THE CASH RATIONING SYSTEM IN ZAMBIA Hinh T

THE CASH RATIONING SYSTEM IN ZAMBIA Hinh T. Dinh AFTM 1 May 23, 2001 1

THE CASH BUDGET IN ZAMBIA I. III. IV. V. V. Origin of the Cash Budget Theoretical Basis Cash Budget Set-up and Management Effects of the Cash Budget Capacity and Institutional Constraints Proposed Solutions 2

World Bank User: While I. its CASH BUDGET ORIGIN OF THE theoretical foundation is wellknown in the runaway inflation of the • Adopted as an emergency measure to stop late 1980 s and early 1990 s. the literature, • Designed as a temporary, short-term this measure to reintroduce financial discipline by linking monthly expenditures closely to actual revenues approach received during the month, excluding any new borrowing from the has not Central Bank. been adapted for assessing fiscal performanc e either 3 over time or

World Bank User: While I. its CASH BUDGET ORIGIN OF THE theoretical foundation is well. Some Common Features of the Cash Budgets: known in · Introduction of cash budgeting usually coincides with achievement of the some macro-economic stabilization. · Implementation of the cash budgetliterature, has the same damaging side-effects on the efficient use and allocation of government resources; i. e. , creating this large, unpredictable monthly fluctuations in expenditures and a shift in approach expenditures from socially and economically important ministries to has not relatively un-productive activities. been · The large monthly fluctuations in cash releases, particularly for O&M adapted forand arrears. (RDC in Zambia), encourage over-commitments · The extent to which damages caused by the cash budget can be minimized assessing or maximized depends on personalfiscal powers of officials in charge of the budget. performanc · For different reasons, once the cash budget is adopted, it is likely to stay. e either 4 over time or

World Bank User: While II. THEORETICAL BASIS OF THE its CASH BUDGET theoretical foundation is wellknown in • In theory, the cash budget is a strict application of the rule for fiscal solvency and sustainability. the By keeping the net borrowing of the central government zero, literature, the cash budget forces the domestic debt/GDP to approach zero as the economy grows. Notice that when this the economy grows faster than the real interest rate (r-g <0) this is a approach stricter condition than the normal fiscal solvency and sustainability has not conditions. been adapted for • In an earlier paper, we derived these conditions reproduced below, where s is primary deficit. assessing fiscal performanc e either 5 over time or

World Bank User: While its Conditions for Fiscal Solvency and Sustainability theoretical foundation is wellknown in the literature, this approach has not been adapted for assessing fiscal performanc e either over time or 6

III. CASH BUDGET SET- UP AND MANAGEMENT Under the cash budget system, the budget as approved by the Parliament no longer forms the basis for actual funding of Government operations. l The actual decision of how much each ministry and other budget head can spend each month in each expenditure category is taken ad hoc by a small committee within Mo. FED. This committee decides upon and issues monthly (or sometimes by-weekly) cash releases. Under the cash budget system, these releases have become the key determinant of government expenditures. What really counts, then, for a ministry is not the amount allocated to it in the budget but the amount of cash released to it each month. l 7

III. CASH BUDGET SET- UP AND MANAGEMENT · The cash budget process goes through ten steps from the moment the budget (Yellow Book) is approved by Parliament and signed by the President and payments are actually made to, say, a government supplier, not taking into account procurement and commitment: 1. After the budget has been signed at the beginning of the year it is divided into four quarters and the latter broken down into months on a straight-line basis. This represents the formal monthly program budget; 2. Early in every month, the Zambia Revenue Authority (ZRA) provides a revenue projection (called “revenue profile”); 3. The monthly surplus necessary to meet the quarterly ESAF benchmark, is determined; 4. Total resources available for expenditures during the month are calculated by deducting the monthly surplus from the revenue profile; 8

III. CASH BUDGET SET- UP AND MANAGEMENT 5. The Mo. FED Committee then allocates total available resources to the budget heads. 6. As the Committee progresses in deciding cash releases for the month, cash is gradually released and ministries and other budget heads are finally informed of their monthly resource envelopes; 7. Domestic debt service is strictly paid at the dates due, and cash releases are structured accordingly. Personnel emoluments are supposed to be paid by the middle of the month. 8. Cash releases for other expenditure categories are usually decided and executed late in the month to which they refer, when revenues are at their peak and the risk of an unexpected revenue shortfall is at a minimum. 9

III. CASH BUDGET SET- UP AND MANAGEMENT 9. After the monthly cash release has been decided, the Budget Office authorizes Bo. Z to transfer money from the government general revenue account to the respective control account. Most budget heads have three main control accounts covering personnel emoluments, RDCs and grants, and capital expenditures. A budget head cannot transfer money from one account to another but can do so within the same account. 10. Since the central bank is not involved in retail banking, for each control account at Bo. Z there is a mirror account at a commercial bank. Budget heads use these mirror accounts to effect their payments. 10

IV. EFFECTS OF THE CASH BUDGET SOME MYTHS ABOUT THE CASH BUDGET l That the cash budget system establishes a close and rigid link between monthly revenues and monthly expenditures. This is not true: in one third of cases, the gaps exceed 20%. l That there is an even stronger assumption that under the cash budget system no deficits can occur and that during any given month expenditures are lower – or at most equal – to revenues. This also is not supported by data. l That there are no arrears or over-commitment. 11

IV. EFFECTS OF THE CASH BUDGET POSITIVE EFFECTS l There can be no doubt that the central government’s fiscal performance has improved markedly since 1991. This had a positive effect on inflation, albeit somewhat diluted by continuous, high deficits of other public administrations and entities. l Whether introduction of the cash budget system in 1993 actually helped reduce the fiscal deficit is not clear. Introduction of the ESAF with its stringent quarterly targets on government borrowing and budget balances was an equally important element. l Given the Government’s limited capacity to control expenditures and coordinate fiscal and monetary management the cash budget was the easiest and most feasible way to establish overall fiscal discipline. However, as discussed below, the system had major negative side effects on social and economic development that became increasingly apparent over time. 12

VI. EFFECTS OF THE CASH BUDGET Zambia: Domestic budget and inflation 13

IV. EFFECTS OF THE CASH BUDGET POSITIVE EFFECTS l Between 1991 and 1998 the Government managed to cut discretionary recurrent expenditures in real terms. Part of this reduction was achieved before the cash budget was introduced at the beginning of 1993 and much of it resulted automatically from the massive inflation during these years that sharply reduced civil servants’ salaries in real terms. l But note that while Government was very successful in bringing its budget deficit under control and limiting its recourse to central bank financing to a minimum, inflation did not decline as rapidly and as strongly as expected. Three years after inception of the cash budget, inflation still exceeded 43 percent and was still above 30 percent in 2000. While this is a substantial improvement over the 100 percent experienced in 1991 and the 200 percent in mid-1993, inflation remains a significant threat to the country’s financial and monetary 14 stability.

IV. EFFECTS OF THE CASH BUDGET NEGATIVE EFFECTS OF THE CASH BUDGET The existing cash budget system affects the quality of government operations in three major ways: It hampers the efficient use of budgetary resources by creating large fluctuations and great unpredictability in the monthly cash releases to budget heads, making it virtually impossible for them to plan their activities more than a few weeks ahead and to undertake major tasks, programs and campaigns at the most appropriate time of the year; · It results in a sub-optimal allocation of resources by encouraging and facilitating the systematic shift in resources from economically and socially relevant ministries to general public administration and from RDCs to wages; · It leads to higher prices charged by government suppliers as a result of growing over-commitments, arrears, and payment delays. · 15

IV. EFFECTS OF THE CASH BUDGET Zambia: Monthly Fluctuations in Cash Releases 16

IV. EFFECTS OF THE CASH BUDGET Zambia: Monthly Fluctuations in Cash Releases 17

IV. EFFECTS OF THE CASH BUDGET VARIATIONS IN CASH RELEASES AND UNPREDICTABILITY IN BUDGETING Econometric analysis shows that while there is a strict relationship between revenue and expenditure by quarters, such relationship no longer holds in the case of monthly data. Three key factors explain this phenomenon: l The need for the budget to reach the quarterly targets on net bank claims on government and on the domestic budget balance of the government, as agreed with the IMF under ESAFs. l Increases in monthly cash releases to certain budget heads, submitted to and accepted ad hoc by the cash release committee, often in complete disregard of original budget estimates. Its root cause is the virtual collapse of budget discipline and transparency following introduction of the cash budget system. l The differences in priority assigned to different expenditure categories. 18

IV. EFFECTS OF THE CASH BUDGET NEGATIVE EFFECTS OF THE CASH BUDGET l Ad hoc decisions of a small committee in Mo. FED replace well thought -out, long-term plans, formally approved by Parliament. This not only led to a loss of transparency; it also triggered substantial reallocations of government expenditures during the course of budget implementation. l As development issues, by their very nature, are always long-term and rarely of immediate urgency, they mostly lose-out in the daily battle for funds once budget priorities are no longer respected. It is indeed difficult to argue convincingly that rehabilitation of a certain rural access road can not possibly be postponed for another month so that the funds can be used to cover the costs of an important diplomatic delegation abroad. 19

IV. EFFECTS OF THE CASH BUDGET NEGATIVE EFFECTS OF THE CASH BUDGET l The collapse of budget discipline after introduction of the cash budget not only led to large, disruptive monthly fluctuations in cash releases to individual ministries; it also stimulated and facilitated a substantial reallocation of government expenditures during the course of budget implementation. A detailed comparison of actual expenditures with original budget appropriations for the year 1997 reveals massive and systematic changes in expenditure priorities during the course of the budget year away from economically and socially relevant ministries towards general public services (such as Defense, Police, Home Affairs) and from the purchase of materials and supplies to wages and salaries. As a result, actual public expenditures turned out to be considerably less development oriented than the budget as enacted at the beginning of the year. 20

V. CAPACITY AND INSTITUTION CONSTRAINTS While it is easy to see the weaknesses of the cash budget, it is harder to design alternatives given the existing weak capacity and institutional constraints in Zambia: l Despite recent improvements in reporting, the accounting system remains weak. An Auditor General’s report identified numerous deficiencies, including weaknesses in the control system, unvouched and inadequately vouched expenditures, irregular accounting, duplicate payments, questionable payments, and non-delivery of paid goods. Weak accounting results in considerable loss of funds and reduces the effectiveness of spending. l Human resources remain a major constraint for accounting. There are only a few qualified accountants in the Ministry of Finance. Few of the 875 government accounting personnel are fully qualified, and job performance is poor. Since adoption of the Public Sector Reform Program, productivity has declined, and internal audit has observed an increase in fraud by people expecting to lose their jobs. 21

V. CAPACITY AND INSTITUTION CONSTRAINTS A further constraint on accurate accounting and reporting is the lack of a government financial management information system. Although a variety of individual systems (for budget preparation, procurement, accounting, expenditure, commitment, and arrears reporting) are in place in the ministries, the systems are not integrated. As a result, expenditures and commitments are inadequately controlled, and overspending and over commitment cannot be automatically prevented. l It takes two years for an audit report of expenditures to come out. Consequently, policy makers have no basis to take decisions in a timely manner. l The public sector’s large size and poor pay is a major bottleneck to attract qualified personnel in finance and accounting. l 22

VI. PROPOSED SOLUTIONS In the longer run, to fully achieve its development objectives, Zambia would have no choice but to phase-out the cash budget system completely and revert to a more regular budget implementation system. This process should take place in the context of a Medium-Term Expenditure Framework (MTEF). l It could be argued that there is no much point of introducing sophisticated new budget techniques at a time when the budget remains largely a theoretical document with little relevance in the real world. However, the design and introduction of a comprehensive MTEF is a lengthy process and needs to be started as soon as possible. l 23

VI. PROPOSED SOLUTIONS In the short term, there a number of possibilities of linking monthly cash releases closer to the annual budget so as to replace the monthly haggling and ad hoc decision making by a largely automatic, transparent and rule-based cash allocation system reflecting the long-term priorities as established by the budget. Ideally, under such a system monthly cash release meetings would no longer be necessary; detailed cash releases for all government budget heads could be easily calculated from a simple rule based on monthly revenue projection. l In the context of FSC 1, to improve predictability, the cash release system has been modified by introducing the concept of a quarterly cash allocation plan. MOFED would inform every spending agency of their projected cash allocation by issuing the cash allocation plan in the Treasury Circulars. Actual cash releases continue to be made on a monthly basis. A set of rules has been issued indicating how reductions in cash allocations are to be implemented if such reductions are deemed necessary. A mid-year budget review has been undertaken. 24 l

VI. PROPOSED SOLUTIONS l To improve accountability in public spending, measures have been implemented to strengthen commitment control and sanctions. To improve budget transparency and governance, and to facilitate monitoring, MOFED would publish a quarterly report on Government expenditures. Among other things, these reports would show from which ministries funds have been taken away to finance new expenditure requests by other ministries. Information about the major state-owned enterprises, including their income statements, has been published in the annual Economic Report issued by MOFED. The Office of the Auditor-General (OAG) has been strengthened. l A number of initiatives are under way in this respect to provide the longer term solution to the budget execution problem in Zambia and to complement the short-term improvement program outlined in this paper. The Bank-financed Public Service Capacity Building Program project (PSCAP), will support introduction of the MTEF, including implementation of an Integrated Financial Management Information System (IFMIS) that would become an integral part of MTEF. The cash budgeting system is expected to be phased out over the next 3 -4 years in the context of this project. 25