A. Background

28. Public Expenditure Management (PEM) is an important instrument of fiscal policy and must support overall economic policy goals. The three key objectives of a good PEM system are: (i) maintaining overall fiscal discipline; (ii) achieving an allocation of resources consistent with policy priorities; and (iii) ensuring prudent management of the government's financial resources. These three objectives are complementary and interdependent, and therefore need to be pursued together. This note provides a broad assessment of Cambodia's PEM system, describes the broad outlines of its ambitious Public Financial Management Reform Program (PFMRP), and identifies key reform priorities for the short and medium term.

29. The latest assessment of the PEM system was conducted in December 2005, as Cambodia became eligible for debt relief from the IMF under the Multilateral Debt Relief Initiative (MDRI).¹⁶ To obtain the relief, Cambodia needed to demonstrate that progress had been made towards a satisfactory PEM system. The assessment shows that Cambodia meets 5 out of 16 PEM benchmarks, compared with an average of 6–7 for the 26 Highly Indebted Poor Countries (HPIC) assessed in 2004. These results indicate a modest improvement on those reported in the World Bank’s Integrated Fiduciary Assessment and Public Expenditure Review (IFAPER) in 2002–03, using HIPC AAP guidelines, under which Cambodia met only three benchmarks out of 15.

30. Serious PEM weaknesses remain, across most of the areas covered by the MDRI assessment:

Budget formulation does not provide an accurate record of public sector spending plans, in the aggregate and in terms of composition. In particular:

• The budget does not fully incorporate non-tax revenues collected and spent by line ministries, and includes only partial information on projects to be financed by external assistance.

• Budget outturns often deviate substantially from the budget plans presented to the National Assembly. This is consistently the case for non-tax revenues and for the composition of current spending, although aggregate current spending is generally in line with the budget.

• Mapping policy priorities, in particular poverty reduction, to specific spending items is only possible at too high a level of aggregation, due to an outdated budget classification.

Budget execution and reporting systems do not support the achievement of the spending priorities set out in the budget.

• Because of shortcomings in budget formulation combined with a fragmented cash management system—the government has over 1,500 bank accounts—resources are often not available, or not on a timely basis, to support budget allocations.

• In spite of that, as internal control is weak and reporting systems do not provide financial managers with adequate information, spending ministries can often continue to undertake spending commitments. In addition to causing deviations from the budget, this can result in a build-up of expenditure arrears. Moreover, it has led the authorities to create mechanisms, such as the Priority Action Programs, that, while aiming to channel resources to policy priorities, undermine further the mainstream budget execution system.

Procurement rules and practices remain problematic. The legal procurement framework is not comprehensive, and the regulations that do exist are weakly enforced (World Bank, 2004). In particular the widespread use of direct purchase or contracting, including for major public concessions, has led to an inefficient use of public resources.

B. The Authorities’ PFM Reform Program

31. The authorities are acutely aware of the need to improve their expenditure management system and have formulated a comprehensive Public Financial Management Reform Program (PFMRP). The PFMRP, which was formally adopted by the Government and made public by the Prime Minister in December 2004, lays out the authorities’ vision for improving the PFM system over a 10-year period.¹⁷ Drawing on lessons learned from prior technical assistance, including the Technical Cooperation Action Plan (TCAP), the PFMRP is built upon four sequenced and prioritized platforms, aiming at making the budget more credible in terms of timely and predictable delivery of funds, and improved financial accountability.

32. The reform program has already begun to address the weaknesses identified in the MDRI assessment. In particular, under the first platform:

• Budget Formulation: Strengthening capacity to formulate and integrate the budget, including redesigning the budget and accounts classification system.

• Budget Execution Systems and Processes: Supporting the modernization of the budget and treasury management systems and processes, including establishing an integrated financial management information system, widening the scope of payments through the banking system including payments of taxes and salary payments to civil servants, and building the Ministry of Economy and Finance’s (MEF) capacity to carry out expenditure tracking surveys.

• Revenue Management: Improving revenue administration by developing a revenue mobilization policy for the national and sub-national levels, strengthening tax department capacity for registering, assessing, collecting, and auditing tax revenues, and providing taxpayers services, and developing and implementing a non-tax revenue collection and compliance enforcement policy, including considering direct payments to the treasury.

• Procurement: Enhancing the procurement system, by, inter alia, developing an enhanced legal and regulatory procurement framework, including the development of a new procurement law, and preparing and disseminating harmonized procurement procedures and documents.

• Internal Audit: Strengthening capacity to carry out internal audit, including establishing arrangements for setting internal audit standards and conducting reviews, and completing the establishment of internal audit departments within each ministry and public enterprise.

• Institutional Strengthening: Developing MEF’s overall capacity, including providing in-house training, assessing and reorganizing its institutional structure, and strengthening its capacity to implement the PFMRP.

33. The PFMRP is supported by the Fund and by a broad range of donors. The World Bank is leading a multi-donor process, focusing on the areas of strengthening budget legislation, developing a Medium Term Expenditure Framework (MTEF), improving the process for post-budget supplementary expenditure, strengthening the procurement framework, and assisting with the initial design of IFMIS. Fund technical assistance has focused on the National Treasury (NT) as well as revenue administration.

34. Monitoring mechanisms to support and track implementation of the PFMRP have been set up by both the authorities and donors. The program is under the oversight, on the government side, of the PFM Reform Committee, chaired by the Minister of Finance, with a Secretariat in the MEF, and, on the donor side, the Development Partner Committee and its Secretariat. Implementation of the reform program needs to be monitored closely, given the size of the agenda, limited staff capacity, and the need to remain flexible in the implementation timetable of detailed measures.

C. Short and medium-term priorities for the PFM Reform Program

35. The short-term priority on public financial management reform is to reassert broad control over public finances. The focus will be on:

• Strengthening the management of non-tax revenue including their collection, accounting, streamlining, and reporting. This activity is also an integral component of establishing the Treasury Single Account (TSA), as it will involve closing spending ministries’ numerous bank accounts that remain outside the control of the NT. In addition, a transparent and competitive bidding process for awarding concession contracts and the regular auditing of the terms and conditions of existing contracts would aid fiscal transparency in the area of nontax revenues.

• Identifying and tracking poverty-reducing expenditure. There is a need to define and track more clearly spending on poverty reduction, rather than budgetary allocations to priority ministries, in a manner consistent with the NSDP. Progress in this area would complement the development of a program budgeting framework, starting with the Priority Action Programs (PAPs), with the support of the World Bank.

• Addressing the payment arrears problems. Cambodia has a significant stock of outstanding payment orders which the authorities intend to eliminate over a five-year period. However, at present the accounting system is not sufficiently well maintained to record, report, monitor and control payment arrears as they arise, requiring an upgrade of the current system of tracking outstanding payment orders. Also, transparent rules should be developed for, both, reducing old arrears and settling regular payment orders.

• Improving the effectiveness of internal control and internal audit. An effective system of control over expenditure commitments needs to be established, and internal control capacity needs to be developed in spending ministries.

• Integrating cash management with budget releases, commitment controls, and payments. There is a need to develop the capacity to manage short-term inflows and outflows from the TSA—establishing a full cash planning function remains a longer term objective. Developing financial instruments such as treasury bills could also mitigate intra-annual cash management problems.

• Establishing a comprehensive reporting system for budget implementation that should cover the approved budget, budget releases, commitments, payment vouchers submitted to the NT, and actual payments, as well as the tracking of identified NSDP expenditures. In undertaking this task, the NT should take advantage of plans to implement an integrated financial management information system (IFMIS), with World Bank support.

• Completing the work on the new chart of accounts (COA) for implementation in the 2007 budget. Considerable progress has been made in preparing a revised COA and budget classification system. Implementation for the 2007 budget will require completing an Accounting Manual and harmonizing the COA for various levels of government. The new COA will allow the derivation of data on an economic classification based on the GFSM 2001, with Fund assistance on improving GFS compilation procedures.

• Streamlining budget execution procedures for various types of expenditures and advances, including expenditures financed by grants and transfers. Procedures at each stage of the spending chain should be reexamined, with a focus on payment, accounting, and expenditure reporting, using the new budget nomenclature and COA. In the near term, applying regular budgetary procedures for the Priority Action Programs needs to be considered.

• Rationalizing and consolidating government bank accounts, following up on the recent completion of an inventory of all such accounts in commercial banks and NBC. The authorities should aim at establishing an operational TSA, which will require continued technical assistance.