic, technical and organizational context shows a complex environment of strengths, weaknesses, opportunities, and challenges in budget transparency, accountability and integrity. The government has supported openness of information, but in practice, it is very difficult to get information on time, it is due to the traditional mindset of pubic offices and officials.

4.13 SWOT Analysis The team observed both the processes and practices of budget formulation. There are many positive initiatives in the reform process, at the same time there are some weaknesses too. After a detailed study, the team took stock of strengths, weaknesses, opportunities and threats. 36 A Study on Budget Formulation Process of the Government of Nepal

These strengths, weaknesses, opportunities and threats are presented below: Strengths Formats: There are prescribed formats for budget formulation. The MTEF is a strong format in budget formulation. The sets of formats have facilitated budget formulation. For budget formulation, large sets of formats are required, from dispatching the budget ceiling to budget approval and authorization of expenditure. The well practiced formats are available to meet the need. Experience: Budget formulation needs long experience and training. In all ministries, there are experts for budget formulation. The expertise is already nurtured in the bureaucracy. Budget formulation, is a technical management task and requires experience. Nepal has experience in the budget formulation process since 1952. It is a long practice, information is available to analyze the situation of then and now. Experience is a valuable strength in budget formulation. Institutional Network: The NPC, MoF, line ministries, and district level institutions are strengths in the budgetary process. The data on expenditure are available at the central level as well as at the local level. These tools are important for budgetary process. The TSA system, one of the reforms is a strength in budget formulation. Every transaction is recorded and displayed in the screen in the FCGO. It is a great initiation towards transparency. At an earlier stage, there were only limited offices to look after accounts and there was single entry account system. But at present, there are 75 district treasurycomptroller offices with a reliable system of control. Trained human resources: Human Resources including technical resources to formulate and implement the budget is available. Private sector (construction industries) is equipped with modern construction equipments. The capacity and skills in construction industries can assist in budget implementation on time. Computer networking: In budget formulation the data are available immediately. On the expenditure side, FCGO office provides up-to-date information. There is a computer screen that displays a daily update of revenue and expenditure. The computer system and networking with all government offices has made this possible. Weaknesses Estimation issue: Resource estimation is based mostly on accounting information and expenditure trends. Variations in the estimated and realized resources is common in every office. The budget is not based on a â&#x20AC;&#x2DC;resource envelop, donor funding takes time to

be approved and late funding leads to a gap between estimated resources and expenditure.

the measures to reform budget implementation process smoothly.

Dominance of a top-down process: In principle, the budget should be based on a bottom-up approach. But in practice, it is more top-down. Mostly the budget is prepared at the central level, while only information is collected from the field level. The legislature puts political pressure to retain projects in the budget and once included in the budget remains there for a long time. There is a shortage of funds for some important projects while in other cases, there is no spending of funds. At the local level, there is the practice of bottom up budget formulation but due to the lack of trained manpower it is ineffective. There are some weaknesses in the implementation of TSA system. The transporting of cheques from DTCO to concerning offices carry a risk. The bearer cheques carry more risks.

New constitution and structuring of states: The Constituent Assembly is drafting a new constitution. The form of government will be federal. It means local governance will be more autonomous than at present. In this context, there are good opportunities to streamline the bottom up budget formulation process. The new constitution should present a clear concept of local self governance.

Lack of time management: The budget calendar is fixed already for all fiscal years. The budget formulation process starts late. The delay in dispatching guidelines and budget ceiling causes delays in budget formulation practice at the local level as well as in the field offices, departments and LMs. It ultimately hampers budget preparation on time.

New role of public institutions: The democratic movement of 2006 gave rise to new kinds of public pressure groups : civil society, civic awareness forums and NGOs etc. Such institutions work as development partners and act as a watch-dog of government operations. Government institutions at the state level will also have a new role to carry out development activities. Although the new institutions may be expensive, there is role for more participatory and effective system of budget formulation.

Distribution of peanuts at the local level: Scattering of the budget in large numbers of small projects is a general practice at the central level and grants at the local level. This is in a way of distributing peanuts which attracts more monkeys to snatch. In the VDCâ&#x20AC;&#x2122;s roads have been constructed in large numbers but there is no transportation. The use of the road is rare, but money has been spent. This peanut distribution process continues at the local level. Duration of Spending: A large proportion of expenses are incurred usually in the last month of the fiscal year. Especially capital expenditure is spent at the last trimester. Mostly procurement procedures are started late due to the preparation of documents, project estimate and design. In many cases low bidding also causes delays in concluding agreements with contractors. The low bidding and carteling system hampers construction on time. Opportunities A flood of reforms: Drafting a new constitution has opened the door to reforms in every aspect of governance The PEFA and PFM are a few of the reforms in the public financial sector. The government is trying to reform all aspects of governance. These opportunities for reform will certainly bring in a new system which will correct the course of financial management and the budget formulation process too. TSA is also one of

Reforms in laws: After the promulgation of new constitution of Federal Republic of Nepal, prevailing rules and regulations need amendment to facilitate the proposed Provinces to be administered in an efficient manner. It is an opportunity to reform the budget formulation process too.

Threats Change in structure needs awareness: There are certain threats in the context of new structure. The budget formulation process is a result of long practice. The new restructuring of state, may change certain aspects of the budget formulation process. It should be noted that, there is a need to be aware of adopting a scientific system of budget formulation. In the name of local identity the traditional system cannot address the present needs of the budget process. Resistance to changes: Change is essential for the development of the country and for the system of budgeting as well. A number of reform measures are essential at this juncture of restructuring of the state. This reform should be targeted towards improving deficiencies of the current budgeting system. There is the need to improve the setting of the overall budget ceiling to enhance coverage of government scope of work. To carry out these reforms there may be resistance. Hence, the participatory approach to changes and ownership is essential to face resistance. Possibility of conflict: The practice of scattering resources in the name of equal distribution, needs to be reformed by consolidating resources to achieve better A Study on Budget Formulation Process of the Government of Nepal

results at the project level. But this step may create confusion and conflict. This threat may be corrected by an updated MTEF. The completion of a project gives an opportunity for the beginning of another project.

Chapter I

Political intervention: In Nepal, the budget is driven more by political objectives rather than economic and social objectives. The capital budget is heavily over programmed. The new reform may also add more political agendas in the budget. This threat may be resolved by creating public awareness by using civil society organizations and civil awareness forum as well. In the financial management sector, reporting based on computerized data management of financial transactions are on the way. It is called TSA and applied in all districts. The system has shown a positive impact on fund management and reporting. This system requires positive encouragement from different ministries. But the traditional mindset on data management attempts to resist these new changes. To coordinate, there should be sufficient training of staff. As the new changes are drivers of reforms, the reform should be institutionalized. This century is the age of knowledge and innovation, so new innovation and research should

38 A Study on Budget Formulation Process of the Government of Nepal

be carried out in the financial sector. While analyzing the financial management and budget issues at the local level, the team observed some weaknesses. Without elected representatives, local bodies seem non-existence. Thus, budget formulation lacks public participation. The so called all-party mechanism is not a legal body and do not represent the public and have no accountability. The internal control system is problematic with limited staff. There is no appropriate system of internal control which leads to poor reporting and monitoring. The capital component of the budget comes from central level which is not predictable. This results in delays in costing of capital expenditure and provisions for maintenance. There is a lack of outputs and outcomes orientation in the budget. The budget formulation process lacks costing of services, resulting in poor cost recovery in sectors like health and education. There is no budget manual to guide budget formulation. The 14 step budget process is not specific and clear to cover all budgetary processes at the local level. Municipalities have great scope for fiscal autonomy but the revenue collected is less than the potential due to a lack of property records in municipal areas.

Chapter V

Findings The team after consultation and meetings with stakeholders and a study of the literature and observations identified problems in budget formulation and implementation in practice. The Government had initiated many financial, fiscal and planning reforms and legal and institutional mechanisms was instituted. Many positive achievements have been observed. The up-to-date and readily available information are disseminated on a regular basis. The peopleâ&#x20AC;&#x2122;s participation in budget formulation is constitutionally ensured and peopleâ&#x20AC;&#x2122;s awareness of their needs, practices and available resources is impressive. Despite these achievements, the team found some gaps in implementation. After analyzing facts and figures the team identified the following problems:

5.1 Problems (local level) There are several problems at the local level in budget formulation. Some of these are budget allocation for new and partially funded projects that are included through local political pressure. The problems identified by the study team are as follows: a. Problems on budget ceiling n At the departmental and field level, budget ceiling is not received on time. This results in delay in budget formulation. At the line agency level, only budget forms are filled. These are only formalities to participate in workshops but the field offices cannot propose financially viable new projects. n There is no resource estimation or revenue envelope at the local level. There are lists of projects but local level institutions have no capacity for resource estimation. b. Problems on budget formulation n In principle, the budget formulation process is meant to be bottom-up, that reflects local needs and priorities in budgetary allocation, but in practice the budget formulation process is top down. Often local level programs proposed through local participation are inadequately funded. There is a low level of linkage between local priorities and budget allocation.

n At the local level, there are frequent changes of party representatives. The local party does not appoint a representative on a permanent basis to attend VDC meetings. This changes in representation disrupts priority setting and results in delay in budget formulation. It is also observed that civil society has not been able to analyze the problems and orient participants on the basis of their research and findings. The overall capacity of civil society is not at the expected level. c. Problems in budget Implementation n The first installment should be released to the DDC within the first trimester. But in practice there is delay in releasing funds. n Weak institutional and technical capacity prevail in the VDCs and municipalities. The people at the local level cannot express their needs. The documentation of priorities is poor due to a shortage of skilled manpower. There is a provision of providing technical assistance from the district level, but there is a constraint in the districts due to workload, limited technical manpower and inadequate financial resources. n At the project level, need assessment is not carried out. At the ward level listing of projects is only adding of a new basket of projects. In practice there is no costing. The feasibility study is not carried out. n In many cases, the political party or their workers influence user committees. DDCs and VDCs are aware of irregularities , so they reimburse only the fund of the project. The user committees in many places, complete the formalities, as the local contractor works on behalf of the user committee. Representatives at the local level and civil society groups are also engaged in listing projects and sharing resources through user groups. d. Problems of human resources n The old organizational structure of DDC and VDC is still in operation. The annual budget of the local government is increasing every year. In the VDC there is a single junior operational A Study on Budget Formulation Process of the Government of Nepal

staff but the annual budget, including the social security fund is a large amount. There is no accountant in the VDC. So financial management is very weak.

Chapter I

e. Problems of monitoring

f. There is a provision for monitoring and supervision at the local level but it is not functional. There is a provision for progress review at the local level, but due to the lack of technical manpower, and lack of logistics, the progress review has been ritual. g. Internal and final audit n There is a audit provision in LSGA. In DDC, the Auditor General conducts final audit. But at the VDC level, the audit is conducted by a registered auditor. There is no effective internal audit and control system. There is room for improvement.

5.2 Problems (central level) There are several reasons for under spending of the capital budget. Some of them are: budget allocation for new but partial proposals of the project, partial release of funds by the donor, incomplete project reports, lack of procurement plans and delays in project approval by NPC or other authorities. Such activities not only slow the pace of capital expenditure but also makes for bad budgeting and poor performance. After analyzing these, the study team found the following problems on budget formulation at the central level . a. Problems of budget ceiling n Major problems exist in the present budget ceiling system, arising from many factors, among them, the approach of setting overall budget ceiling, incomplete coverage of government operations, high level of rebudgeting through virement, and increasing low performance of the capital budget, off treasury expenditure such as revenue expenditure and foreign grants. n The present budget ceiling is ad hoc and incremental. The budget requests from line ministries generally exceeds the budget ceiling. At the time of budget discussions, project wise negotiation takes place. This inflates the budget. The reduction in the budget to accommodate the ceiling sometimes crosses the line of project prioritization. n The resource estimate is based on accounting information and expenditure trends. Variations in estimated and available

40 A Study on Budget Formulation Process of the Government of Nepal

resources is common. The budget ceiling is not based on a â&#x20AC;&#x153;resource envelopâ&#x20AC;?. b. Problem on expenditure prioritization n One of the problems of the central budget includes expenditure prioritization .More than 80% of capital expenditure budget are classified under P1. It is not fruitful to keep most of the projects in P1,while rest of project expenditures are under P2 and P3. Consequently, even projects which deliver results in a long span of time are funded in annual plan. The difficult areas of service delivery also get continued funding whereas essential areas lack funds. Once a project is included in the expenditure head, it continues to get funded in successive years. n The recurrent expenditures are not prioritized. Recurrent expenditures of ministries are prioritized on P1. The basis of prioritization of grants, subsidies and transfer payments are not clearly defined. c. Problems of budget formulation n The budget formulation process which should be guided by social and economic objectives is driven more by political objectives. The capital budget is heavily over programmed because of political pressure. The size of the budget is not consistent with available resources and institutional capacity. The limited resources are scattered, so it does not bear good result. The effectiveness of MTEF is also questionable in this context. n The donor agencies are eager to show their programs in the budget expenditure book, so they bring projects within the budget plan. But at the time of implementation they spend the budgeted amount, using their rules. The expenses of bilateral donors are incurred without the knowledge of the government which makes the formulation of the budget less effective and less transparent. n There is the general practice of tax expenditure without disclosure of how much is spent on tax exemption. The budget data do not cover the huge amount of exemption because this is off budget and off treasury. Another gray area of less transparency is the large amount of contingency fund . It is in the treasury but the expenses incurred are off budget. Both these practices keep a large amount out of the coverage of the budget. n The grant allocated by the annual budget is placed in recurrent budget classification. It

means that local level capital expenditure is not captured by the central level. So the classification is defective. d. Problems of budget implementation n In the context of capital expenditure, project approval is delayed. It is reported that it takes two to three months for project approval. This is because there are many projects and it takes time to prioritize sectoral projects. The project implementation procedure starts after the approval of the projects. DTCO requires a project approval letter from the NPC to release the capital budget. n The procurement act is not effective, as there is no effective procurement plan. In most offices, the procurement plan is only a formality. There is no effective procurement plan. The offices take it as a burden in devising an effective procurement plan. This plan needs price estimation and time schedule in advance, but the traditional practices of procurement in the mindset of officials do not allow it to be practiced in a proper manner. Each field office needs to prepare an annual procurement plan at the time of the submission of the budget proposal. But in practice, they just fill forms but do not prepare the formal procurement plan consequently causing delays in capital expenditure. n The budget makes provisions for grants to some departments and entities. The grant is transferred to other entities. The account of entities or NGOâ&#x20AC;&#x2122;s is not audited by the Auditor General. Thus there is an absence of accountability. n The LMs can reallocate their budget within the same category. This results in delay and gives ground to play by political motives. This weakens accountability and credibility of the budget. n In many cases, the field offices are overloaded

with small projects. The feasibility study, cost and benefit analysis of the project is time consuming. Project is included laterally, pressurized by power center. The field offices lack technical capacity to execute capital budget in time. The DTCO has the power of issuing the cheque under TSA system. This software is working smoothly, however, there is no mandate for DTCO to pre audit expenses. n The capital expenditure at the last trimester is now a regular occurrence. Mostly procurement procedures are started late, due to delays in the preparation of documents, estimation and design of the project. In many cases, too much low bidding, compared to estimation, also causes delays in concluding agreement with the contractor. The low bidding and carteling system is hampering construction on time. e. Problems of human resource at the planning division n In each line ministry, there is a planning division. The planning division is weak in physical facilities, infrastructure and human resources. f. Lack of budget openness n The pre-budget statement is a document of policy direction for the revenue and expenditure of the budget year. The prebudget statement is submitted to the finance committee of the Legislative Parliament, but it is not published and made available to the public. There is no citizen budget. n The enacted budget is the approved budget document. The budget proposal is made available to the public but the enacted laws are made public through the Gazette, which has limited access. These acts are always questioned in the context of budget transparency.

A Study on Budget Formulation Process of the Government of Nepal

Chapter I

42 A Study on Budget Formulation Process of the Government of Nepal

Chapter VI

Recommendations and Conclusion 6.1 Recommendations: Central Level Based on findings and key learning as well as observations, the study team strongly suggests the following recommendations: a. Recommendations on budget ceiling n Ensure all expenditure coverage in the budget ceiling. The off treasury expenditure should also be covered within the budget ceiling. n Prepare the budget ceiling in line with the national development strategy, development priority, and institutional capacity in place of the ad hoc ways of doing n Develop a criteria for project screening to avoid unnecessary expansion of scattered projects and inflated budget. b. Recommendations prioritization

expenditure

n Make the budget more comprehensive by including details of revenue expenditure and other off budget expenses. n Make expenditure prioritization more realistic, based on specific criteria for project prioritization to avoid blocking of funds. Develop a clear criteria for prioritization of recurrent budgets such as grants, subsidies and transfer payments. c. Recommendations on budget formulation n Increase political understanding and commitment in budget formulation in line with social and economic objectives of the government. n Ensure that the size of the budget is consistent with available resources and institutional capacity. n Increase effectiveness of MTEF. n Include donorâ&#x20AC;&#x2122;s grants in the budget and channelize it through the treasury. n Take into consideration the performance of projects in budget formulation n Use sensitivity analysis to forecast economic indicators.

n Cover all expenditures in the annual budget. n Ensure the provision of budget announcement date, at least two months before the end of the fiscal year. It should be stated in the constitution to avoid delays in budget preparation. d. Recommendations implementation

budget

n Ensure project approval on time to reduce delays in project implementation. n Make mandatory provision for feasibility study of proposed project, costing more than the designated amount, to allocate resources at both the local and central level. n Prepare a detailed action plan for each project. n Prepare a procurement plan based on prevailing prices and make provision for price changes in the plan to avoid delays in procurement of goods and services. Prepare procurement document beforehand to save time. n Prepare well defined guidelines for project implementation. n Ensure adequate allocation for capital budget and strengthen implementation of capital projects. e. Recommendations on monitoring n Develop project performance tracking indicators with an effective mechanism to avoid delays in project implementation and ensure timely correction of constraints and problems encountered in implementation to avoid expenditure delays in the capital budget. n Make project monitoring more effective and practical. f. Recommendations on human resources n Enhance the capacity of the planning division of each ministry. n Increase physical facilities of the planning division. A Study on Budget Formulation Process of the Government of Nepal

g. Recommendations on reporting n Start providing a pre-budget statement, Chapter I promote citizen budget and make it available to the public in simple language. n Provide the enacted budget in simple language to ensure openness and transparency of budget formulation and implementation.

6.2 Recommendations: Local Level a. Recommendations on Budget Ceiling n Ensure timely information on budget ceiling of grants to local level. n Practice resource estimation or prepare resource envelope for each local body. n Develop MTEF for local bodies. n Prepare local budget ceiling considering local resources for each year in local level too. b. Recommendations on budget formulation n Ensure that the budget formulation process be bottom-up, in place of parallel and simultaneous use of bottom-up and top-down approach. n Follow budget formulation calendar. n Determine the meeting point of budget formulation process at the local level and the central level. n Review MCPM as a means of grant allocation. n Make the budget more comprehensive, transparent and equity based. n Make local level planning process more participatory. Prepare local level project priorities and guidelines to make local investment cost effective. n Strengthen the planning and technical capacity at the local level c. Recommendations implementation

budget

n Ensure timely release of grant to local bodies. n Practice need assessment in a simple and scientific manner. n Provide technical assistance to local level to implement projects n Review user committeesâ&#x20AC;&#x2122; functions. n Prepare project preparation and implementation guidelines for local bodies. d. Recommendations on human resources n Restructure human resources and organizational structure of local level. There 44 A Study on Budget Formulation Process of the Government of Nepal

should be an accountant and one sub overseer to handle budget and project in each VDC. n Prepare a plan for capacity building of local level. e. Recommendations on monitoring n Develop monitoring and supervision mechanism in local level. n Develop regular reporting system and social audit in local level. n Develop monitoring guidelines for local level. n Develop project performance tracking indicators and effective mechanism to avoid delays in project implementation and to correct expenditure delays in capital budget. n Make project monitoring more effective and practical. f. Recommendations on internal and final audit n Make scientific and practical arrangement of internal audit. n Ensure final audit to be conducted by the OAG (supreme audit authority). n Publish the audit report and make it available to the local people. h. Legal provision n Finalize and implement the budget management and fiscal responsibility bill.

6.3 Conclusion A major objective of the government in the development sector is to provide goods and services to the public. All reforms are targeted towards improving service delivery. Alongside the reform measures and their contribution to increase effectiveness of the state with sustained macroeconomic stability, implementation should be a high priority. In essence, the budget formulation process should be targeted to the maximum effective use of available resources for the betterment of the people. The budget formulation is a continuous process which should be routine work in each and every office and agency. Timely budget formulation and implementation saves time and money. Delays in budget implementation always results in cost and time overrun of projects. It deprives the people of expected benefits with delayed implementation. The low spending capacity of the capital budget is the product of many factors: absence of adequate knowledge of procurement laws, lack of risk taking capacity, dissatisfaction with work, long and cumbersome legal framework and political interference in favor of vested interests. These factors are affecting the performance of officials. The budget formulation

is an essential task of the government, which calls for credible, transparent, accountable and an inclusive budget document. In order to ensure timely, systematic formulation and implementation of the budget, the government has drafted a budget management and fiscal responsibility bill which needs to be enacted as soon as possible. An open and healthy discussion is needed to reform the budget formulation process in the country. A short and limited scope of study, is not sufficient to examine the wide ranging problems; therefore, we

suggest a comprehensive study with primary research tools: questionnaires with local and central level seminars, to include field level problems. The reforms in the budget formulation should be a continuous process in which innovation and research should be a part of this process. As stated earlier, the budget formulation is a continuous task of the government. When the budget formulation of one year ends the process for the coming year begins. The budget preparation of next year takes place, at the same time, the implementation and monitoring are in process.

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Chapter I

References Allen, R (2009). The Challenges of Reforming Budgetary Institutions in Developing Countries. Retrieved April, 2015, from https://www.imf. org/external/ Andrew, M (2008). How far have Public Finance Management Reform come in Africa? Retrieved April, 2015, from www.oecd. org/countries/ghana/ghana.pd Augusto, Lopez Claros (ed.) (2010). Innovation for Development Report (2010/2011). Retrieved April, 2015, from www. innovationfordevelopmentreport. org/supplement.html

Ministry of Finance (2068), Budget Formulation Guidelines (Fifth Edition) 2068: Kathmandu: MoF ––––––––– Economic Surveys 2011, 2012, 2013. Kathmandu: MoF ––––––––– (2013), Nepal Portfolio Performance Review 2012: Kathmandu: MoF ––––––––– (2072), Report on Midterm Review 2071/72. Kathmandu: MoF Ministry of Law and Parliamentary Affairs, GoN (1999). Local Self-Governance Act 1999, Kathmandu: Kanun Kitab Byawastha Samiti

Ernst andYoung (2013). National Fiduciary Risk Assessment, Nepal. Retrieved April, 2015, from www.pefa.gov.np/wp.

––––––––– (1999). The Financial Procedure Act 2055 /1999, Kathmandu: Kanun Kitab Byawastha Samiti

Freedom Forum (2013), Open Budget (in Nepali). Kathmandu: Freedom Forum

––––––––– (2007). The Interim Constitution of Nepal 2007. Kathmandu: Kanun Kitab Byawastha Samiti

Freedom Forum Nepal (2012). Situation of Aid Transparency in Nepal. Kathmandu: Freedom Forum Nepal Ghimire, Madhab P (Lead Researcher) (2013). Mapping of Selected Anti Corruption and Oversight Agencies and Relevant Laws. Kathmandu: Transparency International Nepal Koirala, Bimal (2015). Anti Corruption Intervention in Nepal, Retrieved April 2015, from www. norway.org.np. Krause, P., Stephanie S., E. Hedger and B. Chalise. Operational Risk Assessment of PFM Reform of Nepal. Retrieved April 2015, from www. worldbank.org/content/dam/.../nepal/ora-pfmnepal-report.pdf Krause, P. (2012). Public Financial Management Reforms in Fragile States: The Case of West Bank and Gaza. Retrieved April 2015, from www.odi.org/resources/docs/7840.pdf. Manandhar, Narayan. Lesson of Counter Corruption in Nepal Retrieved April 2015, from www.norway. org.np

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Panta, Uday (2013). "Realistic Budgeting for Capital Expenditure,"A Journal of Public Finance and Economy, August 2013, Kathmandu: MoF PEFA Secretariat (2013). PEFA Journal-2013. Kathmandu, Nepal: PEFA Secretariat Public Procurement Monitoring Office (2071), Annual Procurement Monitoring Report 2071: Kathmandu: PPMO Sangraula, Yubaraj. Accountability, Transparency of Representative in the Perspective of the Existing Parliamentary System of Nepal. Retrieved April 2015, from www.norway.org.np Schiavo Campo, S. and Tommasi D: (1999). Managing Government Expenditure. Retrieved April 2015, from www.worldbank. org/publicsector/pe/oecdpemhandbook.pdf Welham B, P. Krause and E. Hedger. (May 2013). "Linking PFM Dimension to Development Priorities ODI",Working Paper, World Bank Country Office (2013). Nepal Education Studies: School and Household Survey. Kathmandu: World Bank

List of Key Informants Auditor-General Office 1. Bhanu Prasad Acharya, Auditor-General, Government of Nepal 2. Ramu Prasad Dotel, Deputy Auditor-General, Government of Nepal District Local Development Office, Lalitpur 3. Pashupati Pokharel, Local Development Officer 4. Achyut Raj Regmi, Planning Follow up and administrative officer 5. Madan Kumar Kharel, District Governance Expert District Local Development Office, Kavre Palanchowk 6. Santosh Pokharel, Local Development Officer Department of Irrigation 7. Ashok Singh, Deputy Director-General 8. Shiva Prasad Adhikari, Under-Secretary (Account) District Public Health Office, Lalitpur 9. Kedar Raj Parajuli, District Public Health Officer District Public Health Office, Kavre Palanchowk 10. Dr. Rajendra Prasad Shah, District Public Health Officer District Livestock Office, Kavre Palanchowk 11. Raj Kumar Humagain, Officiating District Livestock Officer District Treasury Office, Kavre Palanchowk 12. Ram Bahadur Khadka, Chief Financial Comtroller Ministry of Education 1. Dr. Lava Dev Awasthi, Joint Secretary, Planning Division 2. Balaram Timilsina, Under Secretary, Planning 3. Shiva Kumar Sapkota, District Education Officer, Lalitpur

Ministry of Federal Affairs and Local Development 1. Purna Chandra Bhattarai, Joint Secretary, Planning Division, Ministry of Finance 1. Nirmal Hari Adhikari, Joint Secretary Ministry of Health and Population 1. Dr Padam Bahadur Chand, Joint Secretary, Policy Analysis and Foreign Aid 2. Shri Krishna Nepal, Under Secretary (Account) National Planning Commission 1. Pushpa Lal Shakya, Joint Secretary 2. Gopi Mainali, Joint Secretary 3. Dr. Tirtha Dhakal, Joint Secretary, 4. Lal Shankar Ghimire, Joint Secretary Procurement Office 1. Tanka Mani Sharma, Secretary, PEFA Secretariat 1. Babu Ram Subedi, Deputy Financial ComtrollerGeneral Independent Persons 1. Bishnu Bahadur KC, Former Auditor-General of Nepal 2. Krishna Sapkota, Executive Director, Freedom Forum Development Cooperation Partners 1. Mr. Bigyan Pradhan - Senior Operation Officer, World Bank 2. Mr. Roshan Bajracharya - Research Officer, World Bank 3. Dr. Bhola Raj Dahal - Governance Expert, Royal Norwegian Embassy 4. Ms. Laura Leyser - Governance Adviser, DFID Nepal

A Study on Budget Formulation Process of the Government of Nepal

Participants at the Interaction Program held on May 8, 2015 1. Mr. Bharat Bahadur Thapa - Chairman, Transparency International Nepal. 2. Dr. Shankar Sharma - Former Vice-chairman, National Planning Commission. 3. Dr. Bimal Koirala - Former Chief Secretary, Government of Nepal. 4. Dr. Rewat Bahadur Karki - Chairperson, Rastriya Banijya Bank. 5. Mr. Bamsidhar Ghimire - Former FinancialComptroller General, Government of Nepal. 6. Mr. Ganga Dutta Awasthi - Former Secretary, Ministry of Federal Affairs and Local Development

Chapter I

48 A Study on Budget Formulation Process of the Government of Nepal

7. Mr. Kamal Pandey - Former Planning Chief, Ministry of Physical Infrastructure and Transport 8. Mr. Ashish Thapa - Executive Director, Transparency International Nepal. 9. Mr. Mohan Budhathoki - Program Coordinator, Transparency International Nepal. 10. Mr. Madhab Prasad Ghimire, Lead researcher, Molung Foundation 11. Mr. Khem Prasad Dahal, Researcher, Molung Foundation 12. Mr. Dilli Prakash Ghimire, Researcher, Molung Foundation 13. Mr. Ramesh Neupane, Manager, Molung Foundation