All of the CIS-7 countries underwent difficult economic transitions during the 1990s, with gross domestic product (GDP) contracting sharply. As these countries restructured their economies and squeezed spending to fit within the much reduced budget envelopes, the share of public expenditure in national income fell substantially. Price subsidies and subsidies to state-owned enterprises have been reduced or eliminated. Large public sector investment programs, particularly in infrastructure, have been slashed. The size of the public sector has been reduced through privatization and initial reductions in wider public sector employment following reforms and the elimination of some services, such as preschool education. At the same time, wages and operating costs have declined significantly in real terms, in line with the contraction of overall public sector revenues.

All of the CIS-7 countries underwent difficult economic transitions during the 1990s, with gross domestic product (GDP) contracting sharply. As these countries restructured their economies and squeezed spending to fit within the much reduced budget envelopes, the share of public expenditure in national income fell substantially. Price subsidies and subsidies to state-owned enterprises have been reduced or eliminated. Large public sector investment programs, particularly in infrastructure, have been slashed. The size of the public sector has been reduced through privatization and initial reductions in wider public sector employment following reforms and the elimination of some services, such as preschool education. At the same time, wages and operating costs have declined significantly in real terms, in line with the contraction of overall public sector revenues.

Accompanying the dramatic drop-off in public resource availability has been a fundamental change in the role of government, from that of providing all economic and social services to that of ensuring an appropriate legislative and regulatory framework for economic activity; providing an enabling environment, free of unnecessary bureaucratic impediments, to facilitate vibrant private sector development; and intervening in areas in which the market fails to produce the right level of services at a socially acceptable price (such as public health services).

In response to all of these changes, public spending in the CIS-7 countries declined by an average of 23 percent of GDP during the 1990s.1 Under these constrained conditions, the CIS-7 governments have begun restructuring their public expenditure management systems to improve the efficiency of public expenditures and their effectiveness in achieving policy objectives.

Overview of Public Expenditures and Public Expenditure Management Reforms

The largest reductions in expenditure as a share of GDP were in Tajikistan, Georgia, Azerbaijan, and Armenia.2 Public spending in the CIS-7 countries in 2001 ranged from 15 percent of GDP in Tajikistan to 33 percent in Uzbekistan, with an average of 25 percent (Table 5.1). In per capita terms, public expenditures ranged from just under $25 in Tajikistan to nearly $150 in Armenia (Table 5.2). These differences stem mainly from difficulties in revenue collection (Georgia, Tajikistan); differences in the size of excluded categories, such as externally financed project expenditures, and in the inclusion of extrabudgetary expenditures and local budgets (the Kyrgyz Republic); and differences in the rate of implementation of economic reform, with slower reform associated with greater budget subsidies to public sector enterprises (Uzbekistan).

Table 5.1.

Public Expenditure Levels in the CIS-7 Countries, 1994–2001

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Sources: International Monetary Fund, World Bank, and European Bank for Reconstruction and Development data.Note: Excludes data on expenditures on externally financed investment projects (except the Kyrgyz Republic) and expenditures of public enterprises. Data coverage: Armenia—consolidated accounts of republican and local budgets; Azerbaijan—all levels of government except municipalities and all extrabudgetary funds, including oil fund; Georgia, the Kyrgyz Republic, and Moldova—consolidated state, municipal, and extrabudgetary funds; Tajikistan—excludes budgetary transfers to extrabudgetary funds; Uzbekistan—includes extrabudgetary funds but excludes local budgets.

Data include externally financed public investment program.

Data are distorted by the inclusion until 2001 in official population figures of those who had emigrated.

Table 5.2.

Overview of Public Expenditure Systems in CIS-7 Countries, 2001 (In percent, unless otherwise indicated)

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Sources: International Monetary Fund, World Bank, and European Bank for Reconstruction and Development data.Sources: International Monetary Fund, World Bank, and European Bank for Reconstruction and Development data.

Includes expenditures of state and municipal budgets and extrabudgetary funds. Excludes externally financed public investment program.

Data refer to 2000 outcomes.

Includes central government transfers.

With such low revenues and public spending relative to GDP, growth and poverty reduction efforts in the CIS-7 countries depend crucially on sound management of scarce public resources. Hence, the CIS-7 countries have begun to make changes to budget legislation, the presentation and coverage of budgets, budget preparation processes, treasury systems and overall budget execution, procurement systems, and internal and external audit systems.

Many of the CIS-7 countries undertook the following basic reforms (Table 5.3):

Table 5.3.

Overview of Reforms Under Way in Public Expenditure Systems, CIS-7 Countries, 1991–2001

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Source: Author’s compilation.Note: Reforms in revenue administration and audit are not included.
  • a longer budget calendar that gives sector ministries more time to prepare submissions and the ministry of finance more time to consider sector ministries’ proposals;

  • a more comprehensive budget presentation, including a consolidated budget picture;

  • budget classification, including an economic and functional classification based on government finance statistics and an administrative classification;

  • use of a treasury system and network; and

  • modernization of the legal framework underpinning the budget to cover these new reforms.

A few of the CIS-7 countries have made deeper reforms:

  • use of a public investment program to assist in managing public investment, particularly that supported by external finance;

  • introduction of a medium-term budgetary framework, focusing initially on the determination of the aggregate budgetary resource framework and the setting of sector ceilings; and

  • more flexible sector budgets, to improve efficiency of service delivery,

None of the CIS-7 countries has yet been able to undertake significant reform in the following areas:

  • review of above-the-line accounting and Financial management information systems;

  • improvements in accountability for budgetary control, including the introduction of warranting systems; and

  • review of intergovernmental finance systems, including expenditure and revenue assignment for different levels of government, the equity of intergovernmental transfers, and reviews of municipal finance.

Despite these reforms, budgetary outcomes are poor, largely because of weaknesses in the institutional framework for public sector management, exacerbated by difficult economic coordination and weak governance. More specifically, efficient public expenditure outcomes remain constrained by the following factors:

  • intersectoral budget allocations that are inconsistent with stated policy priorities;

  • intrasectoral budget allocations that are derived from input-based norms and thus do not meet policy reform requirements;

  • input mixes that are inappropriate, particularly between salaries and operations and maintenance expenditures;

  • significant, often ad hoc, changes to budgets during the year;

  • budget outcomes that differ significantly from stated policy priorities and from budget plans; and

  • buildup of expenditure arrears.

Analysis of Budget Trends in the CIS-7 Countries

Assessing how effectively governments use budgets as a tool for achieving their policy objectives requires an analysis of their budget plans. Key issues include how well government policies are linked to budget plans (and constraints to better linkages), how well functional and economic allocations reflect sector needs, and whether the budget formulation process facilitates or constrains the making and evaluation of policy choices.

This analysis concentrates on planned budgetary allocations, as opposed to actual general government or public expenditures, since the former represent governments’ planned expenditures and policy objectives. While significant shares of public expenditure (up to a third) are excluded from budgetary frameworks, representing a significant weakness in meeting good budget principles, difficulties obtaining consistent and sufficient data on nonbudgetary expenditures (extrabudgetary and externally financed expenditures) by appropriate classification prevent more detailed functional or economic analyses.

Allocating Budgets by Sector and Economic Classification

Sectoral Shares

Budget plans should represent government policy aims and aspirations. While budgetary outcomes can reflect weaknesses in budget execution, budget allocations are a good proxy for actual government priorities, which may often differ from stated priorities.

No objective measures exist for determining the appropriateness of a budget’s sectoral distribution, although comparisons can be made across countries between sectoral distributions and a country’s stated priorities. A comparative analysis of the sectoral breakdown of recent budget data for CIS-7 countries shows considerable variations in emphasis across sectors (Figure 5.1).

Figure 5.1.
Figure 5.1.

Planned Spending by Sector, 20021

Sources: Ministry of finance data for each country; IMF staff estimates.1Data for Uzbekestan not included.

Levels of spending in the CIS-7 countries (except Moldova) for defense and law and order are high in comparison with spending in other Central and Eastern European countries, with Armenia, Azerbaijan, and Tajikistan having the highest level of spending. This finding is not surprising, since all of the CIS-7 countries have been involved in conflicts following independence (see Chapter 8). Nonetheless, high expenditures on law and order squeeze resources for other public services, such as health, education, and social assistance, leading to erosion in the quality of these public services and thus less confidence in the public sector.

Spending on the social sectors (education, health, and social protection) is also fairly high. The share of spending on social protection is relatively similar across CIS-7 countries, with most of it directed to entitlement programs and a relatively small amount going to poverty-oriented social assistance and social care programs. Budgetary allocations for health care are lower than for education, reflecting the significant share of health spending accounted for by out-of-pocket payments and extrabudgetary health insurance funds in some countries.

Spending on the economic sectors, including energy, agriculture, and transport, is relatively low. The drop in budgetary allocations in the energy and agriculture sectors reflects reductions in explicit subsidies, but nonbudgetary implicit subsidies remain. Capital investments make up the largest share of expenditures in the transport sector, assisted by external finance. This investment is not being matched, however, by regular or adequate expenditures for maintenance.

The relatively high level of expenditures in the other category in Armenia, Georgia, and Moldova indicates an overly aggregated functional classification of expenditures, often because externally financed expenditures are not broken down by function.

Differences in sectoral distributions between countries arise from differences in policy priorities among CIS-7 countries, leading to faster movement of resources away from infrastructure sectors and toward other sectors, especially the social sectors in Georgia and Tajikistan. In Azerbaijan, by contrast, resources have been targeted more toward the economic and infrastructure sectors and less toward the social sectors in the past five years.

Differences in the ability to implement structural reforms also play a role. Thus, even if policy priorities are similar, the ability to respond through the budget may be very different. An example is the effort to raise the retirement age, which affects the pensions gap and thus often the amount required from the budget to subsidize extrabudgetary pension funds. Georgia increased the retirement age by five years almost overnight, whereas the Kyrgyz Republic managed an increase of just one year and took several years to achieve that.

Also influential are institutional rigidities across countries that prevent strategic movements in resources across time. These rigidities include weak mechanisms for linking budgets to government policies, so that policy priorities are not reflected in budgets.

Changes in Budgetary Allocations Over Time

Continued fiscal adjustment in the majority of CIS-7 countries has eroded overall budgets as a share of GDP since 1997 (Figure 5.2). Especially large decreases in real public expenditure between 1998 and 1999, particularly in Georgia, the Kyrgyz Republic, and Moldova, show the effect of the Russian financial crisis of 1998. Armenia, Azerbaijan, and Tajikistan have managed to stabilize their real levels of spending, with Armenia and Tajikistan assisted by significant external financing.

Figure 5.2.
Figure 5.2.

Total Budgetary Spending in CIS-7 Countries, 1997–2001

Sources: Ministry of finance data for each country; IMF staff estimates.

Despite the high proportion of the budget allocated to social sectors, particularly in Azerbaijan, the Kyrgyz Republic, Moldova, and Tajikistan, social sectors have suffered greater real reductions in expenditures than other sectors, with their share in overall budgets decreasing in recent years in all the CIS-7 countries but Armenia and Georgia (Figure 5.3). Increased spending on general public services and, to a lesser extent, infrastructure has crowded out spending on social services. This change is having an adverse effect on service provision and on access to services by the poor. The overall level of spending on social sectors needs to be protected, and the efficiency and equity of resource allocations need to be improved, by allocating them in line with service delivery priorities (primary education and preventive health) and by ensuring that allocations are needs-based.3

Figure 5.3.
Figure 5.3.

Budgetary Spending on Social Services in CIS-7 Countries, 1997–2002

Sources: Ministry of finance data for each country; IMF staff estimates.

Allocations by Economic Item

Comparing budget allocations to economic items gives insight into the likely sustainability of sectoral reform measures (Figure 5.4). A realistic balance in allocations between wages and operating expenses is critical to providing public sector workers with access to the materials and supplies they need to work and undertake reform measures effectively. At the same time, it is important to ensure that investment resources in key infrastructure are not undermined by inadequate maintenance provision.

Figure 5.4.
Figure 5.4.

Budgetary Spending by Economic Item in CIS-7 Countries, 20021

Sources: Ministry of finance data for each country; IMF staff estimates.1Data for Uzbekestan not included.

Reflecting the low level and highly compressed nature of public sector salaries, the wage bill represents a small share of overall budget allocations, except in Azerbaijan, causing difficulties in retaining staff with key skills. In Azerbaijan, the wage bill increased as a share of sector budget allocations from 66 percent in 1997 to 84 percent in 2000, reflecting salary increases and a larger number of positions. The sharp increases in utility costs during the 1990s are reflected in the relatively large proportion of overall resources allocated to materials and services. Transfers to the population (largely subsidies to entitlement programs) are significant in all of the CIS-7 countries. Domestically financed capital expenditures represent a small share of the overall budget, although capital expenditures are much higher when the externally financed public investment program is included. The shares of capital expenditures are much higher in Armenia, the Kyrgyz Republic, and Tajikistan because they receive more external finance. Spending on wages, utilities, and debt service payments is crowding out spending on operations and maintenance. In most of the CIS-7 countries, with the exception of Armenia, operations and maintenance spending has fallen dramatically as a share of GDP over the last five years (Figure 5.5). Also of considerable concern is the increasing burden of debt service payments, which are squeezing discretionary budgetary resources available to fund public services provision. For example, Georgia’s heavy external debt burden has meant that as much as a fifth of total expenditures have gone to service the external debt. As a result, noninterest recurrent expenditures fell from 10 percent of GDP in 1999 to 7.8 percent of GDP in 2001. In the Kyrgyz Republic, noninterest recurrent expenditures also fell, from 17 percent in 1998 to 14 percent in 2001. In both cases, successful Paris Club debt relief negotiations will reduce the burden of future debt service payments.

Figure 5.5.
Figure 5.5.

Operations and Maintenance Budgetary Spending in CIS-7 Countries, 1996-20011

Sources: Ministry of finance data for each country; IMF staff estimates.1Data for Uzbekestan not included.

This increasing imbalance across economic items is hurting service provision. With salaries and utility payments representing a large proportion of sector budgets and squeezing out other expenditures, it is becoming impossible to sustain a system that employs people but does keeps them from working properly because of inadequate facilities, supplies, equipment, and salaries. The resultant deterioration in social services is contributing to a serious weakening in social welfare indicators, with many schools and hospitals in disrepair and most lacking basic equipment and supplies.

Compounding the problem is the practice in Georgia, the Kyrgyz Republic, and Tajikistan of “protecting” salaries and pension contributions from budget cuts in order to ensure that wages and wage-related contributions are allocated as budgeted. Intended to prevent wage arrears, this measure has further constrained budgets and distorted the balance between salaries and other expenditures. In Georgia, protected items (wages, pensions, debt service) account for an estimated 85 to 90 percent of the recurrent budget, leaving little money for discretionary allocation. In the Kyrgyz Republic, more than 70 percent of the budget goes to wages, transfers, and foreign-financed investments, crowding out purchases of basic materials and equipment, and operation and maintenance expenditures for infrastructure.

Thus, strategic budget allocation suffers because a substantial proportion of the budget is already fenced off from priority setting and budget rationalization. Sector ministries have little incentive to set priorities to improve services, since shifting from protected to unprotected categories introduces the risk that their overall resources will decline during the year. In addition, protecting some budget items can lead to a buildup in arrears on unprotected items.

These rigidities, together with budgeting based on allocating resources according to predetermined norms for physical quantities of inputs (see Box 5.1), make it difficult to reform the delivery of services. To do that, budget managers must be able to move away from these predetermined norms and restructure the package of inputs used to deliver services. In the Kyrgyz Republic, for example, the Ministry of Health has had some success recently in restructuring health services by pooling budgetary and health insurance fund resources at the local level. The resulting savings have enabled institutions to increase their efficiency by improving salary structures, reducing unnecessary inputs, and providing more resources for supplies.

The Problem with Norms

In most CIS countries, budget formulation relies on normative budgeting techniques, or the use of specified input ratios to which standard unit costs are applied. Budget determination is a simple multiplication exercise (cost multiplied by quantity), minimizing the analytical demands on those responsible for preparing and evaluating budget requests.

However, the use of input norms is likely to contribute to inefficiencies in public service delivery by:

  • relieving program managers of responsibility for introducing innovations that improve productivity and the quality of public service provision;

  • providing incentives to managers to increase input use as a means of maximizing their budget allocations;

  • reducing budget analysis in sector ministries to a process of checking whether norms have been applied correctly rather than challenging the assumptions on which budgets are based and considering alternatives; and

  • failing to adequately recognize resource constraints.

Other countries emphasize analysis of budgets at the program level, consideration of alternative means of achieving program objectives, and active dialogue with the finance ministry over funding levels and performance. Legislated norms are replaced by resource allocation guidelines, themselves subject to regular review and updating, placing additional analytical demands on both the finance ministry and sector ministries. This fact is particularly relevant to transition economies, where governments are faced with a wide-ranging agenda of reforms to public services and entitlement programs in order to improve the sustainability and efficiency of public spending programs.

Budgeting in other countries emphasizes analysis of budgets at the program level, consideration of alternative means of achieving program objectives, and active dialogue with the finance ministry over funding levels and performance. Legislated norms have been replaced by resource allocation guidelines, themselves subject to regular review and updating, placing additional analytical demands on both the finance ministry and sector ministries. This situation is particularly relevant to transition economies, where governments are faced with a wide-ranging agenda of reforms to public services and entitlement programs in order to improve the sustainability and efficiency of public spending programs.

Matching Budgets to Government Policies

Budgets in the CIS-7 countries need to be directed more explicitly to meeting government policy objectives. It is difficult, however, to compare budgets with policy statements, since the CIS-7 countries tend not to articulate their policy programs comprehensively in the way that Organization for Economic Cooperation and Development (OECD) countries do. Often, the closest thing to such policy statements are the agreements made with the multilateral financing institutions, such as the Poverty Reduction and Growth Facility. In the future, the Poverty Reduction Strategy Papers being prepared by the CIS-7 countries will provide a useful and comprehensive program of policy reforms.

For now, a rough sense of the links between budgets and policies comes from examining strategic movements in budgetary allocations over time. However, there are a number of difficulties in seeing conclusive evidence of strategic movements in budgetary allocations, away from Soviet policy preferences toward what would be expected to be given priority by governments in a market economy. First, changes in sectoral allocations necessarily will be small in the short to medium term, since budgetary reforms have not been in place long enough to show significant changes in most countries. Recurrent spending, particularly on personnel, is semifixed in the short term through the practice of protecting certain economic items. Second, real expenditures have declined across most sectors, so budgetary support for strategic sectors will take the form not of budgetary increases but of protection from decreases, either in absolute terms or as a share of the budget. Third, changes in how sector budgetary institutions use their allocations are perhaps even more important to the reform program than the distribution of allocations across sectors. For example, in the restructuring of the Kyrgyz health sector, significant increases in allocations for primary care are being planned alongside decreases in allocations for tertiary care. This restructuring is being accompanied by the pooling of funds at the local level, to facilitate more efficient use of inputs.

As demonstrated by the medium-term budget framework exercises under way in a number of CIS-7 countries (particularly in the Kyrgyz Republic and Moldova), ministries of finance have been focusing on ensuring that changes in sectoral allocations are in the right direction, with the highest-priority sectors being allocated higher-than-average nominal increases (or, if possible, ensuring real increases for these sectors), and lower-priority sectors being squeezed in nominal terms.

One way to ensure a better match between allocation decisions for medium-term sectoral budgetary resources and medium-term government policies is to use the budgetary expenditure implications of government policies set out in the interim Poverty Reduction Strategy Papers to compare the growth of sectoral expenditure allocations with the average growth rate of the overall budget. This comparison should lead to appropriate movements in resources toward strategic priority sectors over time. However, this approach requires institutional procedures that enable budgets to be prepared and implemented over the medium term in accordance with government policies; as discussed above, these institutional procedures are not yet in place.

Institutional Constraints to Better Targeting of Expenditures

Instead of being the key tool for implementing policies, budget formulation in the CIS-7 countries continues to be treated largely as an exercise in balancing revenues and expenditures to meet agreed deficit targets. Several institutional constraints in the budget preparation process weaken the ability of CIS-7 governments to use budget plans as a tool for achieving their policies. While some countries have made significant progress in improving budget management, the underlying institutional constraints and fundamental prescriptions are similar across the CIS-7 countries. These constraints underline the case for a fundamental restructuring of the budgetary framework in order to promote a medium-term strategic approach for allocating public finances.

Lack of Clear Policy Directions

Weak analytical and other policymaking capacities impair governments’ ability to make and implement realistic and affordable policies. In contrast to the process in OECD countries, in which policy units undertake detailed analyses of a series of policy proposals, in the CIS-7 countries policymaking has focused on a plethora of sometimes conflicting government decrees, which often have not undergone any analytical scrutiny, particularly to determine whether they are affordable under existing budget constraints and whether they fit with other policy initiatives.

At the same time, sector ministries prepare separate policy documents setting out the general policy directions in which each ministry hopes to proceed. These documents lack practical utility, however, as they are often weakened by unrealistic time frames and by the failure to identify costs and the source of funds for implementing the programs. In practice, government policies end up being those agreed with the multilateral aid agencies. The lack of comprehensive government reform programs and explicit policy priorities is expected to be corrected from 2002 to 2003, when most of the CIS-7 countries complete their full Poverty Reduction Strategy Papers, which should form the framework for future medium-term budgets.

Lack of Guidance on Policy Priorities

In addition to the lack of comprehensive policy documents, the failure to link budgets with policy priorities is due in large part to the lack of adequate strategic direction from the government and the ministry of finance. With weak policy-making capacity at the sectoral level and without overall direction for priority setting (for example, by setting budgetary ceilings across sectors within an overall aggregate budget resource framework), sector ministries have no strategic guidance in preparing their budgets.

Policymakers often become involved in priority setting only at the point of government discussion of the budget, when it is too late to base the budget on an appropriate review of expenditure policies and program prioritization. Political leadership should be involved much earlier in the budget preparation process, particularly in determining expenditure ceilings, and senior managers should be involved and accountable at each stage of the process. This situation is beginning to change with the introduction of medium-term budget frameworks, as in Armenia, the Kyrgyz Republic, and Moldova.

Lack of Procedures for Prioritizing Allocations

Sector budgets continue to be allocated on the basis of norms and inputs (economic items) rather than outputs and outcomes (see Box 5.1). In the absence of strategic budget allocation procedures, budgets are determined by inertia rather than by policy, with incremental budgeting the result. Sector ministries, guided by an inflation projection in the budget circular, merely add a percentage to their previous year’s budgetary allocation.

Thus, sectoral expenditure planning becomes an exercise in managing budgetary inputs (staff, supplies, and materials), with little attention to the outputs and outcomes of public expenditure—that is, the efficiency and effectiveness of public services and the impact on the realization of government policies. Guidance from the ministry of finance at the start of the annual budget preparation process focuses primarily on the level of increase to be applied to the main expenditure items (increases in wages and utility costs). The medium-term budgetary framework being introduced in several of the CIS-7 countries and being planned in others (Azerbaijan, Georgia, Uzbekistan) should eventually improve procedures for prioritizing expenditures.

Staff Capacity Constraints

Many staff members do not have the appropriate skills to cost out policies effectively. The top-down nature of budget decision making is exacerbated by the lack of sufficient analytical capacity within the budget department, the ministry of finance, and sector ministries to analyze and cost policy proposals. Through technical assistance, training is currently being provided to staff in ministries of finance and sector ministries, in conjunction with the introduction of medium-term budgetary frameworks and program budgeting techniques.

Nonstrategic Budget Presentation

In most CIS-7 countries, budgets are presented in a format that provides very limited information on how the allocated resources will be used to meet government policy objectives. The main focus of budget presentation is on providing information to be used primarily for expenditure control—specifically allocations for economic items (salaries, material costs, and the like). No objectives or expected outputs are included in the budget documents, nor are allocations shown by sector programs. The budget documentation provides little discussion of the underlying revenue and expenditure policy issues and choices that should serve as the basis for developing the budget. Line-item budgeting limits the availability of information on expenditures, since information can be analyzed only according to economic item, such as the balance between salary and non-salary budgeted expenditures. As indicated above, this situation is beginning to change, with some countries experimenting with more detailed sectoral budget presentations linked to the preparation of the medium-term budget framework and program-based budgets.

A Focus on One Year at a Time

In many CIS-7 countries, budgeting continues to focus exclusively on the annual budget, with no forward planning of budgetary expenditures. This lack of forward planning makes it difficult for the government to allocate resources in a way that is consistent with policy objectives. Without the information needed to determine which are the highest-priority activities, the lack of forward planning also makes it difficult for governments to have a clear basis for setting sectoral ceilings for future budgets.

The short-term focus perpetuates the donor-driven nature of capital investment. Without a forward resource framework, governments cannot adequately plan their own priority investment projects, which may have to be delayed or slowed because sufficient funding has not been allocated. The lack of a medium-term structure for the budget also means that recurrent costs arising from investment projects are not adequately planned for.

In comprehensive Budgets

Greater effort should be made to bring more public expenditures into the budgetary planning process and to consider public resource use within the broader framework of intersectoral and sectoral policies and priorities. The fact that significant amounts of public expenditure are not included in the budget and thus do not undergo the Same prioritization procedures as budgetary expenditures is an important constraint to using budgets as a tool for implementing government policies. If governments are to exercise effective fiscal management, the budgetary process needs to include all public expenditures. The consolidated budget frameworks of most CIS-7 governments include only revenues and expenditures of the central government and local governments (net of intergovernmental transfers) and in some cases health and social insurance funds. The following elements tend to be excluded from the budget preparation process:

  • Extrabudgetary funds, or earmarked funds. Some CIS-7 countries operate a large number of extrabudgetary accounts, many of which are not shown in the budget documents. As a result, sectoral expenditures are prioritized on the basis not of a consolidated budgetary picture but of a partial view. This is poor budgetary practice, creating rigidities in spending priorities that can lead to inefficient and nonstrategic resource allocations. Substantial funds pass through these extrabudgetary accounts, so procedures for approving budgets and accounting for execution should be established.

  • External assistance. Expenditures financed by external credits, loans, and grants, often substantial, are subjected to different procedures than other budgetary components. In the Kyrgyz Republic, for example, external assistance constitutes more than 25 percent of total expenditures. Some of this external assistance to the CIS-7 countries provides general budgetary support and so is already included in the budget, where it is treated as government budgetary resources. However, much of it supports investments in the rehabilitation and development of public infrastructure and services and is not included in most budget documents. Because such resources are supporting public expenditure, and in the case of credits and loans will incur future debt-servicing costs, they ought to be treated as an integral part of the budget framework.

    Doing so requires a unified budget with full coverage of both investment and recurrent resources, prioritized according to the same methodology. Instead, at present, recurrent and development budgets are considered separately, which can also lead to distortions between capital and noncapital allocations in a sector. A further difficulty is the role played by the aid agencies in preparing public investment projects and the overall public investment program, so that these projects may reflect aid agency priorities more than government priorities.

  • Off-budget (ministry) funds. Off-budget or “special” funds refer to revenues earned by individual ministries from fees for the provision of particular services. These funds can be substantial. In the Kyrgyz Republic, for instance, off-budget funds represent 6 percent of total expenditures. In some countries (the Kyrgyz Republic, Moldova), these funds are shown in the budget, alongside general budgetary funds. In other countries, some or none of the funds are included. But even when revenues and expenditures are shown in the budget, they are segregated from general budget allocations. This segregation impedes accountability for these resources and prioritization of the overall budget picture.

  • Quasi-fiscal deficits. Quasi-fiscal deficits are implicit subsidies to the electricity, gas, and water sectors that result from tariffs that are lower than cost-recovery levels, low collection rates, and a lack of payment discipline. They are a particular problem in Azerbaijan, Georgia, and the Kyrgyz Republic but are difficult to measure. A sustainable reduction in quasi-fiscal deficits requires an improvement in both tariffs and collection policies. Reforms in many of the CIS-7 countries are leading to reductions in these deficits through increases in tariff rates.

Budgets Not Executed as Planned

Finally, problems with executing budget plans can lead to budgetary outcomes that are very different from budget plans (see below).

Effectiveness of Budgetary Outcomes

This section considers actual budgetary outcomes, or whether budget execution systems in the CIS-7 countries can deliver planned spending within the budget aggregates. It looks at how well budget outcomes reflect budget plans, particularly in terms of sectoral allocations, and at deviations between plans and outcomes and how these deviations are related to external macro shocks. It also considers how accurate and effective financial management information systems are in giving budget decision makers the information they need to execute their budgets as planned and how budget execution systems facilitate or hinder good budgetary outcomes.

Comparative Analysis of Budget Deviations

Better expenditure planning is futile without mechanisms to ensure that budget implementation is in line with plans and that good information is available on budget performance. While the CIS-7 countries have made considerable progress in strengthening budget execution systems since the mid-1990s, weaknesses remain. Significant budget deviations undermine good budget practice in several ways:

  • Accountability. Poor predictability in budgets removes a key plank for establishing accountability. Holding budget institutions accountable for monitored performance becomes impossible if resources are unpredictable within very wide margins.

  • Credibility and predictability. The degree of divergence in the functional classification raises concerns about the stability and credibility of the policy. If budget intentions over a one-year horizon are implemented with a large error margin, this has implications for governments’ ability to implement any policy entailing significant medium-term reallocations of resources.

  • legitimacy. The extent of budget deviations raises questions about the legitimacy of the budget process: divergences from budget appropriations indicate a weak link in accountability to the legislature in the budget process.

In general, the main reasons for such deviations include the following:

  • Macro shocks, causing expected budget revenues to shrink and requiring cuts in budget expenditures to meet agreed deficit targets. Volatility in external financing may also be a contributory factor.

  • Unrealistic revenue projections, requiring reductions in planned budgetary expenditures in order to meet agreed deficit targets. Unrealistic projections often are the result of political pressure to raise macro growth rates and revenue forecasts. These projections subsequently need to be revised downward when actual revenue collections are less than expected.

  • Volatility in policies, reflecting changes in priorities—after the budget has been approved by parliament—that are not due to reductions in revenues as a result of macro shocks or poor revenue estimates. This volatility tends to be reflected most in different shares for sectors (rather than in overall deviations) between planned and actual expenditures.

  • Institutional weaknesses in budget planning and execution systems, such as the fact that planned budgets are not credible.

A comparison of actual and planned budgetary expenditures across the CIS-7 countries for 2001 shows deviations overall and within sectors as well as between planned and actual sector shares (Table 5.4). As indicated above, major deviations between budget plans and budget outcomes mean that there has been substantial adjustment of budget allocations after parliamentary approval and significant instability in broad policy decision making. This policy instability results from a highly unpredictable policy environment (macro shocks) and indicates long-term weaknesses in the institutional system for budget preparation and implementation.

Table 5.4.

Comparison of Planned and Actual Budgetary Outcomes by Sector (Function) in Four of the CIS-7 Countries, 2001

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Sources: Ministry of finance for each country; World Bank staff estimates.Note: This analysis is based on a functional classification of budget performance for reasons of data availability and comparability. This methodology may lead to underestimation of actual budget deviations compared with deviations measured by budgetary institutions or spending units.

Overall Deviations

Significant deviations in overall expenditures demonstrate the effects of macro shocks and poor revenue projections (see Table 5.4). Each country’s original budget as approved by parliament was used as the basis for the analysis, because that version was used for expenditure planning by sector ministries and for debate by parliament. Budgets are revised during the year, and deviations between budget plans and outcomes gradually narrow during the year.

Because of the frequently changing political and economic landscape in the CIS-7 countries, it is difficult to be definitive about the causes of budgetary variations across years, since patterns in one year may not carry through into the next. Nonetheless, evidence for some of the CIS-7 countries indicates that the extent of deviations does continue from one year to the next, indicating systemic problems in budget execution.

  • Deviations between budget plans and actual outcome for 2001 ranged from around 2 percent (Armenia) to nearly 20 percent (Georgia). Difficulties in revenue collections are responsible for the significant deviations in Georgia. Outcomes in 2000 were also significantly less than planned, at nearly 35 percent lower than the original budget for that year.

  • Executed budgets were lower than planned budgets, primarily because of lower-than-expected revenues. Overoptimistic revenue projections are the most likely explanation. There is a perverse incentive for countries with a Poverty Reduction and Growth Facility program to overstate their revenues in order to demonstrate that the government is spending sufficient budgetary resources on meeting sectoral reform measure targets.

  • Deviations in some countries (Armenia, Georgia, the Kyrgyz Republic) were the result of significant volatility in the receipt of foreign financing.

As indicated above, predictability in the budget is important, as it enables sector ministries to plan their expenditures strategically in order to implement government policy objectives efficiently. Frequent changes in budgets, either in planned allocations over time or in actual outcomes compared with budget plans, lead to a loss of legitimacy and thus of credibility for the budget.

Some sectors suffered significant deviations between plan and outcome, reflecting in-year changes in policy and poor budgetary planning, thereby undermining budget predictability in these sectors. Sectors with lower budget deviations indicate priority sectors for governments, in that they are relatively protected from general budget cuts. The analysis shows that:

  • budget deviations at the broad functional level suggest that the budget preparation process fails to reflect the factors that affect actual budgetary allocations;

  • general government services (including public administration and defense) underwent disproportionately small budgetary cuts, while economic services underwent disproportionately large cuts;

  • expenditures on public order and safety were protected from budget cuts, reflecting the importance of this sector for the CIS-7 governments;

  • expenditures on social sectors were relatively protected from the largest budget reductions. In Moldova, however, reductions in health and education expenditures were required to meet payment obligations for social protection programs; and

  • requirements to make emergency energy transfers undermined that sector’s budget plans in Georgia.

Ministry-level budget deviations provide even more accurate information on the degree of budget predictability. An examination of the extent of budget deviations for selected ministries in the Kyrgyz Republic shows that defense and national security institutions, as well as central ministries such as the Ministry of Finance, had the smallest variation between budgets and actual outcomes (Figure 5.6). The largest deviations were found in the social sector ministries, particularly the Ministry of Education and the Ministry of Labor and Social Protection.

Figure 5.6.
Figure 5.6.

Budget Deviations for the Largest Budget Users in the Kyrgyz Republic, 2001 (In percent)

Source: Ministry of Finance, the Kyrgyz Republic.Note: The figure shows the sum of absolute budget deviations by budget user as a percentage of the originally approved budget. Total budget deviations in 2001 were 13,6 percent.

Deviations Between Sectors

A comparison of deviations between budget plans and outcomes for Armenia, Georgia, and the Kyrgyz Republic shows the effect of protecting economic items (Table 5.5). As expected, wages and transfers showed relatively lower levels of deviation in all three countries than expenditures on goods and services. The sharp deviation in interest payments in the Kyrgyz Republic reflects the debt reduction strategy approved midyear.

Table 5.5.

Deviations Across Economic Items Between Budget Plans and Actual Outcomes for Three CIS-7 Countries, 2001

(Deviations as percentage of original budget)

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Source: Ministry of finance for each country.

Data are for 2000.

Impact of Budget Execution Systems on Budgetary Outcomes

Weaknesses in budget execution systems compound the difficulties that governments face in linking budgets and expenditures with strategic policies. Modern budget execution systems should assist governments in implementing budget plans by facilitating strategic changes in budgetary allocations during implementation, applying effective commitment controls and preventing significant expenditure arrears from building up, and providing sufficient analytical information for sound financial management. Experience from the CIS-7 countries indicates that weaknesses in budget execution prevent some of these objectives from being met.

Ability to Make Strategic Expenditure Cuts

CIS-7 ministries of finance have limited tools for making strategic budget reductions when there is a shortfall in revenues, since budgets themselves provide little information on the policy areas in which sector budgetary allocations are being spent. The lack of adequate information on how resources are being spent makes it impossible to monitor budget implementation effectively.

Current practices also restrict the ability of ministries of finance to reduce expenditures strategically. Most CIS-7 ministries of finance are prevented from making significant in-year expenditure cuts except through sequestration, which requires parliamentary approval. Many budget laws provide for protection and full financing of certain categories of payments, such as defense, debt servicing, and entitlement programs. Since these items constitute a large proportion of the budget, the scope for expenditure cuts is limited severely. Furthermore, sequestration requires proportional cuts across all nonprotected items, further restricting the flexibility of the ministry of finance to identify low-priority areas. In addition, projects with aid agencies have disbursement schedules that limit maneuverability when revenues fall short of expectations.

Budgets tend to be appropriated by detailed economic item, further limiting the flexibility of sector ministries or the ministry of finance to move resources across economic items in order to use inputs more effectively. Recent reforms in Georgia and the Kyrgyz Republic have increased this flexibility by appropriating entire budgets to individual budgetary institutions such as hospitals, thereby enabling them to restructure budgetary inputs. Some of these institutions have recorded impressive efficiency gains as a result.

At the same time, there is rarely a mechanism for cutting expenditures by sector or program area. Expenditure budgets are enforced by function and economic item. Sector managers have little discretion to switch funds between items within a function. As a result, when overall budget reductions are required, budgets tend to be cut proportionally across all nonprotected items in all sectors, rather than prioritized by government policy areas, even in CIS-7 countries that have a medium-term budget framework. This problem is exacerbated by the highly centralized nature of expenditure control. In many CIS-7 countries, no specific individual in sector ministries is given explicit accountability for that ministry’s expenditures.

Effectiveness of Commitment Controls

Poor commitment recording and monitoring, exacerbated by weak fiscal discipline and the low credibility of the budget preparation process, lead budgetary institutions to take on commitments beyond their annual budget appropriations. The buildup of arrears reflects the lack of a functioning system of commitment controls. In many cases, monthly payment limits are lower than budget appropriations, but budgetary legislation often does not permit ministries of finance to contain expenditure commitments at a lower level. Since actual payment limits are below appropriations, local treasury branches will not authorize payment orders beyond these monthly limits, leading to the accumulation of unpaid invoices. These weaknesses are exacerbated by the paper-based systems used for recording, accounting, and reporting, leading to delays in information flows to the central treasury. Some CIS-7 countries have resorted to noncash transactions, including barter payments, as a way to reduce the stock of (cash) arrears by setting barter “prices” that are higher than market prices. In the Kyrgyz Republic, for example, an estimated 20 percent of state budget operations are noncash in nature.

At the same time, especially in Armenia, sector ministries are not adhering to payment limits that are set below the level of appropriations. Thus, when revenues are less than expected, a cash flow problem ensues. Spending ministries tend to take the view that their budget represents a guaranteed level of expenditures rather than an upper limit and thus find it difficult to reduce expenditures when there is a revenue shortfall. This is a rational response to the belief that if resources are not used, allocations will be reduced accordingly in the following year. However, it results in substantial payment arrears being carried forward and undermines strategic budgetary implementation.

Effectiveness and Availability of Financial Management Information

Timely and accurate reporting on budget implementation is weak, in part because of the absence of the necessary skills and authority in relevant departments in the ministry of finance and sector ministries to interpret the reports and make financial management decisions. Quarterly and annual budget implementation reports are intended to provide governments with the information they need to supervise and monitor budget implementation according to budget plans.

Several weaknesses impede the ability of governments to supervise and monitor budget implementation. In some countries, the ability to use the information on budget implementation is reduced by inconsistencies between the classification system used by the central treasury and that used by budgetary institutions, whose results are compiled by the relevant sector ministries. In addition, poor commitment controls mean that the budget implementation reports do not include information on total commitments, which limits the reports’ effectiveness. Also, financial management decisions require timely reports on budget implementation. The paper-based systems used in most CIS-7 countries to collect data on budget implementation make timely reporting very difficult.

Future Directions for Public Expenditure Management Reform

Weaknesses in budget management and implementation systems throughout the CIS-7 countries have resulted in resources not being available when required and being used for purposes other than intended. The lack of adequate information on how resources are used makes it impossible to monitor budget implementation and to plan budgets effectively. Strengthening budget management and treasury systems is critical for ensuring that resources reach their intended destinations and for making timely information available to program managers and decision makers.

Future Reform Directions

A switch is already taking place from the pattern of ad hoc, piecemeal budgetary measures toward systematically planned, longer-term reform programs. The key challenge is to integrate fiscal and expenditure control issues directly into the policymaking process. This integration implies very different roles and capacities for the ministry of finance (in providing advice on major policy decisions, forecasting the budgetary effects of policy changes, and controlling expenditures) and for sector ministries and service managers (greater role and authority in budget analysis, preparation, and implementation).

Without better budget management, the economic reforms under way in the CIS-7 countries may be jeopardized. If appropriate resources are not being targeted to the desired reforms, the reforms either will not be carried out or will take considerably longer. And if governments are unable to monitor their budgets appropriately, particularly in terms of outcomes, they will not be able to adjust their reform programs and associated resources accordingly.

Strategic Outlook

Most of the institutional weaknesses in the budget process highlight the need for a more strategic approach to public expenditure planning, linking medium-term budgetary resource allocations to sector policies and planned expenditure programs. Several CIS-7 governments have sought to integrate the different elements of a strategic approach to public expenditure management by introducing a medium-term budget framework that provides a multiyear planning horizon, includes all public resources and private expenditures, and allows governments to decide on strategic budget choices. The principal elements of such a framework are a comprehensive macro-fiscal framework that provides a realistic basis for budgetary development, a series of sector expenditure strategies that link sector policies and expenditure priorities, and a set of multiyear expenditure plans that provide the resource ceilings within which sector ministries can plan their expenditure programs.

The CIS-7 countries with the beginnings of a medium-term budgetary framework process (Armenia, the Kyrgyz Republic, and Moldova) should concentrate in the short term on measures to strengthen the framework, particularly its presentation to government (ideally, to an economic or budgetary policy committee) before the issuance of guidelines for the following budget year. The aim in the medium to long term should be preparation and government approval of an operational medium-term budgetary framework with stable multiyear indicative sector ceilings within an overall realistic resource framework that sets out clear policy objectives, provides adequate resources to meet those objectives, and explicitly guides the preparation of the next annual budget. Building that framework will require strengthening and integrating capacities for policy development, programming, and budgeting at the sector level. The aim should be to ensure that expenditure programs both reflect policy priorities and are costed within a realistic and achievable resource envelope.


Through public consultation and participation processes, Poverty Reduction Strategy Papers are emphasizing greater transparency and accountability in planning and implementing government policies and programs. While significant progress in increasing transparency has been made already through the introduction of a central treasury and improvements to budget classification and presentation, more work is needed, specifically in the following areas:

  • preparing and publishing a summary of the medium-term budgetary framework and the annual budget for the general public, focusing on the use and impact of public resources;

  • introducing an operational program classification that can generate program and activity-based expenditure policies for analysis. This classification will enable clear definition of policy expenditure commitments and estimation of the costs of ongoing government services;

  • expanding the format of budget presentations to include sector objectives and programs to increase the transparency of sector budgets. This format will require a change in the methodology for estimating budgets, from estimating by rigid supply-side norms to a more policy-based analysis of how resources are currently used and how they may be targeted better to priority areas. Explicit links should be made with medium-term fiscal frameworks; and

  • ensuring that budget preparation instructions are clear on the revised roles of sector ministry staff and the ministry of finance.


More transparent budgets help improve the government’s accountability for the budget to the public. Further accountability within the budget system itself is needed to ensure that senior managers, in sector ministries and ministries of finance, are individually accountable during each stage of budget preparation and implementation. Reform areas to address include the following:

  • Ensuring that the budget is appropriated by ministry and agency (the administrative classification) to facilitate accountability for budgetary spending. Doing so will give greater authority to sector ministers and accounting officers to program and manage their budgets to fulfill sector policies.

  • Establishing a clear reporting line from an accounting officer in each sector ministry to parliament on the execution of sector budgets. Establishing this line involves assigning responsibility for executing budgets to a senior manager in sector ministries.

  • Giving more authority to sector budget managers to implement their budgets within any set cash limits. Budget managers should have greater discretion for switching funds between economic items within a functional classification. Allowing managers some flexibility should motivate them to be more effective.

  • Over time, increasing delegation for budget responsibility to budgetary institutions such as schools and health facilities, linked to the introduction of improved governance arrangements that ensure accountability to the local communities they serve. This delegation should be accompanied by a more appropriate role for the central ministries. Lessons can be drawn from international experiments focusing on accountability and sanctions for budget mismanagement. Training in financial management will be needed.


The legitimacy of the budget depends on the active involvement of decision makers in setting budget parameters at the beginning of the process and on these parameters remaining reasonably stable during budget implementation. Reforms are needed in the following areas:

  • ensuring earlier political involvement in the budget process, particularly during determination of budget ceilings, to help ministries keep their budget requests within expenditure ceilings;

  • preparing a medium-term budgetary framework and presenting it to the government for approval before the start of the annual budget preparation process, to help ensure senior policymakers’ involvement and approval of the overall budget parameters;

  • emphasizing that sector ceilings will be adhered to in order to increase the legitimacy of these budgetary parameters; and

  • respecting the role of budget managers (those responsible for service delivery) in the setting of budgets rather than imposing budgets from the top, to strengthen ownership of budgets by those responsible for delivering public services.


To be credible, budgets must be achievable and close to eventual outcomes (budget deviation limited to those caused by external shocks). Reform areas to address include the following:

  • improving the methodology for estimating revenue projections to prevent unnecessary changes during budget implementation;

  • ensuring that the ministry of finance enforces sector ceilings during budget formulation. Budgets should be constructed by spending ministries, rather than imposed on them by the ministry of finance;

  • introducing or strengthening a medium-term budgetary framework with credible multiyear indicative expenditure ceilings to increase both the predictability and credibility of the budget; and

  • involving policymakers at an early stage of budget preparation to reduce unnecessary shifts in policy priorities during budget implementation.


Large deviations in annual budgets make it difficult for governments to implement medium-term policies and for sector ministries to plan their policy reform measures effectively. Reforms to improve budget predictability include the following:

  • introducing or strengthening a medium-term budgetary framework with credible multiyear indicative expenditure ceilings; and

  • improving projections of multiyear revenues to increase the reliability of the macro-fiscal framework and sector ceilings.


Budgets should include all cash and noncash transactions, including extrabudgetary funds, off-budget funds, and external finance. All resources should be prioritized according to the same procedures as for the domestic recurrent budget and subject to parliamentary scrutiny and to the associated discipline of the resource allocation process. Reforms to address include the following:

  • incorporating all public investment revenues and expenditures into the medium-term budgetary framework and annual budget, with joint planning and monitoring of sectoral recurrent and development expenditures;

  • requiring sector ministries to provide information in their budget submissions on off-budget revenues and expenditures consistent with overall sector policy priorities;

  • presenting a consolidated budget that includes all extrabudgetary funds; and

  • restricting the use of extrabudgetary funds.

Enforceability and Responsiveness

The budget system should be capable of responding to changed circumstances and should give budget managers some discretion in the use of funds in delivering services, provided expenditures do not exceed authorized amounts. Reforms to address include the following:

  • strengthening the quality of macroeconomic information supporting preparation of the budget framework;

  • improving revenue projections to lessen the risk of budget shortfalls, and when reductions are required, involving sectoral ministries in deciding on cuts;

  • involving political decision makers earlier in the budget process to help reduce the number of ad hoc changes;

  • improving budget preparation by introducing a programmatic structure to the budget and making better information available for making strategic budget cuts, where necessary;

  • introducing or strengthening the methodology for ensuring strict recording of and accounting for commitments;

  • improving the quality, consistency, and timeliness of information flows between budget users and the treasury to improve budget decision makers’ ability to take corrective action;

  • ensuring that the ministry of finance has sufficient institutional capacity to analyze and monitor these data;

  • extending treasury reforms to local treasury branches and introducing new accounting systems based on the Treasury General Ledger to improve the quality of budget execution information available to decision makers; and

  • making it easier for the ministry of finance to reappropriate funds for different administrative levels (government, sector ministries, budgetary institutions) and to move funds from wages to other economic items or from capital to recurrent expenditures, and for sector budget managers to implement and adjust their budgets within cash limits.


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