Budget Planning

Reforms to the budget planning process need to be cognizant of the two immediate determinants of reform, namely: the authorities’ IMF supported economic program and the EU-Ukraine Association Agreement. Essentially, these proscribe the need for an expenditure based fiscal consolidation program and a medium-term budget planning process.

FAD’s previous recommendations on developing a medium-term budget framework have not been implemented to date. In the current environment, full implementation may not be immediately possible but specific measures should be taken to introduce realism and a medium-term outlook to support consolidation and ensure other PFM reforms are successful.

There is a need to introduce medium-term expenditure ceilings on Key Spending Units (KSU), binding for the first year and indicative for the following two together with the introduction of forward budget estimates. Budget projections should also reflect the measures being proposed under the IMF supported program and that spending units take these into account when preparing their budget proposals to prevent future accumulation of arrears.

Plans to prioritize reforms to the existing performance budgeting system should not be considered in the short-term given existing resource constraints. Over the medium-term the legal framework will need to be revised to integrate the MTBF with the budget process.

Developing a cash management strategy

The government’s banking arrangements including the presence of a treasury single account (TSA) largely meet international good practice, but there are some areas that could be improved to maximize the efficiency of cash management operations.

All cash balances of general government including the social funds and balances being held in foreign exchange accounts in the National Bank Of Ukraine (NBU) and the commercial banks should be made available for liquidity management purposes, although some safeguards need to be put in place to ensure that general government entities have access to their own resources when they need them to meet their own obligations. Foreign exchange and Hyrvina bank accounts in the commercial banks should be reviewed with a view to closure and balances in foreign exchange accounts in the NBU should be used for liquidity management purposes.

Before this can be fully achieved cash planning will need to be considerably strengthened. The existing cash planning system is extremely short-term and is not conducive to efficient liquidly management. Capacity should be developed by establishing a cash planning unit in the MoF supported by a high level cash management committee to ensure that information needed to produce accurate and timely cash plans is made available from all relevant stakeholders.

To reduce volatility of cash balances and to better integrate cash and debt management operations the Debt and International Financial Policy Department should be given responsibility for managing the end of day balances on the TSA.

Budget Execution and Internal Control

Existing practices of releasing cash in the absence of an appropriation through the issuance of loans from the TSA and allowing KSUs to borrow to fund capital expenditures in excess of budget appropriations breach fundamental principles of PFM and should be discontinued.

The accumulation of substantial payment arrears also point to weaknesses in existing budget execution and control processes. Commitment controls need to be introduced earlier in the expenditure cycle to prevent accumulation of arrears and support cash management.

Existing rigidities in budget execution make it difficult for program managers to manage threats to their service delivery programs. This could be alleviated by offering KSUs greater flexibility in transferring their budget within certain economic categories. Protected and unprotected expenditures should be abolished as part of a move to introduce greater realism in budget planning and provide adequate resources for all appropriated expenditures.

An extensive control framework of ex-ante and ex-post controls exists, although efforts are in train to further increase ex ante control with little perceptible added value. Initiatives by institutions such as the Accounting Chamber of Ukraine to expand their mandate to include exante controls should be resisted to prevent conflict between their role as an independent assessor and acting as a participant in operational decisions and policy implementation.

The focus should be on ongoing efforts to roll out the internal audit function to all budget entities and putting measures in place to make managers responsible for the internal control processes in their own ministries. Greater budget flexibility and more relaxed external controls should be granted to KSUs once they have demonstrated that they have adequate control processes in place. However, these changes should be pursued in the medium term.

Accounting and Fiscal Reporting

Extensive cash based reports on the execution of the budget are produced and published but the government’s ambition to transition to an accrual based system by the beginning of 2015 will be hampered by weaknesses in current systems including accounting systems; the existing focus on cash based reporting and lack of accountancy capacity.

Progress towards an accrual based framework will require the acquisition of IT systems to support the implementation, as existing systems are inadequate. Even if such systems are put in place relatively quickly, experience teaches that completion of a major reform such as this may take years, and the first step should be the preparation of a realistic implementation plan.

One area that should be explored is the expansion of the coverage of fiscal reporting to cover the wider public sector. State-Owned Enterprises and other public entities outside of general government are major sources of fiscal risk and existing reporting structures do not adequately capture their activities. Obtaining full coverage of reporting of the public sector poses significant challenges in the face of disparate reporting and accounting standards and will require a phased approach before consolidated reporting is achievable.

Management and oversight of state assets

The existing portfolio of state assets is a source of significant value and also of fiscal risk. Government ownership of these assets brings with it a number of conflicting objectives including the desire to maximize value of the portfolio, regulate the industries in which they are present, and implement social policy through the medium of these assets.

The state asset ownership and management framework is decentralized, fragmented, and includes numerous conflicting roles and responsibilities at different levels of government. The legal framework surrounding ownership is also complex, often contradictory and is likely hampering efforts to increase transparency, put in place a coherent management framework and unblock the stalled privatization program.

Three areas should be prioritized to manage the portfolio of state assets and unlock potential value and identify and mitigate the associated fiscal risks: the legal framework, the ownership structure, and transparency polices. Many of these reforms will take a number of years to complete and a phased approach is appropriate. The emphasis in the short-term should be on putting the institutional structures in place to enable: the identification of the size of the consolidated portfolio; the fiscal risks emanating from the sector; and the implementation of a transparency policy with the objective of disseminating details of the value and size of the portfolio to the wider public and potential investors.

To do so, will require the establishment of a unit in the ministry of finance to; determine and manage the risks associated with the portfolio; oversee all financial flows; and establish the portfolio’s value. This should be accompanied by publication of an annual report on the portfolio of state assets to include details of potential values. Over the medium-term a review of the legal framework surrounding management and oversight should be carried out and a more ambitious management structure should be considered to consolidate responsibility for active ownership, financial control and privatizations within a single arms length entity.

Table 1 is a list of summary recommendations and proposals for follow up technical assistance to help implement the PFM reforms being proposed in the report.

Table 1.

Ukraine: Summary of Recommendation and Action Plan

Table 1.

Ukraine: Summary of Recommendation and Action Plan

Rec No.	Action	Short-term	Medium-Term	Responsibility	TA needs
Budget Planning
2.1	2015 Budget projections to include MTFF and expenditure ceiling for KSUs			MoF
2.2	Issue new budget instructions to KSUs			MoF
2.3	Coordinate budget projections with structural reform and rationalization plans			MoF and KSUs	FAD STX
2.4	PFM action plan to center budget preparation reforms on developing MTBF			MoF and donors
2.5	Revise the Budget Code to provide a legal backing for the MTBF reform			MoF, COM, VR	FAD STX2
Cash Management Strategy
3.1	Survey central government commercial bank accounts and rationalize			STU
3.2	Eliminate foreign currency accounts of spending units in the commercial banks			STU and MoF	FAD STX
3.3	Put in place formal arrangements to borrow balances of Social Security Funds			STU, MoF, SSF	FAD STX
3.4	Review foreign currency accounts in the NBU with a view to rationalization			MoF	FAD STX
3.5	Identify impact of lack of liquidity on LGs ability provide legally mandated services.			MoF, STU
3.6	Establish a cash planning unit in the Ministry of Finance or STU.			MoF, STU	FAD STX
3.7	Reduce volatility of TSA through alignment of major receipts and expenditures			MoF Budget Dept
3.8	Debt Department responsible for managing the balance on the TSA			MoF, STU	FAD STX and HQ
Budget Execution and Internal Control
4.1	Introduce commitment controls to the budget execution framework for 2015			STU	FAD STX
4.2	Develop an arrears clearance strategy			MoF	FAD STX
4.3	Eliminate distinction between protected and unprotected items in 2016 budget			MoF
4.4	Produce a strategy for expanding the functionality of STU IT systems			STU and donors	FAD STX
4.5	Provide managers with greater flexibility in budget execution control rules			CoM and MoF
4.6	Limit mandate of the ACU to ex post audit			CoM and VR
4.7	Amend BCU allowing ACU explain budget to CoM and Budget Committee			CoM and VR	FAD STX and HQ
4.8	Continue the roll-out of internal audit and make managers accountable			MoF and SFI	Other Donors
4.9	Grant freedom from ex ante-controls once certification is achieved			MoF and SFI	Other donors
Fiscal Reporting
5.1	Develop implementation plan to achieve compliance with accrual accounting standards			STU	FAD STX
5.2	Include SOEs in the annual financial statements as a separate sector			STU	FAD STX
5.3	Prepare consolidated public sector reporting (likely to take at least 5 years)			STU	FAD STX
State Assets
6.1	Establish unit in the MoF to manage financial aspects of SOE’s			MOF	FAD STX
6.2	Separate commercial and non-market based assets and report on cost of subsidies			MOF	FAD STX
6.3	Decree identifying value maximization as sole objective for commercial assets			MOF
6.4	Carry out a stock-take of consolidated portfolio of state-assets			MOF	FAD STX
6.5	Publish an annual review of state assets in English on the government web site			MOF and CoM	FAD STX
6.6	Review group to conduct a review of legal framework for SOE management			Multiple
6.7	Consolidate ownership within MoF and prepare long-term ownership plan			CoM, MoF	HQ mission

View Table

Table 1.

Ukraine: Summary of Recommendation and Action Plan

Rec No.	Action	Short-term	Medium-Term	Responsibility	TA needs
Budget Planning
2.1	2015 Budget projections to include MTFF and expenditure ceiling for KSUs			MoF
2.2	Issue new budget instructions to KSUs			MoF
2.3	Coordinate budget projections with structural reform and rationalization plans			MoF and KSUs	FAD STX
2.4	PFM action plan to center budget preparation reforms on developing MTBF			MoF and donors
2.5	Revise the Budget Code to provide a legal backing for the MTBF reform			MoF, COM, VR	FAD STX2
Cash Management Strategy
3.1	Survey central government commercial bank accounts and rationalize			STU
3.2	Eliminate foreign currency accounts of spending units in the commercial banks			STU and MoF	FAD STX
3.3	Put in place formal arrangements to borrow balances of Social Security Funds			STU, MoF, SSF	FAD STX
3.4	Review foreign currency accounts in the NBU with a view to rationalization			MoF	FAD STX
3.5	Identify impact of lack of liquidity on LGs ability provide legally mandated services.			MoF, STU
3.6	Establish a cash planning unit in the Ministry of Finance or STU.			MoF, STU	FAD STX
3.7	Reduce volatility of TSA through alignment of major receipts and expenditures			MoF Budget Dept
3.8	Debt Department responsible for managing the balance on the TSA			MoF, STU	FAD STX and HQ
Budget Execution and Internal Control
4.1	Introduce commitment controls to the budget execution framework for 2015			STU	FAD STX
4.2	Develop an arrears clearance strategy			MoF	FAD STX
4.3	Eliminate distinction between protected and unprotected items in 2016 budget			MoF
4.4	Produce a strategy for expanding the functionality of STU IT systems			STU and donors	FAD STX
4.5	Provide managers with greater flexibility in budget execution control rules			CoM and MoF
4.6	Limit mandate of the ACU to ex post audit			CoM and VR
4.7	Amend BCU allowing ACU explain budget to CoM and Budget Committee			CoM and VR	FAD STX and HQ
4.8	Continue the roll-out of internal audit and make managers accountable			MoF and SFI	Other Donors
4.9	Grant freedom from ex ante-controls once certification is achieved			MoF and SFI	Other donors
Fiscal Reporting
5.1	Develop implementation plan to achieve compliance with accrual accounting standards			STU	FAD STX
5.2	Include SOEs in the annual financial statements as a separate sector			STU	FAD STX
5.3	Prepare consolidated public sector reporting (likely to take at least 5 years)			STU	FAD STX
State Assets
6.1	Establish unit in the MoF to manage financial aspects of SOE’s			MOF	FAD STX
6.2	Separate commercial and non-market based assets and report on cost of subsidies			MOF	FAD STX
6.3	Decree identifying value maximization as sole objective for commercial assets			MOF
6.4	Carry out a stock-take of consolidated portfolio of state-assets			MOF	FAD STX
6.5	Publish an annual review of state assets in English on the government web site			MOF and CoM	FAD STX
6.6	Review group to conduct a review of legal framework for SOE management			Multiple
6.7	Consolidate ownership within MoF and prepare long-term ownership plan			CoM, MoF	HQ mission