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Lao PDR: Public Expenditure Mangement Review 2008


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  • 1. Lao People’s Democratic Republic Ministry of FinancePublic Finance Management Strengthening Programme PUBLIC EXPENDITURE AND REVENUE MANAGEMENT REPORT August 2008Jean-Marc LepainPublic Finance SpecialistIntergovernmental Fiscal Adviser
  • 2. IntroductionPublic Finance Management has made an important contribution to economic development of LaoPDR by promoting macro-economic stability based on improved fiscal discipline and by ensuring thatsectors that are keys to the future of the country were receiving sufficient funding. As a result, allmacro-economic indicators have been positively oriented since 2001, budget deficit have beencontained to a sustainable level with a positive effect on inflation, and overall poverty declined from46% in 1992-93 to 33% in 2002-2003. Based on the Human Poverty Index, the Lao PDR rankingmoved from the 137th position world wide in 2000 to the 130th position in 2005 which was the lastyear that the poverty index was updated. Improvements in road infrastructure, access to cleanwater, children vaccination and increases in education enrolment have been the main factors ofpoverty alleviation during the past years.However, because the scope for increasing public spending is limited by the country’s ability togenerate additional revenue, improvement in public expenditure management will make in future aneven more crucial contribution to economic growth and poverty alleviation by improving efficiency inthe use of funds and by ensuring that all expenditures are in line with the Government strategy.Changes in the international environment will have to be taken into consideration with a growinginflation rate that will require stricter fiscal discipline and an economic slowdown in neighbouringcountries that might affect GDP growth and revenue collection.Whereas the national economy has fully recovered from the 1997-2000 economic crises, such is notthe case of the Public Finance System which had suffered severely of a lack of fiscal discipline,especially at the provincial level. Many social sector programs have not yet fully recovered from thecollapse in funding, and from a decline in real wages of civil servants, despite incrementaladjustments which have been made year after year. The wage bill remains under considerablepressure, limiting the ability of the Government to redeploy and expend its services. This pressurehas been aggravated by an aggressive investment policy in some sector that is not well coordinatedwith the recurrent budget capacity. The efforts made to contain public expenditures have fallendisproportionately on non-wage outlays, resulting in a contraction of expenditures for maintenanceand routine operations. This situation can only be corrected by a multi-year gradual adjustment ofwages, non-wages and investment expenditure guided by a sound fiscal policy based on macro-economic management. It has also highlighted the need for structural and legislative reforms ofpublic expenditure management which have started in 2006-2007 with the promulgation of theRevised Budget and its implementation in 2008.To meet all these challenges, the Government has adopted in November 2005 a multi-year mediumto long-term plan for improving public finance management through the Public ExpenditureManagement Strengthening Program (PEMSP). This program provides a framework forimplementing Government policies and strategies laid out in the “Policy Paper on Governance”, theNational Growth and Poverty Eradication Strategy (NGPES), and the National Socio EconomicDevelopment Plan (NSEDP) 2006-2010. Its implementation started in fiscal year 2006-2007. The mainadvantage of the PEMSP is a prioritization of public finance reforms through a well sequenced plan 2
  • 3. taking requirements and institutional capacity into account and supported by the donor community.The program has five components: (1) Fiscal Planning and Budget Preparation, (2) Budget Execution,Accounting and Financial Reporting, (3) Local Government Financial Management, (4) FinancialLegislation and Regulatory Framework, and (5) Capacity Building. During fiscal year 2006-2007 theprogram structures have been put in place and have become fully operational. A plan for fiscal year2007-2008 has been drafted and a Multi Donor Trust Fund (MDTF) has been created to support theproject.Since the beginning of the current fiscal year, significant progress have been made toward theimplementation of the reform agenda: The Treasury Centralization project is in its pilot phase, theTreasury Law is being drafted, initial steps have been take to recruit an expert for theimplementation of the Treasury Single Account, a strategy is being laid out for the Treasury Systemimplementation, a revenue sharing system has been put in place and dissemination of the BudgetLaw has started.The present Public Expenditure and Revenue Management Report is not a report that tries to make adiagnosis of Lao public finance weakness. Those are well known and have been fully identified in thePublic Expenditure Review published by a panel of international institutions in May 2007. Neither isthis report about success. The previous paragraph has already listed progresses made since 2006.The list is impressive by itself but there is no need to enter into the details. This report is aboutprocesses, issues and solutions. Until 2006 the Ministry of Finance had focused all its attention onstrategic planning and building the reform legal framework. Now this phase is almost finished. Fromstrategic planning the Ministry of Finance is moving to implementation and implementation is allabout processes. As it could be expected the implementation phase has its own problems. Newunforeseen practical issues emerged as it is the case with the implementation of the VAT, thedefinition of the accounting policy and the finalization of the Chart of accounts, the strengthening ofthe Medium Term Fiscal Framework (MTFF) and its evolution toward a full-fledged Medium TermExpenditure Framework (MTEF), the integration of the reporting system and the emergence of newdata requirements. Other issues will certainly emerge when the outcomes of the pilot phase of theTreasury centralization project will be better known.By reviewing the different sectors of the reform agenda and by identifying the pending issues, thisreport wishes to offer a platform for discussion, be it with the Government side or with the donorcommunity. 3
  • 4. I. ISSUES AND OBJECTIVES OF PUBLIC EXPENDITURE AND REVENUE MANAGEMENT REFORMS 1. Economic and macro-fiscal outlook in July 2008Since the recovery of the1997-2000 economic crisis macroeconomic performance has remainedstrong. Real GDP increases now at a rate of 8% a year and will continue to do so if the countryeconomy is not negatively impacted by the economic situation of its neighbours. Economic growthremains strongly driven by the development of the service sector (telecommunication, tourism,transport) and of construction, as well as the sizable expansion of mineral production and electricitygeneration. Direct foreign investments, especially in mining and hydro-electricity, have played amajor role in the economy expansion. The country has now entered a virtuous circle in which allmacro-economic indicators are reinforcing each others. The current account deficit is narrowing,reflecting buoyant resource export and rising tourist receipts, and together with higher foreign directinvestments and official development assistance inflows, resulted in an increase in the balance ofpayments and an accumulation of international reserves.However, the economic environment of the country in July 2008 is changing and will requireadjustments in the Government economic and fiscal policy. Inflationary pressure is growing worldwide as a result of a sharp increase in oil and food prices. Inflation is over 8% in Thailand and over20% in Vietnam and Cambodia making for BoL difficult to keep its inflation targets. By July 2008,inflation in Lao PRD was approaching 10%; 2% above the targets set six months ago.Slowdown in the world economy might have also a negative impact on the tourist sector and onexchanges with neighbouring countries. However, despite those negative changes in the countryeconomic environment, the Government remains confident that he can meet its economicobjectives. This confidence is reflected in the 2008-2009 budget which has been approved by theNational Assembly last July. The Government had proposed a budget of 9,951 billion kips,representing a 12% increase from the current fiscal year. The new budget includes a substantialrevaluation of the salaries of government employee in order to take into account last year inflationpressures and to ease economic hardship caused by rising oil prices.There is no doubt that a deteriorating international environment will make of Government fiscalpolicy more policy difficult. Inflationary pressures call for more fiscal discipline. However, theGovernment remains committed to macro-economic stability and to its growth target. 4
  • 5. 2. Budgeting for economic growthThe fast evolution of market economy requires a new approach to budgeting. The years from 2001 to2005 have taught us the lesson that private investment is the main driver of economic growth, notGovernment investment. Excessive investment in the public sector with the ultimate objective ofboosting GDP growth has been the main reason for unrealistic budget in the past. The quality ofinvestments and their linkage to the economic strategy is as much important as the financial volume.In a market economy the link between planning and budgeting is broken because most of theeconomy depends on private investments. In that perspective, government investments becomelimited to large infrastructures or to the delivery of a limited number of services such as security,health and education with objective of improving the business environment. As a consequence, theaim of budgeting is no longer economic planning. In that context, tax policies and macro-economicpolicies achieve paramount importance. Their objective is to ensure macro-economic stability withlow inflation and to provide an economic and fiscal environment able to stimulate private businessand be conducive to economic growth. New developments taking place at the Fiscal PolicyDepartment are taking into account those changes. However, budgeting procedures have changedlittle during the past decency and are in need of complete reengineering. The present linkagebetween policy-making, planning and budgeting does not take into account changes in our economicenvironment and the need to modernize public expenditure management. In a knowledge economymaterial investment cannot be separated from immaterial investment such as training, capacitybuilding and information technology. Line ministries’ needs for modernization and capacity buildingpose an important challenge across all government agencies that cannot be well addressed by thecurrent policy making and planning procedures. 3. Budgeting and Government prioritiesExpenditures at the central and local level do not always reflect priorities defined by the Governmentin the NGPES and the NSEDP. Basic education, rural roads and basic health have been identified aspriority sub-sectors. However the development of human resources has difficulty to keep pace withthe level of investment and most of the recurrent budget is absorbed by salaries. The role of MoF isto ensure that the recurrent and the investment budgets are in line with each others and that thebudget of each sector provides enough non-wage resources for keeping government servicesoperating and for maintaining infrastructure. Additionally, MoF will pay attention that budgetallocations are in line with the Government’s priorities at the national and provincial level.The difficulties to align central and local budgets with the NGPES can be explained by several factors:  The programmatic approach of NPGES is not translated into a managerial reality that would give managerial autonomy to programmes and allow the introduction of programme budgeting. From a funding viewpoint, NGPES objectives are in competition with more traditional activities of government agencies, especially at the local level. 5
  • 6.  There is no methodology to link budget formulation to the NGPES. International experience shows that the key elements of such methodology are (a) a programmatic approach of budgeting that provides a strong link between investments and recurrent expenditures, (b) the introduction of a medium term expenditure framework (MTEF), (c) a system of performance indicators linking budgetary inputs to programmes’ outcomes.  Budget reporting is not integrated with NPGES reporting.  Budget control is restricted to the control of spending limits but does not link expenditures to specific activities that can be evaluated. It can only be done if expenditures are linked to well documented programmes, sub-programmes and projects.Planning and budgeting processes suffer from a number of gaps and fractures that presentsnumerous challenges for integrating NGPES and budget, at the formulation, execution, andaccounting and reporting stages. The main problems identified are: a) Institutional fragmentation, with responsibilities for planning and budgeting, and for recurrent and investment expenditures, born by different ministries or different units within the central government and the provinces. As it might be impossible to change institutional arrangements, innovative technical solutions have to be found; b) Fragmentation of reporting processes that reflects the institutional fragmentation, but also results from a lack of integration of the different processes in MoF; c) Lack of result orientation in budget reporting that would require not only a result oriented system of indicators, but a data sharing system between MoF and line-ministries and a new framework for reporting; d) Weak budget execution systems and informality, which create gaps between policies, their implementation, and their monitoring; e) Information gaps, in terms of missing building block for reporting and missing data; and f) Lack of application of existing information to policy making processes.Integrating a national development strategy with budgets is fraught with difficulties. There arebasically two components in the process: an institutional component and a technical component.MoF has control only over the technical component. Solving institutional issues will require highlevel consultation within the Government. However within the existing institutional arrangement,processes must be put in place for sharing information and for consulting on key fiscal issues.Objective should be to have an operational MTFF / TFEF at the end of next fiscal year in 2009. It givesthe Government time to start a discussion on a programmatic approach of budgeting and ondeveloping a system of performance indicators, if those options are considered, that could linked tothe budget norms under preparation. 6
  • 7. 4. Planning and programme budgetingProgramme budgeting is based on the premise that all budget items can be linked to discrete outputsthat contribute to the achievement of specific policy objectives. The introduction of such anapproach has the aim of increasing the results orientation of budgets through a restructuring of theplanning and budget system. This new approach allows for the creation of explicit links betweenexpenditure on basic activities and their measurable outcome such as the literacy rate, the numberof students enrolled, the percentage of population with access to clean water, reduction of infantmortality, etc.In Lao PDR, due to existing institutional arrangements, converting the whole planning and budgetingsystem to full-fledged programme budgeting does not appear realistic. Moving to a moreprogrammatic approach of budgeting will require a lot of time and need to be done in phase within astrategy planned at the highest level of Government.Planning is not just managing investments. Sector policies can only be implemented by programmeand programmes require well identified sources of financing. As such, planning has become just oneelement of the Government programme policy. Transforming the economy requires transformingGovernment agencies to adapt them to their evolving mission and to improve government servicedelivery. This cannot be achieved by investment only. It requires management improvement, trainingand capacity building, workforce redeployment (especially from the city to the rural areas but alsowithin sectors), use of information technology and better revenue and expenditure management.Better service delivery and improved performance depend on blending all these elements in acoherent strategy. While the Lao PDR has managed to keep a high level of investment during the pastyears, it has not been always able to capitalize on this achievement due to managerial weaknesses,especially in human resources management.Because policy making is the responsibility of line ministries, aspects of planning which are notfinancial should be left to them and a programmatic approach of budgeting should be taken with theobjective of linking together policy-making, planning and budgeting. When sectoral policies aredisaggregated into programmes, each programme must be managed autonomously with cross sectorcontrol. The Finance Department controls all programmes’ finance; the Human ResourcesDepartment controls all programmes’ staffing and capacity building policies, etc. Programme policylinks programmes to identified qualitative and quantitative outputs and objectives, making possiblefor the Ministry of Finance, through the use of programme budgeting techniques, first to ensure thateach programme is allocated enough financial resources to meet its objectives, second, thatGovernment funds are spent wisely in line with the policy defined and approved with sensible andmeasurable results. 5. Local-Central RelationshipUntil 2005, the Lao public finance system has been characterized by vertical imbalance withprovinces collecting around 60% of total revenue and spending 45% of total expenditures. The 7
  • 8. consequences have been weak control over revenue administration, weak control over treasuryoperations, lack of fiscal discipline, exacerbated horizontal imbalance, lack of prioritization ofexpenditures, poor cash management, lack of accountability of local governments to the centralGovernment resulting in a weakening of State institutions.The reform of the centre-province fiscal relations has been identified as curtail both to increasingtotal tax revenue and to reorientation public spending. With the new budget law implementationand the Treasury centralization project the process for reforming the intergovernmental fiscal systemhas been put in place, and significant progress has been made during the past six months. Howeverconsidering the institutional history of the country, only a gradual approach can be taken. Localownership of the reform agenda has been identified as a critical success factor. Provincialadministrations will cooperate with MoF only if the reform agenda creates a win-win situation.The reform programme should have seven main objectives: a) To improve revenue performance for all categories of taxes, including those assigned 100% to the local budget; b) To ensure the rational distribution of fiscal resources across sub-national (local) jurisdictions in an equitable manner in order to correct disparities in fund allocation between provinces (horizontal imbalance). c) To ensure that local administrations adhere to Government policies and reflect the Government priorities in their budget; d) To improve the use of budgets as instruments for poverty alleviation and for sustaining economic growth; e) To improve financial management at the local level; f) To provide incentive for improving Government service delivery at the local levelThe Budget Law has created the legal instrument for the reform process soon to be completed by theTreasury Law. Based on this legal framework, MoF is now working on regulatory aspects and on achange management strategy for implementing structural and managerial changes. Four broad areasare being tackled:  The implementation of the Treasury Single Account that will centralize both revenue and expenditure and a reorganization of budget execution procedures;  The introduction of an improved Treasury System focused on strengthening budget execution, accounting and reporting;  The centralization of revenue administration in respect of both Customs and Tax;  The introduction of new fiscal and budgetary arrangement between the Central Government and the provinces covering: new revenue assignment, revenue sharing, conditional grants, new budgetary proceduresA pre-condition for the introduction of a rational and equitable system of intergovernmentaltransfers is a successful centralization of control over revenue accounts. Because the implementationof the Treasury Single Account will probably take several years (see section III. 3), the new fiscalarrangements, including revenue sharing, will be implemented before the centralization of revenue 8
  • 9. become effective. Meanwhile the Treasury will need to put in place an intermediary system that willensure that all revenues are deposited in one single account separated from expenditures accountsand that all provincial bank account are progressively closed. 6. Budget Control at the provincial levelExisting budget execution procedures at the provincial level are too weak to enforce absolute fiscaldiscipline. Provinces have taken the habit to offset their expenditures against revenues collected forthe central government without referring to the Ministry of Finance. They also make transfersbetween programmes and sectors.This problem will not find a complete solution until the Treasury Single Account is implemented.However, it is possible to take preliminary measures that will reduce very significantly the capacity ofprovinces to offset their expenditures with revenues. A more detailed plan is presented in sectionIII.5. 7. Horizontal imbalanceDespite continuous efforts over several years for correcting disparities in fund allocations betweenprovinces, horizontal imbalance remains a reality. Not only there are still important disparitiesbetween provinces, but there are considerable variations in fund allocation between sectors in theprovinces. As the table below shows, when the average spending per capita is 470 thousand kips,variations between provinces go from 250 thousand kips to 760 thousand kips (from 1 to 3).There are many reasons for these disparities such as:  Line-ministries allocating funds to provinces in an ad hoc manner based on historical considerations;  Some provinces have poor absorption capacity and will not be able to use efficiently additional funding. Capacity for implementing new innovative projects remains low;  Provinces have poor planning capacity and are not able to come with workable plans for extending their services;  Budget prepared by provinces are not aligned with Government priorities.MoF is committed to correct horizontal imbalance in the medium term but in impeded in its missionby poor knowledge of economic and fiscal conditions existing in the provinces. In order to improveits budget allocations to provinces, MoF will need to perform detailed analysis of provincial budgetand to collect data on the implementation of Government’s programmes at the local level. At thepresent time, the Budget Department does not have the capacity to perform those tasks. Thiscapacity will have to be built gradually (see section VI. 8). 9
  • 10. HORIZONTAL IMBALANCE BETWEEN PROVINCES FISCAL YEAR 2007-2008 Poverty Domestic Exp. Operating Exp. Capital Exp. Index /Population /Population /Population Vientiane Capital 1,17 0,45 0,24 0,21 Savannakhet 1,43 0,25 0,22 0,03 Champasak 1,18 0,34 0,26 0,07 Khammoune 1,34 0,32 0,31 0,02 Luangphrabang 1,23 0,36 0,34 0,02 Bolikhamxay 1,29 0,39 0,36 0,03 Houphan 1,52 0,48 0,32 0,17 Oudomxai 1,45 0,72 0,31 0,42 Xayabury 1,25 0,49 0,31 0,18 Xiengkhuang 1,42 0,48 0,42 0,06 Vientiane Pro. 1,19 0,43 0,34 0,09 Bokeo 1,21 0,53 0,38 0,15 Phongsaly 1,51 0,40 0,34 0,06 Luangnamtha 1,23 0,74 0,46 0,27 Saravanh 1,54 0,28 0,23 0,05 Attapeur 1,44 0,76 0,50 0,26 Xekong 1,42 0,60 0,54 0,06 Average 0,47 0,35 0,13 8. Disparities in revenue collectionWhat has been said of vertical imbalance in expenditure is also true for revenue collection. The tablebelow shows considerable variations in revenue collection between provinces. Four provinces(Vientiane Capital, Savannakhet, Champasak, and Kammouane) have in their jurisdiction a number oflarge industries that generate revenue for them. It is the reason that they can cover a highpercentage of their budget through local taxes (from 28.10% to 44.89%). However, variations that wesee in other provinces are more difficult to explain and are not directly linked to the poverty level ofthese provinces. Luangnamtha has a very low poverty index (1.23) but covers only 5% of its localbudget when Bokeo, with a similar poverty level, collects 16%. The Ministry of Finance is not inposition to say if such disparities are due to differences in the structure of the tax base, todifferences in the local economic environment or to deficiency in the local tax system. This lack ofinformation explains why revenue forecasting remains so difficult.A special mentioned should be made of three provinces (Houphan, Oudomxai and Attapeu) thatcover less than 5% of their budget and will require special attention. All three have a high povertyindex. In a typical case of vertical imbalance, those provinces are totally dependent on the centralGovernment for covering their expenditure. In such cases, it is clear that a poverty alleviation policyalone will not solve the economic and fiscal problem of those provinces. Such cases require a 10
  • 11. proactive investment policy to expand the tax base and create additional revenues for the localauthorities.These few cases illustrate the need for the Ministry of Finance to tailor its fiscal and revenue policy toeach province. This will be possible only if the Ministry dedicates additional human resources to thisproblem and builds up the expertise necessary for monitoring closely revenue collection and budgetimplementation in all provinces. LOCAL REVENUES (100%) AS PERCENTAGE OF EXPENDITURES (FISCAL YEAR 2007-2008) Poverty Local As % of Population Per Capita Indicator Revenue Expenditures Revenue 1 Vientiane Capital 1,17 150782,76 44,89% 749813 0,17 2 Savannakhet 1,43 64682,98 29,51% 886806 0,10 3 Champasak 1,18 61994,75 28,10% 652159 0,17 4 Khammoune 1,34 48141,50 41,29% 362270 0,11 5 Luangphrabang 1,23 29640,92 18,59% 437055 0,12 6 Bolikhamxay 1,29 16822,89 17,95% 241915 0,06 7 Houphan 1,52 6410,50 4,39% 301655 0,02 8 Oudomxai 1,45 6339,56 3,07% 284734 0,02 9 Xayabury 1,25 20487,50 11,54% 363643 0,08 10 Xiengkhuang 1,42 8621,00 6,71% 267498 0,02 11 Vientiane Pro. 1,19 33956,80 18,14% 438544 0,22 12 Bokeo 1,21 13254,00 16,06% 155975 0,07 13 Phongsaly 1,51 5079,67 7,12% 178184 0,03 14 Luangnamtha 1,23 6142,50 5,35% 156025 0,02 15 Saravanh 1,54 15985,40 16,30% 348243 0,13 16 Attapeur 1,44 3161,30 3,45% 120388 0,03 17 Xekong 1,42 5108,85 9,33% 91263 0,06 Average 16,58% 0,08 9. Issues with reportingA good reporting system is essential for budget formulation, fiscal policy, budgetary control andreporting to the Parliament. However, the reporting capacity of MoF remains weak due to severalfactors:  The low reporting capacity of GFIS  Low capacity in the Treasury and Budget Department  Lack of data storage and analysis tools  Lack of an integrated reporting policy 11
  • 12. Reporting appears extremely fragmented and performed in an ad hoc manner in completedisconnection with the budget cycle. There is no integration between budget reporting and NGPESreporting and no integrated system to manage data. Although a lot of progresses have been made toimprove GFIS, the technology on which it was developed limits its reporting capacity. Theintroduction of the new Chart of accounts will certainly solve many problems, but GFIS was designedfor ex post control and therefore does not provide the sort of information for making day to daydecision. The implementation of the new Treasury System (TIMS) is expected to change thissituation, but will not become a reality before three to five years. Meanwhile, the MoF needs todevelop an intermediary strategy for improving its accounting and reporting system. This strategyshould list all policy and decision requirements and map them to reporting and informationrequirements in order to identify data requirements and develop an integrated reporting system thatfollows the budget cycle. 12
  • 13. II. THE NEW ROLE AND STRATEGY OF THE MINISTRY OF FINANCE 1. A renewed legal frameworkThe first phase of the Ministry of Finance reform programme has been mostly dedicated to strategicplanning and putting in place the legal framework that will drive the reform agenda. From 2005 to2007, six important laws have been passed by the National Assembly: the Tax Law (May 2005), theCustoms Law (May 2005), the VAT Law, The Budget Law (December 2006), the Accounting Law (July2007), and the Audit Law. FY 2007-2008 has been mostly devoted to the preparation of theimplementation decrees that will make those laws effective. The Tax Law and the Customs Law arealready applicable. Implementation of VAT is planned for January 2009 but could be delayed due tosome technical problems. Implementation of the new Chart of Account is also planned for January2008, but policy issues for application to the public finance sector and more specifically for theMinistry of Finance might take several months to be solved. In the fourth quarter of 2008 the firstdraft of the Treasury Law will be ready and discussions will start with the National Assembly.As important as the laws are the implementation decrees, which are usually more copious than thelaw itself and enter into more details. This approach gives to the legal framework a lot of flexibility asit is easier to change an implementation decree than to modify a law passed in Parliament.An important point will be the articulation of the Treasury Law with the Budget Law. Having beenprepared more than two years ago, the agenda of public finance reform might not have been as clearas it is now, and the Treasury Law might offer a new opportunity to strengthen the Ministry authorityvis-à-vis line-ministries and provinces, especially in the areas of budget execution, accounting andreporting.It is possible that small adjustments will be needed in the law and their implementation decrees tobring more coherence on one hand and to clarify numerous details as it is the case with the VAT Law. 2. A new definition of the role of the Ministry of FinanceThis new legal framework conveys an implicit redefinition of the role of the Ministry of Finance in thepublic finance system of the country. The mission of the Ministry of Finance changes from being thepaying agency of the Government to a twofold mission: (a) planning and managing the Governmentfinance and using the budget as a fiscal policy tool to promote macro-economic stability, povertyalleviation policies and economic growth, (b) controlling all government expenditures to ensure thatthey serve the Government’s objectives, are in line with its policies and socio-economic strategy, andthat the use of funds is efficient and commensurable with expected results and outcomes.The creation in 2000 of the Fiscal Policy Department shows that the first part of the mission is wellunderstood, even if all the instruments of fiscal policy are not yet all in place. The new Budget Law 13
  • 14. covers partially the second aspect and it is expected that the Treasury Law under discussion willconsiderably reinforce the controlling role of the Ministry of Finance.However, to fulfil completely its new mission, the Ministry of Finance needs to meet threechallenges: (i) Developing its own capacity to perform its new mandate (ii) Having the new role of the Ministry of Finance recognised and accepted by other Government’s agencies; (iii) Strengthening the link between planning and budgeting at the provincial level as well as at the central level of line-ministries.The same effort that has been made for building capacity in the Fiscal Policy Department should bemade for the Budget Department and the Treasury. Capacity problems will not be solved only bytraining and redeployment of the existing staff. International experience has demonstrated thattraining has some inherent limitations; in most cases book keeping officers will not become certifiedaccountants. Cash management is a totally new and highly specialized function usually performed bypeople having an experience in bank or corporate treasury management. Clearly, with the currentlevel of staffing, the Ministry of Finance is not in position to fulfil its mission.The position of the Ministry of Finance in the Civil Service system can be characterized by a strongmission but with a weak legal authority. In order to perform its control mission the Ministry offinance will need to raise its profile and have its new role recognized and accepted by othergovernmental agencies. The revised Budget Law leaves the Ministry of Finance with a weak legalauthority. The drafting of the revised Treasury Law offers the opportunity to correct some of theexisting deficiencies and that opportunity should not be lost. However, the Treasury Law will not beable to address some of the existing issues in the planning and budgeting areas and additionallegislation or regulation must be considered.  The revised Budget Law and revised Treasury Law will not cover all areas of public finance living the role and function of the Ministry of Finance not fully defined.  Article 74 of the revised Budget Law covers the rights and duties of the Ministry of Finance, but only in relation to the “Management and control of the State Budget”. Part IV on the “Division of Responsibilities in Relation with the State Revenue and Expenditures” and Part V on the “Formulation and Execution of the State Budget Plan” clarify the role of the Ministry of Finance in functional terms but do not define explicitly its authority and its responsibilities. Responsibilities are defined in terms of sectors such as the tax sector, the customs sector (art. 55,), the National Treasury (art. 60) and the primary and secondary ordonators (art. 58 and 59). The Budget Law implementation decree has also strengthened the authority of the Ministry in the area of control and inspection (art. 58 and 59). As a result, the Ministry of Finance has a strong role in budget execution but its role in budget planning and budget formulation remains vague. 14
  • 15.  The revised budget law is very clear on defining rights and duties of provinces in relation to the Ministry of Finance. It gives to the provinces “ownership in formulating budget” (art. 75) and to the Ministry of Finance the responsibility to control budget execution. However, the law does not say anything on the role of line-ministries in policy making and planning, especially on the relation between the ministries at the central level and their provincial directorates. A better integration of policy making, planning and budgeting will require some clarification that can be provided by secondary regulation.  The revised budget law does not mention explicitly budget circulars. Article 28 of the Implementation Decree mentioned incidentally Budget Circulars as providing instructions for budget planning. The legal authority of the budget circular remains undefined. Article 74 of the revised budget law allows the Ministry of Finance to draft “regulation in finance area” but only “for submission to Government for consideration”. It is important that the drafting committee of the Treasury Law should give full authority to the Treasury to issue “Treasury Instructions” that will apply to all aspects of budget execution.A possible solution for going around those problems could be to issue two implementation decrees:one for the implementation of the Treasury Law when it will be ready and one for completing thefirst decree of the revised Budget Law. The new application decree would address issues related tobudget formulation and its relation to policy making and planning. However solving some of thepending issues will require long consultation with the Government and all stakeholders. The revisedBudget Law has already set in motion a complete transformation of the public finance sector and it isnot easy to identify all the implications. It will probably require several years before a viable strategyfor linking together policy making, planning and budgeting within a result oriented system can beformulated.Contacts between the Ministry of Finance and line-ministries remain limited. The introduction ofbudget norms is only one example of the need for a close cooperation. The same way that ministriesneed to monitor the implementation of their programmes in the provinces, the same way theMinistry of Finance needs to monitor the financial aspects of the implementation. It includes themonitoring of procurement and of budget execution. For such purpose, regular exchanges ofinformation are required which usually go through an appointed “focal point” in each ministry.Capacity for such an exchange of information and for data analysis needs to be strengthened in theBudget Department.The efforts of the Ministry of Finance in developing a new legal framework for public finance,centralizing the treasury, improving budget formulation and developing budget control will producelittle result unless similar efforts are made in the provinces and in line-ministries. A plan alreadyexists for improving budget formulation and budget procedures at the provincial level. However asimilar plan should be put in place at the level of line-ministries. Line-ministries have also a controlmission, but the law does not say anything on the authority of sector ministries in controlling theimplementation of sector policies. Line-ministries should give policy guidance to the province forbudget preparation to ensure that local budgets reflect national priorities. It can be expected thatthe line-ministries will also experience capacity problems in fulfilling their planning and policy controlmission. 15
  • 16. 3. The Public Financed Management Strengthening ProgrammeThe Public Expenditure Management Programme was approved by the Government in November2005 and latter renamed Public Finance Management Strengthening Programme (PFMSP) to includerevenue management. The PFMSP provides a framework for implementing all public finance reformsas well as for developing capacity for implementing Government’s policies and strategies laid out inthe “Policy Paper on Governance”, the “National Growth and Poverty Eradication Strategy” and theNational Socio-Economic Strategy 2006-2010. Recent consultations with AusAID, the EuropeanCommission, the Swedish International Development Agency (SIDA), the Swiss DevelopmentCorporation and the Word Bank have resulted in the creation of a Multi-Donor Trust Fund (MDTF)that will greatly reinforce the programme efficiency.The PFMSP should remain the main framework for addressing all the problems and issues generatedby the Ministry of Finance reform programme. As a flexible instrument, it allows a quick reaction tonew emerging issues and the PFMP should be used for addressing some of the issues identified inthis report.Initially, the implementation of PFMSP has gone at a slower pace than envisaged, mainly on accountof inadequate funding, lack of implementation capacity and restructuring of MoF (completed in2007). During the first three quarters of 2008, progress with PFMSP implementation has remainedbroadly on track. Small delays have been experienced due to the difficulty to identify technicalassistance resources, delays in procurement and lack of capacity in the implementing departmentthat put the entire burden on a few individuals.The programme is made of six essential components: A. Revenue Sharing, fiscal planning and budget preparation; B. Treasury centralization, budget execution, accounting and financial reporting C. Revenue Policy and administration D. Local government financial management; E. Financial legislation and regulatory framework; and F. Human resources and capacity developmentThe PFMSP is currently working on the implementation of the Work Plan for 2008 as part of theMedium Term Implementation Schedule 2005-2011 that set the overall direction of the reformimplementation agenda. The Work Plan for 2008 focuses on the implementation of the Budget Law,including:  The development of the revenue sharing system and a system grant transfer;  The development of a policy for budget norms and high level budget norms for education and health sectors applicable in FY2008/09;  The preparation of the Treasury Law and related regulations consistent with the new mandate of the Treasury;  The development of a simple macro-fiscal forecasting model at the Fiscal Policy ; 16
  • 17.  The development of a revenue forecasting model at the Customs and Tax Departments;  the implementation of MTFF and MTEF methodology, including the development of two sectoral MTEF;  The development of a framework for implementation of the Treasury Single Account along with related IT needs assessment;  The standardization of budget procedures through the preparation of standard budget forms in selected ministries and roll-out to all ministries and provinces;  The upgrading of GFIS core system and other technical infrastructures, including improvement in the system reporting capacity through the use of Crystal Report Writer;  The implementation of the new Chart of Account through GFIS to be ready for next fiscal year, and of the new Budget Nomenclature in the education sector for FY2007/08; and across Government for the FY2008/09 budget;  The development of regulation and accounting instructions necessary for the implementation of the Accounting Law in the public sector;  The Development of standard form for consolidated in-year budget execution reports and management reports as part of a consolidated reporting framework;  The development of a borrowing strategy and establishment of a debt management and recording system;  The harmonization of manuals and procedures and the introduction of performance measuring tools in selected agencies;  The upgrading of the capacity of assets management;  The development of a master plan for tax centralization and customs covering all aspects of tax management and tax collection;  The implementation of the Tax Information System and the ASYCUDA system. 4. The Multi Donor Trust FundThe Multi Donor Trust Fund (MDTF) will address one of the issues responsible for PFMSP slowimplementation: the lack of adequate and timely funding allowing the programme to provide quickresponse to new emerging issues through flexible technical assistance and capacity programs.Additionally, the MDTF will improve coordination between development partners working on publicfinance management reforms and contribute to the harmonization aid policies.The objective of the MDTF is to secure funding for implementing the Government’s reform agendafor the next four years. So far eight development partners (France, Embassy of Japan, JICA, 17
  • 18. Sweden/SIDA, AusAID, European Commission, ADB and World Bank) have express their willingness tosupport the trust fund. PFMSP has been working with the World Bank to develop the trust fundstructure, including the governance structure and the consultative mechanisms, the financialstructure of the trust fund, the reporting requirements and the supervision arrangements. It isexpected that the MDTF will become fully operational before the end of the year 5. Reform sequencingThe long list of items in the previous sections shows that the main difficulty that arises from theMinistry of Finance reform programme is the sequencing and coordination of reforms. The PFMSPhas substituted a strategic approach to a piecemeal approach of reforms. However, coordination andintegration of the different project components remain an issue and will require a considerable efforton the part of the Ministry of Finance.Hiatus in project execution are unavoidable. The Ministry needs to coordinate four spheres ofactions: (a) the planning and policy making sphere, (b) the legal sphere, (c) the process sphere andthe (d) Information technology sphere.Laws and regulations can be developed only when objectives of reforms are clear and policies havebeen defined. By many aspects, the Ministry of Finance is entering uncharted territories and for thatreason pilot projects are important. However, if the pilot projects are important for the fine tuning ofprocedures, they come too late in regard to the legal framework. The Budget Law defines the budgetcontrol procedures and the related authority of the ministry, but leaves out the integration ofplanning and budgeting because no clear policy has yet been devised in this area. Financialstatements cannot be finalized before public accounting policy has been fully clarified. Loopholes inthe VAT Law can stop its implementation or make it very difficult. Without well defined process andprocedures computerization is impossible. Upgrading of GFIS requires a precise mapping ofaccounting procedures to define technical requirements, not just a chart of account and a budgetclassification. The development of accounting codes requires a clear understanding of the relationbetween the Chart of Account and the Budget Classification and of budget execution procedureswhile some of them have not been designed yet.Things get more difficult when progress of some MoF projects depend on the cooperation of otheragencies as it is the case in planning and macro-economic policies. Here the main risk is probablywith the Treasury Single Account (TSA). The TSA implementation requires that the implementation ofthe Treasury System goes in parallel with the implementation of BoL systems, including its GeneralSystem and its payment systems. However implementation of the payment systems will require aPayment Law and a payment processing strategy with usually includes a Real Time Gross SettlementSystem (RTGS) and a Low Value Payment System. 18
  • 19. III. TREASURY CENTRALIZATION 1. The Centralization processThe Treasury modernization project is essential to the overall modernization of the Ministry ofFinance and hinges on the implementation of two components: the Treasury Single Account and theTreasury centralization plan, and the Treasury Information Management System.The Treasury has prepared a centralization plan that establishes a focus on four components: (a)Treasury Single Account (TSA) framework, (b) a human resource management strategy, (c) aninformation technology upgrade, and (c) a legislative and regulatory framework. The reorganizationof the Treasury functions, including the streamlining of the budget execution functions, should beseen as a precondition for the implementation of the Treasury Information Management System.Given the current status of Treasury Systems, capacity, and institutional arrangements, it isestimated that the effective centralization of the Treasury will take 4-5 years. The procurement andimplementation of the Treasury System is expected to take a minimum of 3 years. 2. The Treasury LawThe Treasury Law will provide the regulatory and operational framework for the Treasury System andwill become the basis of more detailed guidelines, procedures, secondary regulations, forms andoperational manuals for budget execution processes required at all levels of Treasury operations andfor payroll management. It will give authority to the Treasury to issue instructions for recording of allGovernment transactionsA committee has been formed for the drafting of the Treasury Law which is following more or lessthe same process as the committee that prepared the Budget Law. Consultation is already takingplace at the provincial level. The first draft is expected to be ready by September 2008. In order toestablish a complete legal framework, all aspects of budget execution must be covered. Changes thatwill be introduced by the law are expected to be as significant as those introduced by the Budget Lawand will probably require a complex implementation plan.The new law will define the statute of the Treasury as the only Government payment centre, and itwill clarify the relationship between the central treasury and the provincial treasury. It will makeclear the separation of revenue and expenditure management competencies and responsibilities.The purpose of the law will be to introduce a clear line of management between centraladministration and provinces for everything related to revenue collection and expendituremanagement. It will strengthen the authority of the Treasury offices at each level of Government,especially in the area of commitment management and budget control and it will improve publicfinancial accountability and transparency. 19
  • 20. The Treasury Law should cover the following areas: (1) General provisions, including references to previous legislation, purpose and scope of the law, validity, entry into force, interpretationdefinitions, Treasury mission and responsibilities, institutional and organizational set-up, secondary legislation and regulation (Treasury Instructions) (2) Appointment and responsibilities of the Treasury officers, Delegation of powers (3) Public money (definition, receipt and deposit in the TSA, immunity, investment, special funds state funds); (4) Functioning of the TSA; (5) Treasury general ledger system and its relation with budget classification, chart of account, and accounting rules or norms (6) Bank accounts (7) Revenue centralization and collection of public monies (8) Budget execution and payments (9) Government borrowing and lending (10)Issuance of guarantees by the State (11)Management of losses and claims (12)Reporting and financial records (13)Internal control of Treasury, budget execution control in other institutions and audit (14)Application of the law to municipalities (15)Miscellaneous (precious metal, gems, disposal of properties found, money and properties held in trust, gifts, donations and sponsorship) 3. The Treasury Single AccountA Treasury Single Account (TSA) is a mechanism for centralizing all State revenues and expenditureson one or two accounts articulated with a set of sub-accounts held in the books of the Central Bank.The TSA uses one single payment system managed by the Central Bank and linking all sub-nationaltreasuries to the central treasury. All transactions passing through the TSA are recorded in theGeneral Ledger of the Central Bank and reconciled with the accounting system of the Ministry ofFinance.A Treasury Single Account brings a number of tangible advantages: 20
  • 21.  The TSA is a powerful tool for centralizing all revenue collection and budget execution transactions, putting the central treasury in full control of both processes.  It will prevent provinces from offsetting expenditures against revenue collection bringing more transparency in the budget;  It will reduce idle cash and offer an opportunity to introduce cash management leading to a more effective use of financial resources;  It will simplify the reconciliation process between banking statements and transactions posted in the Ministry General Ledger;  It will make possible an integrated expenditure management and reporting system, linking budgetary allotments to the final transactions;Design and implementation of a TSA have usually three components: a) The legal and regulatory framework b) The TSA architecture with the procedures governing the different system levels c) The IT infrastructures (General Ledgers and Payment Systems)At this stage, process on the implementation of the Treasury Single Account (TSA), depends verymuch on the progress made on the drafting of the Treasury Law (component (a)). It is the TreasuryLaw that will legally establish the Treasury Single Account and will give authority to the Treasury forissuing secondary legislation. The Treasury Law will establish the basic mechanism of the STA and willalso detail all changes in institutional arrangements necessary to accommodate the new TSA system,including changes to banking and accounting arrangements.In order for the TSA to become operational, the Treasury Law must provide a number of provision:  It must provide a definition of the TSA. A standard definition could be: “The Treasury Single Account is a mechanism made one or more bank accounts opened in the books of the Central Bank or any other financial institution designated by the Minister of Finance (under the Treasury Regulations) used to centralized (all) budgetary receipts and other non budgetary funds, and to manage authorized payments to budget beneficiaries or other institutions designated by the law.”  It must provide a definition of public money, because public money must be remitted in the TSA.  It must provide a definition of “Consolidated Fund” as a broader category than public money because consolidated funds might include funds which are not deposited in the TSA as it might be the case with State Funds which are extra-budgetary funds. Consolidated fund is not an operational concept like the Treasury Main Account, but rather an accounting concept that list all funds that the Treasury needs to consolidate for accounting purpose.  It must provide a definition of the Treasury Main Account as a component of the TSA. 21
  • 22.  It must establish the Treasury ownership over the TSA which is a delicate point because the TSA is operated by the BoL. However it is important that the Treasury keep the regulating authority on the TSA. In practice a central bank should be barred of issuing any regulation related to the TSA.The TSA management mechanism should be kept distinct from the budget execution mechanism.The TSA management mechanism should cover the following issues:  Respective responsibilities of BoL and MoF in managing the TSA and public money deposited  Changes in TSA architectures  Responsibilities of provinces in managing their sub-accounts  Recording of TSA transactions  Rules for Managing the TSA liquidity and prioritization of payments  Reconciliation procedures between the BoL’s General Ledger and the MoF’s FMISOwnership of the Treasury over the TSA and procedures for managing the TSA are often included in aMemorandum of Understanding (MoU) signed between the MoF and the central bank. The MoUmust detail the central bank responsibilities in terms of IT infrastructures, on-line access to data andinformation, reconciliation procedures, payments instruments and access to the different paymentsystems, IT security (procedures in case of system failure, backup of data, etc.).Many regulatory concepts will not be clarified before the TSA architecture is established. Basicallythe Treasury has the option between a two tiers architecture that will put line-ministries on the samelevel as provinces, or a three tiers architecture that will give more responsibilities to line-ministries inmanaging their local office funds. A possible architecture could be: Tier 1 : Treasury Main Account Tier 2: Direct Primary Budget Units, including line-ministries and provinces Tier 3: Provincial offices of ministries, districts and municipalitiesIt is not possible at this stage to say how much time will be necessary for having the TSA fullyoperational. The implementation of its technology backbone depends on the BoL. The Bank will needto implement its own General Ledger as well as a Real Time Gross Settlement System. As it mighttake several years, the TSA implementation strategy will need to identify interim arrangements usingexisting infrastructures. The best approach would be to have the implementation of BoL systemsgoing in parallel with the implementation of MoF systems.A significant project has been considered, but not approved, to modernize the Lao banking system.This process may have significant impact on the manner the TSA is implemented and the way thatMoF can utilize banking as part of the solution architecture. It is essential for the Ministry of Finance 22
  • 23. that the BoL defines its IT strategy as quickly as possible to be included in the TSA implementationplan as well as in the requirements for the Treasury Information Management System. 4. Separation of revenue accounts from expenditure accountsAs mentioned in section I.6, provinces have taken the habit to offset their expenditures againstcollected revenues without referring to the Budget Department, undermining in that way all fiscaldiscipline.Only the implementation of the Treasury Single Account along with the Treasury InformationManagement System will be able to ensure that budget execution regulation cannot be violated.Meanwhile, the Treasury can take some intermediary measures that are in fact part of the TSAimplementation plan: a) Close all accounts in commercial banks and centralise all accounts at the central bank (In practice it does not require the TSA to be operational); b) Separate revenue accounts from expenditure accounts; c) Create three revenue accounts: one for provincial revenues (100%), one for shared revenues and one for central revenues with different persons responsible for their management; d) Create two distinct lines of management for revenue accounts and expenditure accounts e) Maintain a strict distinction of responsibility between the person who order the payment (authorizing officer or ordonators) and the person who execute the payment (the paying officer or the accountant), with the impossibility for the Head of the Treasury to become ordonator. f) Maintain a strict distinction of responsibility between the person who establish the tax base, the person who actually collect the money and the person who manage the revenue account. g) Specify rules for managing the shared revenue accounts. The rule might include:  A cash limit above which the funds are automatically transferred to the Treasury central account;  Daily reporting of the cash position to the Treasury;  No other transfer to other accounts allowed;  Possibility for the Treasury to centralize available funds at any time;  No authority of the Governor over shared revenue account and central government,  Severe disciplinary sanction for violation of the regulation under articles 86, 87 and 88 of the Budget Law (to be reinforced by the Treasury Law) 23
  • 24. These dispositions should be integrated in Treasury Instructions and a Prime Minister Decree. 5. The Treasury SystemDuring the past months, the Ministry of Finance has made significant progress in defining itsinformation technology strategy. As already decided the current Government Finance InformationSystem will be replace by a new system named “Treasury Information Management System” (TIMS).The TIMS will serve as the core system for all MoF Finance applications that will include, amongothers, the tax system, the customs system, and the debt management systems. All MoF systems willbe fully integrated though interfaces to the core system, meaning that the TIMS will set the datastandard for all other systems and that there will be only one General Ledger for all types oftransactions. As a result, the TIMS will become the repository of all MoF financial data. When fully deployed, the TIMS will replace the current Government Financial Information Systemthat was developed in 1994 with the assistance of the Asian Development Bank and later deployedin all 37 ministries and their 17 provincial departments across provinces.The GFIS system suffers from a number of limitations:  Its technology has become obsolete. It runs on a Sybase database not capable of handling multiple users. It connectivity is provided by a dial-up system and can be slow and unreliable. The system cannot easily interface other systems and therefore cannot be used as the core treasury system.  The system does not generate checks and is incapable of cross referencing revenue receipts in any automated manner.  Because the system does not function in real time, it will not be compatible with the management requirements of the Treasury Single Account.  Because of the previous limitations, the system is not compatible with modern cash management techniques.  Due to the limitation of its database, the system has limited reporting capacity and is not able to produce the type of reports that are necessary for budget control and fiscal analysis.  Scalability problems will not allow the system to cope with large volume of data. The GFIS will reach its operational maximum by 2011 and it is critical that the new system be ready by that time.The new TIMS will overcome all these difficulties. The TIMS will be an off-the-shelf solutioncustomized to meet MoF specific requirements. It will have modular architecture offering a singleuser interface. Five other modules will operate around the General Ledger: Budget AllocationManagement, Cash Management, Receipts Management, Payments Management and Procurement.Five Departments or Divisions will have access to user interface for data entry: the BudgetDepartment, the Treasury Department, the Tax and Revenue Department, the Customs Departmentand the Debt Management Division. The system will be linked to the BoL Payment System forpayment processing and the BoL General Ledger for reconciliation purposes. 24
  • 25. The new Treasury Information Management System (TIMS) will bring the following benefits:  The new system, combined with the TSA, will ensure that fiscal discipline is fully enforced at all levels of Government. The budget execution system will be based on a system of limits represented by warrant allocations. Expenditure limits will be set for line ministries by program and by chapter, using the new budget classification code. The line-ministries, provincial governorates and other spending agencies will in turn distribute the warrant allocation to spending units using the same classification code by issuing sub-warrants. No budget unit will be able to overspend. Transfer of funds from one program to another will be possible only with central government control.  The system will streamline all procedures and eliminate unnecessary paperwork, overlapping processes and manual cross-checking of transactions. The automation of data processing will eliminate most errors and make data and reports extremely reliable. As a result, budget execution procedures will become prompt and payment delays will be reduced.  The system will make effective the implementation of the new Chart of Accounts and the new budget classification, allowing the government to follow in a timely manner execution of the approved budget through economic categories.  The system database will provide a repository for all fiscal data that will facilitate reporting. At any time, the Budget Department and the Fiscal Policy will be able to access multi-year data to perform ad-hoc analysis and to prepare reports. On-the-fly reports will become a reality to answer any question at any time. As a result, the timeliness and quality of financial information will be greatly improved.  The improvement of information in budget execution will be reflected in budget preparation. With comprehensive information the Budget Department will be in better position to negotiate budget appropriations with line-ministries. This will allow more effective allocations and a better use of funds.  The System will enable the Government to be in position to determine overall financial / liquidity position on a daily basis. This will allow the Treasury to put in place cash management procedures. Idle cash will be moved between the different sub-accounts of the TSA, reducing the need for liquidity and borrowing.  Monitoring of revenue collection will be greatly improved, not only by providing timing information for cash management, but by also allowing early detection in any anomaly in tax collection. The tax department will be in position to monitor in real time collection against projections and to cross-check revenue collection as reported by the revenue agencies with actual revenue checks banked.  Any revenue / expenditure miss-match will be detected at a very early stage allowing the Government to react swiftly and fully informed, thereby improving budget execution. 25
  • 26.  The System will allow the Government to comply with the provision of the new Audit Law which requires finalization of the Government budget execution report within one quarter of the end of the fiscal year.The Treasury will take ownership of the system implementation. The Treasury will appoint a projectdirector and will take the lead for developing requirements for technical and functional design, whilethe ICT aspects of the system will be developed with the MoF ICT department. Procurement andfinancial support will be provided by the Public Finance Management Strengthening Unit.In July, a World Bank mission was conducted to start discussion on the system design, theimplementation time table, and the management structure to be put in place. Based on the missionconclusions, the Ministry will start working on the system terms of reference, and the RequestProposal for the design consultancy. One of the mission recommendations is that a projectpreparation committee/unit (PPC) be established. The committee will be responsible forcoordinating all aspects of the project preparation, providing guidance to the contracted consultancythat will undertake the Functional and System Design (FSD). The PPC will also be charged withspecifying departmental responsibilities and roles in defining business processes and userrequirements and will be responsible for the TIMS bid evaluation. Once the consultant firm that willassist the in functional design is selected, it is anticipated that PPC role will change to a full-fledgedProject Steering Committee (PSC). The PSC will be responsible for working with the turn-keycontractor to implement TIMS as well as performing project administration functions.The System implementation will be conducted in two major phases: (1) system design and (2) systemintegration and implementation.To prepare the system design, the Ministry of Finance will engage a Consultant to undertake thepreparatory analysis to identify the system requirements (Procurement 1). Based on theserequirements the Ministry of Finance will issue Terms of Reference and following the usualprocurement process will identify and select the system provider that will be responsible for thesupply, installation, implementation, training, change management, documentation, data cleansingand upload, and rollout of the new TIMS.The system provider implementation team will work under the supervision of a ProjectImplementation Support Consultant that will ensure that the system delivered by the vendor meetsall requirement and specification and that the implementation goes according to schedule withoutany additional risk (Procurement 2).Based of the bidding process, a successful contractor will be contracted to provide the turn-keysolution (Procurement 3). Its responsibility will include the phasing out of the GFIS, the supply ofhardware, the solution software, design, development, testing and implementation services, changemanagement, training, project management, and warranty and contract maintenance supportbeyond implementation. 26
  • 27. In order to accelerate the TIMS project and to facilitate the transition from GFIS to TIMS, theTreasury has taken a number of dispositions:  To avoid any problems with the new Chart of Accounts implementation that might interfere with TIMS implementation, the Chart of Accounts will be implemented using GFSI in order to test the consistency of accounting procedures. The Ministry of Education and the Ministry of Health have been selected as pilots during the current fiscal year.  Leased lines to connect the provincial treasury office and the line ministries to the central treasury have been already procured and put in place.  The Oracle database with database modelling tools has been purchased.  368 desktop computer and 21 Notebooks have been purchased to be deployed in provincial treasury offices. 6. Debt Management SystemThe debt Management Financial and Analysis System (DMFAS) of UNCTAD has been identified at thebest available solution for the Treasury and work on its deployment will start shortly. The system hasbeen developed by UNCTAF on the same model as ASYCUDA, with the objective to assist low andmiddle-income countries to develop their debt management capacity. Because DMFAS is developedby a United Nation’s agency, it comes with a technical assistance package that goes beyondassistance for the implementation of an IT system. It includes advice on institutional and proceduralissues, debt management training, support for debt analysis and the development of debtmanagement strategies.Nevertheless, the implementation of DMFAS will represent a heavy task. The implementation planshould be integrated to the PFMSP schedule and special attention should be given that enoughhuman resources are committed to the project success. 7. Rationalization of the budget execution processBefore the TIMS can be established, all budget execution procedures must be reassessed and madecompatible with the new system. The system requirements to be included in the terms of referenceswill be based on those new procedures.A committee has been established to look at the rationalization of the budget execution process withthe objective to streamline the process, eliminate unnecessary formalities and integraterequirements of the new Chart of Accounts and of the new standardized budget execution reportingsystem. The new arrangements take into consideration modifications introduced in the GovernmentFinancial Information System (GFIS) for the next fiscal year. The reengineering of budget executionprocesses has so far focused on a better linkage between the Budget Implementation Plan, allotmentmanagement (cash allocation), commitment management and reducing paperwork by a moreeffective use of computerization and of the GFIS capability. Banking arrangements and paymentprocedures have not been finalized yet as some of the new processes will depend on decision madefor the Treasury Single Account (TSA) strategy. However, as the TSA will not become operational 27
  • 28. before FY 2009-2010. The new procedures will strengthen the commitment control mechanism andbudget control effectiveness.The reengineering of the budget execution process cannot be dissociated from the design of thebudget control system. More detailed information is provided in section VII.5 of this report “Designof the Treasury Control System” on the best ways to ensure a good integration of the two processes. 8. Cash ManagementA concept note on cash management has been drafted with technical support from the EuropeanCommission. However, as long as the Treasury Information Management System is not implemented,progress in cash management will be slow and incremental. The Cash Management system will beone of the last module to be implemented as cash management relies on information coming fromother modules such as the General Ledger, Budget allocation, Receivables and Payable.The Ministry cash management policy will only become effective when the TSA will be fullyimplemented. The TSA will reduce the amount of cash sitting idle on bank accounts and reduce theneed for borrowing. The present system transfers the responsibility of cash rationing to local treasuryofficers, weakening the authority of the central treasury. Presently the Treasury is not able to usecash potentially available from under spending agencies. The only possibility to correct anomaly incash allocation is through a general revision of the budget at the mid-year review. 9. PayrollPayroll of Government employee represent the largest part of the recurrent budget for allGovernment agency, it is therefore important to define a payroll strategy as part of the budgetexecution process.As with the other systems developed by the ICT Department, there is a payroll system for MoF staff.Development of payment mechanism through ATMs as a salary collection option is being discussedwith banks. The payroll system is limited to basic functions and manages the payment recording anddistribution of MoF salaries. It does not supply any human resource management functions. 28
  • 29. IV. ACCOUNTING POLICY 1. Mission of the Accounting DepartmentThe Ministry of Finance is responsible for setting all accounting standards for the public sector,private companies, State Owned Enterprises and Non for Profit Organizations. This responsibility isfulfilled by Accounting Department. In1999, the Accounting Department has created two regulatoryinstitutions to assist in this work: The Professional Organization of Accountants and IndependentAuditors, and the Accounting Council. However, during the past years legislation has changed andthe bylaws of these two organizations need be revised to make them compatible with the newRevised Accounting Law.The Mission of MoF Accounting Department is not limited to setting accounting standards. It alsoacquires the mission of conducting surveys on behalf of the Ministry. With a staff of 23 employees,but only 8 accountants, the Department is under-staffed and in need of additional capacity. 2. The Accounting Legal FrameworkA new accounting law has been approved by the National Assembly on July 2nd 2007 and will start toapply on January 1st 2009. This Law covers both the private and public sector. The revised lawdefines the general principles of the accounting system, the structure of the accounting activities andthe structures and principles of accounting control operations.The Law defines the accounting standards as the basic rules and accounting methods for therecording of economic and financial transaction as well as the preparation of financial statements,including reporting, disclosure of financial information, valuation, accounting policies and recognitionof revenues and expenditures.The Law distinguishes between accounting entities, budget entities, administrative and technicalentities, and Public Funds. Budget entities are defined as a category of accounting entities andinclude “all State organizations which are authorized by the Government to prepare and implementtheir budget plans and to make accounting summaries about their actual implementation”. To someextent, budget entities are different from administrative and technical entities which are “theorganizations which use assets as authorized by the Government to serve the society of whichrevenue and expenditures are planned in the annual Budget.” In addition “Public Funds” are“organizations created under the authorization of the Government to collect revenue in favour of theState Budget and to settle expenditures according to the regulation authorized by the Government.”The drafting of the Treasury law might offer a chance to clarify those concepts and to make themfully consistent with modern budget practices.Because the new Accounting Law is a law on the general principles of accountings, there is little in itwhich is specific to the public sector and it has not abrogated the Decree “Pertaining to thePromulgation of the General Regulation of Public Accounting” also known as Decree No 20 which 29
  • 30. was issued on August 14th 1991 by the Prime Minister. The decree says very little on accountingtechniques, but is important as it defines the legal status and responsibilities of the AuthorizingOfficer and of the Public Accountant - two concepts taken from the French law (L’agent ordonateuret le comptable public)- and specifies principles of budget execution. With the implementation of therevised Budget Law many aspects of Decree No 20 have become obsolete, living its legal status inlimbo. The implementation of TIMS will also affect considerably the mission of the publicaccountants and their role and responsibilities should be reconsidered.Most provisions of Decree No 20 should be integrated in the new Treasury Law after their revisionalthough many details can be left to the application decree of the revised law. Special attentionshould be paid to article 72 and 73 of the Decree, as they define the authority of “the chiefauthorizing officer for revenue and expenditure” and of secondary authorizing officer. The decreelacks clarity and integrating those provisions in the revised Budget Law (and not in a Prime MinisterDecree) will help define the relationship between provincial Treasury Officers and Ministry of Financeofficers at the provincial level to the Central Government and the local authorities.Decree No 20 fell short of establishing the principles of public accounting as distinct from those ofcommercial accounting. 3. Accounting PolicyThe Lao accounting systems has three characteristics that explain some of the difficulties the Ministryof Finance is experiencing for finalizing its accounting policy and defining the State financialstatements: (1) it is derived from the French system, (2) it does not make a distinction betweenpublic and private accounting, and (3) it is cash based until the 2007 law is implemented (Art.5).The Lao accounting system is based on the French accounting system of the 60s. As such it isdifferent from the American standards that have influenced the international standards, althoughsince the 60s efforts have been made to bring the French and other continental European systemscloser to American and international standards. One of the major differences is that accountingstatements are used as tax statements.Because the French financial statements of commercial companies are used for tax purpose, there isa strong need to distinguish between commercial accounting and public accounting as Governmentagencies governed by public accounting do not generate profit. For this reason, Governmentfinancial statements are different in nature from those of commercial companies.However, the Lao system does not make a sharp distinction between commercial and publicaccounting as both sectors are submitted to the same law. The new accounting law says that “allaccounting entities (including Government agencies) are to apply the national accounting standards”.The standards of the Government accounting apply to the budgetary and administrative unit and topublic funds”. (Art. 20) However, the law does not specify what those standards are. Here one isobliged to go back to Decree No 20 of 1995 which, by many aspects is obsolete. 30
  • 31. To solve the problems we need to clarify the difference between commercial accounting standardsand public accounting standards:The main difference between government accounting and commercial accounting are:  The Government borrowing capacity is not determined by the size of its balance sheet;  There is no need to distinguish between the original capital and other assets, or between capital reserves and revenue reserves as those reserves cannot be distributed;  The net worth of the State is only the difference between assets and liabilities. It is an adjustment variable;  Distinction between capital accounts and operating accounts is essential in public accounting;  Asset depreciation does not impact cash flow and capital;  Public accounting does not have a concept of profit;  Public accounting financial statements do not need to take into consideration taxation;  Whereas commercial accounting should use only one accounting methodology, public accounting can combine different accounting methods in a creative way that must be made explicit in Treasury circulars and accounting secondary regulation;  In the public sector the cost of services delivered is a fundamental concept and should be tracked easily.Understanding how those differences between public and commercial might apply to the Lao publicaccounting inspired from the French system is key for solving some of the difficulties that theMinistry of Finance is facing in formulating its accounting policy and in designing the State financialstatements.Like the Lao system, the French system assumes that public and commercial accounting are upheldby common principles. The current French public chart of accounts implemented in 1988 derivedfrom the chart of accounts for commercial companies of 1982 and Article 133 of “General Regulationfor Public Accounting (Réglement Général sur la Comptabilité Publique) says that the State Chart ofAccounts “is inspired from the general chart of accounts” (s’inspire du plan comptable général).However, “ inspired” does not mean similar. Important differences exist in the structure of the twocharts of accounts: (a) class 3 is significantly different because the State does not have a commercialinventory, whereas there is a need to describe various transfers between Government agencies, (b)class 9 describes budgetary operations and class 0 translate concepts such as “profit and loss” and“retained income” in budgetary terms. Since 1986, France has developed an impressive corpus ofpublic accounting regulations and in 2006 a new organic law has been implemented to bring Frenchaccounting techniques completely in line with international standards. As a result, the State balancesheet, the statement of budgetary revenues and expenditures and the Cash Flow Statement havebecome in nature completely different from those of commercial companies. Clearly, the AccountingDepartment will need to develop a similar corpus of regulation if the new Chart of Accounts is to beapplied to all Government entities. 31
  • 32. In Government, the distinction between capital and revenue is almost non existent. It only plays arole when assets are sold, and more specifically land, buildings or state owned enterprises. Sellingassets to cover operating expenditures is not considered good policy and proceeds of asset salesshould either be reinvested or used to reduce Government’s debts. However, in practice, it isimpossible to distinguish which expenditures (operations or investments) are financed by borrowingor by tax revenues.To solve the present difficulties, the Government has two options: (1) It can repeal Decree No 10 and integrate most of its provisions in a new Treasury Law, living the details of the accounting procedures to a Prime Minister Decree. (2) It can repeal Decree No 10, integrate the provision related to Budget execution in the new Treasury Law and prepare a law on public accounting distinct from the law on general accounting.In practice, the two options are not mutually exclusive: option 1 can be implemented quickly, givingthe Accounting Department additional time to prepare the law on public accounting. 4. The new Budget ClassificationThe system previously used did not make a strict difference between the Chart of accounts (CoA) andBudget Classification. As a consequence, categories used for budget preparation not only are notconsistent with international standards, but create difficulties for reporting and budget analysis. Inpractice, governments use two types of accounting: budget accounting and financial accounting. Oneuses a single entry system, the other a double entry system. The coherence between budgetclassification and the Chart of Accounts is embodied in the code structure that will be used forposting transactions in the General Ledger.The Ministry of Finance has finalized the new budget classification which is fully consistent withinternational standards such as COFOG (system of Classification of the Function of Government) andGFS (IMF Government General Statistics Manual). The new classification is now in its pilot phase atthe Ministry of Education and the Ministry of Health. The code structure that links the budgetclassification to the Chart of accounts is also in its testing phase. 5. Budgeting Financial Coding Blocks1Classifying expenditure is important in policy formulation and the identification of resourceallocation among sectors, the identification of activities of the government and the level at which1 Unfortunately, Mr. Pradeep was on leave when this report was prepared and could not be interviewed.Information used in this section comes from one of his PowerPoint presentation: “Chart of Accounts andBudget Nomenclature; Workshop on Draft Changes to Treasury Functions”. 32
  • 33. performance should be assessed, the establishment of accountability for compliance with legislativeauthorization, policies and performance, economic analysis, and day-to-day budget administration.The coding system developed by the Treasury uses only four coding blocks:  Organization  Project  Source of Funds  Economic ClassificationThis four coding blocks are enough to link the budget classification to the chart of accounts, howeverthe system might not be detailed enough to link expenditures to the National Growth and PovertyEradication Strategy. Compatibility of the coding block structure with NGPES reporting requirementsneed to be demonstrated.Advanced accounting and reporting systems use four types of classification in their coding blocks: (1) Administrative classification (2) Economic classification (3) Functional classification (4) Programme classificationThe functional classification organizes government activities according to their purposes (, health, social security) independently from government organizational structure alreadyreflected in the administrative classification. Structure of the functional organization is usuallyprovided by the National Poverty Reduction Strategy, in the case of Lao PDR, the NGPES.Countries having good reporting systems usually use the following coding blocks.  Organization  Sector  Programme  Sub-Programme  Project  Poverty alleviation strategy or other expenditure  Location 33
  • 34.  Source of found  Economic classificationIt seems that in the coding system under development sector, organization, and location have beenaggregated under one coding block. It is also possible to aggregate programmes, sub-programmesand projects, provided that the coding blocks have enough digits. However if the system can onlyreport by coding block, and if the coding block cannot be disaggregated, reporting by the four typesof classification will be difficult. It is possible that GFIS has some technical limitations that restrain thenumber of coding blocks and the number of digits by coding block. At this stage, with the limitedinformation available it is impossible to make a complete evaluation of the coding block system. Fullcompatibility of the system with NGPES reporting requirements need to be demonstrated. 6. The new Chart of AccountsThe revision of the Chart of Accounts is an important component of the modernization of theMinistry of Finance as it is an essential requirement for the implementation of the integratedTreasury System.The current Chart of Accounts and budget classification reflect the need of a centrally plannedeconomy and mix up administrative and economic classification concepts. It does not have anyfunctional (sectoral) classification, making reporting and budget control very difficult. For example,the concept of “salaries” does not capture all wage flows as it does not include “allowances foroverwork” and “family allowance” which in fact are part of the employee compensation. Theconsequence is that the wage bill is systematically underestimated. Similar remarks can be made forthe reimbursement of loans by SOEs that are treated as revenue, or the treatment of amortizationabove the line. Such distortions make international comparisons very difficult and eventuallyundermine the Government credibility in the face of the international community and investorsseeking guarantees of fiscal sustainability and macro-economic stability.The Ministry has formed an inter-departmental committee for the revision of the Chart of Accountsin 2007 which has finalized the new Chart of Accounts (CoA) in a way that makes it consistent withinternational standards, including Generally Accepted Accounting Practice (GAAP), the GovernmentFinance Statistics Manual (GFS), the International Public Sector Accounting Standards and theInternational System of Classification of the Function of Government (COFOG). The committee hasalso worked on a realignment of budget classification to make it compatible with the GFS.The structure of the Chart of Accounts has been approved by the Minister of Finance in April 2007.Based on that approved structure, the Inter-departmental Committee has now finalized the detailedChart of Accounts. The Ministry recruited a CoA technical advisor and a training advisor with supportfrom the Financial Management Capacity Building Project for assisting in the implementation of theChart of Accounts and the budget functional classification. The Government has started piloting therevised Chart of Accounts at the Ministry of Education. It is expected that the new Chart of Accountswill be fully implemented for the next fiscal year. It will be the responsibility of the CoA technical 34
  • 35. advisor to ensure that all reporting requirements, including NGPES reporting, are taken inconsideration by the coding block system.The new Chart of Accounts’ requirements will be taken into consideration for preparing the technicalspecifications of the General Ledger. 7. Budgetary accountingThe French accounting methodology requires a strict separation between budgetary accounting andgeneral accounting. The purpose of budgetary accounting is to record the different phases of budgetexecution: appropriation notification, accounting commitment, verification, issuance of the paymentorders, settlement. General accounting only records the final phase of budget execution within theframework of the chart of accounts, and identifies the source of funds and the payment instruments.The Accounting Department is under the impression that the system which is piloted at the Ministryof Health and the Ministry of Education does not keep a strict separation between budgetary andgeneral accounting. Either it is a misunderstanding, and in that case the misunderstanding need to beclarified to allow the Budget Department to develop the relevant regulation, or there is a real issuewhich need to be address when the pilot phase of the project will be evaluated. Furtherinvestigations of this problem are out of the scope of this report. 8. Financial statementsThe Financial Statements of the Government are expected to provide a record of the Government’sfinancial performance and of its financial position. For a better understanding, financial statementsusually provide a comparison with the previous fiscal year and with the fiscal forecast and give asnapshot of the progress the Government has made in implementing its fiscal strategy and achievingits social and economic objectives. However, there are many ways to present financial statements,depending on different objectives. Financial Statements are developed to serve a purpose and it isthe understanding of this purpose that provides the design guiding principles.For reasons that have been explained in section 3 of this chapter on accounting policy, the Ministryof Finance has not been able to finalize Government Financial Statements. Article 36 of theAccounting Law stipulates that “the financial statements of budgetary units, technical andadministrative units and the public funds include: the balance sheet, the statement of budgetaryrevenue and expenditures or the statement of performance, the explanatory notes of the accountingprinciples and methods in use”. The law does not say if this article applies to the financial statementspublished by the Ministry of Finance on behalf of the State but such is the understanding of theAccounting Department.Recognizing that article 36 is too vague to provide guidance for the design of the State financialstatements, the Accounting Department has taken as model the new French Organic Public FinanceLaw (LOFT) but in doing so is facing a number of problems that arise because many questions of 35
  • 36. accounting policies and accounting techniques have not been decided yet. The two main problemsare assets and debt recording.So far the total value of assets used by each Government Agency is unknown and the principles ofasset valuation have not been decided. This includes depreciation.The same problem arises with the treatment of foreign debt. In a patrimonial approach, theAccounting Department would like to include domestic and foreign debt in the net position of theState where as at the moment the accounting system only captures the cash position of the State.Accrual accounting will solve the problem, but it is not sure yet if GFIS will be able to supply suchinformation. A simple way to go around this problem could be to publish a separate statement forthe debt position of the State.These problems arise because the Accounting Department is following too closely the French systemwith the objective of producing a Balance Sheet and a Statement of Budgetary Revenue andExpenditures modelled on the Profit and Loss Account of commercial companies. In the Frenchsystem, the (taxable) operating result of the Profit and Loss Account must be absolutely equal to thevariation of assets and liabilities recorded in the balance sheet. In public accounting, there is not sucha direct relation between the Statement of Performance and the Balance Sheet and there is noreason for the Balance Sheet to be balanced, as balancing assets and liabilities depends on thevaluation of fix assets such as properties, equipments and military assets. Such valuation can be verysubjective. The difference between assets and liabilities is “the State net worth” which is anadjustment variable difficult to analyse in economic terms. It might take many years before the LaoPDR can develop a system able to calculate the net worth of the State. It implies solving many verytechnical issues such as the definition of State Assets, inventory and valuation of assets and liabilities,the depreciation policy, the accounting treatment of provisions and special funds, etc.Clearly, the Ministry of Finance will need to look at alternatives and develop a strategy over a periodof several years before detailed financial statements can be produced. When developing this strategythe Ministry will need defining clearly the objectives pursued by the publication of the financialstatements and articulate the different information requirements: reporting to the nationalassembly, compliance with donors’ requirements, and transparency on the macroeconomic situationof the country to attract direct foreign investments.At least for a few years a balance sheet might not be necessary to reach those objectives as long asthe same information is provided in a different format. Two options can be considered: a) Substituting to the Balance Sheet a number of statements that will provides information on different categories of assets and liabilities such as a statement of borrowing, a statement on fix asset variations, a statement on financial assets, a statement of commitments, and a statement of quantifiable contingent liabilities and contingent assets. b) Producing a simplified balance sheet that will provide detailed information on the liabilities side, but will detail only assets on which information is available such as liquidity, loans to employees, financial investments, etc. The adjustment between assets and liabilities will be provided by the aggregation of fix asset with the net worth of the state. 36
  • 37. EXAMPLE OF SIMPLIFIED BALLANCE SHEET ASSETS LIABILITIES Liquidity Gross Debt Financial assets Social Liabilities Other assets Other Liabilities Fix Assets and Net Worth Total Assets Total LiabilitiesIf it is difficult to distinguish capital assets from net worth, such is not the case of the gross debt thatis part of the Government liabilities and must be accounted for precisely. It will be impossible toproduce a balance sheet without a complete borrowing statement, and attention should be given tothis issue.In the French reporting system, the emphasis is not put on the balance sheet but on the explanatorynotes. Here the Accounting Department might have misread the French law. The importance of theexplanatory notes is not only in its clarification of “the the accounting principles and methods in use”but more in the level of details on asset and liabilities that they provide. The “explanatory notes”replace the long list of statements that countries using a different system produce, such as thestatement of borrowing, the statement on fix assets and amortization, etc.French public accounting considers that the deficit or surplus of the statement of budgetary revenueand expenditures is equivalent to the operating result of the profit and loss account of a commercialcompany. As such the budgetary surplus or deficit appears in the Balance Sheet. Following this modelis a question of accounting policy and MoF should not fill bound to follow the French model in allaspects. The deficit is financed by a variation in the Government borrowing position and it might bemore important to reflect this variation than to link the balance sheet to the performance statement.Many countries, like Australia and New Zealand, do not record the budget deficit in the BalanceSheet, but consider that the variation in the net worth of the State is more significant. The concept ofnet worth is very elusive in public accounting and its analysis is particularly difficult. It can bedoubted that the absolute value of the State net worth has a macro-economic meaning (you cannotcompare countries by their net worth), but the relative value of the net worth certainly has. Adeclining net worth might indicate that the level of investment is not sufficient to compensate forasset depreciation or that the national debt is growing too fast. Without a concept of net worth, itwill be almost impossible to produce a balance sheet as we cannot expect to reach the level ofprecision required by the French system before a decade.The recommended strategy will give time to focus on the Statement of Budgetary Revenues andExpenditures that also requires detailed explanatory notes. The required explanatory notes need to 37
  • 38. be listed in the accounting regulation and summarized in a Statement of Performance. This willrequire defining the concepts used in the analysis such as the Operating Balance that might notinclude revaluation of assets in the present case. Usually the Operating Balance defines the Stateinvestment capacity. In the case of the Lao PDR, international investments play a major role infinancing the country investment programme and there is the need to calculate an operating balancebefore and after international financing.The Ministry of Finance might be inspired by looking not only at France but also at other countriesthat are considered as models of good reporting such as Australia, New Zealand and South Africa.Explanatory notes might be replaced in some cases by various statements such as the Statement ofFinancial Position, the Statement of Movement in Equity, the Statement of Borrowings, theStatement of Commitments, the Statement of Quantifiable Contingent Liabilities and ContingentAssets, etc. The Ministry of Finance might also look at the IMF statements included in its Reportunder Article IV.In any case, these technical problems will not be solved without technical assistance. Only anaccounting expert can ensure that the solutions provided are consistent with the country generalaccounting policy and might assist in formulating an accounting doctrine. This report does not intendto provide solutions to accounting policy problems but only to identify policy options to beinvestigated. 9. Asset InventoryIn the absence of an asset inventory, it would be impossible to draw a state balance sheet in thesense of Article 36 of the Accounting Law. At the State level, a balance sheet might not be necessary.However, line ministries are requested by the law to report on their assets it will be impossible aslong as an asset inventory is not put in place. At the moment the state budget only capturesinvestments but is not able to determine how much is for new assets and equipments and how muchis for replacement of existing assets.Having an asset inventory is also important for the Fiscal Policy. Without an asset inventory theMinistry of Finance is unable to follow the life cycle of assets and equipments and to evaluatemaintenance cost and replacement cost. In practice those costs are systematically underestimated.The question is even more complex in Lao PDR because many large investments are financed directlyby donors whereas the Ministry of Finance does not have a clear idea of the maintenance cost.Before an Asset Inventory System can be put in place, the Accounting Department need to prepareregulations that can be formalized into a Prime Minister Decree. The regulation needs to cover thefollowing areas: a) Perimeter of State assets b) Principles of asset valuation and revaluation c) Principles of asset depreciation 38
  • 39. The first task is to provide a definition of tangible capital assets that must become part of the law orregulation. Tangible capital assets are usually defined as a significant economic resource managed bya Government agency and that is a key component in delivering Government services orimplementing Government programmes. The law, beside the definition must provide criteria fordistinguishing tangible capital assets from other assets or from stocks of goods. Usually, tangiblecapital assets (a) are held for use in the production or goods and services, for rental to others, foradministrative purposes or for the development, construction, maintenance or repair of othertangible capital assets; (b) have useful economic life extending beyond an accounting period (to bedefined); (c)are to be used on a continuing basis; and (d)are not for sale in the ordinary course ofoperations.The asset definition will help defining the perimeter of the asset inventory that might include notonly buildings, equipments, monetary assets, financial investments, etc., but also works of arts,national heritage buildings, state highways, aircraft and navigation equipments, railway network,electricity generation assets and distribution network, sewage system, commercial forest, mineralreserves, good will and intangible assets, etc.Based on a broad definition of assets in general and of tangible capital assets in particular, an assetclassification must be developed for the purpose of asset management. This asset classification willgo into more details than the budget classification and the Chart of Accounts. Governments usemany different types of asset classification, but all are likely to include broad categories such as: 1. Infrastructure assets 2. Community assets 3. Operational assets 4. Non operational assets 5. Military equipmentsIn a first stage, the Ministry of Finance might consider introducing a distinction between operatingassets and non operating assets and limiting the perimeter of the asset inventory to operating assets.PFMSP Work Plan for 2008 ha scheduled an activity designated as “upgrade of the capacity of assetsmanagement (information correction statistic and state property management in the nation wide)”to be undertaken “by the State Property Management Department after the establishment of theMTDF”. It includes the provision of three months of technical assistance. However, assetclassification needs to be developed jointly with the Accounting Department, as the classificationmust be compatible both with the budget classification and the Chart of Accounts.Asset management is impossible without an IT system and the implementation of such system mustbe integrated in the Ministry’s IT master plan. 10. Need for technical assistance and capacity buildingThe Accounting Department is facing are very complex situation and has limited options. The linkbetween the Lao accounting system is a legacy that goes back to the colonial period. The department 39
  • 40. is right when it insists that the coherence of the system should be maintained. However some of theproblems can only be solved in the long term and we need to recognize that it might take a decadebefore the Ministry of Finance is able to produce a Balance Sheet on the French model.What is crucial at the moment is to prepare the secondary accounting regulation that will benecessary for the full implementation of the new Budget Classification and the new Chart of accountson January 1st 2009. Another important task is the finalization of the State Financial Statements. Bothtasks cannot be completed without a clarification of the accounting policy and a better separationbetween commercial accounting and public finance accounting. Due to the short span of time leftbefore January 2009, the Accounting Department is in need of some Technical Assistance and wouldlike to recruit a consultant familiar with both French public accounting and international standards.In a near future, the Accounting Department will need to prepare policies for valuation ofGovernment assets and amortisation. It will need to prepare policies and regulation for special fundssuch as the road fund, government bond accounting, equities, etc. 40
  • 41. V. CENTRALIZATION OF CUSTOMS AND TAX ADMINISTRATIONCentralization of Customs and Tax Administration is an important component of the implementationof the Revised Budget Law promulgated in December 2006 by the National Assembly and of theMinistry modernization plan. This modernization plan is based on the Customs Law approved by theNational Assembly and the Tax Law in May 2005. General orientations for the implementation of theCustoms Law and the Tax Law have been issued by the Ministry of Finance in an instruction circularentitled “Recommendation of the Ministry of Finance on the Centralization of Customs, Tax andNational Treasury Activities under Vertical Line of Authority” published in July 2007. Thoserecommendations have been reinforced by a Prime Minister Decree published in September 2007.Significant progress has been made during the past six months towards the centralization of tax andcustoms administration. A well defined strategy has been put in place through instructions issued bythe Prime Minister and recommendations given to the relevant department by the Minister. Thesetwo documents provide the framework within which the implementation plan is being put in place.Management structures for the reform process have been put in place. Instructions forimplementation of the laws have been prepared. 1. Customs AdministrationThe Customs Administration has divided the country into 4 regions with their own offices, creating atwo tiers system. The regional customs office will replace the provincial customs administration. Twocustoms offices will be set up in Northern Laos and one in southern Laos. The fourth office will beestablished in Vientiane Capital. Customs at Vientiane Capital and Vientiane Province and somemajor checkpoints will operate under direct supervision of customs headquarter.The project has now entered its pilot phase with the Southern Office chosen as a pilot project. Assoon as conclusions would have been drawn from the pilot phase, the project will be rolled over thethree other regions.A World Bank technical assistance project under the Customs and Trade Facilitation Project has beenprepared and is expected to become effective in autumn 2008. The Ministry has received in July agrant of 51 billion kip (US$ 6 million) for this purpose. This project will address major institutional andprocedural reform requirements and contribute to the uniform application of customs legislation inall customs offices and posts.The customs computer system, Customs 2000, was implemented seven years ago and istechnologically outdated. Adapting the system to customs centralisation will require rewriting thepart of its core program and does not appear feasible. The Customs Department is planning tomigrate to ASYCUDA; a system developed by UNCTAD which has become a standard. A system 41
  • 42. implementation strategy still needs to be put in place with decision to be taken on the environmentwithin which the ASYCUDA will operate.The new system will be able to handle all foreign trade procedures and to process electronicallymanifests and customs declarations, accounting posting and procedures, transit and suspenseprocedures. The system will include a reporting module able to produce on the fly reports providingthe ministry with critical information to manage its revenue flow. The Customs Department is in theprocess of recruiting a foreign expert that will supervise the system implementation.ASYCUDA provides a comprehensive functionality that includes:  Cargo and manifest processing  Declaration processing  Bond and Warehousing  Transit control  Transaction and price analysis  Payment processing and revenue accounting  Selection intelligence and audit support  Trade statistics and management informationThe system will interface directly to the Treasury Information Management System (TIMS). Customstransactions will be posted directly in the Treasury General Ledger providing the treasury with realtime information on its cash position. However the banking arrangements that need to be put inplace have yet to be discussed with the banking sector. Like the Treasury Single Account, technicalaspects of those arrangements will depend on option chosen by BoL for the Banking ModernizationProject. 2. Tax AdministrationDue to the complexity of tax administration, tax centralization will require more time than customsfor its full implementation. The existing tax centralisation plan does not cover yet all aspects of taxcentralization and only addresses some of the functional issues. Like for customs, a pilot projectstrategy has been chosen with the expectation that important lessons will be learnt from the pilotphase and will help in preparing the overall strategy. The strategy is based on three components:professional organization, personnel and budget, and finance and materials.The project has been designed in three phases: phase 1 is the pilot phase, phase 2 the expansionphase and phase 3 the full coverage phase. The pilot phase has started in three provinces:Savannakhet, Kammouane and Bolikhamxay. Following this pilot exercise, centralization of Vientianecapital office and Vientiane Province will follow in early 2009 and by the end of 2009 thecentralization process is expected to be completed. The new organization will require a 42
  • 43. centralization of payroll and recurrent expenditures; a transfer to the central budget is planned forfiscal year 2008-2009.It should be noted that centralisation of taxes cannot become fully effective until the Single TreasuryAccount has been established. As already highlighted in the section of this report on Treasurycentralization, the Single Treasury Account implementation project is a complex project linked to theupgrading of BoL IT systems and to the implementation of the Treasury System. As those projects areexpected to take two to three years, the Single Treasury Account will have to be implemented inphases. The number of phases and the interim arrangements that will be put in place will directlyaffect the process of tax centralization. As long as the strategy plan for the Single Treasury Accountimplementation is not ready, it is difficult to foresee how it will affect tax centralization.The current plan that goes until 2009 caters mostly for functional aspects and the transfer ofresponsibility from the provincial level to the central level. Broader organizational and proceduralreforms might take more time. When the process of overhauling and modernizing the headquartermanagement processes are completed, similar issues at the provincial level will need to beaddressed.The Central Tax Department is facing an important capacity building challenge. Implementation ofthe new tax law and control of the tax collection system not only will require additional staff but alsoa significant upgrade of the staff professional qualification. New functions, such has tax collectionsupervisions, tax payer compliance, legal affairs management, tax data analysis, reporting, andrevenue forecasting, have to be created or strengthen with additional capacity. The Department iscurrently working on a plan for strengthening headquarter management and supervision capacityand is considering the possibility of transferring some experienced staff from provincial offices toheadquarter. However, serious capacity problems also exist at the provincial level. Such problemswill require several years to be solved and might affect the centralization timetable.A general tax administration system is under development with the assistance of ICT and SIDA(Sweden), known as Lao TIS (Lao Tax Information System) and includes six modules: taxpayerregistration, taxpayer management, tax filing, tax payment, tax audit and tax collection. Softwaredeveloped in this framework is now in the testing phase and pilot implementation of the wholesystem is scheduled to start in the three pilot offices.It will be important to coordinate any new developments of Lao TIS with the future TreasuryInformation Management System. Like all in-house developed system Lao TIS will not beneficiatefrom the support of a system vendor and, at the moment, the flexibility of the system cannot beascertained. However, in line with the Government policy to increase its tax revenue, major changesin tax policies can be expected in the forthcoming years. 3. Large Tax Payers UnitAs large tax payers provide the bulk of tax revenues, attention should be paid to the modernizationof the Large Tax Payer Unit (LTU) which is facing problems similar to those of the Tax department interms of capacity, computerization and streamlining of procedures. A plan is being laid down for 43
  • 44. reforming business processes and upgrading IT infrastructures. This task will be conducted through aproject already financed by SIDA. Under that project an operational manual on taxing large taxpayers has been developed and staff will be trained to use it. LTU is included in a tax computerizationplan and is expected to be one of the initial beneficiaries. 4. Introduction of VATBased on the VAT Law approved by the National Assembly in December 2006, and theimplementation decree of October 2007, the Tax Department has prepared a plan for VATimplementation by January 2009. VAT will have a standard rate of 10% and will replace the turnovertax which had multiple rates and which was difficult to collect. The threshold for compulsory VATregistration is 400 million kip. The VAT base has been estimated at 1,800 taxpayers out of 80,000registered tax payers, included Large Tax Payers managed by LTU. Collection of VAT will be theresponsibilities of the LTU and of provincial tax offices. The Tax Department is now concentrating onthe implementation of the Tax Identification Number (TIN) system that needs an important upgrade.TINs are still issued by provincial tax offices without a consolidated data base. SIDA is now assistingthe tax department in developing a computerized TIN system which could also be used for theidentification of importers and exporters by the Customs Department.Following reserves formulated by the IMF and the World Bank regarding the readiness of theMinistry of Finance to implement VAT in January 2009, MoF has asked an independent consultant tomake an assessment of the tax department capacity to meet its deadlines. The mission has takenplace July 14th to July 24th and concluded that implementation of VAT on the scheduled date ofJanuary represents a challenge which, if not impossible, involves considerable risks.Several problems have been identified:  The current VAT Law requires an important amount of adjustment to be made operational.  The Implementation decree of October has fundamentally redefined the role and responsibilities of the Directorate General of Taxes, the Provincial and City Tax Divisions and the District and Municipal Tax Offices respectively, which might require changes in the VAT Law and the Tax Law.  The implementation decree leaves a number of issues uncovered, calling for additional secondary legislation.  Lao Tax Information System will not be available before the middle of 2009 in the best case scenario, making implementation of VAT in January extremely difficult. 44
  • 45. VI. IMPLEMENTATION OF THE NEW BUDGET LAWThe revised State Budget Law was approved by the National Assembly in December 2006. The Lawdefines the budget structure, details States Revenue and Expenditures and gives a generalframework for the division of responsibilities between Central and Local Governments. Due to itscomplexity the revised Budget Law requires a detailed set of instructions which were codified in animplementation decree issued by the Prime Minister in February 2008.Beside aspects that will be covered in the section on Fiscal Policy, the revised Budget Law provides anew framework for revenue and expenditure assignments that will be implemented gradually duringthe next two fiscal years. Many aspects of the budget Law implementation are tied to other projectssuch as Treasury Centralization and the centralization of tax and customs. 1. New revenue assignmentThe revised Budget Law introduces a new revenue assignment system that divides revenues in threecategories: revenues fully apportioned to the Central Budget (Central Pool), revenues fullyapportioned to the local level (Local Pool), and revenues apportioned between the central and locallevel (Shared Pool). The objective of the new revenue assignment is to bring better fiscal disciplinewhile ensuring that provinces get sufficient funding for delivering basic Government services. Underthe shared revenue system, provinces will benefit from an unconditional transfer. In the event thatthe shared revenue transfer combined with local revenues will not be sufficient, provinces willreceive a fiscal grant from the central pool, as mentioned in articles 43 and 44 of the revised BudgetLaw. The principles of this grant transfer are still under discussion but might include earmarkedgrants to support the implementation of policies set forth by the Government and equalizationgrants if shared revenue grants and local revenues are not sufficient to cover recurrent expenditures.Conditionality might be attached to these transfers. 2. Revenue SharingDuring the past weeks, the Ministry of Finance has finalized a revenue sharing system. This system isbased on a policy framework that defines clear objectives embodied in a revenue sharing formula.Objectives and constraints for developing the formula have been defined as follows:  The revenue sharing system must embody principles of fairness and transparency for apportioning shared revenues between provinces on an equitable basis;  The system must be based on unquestionable quantitative and objective criteria; 45
  • 46.  The system must be stable and exclude large year to year variations, while remaining flexible to allow small revisions every three to five years to take into account changes in social and economic development in the provinces or changes in revenue assignment;  The System should aim at correcting gradually horizontal imbalance between provinces, i-e existing disparities in fund allocation and spending per capita;  The System should be pro-poor with the aim of providing additional resources to the poorest provinces to accelerate their social and economic development;  The System should provide incentives for improving the delivery of Government’s services, the provincial economic environment and good public finance management;  The Formula should not increase significantly the budget deficit;  The Formula should not reduce transfers made to any province under the previous budget law.Considering the size of the pool of revenues, it has been decided that shared revenues will be splitequally (50%-50%) between the central Government and the provinces.Based on the above principles and on international experience, three quantitative criteria have beenidentified as the main components of the formula, corresponding to three separate grantcomponents: (1) Population, (2) Land Area and (3) Poverty Level.The weighting of the component has been determined by the use of a macroeconomic model fortesting various formulae, with the main constrains that the formula, under no circumstance, shouldincrease significantly the budget deficit or reduce existing transfers to any province. Based on thetest results, it was found that the best weighting of the three components would be 45% forpopulation, 10% for Land Area and 45% for Poverty Level.The Population based transfer is given by a population index that represents the provincialpopulation as a percentage of the total population of the country.The Land Area based transfer is given by the land area index that represents the land area of oneprovince as percentage of the country land area.The Poverty based transfer is given by the poverty transfer ratio which is calculated from the HumanPoverty Index (HPI) published in 2005 by the Statistics Office. Based on the second digit of theHuman Poverty Index, all provinces have been classified in 5 poverty levels. Based on a mathematicformula, the poverty level has been translated into a poverty ratio which give the percentage of thetransfer to one province.The introduction of a revenue sharing system is an important step in facilitating long term fiscalplanning by reducing uncertainty in revenue assignments when allocations are being made in an adhoc manner. It highlights the necessity for coordination between the short-term budget and thelonger term allocation process that must reflect the socioeconomic strategy of the Government andit will help in implementing fiscal disciple and rationalizing the allocation of resources. 46
  • 47. 3. Revenue Transfer SystemThe Revenue Sharing mechanism will be part of a larger intergovernmental transfer system still in thedesign phase. The purpose of the intergovernmental transfer system, of which revenue sharing isthe most essential component, is to support important national socio-economic policy objectives,such as ensuring minimum standards of services across the nation, fulfilling the redistributivefunction of the national Government in an equitable manner, fostering solidarity between theprovinces, implementing poverty reduction strategies and supporting economic growth.The other components of the system will be designed along the same principled as those chosen fordeveloping the revenue sharing formula. A special attention will be paid at correcting horizontalimbalance between provinces and disparities in spending by sector. 4. Equalization GrantsBecause revenue transferred from the Shared Pool will be insufficient to cover all provincesexpenditures, a system of equalization grant will need to be introduced. The equalization grants willremain relatively small in comparison with the shared revenue transfer. According to simulationmade on FY 2007-2008, the total need for equalization represents 33% of the total budget of allprovinces. Four provinces (Xekong, Saravanh and Phongsaly) would not need any equalization,however the fact that those provinces are among the poorest shows how powerful is the leverage ofthe poverty component in the revenue sharing formula. However this result is also the outcome of avery low level of investment: 60 thousand kips when the country average is 130 thousand kips.Based on this simulation the largest equalization grant should have been given to Oudomxai (15% ofthe total), Vientiane Capital (13%) and Xayabury (11%) and Vientiane province (11%). The fact that noprovince needs more than 15% of total available for equalization grant shows that the revenuesharing system is well balanced.Various factors explain the need for equalization grants. In the case of Vientiane Capital, Vientianeand Xayabury province, the first factor is the size of the population and its relation with thegeographic areas. However in the case of Oudomxai the main reason is an exceptional level ofexpenditure: the Government spends 72 thousand kips per inhabitant when the country average is47. These variations will make it difficult to find an equalization grant formula that will fit allprovinces. The solution could be to split the grant into two components: one for recurrentexpenditures and the other for investments, and to tie one of the components to local revenuetargets to provide an incentive for revenue collection. Ten provinces are not able to cover theiroperating expenditure without an equalization grant. In the case of Vientiane Province the deficit tobe covered represent 36% of the recurrent budget and 34% in the case of Luangphrabang. 47
  • 48. 5. Expenditure need assessmentThe main difficulty of the Equalization Grant System is not in the formula that will determine the sizeof the grant, but in assessing expenditures needs. Contrary to the revenue sharing system, theamount of funds available at the beginning of a fiscal year for equalization is not known. It does notdepend only on revenue objectives but also on the size of the budget deficit that is consideredacceptable in relation to the Government economic objectives. The size of that deficit will dependon four factors: (a) the size of the deficit that is considered sustainable from a macroeconomicviewpoint, (b) the effort made on prioritizing expenditures, (c) the effort made to correct horizontalimbalance between provinces, and (d) the impact of budget norms on the total budget.All these calculations are directly linked to the Medium Term Fiscal Framework (see section VII of thisreport) and should be made with a medium term perspective. Without an assessment of expenditureneeds in the perspective of correcting horizontal imbalance, designing the equalization grant systemand introducing budgetary norms will be difficult.The expenditure need assessment should start from the costing of NPGES which has already beendone. The costing should be translated into an expenditure plan that includes not only investmentsbut also the investment impact on recurring expenditures with a mechanism for prioritizingexpenditure. Then the expenditure plan should be integrated in the MTFF and later in the MTEF toensure its sustainability. Without such a system in place it will be impossible to ensure thatexpenditures are in line with Government priorities defined in the NPGES. 6. Budgetary NormsBudget norms are an important mechanism to ensure that resources are spent in line with theGovernment socio-economic strategy and that each province allocates to each sector sufficientfunding for the provision of basic services.Article 2.11 of the revised Budget Law stipulates that budgetary allocation norms will berecommended targets in determining allocations to sectors, provinces and localities, based onstandards specified for each sector and adjusted to local conditions such as geographic conditions,population, land area and development needs. The implementation decree of the Budget Lawspecifies that the system will be based on two types of norms: norms for the allocation of recurrentexpenditures and norms for investment expenditures.Budget norms systems are complex and are usually developed over several years. The Ministry ofFinance thinks that a simple budgetary norm system can be implemented over a two to three yearperiod of time. A Budgetary Norm System has two components: a policy framework and a set ofnorms. Norms can also be used by Inter-governmental system with budgetary norms build in grantcalculation formula.In a first phase, the Ministry of Finance will work on the policy framework and put in place only highlevel norms. Because of time and fiscal constrains the number of norms that can be implemented infiscal year 2008-2009 will be limited. In July, the Budget Department has started to work on non- 48
  • 49. wage norms and has decided to focus on the Education and Health sectors. Non wage norms areimportant because the wage bill tends to grow faster than the current budget, reducing theallocation for non-wage recurring expenditures. The consequence is that budget users getinsufficient funding for maintenance and routine operations. For example, according to standards, itis considered that the minimum allocation for non-wage recurring expenditure should be more than10% of wage expenditures for a school to operate properly. However, the average in Lao PDR is 5,4%with some provinces ranking as low as 2,3% (Vientiane Province) or 2.7% (Bolikhamxay).During the next fiscal year, the strategy of the Ministry is to take a macro-economic approach to thenorm system. Budgetary norms will be used to correct horizon imbalance between provinces andfunding gaps within sectors. As the introduction of sector norms might increase the overall provincialbudgets, in order to maintain fiscal discipline, MoF will ensure that the budget increase that willresult in a number of provinces can be absorbed by the budget increase resulting from GDP growthwithout requiring any additional borrowing.In a second phase, the Ministry of Finance will develop norms at the micro-level to answer problemsspecific to a certain sector or to a certain province. For example, the non-wage norm for theeducation sector could be desegregated into three non-wage norms for primary education,secondary education and high education. In the long term the non wage norm should not be basedon the wage expenditures but on the number of students enrolled. Similarly, budgetary norms forthe health sector will be disaggregated by program.Although the Budget Law distinguish between norms for recurrent expenditures and norms forinvestments, recurrent expenditures can play an important role in determining the optimum level ofinvestment for a given sector. An investment plan is sustainable only if the staff required foroperation can easily be absorbed by the wage bill without reduction of non-wage expenditure. Forexample, the pace of school construction should be compatible with the capacity to recruit teachers,to train them and to pay them without reduction of other non-wage expenditure. Identically,knowing that the maintenance cost of road is approximately 10% of the construction cost, we shouldnot build more roads than we have the capacity to maintain.The budgetary norm system should be designed in a way that is affordable and sustainable. Eachtime that a norm is introduced, it generates a small increase in the overall budget. As long as theincrease remains reasonable, it can be absorbed through revenue increase resulting from GDPgrowth. However, the risk is to develop norms without a comprehensive system reflectingGovernment priories. A budget envelop for budget norms and for correcting horizontal imbalanceshould be first identified, then the total amount should be distributed between sectors. Otherwisethe risk is to be too generous with the first norms (non wage expenditure for Health and Education).Basically, the Government will have to trade off increase in expenditures resulting from correction ofvertical imbalance with an increase of civil servants number and salaries.However, it should be stressed that the introduction of budgetary norms cannot solve the budgetproblems of any sector. Budgetary norms cannot replace a sound sector policy. From thatperspective, it is clear that key sector budget should be completely reengineered in a zero-baseapproach with multi-year projections. 49
  • 50. 7. Correcting horizontal imbalanceBudget norms will assist in correcting horizon imbalance but might not be sufficient. Equality intreatment of provinces is a long term objective. It does not depend only on fiscal justice but also onabsorption capacity. The number of teachers or doctors cannot be raised overnight. Bridges androads not only need time to be built but require competent contractors for construction andmaintenance. Development of human capacity takes time. Typically, an underdeveloped regionunder spends because its planning and implementing capacity is low. Raising budget allocation mustgo hand in hand with raising capacity.In each case, we need to calculate the financing gap for all provinces and all sectors. Fiscal andeconomic reasons for this financing gap must be analysed: typical reasons can be low local revenuecollection, over investment or under investment, mismatch between revenue and expenditures, lownon-wage expenditures, etc.When the financing gap is known, we need to identify all constrains and bottlenecks. The first type ofconstrains is the fiscal constrain: overcoming the financing requires an effort that must spread overseveral years. This effort must be integrated into the Medium Term Fiscal Framework and theMedium Term Expenditure Framework. When fiscal constrains have been identified, they must becompared to capacity constrains to define time necessary to overcome the horizontal imbalance.Correcting horizontal imbalance in Lao PDR might take a decade. 8. Local BudgetingWith Treasury centralization and the new Budget Law, budget structures and processes need to berevised completely. The Budget Law provides little guidance in this area and a framework for reformsin this area has yet to be developed.This aspect of budgetary reforms is not expected to start before a year because consequences ofTreasury centralisation must be better known and the basic regulation of the Treasury Single Accountneeds to be prepared before significant progress in local budgeting can be made.Provinces have developed different approaches to local budgeting and the Ministry of Finance needsfirst to get a better understanding of the current practices before being able to recommend a pathfor reforms. However, the problems of local budgeting are well known by their effects: unrealisticrevenue and expenditure forecasts, tendency to overspend the budget, lack of alignment withnational priorities, lack of budget control, low procurement capacity and low compliance withprocurement regulation.The treasury centralization process and the implementation of the new budget law will address someof these problems, but will not solve the structural issues that weaken the local budgeting process.To solve these structural issues, the Ministry of Finance will put in place a work plan in five points: a) The Budget Department will undertake an in-depth study of the local budget structure and budgeting process. The study will examine the current arrangements and provide a 50
  • 51. detailed assessment of their impact on service delivery and effective financial management at the local level. Broad options reforms will be identified; b) The Ministry of Finance will open a broad dialogue with all stakeholders to share the analysis and to identify a preferred general option for reforms; c) The Budget Department will prepare detailed plans for the preferred option for reform covering both the substance of the reform and the key steps and processes; d) In parallel with the above work, specific short term proposals will be made regarding improvements to the provincial budget process; e) To perform these tasks the Budget Department will build its own capacity and reform its budget formulation and budget control processes. 9. Standard budget formatThe work on developing standard budget format for budget preparation by all line-ministries andagencies is on-going. It is expected that standardized templates will be used for the preparation of FY2008-2009 budget. 51
  • 52. VII CONTROL OF BUDGET EXECUTION AND AUDITINGControl of the budget execution is part of the general budgetary control system of a country thatincludes external and internal control. External controls are the control made by the Parliament andthe Supreme Audit Office and are out of the scope of this discussion. However, it should beunderlined that external and internal controls are based on the same accounting and reportingcapacity. Weak budgetary control systems are usually associated with weak reporting capacity.Improving the reporting capacity of the Ministry is therefore a prerequisite for a good budgetarycontrol system and a good audit system.So far, the practice of budget control in the Treasury has been mostly restricted to the control of cashlimits and commitments given to Government agencies and to ministries. However, in modernexpenditure management, MoF responsibility goes beyond limit and commitment control andincludes control of the expenditure effectiveness. MoF must control that expenditures are made inconformity with the intention of the law maker when the budget was approved by the NationalAssembly and have reasonable outcomes in line with the Government’s social and economic policy.Expenditure management practices require that a ministry of finance follows budget execution inreal time. It implies that the Ministry of Finance should stay in close contact with all governmentagencies, exchanging information on a daily basis. At this stage, not only MoF does not have thecapacity the follow the budget execution in real time, but line-ministries and provinces do not seemready to accept that role. This point should be clarified in the Treasury Law. In this context, not onlyit is difficult for MoF to monitor the budget execution and perform the necessary control, but noinstitutional mechanism exists to put in place the basic reporting from Government’s agencies toMoF. 1. Responsibility of the Inspection DepartmentThe Inspection Department has the role as a Chief for Ministry of Finance to manage and performinspection broadly in public organisations at all levels - state owned enterprises, governmentstakeholders and relevant organisations that are involved in public finance both inside and outsidethe country.Among the specific duties for the department are to:  Define the general audit policy of the ministry  Defined audit standard to be applied for fulfilling its mission  Ensure that the implementation of regulations in the area of public finance is properly performed;  Prevent any misconduct that infringes the law, regulation and other relevant provision in order to ensure the security of properties; 52
  • 53.  Create plans for inspections based on collective information and activity plan of Ministry of Finance that has been drafted in each period;  Finalise a report to the Minister and propose recommendations for obstacles based on regulation that is currently enforced;  Carry out any other special assignments as per Minister’s direction.Inspection Department is also entitled to propose improvements, alterations, abolish rules andregulations that are inconsistent with current legal framework.Budget control falls under the purview of the Inspection Department but should remain the primaryresponsibility of the Treasury. It is important to clarify respective responsibilities between theInspection Department and the Treasury Accounting and Inspection Division to avoid overlap. TheInspection Department should be responsible for defining audit standards that will be applied by theTreasury Accounting and Inspection Division. 2. Budget Execution, accounting and financial reportingThe three components of budget control – budget execution, accounting and reporting – showstructural weaknesses that need to be addressed.  Budget execution processes have been reengineered to fit the new budget law, but are still in their pilot phase.  Accounting will be greatly improved by the new budget classification and the new chart of account. However, section IV of this report has shown that there are still many issues pending. Accounting regulation needs to be prepared. Accounting manuals need to be written. Accountants need to be trained.  Reporting capacity remains very weak due to the technical limitation of GFIS, the lack of human resources, and the absence of an integrated reporting policy.The result of this situation is a weak authority and capacity of the Treasury offices at each level ofGovernment. Authority of the Treasury can be restored only through a strong legal and institutionalframework. Because the Budget Law does not give strong authority to the MoF to organizeexpenditure management at all level of the State, including by setting minimum requirement in line-ministries, it is critical that the new Treasury Law under discussion should give such authority to MoF.Procurement is another area on which MoF has too little control. Due to the fact that MoF is alreadyoverstretched, probably little can be done in this area until TIMS is implemented. When cashmanagement will become effective, the Budget Department along with a new ProcurementDepartment should be able to set authority limits for different volume of procurement and monitorin real time contract awarding and the resulting disbursements. It implies that MoF will monitor theprocurement activities of all Government agencies. 53
  • 54. 10. Nature of budget execution controlThe control of budget execution has three levels: (1) Internal control or management control that comprise the policies and procedures put in place by the Treasury under the supervision of the Minister to ensure the effective functioning of all units under the supervision of the Treasury and the proper use of funds appropriated to budget users. (2) Internal audit, in turn, has the key function of reporting to the senior management (the Director of the Treasury Department, the Minister, the heads of agencies, etc.) on the functioning of the management control systems, and recommending ways for improvement. (3) External Audit is entrusted to a separate organization (the Supreme Audit Institution) that has the mandate to investigate most aspects of the Government’s activities and report their findings to the Legislature. External audit does not focus on the adhesion to procedure but tries to detect mismanagement of misappropriation of funds. It controls that the use of fund has been consistent with the approved budget.The objectives of the budget control system are:  Assure implementation of the budgetary and other policy decisions;  Avoid improper use of funds and detect and correct instances;  Assess the efficiency of operations and seek ways of improving that efficiency;  Obtain reliable reporting of financial data concerning the execution of budget decision; and  Gather information about programme/projects implemented by budget users to assess results and outcomes in a way that can be used to adjust future policy decisions and budgets.Budget controls must rest on a budget control policy which still remains to be formulated in a budgetexecution manual.Budget execution and internal control policy must be based on a number of principles: a) The establishment of responsibility b) The segregation of duties c) The documentation of proceduresThe procedure manual must detail the procedures of the six fundamental stages of budgetexecution: 54
  • 55. (1) Authorization stage: the allotment process must be consistent with legal appropriation and must be as precise as possible in the description of what is financed; (2) Commitment Stage: Commitment must be made as soon as a purchase order has been made or a contract is signed. The commitment stage offers the possibility to review the procurement process. Good linkage between commitment management and procurement management is essential. Ex ante commitment controls can be performed by the Treasury either at the central or local level. However, such controls should not lead to excessive interference in the day-to-day management of line-ministries’ budgets leading to payment delays. A way to avoid this problem is to ask implementing agencies to keep a commitment register for ex post control. In practice it all depends on the sophistication of the Treasury system. Considering GFIS capability, commitment control will have to rely on ex post local control. With TIMS, more centralization can be introduced. (3) Verification Stage: This might include the verification of the payroll or the verification that goods have been delivered as per the contract. The verification process must follow a number of step that need to be clearly identified by the budget execution manual for all possible occurrences and each step must be documented to leave a paper track that can be audited. (4) Payment Authorization Stage: the person who orders the payment must be different from the person who has authorized the payment and from the person who has verified the documentation. The officer must verify that all three previous stages have been properly documented and approved. (5) Payment stage: the paying officer executes and records the payment identifying properly the payment instrument. (6) Accounting Stage: the transaction is recorded in the budgetary system as completed and posted in the General Ledger. Accounting controls are by nature different from management controls and more complex. Although accounting can prevent blatant cases of misuse of appropriation, it will be however presumptuous to consider that they are sufficient to ensure the integrity of the whole budget execution process. As long as the TSA will not be implemented allowing reconciliation between the BoL ledger and the Treasury TIMS, accounting control will remain weak and accounting records will have to be subjected to regular and comprehensive audits.Control of the process should be both ex ante and ex post. Ex ante, the central treasury must be ableto exert a minimum of control over the local treasury through the following mechanism: a) A centralized commitment control system that monitors in real time transaction approvals b) A centralized control of commitment limits for all budget users c) A system of cash limits with control of the utilization of cash against commitments 55
  • 56. d) A monitoring of the procurement process through procurement limits and control of the procedureEx post controls are made by the central treasury audit division and by external auditor based on theregulation, the budget execution manual and the audit manual of the Treasury.The benefits of multiplying ex ante controls beyond the standard processes of administrative controlssuch as those that we have described is often barely perceptible. Ex ante controls generally hinderefficient management because of bureaucratic procedures and multiple checkpoints that slow downthe budget execution process. The right balance between ex ante and ex post controls must befound depending on the reliability and capacity of budget execution officers, the robustness of the ITsystem, the reliability of accounting procedures, the quality of reporting, etc. As most of thoseelements are still in the design phase, it is difficult to make any recommendations. 11. INTOSAI Standards for control and auditingThe International Organization of Supreme Audit Institutions (INTOSAI) has developed standards formanagement controls as a framework for countries to use in designing and developing their systemsof management control and as a guide for auditors in assessing those controls. Those standards willbe of great help for developing the Treasury Audit Manuals. 12. COSO Standards for control and auditingCOSO (Committee of Sponsoring Organization of the Treadway Commission) is a nonprofitcommission that in 1992 established a common definition of internal control and created aframework for evaluating the effectiveness of internal controls. COSO standards have becomeworldwide accepted standards and it is highly recommended that MoF Budget ControlSystem and auditing procedures integrate those standards.According to COSO, the three primary objectives of an internal control system are to ensure (1)efficient and effective operations, (2) accurate financial reporting, and (3) compliance with laws andregulations. This is achieved through five essential components of an effective internal controlsystem: (1) The control environment, which establishes the foundation for the internal control system by providing fundamental discipline and structure; (2) Risk Assessment, which involves the identification and analysis by management—not the internal auditor—of relevant risks to achieving predetermined objectives; (3) Control Activities, or the policies, procedures, and practices that ensure management objectives are achieved and risk mitigation strategies are carried out; 56
  • 57. (4) Information and communication, which support all other control components by communicating control responsibilities to employees and by providing information in a form and time frame that allows people to carry out their duties; (5) Monitoring which covers the external oversight of internal controls by management or other parties outside the process; or the application of independent methodologies, like customized procedures or standard checklists, by employees within a process.This methodology must be used for designing the control system and integrated in the Audit Manual. 13. Mission of the Treasury Accounting and Inspection DivisionAudit and budget control within the treasury is the responsibility of the Accounting and InspectionDivision. The audit function has to be put in the wider context of auditing practices within MoF and theMinistry Audit Department has already produced in May 2007 a Strategy Plan for “Strengthening ofInternal Control that defined the responsibility of the Treasury in relation to internal control.Based on that document, the inspections performed by the Accounting and Inspection Division are to beexecuted based on the following criteria, targets, form and methods: a) Regularly inspect performance of duties and authority of the treasury at each level in accordance with an inspection or on an ad hoc basis based on specific queries; b) Draft and introduce regulations on inspection and internal auditing of the treasury system in cooperation with the Inspection Department of the Ministry of Finance; c) The inspection of activities of the National Treasury will encompass implementation of laws, policies, financial and accounting regulations for the sector including all activities of the treasury units as prescribed by the regulations. Inspections will result in a report and make recommendations to management on improvements, adjustments with the aim of improving operations of the treasury; d) Sum up results of quarterly, semi-annual inspections of the entire treasury system for submission to the Director General of the National Treasury, the Inspection Committee and the Inspection Department of the Ministry of Finance; e) Draft a detailed inspection-auditing plan based on analysis of the performance of different entities of the national Treasury; f) Coordinate the inspection of National Treasuries with the Inspection Department; g) Coordinate with departments concerned on the formulation and implementation of the training program on inspection for inspection staff in the entire treasury system; 57
  • 58. h) Systematically collect and file documents involved in internal and external inspection-auditing; i) Perform other duties as assigned by the Director General of the National Treasury. 14. Designing the Treasury Control SystemControl systems must be developed in an integrated manner. It means that the design orreengineering of the budget execution processes must go hand in hand with the design ofthe control system and that both processes should be used to define the reportingrequirements.The Public Expenditure and Revenue Management Report is not the place where a completesolution for the Treasury budget execution control system and the auditing process can bedeveloped. We can only set the policy principles, highlight the methodology and leave tofuture technical assistance the responsibility to design a full-fledged system:Here are some of the basic steps that need to be taken: 1) Prepare a complete risk analysis; 2) List all sources of information and identify processes. Link the processes in a function hierarchy; 3) Produce a process map of budget execution using process mapping tools; 4) Detail each of the six phases of the budget execution as an independent process and link all the processes together; 5) Identify each step of the process where a decision needs to be made; 6) Identify each business unit or person involved in the process and define responsibilities for each of them. Ensure that a proper segregation of duties applies; 7) Identify for each decision the information requirements, check the completeness of forms that are being used, and ensure that information requirements are properly documented; 8) Identify all the decision possibilities using the yes/no modeling process and finalize the map according to all possibilities; 9) Based on the information requirement for each decision, identify the proper control mechanism; 10) Due a similar process mapping analysis for procurement and ensure that procurement controls link with budget execution controls; 11) List and detail all reports that need to be produced; 12) Integrate all information in the Budget Execution Manual; 58
  • 59. 13) Integrate all information in the Audit Manual and ensure compliance with COSO standards; 14) Draft a Treasury Instruction that will define how issues indentified in the audit report will be addressed.The design of the control system is essential not only for management control but also forauditing. It should not be based on general principles only, but on an intimate knowledge ofall processes that can be provided only by process mapping. Managers are sometimestempted to shortcut the design process and loopholes and flawed controls are frequent inbudget execution control systems. A flawed design may leave the impression of safety butmay overlook important risks or may create unnecessary inefficiency. 15. Internal Audit and EvaluationThe role of internal auditing is to measure and to assess the effectiveness of other controls and tomake recommendations for their improvement. In addition, the internal audit can be used toexamine apparent irregularities. Its findings can serve both as evidence of the need to strengthen thecontrol systems and as a basis for determining what action may be appropriate against those whocaused the irregularityThe audit of budget execution can be performed either by the Audit Department of MoF or at theprovincial level by a central Treasury Department. With seventeen province, the Treasury mustensure that its local office are audited a minimum of once a year. When capacity is low morefrequent audits are required.If the option of having a team of “Treasury Inspectors” to perform on site on audits is taken, it will benecessary to define the Treasury Inspectors’ responsibilities in relation with the auditor of theministry audit department and vice versa. VIII. FISCAL POLICY 1. Revenue ForecastingRaising revenue collection to 15% of GDP is one of the most critical success factors of theGovernment economic strategy. This strategy requires a reform of the tax policy that is wellunderway. In this context, good revenue projections are of paramount importance. Improved andreliable revenue projections can be considered as one of the most important successes of the FiscalPolicy Department.Work on revenue projections started in 2000, but has remained very unreliable until 2005. The mainreasons were: (a) unrealistic GDP projections, (b) unrealistic revenue targets due o an aggressive 59
  • 60. investment policy, (c) the difficulty to assess tax evasion and to bring it under control, (d) lack ofmacro-economic and fiscal data from provinces.From 2000 to 2005 the Revenue Division focused on consolidating historical data to identify mediumterm trends and issues. A model was developed covering five years from 2000 to 2005. Weaknessesin the revenue collection system were identified and the Revenue Division assisted in defining thenew tax policy that was formalised in the new tax Law of May 2005.Structural reforms in MoF starting in 2005 have helped solve some of these problems. Taxadministration and tax collection data quality have improved and tax evasion has been reduced.Building on the experience of the previous year a model has been developed. The Revenue Divisionhas developed a comprehensive revenue forecast methodology and a reliable model that is updatedon a regular basis. The model covers FY 2006-2007 to 2010-2011 and will expand soon to 2015.The methodology is based on the analysis of the different revenue flows. The main flows arecustoms, taxes on petroleum products, tax on vehicles, mining, hydropower, over flight fees, tax ondomestic production and salary taxes. For all these revenue flows , specific methodology have beendeveloped based on production growth, price structure, consumption trends, employment based,import and export of goods, etc.The Revenue Forecasting model has become more reliable, but important problems still exist:  Data collection is difficult and data quality is an issue in the absence of a data sharing system. Ultimately, data collection is based on the good will of Government agencies and data manipulation cannot be excluded.  Because data collection is fragmented and not systematic, cross checking data to assess their quality is almost impossible.  Provinces communicate only aggregated data to the central Government. Desegregation of data is impossible.  There is no system to analyse production of goods and services at the provincial level. Revenue forecast is made at a national macro-economic level. Revenue forecast at the provincial level is impossible. This makes it difficult to assess the tax base of each province. The Fiscal Policy Department is not in a position to say if low revenue in a province is due to weaknesses in the tax base or weaknesses in revenue collection.  The Tax Department does not have detailed information on tax payers in provinces.Revenue forecasting at a macro-economic level, obviously has some limitations. With the existingconstrains, and despite some more fine tuning in the near future, the prospect for improvement inrevenue forecasting is limited. To improve revenue collection, the Ministry of Finance needs to lookat its tax policy by province. Having disaggregated data by province will become more and morecritical. This cannot be achieved without a data sharing system between the Central Government and 60
  • 61. the provinces or in the short turn an improvement in the reporting from local agencies and thedissemination of information. 2. The Medium- Term Fiscal FrameworkDuring FY 2003-2004 a basic Medium-Term Fiscal Framework was developed with the assistance ofthe Asian Development Bank. The objective of the MTFF is to ensure consistency of theGovernment’s budget policy with overall macroeconomic policy targets such as the GDP growth rate,inflation, exchange rate, balance of trade deficit, debt sustainability, etc.The ADB project supported the preparation of the MTFF, including the training for the frameworkapplication. Because of its macro-economic aspect, the MTFF is normally a joined effort between theMinistry of Finance responsible for budget policy and the Central Bank responsible for monetarypolicy. However, due to its important role in investment planning, the Committee of Planning andInvestment was also associated with the development of the MTFF. However, the ADB project wasonly half a success. The so called MTFF is in reality an expended Medium Term Macro-economicFramework (MTMM) because it does not provide sector ceilings and the Fiscal Department found itdifficult to maintain after the departures of the foreign experts.There are several reasons for this situation that require an analysis:  There has been a lack of ownership of the project outside of MoF.  The Lao system of planning and of macro-economic management is complex and requires the collaboration of many institutions. Updating an MTFF on a regular basis will require collaboration between those institutions to be institutionalized, through for example the creation of a join committee. Institutional aspects of macro-economic policy and of macro- fiscal management need to be clarified.  In the absence of a central repository of fiscal and economic data such as usually provided by integrated Treasury and Budget Preparation System, the development of the MTFF is a challenge and will remain as such until TIMS is implemented and proper reporting and modelling tools are put in place. However, TIMS by itself will not solve all data problems. A system to collect macro-fiscal data should be considered.  ADB technical assistance did not provide the tools to manage the MTMM / MTFF in the long term. In a pilot phase a simplified MTFF can be developed using Excel spreadsheet. However, in the long term an MTFF requires a small database such as Access Database and modelling tools that can be developed in house.  The ADB project was too short. Technical Assistance for a MTFF should cover a least a year of maintenance to ensure that the local team can update the MTFF for a new budget cycle.  ADB projects provided good training to a number of individuals; however those individuals have left the fiscal department. 61
  • 62. In its plan to move to a full-fledged Medium Term Expenditure Framework (MTEF) the FiscalDepartment will need to draw conclusions from its previous experience and put in place amechanism to update the MTFF on a regular basis. It must also ensure that technical assistance willnot be limited to the design phase of the MTFF. 3. From Fiscal Framework to Expenditure FrameworkTransforming a Medium Term Fiscal Framework into a Medium Term Expenditure Framework is along process and the difficulty of the task should not be underestimated. The first requirement is abetter MTFF. The Ministry of Finance is conscious of the difficulty and has taken the option ofdeveloping the MTEF gradually by sector. In the first stage, the MTEFF will be prepare for only twosectors: Heath and Education.This approach has some limitations of which the Ministry of Finance should be conscious:  An MTFF limited to two sectors is not a decision making tool, it is just a sectoral model that will be useful to analyse the sector’s strength and weaknesses.  Linking the sector policy to the macro-economic framework will be difficult if not impossible.  A sectoral MTFF requires an approach by programme, but sectoral programs in Lao PRD are just a concept used in economic planning without a managerial reality.  In the absence of a performance indicator system, the MTEF will remain focused on financial inputs, not on results and outcomes. It will not be a tool to measure expenditure efficiency. Control of outcomes will remain difficult.  Without a database and modelling tools, the MTEF will remain as difficult to update as the MTFF. Considering the volume of data necessary to expand the model to all sectors, quickly it will become impossible to manage it on Excel spreadsheets.  The Ministry does have the capacity to track poverty-reducing public spending. The Fiscal Policy Department should take part in discussion with the Treasury to ensure that GFIS/TIMS coding blocks will provide that capacity.Although we can expect some very valuable lessons from a sectoral MTEF limited to Heath andEducation, the project should be considered as a learning exercise. The predictive capacity of theMTEF will be limited to non financial data (number of students, population immunized, number ofhospital beds), therefore expectations should remain low.Solving the data management problem is a prerequisite to the project’s success. Excel generates twoproblems: the rounding of figures and the limited number of tables that can be linked together.Although a simplified MTMM can be managed on Excel spreadsheets, a detailed MTFF will quicklyrich the limit of the software. For example, the summary of revenue project should be linked totables representing the different flows of revenue for each year. Only revenue projections canrequire fifteen or twenty tables depending on the complexity of the model. 62
  • 63. We should not forget that the MTFF is the foundation of the MTEF. Without a strong and robustMTFF that can be easily updated, the MTEF will not become a reliable tool for decision making.Developing a reliable MTFF remains the top priority. 4. Lack of data and data managementFiscal policy is basically about fiscal and economic modelling and modelling needs data. However theFiscal Policy Department face important difficulties in accessing the data it needs. Usually a FiscalDepartment use different sources of data: (a) the General Ledger and the Treasury System, (b) theBudget Preparation System, (c) the tax and customs system and (d) miscellaneous sources ofeconomic data such as the Central Bank and other economic agencies.The GFIS has only a limited reporting capacity. It cannot generate on-the-fly report and answeringspecific queries is so difficult that most of the time it is not practical. The GFIS database cannot beuse as a repository of fiscal and financial data. Budget execution data is not very reliable and onlypublished late in the next fiscal year. Because GFIS records transactions only at a much aggregatedlevel, it is impossible to draw conclusions from budget execution data.There is little information sharing culture in the Ministry of Finance. Accessing information from theTax Department often requires a written procedure that takes time. The problem gets worse whenMoF wants to access data from other Government agencies. In the information age, data should beaccessible in real time.This situation is expected to last for a minimum of five years with only gradual improvement. TIMSwill not produce data before 2012 at best. A Budget Preparation System will probably not becomeoperational before 2015. The tax system will become operational in 2009 but without interface withTIMS, it will still be difficult to access data.Considering the internal and external challenges that the Fiscal Department is facing, solving the datacrisis is of paramount importance. As already suggested for the MTFF and MTEF, an Access databasewith simple reporting tools could help solving the data crisis. The data base could be structured bysector and province. Beside budget preparation and budget execution data it could include“provincial profile”. The provincial profile will be a document offering a synthesis of all economicdata available for a province such population, number of students, health infrastructures, tax basedata, etc. Similar profiles could be developed for sectors.The creation of a databank used by the Fiscal Policy Department and the development of the MTFFthat also require data storage and data analysis capacity could be merged in one project. The ITcomponent of the ADB could be used to develop the technical requirements and the same databasecould be used. 63
  • 64. IX. STATE FUNDS 1. Budgetary scope of the State FundsThe GoL operates six State funds for a total of 364,267 millions kips representing 6% of the totalrevenue plan for FY 2007/08. The six funds are:  The Road Maintenance Fund  The Reforestation Fund  The Social Welfare Fund  The Social Security Fund for Public Sector  The Environment Protection Fund  The SMEs Development and Promotion FundThe main fund is the Road Maintenance Fund that represents 50% of the total revenue plan forspecial funds. The second most important fund is the Environment Protection Fund with 20% of thetotal. Those two funds receive significant donor contributions. Donors finance 13.8% of the RoadMaintenance Fund and 92.4% of the Environment Protection Fund.Although the law defines the six funds as extra-budgetary funds, practice has diverged and broughttheir management closer to those of de facto off-budget funds. The quality of financial reporting ofthose funds has been very low and due to the lack of transparency and accountability there isconcern about their efficiency. It appears now imperative to bring the management of those funds inline with the macro-economic and fiscal policy of the GoL, the revised Budget Law and the newAccounting Law.Public Finance good practices tend to limit the scope and number of extra-budgetary funds becausethey have a negative impact on the soundness of fiscal policy and analysis; they underminecomprehensive budgeting, fragment financial reporting and cash management and raisetransparency, oversight and accountability issues. However, they might be legitimate reasons forcreating extra-budgetary funds, especially in the case of road funds, health insurance and pensionfunds or funds which are mainly financed by donor contributions.The fact that GoL has established those funds as extra-budgetary funds is justified by severalobjectives:  To earmark revenues in order to avoid that certain important activities become under funded in the annual budget. The establishment of a road fund or an environment protection fund is a political act of recognition of the importance of these activities.  To insulate donor funded projects to avoid cash restriction that might occur from time to time, to facilitate reporting to the donors and to address donors’ fiduciary requirements. 64
  • 65.  To increase efficiency in the area of activity covered by the fund by giving more autonomy to the managers, aligning contracting practices on the commercial market, and simplifying budget execution procedures.  To dissociate the planning process of the fund from the planning process of the supervising ministry for greater flexibility and efficiency.However, the freedom of action to take decision about both operational management and theplanning and use of resources may open door to new set of risks if the governance and publicfinancial management arrangements of these bodies are poorly designed. Those risks include:  Inefficient use of public money due to a lack of oversight and control;  Public money and public assets being used for purpose not intended by government and National Assembly;  New opportunity for corruption or misappropriation of funds;  Procurement mismanagement;  Inefficient staffing and lack of oversight of personnel cost;  Accountability arrangement such as transparency, financial reporting and auditing being neglected;Recently there has been a growing concern in the international community about the proliferation ofextra-budgetary and off-budget funds. The OECD has published recommendations that include theestablishment in each country of a comprehensive framework for the governance and financialmanagement of public agencies, including social funds and off-budget funds. This framework coversareas such as: the control and management of assets, revenue raising policies and borrowing,earmarked contribution, budget formulation and budget approval, oversight of human resourcemanagement, budget execution and control, performance management, accounting and reporting.Additionally the IMF’s Government Statistic Manual, the IMF’s Manual on Fiscal Transparency andthe IMF’s Guideline on Public Expenditure Management give a comprehensive set ofrecommendations and accounting norms for extra-budgetary fund management. Therecommendations that we present at the end of this document are mostly based on these foursources of information.Within the short timeframe given for the preparation of this report, it has not been possible toanalyse in details the operations of all the six State Funds. More attention has been given to the RoadMaintenance Funds because this fund represents 50% of all extra-budgetary funds and wasconsidered by the MoF as reflecting well issues encountered in other funds. Additionally, regulationof the Forest and Forest Resource Development Fund has been reviewed to confirm that there wereno important discrepancies between institutional and financial arrangements of that fund and thoseof the Road Maintenance Fund.Because no financial statement has been reviewed, this report focuses more on the financialregulatory framework and international best practices. A complete management solution of extra- 65
  • 66. budgetary funds would require on site investigation and a complete review of by-laws and financialstatements. 2. State Funds and the Revised Budget LawUnder the revised Budget Law, State funds are budgetary unit submitted to the same rules regardingthe management of their revenues and expenditures. Article 3 gives a definition of State funds as “anorganization unit established with the authorization of the Government for the purpose of extendingservices to the society, and total revenue and expenditure of these agencies shall be reflected in theannual budget plan.” Article 10 stipulates that “Revenues and expenditures of the State’s Funds shallbe recorded in the annual state budget plan, executed at the National Treasury to be used forexpenditures in accordance with the funds’ regulations approved by the Government. All revenuesand expenditures of the funds shall fall under the management, monitoring and control by the sectorconcerned and by the finance sector.”Based on the review of the Road Maintenance Fund and the Forestry Fund, it does not appear thatthe decrees are in contradiction with the budget law. However, the essential reason is that thedecrees say very little on budget execution, financial reporting and auditing.It will pertain to the new Treasury Law to define how the Treasury will oversee budget execution inthe State Funds. The recommendation is that the budget execution rules for States Funds should bealigned as much as possible on the rules for other budget users. The Treasury should be given thepowers to audit budget execution procedures and budget accounting in all State Funds, leaving auditof general accounting and financial statements to MoF’s Audit Department and to the Supreme AuditInstitution. 3. State Funds and the new Accounting LawThe new Accounting Law defines State funds, also called “Public Fund” as “accounting entities” (Art.3) and gives a definition of public funds close to the definition provided by the Budget Law. Article 1stipulates that public funds are submitted to the same accounting rules as other accounting entities.As a consequence, Article 36 establishes that public funds as accounting entities must publishfinancial statements that include a balance sheet, a statement of budgetary revenue andexpenditures and explanatory notes. Additionally, Article 34 stipulates that “the budgetary units,administrative and technical organizations, and public funds, being the subject to book-keeping mustestablish a monthly and quarterly statement of budgetary revenue and expenditures or thestatement of performance”.The two funds’ decrees that have been reviewed do say any thing on the organization of accountingin State Funds. The Road Fund Prime Minister Decree and the subsequent ministerial decree do nothave any provision for accounting. The Forestry Fund decree says only that the “Secretaries 66
  • 67. Committee” “manages the Fund’s accounting system” (Article 11.2). The recommendation is thatspecific accounting instructions should be given to all State Funds. 5. Integration of State Funds into Budgetary Accounting and General AccountingBecause State Funds are not off-budget funds, their accounting should be managed like any otherprimary budget user. Their transactions should be recorded in a separate sub-set of books inGFIS/TIMS. No valid reason can justify letting them to develop separate accounting systems. Strictseparation between budgetary accounting and general accounting should be maintained (we havenot been able to check if the funds follow the general practice for budgetary accounting). However,to meet their statutory obligations, the funds should be given full responsibility for producing theirfinancial statements according to the requirements of the accounting law 6. The Road Maintenance FundAs already said, due to time constrains, only the Road Maintenance Fund has been analysed indetails. However, we have good reasons to believe that many remarks made on the RoadMaintenance Fund are also valid for the other fund. As could be expected, the issues are not only aweak reporting capacity, but also a lack of transparency in the planning and budgeting process andthe incapacity of MoF to measure the fund performance. 6.1 International PracticesRoads have to compete for their preservation and maintenance for funds against other visible andpopular sectors like agriculture, health and education. This usually places them at a considerabledisadvantage in the annual budget debate. Many countries have responded to the growing shortageof finance by earmarking selected road related taxes and charges and depositing them into a specialoff-budget account, or road fund, to support spending on road maintenance.Road funds are critical because the average annual maintenance cost of road is around 10% of theconstruction cost. However, if maintenance is neglected, the repair cost raise exponentially with 30%after two years without maintenance. Depending on climate, the total investment can be lost withinfive years.The first generation of road funds were not entities as such but national budget line items managedby the sector ministries. The performance of such funds was however mixed, and generally quitepoor. Some of the common problems cited were poor financial management, absence ofindependent audits, extensive use of funds for unauthorized expenditures, diversion of funds, andweak oversight. 67
  • 68. To answer these issues, many road funds have been reformed and established as independententities. A critical dimension of this second generation road funds was the creation of a specific legaland institutional framework which would assure proper management of the funds and accountabilityto users and government. The Lao PDR’s Road Maintenance Fund appears clearly to be of the secondgeneration and its institutional arrangements are sound and well in line with international bestpractices.The idea behind the road fund is that roads were to be managed like a business having its ownindependent source of funding through duties and charges levied on road users. Common sources offunding are:  Fuel levy  Bridge, ferry and road tolls  Vehicle licence and inspection fees  International transit feesIdeally resources earmarked to the fund should be enough to cover all the fund expenditures withoutany need for transfer from the central budget. The Lao PDR RMF has sources of funding that cover allthe range of usual fees and levies.The establishment of a road fund answer an important fiscal policy question: what is the optimumsize of the road network that a country can afford? Considering the high maintenance cost of roadsin a traditional approach, the main constrain on the size of the network is the size of the budget.With a road fund, the size of the network is determined by the preferences of road users and theirwillingness to contribute to the road fund. Although those funds should remain part of the budget,and submitted to the same budgeting rules, special arrangement can be made for budget executionand reporting. 6.2 Structure and financing of the Road Maintenance FundThe Road Maintenance Fund (RMF) was established in 2001 on a user-pay principle. The RMF ismanaged by an advisory board, which comprises seven representatives of the MCTPC, the Ministry ofFinance, the Ministry of Commerce, the State Fuel Company, the Chamber of Commerce, the StateBus Company, and a private owned freight forwarding business. Other institutional arrangements areconsidered by the international community as structurally sound. The responsibility for roadmanagement is divided among the MCTPC, its provincial departments and the district offices.Funding for road maintenance of national road is determined by the RMF Board, and provincialdepartment of MCTPC make decision at the local level.For many years, the GoL has made road development a high priority and used road spending as apolicy instrument to achieve socio-economic objectives. The result has been a high level ofinvestment in new roads until fiscal year 2004/5, with annual expenditures for roads ranging from20% to 35% of the national budget, and a very insufficient level of funding for maintenance. Since 68
  • 69. 2004/5 the level of funding for maintenance has rose to 29% of total road expenditures. However,maintenance is not yet fully funded.Since 1990, donors have contributed more than 80% of all public expenditure on road. However,during the last years, revenues from domestic from domestic sources have been increasing steadily. 6.3 Problems the RMF is facingThe RMF is facing three major problems: (a) Insufficient funding for road maintenance; (b) Horizontal imbalance in fund allocation; (c) Lack of capacity for financial management in general and accounting and reporting in particular.The main reasons for the lack of funding are: (a) Insufficient fuel levy; (b) The small number of road users; (c) The size of the required road network to link all urban centres in a low population density and mountainous country; (d) The vulnerability of roads during the rainy season.A complete evaluation of the maintenance cost of the road network in Lao PDR is not available, andthe Public Expenditure Review of 2007 has only produced a “guestimates” that the RMF covers only45% of the maintenance need. This could put the funding need as high as $95M. A previous estimatein 2006 was putting the total cost at $69M, with a total value of the road network of $3 billions.However it should be noted that when maintenance is neglected, repair cost grow exponentiallyfrom year to year.Traffic remains small in comparison with other countries. Lao PDR has a low population density of 23inhabitants per square kilometre and very few large urban centres. Only 9.4% of national roads carry1000-3000 vehicles per day (including motorcycles). As a consequence, the tax base for fuel levyremains very small.The current fuel levy remains one of the lowest in the world and the current objective to raise it to300 kip per litter in FY 2008/9 is still more 50% below the average in countries with comparabledevelopment level.The challenge of maintaining roads in Lao PDR has clearly a macro-fiscal dimension. Insufficientfunding of road maintenance can result in the complete loss of the initial investment and raisingtransport costs that impact negatively the economic growth. Solving this problem is beyond theability of the RMF and will require MoF’s direct involvement. The Ministry of Finance should consider 69
  • 70. the possibility to provide additional funding to the RMF either by raising progressively the fuel levy tothe required level or by identifying other source of funding, including the general budget and donors’funding. The first step should be to produce an estimate of maintenance and repair cost of the entireroad network.Determining the adequate level of fuel levy is a fiscal policy issue that should be solved using theMTFF and a sector MTEF as it might impact negatively inflation, especially at a time when oil pricesare raising.The Fiscal Policy Department should assist the Ministry of Communication, Transport, Post &Construction (MCTPC) to determine the optimal size of the road network whose maintenance isfiscally sustainable. No investment should be undertaken in the road sector unless maintenancefunding has been initially identified and secured.The table below shows that the same type of horizon imbalance that exist for domestic expenditureexist also for road maintenance with a strong bias in favour of the poorest Northern provinces. Road Local Road Expenditure expenditure Province Poverty Population Area Length Expenditure per km per person Domestic Exp./ Index (sq km) (km) (mil. Kip) (mil. Kip) PopulationOudomxai 1,45 264 830 15 370 1 089 75 654 69,47 0,29 0,72Xekong 1,42 85 316 7 665 510 26 915 52,77 0,32 0,60Vientiane Capital 1,17 695 473 3 920 1 696 78 116 46,06 0,11 0,45Phonsali 1,51 167 181 16 270 773 26 357 34,10 0,16 0,40Luangphrabang 1,23 405 949 16 875 1 088 30 685 28,20 0,08 0,36Khammouan 1,34 336 935 16 315 2 654 39 698 14,96 0,12 0,32Bokeo 1,21 145 919 6 196 759 10 340 13,62 0,07 0,53Luangnamtha 1,23 145 231 9 325 925 12 431 13,44 0,09 0,74Xaisomboun n.a. 38 549 7 105 494 3 751 7,59 0,10 n.a.Bolikhamxai 1,29 225 167 14 863 1 247 8 747 7,01 0,04 0,39Champasak 1,18 603 880 15 415 2 378 16 118 6,78 0,03 0,34Houaphan 1,52 338 044 16 389 1 262 7 864 6,23 0,02 0,48Xayaburi 1,25 280 780 16 500 1 555 5 699 3,66 0,02 0,49Saravanh 1,54 324 470 10 691 1 311 3 667 2,80 0,01 0,28Attapeu 1,44 112 171 10 320 650 1 703 2,62 0,02 0,76Savannakhet 1,43 824 662 21 774 4 347 9 622 2,21 0,01 0,25Xiengkhouang 1,42 228 882 15 880 1 476 3 226 2,19 0,01 0,48Vientiane Province 1,19 386 558 15 927 1 769 1 052 0,59 0,00 0,43 5 609 997 236 800 25 983 361 645 13,92 0,06The imbalance coefficient is 117.8 for maintenance expenditure per kilometre against an imbalancecoefficient of only 1.7 for domestic expenditure per capita, suggesting that horizontal imbalance isvery much aggravated for road maintenance. 70
  • 71. 7. Other funds and general recommendations for extra-budgetary fund managementAlthough the institutional arrangement of State Funds appear to be sound, the existing regulatoryframework fails to provide detailed instructions for financial management in general, and for budgetexecution, accounting and reporting in particular.Following the OECDE and IMF general recommendation for the management of extra-budgetaryfunds, the Lao PDR should put in place a regulatory framework that will be common to all StateFunds. As it seems that there is no contradiction between the funds’ bylaws and the revised BudgetLaw, this new regulatory framework could take the form of a few dispositions in the new TreasuryLaw under discussion and a Prime Minister Decree that will cover accounting, reporting and auditingissues.The regulatory framework should:  Clarify and harmonize the legal status of all State Funds;  Define the concept of “consolidated funds” and “consolidated budget” and rules for presenting State Funds’ budgets in the annual presentation of the budget to the National Assembly;  Subject State Funds to at least the same degree of scrutiny as on-budget spending, including issues of outcomes, efficiency and effectiveness within a detailed budget review process;  Clarify common requirements for accounting, internal control, internal audit, and reporting;  Redefine MoF responsibility in the budgeting process.It should be stress that the State Funds being extra-budgetary funds should be submitted to thesame scrutiny as other budget users during budget preparation. That includes the integration of thefunds in the MTEF and the MTFF.Additionally, a number of dispositions should be integrated either in the Treasury Law or in a PrimeMinister decree:  All State Funds account must be opened at BoL and MoF must have access to the banking statements. All banking arrangements must be approved by MoF. Accounts at the provincial level must be consolidated.  Although integration in the TSA might not be possible (this point need further discussion and investigation), integration of their budgetary and general accounting in GFIS/TIMS and the central public management system must be pushed as far as possible. In cases where a separate system for management and control is required, the system should meet the same requirements as those of FGIS/TIMS, especially in relation to control and fiscal reporting.  State Funds should follow the same type of accounting arrangement as line-ministries and other budget users. The accounting should be centralized as much as possible. The Treasury should be responsible for keeping separate sets of books for State Funds. The Accounting Department must provide guidance and regulation for State Funds’ accounting. 71
  • 72.  Classification of State Funds’ expenditures must be fully compatible with GFS standards (this point needs to be verified) and links with the NGPES must be identified for reporting purpose; As stipulated by the Accounting Law, State Funds must publish a balance sheet, a statement of performance and explanatory notes. Responsibilities between the Funds and the Treasury should be clearly identified. The Board of each fund should be responsible for approving the financial statements. State Funds must be included in the annual budget presentation to the Parliament as part of the “Consolidated Budget” with the same amount of details as other budget users. MoF should set budget ceilings for State Funds like for any other budget users and general budgetary orientations for the sake of fiscal policy. Within the budget ceiling, State funds should prepare their budgets independently with the minimum of interference from the supervising ministry or from MoF. However in the Budget Execution Report, MoF must publish an appraisal of State Fund financial performance and identify any potential issue. For preparation of the MTFF and MTEF, State Funds must be integrated in the relevant sector. State Funds should be integrated in the consolidated fiscal position of the Government. A more detailed audit policy should be prepared and integrated in the regulatory framework. Financial performance of the State Funds should be evaluated every year and included in the budget execution report. 72
  • 73. X. CAPACITY BUILDINGThis report has demonstrated that the mission of the Ministry of Finance is changing because theeconomic and social environment is changing. A number of factors have been identified:  The economy has moved from a centrally planned organization to a market driven organization requiring a better linkage between policy making, planning and budgeting  Because economic growth, inflation and exchange rates are affected by external factors, budget policy has become the government’s best tool for achieving its economic objectives and to implement its poverty reduction strategy.  Treasury centralization in the provinces will require the Treasury Department to adapt its structure to the new situation.  Fiscal policy will play a major role in budget formulation and must develop decision making tools such as the MTFF and the MTFF  Fiscal discipline has become vital for macro-economic stability and fiscal discipline cannot be enforced without budget control procedures.  With the implementation of new information system the business environment of the Ministry of Finance is changing completely. Simple bookkeeping tasks will progressively disappear and be replaced by control and analysis tasks requiring more qualifications of the staff.  New control functions will have to be created to monitor carefully budget executionDuring the past eight years, the Ministry of Finance has made significant efforts to build capacity inthe Fiscal Policy Department. A similar effort must be made now in the Treasury and the BudgetDepartment. Capacity building has many aspects: staffing, training and technical assistance. Thosecomponents must be integrated into an overall plan.The Capacity Building plan to be developed will comprise of six main activities:  Developing of a capacity building strategy covering all key areas of MoF reforms such as Treasury centralization, accounting, reform of the budget formulation process, provincial budgeting, budget control, macro-economic policy, etc.  Accessing staffing need, potential for staff redeployment and other human resource management issues;  Creating an in-house structure to manage the capacity building plan; 73
  • 74.  Converting the capacity building strategy into a work plan with an implementation timetable;  Identifying technical assistance necessary for developing the capacity building plan;  Implementing of the work plan.Technical Assistance is the easiest part because it can be provided through PFMSP. Staffing is themost difficult issue. Clearly, the Budget Department and the Treasury are overstretched. In theirpresent organization and structure they are not in position to expend their mission as required bythe reforms that have been undertaken. It is necessary for MoF to bring new in-house expertise.Financial constrain must be identified at an early stage. Although the Multi-Donor Trust Fund willfinance most of the activities, the MoF will need to expand its staff at the central and local level. Thismust be discussed within the Government because capacity building is not an issue limited to MoF.Most line-ministries are under staffed at the central level with the implication that policy making,planning, budgeting and overall control of ministries activities in the provinces weak. Solving theproblem in MoF will be a step in the right direction, but will not be enough to correct some of thepresent weaknesses. A good starting point could be to prepare a plan to strengthen expendituremanagement capacity in the line-ministries. 74