In this chapter the main responsibilities of the minister of finance in the application of PFM/IC are described, including the impact that the reform will have on the main departments and activities of the ministry of finance itself. The reform is a complex reform, and as with many complex reforms, there is always a risk of unintended consequences. The possibilities of this occurring are discussed in Chap. 6. If ministries of finance stand in the way of such developments and do not recognise the managerial consequences, this will make achieving the benefits of the reform very difficult.

The reform will impact upon the budgetary and financial accounting arrangements within line ministries and local governments, and the ministry of finance should both recognise and encourage this development. This is because individual managers within line ministries and local governments with PFM/IC will want to know what the total budgets are for their areas of responsibility set against their objectives and performance standards. They need this information to establish efficiency and effectiveness in service delivery. A consequential need will be to develop management and cost accounting because the traditional financial accounting arrangements will not provide the type of information a management requires to secure efficiency and effectiveness.

An important activity of a ministry of finance ought to be to challenge line ministries about the cost and quality of the policies ministries are proposing to adopt and the quality of their proposed objectives and performance standards, along with the resources they require to achieve them.

The reform will also impact upon the parliament by increasing the ability of parliament to scrutinise the budget and the operational management of line ministries and other public organisations. The ministry of finance as a result is likely to be expected to provide evidence to parliament to support its scrutiny arrangements.

Successful application of PFM/IC also depends upon the management of line ministries and local governments accepting that they are responsible for adopting a disciplined internal control structure and ensuring that internal control is effective. An objective of internal control is to control risks to an organisation. Those risks can be to the delivery of the objectives and performance standards of an organisation, to achieving efficiency and effectiveness as well as financial, legal, environmental, and wider reputational risks. Where a ministry of other organisation is involved in the collection of income, including taxation, internal control applies equally to these activities. Internal control is not simply about financial and budgetary control, and neither is it simply about the short-term financial/budgetary situation.

In some countries other ministries besides the ministry of finance may also be involved in the financial management process such as a ministry of planning responsible for the control and approval of investment expenditure. Whatever the benefits of such an arrangement, this does complicate the implementation of PFM/IC. It also adds to the complexities of the role of the head of finance not least because constraints on current budgets may not be replicated in the investment budgets. This also has to be taken into account in implementing PFM/IC.

5.1 The Responsibilities of a Minister of Finance and Senior Officials

This chapter covers the impact of the application of PFM/IC on and the specific responsibilities of the minister of finance, the most senior civil servant within that ministry, and other senior ministry officials. Application success depends very heavily on the extent to which these officials recognise their responsibilities for the reform and the changes that the reform will bring about. Also discussed is the relationship of the minister with parliament.

The chapter covers the critical aspects of the reform that are likely to require decisions by the minister and the ministry staff before, during, and in sustaining the reform. Although the minister will take the key decisions, in practice many of the day-to-day responsibilities will be addressed by staff within this ministry. The key figure in the ministry who should, in effect, supervise application throughout all line ministries and other public organisations should be the chief official of the ministry (the state secretary or equivalent).

5.1.1 The Minister of Finance and PFM/IC

The finance minister will be a senior minister within a government responsible usually for the management of the government finances, economic policy, levy and collection of taxes, government borrowing, and financial regulation. This minister may also be responsible for monetary policy, although this can be a responsibility of the central bank. (Actual responsibilities do vary widely between countries.) Within this broad range of responsibilities, the ministry of finance will have the specific objectives of determining and raising taxes, maintaining budgetary and financial control of public expenditure, and improving public sector productivity. It will also be concerned with the achievement of the government objectives and ensuring that line ministries and local governments do not enter into commitments which may be difficult to finance in the future or which to finance them may have adverse effects upon other current activities of an organisation. The minister of finance would normally be the minister with overall responsibility for the introduction of the policy of PFM/IC.

In exercising these responsibilities, a particular activity of a minister of finance and by extension the ministry of finance should be to challenge how well a line ministry or other public organisation has defined and costed policy and used available public resources to achieve its objectives and performance standards. In assessing the quality of that utilisation, a ministry of finance should be concerned about the improvements in efficiency and effectiveness, if any, with which those resources have been used. The implementation of PFM/IC will help them to achieve these objectives:

The challenge function will be thought of as the investigation and scrutiny of the spending, expenditure management processes and policy choices of line ministries, departments and agencies. Where these do not align with the objectives of the finance ministry, an effective challenge function typically means the finance ministry asking, requiring or persuading line ministries to do something different to what they might otherwise have done. Such a relationship is necessary if a finance ministry is to deliver its many functions and achieve its economic, spending and policy goals.Footnote 1

Whether or not the tests described in Chap. 4 to assess the feasibility of the reform can be met depends heavily upon the reaction of the minister and staff of the ministry of finance. The most important departments of the ministry that will be directly affected by the reform are the budget department and the department responsible for treasury matters including financial accounting and overall government financial control. (If the ministry of finance is also responsible for procurement, that department too is also likely to be significantly affected.) Not only will these departments be affected technically but they will see the modification to some of the powers that they presently have. If the minister of finance, and by extension the ministry of finance, is not willing to agree to the quite fundamental changes which will facilitate the establishment of a managerial culture, then the PFM/IC reform should not proceed. Therefore, that these departments of the ministry should have a clear appreciation and an acceptance of their role in the reform, is pivotal.

Earlier chapters in this guide show how the application of PFM/IC impacts upon the whole approach to public financial management. It shifts the focus of management from control of inputs to control of outputs, although still requiring a control of inputs. The result, if the reform is successful, is the establishment of a managerial culture compared with a traditional administrative culture.

5.2 Before the Reform!

Introducing PFM/IC should not be regarded as simply a matter for officials. As was pointed out in Chap. 4, parliament has a potentially powerful role in approving and driving forward the application of the reform. In doing so parliament would hold the minister of finance to account for progress. As was pointed out in Chap. 4 a reform of this operational significance in the management of public expenditure is, in reality, likely to cause resistance to change, especially to the managerial reforms that will be required and potentially delay the implementation timetable. Parliamentary support for the reform can therefore be of considerable assistance to a minister of finance in broadening political support, even within the government.

The responsibility of the minister of finance should be to secure parliamentary appreciation of the significance of the reform, what the reform requires by way of managerial changes and the distinction that will be necessary between responsibility for operational management and that for policy and strategy development. Parliament should also be made aware of the potential costs and benefits as well as approval to the reform application arrangements. This would include the reform timetable. The minister of finance should report periodically on the progress in the application of the reform, say six monthly, with parliament then being required to approve changes to the timetable for application and made aware of major difficulties.

The involvement of parliament is not normal practice in this author’s experience nor is this a requirement referred to in literature on the subject.Footnote 2

5.2.1 The Initial Assessment

As has been previously explained, establishing a managerial culture has a major impact upon how line ministries and local governments are organised and the relationships between political officials and the civil or local government service officials. PFM/IC affects the relationship between central ministries, particularly the ministry of finance, and line ministries. Public administration (civil service) reform and PFM/IC reform activity also needs to be integrated. Before any decision is made to adopt this reform there ought to be a clear appreciation of these impacts (see the tests outlined in Chap. 4) not least because this indicates not only the managerial impact but also the scale of the reform. This may of course lead to a decision that this is not an appropriate reform at this time. It is far better to make such a decision at the outset rather than part way through the process.

As was explained in Chap. 4, the person who should have responsibility for explaining these impacts at the highest levels of the public administration ideally should be the chief civil service official in the ministry of finance (the state secretary or equivalent). This official should have a central role in the development of PFM/IC. Not only has this official responsibility for explaining to the minister of finance what the implications of the reform are, but for the reform to be successfully applied, he/she needs to convince and involve the equivalent officials in line ministries (and in some countries, local governments as well) in the development of the reform. Not only does this provide a greater appreciation of what the reform involves, but it also encourages ‘local ownership’. In those countries where there is a separate head of the civil service, then the ministry of finance state secretary should also consult with this official whose support would be essential. He/she may also need to consult with the staff of the parliament to explain how the changes are likely to impact on the role of parliament. 

The aim of the ministry of finance state secretary should be to establish an appreciation throughout government of what this reform involves and the benefits arising from the reform. This may require collaboration with those responsible for civil service reform to ensure that such reforms are compatible with the needs arising from the PFM/IC reform. It will also mean collaboration with the most senior civil servant in each ministry or public body to inform them of the main consequences of the reform for themselves and the civil service organisation they are, or should be, responsible for. Not least this will involve a switch in the focus of control from simply a control of inputs to in addition a control of outputs and then to ensure that regard is had to enhancing public value, that is, the efficient and effective use of public resources.

As was pointed out in Chap. 4 to assist the ministry of finance state secretary ideally a specialist department should be established with a specific responsibility for driving the implementation of the reform. (The responsibilities of such a department are discussed in Chap. 9.)

The first step in the implementation of PFM/IC should be for the ministry of finance state secretary, with the assistance of the driver department, to commission research into the practical implications of the reform and to prepare a ‘strategic analytical and planning policy paper’ for the minister of finance and the cabinet of ministers to explain the implications of the reform. (How this should be undertaken and the details of the areas that should be covered in this policy paper are described in Chap. 9). In preparing this policy paper the ministry of finance state secretary should consult with the chief civil servants in other ministries and public organisations. This ‘strategic analytical and planning policy paper’ would cover not only the principles of the reform but also the key changes that would be required including such matters as the management changes, budgetary and accounting changes, the redistribution of authority between the politician and the civil servant, the implementation processes and timescale, the costs that are likely to arise from the application of the reform policy and the potential benefits. (The benefits and costs are described in detail in Chap. 10.)

Where the reform is also intended to cover local government then all the points referred to above would also need to be discussed with representatives of local government.

5.2.2 The Appropriateness of the Decision to Introduce PFM/IC

The ‘strategic analytical and planning policy paper’ would enable the government to decide whether to proceed with the PFM/IC reform. This is not necessarily an easy decision especially where a country is under pressure from external organisations, such as aid organisations, to introduce the reform because it represents best international practice (and consequently, by definition, must be a ‘good thing’). Such pressure usually comes with an offer of funds. However, there are critical factors in determining whether to proceed with the reform and which should be addressed by the minister of finance and the state secretary. These are described in the nine tests set out in Chap. 4 which may be summarised as the potential risks arising from the reform. These include whether:

  • The present civil service organisational arrangements are appropriate, and the civil service has the capacity to accommodate the reform.

  • A willingness by ministers exists to delegate operational management to the civil and local government service.

  • The changes that may be required to the governance arrangementsFootnote 3 including those of second-level organisations are acceptable.

  • The quality of the present financial and budgetary controls and therefore the level of budgetary discipline is adequate to allow delegation.

  • There is a high risk of fraudulent and/or corrupt activity by officials, political or appointed, within the organisation (e.g. rent seeking by corrupt officials) which would be accentuated by the delegation arrangements associated with PFM/IC.

  • The capabilities of public organisation finance departments are adequate to provide the information managers will require.

  • The public finances are stable and are likely to remain stable given current internal and external factors.

  • There will be resistance to the development of transparency and public accountability.

Some argue that where weaknesses exist in the control arrangements a strengthening of internal audit within organisations would be the reform that is required. That though is an inappropriate reform where the management is weak, governance poor and financial analytical capability low. It would certainly not address the managerial or the financial management problems that are necessary to achieve a successful PFM/IC reform.

To make a thorough assessment of the risks associated with the reform the ministry of finance state secretary risk assessment should be an important factor in the discussions with other senior officials before drawing up the strategic analytical and planning policy paper.

Unless the proposed strategic analytical and planning policy paper can be positive about the issues referred to above, introducing the PFM/IC reform would be inappropriate and other reforms would be required first.  

To emphasise, where such a strategic analytical and planning paper demonstrates that adverse circumstances exist for the introduction of PFM/IC then a conclusion is likley to be that this is the wrong reform. Instead probably the most appropriate reform should be to strengthen PFA/IC. This could be coupled with proposing the introduction of the basic managerial elements of PFM/IC through proposals for the reform of the public administration. This will mean maintaining the external controls exercised by the ministry of finance over line ministries and local governments, or if the external controls exercised by the ministry of finance are weak, strengthening those controls.

5.2.3 A Critical Issue for a Minister of Finance

A principal responsibility of a minister of finance is that of the annual budget preparation. In preparing the budget a minister of finance will almost always be under pressure to increase public expenditure. This pressure may come from parliament, civil society as well as individual line ministries. As result the minister is bound to ask this question: ‘if we adopt PFM/IC, can we still maintain control of public expenditure when line ministries and local governmentsFootnote 4 have more control over expenditure decisions and can we raise our income more efficiently and effectively?’ As adopting PFM/IC, introduces a managerial culture into line ministries and local governments, managers need to have the discretion to make decisions and those decisions may affect both the levels and the distribution of public expenditure. Hence, potential ministry of finance anxiety!

However, the PFM/IC reform, if properly applied, is consistent with ministry of finance objectives of maintaining budgetary and financial control of public expenditure, securing adherence to the laws and regulations, achieving objectives, improving efficiency and effectiveness and ensuring that line ministries and local governments do not enter into commitments which may be difficult to finance in the future or which to finance them may have adverse effects upon other current activities of the organisation. In addition, PFM/IC should result in an improvement in the quality of the operational management and ultimately in the quality of policy making. Managers should also become more financially aware. In addition here should be a greater focus on the effectiveness of public sector activity, improved availability of the information necessary to inform effective policy making, a better quality of accountability and an improvement in corporate governance, not least because of improvements in decision making processes, including in internal control. It should also result in an improvement in the budgeting process because of an increased emphasis upon the linkage of financial inputs with the outputs expected from those inputs. In the managerial environment that PFM/IC introduces, as has been shown, finance is not simply about costs and income and comparisons with budgets. It is also about how well the money is spent and how all resources are raised and used in achieving the policy objectives and performance standards and objectives expected of an organisation. All of these benefits would be of advantage to a ministry of finance.

Parliamentary and ministry of finance interests in the establishment of PFM/IC should in large measure coincide. PFM/IC creates the opportunity for parliament to have available to it a better quality of information about objectives and performance, with potentially greater accountability and transparency and that in turn improves the quality of parliamentary scrutiny of the budget, of line ministry and other public organisation management which in turn impacts upon the quality of budgetary preparation and accountability.

To enable managers to make judgements about how well money is being spent or being raised, as has been pointed out previously, they are likely to require different analyses of information than that required for ministry of finance purposes. The minister of finance (and, by extension, the officials in that ministry), should accept this. They should also accept that this reform has consequential effects upon traditional budgetary and financial accounting arrangements within line ministries and local governments. The minister should recognise that as PFM/IC is a management reform, managers within line ministries, whilst continuing to meet the financial, budgetary and cash flow controls set by the ministry of finance, will need extended budgetary and accounting information in order to deliver their objectives efficiently and effectively. This will require the development of management accounting (including costing) within line ministries and local governments and the minister of finance should encourage this. Management accounting will provide a different form of analysis from that required for ministry of finance financial accounting and statistical reporting purposes. (A fuller description of the differences between financial and management accounting and the relationships between the two is given in Chap. 8.) The main point is that the determinant of that analysis should be the individual manager, usually in conjunction with the line ministry or local government’s head of finance, not the ministry of finance. Budgets also should be much more closely tied to expected outputs than normally occurs with traditional arrangements. (These radical changes point to advantages accruing from a pilot reform process before launching a full scale reform so that the ideas associated with the reform can be tested.) Individual operational managers will also need information about the total budget for their areas of operation, not just some elements (and very often with traditional arrangements in many countries heads of departments (the potential managers) will only have available to them limited budgetary information) . This will mean that the ministry of finance should accept from the outset that line ministry and local government budgets will probably have to be reanalysed to allocate them over managerial responsibilities. This reallocation would be a responsibility of the different public organisation managements. This means, for example, the allocation of all personnel, supplies and services, transport costs, all maintenance costs of assets and overhead costs. With current arrangements some, or all, of these costs may be held centrally by each line ministry or local government. The management accounting information required by the manager should enable the manager to identify the costs of different areas of activity including different cost centres and cost drivers. (See previous chapters.) A minister of finance should ensure that the top operational managers in line ministries and local governments have the willingness and capacity to provide the information managers need to deliver their objectives efficiently and effectively and within budget limits.

As a result, the minister of finance should recognise that ministries and other organisations will want to develop their own analyses of expenditure and income and hence coding structures for their own management purposes. This will be in addition to the coding specified by the ministry of finance for its purposes. The responsibility of a minister of finance is not to prevent this but to encourage it and at the same time ensure that the information it requires for financial reporting, international statistical purposes and for budgetary control purposes in accordance with the format of the budget approved by the parliament, is still available. An example of how this objective might be achieved is set out below in Sect. 5.3.4.

5.2.4 The Benefits and Costs of the Reform

The minister of finance will want to ensure that the benefits arising from the reform are achieved and the areas of cost arising from the application of this reform are fully identified. The minister will also require an assessment of the period over which these benefits will accrue, and costs will be spread. Chapter 10 describes in detail the range of benefits and costs that could result. The benefits potentially are substantial because they arise from a better quality of management and that strengthening internal control, which with the introduction of PFM/IC will have a focus upon outputs as well as inputs. However, such benefits are not immediately quantifiable. Costs can be immediate and quantifiable, and the principal costs will arise from the development of IT systems needed to facilitate financial analyses and to provide performance information, as well as investment in training of both managers and finance staffs. IT costs can be very substantial, especially if the country adopting PFM/IC has purchased an ‘off-the-shelf’ IFMIS which is not sufficiently flexible to allow alternative analytical information to meet the needs of managers.

The minister of finance should be determined to ensure that policies are developed to ensure that the potential benefits actually emerge, and that in turn depends upon the quality of management.

5.2.5 The Ministry of Finance and the Finance Function Within Line Ministries and Local Governments

An assumption in this section is that the current and investment budgets are integrated. If they are not this adds to the complexity of securing quality in public expenditure, especially where the different budgets are subject to different financial pressures. A further complication may also be that responsibility for expenditure on staffing may also lie outside the ministry of finance. A risk in such circumstances is to the development of a managerial culture within a line ministry of other public organisation, again raising questions about the appropriateness of the PFM/IC reform.

A managerial culture if properly developed should raise questions about how well public money is being spent and whether public resources are achieving the objectives and performance standards and objectives expected of line ministries and local governments. This, in turn, raises further questions that should exercise the minister of finance and the staff of that ministry about the quality of the financial and performance information on which a line ministry or local government’s policy and the strategy decisions for applying that policy are made. This should affect how a ministry of finance looks at their expenditure planning and budget execution processes. Other questions will include those about the financial resilience of the organisation. The answers to these questions, given a decision to proceed with the reform, will (or should!) affect ministry of finance judgements about the allocation of budgetary resources and how far it feels able to relinquish or modify its own controls. This consequently draws a minister of finance into considerations about the quality of line ministry or local government financial management.

An important feature therefore of the introduction of PFM/IC is the development of the role and responsibilities of the head of finance within ministries and local governments. A key management challenge is how to make the best use of public resources and an understanding of finance is central to that. The internal control standards referred to below in Sect. 5.3.5 (i.e. COSO) emphasise the importance of achieving efficiency and effectiveness. The head of finance is central to achieving that objective. The head of finance should aim to develop and maintain financial awareness and the policies and processes, such as management accounting and costing to control and manage the efficient and effective use of resources by the organisation’s management including that of second-level organisations. The head of finance should also be required to develop a long-term financial planning capability. All this information should be designed to support managers in the delivery of objectives efficiently and effectively. In Chap. 8 the responsibilities of the head of finance are described in detail. Given the enhanced role of the head of finance with PFM/IC the position should be of high status and where the senior staff of an organisation are formed into a ‘management team’ then the head of finance should be a member of that team. The state secretary in a ministry of finance should exercise influence to ensure that this occurs. 

In many countries the quality of financial management (i.e. as compared with financial control) will be a new area of interest for a ministry of finance. A ministry of finance should want to ensure that each line ministry or local government has a sufficiently high quality of financial management to enable it to deliver the objectives and performance standards and objectives that are or should be incorporated within the budgetary settlement, do so efficiently and effectively, and at the same time maintain budgetary and financial control. A better quality of financial information should also feed into the policy making process as operational management provides advice on the practicality of political proposals. With PFM/IC finance should be at the heart of decision making within each line ministry and local government. Because the role of finance is so central to the development of efficiency and effectiveness, as well as to control, a ministry of finance, with the application of PFM/IC should want to ensure that the quality of financial management across the public sector is of a consistently high standard. This would mean that as part of the reform the ministry of finance should consider the possibility of incorporating within it a department with a specific responsibility for enhancing the quality of financial management in all line ministries and local governments by:

  • Developing through training a resilient and expert community of finance professionals.

  • Ensuring that these finance professionals have a capability to provide the financial analyses that operational managers require to deliver objectives efficiently and effectively.

  • Establishing robust financial systems, standards, and policies, that provide reliable financial information, are up to date, cannot easily be corrupted because they are accompanied by standards and policies that are rigorously reviewed and enforced and that there is an appropriate division of responsibilities.

  • Sharing knowledge and best-practice across line ministries and local governments and with internal audit.

  • Developing frameworks, guidance, and tools to facilitate more informed, effective, and financial planning, performance, and management.

  • Developing those linkages that would facilitate effective cross-government collaboration, that is, the avoidance of ‘silos’, recognising that this is a difficult objective to achieve and demands cooperation at the highest levels.

A head of finance in a line ministry or local government adopting PFM/IC is not simply to act as a recorder of financial information, that is, levels of spending and income, acting as a financial controller. In most developing and transition economies, currently this is what the role appears to be. With PFM/IC it must be much more than that and a purpose of a ministry of finance should be to ensure that this wider role is appreciated and established in practice. This wider role includes ensuring:

  • In developing organisation policy, finance is fully considered.

  • Operational management is financially aware, has the financial management information it requires and incorporates financial judgements in its operational decision making.

  • Resources, both current and capital/investment, are used efficiently, effectively, and economically. (This may be complicated where different ministries are responsible for the current and investment budgets and where there are different pressures on those budgets.)

  • Management recognises that decisions made in one organisation can have significant impact upon other organisations (e.g. raising the school leaving age can affect employment policies, youth policies and policing policies).

  • Sound financial forecasting and long-run financial resilience is maintained.

This also means ensuring that financial data and data impacting upon finance, such as performance data, is robust.

The competencies needed by a head of finance have been defined by the Chartered Institute of Public Finance and Accountancy (CIPFA) and include:

  • Innovator: exploring ways to make the taxpayers’ money stretch further, often in collaboration with other organisations.

  • Business partner: influencing strategy and business outcomes, collaborating with managers to further policy goals, offering expert analysis and interpretation, presenting options to resolve problems and exploit opportunities; developing financial understanding and informed decision making.

  • Steward: safeguarding resources from loss, waste, abuse, or corruption; giving a reliable account of how resources have been used.

  • Provider/commissioner: maintaining the financial operation infrastructure and core financial administration processes, including specialist services, both directly and through commissioning external providers.Footnote 5

Because the capability of the head of finance coupled with the capabilities of the finance department of each line ministry and local government are central to the successful delivery of PFM/IC, the ministry of finance through the department responsible for the application of PFM/IC should be confident about this capability. Without this the benefits of the reform are unlikely to be achieved. Judgements about the head of finance capability would be based upon actual performance in the post and in the effectiveness of the finance department in meeting managerial requirements, and where appropriate those of the ministry of finance.

The development of the role of the head of finance may have the consequence that it leaves that official exposed to inappropriate pressures to approve of managerial actions (sometimes official and sometimes political) affecting finance which the head of finance may find difficult to resist even though such pressures may lead to a breach of the government wide financial regulations or to inappropriate decisions being made. Examples of inappropriate decisions are the overstatement of likely revenues to be derived from a particular activity, an understatement of the financial or fiscal risks that might accrue from pursuing a particular course of action. An issue therefore that a minister of finance should consider is whether the appointment and dismissal of a head of finance should be subject to the approval of the minister of finance, even though the actual appointment may be the responsibility of the relevant line ministry or local government. The need for the approval of the minister of finance to the appointment and dismissal of a head of finance would have the effect of strengthening the position of the head of finance where inappropriate pressures may develop. However, the role of the minister of finance would have to be exercised sensitively because a head of finance could not function effectively if he/she were regarded as a creature of the minister of finance rather than being wholly committed to the employing organisation.

In Chap. 7 the responsibilities of the head of operational management within a line ministry or local government are set out, and in Chap. 8 the changed role of the head of finance is discussed in depth.

5.2.6 How the Minister of Finance Should Regard PFM/IC

Critical to the introduction of PFM/IC is that the minister of finance regards the introduction as a:

  • Necessary reform to provide an overall better-quality management of public resources with greater financial awareness.

  • Complement to the introduction of other reforms designed to secure greater efficiency in the allocation of resources, such as long-term financial planning with the aim of securing long-term financial resilience in line ministries and other public organisations, medium-term budgeting, programme/performance budgeting, and gender budgeting.

  • Reform designed to create a greater possibility of achieving the objectives of the government.

  • Reform designed to improve the quality (i.e., better value for money) of public expenditure and income collection given the focus on achieving greater efficiency and effectiveness in the utilisation of resources.

  • Factor in reducing the need to resort to tax increases or borrowing to finance increasing or new demands for public services or to raise the standards of existing services because of the potential improvements in efficiency and effectiveness.

  • Method of improving the quality of governance so that there is a reduced risk of misuse of public resources through improper use of assets and other resources, fraudulent and corrupt behaviour.

  • Reform that the ministry of finance should want to see introduced irrespective of any requirements by an aid donor or other external organisation.

A minister of finance should accept that this reform is neither easy nor quick to introduce. It is a major reform which has an impact upon how public services and activities are managed. The impact of the reform may require a considerable change to traditional human resource (HR) and other administrative arrangements (see Chap. 14).

5.2.7 Coordination with the Different Ministry of Finance Technical Departments

Close cooperation will be necessary between the ministry of finance departments responsible for budgeting, treasury, and financial accounting activity (depending upon how the ministry of finance is organised) and a department established to support the state secretary in overseeing the application of PFM/IC. This is because the interests of the budgeting, treasury, and financial accounting departments will dominate the control interests of the ministry of finance; whereas the department responsible for the application of PFM/IC has a wider management focussed remit. These traditional departments of the ministry of finance may also perceive a loss of power because responsibility for some expenditure decisions will be transferred to line ministries. An objective of the department responsible for the application of PFM/IC should be to introduce into these ministry of finance departments an appreciation of the financial management information needs of management. The person with the principal responsibility for securing coordination between these different departments should be the ministry of finance state secretary. However, experience indicates that those more well-established traditional departments within the ministry of finance can be difficult to convince of the need for those changes that will be required for the effective application of PFM/IC. The overriding concern of those departments will be to ensure that budgetary control in the format for which the ministry of finance expects to be accountable is not weakened and that the ministry of finance’s ability to complete international statistical returns for organisations such as the IMF, the UN, Eurostat, and the Organisation for Economic Cooperation and Development (OECD) is not affected.Footnote 6

However, another problem will arise from the impact of the reform upon the financial information system in use by the ministry of finance. Where the ministry is using a standard ‘off the shelf’ commercial package there could be these types of problem which could cause difficulties for a ministry of finance:

  • The ‘off-the-shelf’ packages tend to be very rigid in their design. Governments must adapt their procedures and data to the computer system—not the other way around: therefore, providing the additional information or information in a format managers may require could be difficult.

  • The commercial suppliers of these packages may charge for the simplest modification/addition—typically if the ministry of finance or a ministry asks for some new reports they will be charged for, and therefore if managers require different reports from the standard reports this could be costly. This could also apply if managers wanted more detailed information which would require the development of the chart of accounts coding structures for an individual ministry (and each ministry could require that).

If a country has developed its own financial information system, these problems may not apply, but even so such a system is likely to require modification, not least to accommodate the additional information managers may require. Individual ministries may still need to develop their own financial information systems which must link with the ministry of finance system (see also Sect. 5.3.5).

The department responsible for the application of PFM/IC should recognise the existence of these concerns but at the same time explain the needs of line ministry and local government managements if they are to deliver objectives and performance standards efficiently and effectively. Some of the fears of these departments of the ministry of finance should not be realised provided that line ministries and local governments have an appropriate managerial and technical capacity to apply the PFM/IC reform. This is the point where confidence (trust!) does need to be built and if that does not exist these departments of the ministry of finance may be reluctant to engage in the reform.

The coordinating role of the ministry of finance state secretary is more complex in those countries where the investment budget is the responsibility of a ministry other than the ministry of finance and where responsibility for civil service staffing (HR) is also the responsibility of an organisation lying outside the ministry of finance. The policies of these ministries/organisations will need to be adjusted to reflect the development of PFM/IC.

5.2.8 The Minister of Finance and Other Ministers

PFM/IC should be accepted as a government wide reform with the prime minister (or in some countries, the president) having an overall responsibility. The minister of finance would need to work closely with this official to secure acceptance of the reform and this is likely to include the minister of finance having a responsibility to persuade fellow ministers of the need for this reform and the benefits that will accrue from its application. This will be part of the process for achieving local ownership at the organisation level. The minister of finance will also have to persuade them that to achieve the benefits of PFM/IC, organisational changes will be necessary to establish a managerial culture including changes to the public administration and HR arrangements. Therefore, other ministers would need to accept that there would be changes in how they work and in their day to day responsibilities. The changes were described in Sect. 4.2.4 of Chap. 4 and may be summarised as ministers responsible for line ministries should recognise that responsibility for operational management should be delegated to experienced civil service managers and that their own focus should be on policy and strategy development with an oversight role of the performance of the operational management. The minister of finance responsibility would be to persuade other ministers that this separation would be essential to the introduction of PFM/IC and the benefits it could bring. This also recognises that with the introduction of PFM/IC management becomes much more demanding. No longer will it be simply a matter of delivering an activity within budget. The minister of finance will need to make clear to other ministers that the PFM/IC reform will also require that ‘activities’ are clarified with objectives and performance standards and objectives and that their responsibility is to ensure that those objectives are delivered to time, to standard, efficiently and effectively as well as within budget and in conformity will all legal and regulatory requirements. As a result, the quality of budgets will need to be improved with objectives and performance standards and objectives being linked to budgets. This means that ministers and their operational managers agree that the objectives and performance standards and objectives are capable of being delivered within the available budget. (If not, as has been explained previously, then either the budget or the objectives and performance standards should be changed.) A similar understanding would need to be communicated by the ministry of finance state secretaries to equivalent officials in other public organisations.

Political management will also be required to satisfy itself that senior operational managers at all different levels, as well as themselves, can maintain overall control of the organisation, including over second-level organisations (see Sect. 5.3.9 and Chap. 12). To achieve that managerial accountability arrangements will have to become established which complement the arrangements for delegation. Ministers will also have to be persuaded by the minister of finance that they should invest in improving the capabilities of their organisations to deliver services efficiently and effectively. This means that operational managers have the financial and performance information that they need to secure efficiency and effectiveness.

Whilst the ministry of finance should welcome this reform other ministers may not do so. This can be due to several factors. For example, there may be resistance to increased transparency and accountability, a lack of willingness to delegate operational responsibility, tighter control over second-level organisations may be objected to because it reduces the scope for budgetary manipulation, tighter budgetary control because ministers will be accountable for delivering objectives and performance standards and objectives, as well as meeting budgetary controls, and doing so efficiently and effectively. A minister of finance should be prepared for these arguments and be willing to resist them.

Where the reform is intended to apply also to local government the minister of finance and the state secretary will need to establish similar relationships with mayors or their representative bodies.

In some countries a ministry of finance may seek to impose its view of efficiency. However, a ministry of finance is really in no position to make such a judgement. The responsibility lies with the operational management within a line ministry. However, a ministry of finance should have the capacity to challenge the judgement of that management and ought to do so where appropriate. Such challenges may occur during, for example, budgetary negotiations. Success in such negotiations depends upon the establishment of trust between a line ministry and the ministry of finance. A line ministry should set realistic and deliverable performance targets and not try to ‘game’ the system. The ministry of finance should be able to trust the judgement of line ministry specialists and as a result make available reliable funding.

5.2.9 The Minister of Finance and Parliament

The minister of finance should have not only a responsibility to agree the introduction of the PFM/IC policy with parliament and that means explaining all the different features of the policy, but also a responsibility to keep parliament informed of progress. This means that the minister should report regularly to parliament and where changes to the implementation policy occur, as they could well do, that parliamentary approval is sought. The minister should be accountable for success or failure to parliament.

The success with implementation should be assessed annually through the preparation of a ‘statement of internal control’ (see Chap. 13). This statement would be prepared by each public organisation, submitted to the ministry of finance who in turn should report on this statement to parliament. The statement would also be available to the external auditor who should review progress as part of the normal external audit activity and will provide a brief to parliament. This may form the basis for the interrogation of the minister of finance.

5.3 During the Reform!

5.3.1 Establishing the Appropriate Organisational Structures to Apply the Reform

As has been pointed out previously, the responsibility for operational application should be delegated from the minister of finance to the ministry state secretary who should be supported by a specific department responsible for the operational application of PFM/IC throughout the public sector. This department should issue detailed guidelines about how to apply the reform and should report to the chief official in the ministry of finance about the organisational application of the reform. It should also be responsible for maintaining the quality of the reform over time ensuring that the PFM/IC arrangements also reflect the changing operational environment.

The minister of finance, together with the state secretary should ensure that the department is appropriately staffed and has an ongoing capacity to oversee the reform. (The capacity requirements are set out in Chap. 9.) Countries wishing to join the European Union are required to establish such a department, often called a central harmonisation unit or department. The existence of such a department is regarded as one of the three pillars to the successful application of PFM/IC within those countries aspiring to meet the European Commission requirements. This arrangement provides a model that other countries could well follow. However, other aid organisations involved in supporting the application of PFM/IC may take a different view of the need for such a specialist department, although this author would regard such a department as an essential feature of the successful development of PFM/IC.

There will be some responsibilities that the state secretary can alone undertake. That official should have a personal responsibility for informing and coordinating the responses of equivalent chief officials in line ministries and for establishing regular meetings with such officials to review progress and to decide collectively how to address emerging problems. These personal responsibilities could also extend to local governments but whether they would depends upon the constitutional relationships between central and local government (see also Chap. 7). How the coordination arrangements should operate and the role of the state secretary are described in Chap. 9.

5.3.2 Cooperation with the Ministry or Department Responsible for Public Administration or Civil Service Reform

A crucial feature of success in the application of PFM/IC will be cooperation between the department responsible for overseeing the reform in the ministry of finance and the ministry or department responsible for civil service and public administration reform. If coordination does not occur, perhaps because no public administration reform programme exists (which in this author’s experience does occur) the PFM/IC reform, because it is a managerial reform, will seek to drive civil service and public administration reform. However, in practice it cannot do this. The minister of finance, and by extension the state secretary, has a responsibility to ensure that this coordination occurs, and that civil service and public administration reform takes into account the requirements of the PFM/IC reform. If no public service reform plan exists then it is doubtful if the PFM/IC reform will be successful. Consequently, this need for coordination will affect the timing of the arrangements for the application of PFM/IC reform. (It should be borne in mind that even though PFM/IC is a major reform, so too is civil service/public administration reform and it will similarly take a long time to become established.)

5.3.3 The Use of Performance Information

Many governments, usually through the ministry of finance, use performance indicators (sometimes called ‘key performance indicators’—KPIs) to assess the performance of organisations towards achieving policy objectives. These indicators can be simple (recording one element only of an activity), or composite (covering several aspects of an organisation’s activities). An example of a performance indicator is measuring the number of caesarean births (C-sections) and using that as a proxy indicator for the availability of certain maternity services. Such a measure could also be used as a key performance indicator expecting that a level of between, say, 5% and 15% of such births in a population would be through C-section with a higher or lower proportion raising questions about why this is the situation. Such a measure could then lead on to an investigation into the reasons.

However, performance information also needs to be used with care and can lead to unanticipated consequences. There is always the risk that a management focus is on what can be measured rather than the total service delivery context and ministries of finance should be aware of this.

A further issue that the ministry of finance ought to consider is whether performance objectives and/or performance indicators should be published along with the relevant financial information. This is important from an accountability point of view and the information needs of its key stakeholders such as consumer groups, parliament, and taxpayers. Publication may also be required for some services to meet international statistical requirements, such as those of the World Health Organisation. Publication may lead to challenge, but the benefits of challenge should not be overlooked, uncomfortable though on occasion, challenge might be.

The ministry of finance with the development of PFM/IC in making budgetary allocations should take an interest in the development of objectives and/or performance indicators by line ministries and other public organisations. Its interest will be much wider than that of external parties because it will need to be satisfied that the relationships between the financial allocations and the objectives, performance standards and performance objectives are robust and therefore that, as far as possible, each element represents reality. This again points to the need for trust to be established between the ministry of finance and line ministries.

Achieving precision in policy objectives is likely to take some time and the reality is that policy objectives and performance indicators will be refined over time. That precision will usually focus on the definition of the ‘outputs’ of policy objectives which for some services can be relatively easily defined, but for others, not, or there can be conflict in the objectives. Consequently, performance measurement can be difficult.

However, some would argue that anyway, ‘outputs’ are not that important and that what governments should aim for, is to achieve ‘outcomes’. The problem with ‘outcomes’ is that from a management point of view not only are they difficult to define with precision but ‘outcomes’ so far as public services are concerned can be influenced by many factors which lie beyond the ability of individual managers to control the results, no matter the level of budgetary resources which are available. ‘Outcomes’ rarely can be captured by a single budget or programme heading or even by a single public organisation. Outcomes can also take many years to achieve and would require very long-term budgeting, that is, well beyond the 3 years that apply even in the most developed economy countries. Therefore, for all practical management purposes the focus of financial management and internal control should be upon the achievement of the ‘outputs’ of policy objectives, with high-quality managers recognising that this only represents an interim step in achieving policy ‘outcomes’. For example, a policy outcome of reducing crime depends upon many factors and the activities of many organisations. First, the nature of crime has to be defined and what type of crime is the policy aimed at? Secondly the causes of that type of crime need to be understood and these can include, poverty, social attitudes, quality of housing, levels of policing, policing policies, public attitudes to the police, sanctions (that is both the level and types of sanction) and so on. The policy ‘outcome’ can only be achieved through a management structure designed to address each aspect of the policy with the results then coordinated. To do that effectively, individual managers need to be clear about what they are to achieve, that is, the ‘outputs’ and their activities need to be coordinated with a wide range of other managers, including coordination of budgets (often an impossible task). Some desired policy ‘outcomes’ are also not capable of being managed and require long-term societal changes of attitude, for example, to the role of the police and how society regards its relationships with the police.

Another approach is to require objectives to be broken down into sub-objectives because the sub-objectives are easier to define and hence the subsequent performance measures. This would then allow policy makers and senior officials to make decisions about what they wish to achieve in specific areas, rather than in a broader, but less easily definable, overall objective.

The same points also apply to ‘performance standards’. As indicated, an important element of management is to define the operational performance standards that should be applied. Some will be quite simple to apply, at least superficially, such as all customer queries must be replied to within 1 week, but that says nothing about the quality of the reply. That can only be judged by the quality of the managerial supervision and the existence of arrangements where the customer can complain about or follow up, in this example, on the quality of the reply. Other performance standards can be extremely complex, such as assessments of the educational performance of children, which in turn can depend upon a wide range of factors, or in the development of health policy measures to assess public and personal health. And then there is the question of performance objectives. These will identify or set targets for the amount of work to be undertaken, such as to undertake a particular number of vaccinations within a given period or to complet a specified number of asylum claims within a given period.

Or again both objectives and performance standards and objectives can be short term or long term, such as care for homeless persons. If the objectives or performance standards are short term, this will not address what could be the underlying problems and in that event the problems that they are designed to address will merely be repeated.

This though is the nature of public services. Political decisions may be required about specific objectives and performance and that can add to the complexity of any measures. (This is what makes the management of public services so difficult compared with the management of market based services and why political judgements need to be made.) However, despite these difficulties, with PFM/IC some measurement of success should be available to the manager even if it does not specifically address the overall main objective that a top or senior political manager is concerned about. Therefore, the reality is that in practice compromises may be necessary because precision in objectives or performance standards cannot be achieved.

None of this means that PFM/IC should not be developed; it however does demonstrate that achieving public policy objectives can be very difficult in practice and the limitations should be recognised. The boundary of these limitations will change over time as more experience is gained and information is obtained. PFM/IC is a practical recognition of that and that is why the implementation of the PFM/IC policy is so desirable, but the appropriate conditions must exist if the benefits are to be achieved. The benefits are also likely to take some time to emerge because of the fundamental nature of the reform and the learning processes involved.

5.3.4 The Organisation of Financial Information for Management Purposes

To facilitate the achievement of the benefits of PFM/IC managers in line ministries and local governments will require that budgetary and financial information is available to them in a form that suits their needs as well as those of the ministry of finance. There is no reason why individual line ministries (and local governments) should not develop their own financial analyses to suit their own needs and a ministry of finance should not stand in the way of this. In practice it would mean that individual public organisations develop their own coding structures designed to meet their own managerial needs but with the important proviso that such coding structures should link with those of the ministry of finance. The head of finance should have a key role in working with individual managers to determine their financial information requirements. (However, as has been pointed out previously, where countries have purchased off-the-shelf IFMIS this may be difficult because of the inflexibility of their coding structures.)

To illustrate the approach an extract is set out below from the government of CanadaFootnote 7:

The Receiver General—Central Accounting and Reporting SectorFootnote 8 is responsible for maintaining the accounts of Canada under Section 63 of the Financial Administration Act which includes the day to day management of the government-wide Chart of Accounts (COA) which specifically involves the creation, deletion or modification of accounts or codes, and the publishing of updates on the Receiver General government-wide COA website. In addition, the Receiver General provides functional direction, supporting operational instructions and other guidance to departments and agencies pertaining to the government-wide COA and government-wide coding. The Receiver General also performs a monitoring role for the overall quality of the information contained in the departmental monthly trial balances submitted to the Central Financial Management Reporting System (CFMRS) for inclusion in the accounts of Canada.

Departments are responsible for ensuring that their departmental coding is linked to the appropriate accounts and codes contained in the government-wide COA and that their financial transactions are complete and accurate. At the end of each month, departments summarize their financial transactions (based on the government-wide coding) and send their trial balances to the CFMRS for inclusion in the accounts of Canada. (Author’s emphasis)

Although this extract reflects the arrangements in Canada for the management of financial information for the purposes of financial and statistical reporting purposes, it also recognises the need for individual departments [i.e. ministries] to develop their own financial analytical arrangements but with the condition that whatever those analytical arrangements, each organisation must retain the capability to provide the information that the central finance organisation requires. Therefore, management accounting information, however it is produced, should be linked to the financial accounting systems of the ministry of finance to ensure that the ministry can fulfil its responsibilities. This linkage also ensures that the same basic financial information is used for budgetary control, financial reporting, and managerial purposes.

A consequence of introducing PFM/IC therefore will be a need for additional information technology capacity (IT) to provide the analysis managers require.

Because the PFM/IC reform extends the idea of control beyond simply budgetary and financial controls to include those controls designed to achieve the objectives of an organisation, to standard, to time, efficiently and effectively this extension creates the opportunity for ministries of finance to link budgetary inputs with the outputs expected for those budgetary inputs. This also means that managers should commit themselves to delivering those outputs. This is an important feature of PFM/IC.

5.3.5 Internal Control Arrangements Within Line Ministries and Local Governments

Success in applying PFM/IC depends upon the management of line ministries and local governments adopting a disciplined internal control structure and a ministry of finance has a key interest in this. Internal control enables the management of an organisation, and external stakeholders, including the ministry of finance, to have greater confidence that its objectives will be achieved, that financial and performance reports are reliable, that resources will be used only for the purposes of the organisation and that they will be utilised efficiently and effectively. The minister of finance should be responsible for specifying the principles of internal control that should apply within line ministries and local governments. In many countries the principles would be those developed by the Treadway Commission (COSO)Footnote 9 and these are explained in detail in Chap. 11. The responsibility for applying those principles within each line ministry and local government lies with the management of the organisation. The actual person responsible for the quality of internal control would be the person responsible for operational management, that is, the head of the civil service within a ministry (or equivalent in local government). That person should then report to the political head as appropriate under the managerial accountability arrangements. The ministry of finance should satisfy itself about the quality of these internal control arrangements which also provide an indicator of the success of the implementation of PFM/IC, and that the effectiveness of such controls is monitored and maintained as operational circumstances, policies, and personnel change over time. (See Sect. 5.4.3 on the annual review arrangements and also Chap. 13 on the ‘statement of internal control’.) The quality of the internal control arrangements would be subject to review by the state auditor who should report to parliament on that quality.

The responsibility of the ministry of finance (if a country decides to adopt the COSO approach) should be to ensure that the principles of internal control defined by COSO are properly applied. ‘Properly applied’ means that the management regards them as central to the management process, appreciates the managerial assumptions that lie behind them and is not prepared to accept a superficial approach which amounts to a focus only on the bureaucracy of the application of the 5 standards. That approach amounts to ‘tokenism’.

5.3.6 PFM/IC and Budgetary Control

The minister of finance, as part of the budget preparation process, will issue a budget circular. This circular will set out the guidelines for framing the budget and any instructions about how to address specific items. It will include a timetable for the provision of information to the ministry of finance and may also include a set of forms which individual ministries will be expected to complete. A consequence of the application of PFM/IC is that the content of the budget circular should be expected to change, and in some countries, this would be a considerable change, especially where the current budget circular contains very detailed instructions about the calculation of individual line item. (In one country known to this author the detail required included a specification of the amount of drinking water that could be allowed for by ministry employees.) This type of detail would be inappropriate with PFM/IC. The government through the ministry of finance would still determine budgetary policy including policy decisions about the overall allocation of resources and the totality of expenditure within any ceilings although the assessment of those ceilings should be better informed because of the linkages between input costs and outputs. Where medium-term budgeting has been developed the existence of detailed instruction about the development of the future year’s budgets will also require change. The reason for such changes is that as a key objective of PFM/IC is to encourage line ministries to become managerially oriented making their own decisions about the best way of achieving objectives efficiently and effectively, they need the scope to do so. In other words, PFM/IC allows managers increased discretion to use their initiative and detailed instructions from a ministry of finance about how to construct budgets can have the effect of removing or at best limiting managerial initiative.

PFM/IC also can affect the way in which many ministries of finance exercise control over budgetary changes proposed by line ministries, that is, over virement arrangements. The extent to which approval currently may be required depends upon the precise arrangements within the country and specified within the law. With PFM/IC ministries of finance should not seek to ‘second guess’ line ministries or seek to control at a detailed level the decisions of line ministries, or local governments especially where their managers are aiming to make changes to improve efficiency and effectiveness. For a ministry of finance to question every detail of a proposed change effectively puts them into a form of ‘superior’ manager exercising financial control, even if it does not intend to act in that way. This is incompatible with the idea of managerial competence, discretion, and hence accountability.

Consequently PFM/IC will impact upon ministry of finance/line ministry relationships, that is, they cannot remain the same. Indeed, if a ministry of finance tried to ensure that they remained the same this would undermine a key objective of PFM/IC which is to encourage line ministries to become managerially oriented making their own decisions about the best way of achieving objectives efficiently and effectively. In other words, PFM/IC allows managers increased discretion to use their initiative. Tight budgetary development rules and virement controls stifles initiative.

Therefore, some ‘control’ changes affecting the ministry of finance will be required, for example:

  1. 1.

    Traditionally the management of a line ministry or other organisation usually cannot adjust a budget at its own discretion unless the budget code within a particular country permits some change, but the degree of change is often set to ensure that a ministry of finance effectively retains a monetary budgetary control, rather than facilitating the achievement of objectives. Total budgets for an organisation usually cannot be changed although some redistribution over different detailed budget lines (i.e. ‘virement’) may be permitted. Some countries allow a ministry or other organisation to make changes up to a specified percentage, others require ministry of finance approval to any change. Exactly how these virement controls operate and the impact they have depends upon the extent to which they apply to each budget line and each department or activity of a ministry. If the virement control operates at a detailed level, then a line ministry or other organisation has little or no scope to make changes without the approval of the ministry of finance. This will inhibit effective management and should change.

  2. 2.

    In many countries the detailed budget is enshrined in legislation (the annual budget law). Changes to budgets affect the budget law and therefore at some point the approval of parliament is required. Limited changes initially may be approved by a ministry of finance, but the risk is that the bureaucracy may inhibit the extent to which managerial flexibility is required in order to improve efficiency and effectiveness.

  3. 3.

    Cash flow controls are again largely determined by the interests of the ministry of finance and the more detailed those controls the less scope managers have for change. Cash flow controls also follow the budget as determined by the ministry of finance rather than the operational activity requirements of the manager. They are often determined by the overall state of the government’s finances. Where ministry of finance approval is required to modifications to proposed cash flow this may prevent the line ministry manager making decisions, hence affecting that manager’s ability to deliver objectives efficiently and effectively. Therefore, cash flow controls may need to be reformed. (In some countries cash flow can be the determinant as to whether or not a manager is able to deliver objectives and examples have been provided to this author affecting the delivery of health and education services. Weaknesses in cash flow control can have their roots in inadequate budgeting such as over optimistic assumptions about tax flows.)

  4. 4.

    Linking budgets precisely to objectives and performance for some services and activities can be very difficult to achieve, no matter how good any financial analyses are. Therefore, when changing from a focus on budgetary inputs to an output focus this again ought to be accompanied by a rethinking of the rules on virement. In any event budgets are just forecasts and can be overtaken by changes of circumstances which may arise for economic, environmental, legal, international, or other reasons. Budgets are frequently based upon what happened in the previous year and do not necessarily reflect the performance objectives of a management and managers may not be able to foresee exactly how circumstances arising in the current operational year are likely to affect their ability to deliver objectives. This again points to a need for more flexibility in a ministry of finance approach to virement and in turn the detail which is to be included in any budget law.

What this means for budgetary control is that the ministry of finance with PFM/IC should be willing to shift its ‘control approach’ with the adoption of PFM/IC from that of detail to a broader concern for how a line ministry or local government is delivering its objectives to time, to standard, efficiently and effectively but within an overall budgetary envelope. (A traditional budgetary process may result in a tight budgetary and cash flow control, but it effectively inhibits managerial initiative within line ministries or local governments, aimed at achieving objectives.) However, to emphasise, such a shift should not occur unless the ministry of finance has full confidence that overall financial and budgetary control will be maintained by the line ministry and other public organisation management (see test of 1 Chap. 4).

5.3.7 PFM/IC and the Quality of Public Expenditure

Developing managerial initiative is an objective of PFM/IC. The aim is to improve the quality of public expenditure. Improving the quality means considering not just the control of spending but determining what is being achieved for that spending and how it is being achieved. PFM/IC therefore has the effect of highlighting a conflict, which should not exist, between traditional budgetary and cash flow controls and a desire to improve efficiency and effectiveness in public expenditure. Traditional controls have no regard for efficiency and effectiveness even though they remain essential if the conditions described in test 1 of Chap. 4 cannot be met. A ministry of finance should recognise the existence of this conflict and its adverse effect upon any drive to improve efficiency and effectiveness. Consequently, ministers of finance should reconsider how traditional budgetary controls operate. Ministers of finance will always remain concerned about pressures to increase public expenditure and their budget officers will be very alive to this issue. With the introduction of PFM/IC a minister of finance should look for ways of reconciling the requirements for expenditure control (the inputs) with the policy outputs that managers should be aiming to achieve.

Similar types of control to those which exist for expenditure may also exist for personnel. They have the same effect of limiting a manager’s ability to make changes to the personnel structure without the approval from another ministry or the ministry of finance. Again, the introduction of PFM/IC should cause a rethinking of the purpose and effectiveness of such controls. If a manager has no or very limited control over the utilisation of personnel resources, then the manager’s ability to deliver objectives efficiently and effectively can also be limited. (An example given to this author by the head of a maternity hospital was that he was not allowed to change a gardener post for a nurse post, at the same cost, to improve the utilisation of resources because the ministry of finance would not approve because of the risk of creating a precedent.)

A further feature of PFM/IC is that a consequence of the requirement to improve efficiency and effectiveness is that line ministries and local governments should take a longer-term view of their finances. (A ministry of finance should encourage this.) This means that they will need to develop long-term financial planning, that is, which may go well beyond the requirements for 3- or 4-year medium-term budgeting. Public services usually require long-term commitments and therefore efficiency and effectiveness should also be considered over the longer term. Decisions should not be made which do not have regard to the long-run financial implications of that decision, both on a particular service or activity and on other services and activities provided by the organisation. (That a particular decision secures a lower cost result in the short term does not necessarily improve efficiency and effectiveness: consideration should also be given to those other factors, such as quality, which will affect the long-run costs even if that means higher immediate costs.) Assessing long-run costs should be a key factor in decision making. It should also be a factor in securing the long-run financial resilience of an organisation. This should be of active concern to a head of finance. (This also illustrates the difficulty of relying simply upon foreign aid finance to support the development of PFM/IC because such aid is usually only committed for short periods and can be variable depending upon the interests and circumstances of the donor country.)

5.3.8 The Impact of PFM/IC on the Control of Second-Level Bodies Such as Agencies and State-Owned Enterprises

The PFM/IC reform will also require a much tighter control by first-level organisations, that is, by line ministries and local governments over second-level organisations such as agencies and state- and local government–owned enterprises. Overall, there should be a strengthening of accountability between second-level and first-level organisations, whether agencies or state- and local government–owned enterprises. The ministry of finance should consequently encourage controlling or owning first-level organisations to set for second-level organisations, objectives, and standards of performance and then first-level organisations must develop a capacity to effectively monitor the activities of those second-level organisations. Without this second-level organisations will tend to drive first-level organisations, rather than the other way round. This is because a second-level organisation will always know in more detail than the controlling or owning first-level organisation about their operational environment, and they will also be protective of their own interests and resist pressure to reform including pressure to improve efficiency and effectiveness. Therefore, the first-level organisation must always have the capacity to challenge.

The minister of finance also should ensure that where a first-level organisation wishes to establish a second-level organisation, that this is an appropriate action. The minister of finance should also ensure that when established the second-level organisation is efficiently managed and effectively supervised by the controlling first-level organisation. Controls over second-level organisations in countries with traditional public administrative systems tend to be weak. Introducing PFM/IC creates an opportunity for the minister of finance to require the strengthening of the controls and reporting arrangements for these second-level organisations. Set out below are the key policy points the minister of finance should address in strengthening controls (control requirements are discussed in full in Chap. 12). These key policy points ought to be included within a report to parliament:

  • The exact arrangements for the establishment of second-level organisations, including the content of the formal authorising authority, the minimum size before such an organisation may be established, the frequency of the review of that authorising authority including its continued existence.

  • The corporate governance arrangements for the second-level organisation and this is especially important for state-owned or local government–owned trading enterprises.

  • The arrangements for the appointment of the chief officials of the second-level organisation both members of any board and other senior officials.

  • The content of service level or performance or oversight agreements between the first and the second-level organisations, including for state or local government–owned enterprises, the financial arrangements and financial expectations for the enterprise: specific conditions should apply where an organisation provides services both to the public and to the private sector; the ministry of finance (or another appropriate central ministry) may specify the financial returns which should be expected from state-owned enterprises.

  • Where a state-owned or local government–owned enterprise operates in competition with the private sector it should be required to operate in such a way that it does not undermine the development of the private sector: this would be, for example, by ensuring that in developing its pricing structure a notional cost of capital was included, that it took into account commercial risk and that no cross subsidy existed between services and activities provided for the public sector and those provided for the private sector.

  • Where a second-level organisation earns income, whether a trading organisation or not, the second-level organisation should not be permitted to treat any such income as private to itself and therefore outside the controls applying to public sector income.

  • The arrangements for the making of payments (fees, salaries, and expenses) for members of the governing body of the second-level organisation.

  • The financial reporting standards that are to apply to state- and local government–owned enterprises; these should be those that would be expected to apply to private sector enterprises operating within the country.

  • The content of the formal annual report of the chairman and/or chief executive of a state- or local government–owned trading organisation and such a report should be a public document.

  • The external audit arrangements for state- and local government–owned enterprises.

Parliament should have the ability to scrutinise the operations of second-level bodies and be able to call the management to account as part of the scrutiny arrangements.

No second-level organisation should be permitted to agree its budget directly with the ministry of finance and ultimately with parliament, apart from those with a judicial authority and the state auditor. This is the practice in some countries but with PFM/IC all communications with the ministry of finance should be through the first-level organisation. Budgetary information about second-level organisations should be incorporated into the relevant first-level organisation budget which in turn should provide appropriate reports to parliament identifying the budgets for the second-level organisations controlled by the first-level organisation. If there are to be any exceptions these should be specifically agreed with the parliament.

With non-market second-level organisations the minister of finance should ensure that first-level controlling organisations satisfy themselves that the objectives and performance standards of the second-level organisation are consistent with their own and that they monitor the performance of the second-level organisation during the year.

The ministry of finance should ensure that a periodic review process exists to determine whether the second-level organisation should continue in existence.

5.3.9 PFM/IC: Securing the Managerial and Technical Capacity: Advice and Training

A particular responsibility of the department within the ministry of finance responsible for the application of PFM/IC will be to provide advice on managerial questions and technical support to line ministries and local governments. Examples of the type of advice that may be required include on managerial structures, delegation, and managerial accountability arrangements and on the management of relations with second-level bodies. Technical advice could include the specification and utilisation of financial information and for finance officials on budgetary, financial, cost and management accounting and on longer-term financial forecasting.

Civil servants will require training to help them develop the managerial skills that will be required. Heads of finance will require training to develop the skills needed to support a managerially oriented public administration. Skilled managers and finance officers are in short supply especially in the public sectors in many countries. This indicates a serious need to accompany the PFM/IC reform with the development of appropriate training programmes. Such training can be expensive, but the issue is ‘no training, no management’. (Note: this is NOT about training in the bureaucratic requirements of the COSO internal control arrangements.) The department responsible for the application of PFM/IC should not be expected to deliver such management and financial training but in conjunction with the organisation responsible for public administration/civil service reform should specify what is required. The training itself should be undertaken by an expert training organisation such as a local university and almost inevitably would require that training organisation to develop specialist post graduate courses. So far as finance officer training is concerned, such officials would require a basic training in accounting and economics, and they would need advanced training to develop the competencies set out in Sect. 5.2.5. The department responsible for the application of PFM/IC may specify what the training should cover but as with management training, the programme of training should be provided by a university or a similar training institution such as a professional accountancy body.

There is another aspect of training that is frequently overlooked and that is the training of parliamentarians and especially those involved in the scrutiny processes. Parliamentarians will need advice on the impact of PFM/IC and how it will affect the construction of the budget, the management of public services, the distribution of responsibilities between the members of the government and the civil service and the arrangements for accountability and transparency. Without such training there is a risk that parliamentary scrutiny will continue along traditional lines and that too, over time, at least, will affect the success of the PFM/IC reform.

5.3.10 Encouraging Managerial Initiative: A Need to Review Penalty and Inspection Arrangements

Test 8 in Chap. 4 identified a need to review the penalty, inspection, and sanction arrangements affecting civil servants and local government officials and the way in which inspection arrangements operate. The minister of finance should assess whether such arrangements remain appropriate in an environment where delegation and managerial accountability are such a key element in reform. This is because current civil service laws as well as existing inspection and penalty arrangements can act as a barrier to the exercise of initiative, and the delegation of responsibility. They can lead not only to financial penalties but also to disciplinary action being taken against a civil or local government official for making what some critics may regard as a wrong judgement. This is even though such a judgement has been made in conformity of all the relevant rules and regulations. This can occur where, for example, a political official takes a different view from that of the decision making appointed official. However, where the bureaucratic arrangements follow Weberian principles, civil service officials should be protected from political sanction. However, quite properly, civil or local government officials should be subject to disciplinary arrangements, and even to criminal investigation for wrongful acts, abuse of power, a failure to act in the public interest or actions which cause damage to public assets. The code of conduct affecting public officials should not expose officials to undue sanctions or pressure when making decisions under the delegation arrangements developed as part of the PFM/IC reform.Footnote 10

A very useful paperFootnote 11 has been published which examines how a regime of penalties or sanctions for breaching public financial management (PFM) laws and regulations can be designed to increase compliance with these laws. It advocates that designers of penalty regimes should have regard to five principles, that is:

Principle 1::

Sanctions should be applied fairly, consistently, and impartially. If this principle is not applied, the sanctions regime may be perceived as unfair, or designed to protect powerful elites. The regime will lose credibility, and the incentives to comply with sanctions are likely to be weakened.

Principle 2::

Sanctions should be proportionate to the severity of irregularities. If harsh sanctions, such as imprisonment, can be imposed for minor irregularities, the regime may be used to target political opponents, especially in countries where corruption in the public administration is widespread.

Principle 3::

Sanctions should be applied with a high probability of detection. Compliance with the regime may be reduced if wrongdoers know that irregularities are unlikely to be detected.

Principle 4::

Sanctions should be imposed transparently. Even if all the principles noted above are satisfied, a sanctions regime will only be effective if information is published on the irregularities that have occurred and the sanctions imposed.

Principle 5::

The design of the sanction’s regime should reflect that wrongdoers do not always react ‘rationally’ to the possibility of being detected. Several criminological studies have proposed a ‘tipping point’ theory, in which a sanctions regime has a non-linear relation with a reduction in the number of irregularities. If the frequency of penalties exceeds the tipping-point, the number of irregularities tends to increase … In the context of PFM systems, this theory suggests that imposing more sanctions will not necessarily have a positive effect on compliance.

5.3.11 Financial Regulations and Other Advice to Be Issued by the Minister of Finance

Many governments through the minister of finance have issued a set of financial regulations which determine how specific financial transactions are to be dealt with. Such financial regulations ought to be issued and reviewed regularly by ministries of finance in conjunction with line ministries and local governments. These regulations could be significantly affected by the introduction of PFM/IC and the decision to introduce this reform should stimulate review. For example, because a feature of this reform is that delegation and managerial accountability are developed, this will impact upon existing financial regulations if there is no recognition currently of the existence of these features. Again, advice could be provided through the financial regulations on the scope that could be granted by individual ministers or other senior officials, such as state secretaries, for the delegation of the approval of contracts and invoice payments, depending upon the size, complexity, and sensitivity of the transaction.

The coverage of those regulations is summarised in an annex to this chapter.

5.4 Sustaining the Reform

5.4.1 The Minister of Finance and the Timescale for Application

As was indicated previously, because of the fundamental nature of the reform the timescale for application is likely to be lengthy. In Chap. 4 there was a discussion about timing. In summary, ministers of finance ought to envisage at least 10 years from the development of the policy to actual application although in reality, financial management and internal control reform is an ongoing process as new experience is gained, new ideas developed and operational circumstances change. Exactly how long the initial application process will take though depends upon the starting point. Thus, if there is already a developed managerial culture with extensive delegation of decision making authority and developed managerial accountability processes, the timescale could well be much shorter. Again, where management accounting (including costing) has already been developed then this too will permit a shorter initial application period. What could also be an important factor in the time period is the extent to which both management training and accounting technical skills require developing. The length of time required to introduce PFM/IC will also depend upon whether other public financial management reforms are being introduced at the same time. For example, where accrual accounting is being introduced, this will have a significant impact upon the management accounting arrangements, upon financial and budgetary control and upon the responsibilities of management. Accrual accounting is both a technical and a managerial reform, if properly introduced. Application of both reforms at the same time, if the needs of both are to be properly considered will be delayed. Again, the same applies where programme budgeting is being introduced as well as the PFM/IC reform. Whilst these are complementary reforms developing them at the same time will stretch out of the reform timetable.

Another factor affecting the length of time the reform will take to apply will be the timetable for the reform of public administration.

Too many reforms undertaken in parallel also risk overstretching the resources of the ministry of finance and those departments or ministries responsible for civil service or public administration reform.

5.4.2 The Need for a Consistency of Approach over Time and for Consensus Between Different Strands of Political Opinion

Because of the length of time that it will take to introduce the PFM/IC reform ideally an agreed approach supported by all strands of political opinion, should be adopted. An important responsibility of a minister of finance would be to encourage this ‘cross-party’ support. Consistency in the reform policy over time will be an important factor in securing effective delivery in the shortest possible timescale. Even though a government may still remain controlled by the same political group(s) individual ministers may change. In such circumstances ministers of finance should recognise that there is a real risk that approaches to the application of PFM/IC may also change. Therefore, a minister of finance should ensure that arrangements do exist to secure consistency over time. Parliamentary oversight of the reform could also secure consistency of support and stimulate application especially where there is a regular change to elected officials.

In some countries the administrative and managerial arrangements within a ministry are governed by a ministerial decree issued by a minister and those issued by one minister may not be automatically continued in force without the specific authority of a new minister. Such a decree is unlikely to challenge the principle but may affect how the PFM/IC reform is applied in practice. The minister of finance has a responsibility to ensure that this situation does not occur, and this can be achieved in several ways. One would be regular assessments by the cabinet of ministers of progress in the application of the reform. A second would be by legislation requiring that ministerial decrees affecting the application of PFM/IC were approved by the ministry of finance (perhaps by the department responsible for the application of PFM/IC on behalf of the minister of finance). A third would be by a legislative requirement that ministerial decrees affecting the application of PFM/IC had no effect unless they were agreed with the ministry of finance. Or alternatively, by some combination of these approaches!

5.4.3 The Ministry of Finance and Annual Arrangements for the Review of the Impact of PFM/IC

Annually line ministries and local governments should prepare a formal statement explaining how they have applied PFM/IC and its effectiveness, including what has gone wrong, identifying failures to meet objectives and performance standards and objectives, and what corrective actions have been taken. This statement could also incorporate information about the risk assessment arrangements, including information about the types and level of risk that the organisation is willing to accept (the ‘risk appetite’). (See Chap. 11 for a detailed discussion about risk.) If this statement about the application of PFM/IC did not incorporate the information about risk, then a separate statement should be published. This statement should be signed both by the head of operational management and by the political head of the organisation. (A full description of such an annual statement, a statement of internal control, is included in Chap. 13.)

This is potentially a very important statement for a ministry of finance to consider. It should provide valuable information about the quality of PFM/IC within an organisation. Ideally this statement before it is issued should be reviewed by internal audit and following publication by external audit. The ministry of finance ought to consider the content of this annual statement and this should affect this ministry’s view of the quality of the PFM/IC arrangements applying not only in a particular organisation, but as all line ministries and local governments should prepare such a statement, including state-owned enterprises, more generally across the public sector. (The department responsible for the application of PFM/IC should have the responsibility to prepare a report of findings from these statements.)

The ministry of finance should issue guidance on the content of such statements. These statements should be publicly available and ought to be submitted to parliament as a feature of the accountability and transparency arrangements. When submitted to parliament they should normally form an element of the annual report which all public organisations ought to prepare, and which should be subject to review by the state auditor.

So far as local government is concerned a minister of finance should ensure (subject to individual country constitutional arrangements) that individual local governments also make public annually such a statement including for local government–owned enterprises.

5.5 Summary

The minister of finance has the principal responsibility for securing the effective application of PFM/IC. The ministry of finance is the ‘mechanism’ through which this responsibility will be exercised and the benefits achieved. The main aims of the reform are to secure the delivery of policy with the achievement of the objectives of a line ministry or local government, to do so efficiently and effectively and to improve governance, transparency, and accountability. The driving force for the application of the reform should be the minister of finance together with the state secretary who should be supported by a specialised implementation department.

Because the PFM/IC reform is primarily a management reform a key minister of finance responsibility is to ensure that coordination exists between those responsible for public administration (or civil service) reform and the staff of the department in the ministry of finance responsible for the PFM/IC reform. The minister of finance should also recognise the broad impact the reform will have upon many of the responsibilities of the ministry of finance. In particular, the introduction of PFM/IC will affect or complement:

  1. 1.

    Budgetary reforms such as the introduction of programme, performance, and other developments in budgeting.

  2. 2.

    The structure of budgets because of the need to recognise budgets as an important operational management tool as well as an economic management/budgetary control tool and therefore the structure of the budget should take into account not only the needs of the ministry of finance but also the needs of the managers in line ministries and local governments.

  3. 3.

    The form of the control exercised by the ministry of finance over budgets and in particular over variations to budgets during the year (i.e. virement).

  4. 4.

    The development of management and cost accounting to provide managers with the information they need to enable them to make judgements about efficiency and effectiveness both in income collection and in expenditure. This will affect the development of individual organisation coding structures. Managers should be able to determine how costs should be allocated for management purposes whilst at the same time continuing to provide the information the ministry of finance needs for budgetary control and statistical purposes.

  5. 5.

    The budgetary arrangements which should have a focus on the achievement of objectives, performance standards and performance objectives, that is, to the achievement of outputs within prescribed budgetary ceilings.

  6. 6.

    Responsibility for detailed budgetary control in the delivery of operational objectives and performance standards, within any constraints specified by political leaders in determining policy and the strategy for applying that policy, will shift to individual managers within line ministries and local governments from the ministry of finance with the latter retaining responsibility for overall control.

  7. 7.

    The approach to efficiency and effectiveness in the collection of income and in the delivery of public services and activities.

  8. 8.

    Lead to a longer-run concern for the financial resilience of the organisation;

  9. 9.

    Cash flow controls may also need to be revised so that management has more scope to meet objectives, to deliver performance standards and performance objectives as well as ensuring that arrears of payments to suppliers do not occur.

  10. 10.

    The arrangements for the relationships between first- and second-level organisations, whether agencies or state-owned enterprises, which will need to become more disciplined with the minister of finance issuing guidance of these relationships.

  11. 11.

    The issue and up to date maintenance of a set of financial regulations which define how the financial affairs of line ministries and local governments are to be managed.

  12. 12.

    The status and responsibilities of a head of finance because of their additional responsibilities which should include acting as advisers to managers and providing leadership throughout the organisation on financial matters. Where organisations have established ‘management teams’ the head of finance should be a member of that team. The added responsibilities of the head of finance potentially expose that person to greater risk and criticism and the minister of finance may feel as a result that the ministry of finance should coordinate the development of the finance function and become involved in proposals to appoint or dismiss finance officers.

  13. 13.

    Delegation and managerial accountability, cornerstones of PFM/IC, which require managers to make judgements in the delivery of objectives. Inevitably this involves risk but the present administrative laws, financial inspection and penalty arrangements may act in such a way as to inhibit the development of managerial capacity. The minister of finance should review all such laws and arrangements to ensure that they are compatible with the development of PFM/IC.

The minister of finance should ensure that internal control arrangements exist in conformity with its guidelines and that it assesses annually the quality and adequacy of line ministry and local government compliance. Line ministries and local governments should be expected to prepare an annual statement setting out how well the internal control mechanisms have performed during the year including failures and deficiencies (such as not meeting objectives and performance standards) and the corrective actions that have been taken.

A critical feature in the success of the PFM/IC reform will be the ability of the prime minister or other head of government supported by the minister of finance to convince fellow ministers of the need for this reform and the benefits that will flow from effective application. The minister of finance will consequently require a capacity to challenge the arguments of those who wish to retain traditional arrangements.

The reform is a long-term reform. An important responsibility of the minister of finance is to maintain the momentum of the reform over time and to ensure that it has widespread political support, that is, local ownership of the reform. A key to maintaining the momentum of the reform will be the establishment within the ministry of finance of a well-resourced and expert specialist department responsible for the detailed introduction and development of PFM/IC. This department should have equal status to other ministry of finance departments.

The benefits from the application of the reform are substantial but there are costs that will offset some of those benefits. However, if the reform is not properly applied and is regarded simply as a technical financial control reform focussed on introducing additional bureaucratic procedures the benefits of the reform will not be achieved.