II. World Bank—Fiscal Issues Review26
48. The World Bank is conducting a review of fiscal issues in the OECS with the objective of recommending actions to improve the allocation of public expenditures in a fiscally sustainable manner in each of the member countries. Individual reports are being prepared for each country and will cover four key areas: (i) issues related to the conduct of overall fiscal policy and macroeconomic management including the cyclically and sustainability of public expenditures; (ii) management and execution of the public sector investment program (PSIP); (iii) public sector wages and employment; and (iv) public expenditures in the social sectors and for social safety nets. Reports on four countries (Grenada, St. Kitts and Nevis, St. Lucia, and Dominica) have been drafted and the complete set of reports is expected by end-2003. The following are preliminary findings of this analysis, to date.
A. Fiscal Policy
49. The majority of the countries lack a well-defined and coherent medium-term economic framework (MTEF) to guide fiscal management and create space for counter-cyclical policies. This is manifested in a combination of (passively) pro-cyclical public spending; irregular and often poorly conceived public investment programs and consequently weak debt management; and an excessive use of tax concessions aimed at attracting foreign investment.
- In light of the repeated external shocks to which these economies are exposed—including natural disasters—there is a curious absence of medium term risk management strategies in terms of both fiscal policy and real activity, e.g., disaster mitigation and preparedness. As a result, fiscal policies appear to have been passively pro-cyclical and have amplified the economic cycles.
- The main reason for the recent rapid build-up of indebtedness has been increases in government expenditures, namely for large, poorly conceived public investment projects that have been financed by commercial borrowing and have not yielded the expected impact on growth and diversification. The management of public sector investment programs (PSIPs) needs to be systematic based on sound analysis for project selection. The OECS countries also need to articulate clear debt management strategies in the context of medium-term economic frameworks and to improve public debt management, in particular by strengthening legal and institutional frameworks and increasing the transparency of public debt contracting mechanisms.
- Tax concessions, both discretionary and statutory, have been the preferred instrument for investment promotion, rather than efforts to lower the cost of doing business and raise competitiveness.
50. As a currency union, the OECS needs to make steady progress on options requiring sub-regional coordination, both at the policy and service-provision levels—including the establishment of fiscal benchmarks for preserving the exchange regime within a consistent policy framework; harmonization of tax policy and fiscal incentive regimes; and functional cooperation (i.e., regional provision) in more public services to exploit economies of scale.
B. Budget and Financial Management
51. Within the OECS, the formal institutional frameworks (national constitutions, legislation, regulations, and procedures) for budget management are broadly adequate, and have been improving steadily. However, these improvements have not been supported by the necessary complimentary reforms in public sector management policies and practices. As a result, these efforts have not yet altered incentives of some line ministries to push for consistently higher budgetary allocations and spending. Consequently, repeated overestimation of revenues and expenditures has undermined the usefulness of the budget as a tool for priority setting. In some cases, approved estimates are not viewed by line ministries as hard budget constraints and new initiatives are introduced on an ad hoc manner outside the budget process. The framework for budgeting needs more explicit and systematic use of a medium-term economic framework as a tool for drawing up public expenditure plans.
- Budgets are often still not consolidated or comprehensive. Most OECS countries still operate systems of dual budgeting for capital and recurrent expenditures. Also, large amounts of external assistance are still not brought into the main public accounts, because donors and project directors do not report aid receipts and expenditures promptly to the Accountants General. In addition, in many cases operations of the state-owned enterprises often escape effective scrutiny by the Ministries of Finance and consequently public accountability.
- The legislative framework for financial management is in need of updating in most of the OECS countries, and efforts to do so have begun to take place, with support from the CIDA-financed program known as ECEMP. While St. Lucia has moved forward with legislative reforms, the other countries have not passed and implemented new legislation. High priority should be given to completing this process.
- Progress on automating systems for government budgeting, accounting, and reporting has facilitated effective monitoring and up-to-date accounting for current transactions. However, in most countries, these systems have not been rolled out to all line ministries. In addition, although the new systems will prevent excess expenditures by automatically rejecting any over-budget requests, they will not prevent excessive commitments. The systems in use (SIGFIS/Smart Stream, St. Kitts and Nevis FourGen and the Antigua and Barbuda Oracle system) should have commitment control functionality, for better expenditure control and cash management.
52. Oversight of public finances and financial management is generally weak in the OECS countries. Public Accounts Committees do not function effectively in most countries, thereby severely reducing the effectiveness of the audit function. Internal control is left to heads of departments who have no internal audit units and very little technical support. The actual autonomy of Directors of Audit in many cases is not enshrined in the legislation and depends entirely on informal relationships. Moreover, the production and tabling of audited financial reports for central government, while generally timely in Dominica and St Kitts and Nevis has significant backlogs in Antigua and Barbuda, Grenada, St. Lucia, and St. Vincent and the Grenadines. Clearance of these backlogs would be an important step toward improving the control environment in these countries. Given the shortage of skilled staff through the sub-region, the audit function is a good candidate for regionalization.
C. Public Sector Investment
53. Despite significant improvements introduced in recent years, the PSIP process in most of the OECS countries still presents significant weaknesses. Specifically, there is relatively little technical analysis to support project prioritization and selection and, usually, no cost-benefit studies are undertaken unless required by financing agencies. The absence of a medium term economic framework and/or detailed development strategies further complicates prioritization, cross-sectoral tradeoffs and programmatic (multi year approaches). As such, hard decisions about project selection are often avoided. In general, the single most important element in project selection is the availability of external financing, which makes external agencies key players in establishing governments’ priorities. Moreover, there is little central monitoring of physical project execution, and ex-post evaluations are generally not performed unless required by international agencies.
54. The impact of capital projects on the current budget is not consistently estimated and, therefore, operations and maintenance activities are usually not budgeted for.
55. Implementation rates are usually low because of overestimation of annual capital budgets for reasons mentioned above; capacity constraints within line ministries to manage large and multiple projects; and complex local procurement procedures including an over-centralization of procurement authority; and the diversity of donor processes which slow down disbursements of external assistance. St. Kitts and Nevis and St. Lucia have made progress in pooling capacity within and across line ministries through the use of a single project management unit, while St. Vincent and the Grenadines refocused their PSIP on key sectors in order to more effectively utilize limited technical personnel.
56. Improvements in procurement rules and practices could help raise implementation rates for public investment. Procurement rules, including procurement methods and awards of contract, are incomplete and imprecise, leading to arbitrary decisions that result in inefficiency and lack of transparency. The regulatory framework for procurement within the sub-region could be strengthened by the enactment of a common legal instrument comprising an adequate legal and administrative framework and complete procurement rules and the establishment of a permanent independent body to which the contractors and suppliers can appeal decisions. In addition, decentralizing decision-making authority to line ministries, with appropriate capacity building and central oversight, would help to accelerate investment projects.
D. Public Sector Wage and Employment
57. While large public sector wage bills are a generalized phenomenon in the OECS, the pattern varies across countries as to whether this is underpinned by large employment numbers or high average wages. In addition, the trends also vary significantly between countries. In some countries, there has been little control over the increase in the number of established and non-established workers. In others, apparent, and some yet-to-be-determined compensation, entitlements (pending Court rulings) are sources of concern. In yet others, there are structural reasons for relatively large public service establishments related to the mode of delivery of social services at the community level.
58. Performance appraisal systems work unevenly in different OECS countries and some do not perform as expected due mainly to implementation difficulties. As a result, in some cases performance increases are awarded in the absence of an a priori overall spending envelope that limits unreasonable increments.
59. Public wage increase awards are generally not based on any explicit or implicit trends in productivity. As such, the impact on competitiveness within a fixed exchange rate regime generally does not factor into wage negotiations.
E. Social Sector
60. Past investments in human and social development have yielded relatively good social outcomes in the OECS countries. However, the current fiscal crisis and medium-term macroeconomic outlook indicate that systems may have become too expensive to maintain, resulting in declining quality of service and outcomes. Non-wage current expenditure in the social sectors is generally inadequate and the public sector investment program is often inconsistent with the strategy in the education and health sectors.
61. Demographic changes, improvements in transportation and communications, and curriculum reform do offer some scope for reducing costs and raising the quality of outcomes, mainly through the consolidation of service delivery points and better deployment of human resources, and protection of critical non-wage inputs. In some cases, reallocation of human resources toward some functions (e.g., planning and policy in Ministries of Education and Health, and for nurses) is recommended. In others, high teacher-pupil ratios could be reduced to achieve greater efficiency.
62. In addition, there is scope for increased cost recovery and better targeting of subsidies in a number of services. In the health sector, heavy subsidies for patients are extended at all levels (including hospital facilities and drugs). The modest revenue generated by the system is deposited (by law) into the Consolidated Fund, providing little incentive for better performance. This is a critical financial issue for countries targeting universal secondary education and protecting the social development gains of the last decade in the face of a difficult external environment and slower growth prospects over the medium term.
F. Social Safety Nets
63. In all OECS countries, there is a lack of an overall social protection strategy, and consequently a duplication of uncoordinated safety nets programs and administrative systems across the public sector. For instance, in St. Kitts and Nevis, there are approximately twenty social protection programs, administered by at least five different ministries and statutory bodies, and using four separate means testing systems.
64. Inappropriate or non-existent targeting mechanisms diminish the transfer of resources reaching the actual poor. Despite the lack of data on the incidence of programs and public spending, anecdotal evidence clearly suggests the need for more transparent and reliable means testing.
65. In addition, expenditure on safety net programs is not systematically reported in the budget since they are considered sub programs for budget purposes. As a result, there is lack of comprehensive expenditure information and consequently Governments have little ability to assess the cost, incidence, and effectiveness of the various programs and overall spending on safety nets.
66. In light of the existing fiscal constraints in the ECCU and their need to address the possible social cost of stabilization and structural reforms, the rationalization and coordination of social safety net programs and their effective targeting have become a priority.
Prepared by Antonella Bassani (World Bank). These are preliminary findings.