Resilience and Growth in the Small States of the Pacific

Chapter 15. Planning Public Financial Management Reforms in Pacific Island Countries

Hoe Khor, Roger Kronenberg, and Patrizia Tumbarello
Published Date:
August 2016
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Tobias Haque, Richard Bontjer, Mary Betley and Ron Hackett 

Weaknesses in public financial management (PFM) compound economic vulnerabilities in many Pacific island countries (PICs). These countries face challenges in small domestic markets, high transport costs, and exposure to a wide range of shocks such as natural disasters and volatility in the terms of trade. Yet their weak PFM systems—and government processes for raising public revenues, implementing macroeconomic policy, and ensuring the efficiency and effectiveness of spending programs—often limit their abilities to respond effectively. Accordingly, many PICs are prioritizing PFM reforms to build revenue bases, better align government spending programs and social and economic objectives, and bolster resilience to economic volatility and natural disasters.

PFM reforms face unique constraints in PICs. In addition to the challenges larger countries face in implementing PFM reforms, most PICs must also grapple with the constraints particular to small populations (Haque, Knight, and Jayasuriya 2012). With limited human resources, civil servants, and secondary and tertiary educational institutions crucial to development, PIC labor markets often lack the skills for some specialized PFM functions. Frequently, there are simply too few people to complete all of the functions required in a full PFM system, with available staff stretched across a wide range of functions. PIC public sectors also face strong competition for human resources from the local private sector, donors, and nongovernment organizations, both locally and overseas. Capacity building is often disrupted, as staff with newly acquired skills and qualifications move to new roles in and outside of the public service.

Capacity constraints have not always been adequately reflected in the design of PFM reforms in the Pacific. It is common practice to develop PFM reform plans or “road maps” based on the weaknesses identified in standardized assessments of PFM systems under the Public Expenditure and Financial Accountability (PEFA) framework, rather than setting priorities for reform.1 It is therefore important that PICs identify these objectives when a PEFA assessment lists more PFM weaknesses than they can realistically address. Broad and ambitious reforms often not only provide ineffective support for sustainably improved PFM performance, but can actually harm PFM systems by diverting scarce capacity away from areas that are more important for service delivery and macroeconomic stability.

PFM reform needs to fit Pacific realities. This chapter suggests ways reforms can do so and better match the development priorities of PICs. Taking account of the inevitable resource and capacity constraints in these countries, there should be an emphasis on:

  • Tight prioritization of reforms—Capacity constraints mean that PICs cannot implement all of the functions assessed under the PEFA framework or expected of PFM systems in larger countries. PICs therefore need to target available capacity to improve PFM functions that are likely to have the greatest development impact, even if this means poor PEFA scores in lower priority areas.
  • “Good enough” rather than “best practice” solutions—In specific priority areas for individual PICs, establishing processes that achieve goals and address key risks is more important than implementing processes that resemble those used in larger countries. One example of an often repeated failure is the approach tried in some PICs to move toward “outcome budgeting.” Sometimes, this has been tried in a rather abstract and remote way from the activities that service-providing departments are conducting on a day-to-day basis. These approaches have often ignored a basic building block of any good approach to budgeting—getting the divisions or units of a ministry or line department to first prepare budget narratives that clearly state what they do, what they think they should do, the issues they face, and how public services will change if their funding request is granted.
  • A broad range of approaches to addressing capacity constraints—Capacity-building efforts have been the standard solution to capacity constraints in PICs for many years. These approaches have met with uneven success, however, because of high staff rotation, emigration of skilled staff, and fundamental constraints to the number of specialized tasks that a small number of public servants can perform. Alternative approaches to meeting capacity gaps include drawing on regional facilities for capacity supplementation in vital areas, and contracting certain specialized PFM functions to private sector or nongovernment providers. If appropriately designed and implemented, these approaches—in some circumstances—can be more sustainable than attempts to build local capacity.

The rest of this chapter outlines good practice in planning PFM reforms, presents a framework for prioritizing PFM reforms for best possible use of available capacity, and suggests ways PICs can ameliorate capacity constraints. The chapter complements, and is consistent with, extensive previous work by other organizations supporting improved PFM globally and across the Pacific, including the Pacific Financial Technical Assistance Centre, the PEFA Secretariat, the IMF, and the European Commission.2

Planning Public Financial Management Reforms

There is no single blueprint for designing and implementing PFM reforms. Suitable approaches will vary by country and circumstance. The experience in the Pacific region shows that careful planning of reforms is vital to sustainable gains given the importance of making the best possible use of scarce capacity. Development of “PFM road maps” has emerged as a common approach to planning and sequencing these reforms in PICs, and one regional agencies and PIC governments have endorsed as good practice.

Functions of a Public Financial Management Road Map

PFM road maps are used to convert a PEFA assessment and other analytical inputs into a reform process. They outline a realistic list of specific, prioritized, and sequenced PFM activities to be undertaken over a given period. They identify expected improvements and assign responsibility for undertaking these reforms to specific teams or agencies within government. A good road map will provide a framework for monitoring progress and a tool with which to communicate and build consensus around PFM reform plans.

PEFA assessments, generally undertaken by teams of government officials and donor-financed technical advisors, are often the starting point for PFM reform programs in PICs. But such assessments, alone, do not provide an adequate basis for planning PFM reforms. In particular, the PEFA assessment does not provide information on (1) priorities for PFM reforms, when there may be many “low” PEFA scores (that is, C, D, or NR [not rated] scores against particular dimensions and indicators); (2) appropriate sequencing of PFM reforms, given that progress in one area of PFM is often dependent on progress in another; (3) specific actions to address underlying causes of PFM weaknesses, including capacity development or supplementation requirements; and (4) limits to the extent of possible reform arising from capacity and resource constraints. Attempting to simultaneously address every low score in a PEFA assessment is unlikely to be feasible, or represent an effective use of scarce resources. Countries need to carefully consider which weaknesses to address, how to address them, and in which order to address them.

Good Practices in Public Financial Management Road Map Development

The process used to develop a PFM reform road map is critical. Experience in PICs has demonstrated the importance of the following factors:

  • Taking account of the political context—Planning PFM reforms is not just a technical process. Planning PFM reform involves the allocation of resources, work, and responsibility, which may have impacts not in the narrow interests of all parties. Planning PFM reform is therefore, inevitably, political. Plans that do not take account of the interests of key stakeholders are unlikely to be implemented. At all stages, planning processes should take account of potential sources of political opposition, allow space for discussion and debate over reform priorities, and build broad ownership and political support for planned reforms.
  • Allocating sufficient time and resources—The same capacity constraints that impede PFM systems and reforms can also impede the planning of PFM reforms. Investing the time and effort of available staff in road map development can have high opportunity costs. But such investment is, ultimately, likely to be worthwhile given the potential inefficiency that can arise from a poorly designed PFM reform process. Allocation of adequate time from finance ministry officials is vital, but it is also important to ensure that sufficient staff time is available within other central and line ministries affected or involved in reforms.
  • Government leadership—A PFM road map is ultimately a government document, although it may also serve some purpose in communicating with donors or external stakeholders. Government resources will be used to implement reforms, and the actions of government employees will determine their success. Government leadership of the PFM road map development process is therefore vital, with government staff both making the required decisions and leading the drafting of the document. While technical assistance can be a useful input to this process, required levels of ownership can only be achieved if officials, in close contact with ministers, lead the process.
  • Ensuring extensive consultation—Consultation is required with technical staff working in different PFM areas, senior managers overseeing these areas, and representatives at the political level. Consultation with donors, while not always necessary, can help build support for the PFM priorities identified by the government and facilitate the provision of required resources and technical assistance. Civil society organizations and the private sector could also be involved in consultations. While potentially time consuming, this can help build ownership and consensus around the road map and ensure that it incorporates the government’s priorities for reform. If external consultants are used to develop a PFM road map, terms of reference should emphasize the need for close coordination with the government to ensure the road map is consistent with government objectives and priorities and well understood by all key government actors.
  • Taking a medium-term focus—PFM reforms take time to implement. If the time frame for the road map is too short, goals are unlikely to be achievable. But time frames for implementing reforms also need to be short enough to ensure that progress can be regularly assessed to ensure accountability and demonstrate results. In PICs, a time frame of three to four years for the reform action plan is generally appropriate.
  • Building in adequate flexibility—While planning is important to build political support and achieve efficient resource allocation, PFM priorities will change with broader economic and political circumstances. Building flexibility into plans can be important, particularly when plans span political cycles.

Box 15.1.New Approaches to Road Map Development

The Pacific Financial Technical Assistance Centre (PFTAC) in 2012 began changing the legacy approach used to develop road maps. Instead of continuing the earlier practice of allowing them to be prepared just by external consultants, the new approach provided a mentor to teams of officials from the country preparing a road map. The Public Expenditure and Financial Accountability (PEFA) framework’s “self-assessment workbooks” were used to ensure that team participants understood the PEFA rating criteria used to evaluate their systems. Participants were then encouraged to discuss public financial management shortcomings identified by their PEFA assessments and prioritize changes that in their view were most critical to their county’s development. They were also asked to write the road map themselves to improve ownership. The mentor was available for advice and guidance during the preparation process if needed, but the goal was for country officials to develop their own improvement plan. The process has been successfully implemented in almost all of the countries covered by PFTAC.

Methodology for Road Map Development

Approaches to developing a PFM road map will vary (Box 15.1). The methodology needs to be tailored to take account of available capacity and resources, existing analysis and background material, political interest, and the role to be played by technical assistance or other external stakeholders. While individual approaches will be country specific, all should lead to an output based on the government’s own priorities and be realistic in terms of the resources available.

Prioritizing Public Financial Management Reforms

One of the most important functions of a PFM road map is to identify the relative priorities for reform when a PEFA assessment identifies more weaknesses than can realistically be addressed. PFM reforms, especially those involving changes to established processes and systems, are notoriously effort intensive and time-consuming. Limited resources and capacity mean that the scope of achievable reforms will be constrained and prioritization of possible PFM reforms is necessary. Owing to resource constraints, not all areas of the PFM system can be improved at the same time (Box 15.2).

A wide range of factors will inevitably determine the prioritization of PFM reforms. These include political imperatives, the capacities of staff, development partner requirements for budget support or project assistance, and windows of opportunity arising from particular pressures or needs. Prioritization, however, should also be guided by identifying the PFM reforms likely to have the greatest impact. This section can help trace the common elements linking the common PFM challenges that undermine macroeconomic management and service delivery in PICs and the most important reforms for addressing them.

Figure 15.1 shows four such PFM challenges. The following subsections outline a process for determining how to prioritize scarce PFM capacity to address the challenges. In developing a PFM road map, countries can use this process to identify which of the challenges is most relevant to achieving improved development outcomes in their particular country context (Haque and others 2013). From here, countries can identify (1) the PFM reforms that could be prioritized, (2) the specific PEFA dimensions that relate to a particular challenge and might be identified as priorities for improvement, and (3) gaps in the PEFA framework where reform steps may be required to address a particular challenge but are not measured by PEFA assessments.

Figure 15.1Weaknesses in Service Delivery or Macroeconomic Management

Box 15.2.Progress in Addressing Public Financial Management Constraints

Many Pacific island countries have acknowledged some of the problems discussed in this chapter and have taken steps to improve public financial management recently. Some of the changes implemented or being started in different Pacific island countries include:

  • Redesigning budget documentation to provide a more strategic medium-term focus (Cook Islands, Fiji, Papua New Guinea, Samoa, the Solomon Islands, Tuvalu).
  • Using professional procurement agents to supervise government procurement (Nauru).
  • Activating commitment control features in financial management information systems and improving financial reporting to line agencies to help them understand and control their spending commitments (Samoa).
  • Combining staff from previously separate planning, budgeting, or aid management units into one integrated division and reorganizing staff into sector groups (for example: education, health, and natural resources) with each staff member in the sector groups performing integrated budgeting, planning, and aid management tasks (Kiribati).
  • Consolidation of previously separate corporate plans, annual plans, and budget documents into one integrated policy and service focused budget document (Niue, Tonga).
  • Integration of previously separate recurrent and development budgets into one unified document (Papua New Guinea).
  • Adding a narrative that is focused on medium-term issues to budget documents at the program and activity levels (Fiji).

This framework is intended to guide prioritization and is not prescriptive. Countries may face public finance challenges not described in this section. In other situations, the solutions suggested here may be impractical or unsuitable. The framework should therefore be applied selectively and carefully. The underlying logic of the approach, however, is generally applicable when developing PFM road maps. Prioritizing PFM capacity to address the challenges most relevant to development outcomes can avoid the risk of overstretching available capacity and maximize the probability of sustainably overcoming them.

Budgets Lead to Unsustainable Deficits

PICs often face problems of macro-fiscal stability, with aggregate expenditure exceeding sustainable levels. Expenditure beyond sustainable levels leads to the accumulation of debt or the depletion of investments, such as sovereign wealth funds. These problems can often be driven by revenue inflows falling short of budgeted levels or expenditure exceeding budgeted levels (Figure 15.2).3

Figure 15.2Budgets Lead to Unsustainable Deficits

Revenue can fall short of forecasts because:

  • Revenue forecasts are unrealistic—Revenue projections provide a foundation for budgeting, but budgeting in PICs is often undermined by unrealistic revenue forecasts. If macro-fiscal sustain-ability is suffering due to unrealistic revenue projections, countries can prioritize improvements in revenue forecasting. Sophisticated modelling is seldom needed to achieve reasonable revenue estimates. Because PIC economies with narrow export bases and high reliance on imports are more vulnerable to economic and other shocks, uncertainty is inevitable, and a conservative approach to revenue forecasting is generally appropriate.

Expenditure may exceed sustainable levels because:

  • Upcoming expenditure obligations are not reflected in the budget—PIC governments must often deal with nondiscretionary expenditure pressures during the fiscal year. These could sometimes be foreseen if better systems were in place to record expenditure obligations and fiscal risks. Clearly foreseeable costs for utilities and other essential items are sometimes underestimated to comply with expenditure ceilings at the ministry level. Close oversight by the finance ministry and comparison with previous-year spending patterns can help eliminate deliberate underestimation. Furthermore, spending obligations can arise from debt-servicing requirements, the realization of unrecorded contingent liabilities, the need to meet accumulated arrears, failure to consider in advance the needed future costs to operate donor-funded infrastructure projects upon completion, inadequate recognition of the effects of demographic flows, failure by cabinets to request or consider fiscal reviews of policy or project proposals before taking a decision, or the ongoing costs of policy decisions. If macro-fiscal planning is undermined by inadequate allocations for expenditure pressures and obligations, countries can prioritize improvements in systems to record and monitor these pressures and ensure they are reflected in budgets. Genuinely unforeseeable spending pressures can also arise from natural disasters or other shocks. Ensuring adequate contingency allocations in the budget is the most appropriate means of dealing with these risks, but—with inevitably limited resources—in-year reallocation may still be needed in the case of major shocks.
  • Allocations are increased to finance new discretionary programs—Expenditure pressures can sometimes arise from decisions to fund new, discretionary programs outside of the regular annual budget process. The scope to manage such pressures through PFM reforms is limited. If macroeconomic sustainability is undermined by pressure from new discretionary spending, countries can prioritize systems to ensure that such decisions are made transparently, and that the budget process allows sufficient opportunity for priority programs to be adequately financed during regular annual budget formulation. Training for parliamentarians and cabinet members can augment their understanding of the budgetary process, including their role in setting ceilings and the consequences of approving additional between-budget expenditures.
  • Controls are inadequate to prevent aggregate expenditure exceeding allocations—Even with good revenue forecasts and systems to record spending obligations, macro-fiscal sustainability in PICs is sometimes undermined simply because governments end up spending more than was intended. This can occur through inadequate controls on expenditure and commitments and inexact tracking of expenditures during the year. If macro-fiscal sustainability is impaired because aggregate expenditure exceeds allocations, countries can prioritize systems to exert expenditure control. Priorities for reform will depend on whether overspending is driven by payroll or other expenditure. Systems should be improved to address the cause of the overspending. For example, payroll expenditure may exceed limits because of outdated and inaccurate personnel and payroll data or because of the illegitimate alteration of payroll and personnel information during the year. Other spending may exceed limits because commitment rules are inadequate or unclear, or because rules are not complied with.

Budget Allocations Do Not reflect Government priorities

Mismatches between government policy objectives and budget allocations often reduce the effectiveness of public expenditure in PICs (Figure 15.3). Ministries’ budgets do not reflect what they are expected to deliver during the year, disrupting implementation, and making it more difficult to hold ministries accountable for delivering on policy objectives. Resources are expended in ways that do not align with development goals, slowing development progress. Inadequate planning and failure to take account of plans when budgets are developed are two PFM weaknesses often driving these problems.

Figure 15.3Budget Allocations Do Not Reflect Government Priorities

Plans may be inadequate to inform budget development because:

  • Plans are not prepared or do not provide a realistic basis for prioritizing resources—National development strategies, sector strategies, or ministries’ corporate plans in PICs are often inconsistently prepared or contain insufficient information to inform or justify the allocation of resources through the budget. Clarity concerning agency deliverables and expected costs is often lacking. Plans often include unrealistic and unaffordable objectives. Where plans cannot inform the allocation of resources, better plans that can guide prioritization under realistic resource constraints are a clear priority. But preparing exhaustive plans with realistic cost estimates at the national, sector, and ministry levels can be a major drain on limited human resources. Instead, line ministries can prepare simple, short written explanations in their annual budget documents relatively easily, outlining the activities to be undertaken, links to national development plans, and trade-offs between activities that would have to be made under different, realistic resource envelopes. These documents can be used to meet both corporate planning and budget process requirements. High-level national strategies with a focus on the country’s most significant government sectors can be incorporated into annual medium-term fiscal strategy statements developed prior to, and to inform, annual budgets. Annual corporate plans with a medium-term outlook, however, can and should be developed as part of budget documentation to ensure consistency and integration between budgets and objectives for service delivery. In all cases, it is vital to ensure that planning and budgeting are aligned and consistent, and that plans take account of the availability of resources. Central agencies have an important role to play in assisting ministries in the development of plans, including avoiding overlaps and gaps in activities and ensuring affordability within aggregate fiscal resources. This process can be facilitated if the responsibility for planning and budgeting is not separated between different staff members in different teams within central and line agencies.

Even if adequate plans are developed budgets may not reflect plans because:

  • Administrative problems prevent the integration of planning and budgeting—Budgets and plans are often inconsistent in PICs because different staff at different times prepare documents, with insufficient contact and coordination. Plans and budgets need to be well integrated and should be prepared at the same time by finance ministry staff involved in both processes, closely liaising with line ministries. Institutional divisions between budget and planning divisions in finance ministries are sometimes an important constraint on this integration. The introduction of a single calendar for budgeting and planning processes, improved coordination among staff, joint responsibility for planning and budgeting within the same teams in central and line agencies, and combining budgeting and planning information into single ministry documents can help address these problems.
  • The executive and parliament have insufficient opportunity to ensure budgets reflect government priorities—In PICs, budget allocations are often weakly linked to development objectives because cabinet and parliament have limited engagement in relevant stages of the budgetary process. Without strong executive and parliamentary involvement, budgeting sometimes becomes a technocratic exercise involving consideration only of the cost of programs and inputs, and not linked to government priorities. Budget preparation and reporting processes can be strengthened to ensure that the cabinet sets budget ceilings, proposes a budget within this framework that reflects policy priorities, and monitors execution throughout the year. Processes can be improved to ensure that parliament has the opportunity to review the proposed budget for how closely it links to policy objectives.
  • Insufficient flexibility in the budget to implement government priorities—In small PICs, governments are often hindered in carrying out policy priorities through the budget because a large proportion of spending is considered already committed to ongoing activities and programs and meeting payroll or other cost increases. Ensuring that plans list ministry activities and options for changing the mix of these activities within a range of realistic expenditure envelopes would allow the executive to consider prioritization options across all expenditure, rather than focusing on the allocation of often small amounts of marginal additional expenditure during the budget.

Budgets Are Not Executed as Appropriated

The effectiveness of public expenditure in PICs is often reduced by large differences between the planned budget and actual resource use (Figure 15.4). Reallocation of resources leads to disruptions in service delivery. It also impedes the usefulness of the budget as a planning tool and makes it difficult to implement policies and achieve development objectives. PFM weaknesses that often drive these problems include (1) weak cash management systems, (2) the transfer of resources away from allocated areas by line ministries, and (3) changes to expenditure allocations during the year to meet in-year pressures. Cash-flow problems can disrupt execution if:

Figure 15.4Budgets Are Not Executed as Appropriated

  • Expected cash is not available to the finance ministry—Shortages of cash held by Pacific island finance ministries often force cash rationing, which can cause serious disruptions to service delivery. Shortfalls in expected cash to the finance ministry may occur because overall revenue forecasts are inaccurate, inadequate account has been taken of unevenness in revenue receipts throughout the year, expected donor funds have not been forthcoming, or because revenue flows have been disrupted by economic or other shocks. If cash flow problems arise because expected cash is not available to the finance ministry, countries can prioritize improving revenue forecasts—including monthly cash revenue forecasting at the level of revenue items—and building up sufficient cash reserves to deal with external shocks.
  • Information on the cash needs of the line ministry is inadequate or incomplete—Even if revenue flows to the finance ministry as expected, cash rationing may be necessary because the cash needs of ministries have not been adequately taken into account. This problem often arises because line ministries do not prepare, regularly update, or submit proper cash-flow forecasts to the finance ministry. If cash-flow problems arise from inadequate forecasting of cash needs by spending ministries, countries can prioritize improvements in the processes for (1) preparing annual cash flow disaggregated monthly forecasts (going beyond the common practice of assuming an equal amount of cash is needed in each month of the year) and submitting these to the finance ministry; (2) recording in-year expenditure by line ministries, so that actual cash needs can be monitored; and (3) reviewing cash flow needs throughout the year, and communicating changes to the finance ministry as necessary.
  • Available cash is exhausted because of additional expenditure or changed priorities during the fiscal year—In some PICs, cash rationing has been required because additional expenditure has been authorized during the fiscal year without regard to available cash. In this situation, countries can prioritize processes to ensure that (1) clear rules and transparent processes exist for new in-year spending (including clear processes and criteria for accessing the contingency fund), (2) funding sources are identified for all new spending proposals, and (3) availability of cash is taken into consideration.

Ministry expenditure may not be aligned with budgeted allocations if:

  • Controls to ensure appropriate spending are inadequate, unsuitable, or not enforced—Budget execution is undermined in some PICs because there are inadequate controls to ensure that resources are used in ways that align with budgets. In these cases, budget allocations may reflect government priorities, but actual expenditure does not reflect allocations. Large variances between budgeted allocations and actual spending at the level of inputs and functions can disrupt the implementation of government priorities and the usefulness of the budget as a planning tool. Problems can arise because formal controls do not exist, appropriate controls are in place but not enforced, or controls are excessively burdensome or poorly matched to available capacity. If budget execution is weakened by problems with expenditure controls, countries can prioritize the development or revision of expenditure control systems. Reforms should be aimed at ensuring expenditure is aligned with the budget without imposing unrealistic burdens on available capacity or preventing flexibility when it is necessary and appropriate.

Allocations may be changed throughout the year to meet expenditure pressures because of:

  • Insufficient allocations to address expenditure pressure—Budget execution in PICs is often disrupted by the reallocation of expenditure during the year as foreseeable and unforeseeable priorities emerge. Many pressures could be foreseen and budgeted for if better systems were in place to record medium-term expenditure obligations. These spending obligations can arise from inadequately budgeted debt-servicing requirements, insufficient provisioning for contingent liabilities, the need to meet accumulated arrears, the effects of demographic flows that have not been recognized earlier, or ongoing costs of policy decisions. If budget execution is undermined by the need to meet foreseeable in-year expenditure pressures, countries can prioritize improvements in systems to record and monitor these pressures. Genuinely unforeseeable spending pressures can also arise from natural disasters or other shocks. Ensuring adequate contingency allocations in the budget is the most appropriate means of dealing with these risks, but, with inevitably limited resources, in-year reallocation may still be needed for major shocks.

Inefficiency and Ineffectiveness in Spending Undermine Service Delivery

Service delivery in PICs is sometimes undermined by poor-quality spending (Figure 15.5). Public funds are often used to purchase poor-quality inputs. Here, inputs are purchased in combinations inappropriate to policy priorities. PFM weaknesses that often drive these problems include inadequate control measures to ensure good-quality spending and a lack of transparency and oversight of spending decisions. However, such weaknesses are often also caused by weaknesses at the line level that are not assessed in the PEFA framework and are not fully amenable to being addressed through the reform of central PFM systems. Policymakers concerned about the impact of inefficiency and ineffectiveness of spending at the line level should consider improvements in government-wide PFM systems as only one tool in a range of reform solutions.

Figure 15.5Inefficiency and Ineffectiveness in Spending Undermine Service Delivery

Systems may be inadequate to ensure good-quality spending if:

  • Weak internal controls lead to low-quality inputs—The efficiency and effectiveness of expenditure is sometimes undermined in PICs because of inappropriate controls. Control systems in procurement and payroll play an important role in preventing inappropriate spending or deliberate misuse of funds, as well as improving public perceptions regarding the integrity of systems. These systems, however, will only be effective if compliance is enforced. Spending quality can also be harmed if very tight expenditure control systems cause bottlenecks and impede the appropriate input mix at the line level. If expenditure quality is undermined by weak control systems, countries can prioritize improvements in these systems to achieve a more appropriate balance between control and flexibility.
  • Systems provide excessive or inadequate flexibility to line ministries in determining what they spend money on—Efficiency and effectiveness in public expenditure are sometimes undermined in PICs by either excessive or insufficient management discretion over the input mix. Inflexibility in the inputs available to ministries—such as staff, equipment, or contracted services—can lead to inefficiency, with managers often having too much of a particular input or not enough. Discretion over inputs can provide important benefits by allowing those with direct accountability and good information to decide what is needed to deliver programs and achieve objectives. But, if excessive, such discretion can lead to poor outcomes. Discretion will only lead to better spending if there are strong incentives for delivery, good accountability systems, mechanisms for monitoring outputs or outcomes, and a performance culture. If expenditure quality is being harmed by excessive or insufficient flexibility in the input mix, countries can prioritize reforms of systems to achieve a more appropriate level of flexibility, taking account of the broader context and the extent to which managers can and will be held accountable for resource use and delivery. In most PICs, granting some discretion to line ministries over the use of inputs may be appropriate. But few countries have the accountability systems in place to grant full discretion over inputs.

There may be inadequate transparency and oversight over expenditure decisions if:

  • Insufficient information is available—Transparency can be an important driver of efficiency and effectiveness in the use of public resources. Limited access to high-quality fiscal information may be impeding the efficient use of public resources in some PICs. Accountability to the public, parliament, and the executive relies on the availability of information, including information on policy priorities, budget allocations, debt, cash flows, future liabilities, and procurement decisions. If the efficiency and effectiveness of expenditure are undermined by a lack of information, countries can prioritize (1) the collection of key fiscal information by the finance ministry, (2) analysis of relevant information to identify trends and patterns that may be of interest to the public or decision makers, and (3) dissemination of information in an accessible format to relevant audiences (including the executive, parliament, the public, development partners, and civil society organizations).
  • Available information is not being used—The collection and dissemination of information will not lead to improved efficiency and effectiveness unless that information is used by decision makers to make better decisions, reward good performance, and address underperformance. In PICs, as in other countries, action sometimes does not occur even when the right information is collected. While resolving this problem may be beyond the scope of a PFM reform process, countries may wish to prioritize broader engagement between the finance ministry, the cabinet, parliament, and the public accounts committee on budget formation and execution and various review processes (including audit). Options for direct public engagement, including through outreach to nongovernment organizations and civil society groups, could also be considered.

Accessing Capacity for Public Financial Management Reform

The process of implementing PFM reforms can be difficult and resource intensive, and PFM road maps must also address how capacity gaps can be filled. The design and introduction of new processes, systems, and structures may not only place temporary additional demands on capacity, but may lead to permanent changes in the skills required. PFM reforms should involve explicit consideration of and planning for changed capacity needs. Different approaches to addressing capacity gaps might be needed in countries in which capacity constraints are particularly pressing. Along with traditional capacity-building approaches, attention should also be given to accessing capacity from alternative sources, such as regional institutions or long-term arrangements with development partners, private firms, and individuals with required skills.

There is no single solution to capacity needs. Rather, consideration should be given to what will work best in the circumstances. The following section provides an overview of options available to meet capacity gaps when implementing PFM reforms and a framework for choosing among these options.

Options for Meeting Capacity Gaps

Countries with small populations face particular challenges in building local capacity, even over a longer time frame. Thought should be given to the full range of possible approaches to addressing capacity needs, including capacity building, capacity supplementation, and capacity substitution. These options include (1) training and education, with staff acquiring new skills to undertake a broader range of PFM functions, (2) supporting PFM improvements by external advice and assistance (but responsibility for delivery remains with local agencies and staff), and (3) outsourcing responsibility for the delivery of improved PFM functions to external providers.

Deciding among Options

Governments need to consider which approach, or combination of approaches, is most appropriate to address identified capacity needs. There are a number of practical issues that need to be weighed when deciding on capacity options, including:

  • Complexity of specific functions—More demanding technical and specialized PFM skills are difficult to establish and costly (or difficult) to retain. These skills might include specialist accounting, fiscal policy, modeling, and forecasting. In these instances it may be more economical and less risky over time to use pooled regional resources or outsourced arrangements to establish formal contractual arrangements.
  • Efficient scale for providing specific functions—A feature of the Pacific region is the prominence of many small island states that cannot take advantage of scale, but are still expected to provide certain PFM functions. This comes at a high cost. It is therefore in the interests of PICs to undertake some of these functions on a regional scale to reduce this cost burden without compromising sovereignty or national interests. A regional approach is one way to lower costs through the sharing of skilled resources or knowledge. Outsourcing can realize similar advantages, particularly if done in collaboration with other PICs. Regional approaches can also support the development and deployment of capacity with relevant regional experience, leading to higher-quality advice and reducing the amount of investment required in familiarization. Furthermore, regional approaches can encourage the adoption of similar systems, standards, and policies across countries, allowing further economies of scale and facilitating the transfer of specific capacities and skills. For example, the use of common revenue and customs systems allows economies of scale in training. Regional approaches can be used to support all approaches to addressing capacity gaps, including capacity building, capacity supplementation, and capacity substitution. Existing regional approaches involved in addressing PFM capacity gaps include (1) shared training facilities and courses (University of the South Pacific and the Pacific Islands Centre for Public Administration); (2) pools of skilled and specialist resources that can be shared across countries (Pacific Financial Technical Assistance Centre, Pacific Islands Forum Secretariat, and the Pacific Islands Centre for Public Administration); and (3) opportunities for networks of information sharing (the Pacific Islands Financial Managers’ Association and the Pacific Islands Tax Administrators Association).
  • Funding constraints and options—The appropriateness of outsourcing will depend on afford-ability.
  • Capacity for managing external providers—Contracting out requires specific capacities, ranging from procurement to legal framework and contract management skills.

Decisions also need to be made regarding the appropriate duration for various approaches. Different models for accessing specific capacities can be used in different ways over time, with assorted approaches applied over the short, medium, and longer term. Externally sourced capacity is often viewed as a short-term option to be provided only until local capacity can be developed. But the permanent external provision of certain functions has often proved cheaper, more sustainable, and less risky in some PICs, owing to a limited availability of specialized local staff to take on all required functions, even over an extended time frame.

Lessons from International Experience

There is extensive international experience to learn from. Many reviews have now been completed of capacity-building projects undertaken around the world.4 These highlight that improving capacity is difficult and outcomes often fall short of objectives. Lessons from the extensive regional and international experience with accessing PFM capacity include the following:

  • Strong ownership and political leadership are required.
  • Extensive planning and long time frames are necessary. Capacity-building efforts in PICs have often been fragmented, sporadic, and inadequately planned. The amount of time necessary to build capacity has often been underestimated, and frequent changes in the involvement of donors, in the scope and coverage of capacity-building projects, and in the advisors who are financed by such projects have led to duplication and gaps.
  • Role clarity and appropriate accountability arrangements are important. In PICs, capacity substitution is frequently used, but its use is sometimes not explicitly acknowledged due to common expectations that technical assistance should always be intended to build local capacity. This is problematic, as capacity-substitution goals are not reflected in project monitoring and evaluation arrangements, leading to a lack of accountability. Advisors contracted to build capacity but fulfilling in-line roles typically report to donor agencies rather than to the government, impeding ownership and management. And funding for advisors is usually available only for a fixed period, generating risks for sustainability when in-line roles are performed without an exit strategy.
  • Sustainability can be achieved in different ways in different contexts. Claims that long-term capacity supplementation and capacity substitution are less sustainable need to be carefully tested. Capacity supplementation and capacity substitution can be delivered sustainably if costs are acknowledged and planned for. At the same time, experience in the PICs shows that specialized technical skills may be costly to develop locally and difficult to retain; regional or outsourced approaches may sometimes be more economical and longer lasting. Furthermore, there is an opportunity cost in dedicating scarce skills in areas that are not critical (for example, resourcing administrative functions can divert capacity away from policy development, where local staff might be better utilized). It is important to recognize that advanced economies take advantage of outsourced service provision to enable civil servants to focus on core government roles and responsibilities.


Sound public financial management provides a vital foundation for efficient service delivery and macroeconomic management. PICs must deal with particularly severe capacity constraints when designing and implementing PFM systems. It is essential to take explicit account of the importance of capacity constraints through (1) ensuring public financial management reforms are well planned and have political support, (2) prioritizing available capacity toward reforms that are likely to have the greatest impact in achieving development objectives and policy goals, and (3) considering the full range of possible approaches to addressing capacity needs, including capacity building, capacity supplementation, and capacity substitution.


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    Diamond, Jack.2013b. “Background Paper 1: Sequencing PFM Reforms.” Public Expenditure and Financial Accountability Secretariat, Washington.

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    Haque, Tobias, David S.Knight, and Dinuk S.Jayasuriya.2012. “Capacity Constraints and Public Financial Management in Small Pacific Island Countries.” Policy Research Working Paper 6297, World Bank, Washington.

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    Haque, Tobias, RichardBontjer, MaryBetley, RonHackett, VivekSuri, and FranzDress-Gross.2013. “Pacific Islands—PFM Design under Capacity Constraints: Planning Public Financial Management Reforms in Pacific Island Countries.” Guidance Note, World Bank, Washington.

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    Pacific Islands Forum Secretariat and Pacific Financial Technical Assistance Centre (PFTAC). 2010. “A Public Financial Management Roadmap for Forum Island Countries.” Regional Papers, Pacific Finanacial Technical Assistance Center, Suva.

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    Pacific Islands Forum Secretariat and Pacific Financial Technical Assistance Centre (PFTAC). 2012. “Update on Public Finance Management Roadmap Implementation.” Briefing paper prepared for the Forum Economic Ministers’ Meeting, Tarawa, Kiribati, July2–4.

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    Tommasi, Daniel.2012. “Background Paper 2: The Core PFM Functions and PEFA Performance Indicators.” Public Expenditure and Financial Accountability Secretariat, Washington.

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    Welham, Bryn, PhilippKrause, and EdwardHedger.2013. “Linking PFM Dimensions to Development Priorities.” Working Paper 380, Overseas Development Institute, London.

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    Wescott, Clay.2008. “World Bank Support for Public Financial Management: Conceptual Roots and Evidence of Impact.” Internal Evaluation Group Working Paper, World Bank, Washington.

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This chapter is adapted from a guidance note prepared by a joint World Bank and IMF/Pacific Financial Technical Assistance Centre team.


The PEFA assessment has become a standard mechanism for assessing the quality of PFM systems globally and in the region.


See Pacific Islands Forum Secretariat and Pacific Financial Technical Assistance Centre (2010, 2012), Welham, Krause, and Hedger (2013), Diamond (2013a, 2013b), and Tommasi (2012).


We include budget support grants as a source of revenue in this framework, given the importance of such inflows for several PICs.


See Wescott (2008) for a useful example.

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