The previous chapters explained PFM/IC and the implementation arrangements. This chapter distinguishes between public financial administration and internal control (PFA/IC), with a detailed explanation of what is meant by PFA/IC and compares it with public financial management and internal control (PFM/IC). The main difference lies in the role of ‘management’ and the greater discretion that management has in the decisions about the delivery of services with PFM/IC, including responsibility for achieving greater efficiency and effectiveness in service delivery. In the previous chapter the statement was made that PFM/IC should not be introduced until a robust PFA/IC exists, and this chapter explains what a robust PFA/IC involves. It also highlights deficiencies in the PFA/IC arrangements when compared with PFM/IC.

3.1 Public Financial Administration and Internal Control (PFA/IC)

3.1.1 Control Prior to the Adoption of PFM/IC

Before the introduction of PFM/IC should be attempted a robust PFA/IC should exist. The focus with PFA/IC is upon control and compliance. Control and compliance are critical attributes which all countries ought to strive to attain. They mean that spending conforms with budgetary limits, that all spending is in accordance with the relevant laws and regulations, and that such expenditure is only for public policy purposes. If control and compliance do not exist, the sophisticated system which is PFM/IC, with the increased discretion available to managers, is being introduced without the underpinning basic financial control stability and without recognition and acceptance of the structures necessary to achieve and maintain that stability and propriety. With their present PFA/IC arrangements, many governments have potentially good-quality financial and budgetary control systems. These ‘good-quality’ financial and budgetary control systems, often known as integrated financial management information systems (IFMIS), will be electronic information (IT) systems. They may be local ‘custom-built’ systems or ‘off-the-shelf’ commercial systems. They are designed to help governments and ministries of finance maintain control and compliance whilst operating within a PFA/IC framework. The accompanying financial, budgetary, and procurement regulations should complement the PFA/IC arrangements and be designed to prevent inappropriate actions.

However, such systems have their weaknesses often caused by poor security or by non observance of the accompanying rules and procedures. IT security in some countries can be limited and IT systems can be subject to hacking or made vulnerable by a lack of IT discipline. A further problem is that countries using advanced commercial ‘off-the-shelf’ IT systems need to adapt their processes and arrangements to meet the requirements of the IT system, rather than the other way round. This adds to the difficulty of application which can take a considerable period to applyFootnote 1 (up to 9–11 years in some countries) and causes delay in the implementation of other financial management reforms. Such systems also tend to be very expensive. Claims are also made that implementing such a system will result in improvements in efficiency and effectiveness but, such claims can only apply to the financial processes and not to the delivery of public services where the crucial factor is the quality of management. Consequently, that such systems may exist should not be a reason to argue that a PFM/IC reform is unnecessary. Their existence also does not guarantee that a robust PFA/IC presently exists. The adoption and application of the PFM/IC policy will not automatically remove any weaknesses. The same types of operational challenges will remain.

3.1.2 The Control Environment

Parliament through its approval of the budget and, in most countries the accompanying budget law, should dominate the approach to control. Parliament should approve variations to budgetary allocations in accordance with the requirements of the budget law, where these are found to be necessary. It should also be informed of significant variations in the income generating capacity of government. The ministry of finance has a responsibility for the overall operational control of the budget, reporting to parliament where budgetary spending changes are required and seeking parliament’s approval.

The budget law with PFA/IC will focus on financial limits rather than also on the ‘outputs’ to be achieved although the statements accompanying the budget are likely to include broad political aims, rather than specific managerial objectives. Some countries have experimented with different forms of budgeting such as programme and performance budgeting in order to increase the emphasis upon ‘outputs’ but with different degrees of success. Such budgetary reforms have not usually been accompanied in developing and transition economy countries by any managerial reforms, which are essential if they are to be effective. The following is a quotation from an OECD report on ‘Budgeting and Public Expenditures in OECD Countries 2019’.Footnote 2 It illustrates the importance of the comprehensive cultural change that is required to extend the concept of control based upon the budget to include ‘outputs’. Adopting PFM/IC, although not specifically referred to in the quotation, is an important element in that change:

[Performance budgeting] PB is a recurring focus of innovation because efforts to base allocations on results often fall short of the mark. Instead of abandoning the pursuit of performance, various countries have retained the PB label and reoriented it from performance-based to performance-informed budgeting or from central budget decisions to performance management in line ministries. Many countries have repeatedly tinkered with the definition and classification of key concepts, such as outcomes and results, and with their use in the submission and review of budget requests. Others have shifted from PB’s original focus as an instrument for deciding the budget to a means of classifying or displaying decisions taken during constructing the budget.

Some Member countries [i.e. of the OECD] have had considerable success with PB-type arrangements by recognising that performance has to be embedded in the culture and systems of public management, especially the strategic processes and goals of government, and has a robust infrastructure across government to support the production and use of performance information. These critical linkages are recognised and defined in the OECD Good Practices for Performance Budgeting. To this writer, several key insights emerge from the Good Practices and if properly adopted, will open the door to more effective application of performance budgeting. First, PB cannot be a stand-alone innovation; it must be closely aligned to national performance and medium-term expenditure frameworks and evidence- based assessments of policies and resources. Second, PB should be adapted to country circumstances, with due regard to the role and interests of important stakeholders. Third, there should be systematic use of performance information, guided by the central budget authority, but also involving line ministries, the legislature, and the supreme audit institution. Centres of Government (CoGs) have a critical stake in orienting programmes and line ministries to performance and results, but their role usually is limited. COGs can inspire and prod, they can demand performance information, and occasionally review budget options in the light of evidence on results. Overall, however, COGs have many other things on their mind that crowd out sustained attention to performance. Moreover, they may regard it prudent or necessary to leave sensitive questions—for example, how to improve the performance of teachers and schools—to others.

With PFA/IC the responsibility for detailed day-to-day financial and budgetary control lies with the ministry of finance or its equivalent. Thus, with PFA/IC the central ministry of finance is initially responsible if there is evidence of losses due to the failure of budgetary and financial control. Of course, it may seek to blame others, but the initial question is why it was possible for such losses to occur? Why were the ministry of finance controls not effective? Whilst deliberate manipulation may have occurred within a line ministry or other public organisation which the central ministry responsible for control did not identify, the question then becomes, why not? Consequently, although the actual source of the failure may lie within a line or spending ministry or other public organisation a ministry of finance cannot shift all responsibility for the ineffectiveness of the control arrangements onto individual organisation managements. With arrangements for PFA/IC line ministry or service administratorsFootnote 3 will be subject to the detailed central control over ‘inputs’ exercised by central controlling ministries. The usual organisational structure in line ministries and other organisations is for administrators to be appointed who may be politicians or civil and local government officials. Their control focus will be on ‘inputs’ because that will be the primary concern of the controlling central organisations and parliament. They usually will not have the performance and financial analytical information to enable them to deliver services and activities efficiently and effectively and to standard or to ensure that the arrangements for the collection of income have the same characteristics. The likelihood also is that clarity of objectives will be lacking and management disciplines such as risk management will not exist or if they do, they will tend to be cosmetic in nature.

Whilst the main input controls exercised by a ministry of finance with PFA/IC will be financial ones, a central ministry, either the ministry of finance or another central ministry may also control the numbers and types of personnel who may be employed. Such numbers may be included in the budget documents and may in some countries form part of the budget law. Such personnel controls may also extend to the rates of pay that may be available, including payments to consultants, such as engineers working to support particular public service provision. This also has the effect of removing an important area of responsibility from a line organisation’s administrations, such as a ministry responsible for delivering individual services. Similarly, line organisations may have responsibility for the instigation of procurements, although often the actual procurement processes are managed through a central ministry. Where though a line organisation has a responsibility for the actual procurement process, it should be expected to operate within centrally specified procurement rules.

Improvements to PFA/IC will be focussed by central ministries upon securing a strengthening of control over ‘inputs’, including commitments. In some developing and transition economy countries attempts may be made to incorporate ‘outputs’ especially where countries are seeking to introduce programme budgeting. Control over ‘inputs’ is an important requirement but, as explained, can be a limiting management requirement if those controls are externally imposed and have no regard to the expected outputs. Such financial and budgetary controls will be designed to ensure that spending does not exceed that approved for individual budget lines or groups of lines and that the detailed financial control regulations are observed. This process in effect denies to administrators the discretion they would require as effective managers, as well as not recognising that they will need different and more detailed information if they are to deliver objectives efficiently and effectively. Managers also need more flexibility if they are to succeed in this and that means that the virement rules need to be more relaxed. This, in turn, depends upon the attitude of parliament. Budgetary policy will also be designed to ensure that budget funds are allocated in accordance with government ‘input’ priorities such as ‘we wish as a government to spend more money on schools, or healthcare, or prisons, or infrastructure’. Only rarely will this be translated into a specific objective linked directly to the available budget because the information available to do so does not usually exist. And then with PFA/IC a management with the discretion able to actually deliver the specific objective will not exist either.

Because responsibility for the strength of such financial and budgetary controls with PFA/IC rests with the ministry of finance within any confines set by parliament, that ministry will dominate the control process requiring public organisations to meet its requirements. In other words, the ministry of finance will define and secure the application of the control processes and how those control processes will operate. The aim will be to ensure that through its control mechanisms, spending conforms to budgetary limits, that is, ‘inputs’, specified in the budget law.

The budgetary structure is also important in determining how effectively managers can operate. With PFA/IC line ministries and other public organisation administrators may have little or no say in the budgetary structure and they will be responsible for compiling the budget in accordance with that externally imposed structure. That externally imposed budget structure will be approved by parliament and be designed principally to meet the needs of the ministry of finance. These needs, in turn, are likely to reflect the analysis required for international statistical reporting purposes, not the needs of the individual public organisations. In some countries the ministry of finance may also set out in detail how budgets are to be constructed indicating, for example, unit allowances for such items as vehicle running costs, or even ministry administrative costs. Where variations are required to any budget heading or, in some countries, groups of headings, ministry of finance approval will be required.

No matter how detailed ministry of finance control is over the construction of the budget it may also specify in financial regulations how day-to-day financial control is to be exercised to ensure that financial resources (both current and investment resources) are used to ensure that they are used only for public purposes and that effective day-to-day control exists to ensure that fraudulent, corrupt, or other improper activity does not occur. As was pointed out in the previous chapter those affected by the ministry of finance control processes are unlikely to have any say in how they should be applied.

A further control exercised by a ministry of finance is cash flow control. This will require other public organisations to ensure that spending complies with forecasts of cash flow requirements. Cash flow controls in some countries can be very detailed and be applied to most (or all) budgetary headings and in others can be limited to the main headings only. The dominating interest with cash flow controls is likely to be that of the ministry of finance. However, the more detailed the cash flow controls the more this draws a ministry of finance into line ministry and other organisation decision making processes. Also, the more detailed the cash flow controls are the more unreliable they are likely to be, and this is likely to affect the level of ‘trust’.

In summary, systematic accountability arrangements with PFA/IC within line organisations is likely to be limited to ensuring that budgetary and financial controls over inputs are maintained and that the requirements of the associated regulations are met.

These budgetary control rules may or may not apply to second-level non-market organisations such as agencies but are unlikely to apply to state owned enterprises. If they do not apply in detail to agencies, they will usually apply to the subventions from the first to the second-level bodies. In some countries this allows second-level bodies direct control over what is regarded as its ‘own income’, where it engages in activities that provide sources of income. Consequently, income generated by an agency may not be subject to control at all and may not even be reflected in the budgetary calculations of the controlling ministry or local government. (Indeed, one of the reasons in some countries for establishing such agencies is to avoid the detailed budgetary controls that would apply to the controlling first-level organisation.) Although this is the reality of the situation this arrangement is inappropriate and can lead to abuse. In particular, an agency’s ‘own income’ ought to be incorporated into the budgetary process and the controlling first-level body should ensure that the methods used by an agency to determine ‘own income’ charges are appropriate and that forecasts of ‘own income’ are reliable and are met in practice. The first-level body should also ensure that all second-level bodies, other than state owned or local government owned enterprises, apply the same budgetary and financial control rules as the first-level body irrespective of whether PFA/IC or PFM/IC applies.

Where state owned enterprises are exempted from budgetary control rules and the financial regulations that apply to non-market public organisations the controlling or owning first-level body should have a responsibility to ensure that equivalent or appropriate controls are applied and are effective. These other forms of control should include the arrangements for governance and could also include specific financial controls such as rates of return on capital to be achieved, limitations on payments to members of boards of directors, limitations on certain types of expenditure such as entertainment, a ban on the acceptance of fiscal risks without the specific approval of the controlling/owning first-level body and/or the ministry of finance. In Chap. 12 a more extensive discussion of the controls that should exist over second level organisations is set out.

3.1.3 Limitations of PFA/IC

PFA/IC, when applied well, is a robust system to ensure financial probity and compliance with public budgetary rules and regulations. However, even when applied effectively there remain limitations, hence the general drive towards the development and application of PFM/IC.

The principal deficiency with the whole concept of PFA/IC is the narrowness of the focus of the financial interest onto budgetary and financial compliance. A complementary focus is also on the current budget, whether 1 year or 3 years. The broader financial and operational environment with the ability of the manager to deliver better value is not addressed and neither is the longer-term financial viability of the organisation. Also, there is no linking of finance with objectives and performance standards and with the establishment of mechanisms to determine efficiency and effectiveness. In other words what is lacking is a reference to the quality of public expenditure and sustainability. (PFA/IC is not alone in this and international measures, such as PEFAFootnote 4 also just focus upon expenditure and do not reflect quality.) In addition, even with a sophisticated IFMIS the system itself says nothing about the quality of public expenditure, that is, whether it is efficient or effective. Adopting PFM/IC will not change this if it simply concerns itself with technical changes and ignores the managerial impact dimension. Corruption, where it exists, complicates the introduction of PFM/IC because PFM/IC relies on the integrity of the managerial structures.

What is important in the development of a PFM/IC reform is a strengthening of the quality of policy development and operational management. As was pointed out in the previous chapters this requires the separation of policy and strategy development from operational management with the delegation of operational management responsibility from the political level coupled with greater accountability. But this can only occur with the development of a quality, managerially oriented civil or local government service. Added to this should be a strengthening of the overall governance arrangements and greater transparency. This will improve the quality of the checks and balances in the system, enhance user pressure to make public services more efficient and responsive to user needs (i.e. effective) as well as lessening the risks of corrupt and fraudulent activity.

This also impacts upon the role of a ministry of finance. The more the ministry of finance seeks to control the detail of public expenditure the more it discourages line ministry and other officials from becoming ‘financially aware’ and ensuring that public funds are spent efficiently and effectively and achieve specific objectives.

3.2 Comparing PFM/IC and PFA/IC

3.2.1 An Overview of the Comparison

This next section compares PFA/IC and PFM/IC and highlights the systemic and operational changes that need to be considered in any transition to PFM/IC.

With the application of PFM/IC the parameters that need to be kept under review are much more extensive than those required with PFA/IC. A comparison is summarised in Table 3.1 (a detailed comparison is set out in the Annex to this chapter.)

Table 3.1 Summary comparison of public financial administration and public financial management
Full size table

Introducing PFA/IC compared with PFM/IC does not have the same impact upon traditional customs and practices and therefore is easier and speedier to develop. In practice in this author’s experience many of the reforms aiming to introduce PFM/IC have only had the effect of strengthening PFA/IC. This is not a ‘bad thing’ but it does not achieve the benefits that can be achieved through the application of PFM/IC.

Key elements that need to be considered before any move to PFM/IC should be considered are encapsulated in the comments of Antoinette Sayeh, former Director of the IMF’s African Department:Footnote 5

  1. 1.

    ‘Budgets are often better prepared than they are executed: Even though the credibility of the annual budget remains work in progress in many African countries, the budget preparation PEFAFootnote 6 scores are on average better than scores for budget execution and oversight.

  2. 2.

    There is a severe implementation gap: Laws and processes may be in place but are not necessarily implemented.’

Antoinette Sayeh went on to say:

  1. 3.

    ‘Consolidation of responsibilities often yields better results. The success of Treasury Single Account development and strengthened cash management in some countries is an impressive example of how consolidation can achieve excellent results. For macroeconomic stability, centralized decision-making is important to enforce fiscal rules and budget discipline. These topics, with reliable fiscal reporting, still comprise the “bread and butter” of technical assistance by the IMF in African countries.’

These three elements need to be addressed before a move to PFM/IC should be contemplated. However, point 3 potentially conflicts with the PFM/IC requirement for the devolution of decision making and authority to make budgetary decisions. Central departments with control responsibilities, because of these types of risk and for other reasons can be very reluctant to relinquish their responsibilities. Also, there is a certain tension between point 3, ‘the consolidation of responsibilities’, and the devolution of responsibilities envisaged by PFM/IC. The example from hospital services provided by De Geyndt and quoted in Chap. 1Footnote 7 also illustrates this tension. Yet to achieve improvements in performance, change is needed and that change requires managerial involvement in the delivery of services and activities with managers having a focus on the quality of services provided, that is, ‘outputs’ and the authority to make changes without central authority, except in specific cases, such as those involving high political resonance or high cost and risk. The introduction of PFM/IC makes this change possible but a critical factor in the devolution of responsibility is the existence of confidence by central controlling ministries, not least the ministry of finance, that devolution will not result in a damaging loss of control over ‘inputs’ and will actually achieve the ‘output’ benefits that are claimed. Those damaging consequences can be caused by incompetence, a failure to recognise the importance of control and not least financial and budgetary control, an inability to balance off service demands against available resources and worst of all, corrupt practice. What this does is to emphasise yet again that central to the success of PFM/IC reform is managerial reform and the prior existence of a robust PFA/IC. In turn it also emphasises that ministries of finance and other central controlling organisations need to rethink how they exercise control. Unless demonstrably, the concerns expressed by Antoinette Sayeh in point 3 of her remarks can be met the PFM/IC should not be proceeded with until macroeconomic stability, fiscal rules and budget discipline together with reliable fiscal reporting can be achieved.

3.2.2 The Objectives of Control

As described in Chap. 2, the objectives of control are different between PFA/IC and PFM/IC. Control with PFM/IC is not simply about financial, budgetary, and legal/regulatory control as with PFA/IC (see Sect. 3.1.1 above) but is also about achieving objectives to time, to standard, efficiently and effectively. Parliament and a ministry of finance (and possibly another ministry if a separate ministry is responsible for investment expenditure) will have an interest in each of these elements of control, but a ministry of finance cannot be held responsible for these wider elements of control, nor is it in any position to achieve them. Responsibility firmly lies with the manager of a line ministry and other public organisations.

With PFM/IC responsibility for the quality of controls is moved away from a ministry of finance (and that other ministry if applicable) onto the management of each public organisation. The primary responsibility for control therefore lies with the line ministry or other public organisation management and not with a central ministry. Consequently, blame cannot be so easily shifted. This creates an opportunity for the development of greater public transparency and accountability, not least to parliament who should be able to broaden its interest to the quality of the management responsible for the delivery of public objectives, that is, the quality of public expenditure. Parliament may need to adapt its scrutiny arrangements through the development of specialist committees to enable it to do this and with the support of the state auditor.

What should be of particular concern to a ministry of finance is securing the achievement of overall macroeconomic stability, the observance of fiscal rules and overall budgetary discipline together with reliable fiscal reporting. It will want to secure the quality of the budget process ensuring that the objectives and performance standards for which the budget has been allocated are delivered. In addition, a ministry of finance may wish to ensure that expenditure on certain key items, such as personnel does not exceed specified limits and where that is the situation it may introduce specific controls to secure its interest (although it should be borne in mind the more it does so it detracts from the management of a public organisation responsibility for the delivery of its objectives). With PFM/IC therefore the ministry of finance in particular and also possibly the ministry responsible for personnel management, should be substituting detailed control for a macro type of control to enable line ministry management to exercise its full control responsibilities. However, to allow a ministry of finance to do that it must be satisfied that the overall financial and budgetary control and personnel controls will be effectively exercised by line ministries and the subsidiary organisations for which they are responsible. The offsetting potential gain is an improvement in the quality of the utilisation of public resources in terms of achieving objectives and not least in efficiency and effectiveness. Consequently, the development of PFM/IC represents a risk for central controlling ministries, although as noted in Chap. 1, the need to prevent the misuse of funds may be superseded by the need to deliver results.Footnote 8 In other words, is the traditional practice of detailed control of inputs still relevant, to quote Schick in ‘an era of big activist government’?

But whether that ‘fundamental shift’ will occur depends very much upon the existence of ‘trust’. Do those central ministries or politicians who will be required to relinquish control or the opportunity to make decisions through the development of delegation really trust others, line organisations and officials, to actually take on the responsibilities for control and to make decisions? Merely saying that they will be required to do so will not be effective! This is because ways will always be found round any notional reforms. Sometimes there is more at stake than simply concern about control, as was pointed out in Chap. 2, because the PFM/IC reform can mean a loss of authority and power and even opportunities for promoting particular objectives or indeed personnel. ‘Trust’ has to be built over time and ‘trust’ will develop when it can be demonstrated that devolution of control can work well, that objectives can be delivered and that public organisations can operate more efficiently and effectively. This in turn affects the length of time that will be needed to implement the reform. Consequently, building ‘trust’ is a factor that reformers should not overlook (although unfortunately this never seems to be a factor in reform agendas).

The central point, made in previous chapters, is that ministries of finance should recognise that with PFM/IC to the traditional ‘inputs’ focus of control is added a focus on ‘outputs’, which are what service users and taxpayers are really interested in, that is, the quality, relevance, timing, and volume of public service availability. Unless attention is paid to ‘outputs’ no improvements in efficiency and effectiveness can be achieved. Service quality, relevance, and timing are very much functions of management. Service volume in most countries will be linked to the totality of the budget inputs rather than to a conscious decision about service quality and effectiveness (i.e. the outputs).

An unresolved question is whether ‘outputs’ should be incorporated into the budget and hence into the budget law. The introduction of PFM/IC because of the emphasis placed upon management and managerial discretion would clearly help but it would be impractical to incorporate into the budget law and for parliament to seek to exercise oversight at the managerial level. It would equally be difficult for a ministry of finance to also exercise such detailed output control and this would also risk a ministry of finance in effect becoming the ultimate decision maker rather than the manager of the line ministry or other public organisation. However, what could be appropriate in some countries, but only as a managerially oriented public service becomes established would be for the ministry of finance to require line ministries and other public organisations to specify what is to be achieved from the utilisation of budgetary resources and how performance is to be assessed. This would be difficult to specify where public service outputs cannot be easily defined in specific performance terms (see Chap. 6 on risks and unintended consequences). However, making line ministries and other public organisations more managerially oriented through budgetary disciplines should be a characteristic of the development of PFM/IC and of accountability and transparency.

An article in 2007 in the OECD Journal on BudgetingFootnote 9 discussing the benefits of incorporating performance information commented:

Increasing the use of performance information in budget processes is an important initiative that is widespread across OECD countries. It is part of an ongoing process that seeks to move the focus of decision making in budgeting away from inputs (how much money can I get?) towards measurable results (what can I achieve with this money?). OECD countries have reported a number of benefits from the use of performance information (PI):

  • It generates a sharper focus on results within the government.

  • It provides more and better information on government goals and priorities, and on how different programmes contribute to achieve these goals.

  • It encourages a greater emphasis on planning and acts as a signalling device that provides key actors with details on what is working and what is not.

  • It improves transparency by providing more and better information to parliaments and to the public, and has the potential to improve public management and efficiency.

3.2.3 Budgetary Control

There are two types of budgetary control, namely one centralised within the ministry of finance and the other decentralised within ministries and agencies. These have been described in an IMF paperFootnote 10 with their advantages and disadvantages as follows:

Centralized systems, particularly with centralized commitment and accounting controls, have the advantage of: (i) reducing the scope for variable interpretation and application of control criteria by multiple agencies; (ii) facilitating integration between aggregate cash control and commitment control at the transaction level; and (iii) allowing the ministry of finance direct access to a centralized repository of expenditure data for budget execution monitoring/reporting. At the same time, centralization has the disadvantage of: (i) undermining spending responsibilities of managers in line agencies in the day-to-day management of line ministries/agencies’ budgets; (ii) increasing the risks of noncompliance and/or collusion (as both the authority to spend and the responsibility to ensure the regularity of transactions is assigned to the same agency) in the absence of strong internal and external audit functions; and (iii) inefficient decision-making (including superimposed prioritization) and rigid controls by the ministry of finance when it lacks the detailed information on the spending requirements of agencies; and (iv) presenting opportunities for rent seeking by officials implementing multiple and cumbersome controls.

Decentralized frameworks have the advantage of: (i) aligning expenditure decision making with the spending priorities of line agencies; (ii) minimizing/eliminating redundant controls which in turn improves the efficiency and speed of expenditure execution; and (iii) making each line agency directly accountable for its spending programs. At the same time, they have the disadvantage of: (i) potential disparate application of controls by various agencies particularly when the control criteria are not well defined; (ii) increasing the risks of noncompliance and/or collusion (as both the authority to spend and the responsibility to ensure the regularity of transactions is assigned to the same agency) in the absence of strong internal and external audit functions; and (iii) prolonging the preparation of financial reports (as expenditure data has to be collected and complied from multiple sources) required by central agencies for budget execution monitoring.

The actual process of budgetary control where PFA/IC exists will normally be exercised by the ministry of finance through an IT-based IFMIS (see Sect. 3.1.1) and therefore be representative of the centralised system also described above. The approved budget will be entered into that system as will actual line ministry spending (and for local governments if they are using the same system). That system would normally block any proposed spending for which there is no budgetary provision. Ideally commitments should also be entered into the system but this can be a weakness or if commitments are entered the information is not comprehensive being limited to current orders for goods and services and not reflecting future orders to be placed during the remainder of the year or impacting upon future years. However, how effective such systems are in facilitating budgetary control depends upon the controls that in turn exist over the operation of this system and the managerial attitude to control. As was pointed out in Sect. 3.1.1, weaknesses in security particularly, can lead to abuse and misuse of resources.

Consequently, with PFM/IC the budgetary control process will be more devolved and hence more representative of the decentralised system referred to above. A ministry of finance will still require information about spending in accordance with the framework specified by that ministry no matter how budgetary and accounting information is reanalysed for internal public organisation managerial purposes. How frequently the central ministry of finance will require that information will depend upon local country arrangements. An example from Canada (see also Chap. 5) illustrates how such information can be collected by the central ministry:Footnote 11

The government-wide chart of accounts is a framework that explains how departments [i.e. ministries] and agencies should identify, collect and report financial transactions to consistently satisfy the government’s corporate information requirements. The chart of accounts contains the accounts and codes for all the fields that comprise the government-wide coding block.

Departments and other reporting entities use these accounts and codes to input their monthly trial balances in the fields that make up the government-wide coding block. The departments then transmit these balances to the Central Financial Management Reporting System.

What this shows is that decentralisation does not automatically prevent the ministry of finance from obtaining the information it requires.

A crucial control where PFM/IC has been established is to ensure that the information contained in the financial information system used by the manager is entirely consistent with that used by the ministry of finance. To secure that consistency should be a responsibility of the head of finance (see Chap. 8 on the role of the head of finance). Regular reconciliation between the line ministry system and the ministry of finance system should be a consistent feature of financial management. This can be ensured through a coding system which has the flexibility to allow both the manager in a line ministry or other public organisation and the ministry of finance to obtain the information that they both require. This may be facilitated using modern IT systems.

3.2.4 Development of Budgets

The responsibility of line ministry administrators where PFA/IC applies from a financial perspective is limited to ensuring that budgetary limits are not exceeded, that financial regulations (including procurement regulations) and any cash flow limitations are observed. These line ministry responsibilities are usually exercised by the line ministry or local government accountant/finance officer, rather than by the actual administrators. The administrator responsible for a particular area of activity may not know exactly what budget is available for what service delivery purpose, because the structure of the budget and the corresponding accounting arrangements will be designed to meet the needs of the ministry of finance rather than the needs of the administrator. For example, personnel budgets may be amalgamated into a single heading for a whole ministry rather than be allocated to each element of a service or activity and budgetary control will be exercised on that basis.

With PFA/IC there is often no linkage of budgets to specified managerial objectives and performance standards, although broad political objectives (aspirations!) are frequently included in budget statements. Neither is there a requirement to achieve efficiency and effectiveness except again as a broad political objective. There will be no specific managerial structures with delegated powers and accountability arrangements specifically designed to deliver objectives or improvements in efficiency and effectiveness. The budget making process is likely to be dominated by the interests of the ministry of finance who will specify in the annual budget circular how the budget is to be compiled. Administrators are unlikely to have the ability to intervene in budget making, except at the margins, and anyway without objectives and performance standards or the information to enable a judgement to be made about efficiency and effectiveness the relevance of budgetary allocations to political policies and objectives is difficult to determine with any sort of precision. What will dominate is the overall fiscal situation and the government view of political priorities. Therefore, budgets can come to be regarded as being ‘imposed’ externally rather than being ‘owned’ by the administrator. The result is therefore that pictured by Antoinette Sayeh, namely that budgets can be better prepared than executed.

Service administrators are under different pressures than a ministry of finance. Service administrators will want to respond to pressures from customers or clients of the public services for which they are responsible. However, the likelihood is that budgets in these circumstances will be dominated by the objectives of the ministry of finance rather than jointly determined between the ministry of finance and the line ministry administrator.

This contrasts with the situation where PFM/IC exists and where there is a much greater actual or potential opportunity for the establishment of budgetary ‘ownership’ by the manager and hence for both better-quality budget making and execution. This is because the manager should have a responsibility not only to secure budgetary control but also to deliver a set of objectives and performance standards. If the manager is to do that, that manager must be involved in the budgetary decisions. If the manager is not involved no commitment can be given to deliver those objectives and standards.

How the information about actual levels of spending (and income) against the budget will be provided will depend, as shown above, upon whether the budgetary control system is centralised or decentralised. In some countries information about spending against budgets is provided within line organisations only every three months although in others the routine is monthly reporting. With more advanced IT systems, whether there is a centralised or decentralised system, ‘on-line’ arrangements mean that spending information is current but only provided in accordance with the budgetary analysis required by the ministry of finance because of the need to control against budget inputs. The frequency of reporting is important for management reasons but with PFA/IC these management reasons are limited to those seen as important to the ministry of finance. With PFM/IC three monthly reporting is quite inadequate because it gives too little time for adjustments to be made to spending patterns to enable managers to maintain or adjust service levels where budgets appear as though they will be exceeded and objectives may not be met. Or if the indication is that budgets will be under-spent and yet objectives met managers, with three monthly reporting managers are in no position to consider alternative fund usage provided the ministry of finance budgetary controls permit this. With PFM/IC managers should also be provided with information about performance and such information, depending upon the activity, could be provided at different intervals, some of which could be very short intervals. Consequently, managers should be making operational as well as financial performance judgements and therefore reporting arrangements do need to be linked as far as possible.

With PFA/IC 3-monthly reporting anyway is also inadequate. This is because if spending appears as though it will not meet budgetary limits, and the emphasis is simply upon spending, and the indicator is that if budgets will be under-spent the incentive will be just to increase spending not least in order to maintain a claim on the same level of budget for the next financial year. This is even if funds are allowed to be transferred to meet an overspending elsewhere. If there is a possibility of overspending the incentive will be to make cuts to spending levels without necessarily any regard to the quality of service or the achievement of objectives. If, as with PFA/IC, the focus is only on spending levels, rather than also on the achievement of objectives, and there is a risk of overspending the budget, pressure is then generated to permit supplementary estimates or budgetary variation arrangements or to use ‘other devices’ to avoid breaching budgetary limits. An example of ‘other devices’ would be allowing the accumulation of arrears of payments to creditors or service levels are abruptly reduced or attempts can be made to reclassify current expenditure as capital investment. Such devices usually result in increased costs or greater inefficiencies or ineffectiveness in public service delivery and there is no regard to the achievement of objectives. This could also happen with PFM/IC but the likelihood is that the incentives will be less and the circumstances in which the possibilities will arise will be fewer, not least because of the focus upon the achievement of efficiency and effectiveness.

An associated weakness with PFA/IC is that countries do not seem to require that regular re-forecasts are made of expenditure and income to the end of the year. Consequently, there is no opportunity to plan for how potential overspendings might be accommodated (or under-spendings). Such re-forecasting ought to be an automatic requirement exercised by the head of finance where PFM/IC has been implemented although there is no reason why it should not occur with PFA/IC. However, the incentive is much less because the focus is simply upon budgetary control not also on the delivery of objectives.

3.2.5 Parliamentary Scrutiny

Another factor affecting the frequency of reporting is the need to keep parliament informed of progress against the budget (i.e. for both expenditure and income) and to allow for effective financial scrutiny by parliament. The purpose of parliamentary financial scrutiny is part of the process of developing transparency and accountability. The aim is to make the government, individual ministries and other public bodies accountable for their financial decisions—in other words, requiring them to justify their revenue-raising and spending plans. With the development of PFM/IC the government and individual ministries and other public bodies should be able to explain whether the expenditure achieved its objectives and, if not, why not. The degree of detail involved in the parliamentary scrutiny process will vary between countries, but the underlying principles should be to:

  • Make the government’s financial decisions transparent, including the relationship between its stated priorities and its funding decisions.

  • Encourage civil society to become involved in discussions about public expenditure through the provision of evidence to parliament as part of the process of informing the parliamentary debate.

  • Influence the government’s financial decisions.

  • Hold the government, individual ministries and other public bodies to account for their financial decisions and quality of financial management; and through the scrutiny process to contribute to an improvement in the quality of financial decisions and management and improved value for money in public services.

Financial scrutiny matters because the quality of financial decisions and financial management is likely to be higher if they are made transparent and if those responsible for them know that they will be scrutinised rigorously and mismanagement will be exposed. Better financial scrutiny should therefore result in more efficient and effective public services.Footnote 12

To enable scrutiny to be effective parliament will need an appropriate level of support resources. This can be provided by the development of parliament’s own staff and/or through support from the state auditor.

How frequently reporting to parliament should occur will depend upon local country circumstances but the OECD in a 2002 report on Best Practices for Budget TransparencyFootnote 13envisaged monthly, mid-year, and annual reports. These reports would serve different purposes, but detailed scrutiny could not occur monthly and probably only annually. In practice, the likelihood is that detailed parliamentary scrutiny of individual public service provision budgets would occur on a cyclical basis.

3.2.6 Internal and External Audit

Whether PFA/IC or PFM/IC exists there is an important role for internal audit. Internal audit should identify and suggest remedies to address control weaknesses. The potential weaknesses depend upon whether control is centralised or decentralised, as the IMF paper referred to above has identified. However, realistically, if control weaknesses are extensive with PFA/IC because of a divided responsibility between a ministry of finance and a line organisation or a lack of interest or involvement in financial, budgetary, and other controls by line ministry administrators, the likelihood of internal audit being effective will be limited, even where the internal auditor may report directly to the political head of the organisation. This also suggests that changing to PFM/IC could enhance the effectiveness of internal audit because of the clear focus of responsibility for the operational effectiveness of all controls would be the responsibility of the head of operational management. But then that raises the question of to whom the internal auditor should report? With PFM/IC the more appropriate reporting line would be to that head of operational management, rather than to the political head. (This question of reporting for internal audit is discussed elsewhere in this guide, see Chap. 7.) Another factor affecting the quality of internal audit will be the relationship with and attitude of the external auditor. External auditor support for the internal audit in some countries will be essential in developing internal audit quality and independence. The development of PFM/IC also creates greater opportunity for the internal auditor to undertake value for money audits, partly because of the financial and performance information which becomes available and partly because the managerial orientation that would be required of management should encourage such an audit approach. The same would also be true for external audit which has an increasing focus upon audits which address the issue of public value through performance audits.

3.2.7 Consequential Features of PFM/IC That Do Not Exist with PFA/IC

There are consequential features of PFM/IC which do not exist, and usually cannot exist with PFA/IC. One important feature in securing the achievement of objectives is the development of risk management, that is the identification and management of those risks that will affect the achievement of the objectives and performance standards and performance objectives of the organisation. Another is that to be confident of achieving objectives managers must engage in strategic and business planning. Such planning will help managers identify the practicality of achieving the objectives of the organisation within the financial constraints that will inevitably exist, not only within the budgetary period but also over time, the length of time depending upon a particular service. A usually completely overlooked feature of PFM/IC, is that management should be always concerned with the longer-run financial resilience of the organisation. This is not simply, as has been indicated previously, a matter of preparing, say, 3-year medium-term budgets but of looking much further forward and assessing the impact of current policies and investment decisions as well as external factors (such as demographic changes) upon the possible future financial resources of the organisation.

Each of these features of PFM/IC is addressed in detail in later chapters of this guide.

3.3 Summary

Before PFM/IC is developed there should be in existence, as emphasised previously, a robust PFA/IC. The principal differences between them are:

  1. 1.

    Responsibility for detailed control of expenditure is shifted with PFM/IC from the ministry of finance to line ministries. (This can include ‘personnel’ controls as well.)

  2. 2.

    The focus of control with PFA/IC is on financial inputs whereas with PFM/IC control should incorporate the achievement of objectives and performance standards and performance objectives as well. This in turn provides an encouraging environment for the development of value for money (performance) audits by both internal and external audit.

  3. 3.

    The budget structure with PFA/IC will be designed to meet the needs only of the ministry of finance with little or no regard for line ministry managerial needs. With PFM/IC the budget structure must meet the needs of both the ministry of finance and the manager.

  4. 4.

    Controls over second-level organisations are likely to be weaker with PFA/IC than with PFM/IC.

  5. 5.

    With PFA/IC there is not the same possibility of achieving efficiency and effectiveness (no matter what laws and regulations say on achieving these characteristics).

  6. 6.

    PFM/IC is consistent with the development of a ‘managerial culture’ and raised financial awareness amongst managers.

  7. 7.

    The development of PFM/IC offers the potential to improve the quality of budgeting.

  8. 8.

    Managerial effectiveness with PFM/IC depends also upon the existence of a high quality of relevant financial information, such as information about cost drivers and cost centre analyses, not normally required with PFA/IC together with the existence of strategic and business planning as well as long-term financial planning.

  9. 9.

    With PFM/IC there is a greater opportunity to develop effective parliamentary scrutiny.