Chapter

Chapter 5. Implications of Monetary Union for National Fiscal Institutions in East Africa

Author(s):
Paulo Drummond, S. Wajid, and Oral Williams
Published Date:
January 2015
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Author(s)
Richard Hughes

As discussed in the previous chapter, regional monetary integration requires enhanced fiscal coordination among member countries of the East African Community (EAC). Enhanced fiscal cooperation is needed in monetary unions in general for three main reasons. Over the long term, member states need to be prevented from running unsustainable fiscal policies that could undermine the long-term credibility of the common currency. In addition, member states need to ensure that the national fiscal stance is consistent with the region-wide monetary policy being pursued by the regional monetary authority. In the near term, member states need to rely on fiscal policy as the principle tool for managing domestic aggregate demand in the face of country-specific macro economic shocks.

Recognition of the need for enhanced fiscal coordination in monetary unions has prompted most common currency areas to adopt some form of fiscal convergence criteria applicable to all member states. To ensure national fiscal policies are sustainable over the long term, these convergence criteria typically take the form of upper limits on government fiscal deficit and debt. For example, the European Union’s (EU’s) 1997 Stability and Growth Pact required all member states to keep their fiscal deficits lower than 3 percent of GDP and debt below 60 percent of GDP.1 To ensure that national fiscal policies also support macroeconomic stability over the medium term, these convergence criteria often also require member states to target a fiscal balance over the next three to five years. For example, the West African Economic and Monetary Union’s (WAEMU’s) 1999 Stability, Growth, and Solidarity Pact requires all member states to target a zero or positive fiscal balance (excluding grant-financed expenditure) over the medium term.2 To allow national fiscal policy to support domestic demand in the face of country-specific macroeconomic shocks, these fiscal convergence criteria sometimes make explicit allowance for countercyclical fiscal policy. For example, in the 2005 revisions to its Stability and Growth Pact, the EU called for member state’s medium-term fiscal policy objectives to be expressed in cyclically adjusted terms.

The effective monitoring and enforcement of these fiscal convergence criteria typically requires the harmonization of member states’ institutional arrangements for fiscal reporting and budgetary management. Fiscal convergence criteria need to be applied consistently and fairly across member states. This requires, among other things, common definitions of “government,” common bases for measuring their fiscal deficits and debts, common methodologies for measuring and adjusting for cyclical effects, and common time frames and formats for reporting fiscal data. If they are to be respected, fiscal convergence criteria also need to shape all aspects of national fiscal policymaking from budget preparation through to end-of-year financial reporting. This requires national budget frameworks that can meet the demands of rule-based fiscal policymaking. The need to harmonize institutional arrangements for national fiscal policymaking in common currency areas has prompted several monetary unions to adopt directives on the budget frameworks of member states. Beginning in 1997, the WAEMU has introduced six directives that set minimum standards for member states’ annual budget laws, public accounting, budget classification, chart of accounts, summary fiscal reporting, and fiscal transparency.3 The Central African Economic and Monetary Community (CEMAC) introduced a similar set of public financial management directives in 2008.4 As part of its efforts to strengthen fiscal oversight and governance in Europe, the EU adopted in 2011 a new fiscal compact that included eight new regulations and directives regarding member states’ budget frameworks and fiscal reporting arrangements.5

This chapter considers the implications of East African Monetary Union (EAMU) for national fiscal institutions in the EAC. In doing so it:

  • discusses the implications of monetary integration for national fiscal institutions;
  • reviews recent efforts to harmonize national fiscal institutions in monetary unions in the EU and in Africa (specifically CEMAC and the WAEMU);
  • assesses the degree of harmonization between national fiscal institutions of the five EAC member states relative to the 27 member states of the EU; and
  • recommends a series of actions to help EAC member states to prepare for enhanced fiscal cooperation in the context of eventual monetary union.

Implications of Monetary Union for National Fiscal Institutions

As discussed in the previous section, monetary unions typically rely on a set of fiscal convergence criteria to promote fiscal policy coordination among member states. These often take the form of numerical limits and/or targets for fiscal deficits or government debt, and are typically set out in regional treaties, such as the EU’s 1997 Maastricht Treaty or the WAEMU’s 1994 Dakar Treaty. However, as long as fiscal policy remains the preserve of national governments, the surveillance and enforcement of regional fiscal rules depends on the quality and consistency of the institutional arrangements that govern fiscal policymaking in individual member states.

Translating regional fiscal rules into national fiscal outcomes requires strong legal, institutional, and procedural arrangements at each phase of the national fiscal policymaking cycle. As shown in Figure 5.1, one can identify six key fiscal institutions that need to be in place in all member states to ensure effective regional fiscal coordination across:

  • fiscal responsibility legislation which translates regional fiscal convergence criteria into legally-binding national fiscal rules,
  • fiscal risk management arrangements which ensure that national fiscal rules are met on a range of macroeconomic scenarios,
  • medium-term budget frameworks which translate national fiscal rules into a multiyear plan for government revenue and expenditure,
  • a top-down sequence to budget preparation and approval which ensures that annual budgets are consistent with government’s medium-term budget plans,
  • expenditure controls which ensure that annual budget limits are respected during execution, and
  • fiscal accounting, reporting, and audit arrangements which ensure that fiscal convergence criteria are accurately monitored and consistently applied.

Figure 5.1Implications of Monetary Union for National Fiscal Institutions

Source: Author.

The rest of this section discusses how these national fiscal institutions support fiscal coordination in a monetary union.

National Fiscal Rules

Given that fiscal policy typically remains the competence of member states in monetary unions, regional fiscal convergence criteria need to be given legal effect in each member state. This is often done through the passage of some form of fiscal responsibility legislation that requires the government to state and adhere to one or more numerical fiscal targets or rules in preparing and executing its annual budget. These national fiscal rules are sometimes directly transposed from the regional fiscal convergence criteria themselves and are sometimes more stringent than those criteria.

The need for regional fiscal convergence criteria to be translated into national fiscal rules is reflected in the public financial management directives introduced by monetary unions in Europe and Africa. For example, Article 5 of the EU’s 2011 Budgetary Frameworks Directive requires each member state to “have in place numerical fiscal rules which are specific to it and which effectively promote compliance with its obligations deriving from the Treaty on the Functioning of the European Union.”6 In Central Africa, Article 7 of the WAEMU’s Budget Directive required each member state to “define a medium-term fiscal objective which is consistent with the Central African Economic and Monetary Community convergence criteria.”7

Experience with fiscal rules over the past decade has highlighted a number of desirable characteristics. Recent surveys of the performance of fiscal rules across different countries suggest that the most successful fiscal rules tend to be:

  • enshrined in national legislation either in constitutions, through a freestanding fiscal responsibility law or via a clause in the national public finance or organic budget law;
  • comprehensive in coverage so that they apply not only to the central government budget but to a broader definition of the public realm, such as the general government or public sector;
  • expressed over the medium-term (i.e., a period of 3–10 years); and
  • monitored by independent fiscal institutions such as a fiscal council or parliamentary budget office.

By comparison with the EU, national fiscal rules are relatively rare and weakly specified in the EAC. As shown in Figure 5.2, around half of the EU members had at least one national fiscal rule in place compared with only one of the EAC’s members (Kenya). The EU’s fiscal rules tend to be broader in coverage, with around half applying to the general government or public sector. By contrast, Kenya’s fiscal rules apply only to the central government. The EU’s fiscal rules are also increasingly enshrined in national laws or constitutions, whereas Kenya’s fiscal rule is merely a political commitment of the government. Independent fiscal agencies are playing an increasingly important role in monitoring government’s compliance with their fiscal rules, although one EAC country, Uganda, has such an institution in place (the Parliamentary Budget Office).

Figure 5.2National Fiscal Rules in the European Union and East African Community

Sources: IMF, Fiscal Rules Database; and author’s estimates.

Note: EAC = East African Community; EU = European Union; MoF = Ministry of Finance.

1 Percent of all member countries.

2 Percent of member countries with at least one fiscal rule.

Fiscal Risk Management

If member states are to adhere to regional and national fiscal rules, they need to ensure their fiscal settings are consistent with meeting those rules on a range of scenarios. This requires member state governments to have in place mechanisms for evaluating the fiscal risks that can threaten the achievement of those rules. These mechanisms typically include the preparation of comprehensive fiscal risk statements, which evaluate both (1) the sensitivity of the government’s fiscal forecast to changes in underlying macroeconomic assumptions; and (2) the estimate and disclosure of discrete risks to the public finances such as guarantees, public–private partnerships, and natural disasters.

The public finance directives of both CEMAC and the EU include obligations on their member states to report on fiscal risks. Section IV.1 of the 2011 CEMAC Directive on Fiscal Transparency and Good Governance includes a requirement that member governments’ “annual budget documents presented to Parliament be accompanied by a report which identifies and evaluates the principal fiscal risks.”8 Article 4 for the 2011 EU Budget Frameworks Directive requires all member states to provide macrofiscal sensitivity analysis showing the “paths of the main fiscal variables under different assumptions as to growth and interest rates.”

The disclosure of fiscal risks remains relatively underdeveloped in both the EU and the EAC. As shown in Figure 5.3, just under one-third of EU member states include alternative macroeconomic scenarios in their budget documentation, and one-quarter present the fiscal implications of these alternative macroeconomic assumptions. Among the five EAC member countries, only one routinely provides alternative economic scenarios in their budget documentation and none routinely provides alternative fiscal scenarios. Disclosure of discrete fiscal risks is more advanced in both regions with 60 percent of EU members states and 40 percent of EAC member states including some qualitative discussion of specific fiscal risks in their budget documentation. However, less than 30 percent of EU member states and no EAC ones routinely publish quantified fiscal risk statements as part of budget documentation.

Figure 5.3Fiscal Risk Reporting in the European Union and the East African Community

(Percent of member countries)

Sources: Organization for Economic Cooperation and Development, Budget Practices and Procedures Database; and author’s estimates.

Medium-Term Budget Frameworks

Medium-term budget frameworks are a set of institutional and procedural arrangements through which governments commit to a particular path or plan for expenditure over a period beyond the annual budget horizon. In the context of monetary unions, such frameworks provide an institutional mechanism for member states to demonstrate that their current fiscal policy settings are consistent with respecting both regional and national fiscal rules not only in the budget year but also in the years beyond. The frameworks vary in time horizon, institutional coverage, degree of commitment, and level of detail. However, experience suggests that the simplest and most effective medium-term budget framework models cover a three- to five-year horizon, focus on controlling expenditure at either the aggregate or ministerial level, and set binding multiyear limits on expenditure which are only revised every two, three, or four years. By contrast, more indicative medium-term budget framework models that provide detailed multiyear projections of expenditures at the program or line item level and which are revised on an annual or infra-annual basis seem to contribute little to the establishment of multiyear fiscal discipline. The public finance directives of the CEMAC, the WAEMU, and the EU oblige their members to produce indicative medium-term budget frameworks. Article 53 of the 1997 the WAEMU directive on annual budgets requires each members’ annual budget document be accompanied by “multi-year expenditure planning documents which forecast, for a period of a least three years, the indicative evolution of expenditure and outcomes expected under each program.”9 Article 9 of the EU’s 2011 budget frameworks directive stipulates that all member states “shall establish a credible, effective medium-term budget framework providing for the adoption of a fiscal planning horizon of at least 3 years.”10

While medium-term budget frameworks are more prevalent in the EAC than the EU, they tend to be the less binding in the EAC than the EU. As shown in Figure 5.4, all five EAC countries have in place medium-term budget frameworks that cover the next three years as opposed to only 64 percent of EU countries. At the same time, the frameworks in the EAC tend to focus on detailed planning of expenditure at the program or line item level rather than maintaining overall expenditure discipline at the aggregate or ministerial level as in the EU. This is partly a function of the influence of external donors on the design of the medium-term budget frameworks in East Africa who regard these frameworks as a means to coordinate externally and domestically financed activity in particular sectors or for specific projects. The emphasis on detailed, bottom-up planning over broad, top-down discipline in the design of medium-term budget frameworks in the EAC can also be seen from the prevalence of rolling or indicative frameworks among EAC countries. In fact, all revise their medium-term budget framework ceilings every year compared with the EU, where 28 percent of countries’ frameworks fix multiyear expenditure ceilings that are not revised for two, three, or even four years.

Figure 5.4Medium-Term Budget Frameworks in the EU and EAC

(Percent of member countries)

Sources: Organization for Economic Cooperation and Development, Budget Practices and Procedures Database; and author’s estimates.

Note: EAC = East African Community; EU = European Union; MTBF = medium-term budget framework.

Top-Down Budgeting

If the multiyear expenditure limits set out in a member state’s medium-term budget framework are to be respected, the preparation and approval of annual budgets need to follow a top-down approach. This implies that the government makes a binding decision on expenditure at the aggregate level before deciding on the allocation of expenditure between individual ministries or programs. Where a country also has a medium-term budget framework in place, the expenditure limits set out in the previous year’s framework usually provide the initial limit for the following year’s budget. Comparisons between bottom-up and top-down approaches to annual budget preparation suggest the latter are more effective in ensuring that the approved budget is consistent with the government’s medium-term budgetary and fiscal objectives.

A top-down approach to budgeting is a requirement under the CEMAC, the WAEMU, and EU public finance directives. Article 57 of the 2009 the WAEMU directive on the annual budget requires member states to submit a medium-term economic and budgetary strategy to parliament for a budget orientation debate before the end of the second trimester of a year. The EU’s 2011 directives on strengthening economic and fiscal surveillance applies a top-down approach at the regional level by introducing the so-called European semester in which member states submit their medium-term budget frameworks to the European Council and European Commission for their approval in April prior to preparing their annual budgets.11 Article 10 of the budget frameworks directive then requires that member states’ “annual” budget legislation shall be consistent with the provisions of the medium-term budget framework. Specifically, revenue and expenditure projections and priorities resulting from the medium-term budgetary framework shall constitute the basis for the preparation of the annual budget.12 Finally, to ensure that the final budget approved by the national legislatures of member states remains consistent with the medium-term budget framework limits approved at the start of the budget process, both CEMAC (Article 54) and the WAEMU (Article 59), and directives on the annual budget prohibit legislatures from proposing amendments to the annual budget law that increase expenditure or reduce revenues.

Top-down budgeting is more prevalent among EAC countries than in the EU, though in both regions the budget process in the legislature continues to follow a largely bottom-up process. As shown in Figure 5.5, all EAC member state governments set overall and ministerial ceilings at the start of the budget process. This compares with only 72 percent of EU countries setting overall ceilings and 64 percent setting ministerial ceilings. At the same time, only 20 percent of EU and EAC countries’ legislatures hold formal budget orientation debates. And in only 36 percent of EU countries and 40 percent of EAC countries do legislatures first approve the overall expenditure level before voting on the allocation of expenditure between ministries, programs, and line items.

Figure 5.5Top-Down Budgeting in the East African Community and the European Union

(Percent of member countries)

Sources: Organization of Economic Cooperation and Development, Budget Practices and Procedures Database; and author’s estimates.

Budget Execution

Once the annual budget has been approved by parliament, hopefully in line with regional and national fiscal rules, member-state governments need to have in place the expenditure controls that ensure budgetary limits are not exceeded during execution. Robust expenditure controls regimes comprise a range of preventative, compensatory, and punitive measures for dealing with overspending. Among the most important are systems of commitment control that prohibit line ministries from making expenditure commitments that exceed their appropriations. Where these controls fail to contain emergent expenditure pressures, most governments set aside a small, unallocated contingency reserve within their budget to fund these unforeseen expenditures. In cases where this contingency reserve is exhausted and it becomes necessary to exceed one or more appropriations approved by parliament, governments should be obliged to seek prior legislative approval via a supplementary budget. If ministries are found to have exceeded their appropriations without prior approval of parliament, then administrative, financial, or criminal penalties should be imposed on the parties responsible.

Provisions concerning expenditure control feature more prominently in the public finance directives of the CEMAC and the WAEMU than those of the EU. Both the CEMAC and the WAEMU directives on their annual budgets devote an entire chapter to budget execution. The CEMAC directive has the most elaborate set of requirements in this area which, among other things, obliges member states to (1) grant the minister of finance the power to nullify appropriations in cases where the government’s fiscal objectives are threatened, (2) identify the officers in each ministry responsible for the enforcement of expenditure controls in each ministry and public entity, (3) ensure that systems are in place to prevent expenditure commitments from exceeding appropriations released to each ministry or entity, (4) require governments to seek legislative approval via a supplementary budget for any breach of the limits approved by parliament, and (5) have in place an escalating set of sanctions to be levied against those officers responsible for financial mismanagement. By contrast, the EU 2011 budget frameworks directive concerns itself primarily with budget preparation and fiscal reporting with no specific provisions relating to budget execution.

Controls over budget execution are another area where EAC countries lag behind those in the EU, despite the latter’s lack of any specific regional obligations in this area. The organic budget laws of 40 percent of EAC member countries permit the government to overspend their original budget up to a certain amount before they are obliged to seek parliamentary approval of a supplementary budget. By contrast, only 8 percent of EU countries include such a loophole in their organic budget laws. Central contingency reserves tend to be less common in the EAC than in the EU with only two of the five EAC members including some central reserve provision in their budgets compared with 80 percent among EU countries. As a result, supplementary budgets tend to be more common and larger among EAC countries than in the EU, with the average overspending among EAC countries at over 5 percent per year, compared with an average of less than 2 percent among EU countries (Figure 5.6).

Figure 5.6Budget Execution in the East African Community (EAC) and the European Union (EU)

Sources: Organization of Economic Cooperation and Development, budget practices and procedures database; and public expenditure and financial accountability reports.

Fiscal Reporting

The effectiveness of the surveillance of member states’ compliance with regional fiscal convergence criteria depends on the quality of national fiscal reporting practices. The consistent application of regional fiscal rules requires standardized institutional coverage, accounting basis, and formats for fiscal reporting. The proactive surveillance of member states’ compliance with those rules requires common standards for the frequency and timelines of reporting. To ensure the integrity of reported data, fiscal data should be prepared in line with international statistical and accounting standards, disseminated by an independent statistics agency (in the case of fiscal statistics), and audited by an independent audit body (in the case of financial accounts).

The CEMAC, the WAEMU, and EU public finance directives all place considerable emphasis on the harmonization of fiscal reporting standards and practices across their members. Five of the six CEMAC and the WAEMU public finances directives relate to various aspects of fiscal reporting including member states’ transparency, accounting standards, budget classifications, charts of accounts, and summary fiscal statements.13 The EU budget frameworks directive requires all member states to report in line with the EU’s own statistical standards, the 1995 European System of Accounts. The directive also instructed the European Commission to assess the suitability of requiring all member states to adopt International Public Sector Accounting Standards as the basis for the production and complication of public accounting data.

Fiscal reporting practices are considerably more comprehensive and harmonized across EU member states than among EAC countries. As shown in Table 5.1, the coverage of fiscal statistics among EAC countries is limited to either budgetary central government or central government in four of the five EAC countries. Only Rwanda publishes fiscal data covering the whole of general government (consolidating central government, local government, and social security funds). By contrast, in the EU all member states are required to report fiscal data for the general government. Fiscal reports among EAC countries typically include only cash transactions, though Burundi and Uganda report some accrual-based flows. Coverage of stocks is even more limited with only two countries providing some balance sheet information. In the EU, member states are obliged to report stocks of financial assets and liabilities. Reporting of fiscal data is relatively frequent among EAC countries with three of five countries publishing data on a monthly basis, though sometimes with a lag of two months or more. In the EU, member states are required to report data only on a quarterly basis, although many report more frequently. Finally, assurances of data integrity are general weaker among EAC countries than in the EU. Only two of five EAC countries undertake the full set of consistency checks (between flow measures, between stock measures, and between flows and changes in stocks), which are required among EU member states. In none of the five EAC countries is responsibility for compilation and dissemination of fiscal data vested in an independent agency, whereas this is a requirement of all EU member states.

Table 5.1Fiscal Reporting in the East African Community (EAC) and European Union
EAC Member Countries
BurundiKenyaRwandaTanzaniaUgandaEuropean Union
Coverage of institutionsCentral governmentBudgetary central governmentGeneral governmentBudgetary central governmentCentral governmentGeneral government
Coverage of flows Coverage of stocksCommitment NoneCash NonePayment orders NoneCash Financial liabilitiesModified cash Financial assets and liabilitiesModified accrual Financial assets and liabilities
Frequency of reportingMonthlyMonthlyQuarterlyQuarterlyMonthlyQuarterly
Consistency checksFlowsStocks, flows, and stock flowStocksStocksStocks, flows, and stock flowStocks, flows, and stock flow
Statistics agencyMinistry of FinanceSemiautonomous agencyMinistry of FinanceMinistry of FinanceSemiautonomous agencyIndependent agency
Source: Authors.
Source: Authors.

Conclusions

A concerted effort to enhance and harmonize national fiscal institutions among EAC countries is required if the fiscal convergence criteria underpinning any monetary union are to be respected. The effort will require reforms in all member states and at all stages of the budget cycle. The foregoing analysis identifies the need for action to:

  • require all EAC countries to legislate for comprehensive, medium-term, and independently monitored fiscal rules that are consistent with meeting EAC-wide convergence criteria and can be temporarily exceeded only in exceptional circumstances;
  • routinely analyze, disclose, and manage fiscal risks arising from both macroeconomic shocks and discrete sources;
  • adopt more binding medium-term budget frameworks that ensure national fiscal rules are supported by credible, multiyear budget plans;
  • adopt a more top-down approach to the discussions and voting on the annual budget in national legislatures to ensure that budgets approved by parliaments are consistent with government fiscal rules and medium-term budget plans;
  • require all EAC countries to make adequate provision for contingencies during budget preparation and tighten the rules around the use of supplementary budgets; and
  • improve the comprehensiveness, timeliness, and reliability of fiscal reporting.

Based on the experiences of other monetary unions, bringing about the harmonization of national fiscal practices will require the development of a national budget frameworks directive. Such a directive, modeled on those of the EU, the CEMAC, and the WAEMU, would need to specify the minimum requirements of the budget frameworks of those EAC member states wishing to join the monetary union. This directive needs to be supported by a program of technical and mutual assistance to help countries bring their fiscal institutions and practices into line with the requirements of the directive. The implementation of the budget frameworks directive also needs to be monitored and enforced through a process of peer review by EAC member countries and/or central monitoring by the EAC secretariat.

References

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1Resolution of the European Council on the Stability and Growth Pact, Amsterdam, June 17, 1997 (97/C 236/01).
2Pacte de Convergence, de Stabilité, de croissance, et de solidarité, December 1999 (Règlement N° 11/99/CM/UEMOA).
3WAEMU Directives 01,06,07,08,09,10/2009/CM/UEMOA, 2009.
4CEMAC Directives 01-06/11-UEAC-190-CM-17, 2011.
5EU Regulations No. 1173-7/2011, 2011, and Directives 2011/85/EU, 2011.
6European Council Directive 2011/85/EU, November 8, 2011.
7CEMAC Directive 01/11-UEAC-190-CM-22.
8CEMAC Directive 06/11-UEAC-190-CM-22.
9WAEMU Directive 06/2009/CM/UEMOA, 2009.
10EU Directive 2011/85/EU, 2011.
11EU Regulations No 1175/2011, 2011.
12EU Directive 2011/85/EU, 2011.
13CEMAC Directives 02,03,04,05,06/11-UEAC-190-CM-17, 2011. WAEMU Directives 01,07,08,09, 10/2009/CM/UEMOA, 2009.

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