## 1ukrea2019004 ## Source details **Canonical URL:** [1ukrea2019004](https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019004.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1ukrea2019004.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1ukrea2019004.pdf.json) --- ### PREFACE — Mission context, leadership, and engagements - Mission period: October 3–16, 2017. - Responded to request from the Minister of Finance, Mr. Oleksandr Danyliuk. - Technical assistance from IMF Fiscal Affairs Department (FAD) and Legal Department (LEG), financially supported by the Government of Canada. - Mission led by Miguel Alves. Team members: Veronique Salins (FAD); Alessandro Gullo (LEG); Camila Aguilar (FAD short-term expert); Francis Conway (FAD short-term expert); Nikita Aggarwal (LEG short-term expert). - Principal meetings with central government officials including Ms. Oksana Markarova, Mr. Serhiy Marchenko, Mr. Gennadiy Zubko, and senior staff of MoF, MRD, MoH, MoE, State Audit Service, State Treasury, and members of the Local Budgets Sub-Committee of the Verkhovna Rada. - Local engagements: Kyiv City State Administration; Cherkasy City and Oblast; Amalgamated Territorial Community of Baranivka. - Engagements with civil society and international partners including Associations of Ukrainian Cities, Reanimation Package of Reforms, Support to Decentralization in Ukraine Project, U-Lead with Europe Project, World Bank, European Commission, OECD, Swedish and Canadian Embassies. ### EXECUTIVE SUMMARY — Overview and headline outcomes - Reform outcomes and trends: - Decentralization reform introduced in late 2014 improved subnational government’s financial capacity, self-sufficiency, and flexibility. - Compared with 2014, own revenues of subnational governments increased, while current expenditure declined. - Capital expenditure almost doubled as a percent of GDP from 2014 to 2016. - Overall subnational governments recorded a combined surplus of 1.0 and 0.7 percent of GDP in 2015 and 2016, respectively. - Main drivers of positive outcomes (and vulnerabilities): - Overperformance on shared taxes (primarily the Personal Income Tax, distributed on a basis disconnected from service provision). - Bottlenecks in execution of capital expenditure. - Devolution of spending responsibilities in successive stages and not always through fully transparent systems. - Cross-cutting recommendations (high level): - Improve amalgamation design and process; clarify roles and responsibilities across levels; align revenue and expenditure assignments; introduce multi-year budgeting and MTBF; strengthen MoF mandate for fiscal risk oversight; establish Intergovernmental Commission; improve treasury arrangement and active cash management. ### TERRITORIAL ORGANIZATION — fragmentation, amalgamation, and legal clarity - Territorial structure and amalgamation status: - Four principal levels — 24 oblasts plus two cities of special status and the Autonomous Republic of Crimea; 474 rayons; 166 cities; over 8,800 hromada. - Amalgamation status (as of August 2017): 648 amalgamated hromada formed from 3,040 hromada, with total population around 6 million (14.1 percent of total population) covering 151 thousand square kilometers (26 percent of the area of Ukraine). - Total remaining hromada: 8,823 (short of target of 1,500). - Average population of amalgamated hromada: around 8,900 persons per unit; around 35 percent of new units have less than 5,000 inhabitants. - Table 1.1 totals (as of August 11, 2017): TOTAL 159 (2015) 207 (2016) 248 (2017) = 648 amalgamated hromada; Oblast area total 575,756 sq.km; AH area 151,082 sq.km; No. of hromada 11,215; No. of hromada amalgamated 3,040; No. of AHs with population less than 5 thous. persons = 215 (35.3 percent). - Challenges to voluntary amalgamation: - Revenue allocation basis (employer location) disadvantages suburban hromada that host residents who use services locally. - Land ownership and rent concerns undermine incentives to amalgamate. - Political economy: local leaders fear loss of positions. - Legal/organizational mismatches: - Hromada and amalgamated hromada are not clearly recognized as territorial subdivisions under the Constitution; overlaps and unclear demarcations between oblasts, rayons, cities, and hromada. - Lack of clear distinction between assigned, delegated, and shared powers. ### Recommendation cluster — Amalgamation and legal clarification - Recommendation 1.1: Future amalgamation criteria to ensure financial viability — suggested criteria include: - Minimum population: The new authority must have a minimum population of 3,000–5,000 inhabitants; - Self-sufficiency: The authority’s own and shared resources must cover at least 50 percent of their total expenditures; - Provision of basic services: access to full range of basic local services including primary education and healthcare and municipal services; - Efficiency of service delivery: realize economies of scale; possible minimum thresholds (e.g., at least 100 pupils per school; at least two doctors and two nurses per clinic); - Fiscal space for development: spend at least 10 percent of total budget on investment; - Financial integrity: a clean external financial audit within the past year validating compliance. - Recommendation 1.2: Mandatory amalgamation for chronically deficit hromada: - Mandatory for hromada incurring recurrent deficits for more than five years; MRD to enforce; debt servicing responsibility to remain with resulting amalgamated hromada, with possible rescheduling support. - Recommendation 1.3: Clarify legal framework: - Adopt a clear two-tier distinction between (1) state and (2) local government; distinguish assigned, delegated, and shared powers (possible amendment to Law on Local Self-Government); clarify administrative status of hromada; streamline administrative structures; remove overlaps. ### REVENUE ASSIGNMENTS AND SHARING — PIT, own revenues, and grants - SNG revenue trends (percent of GDP): - 2014: total SNG revenues were 14.6 percent of GDP; - 2015: increased by 0.2 percent (to 14.8 percent of GDP implied); - 2016: SNG revenues were 15.2 percent of GDP (increase of 0.6 percent compared to pre-reform). - Distributional shift of revenue across tiers (percent of total SNG revenue): - Oblast: from 21% (2014) to 14% (2016); - Rayons: 31% (2014) and 31% (2016); - COS (cities of oblast significance): from 43% (2014) to 47% (2016); - Hromada: from 5% (2014) to 6% (2016); - AH (amalgamated hromada): 2% (2016). - Shared taxes and PIT performance: - Shared taxes as percent of total SNG revenue: 2014: 29.4 percent; 2015: 23.6 percent; 2016: 27.4 percent (2016 increase driven by PIT over-performance). - As of 2015 distribution: State retains 25 percent of PIT yield; oblasts receive 15 percent; COS and rayons receive 60 percent. Unconsolidated hromada lost the 25 percent PIT share as an incentive to amalgamation. - Own revenues: - Own revenues grew in most tiers but less than anticipated; share observed in 2016 was 17.1 percent (increase of 6.6 percentage points from 2014), short of expected ~28 percent. - Grants and subventions: - Large number and size: 11 grants and 56 subventions in 2016. - Basic grant accounts for almost 80 percent of total value within grants. - Subventions account for about half of total revenues of subnational governments. - Total amount for the equalization grant: 6.7 UAH billion (2 percent of total subnational revenues). - Information used in subvention formulas is not transparently available to local governments. ### Recommendations on revenue assignment and own revenues - Recommendation 2.1: Adjust PIT sharing to reflect residence of employees (share PIT revenues based on where employees reside and not where the employer is located). - Recommendation 2.2: Adjust the real estate tax design and administration to collect greater own revenue and improve vertical fiscal balance, including: - Use market value in tax calculation; eliminate tax-free thresholds and exemptions to non-living spaces and commercial properties; adopt maximum allowable tax rates; fix a centrally determined rate range with a positive starting rate of 1 percent to a maximum rate of 2 percent; improve cadaster/land registry data; incentivize cadaster updates. - Recommendation 2.3: Enhance transparency and predictability of grants/subventions: - Clarify coverage of expenditure subventions by SNG level; publish parameter data used in subvention formulas; undertake a population census (last in 2001); discuss in advance responsibilities to be transferred. - Recommendation 2.4: Align expenditure and revenue assignments in the Budget Code with distribution of powers under the Law on Local Self-Government. - Recommendation 2.5: Reduce revenue assigned to administrative levels (Oblasts and Rayons) according to their roles after decentralization, with clearer coordination and accountability. ### SNG BUDGET FORMULATION, CASH BALANCES, AND CAPITAL EXPENDITURE - Budget structure and rigidity: - Two main funds: General Fund (Revenues: 93 percent; Expenditure: all current) and Special Fund (Revenues: 7 percent; Expenditure: current & capital). - Protected expenditure items (2016): Total Protected Items 260,333 (UAH million) equal to 74.3 percent of total SNG expenditures. Total Expenditure Outturn 350,413 (UAH million). - Earmarked revenues have accounted for more than half of total SNG revenues: 58.1 percent in 2015; 52.9 percent in 2016; 56.4 percent in 2017 (as of August). - Budget Code limit on “working balance” (2 percent of planned expenditures of the general fund) is unclear and does not preclude an SNG ending the fiscal year with a deficit. - SNG deposits (State Treasury) and cash ratios: - As of January 1, 2017 total SNG deposits: 36,152 (UAH million) = 1.5 percent of GDP. By September 2017 total deposits: 51,780 (UAH million) = 1.9 percent of GDP. - Treasury deposits by tier (UAH million, Jan 2017 / Sept 2017): Oblasts 7,212 / 11,710; Kyiv city 4,023 / 11,302; Cities of Oblast Significance 10,207 / 8,891; Rayons 12,750 / 16,495; Amalgamated hromada 1,959 / 3,382; Total 36,152 / 51,780. - GDP (UAH billion) figures: 2014 1,465; 2015 1,587; 2016 1,989; 2017 2,383 (Jan) and 2,734 (Sept estimate). - Deposits as months of expenditure (Jan 2017): Oblasts 1.8; Rayons 1.4; Kyiv 1.4; Cities (OS) 0.9; Amalgamated hromada 3.9; Total 1.3. - Revenue and expenditure monthly snapshots (UAH million): - Total Revenues year-end 2015: 24,538; year-end 2016: 30,503; Aug 2017: 39,928. - Transfers year-end 2015: 14,498; year-end 2016: 16,283; Aug 2017: 21,966. - PIT year-end 2015: 4,933; year-end 2016: 7,071; Aug 2017: 9,181. - Total Expenditures year-end 2015: 23,339; year-end 2016: 29,201; Aug 2017: 36,133. - Payroll year-end 2015: 8,809; year-end 2016: 9,693; Aug 2017: 10,217. - Balance year-end 2015: 1,199; year-end 2016: 1,302; Aug 2017: 3,795. - Capital expenditure trends and state investment grants: - Capital shares by tier (percent of total expenditure): 2014: Oblasts 2.8; Cities 9.1; Rayons 1.3; Hromada 16.1. 2016: Oblasts 14.3; Cities 20.0; Rayons 4.2; Hromada 29.2; Amalgamated Hromada 31.4. - State investment grants doubled from 2015 to 2016 and doubled again in 2017. Major 2017 allocations: SSED UAH 5 billion; SFRD UAH 3.5 billion; MRD fund for amalgamated hromada infrastructure UAH 1.5 billion; Allocation to develop health system in rural areas UAH 4 billion. - Over 7,600 investment projects approved for SSED and amalgamated hromada infrastructure programs. - Recommendations on budgets and cash management: - Recommendation 3.1: MoF to develop a standard policy for an appropriate cash balance for SNGs; require SNGs to evaluate and, if needed, prepare plans to conform. - Recommendation 3.2: Amend Budget Code to replace General/Special Fund distinction with separate appropriations for operating and capital expenditure; reduce earmarking and protected items (except contractual obligations like interest). - Recommendation 3.4: MoF coordinate with MEDT to improve forecasting of SNG revenues, analyze PIT overperformance, refine forecasting techniques, and disclose methods to SNG officials. - Recommendation 3.5: MoF to pilot multi-year capital budgeting for SNGs (as early as 2018) including investment pipelines and operating/maintenance cost projections. ### EDUCATION FINANCES — 2015–2018 projections and wage pressure scenario - Education expenditure and grants (Cities of Oblast Significance): - Education Expenditure 2015: 35.8 (UAH billion). - Education Expenditure 2016: 40.4 (UAH billion). - Education Grant 2015: 16.7 (UAH billion). - Education Grant 2016: 15.1 (UAH billion). - Grant (percent of Expenditure) 2015: 47.6; 2016: 37.3. - Aggregate SNG education figures 2016 (UAH million): - Total Education Expenditure: 90,075; Education Wages: 56,215; Total Education Grant: 44,099; Revenue - Wages: -12,116. - Share of wages on total education expenditure (2016): All (Avg/Total) 59%. - Detailed 2016 figures (UAH million) and revenue-wage balances: - Oblasts: Education Wages 4,818; Total Education Expenditure 11,388; Total Education Grant 5,559; Revenue - Wages 741. - Cities: Education Wages 25,294; Total Education Expenditure 40,391; Total Education Grant 15,090; Revenue - Wages -10,203. - Rayons: Education Wages 21,554; Total Education Expenditure 30,636; Total Education Grant 21,743; Revenue - Wages 189. - Hromada: Education Wages 2,827; Total Education Expenditure 4,844; Total Education Grant 16; Revenue - Wages -2,811. - AH: Education Wages 1,723; Total Education Expenditure 2,815; Total Education Grant 1,691; Revenue - Wages -32. - Projected 2018 scenario (assumptions: wage increase of 20 percent; 5 percent decrease in subvention): - ALL: Education wages 2016 56,214,981; Education Subvention 2016 44,099,231; Balance 2016 -12,115,750; Education wages 2018 P* 67,457,977; Education Subvention 2018 P* 29,399,487; Balance 2018 P* -38,058,489. - Aggregate projected deficit 2018 P* would be 38,058,489 (UAH million), three times larger than the 2016 deficit. - Recommendation 2.6: Ensure greater continuity in policies affecting revenue-sharing and expenditure assignments: - Calculate real costs intended to be covered by subventions; - Review every three years whether subvention formulas allow full coverage and adjust; - Minimize ad hoc legal changes during three-year periods; when inevitable, develop rules to estimate medium-term impacts on SNG finances. ### INTERGOVERNMENTAL FISCAL COORDINATION, FISCAL RISKS, AND SUBNATIONAL FISCAL RULES - Gaps and risks: - No structured arrangement to ensure collaborative pursuit of broad fiscal objectives across government levels. - Oversight weaknesses: subnational borrowing and PPPs, in-year monitoring, internal/external audit, State Treasury management. - Accumulated SNG surplus estimated at 1.9 percent of GDP by end-September 2017 could translate into sizable SNG deficits later. - No fiscal rule in place to limit expenditure growth, ex post deficits, or carry-overs. - Comparative examples preserve a wide menu of subnational fiscal rules from European countries (Budget balance rules, Debt ceilings, Expenditure growth constraints) with exact numeric ceilings and modalities detailed in Annex II. - Recommendations: - Recommendation 3.3: Amend Budget Code to preclude recurring negative outturns (e.g., requirement to return to balance within two or three years; sanctions for recurrent deficits). - Recommendation 4.1: Strengthen intergovernmental coordination framework with subnational-specific fiscal rules; possible rule forms include limit on expenditure growth rate or limit on overall deficit of subnational governments. Until rules are in place, MoF should establish a State Budget reserve to accommodate SNG overspending from idle balances. - Recommendation 4.2: Establish an Intergovernmental Commission chaired by the Minister of Finance (or Deputy) including representatives of all levels, to meet at least twice a year, provide strategic guidance, monitor SNG finances, be consulted on draft laws affecting local finances, and be consulted on borrowing and State loans/guarantees. - Recommendation 4.3: MoF Local Budgets department to set up a monitoring system tracking fiscal stress indicators (overall balance, operating, accounts payable, debt and debt service), identify persistently distressed hromada, compel corrective measures, require explicit MoF approval for domestic borrowing above thresholds and for foreign-currency borrowing, require PPP reporting and MoF approval for PPPs > 10 percent of local operating revenue, and strengthen external audit frequency (major units at least every two years). ### MONITORING, BORROWING, PPPS, AND AUDIT — legal and institutional actions - Legal limits and issues: - Local debt service limited to 10 percent of expenses of the general fund in any budget period when servicing is planned. - Limit on total local debt (including guaranteed debt) of 200 percent of forecast revenues of the development budget (400 percent for City of Kiev). Annual local budget sets limits yearly. - Lending between local budgets prohibited (Art 73 BC). - MoF approval required for guarantees but local PPPs not subject to MoF approval; MoF approval is automatically granted on lapse-of-time basis unless explicitly blocked. - No central database recording total fiscal commitments under PPPs. - Audit framework: - Internal audit under State Audit Service (SAS) and internal audit units (IAU); ACU can audit local budgets “at their request” but frequency not defined. - Recommendation 4.3 (detailed): improve monitoring and management of fiscal risks; reconfigure borrowing rules; require PPP reporting and MoF approval for significant PPPs; strengthen external audit requirements and frequency and allow approved private audit firms to complement ACU. ### CASH MANAGEMENT AND TREASURY ARRANGEMENT - Three pillars for modern cash management: (i) consolidated TSA; (ii) accurate cash flow forecasts; (iii) active cash management with dynamic cash buffer. - Current TSA and issues: - Article 43 BCU establishes a TSA structure with National Bank of Ukraine; all revenues paid into TSA; STS responsible for TSA management. - Local authorities accumulated idle balances at State-owned commercial banks; STS does not remunerate funds in TSA. - Local authorities allowed to deposit idle balances exclusively with state-owned commercial banks and return them no later than 10 days before fiscal year end. - STS provides short-term unremunerated loans to cover in-year shortfalls. - Example liquidity mismatch: stock of Treasury Bills increased by UAH 30 billion while accumulated idle local government funds in commercial banks reached around UAH 16 billion. - Recommendation 4.7: Establish an attractive treasury arrangement for local authorities: - Decide location of new treasury arrangement (Debt Policy Department candidate); - Develop concept note; identify target local authorities; run road shows; - Design instruments for lending/borrowing at market rates; analyze legislative changes; build front/back office systems; recruit/train staff; implement risk management and controls; launch services possibly with marketing support. ### FISCAL RISK OVERSIGHT AND MEDIUM-TERM BUDGETARY FRAMEWORK (MTBF) — draft Budget Code amendments - General observations: - Draft amendments to Budget Code aim to provide legal basis for MoF fiscal risk oversight and MTBF; language often generic and lacks detail; more prescriptive provisions recommended. - Surgical amendments are sub-optimal; MTBF impacts broad aspects (e.g., removal of general/special fund distinction) and requires comprehensive revision and operational strategy. - Fiscal Risks Monitoring — main recommendations (Recommendation 5.1): - Strengthen MoF mandate and powers to collect fiscal risk information; broaden definition of “fiscal risks” to include all factors that may deviate fiscal outcomes; prescribe that a CMU resolution specify roles/responsibilities and allow CMU to detail contents of fiscal risk statement; require publication of fiscal risk statement. - Authorize MoF to request information directly from SOEs (limited to financial performance data) and require cooperation; specify sanctions or referral processes for non-cooperation (MoF informs CMU). - Cabinet of Ministers to set methodology, timeframe, roles, and detailed contents of fiscal risk statement by resolution. - MTBF — main recommendations (Recommendation 5.2): - Expand Budget Declaration contents to include consolidated general government perspective and criteria for determination of expenditure ceilings; provide CMU authority to specify further contents via resolution. - Modify budget calendar to provide for stronger strategic involvement of CMU and earlier top-down ceiling negotiations. - Strengthen legal provisions on expenditure ceilings: remove distinction between general and special fund regarding legal regime for ceilings; require transparency and explicit explanation for any deviations from approved ceilings. - Expenditure ceilings framework issues: - Draft amendments allow ceilings to be revised in two circumstances: (i) deviation from key macro indicators from forecast; (ii) approval of legislation impacting budget indicators. - Draft does not distinguish between fixed and indicative ceilings; recommends explicit CMU approval, clearer ceiling definition as government/KSU commitment, and transparency requirements for deviations. - Calendar and process details preserved: - Timeline: central body submits projected macro indicators prior to or on March 1; MoF determines draft aggregate ceilings prior to or on March 15 and KSU ceilings prior to or on March 31; CMU examines/approves aggregate ceilings prior to or on April 15; MoF submits draft Budget Declaration prior to or on May 31; CMU reviews/approves Budget Declaration not later than June 15 and submits to Verkhovna Rada; Verkhovna Rada adopts resolution by June 30. - Budget Declaration contents (preserved): key macro indicators; main tasks of budget policy (deficit/surplus, share of GDP appropriated, marginal state debt and guarantees, amount of minimum salary, subsistence minimum and coverage level, marginal state capital investments and priorities); tax policy priorities; info on consolidated general government and local budgets; summary fiscal risks; general indicators of revenues/finance/expenditures/loans; aggregate and KSU ceilings and criteria; strategic goals and performance indicators for KSUs; other items as CMU resolution may specify. ### INSTITUTIONAL MONITORING, FINANCIAL STRESS INDICATORS, AND SNG FINANCIAL POSITION (end-2016) - Key observations: - Consolidated SNG position masks disparities: by end-2016 more than half of villages recorded a deficit; about a fourth of cities and rayons recorded a deficit; a fifth of oblasts recorded a deficit. - Among 453 villages remaining unamalgamated by end-2016: 251 recorded a deficit; 286 spent more than 50 percent of operational revenue on remuneration. - Selected Table 4.2 highlights (2016, UAH million, counts preserved): - Oblasts (24): Rev. UAH 53.1 million; Exp. UAH 48.5 million; Balance UAH 4.6 million; # in deficit 4; # with Personnel exp. / op. exp.>50 percent 13; # with Dev. Exp./Rev.< 10 percent 13; # with Dev. Exp./Rev. < 20 percent 20. - Rayons (457): Rev. UAH 111.6 million; Exp. UAH 107.5 million; Balance UAH 4.0 million; # in deficit 110; # with Personnel exp. / op. exp.>50 percent 2; # with Dev. Exp./Rev.< 10 percent 446; # with Dev. Exp./Rev. < 20 percent 457. - COS (148): Rev. UAH 170.5 million; Exp. UAH 163.6 million; Balance UAH 7.0 million; # in deficit 40; # with Dev. Exp./Rev.< 10 percent 74; # with Dev. Exp./Rev. < 20 percent 126. - Villages (453): Rev. UAH 20.9 million; Exp. UAH 22.1 million; Balance UAH -1.2 million; # in deficit 251; # with Personnel exp. / op. exp.>50 percent 286. - AH (160): Rev. UAH 7.1 million; Exp. UAH 6 million; Balance UAH 1 million; # in deficit 11; # with Personnel exp. / op. exp.>50 percent 135. - Heat map (Table 4.3) — oblasts and City of Kiev (number of oblasts): - Debt service coverage ratio (available revenue/annual debt service): Low risk: 25 [More than 2.5 times]; Medium risk: 0 [1.5-2.5 times]; High risk: 0 [Less than 1.5 times]. - Personnel expenditure/operating expenditures: Low risk: 1 [Less than 35 percent]; Medium risk: 2 [35-50 percent]; High risk: 13 [Greater than 50 percent]. - Development expenditures: Low risk: 4 [Greater than 20 of revenue]; Medium risk: 7 [10-20 percent]; High risk: 13 [less than 10 percent of revenue]. *Source: IMF Fiscal Affairs Department and Legal Department technical assistance mission report, October 3–16, 2017.* ### PREFACE _________________________________________________________________________________________ 6 ### PREFACE ### Mission context and purpose - A technical assistance mission from the Fiscal Affairs Department (FAD) and Legal Department (LEG) of the IMF visited Kiev, Ukraine during the period October 3–16, 2017. - The mission responded to a request from the Minister of Finance, Mr. Oleksandr Danyliuk. - The mission assisted the authorities in reviewing the results of the 2015 fiscal decentralization reform and the amendments to the Budget Code for implementation of certain PFM reforms. - The technical assistance was provided with financial support from the Government of Canada. ### Mission leadership and team composition - The mission was led by Miguel Alves. - Team members included: - Veronique Salins (FAD) - Alessandro Gullo (LEG) - Camila Aguilar (FAD short-term expert) - Francis Conway (FAD short-term expert) - Nikita Aggarwal (LEG short-term expert) ### Meetings with central government authorities and agencies - Ministry of Finance: - Ms. Oksana Markarova, First Deputy Minister of Finance - Mr. Serhiy Marchenko, Deputy Minister of Finance - Mr. Mykhailo Bosak and Ms. Olena Mykhailenko, Deputy State Budget Directors - Ms. Olena Malchuna, Deputy Director of the Department of Local Budgets - Mr. Andrey Savenko, Head of the Fiscal Risk Management Division - Ms. Olena Skrypkina, Head of Legal Department - Mr. Gladun Yevhen, Head of the Revenue Forecasting Department - Ms. Polina Yakova, Deputy Director of Debt Policy Department - Nataliya Nabedryk, Head of Intergovernmental Relations at the State Treasury Service - Other central authorities and agencies: - Mr. Gennadiy Zubko, Vice Prime Minister and Minister of Regional Development, Building and Housing and Communal Services of Ukraine - Mr. Pavlo Kovtonyuk, Deputy Ministry of Health - Ms. Olga Shchelgova, Ministry of Education - Mr. Roman Kropivnitsky, Ministry of Economic Development and Trade - Mr. Ihor Volianskyy, State Audit Service - Senior staff of the above agencies - Members of the Local Budgets Sub-Committee of the Verkhovna Rada ### Meetings with local authorities and officials - Kyiv City State Administration: - Mr. Volodymir Repik, Director of Finance - Cherkasy City: - Ms. Tetyana Kharenko and Mr. Roman Zhovnir, Deputy Directors of Cherkasy City’s Financial Policy Department - Cherkasy Oblast: - Ms. Natalia Kravchenko, Director of the Finance Department of the Cherkasy Oblast - Amalgamated Territorial Community of Baranivka: - Anatoliy Olexandrovych, Mayor - Senior staff of these local authorities ### Engagement with civil society and international partners - Local civil society groups: - Associations of Ukrainian Cities, Villages, and Amalgamated Territorial Communities - Reanimation Package of Reforms - International donor community and projects: - Mr. Erik Faxgård and Ms. Jasmina Dikic of the Support to Decentralization in Ukraine Project - Ms. Alexandra Fehlinger, Team Leader of the U-Lead with Europe Project - Representatives from the World Bank, the European Commission, the Organization for Cooperation and Economic Development, and the Swedish and Canadian Embassies ### Acknowledgements - The mission thanked the authorities and other participants for their collaboration during the mission. - The mission expressed gratitude for the support given by staff at the IMF office, in particular to Mr. Ihor Shpak for coordination support. - The mission acknowledged Ms. Oksana Burakovska and Mr. Victor Verhun for interpretation and translation efforts over the course of the mission. *Source: PREFACE, technical assistance mission report, IMF Fiscal Affairs Department and Legal Department, October 3–16, 2017.* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview and headline outcomes - Decentralization reform introduced in late 2014 improved subnational government’s financial capacity, self-sufficiency, and flexibility. - Compared with 2014, own revenues of subnational governments increased, while current expenditure declined. - Capital expenditure almost doubled as a percent of GDP from 2014 to 2016. - Overall subnational governments recorded a combined surplus of 1.0 and 0.7 percent of GDP in 2015 and 2016, respectively. - Despite reforms and positive fiscal outcomes, the subnational finance system still faces important challenges. ### Organization of Subnational Government - Territorial organization remains highly fragmented: around 9,300 subnational units organized on a four-tier structure. - Distribution of powers and responsibilities between State administration levels (oblasts and rayons) and local self-governments (cities and hromada), and among the latter, is unclear. - Design issues slow voluntary amalgamation and risk proliferation of small units with low potential for financial self-sufficiency. - Recommended measures: - Improve the amalgamation process by (i) basing it on clear criteria that ensure the financial viability of the resulting new units, and (ii) making it mandatory for the smaller units that incur in recurrent deficits. - Clarify the roles and responsibilities of each level of government, distinguishing assigned, delegated, and shared powers and the rights and responsibilities associated with each. ### Balance between Revenue and Expenditure Assignments - Positive subnational outcomes driven primarily by: - Overperformance on shared taxes (primarily the Personal Income Tax, distributed on a basis disconnected from service provision), - Bottlenecks in execution of capital expenditure, and - Devolution of spending responsibilities in successive stages and not always through fully transparent systems. - These factors will exert pressures on subnational finances and the current trend will likely not continue. - Own-revenues grew considerably but less than anticipated (primarily due to technical difficulties on real estate property tax). - Subnational governments still rely substantially on grants and subventions from the State to cover a rigid structure of expenditure. - State Administration levels have seen a reduction in spending responsibilities, but their revenues have not been reduced proportionally to the tasks assigned to local self-government units. - Measures to achieve overall and vertical fiscal balance: - Share PIT revenues based on where employees reside and not where they work, and address the technical/design feature of the real estate property tax. - Facilitate local projection of funding for health and education by clarifying subvention coverage and transparently sharing parameters used in subvention formulas. - Reduce revenue assigned to administrative levels (Oblasts and Rayons) according to their roles after decentralization. - Ensure greater continuity in policies impacting subnational finances and regularly review the system to identify potential mismatches. ### Formulation and Execution of Subnational Government Budgets - Local governments accumulated large idle deposits in response to: - Uncertainty about devolution of spending responsibilities, - Rigid structure and short-term focus of budget formulation and execution processes, and - Difficulties building a pipeline of investment projects. - To improve budgetary efficiency and reduce cash-at-hand needs: - Replace the General and Special Funds with separate appropriations for operating and capital expenditure. - Reduce the number and scope of earmarked revenues and protection of specific expenditure items. - Improve forecasting of subnational government revenues. - Introduce a framework to address fiscal distress of local authorities. - Implement multi-year budgeting at the subnational level, starting with capital budgets, accounting for construction, operation, and maintenance costs. ### Framework for Intergovernmental Fiscal Coordination - No structured arrangement exists to ensure collaborative and coordinated pursuit of broad fiscal objectives and fiscal sustainability across government levels. - Recommended steps: - Introduce fiscal rules for subnational governments, such as a limit on the deficit or expenditure growth rate. - Until such rules are introduced, pursue the general government fiscal target through a reserve at the State Budget large enough to accommodate any SNG overspending arising from the use of accumulated idle balances. - Establish an Intergovernmental Commission to agree on each level’s contribution to broad fiscal policy objectives and analysis. - Enhance monitoring and management of fiscal risks arising from subnational governments. - Establish an efficient and transparent treasury arrangement for local authorities for more active cash management across the general government. ### Legal Framework for Fiscal Risk Management and Medium-Term Budgetary Framework (MTBF) - Authorities plan targeted amendments to the Budget Code in two PFM areas: fiscal risks oversight and the medium-term budgetary framework; Fund provided recent technical assistance. - Draft Budget Code amendments could be made more prescriptive and specific to foster transparency, accountability, clarity, and to mitigate fiscal risks. Fiscal Risk Oversight — recommended revisions to draft amendments: - Strengthen the mandate of the MoF and its power to collect information related to fiscal risks. - Prescribe that a CMU resolution specify roles and responsibilities of the MoF, ministries and government agencies in preparation, approval and publication of the fiscal risk statement, and allow further detail of the fiscal risk statement contents. - Broaden the definition of fiscal risks. Medium-term Budgetary Framework — recommended revisions to draft amendments: - Prescribe additional contents for the Budget Declaration, such as information on the consolidated general government sector and criteria for determination of expenditure ceilings. - Modify the budget calendar for approval of the Budget Declaration to provide stronger strategic involvement of the CMU at an early stage. - Strengthen legal provision on expenditure ceilings by, among other things, removing the distinction between general and special fund and providing transparency requirements for changes to ceilings after approval of the Budget Declaration. ### Key quantitative and structural facts (as presented) - Territorial structure: four principal levels — 24 oblasts plus two cities of special status and the Autonomous Republic of Crimea; 474 rayons; 166 cities; over 8,800 hromada. - Amalgamation status (as of August 2017): 648 amalgamated hromada formed from 3,040 hromada, with total population around 6 million (14.1 percent of total population) covering 151 thousand square kilometers (26 percent of the area of Ukraine). - Total remaining hromada: 8,823 (noted as high by international standards; short of target of 1,500). - Average population of amalgamated hromada: around 8,900 persons per unit; around 35 percent of new units have less than 5,000 inhabitants. - Coverage variation across oblasts: example ranges given (54 percent in Zhytomir to around 3 percent in Kyiv). - Table 1.1 reported totals (as of August 11, 2017): TOTAL 159 (2015) 207 (2016) 248 (2017) = 648 amalgamated hromada; Oblast area total 575,756 sq.km; AH area 151,082 sq.km; No. of hromada 11,215; No. of hromada amalgamated 3,040; No. of AHs with population less than 5 thous. persons = 215 (35.3 percent). ### Implementation priorities and action planning (high-level) - Key responsibilities identified across MoF, MRD, UkrStat, MoH, MoE, CMU, Rada, and subnational representatives for measures including legal amendments, Tax Code changes, cadaster and land registry updates, population census, fiscal rules design, establishment of Intergovernmental Commission, treasury arrangement design and launch, stronger MoF mandate and CMU resolutions, and MTBF enhancements. - Phasing in recommendations outlined across time windows: November 2017 – April 2018; May – December 2018; 2019/2020 for adoption and implementation steps. *IMF Staff report: Executive Summary of IMF technical assessment of Ukraine’s fiscal decentralization and subnational public finance reforms.* ### 7. Voluntary amalgamation will be increasingly difficult. Hromada amalgamation is ### 7. Voluntary amalgamation will be increasingly difficult. Hromada amalgamation is ### Challenges to voluntary amalgamation - Hromada amalgamation is essentially a voluntary process, regulated by the Law on Voluntary Amalgamation of Territorial Communities 2015. - Mission discussions point to a lack of incentives for smaller hromada to amalgamate due to: - shared taxes being distributed to amalgamated hromada according to the location of the employer, which often differs from the location of education and health facilities used by the commuting population; amalgamation of a suburban community will likely yield little additional revenue but substantial expenditure; - ownership of land and rents from leasing land weighing significantly in the decision to amalgamate, because smaller communities fear their available land will be taken over by more powerful neighboring communities or that they will lose control over the use of rent revenue; - political economy considerations, whereby leaders of unamalgamated communities fear losing access to power positions within the structure of the new amalgamated units. ### Risks of the current framework - The Law on Voluntary Amalgamation of Territorial Communities includes no criteria on the financial condition of the amalgamating community. - The law grants amalgamated communities direct access to State support, including additional funding to support amalgamation. - This combination of design features and practical challenges poses a risk that future amalgamations will create units of insufficient size to ensure financial viability and development, leaving them dependent on State funding. ### Recommendation 1.1: Future amalgamation criteria to ensure financial viability - The 2015 FAD TA Report suggests criteria including: - a. Minimum population: The new authority must have a minimum population of 3,000–5,000 inhabitants; - b. Self-sufficiency: The authority’s own and shared resources must cover at least 50 percent of their total expenditures; - c. Provision of basic services: The authority must be able to provide access to the full range of basic local services to their population including primary education and healthcare and municipal services (but not necessarily of the same quality and level of access); - d. Efficiency of service delivery: Services must be organized so as to be able to realize economies of scale in each sector. There could also be specific criteria regarding the minimum number of pupils per school (e.g., at least 100 pupils) or doctors and nurses per clinic (e.g. at least two of each to cover absences and vacancies); - e. Fiscal space for development: The new authorities must be able to spend at least 10 percent of their total budget on investment to ensure the area has the potential for growth; and - f. Financial integrity: The new authority must have had a clean external financial audit within the past year which validates its compliance with all of the above criteria. ### Recommendation 1.2: Mandatory amalgamation for chronically deficit hromada - Amalgamation should be made mandatory for those smaller unamalgamated hromada that incur recurrent financial deficits for more than five years. - Main features of this policy change: - The MRD, while coordinator of the decentralization reform, would be the unit in charge of enforcing this compelled amalgamation, following the criteria described in Recommendation 1.1; - Responsibility for servicing the debt accumulated prior to amalgamation should remain with the resulting amalgamated hromada, but the authorities may consider supporting a rescheduling process to attenuate the initial financial impact; - Further legal amendments will be required to reflect a mandatory process of hromada amalgamation, including a possible amendment to the Constitution to recognize “mandatorily” amalgamated hromada, and as a result of which, their right to local self-government. ### Organizational structure and legal framework issues - The basic territorial division identifies territorial subdivisions, rather than forms of “local self-governments” per se (Article 133 of the Constitution lists territorial subdivisions; hromada and amalgamated hromada are not identified under the Constitution as territorial subdivisions). - There are mismatches between the right to local self-government (given to hromada and amalgamated hromada) and the competences and powers of local self-government, which are specifically granted to village, settlement and city councils under the Law on Local Self-Government. - Several apparent overlaps exist between obligations and powers of different levels of government; examples include uncertainty about whether oblast or rayon council approval is required for development programs approved by hromada local governments. - Lack of clarity on how functions are granted (delegated, assigned or shared) from the State to/with subnational governments; the concept of “shared” powers does not appear to be addressed in the legal framework. - The current arrangement is complex, with significant duplication and asymmetries in distribution of obligations and powers, clouding financial responsibility and accountability at the subnational level. ### Recommendation 1.3: Clarify legal framework for territorial organization and fiscal decentralization - Clarify the distinction between different territorial subdivisions and their relationship inter se as well as with the State government; adopt a clear two-tier distinction between (1) state and (2) local government, clarifying which territorial subdivisions fall under which category. - More clearly distinguish between powers that are assigned, delegated, and shared with subnational government, and the rights and responsibilities associated with each (possible amendment to Law on Local Self-Government). - Clarify the administrative status of hromada (hromada are not a legal territorial subdivision of Ukraine recognized under the Constitution, yet the right to self-government is assigned to them under the Law on Local Self-Government). - Streamline administrative structures at each subnational level; for example, unamalgamated hromada do not have a separate administrative structure to exercise rights, competencies, and powers of self-government and must exercise these through the legislative and executive bodies of the villages, settlements and towns that comprise the hromada. - Remove overlaps in the powers and obligations of each level of government. ### II. Improving the balance between revenue and expenditure assignments — Revenue Sharing Arrangement: overview and trends - Subnational Government (SNG) revenue growth: - 2014: total SNG revenues were 14.6 percent of GDP; - 2015: increased by 0.2 percent (to 14.8 percent of GDP implied); - 2016: SNG revenues were 15.2 percent of GDP, an increase of 0.6 percent compared to pre-reform observed SNG revenues. - The increase in SNG revenues has been driven by both shared taxes and own revenues, but is lower than anticipated from the reforms. - Distributional shift of revenue across tiers (percent of total SNG revenue): - Oblast: from 21% (2014) to 14% (2016); - Rayons: 31% (2014) and 31% (2016); - COS (cities of oblast significance): from 43% (2014) to 47% (2016); - Hromada: from 5% (2014) to 6% (2016); - AH (amalgamated hromada): 2% (2016) as depicted. - The shift reflects decentralization objectives of attributing more resources to levels of government closer to citizens; oblasts were main “losers” primarily due to decrease in shares of taxes attributed to them and transfer of the basic grant directly to local self-government levels. ### Revenue sharing legal and practical issues - The Budget Code’s delimitation of revenue between different budgetary levels is often unclear, creating room for misinterpretation (examples provided on license and certificate revenues showing overlapping provisions in Articles 64, 66, and 69). - Shared taxes are distributed across subnational governments according to where they were generated, as an incentive to increase collection, resulting in larger resources flowing into big cities and less income to suburbs where employees demand most services. - Shared taxes include personal income tax (PIT), corporate income tax (CIT), the recently introduced excise tax, and environmental fees and concessions. - As of 2015 distribution: the state government retains 25 percent of the yield of the tax; oblasts receive 15 percent; COS and rayons receive 60 percent. Unconsolidated hromada lost the 25 percent of the PIT share as an incentive to amalgamation. - For total SNGs, shared taxes as a percentage of total revenue: - 2014: 29.4 percent; - 2015: 23.6 percent; - 2016: 27.4 percent (increase driven by PIT over-performance due to an upturn in the economy). - Note: PIT is likely to decrease again; the 2016 increase should not be confused with a structural improvement in overall revenues. ### Recommendation 2.1: Adjust PIT sharing to reflect residence of employees - Share PIT revenues based on where employees reside and not where the employer is located. - Expected effects: - Attribute revenue on a basis closer to demand for services provided by subnational units; - Provide subnational governments with resources for improving transport infrastructure used daily for commuting from residential suburbs to metropolitan places of work; - Along with financial viability criteria for amalgamation, create incentives for rationalization of service provision networks. ### Own revenues and vertical fiscal balance - Own revenues include land and property taxes, rents, proceeds from the sale of assets and other fees and charges, own revenue of budget users, and the single tax. - The state government sets rate and thresholds for single tax application, but 100 percent of collected single tax goes to subnational governments. - Own revenues have been on a growing trend in all levels of subnational government except for oblast level, but the percentage of own revenues is still very low compared to other countries of the region. *Source: IMF staff report content as provided.* ### 23. Hromada collect a higher share of own revenues than the rest of subnational ### 23. Hromada collect a higher share of own revenues than the rest of subnational ### Revenue composition and own revenues - Hromada collect a higher share of own revenues than the rest of subnational governments. - The share of single tax increased significantly due to the decision of the state government to increase the rate, in addition to an improved collection of revenues from fees for services provided by budgetary institutions under the law. - Land and Property taxes almost doubled between 2014 and 2015. - At the time of the introduction of the decentralization reform, the authorities expected the share of SNGs’ own revenues to reach around 28 percent (an 11.5 percentage points increase relative to the pre-reform share). - The share observed in 2016 was 17.1 percent, 6.6 percentage points increase from 2014. - Some proposed adjustments (greater flexibility to vary tax bases and rates for own taxes and design features in real estate tax) were not fully implemented, reducing the expected impact of the decentralization reform. ### Real estate tax: problems and Recommendation 2.2 Key obstacles to adequate collection and growth of the real estate tax: - Technical problems related to the cadaster and registry of property and improved building spaces. - Design features that reduce revenue-raising potential: - assessment of the tax based on the size of the property, rather than its market value; - unnecessary exemptions for properties of a certain size; - setting of tax rates well below the ceiling rate. - Previous FAD recommendations were identified in November 2014 but little action was taken; those recommendations remain valid. Recommendation 2.2 — Adjust the real estate tax to collect greater own revenue and achieve vertical fiscal balance by actions including: - Put in place a transparent market for properties, particularly agricultural land, and take into account the market value of properties in the calculation of the tax; - Broaden the base by eliminating current tax-free thresholds and exemptions to non-living spaces and commercial properties; - Adopt the maximum allowable tax rates; - Improve the quality of information on the surface area of real estate stock or value of capital improvements within their jurisdictional boundaries; - Systematically record new or improved building spaces; - Fix a centrally determined rate range for real estate tax with a positive starting rate of 1 percent to a maximum rate of 2 percent. This would help protect the tax base against a race to the bottom by subnational governments seeking to attract new business and residents and relieve pressure on shared revenues and transfers; - Design an incentive scheme to update the cadaster and land registry information to improve the performance of the tax. ### Grants and subventions; transparency and Recommendation 2.3 Findings: - Grants and subventions remain large in both size and number of specific schemes: 11 grants and 56 subventions in 2016. - Subventions and grants still account for a substantial part of SNG revenue. - There are many types of subventions; the most significant relate to assistance and privileges. - Within grants, the basic grant accounts for almost 80 percent of the total value. - Subventions account for about half of the total revenues of subnational governments. - The equalization grant existing before the reform was adjusted and complemented with a basic grant; this did not effectively achieve the intended simplification of the system. - Kiev is excluded from the equalization formula because it has a different revenue-sharing arrangement. - The total amount for this grant was 6.7 UAH billion, two percent of the total subnational revenues. - Information used in subvention formulas is still not transparently available to local self-government units; formula parameter data is consistently lower than locally held data used for planning. - Formula-based subventions have been introduced (health-related ones still under discussion), but transparency, predictability, and efficiency can be enhanced. Education and health subvention weaknesses: - Education subvention: - The formula used divides the total pool of funds allocated to education by the weighted number of students in the country (weights reflect different relative costs). According to Herczynski (2017), this formula has weaknesses: - a. It does not put pressure on optimization of schools, but instead results in increasing average class size. - b. Some schools are overfunded while others are underfunded. - c. It cannot be determined if the level of allocated funding is enough. - d. There are important inherent difficulties to review or change the allocation formula. - e. Due to lack of clarity in the legislation, subnational governments expect the subvention to cover all educational expenditure, but the Budget Code specifies that it is supposed to finance only wages of teachers (those of non-pedagogic staff and other expenses have to be funded through own resources). - Health subvention: - Calculated according to principles similar to education subvention and therefore prone to the same weaknesses. - Current medical subventions cover prevention, primary care, and outpatient/inpatient services. - The total amount of medical subvention is calculated for each level of government according to a capitation formula that accounts for population size and differences in service provision, with an additional coefficient for providing services in geographically disperse areas. - The parameter data used in the formula is not directly observable by local governments. Recommendation 2.3 — Facilitate projection of funding for health and education by local authorities by: - Clarifying the coverage of expenditure subventions for each SNG level; - Publishing the source of parameter data used in subvention formula calculations and transparently disclosing those data to SNG units; - Undertaking a population census. The last one was made in 2001; - Discussing in advance the responsibilities that are going to be transferred in order to permit internal arrangements and planning. ### Expenditure assignments and Recommendation 2.4 Findings: - The share of expenditures by local self-governments increased from pre-reform levels. - Oblast expenditure fell from 19 percent to 14 percent of total expenditures between 2014 and 2016, in favor of local self-government units (COS and hromada). - The share of the State administration levels was 45 percent of total SNG revenue in 2016. - The Budget Code assigns broad categories and specific items of expenditure to different levels, but there are many overlaps and unclear demarcation of responsibilities, particularly among subnational government levels. - The distribution of expenditure and revenue under the Budget Code could be better aligned with the distribution of powers under the Law on Local Self-Government (LSG); local governments have extensive powers under the LSG in some areas (for example, education), while expenditure responsibilities under the Budget Code are more limited. - The decentralization reform did not induce large changes in the structure of expenditure across SNG tiers between 2014 and 2016 for functions such as education and health; social care spending remained predominant at oblast and rayon levels. - Availability of funding for infrastructure development resulted in an increase in the share of capital expenditure between 2014 and 2016: - For oblasts this share increased 5 times, from 4 to 15 percent. - Rayons capital expenditure tripled. - COS and hromada capital expenditure doubled. Recommendation 2.4 — Align the distribution of expenditure and revenue assignments in the Budget Code with the distribution of powers to local self-government units under the LSG to ensure the legal framework for fiscal decentralization is harmonized, clear, and stable. ### Balance of the arrangement, Recommendation 2.5, and risks to future surpluses Findings: - Subnational governments achieved a surplus in all years after the reform, a trend observed in all levels except unamalgamated hromada. - Introduction of education and health subventions as of 2015 implied a consistent increase in surpluses at the Oblast and Rayon levels, reverting most deficits observed in 2014. - Cities and Hromada observed better results due to increased collection of own revenues plus subventions. - There appears to be a mismatch between assigned revenues and spending responsibilities: - State administration levels adjusted smoothly with regard to revenues. - Rayons observed a reduction in responsibilities under decentralization but their revenues were not reduced proportionally; shared taxes increased 1.2 percent between 2014 and 2016. - Observed surpluses at oblast and rayon levels may imply no proper analysis of costs of the tasks assigned; these tiers may have to adjust to reduced resources. - Devolution to cities was implemented in successive stages via annual ad hoc changes to the Budget Code, preventing effective financial planning. Recommendation 2.5 — Reduce revenue assigned to administrative levels according to their roles after decentralization through a more precise arrangement of responsibilities, coordination, and accountability mechanisms between State administration and local self-government tiers. Reasons to expect surpluses to deteriorate: - a. The PIT overperformance will likely not materialize in the coming years. One of the main drivers of the surpluses has been the increase in shared taxes, in particular the PIT. The latest IMF Staff Estimates point to a substantial decrease in the growth rate of PIT, from 2018 onward, due to a declining average wage growth, which is partly related to the recent hikes in the minimum wage. - b. Capital expenditure will likely increase. Most local authorities had no investment project pipeline at the launch of the reform; given the availability of specific funding for investment projects, they are likely preparing new projects, which will significantly impact SNG finances once implemented. - c. New expenditure responsibilities have recently been devolved to SNGs. The education and health reforms assign additional expenditure to subnational governments without attribution of additional funding. Notes on amalgamated hromada surplus: - The surplus of amalgamated hromada should be interpreted carefully: it may reflect operational difficulties preventing normal spending during initial amalgamation stages rather than strong economic performance. - Remaining (unamalgamated) hromada may lack resources to attract others to join them, likely continuing to negatively impact aggregate balance. *Source: 1ukrea2019004 - 23. Hromada collect a higher share of own revenues than the rest of subnational* ### 46. SNG’s own revenues are still not sufficient to cover their basic expenditure ### SNG’s own revenues are still not sufficient to cover their basic expenditure ### Key findings on SNG finances and education - SNGs remain highly dependent on subventions; basic expenditure responsibilities are not clearly defined. - Education in Cities of Oblast Significance (COS): - Education Expenditure 2015: 35.8 (UAH billion) - Education Expenditure 2016: 40.4 (UAH billion) - Education Grant 2015: 16.7 (UAH billion) - Education Grant 2016: 15.1 (UAH billion) - Grant (in percent of Expenditure) 2015: 47.6 - Grant (in percent of Expenditure) 2016: 37.3 - In 2016 SNGs received 44,099 (UAH million) for the education subvention and spent 56,215 (UAH million) on wages in education, leaving aggregate wage expenses 12,116 (UAH million) higher than the education subvention. ### Education wages and subvention shortfalls by tier (2016) - Share of wages on total education expenditure (2016): All (Avg/Total) 59% - Detailed 2016 figures (UAH million): - Oblasts: Share of wages 42%; Education Wages 4,818; Total Education Expenditure 11,388; Total Education Grant 5,559; Revenue - Wages 741 - Cities: Share of wages 63%; Education Wages 25,294; Total Education Expenditure 40,391; Total Education Grant 15,090; Revenue - Wages -10,203 - Rayons: Share of wages 70%; Education Wages 21,554; Total Education Expenditure 30,636; Total Education Grant 21,743; Revenue - Wages 189 - Hromada: Share of wages 58%; Education Wages 2,827; Total Education Expenditure 4,844; Total Education Grant 16; Revenue - Wages -2,811 - AH: Share of wages 61%; Education Wages 1,723; Total Education Expenditure 2,815; Total Education Grant 1,691; Revenue - Wages -32 - All (Avg/Total): Share of wages 59%; Education Wages 56,215; Total Education Expenditure 90,075; Total Education Grant 44,099; Revenue - Wages -12,116 - Cities and hromada are most affected: in 2016 cities covered 10,203 (UAH million) of wages from their own resources and hromada covered 2,811 (UAH million). In 2015 they covered 6,000 (UAH million) and 3,000 (UAH million) respectively (figures noted in text). ### Projected impact of wage increases (scenario for 2018) - Assumptions: wage increase of 20 percent for 2018 and a 5 percent decrease in the subvention (assumption derives from the subvention no longer covering wages of non-pedagogical staff). - 2016 vs projected 2018 balances (UAH million): - Oblast: Education wages 2016 4,818,331; Education Subvention 2016 5,559,322; Balance 2016 740,991; Education wages 2018 P* 5,781,997; Education Subvention 2018 P* 3,706,215; Balance 2018 P* -2,075,783 - Cities: Education wages 2016 25,293,595; Education Subvention 2016 15,090,460; Balance 2016 -10,203,135; Education wages 2018 P* 30,352,314; Education Subvention 2018 P* 10,060,307; Balance 2018 P* -20,292,007 - Rayon: Education wages 2016 21,553,542; Education Subvention 2016 21,742,579; Balance 2016 189,037; Education wages 2018 P* 25,864,250; Education Subvention 2018 P* 14,495,053; Balance 2018 P* -11,369,198 - Hromada: Education wages 2016 2,826,553; Education Subvention 2016 15,509; Balance 2016 -2,811,044; Education wages 2018 P* 3,391,864; Education Subvention 2018 P* 10,339; Balance 2018 P* -3,381,524 - AH: Education wages 2016 1,722,960; Education Subvention 2016 1,691,361; Balance 2016 -31,599; Education wages 2018 P* 2,067,552; Education Subvention 2018 P* 1,127,574; Balance 2018 P* -939,978 - ALL: Education wages 2016 56,214,981; Education Subvention 2016 44,099,231; Balance 2016 -12,115,750; Education wages 2018 P* 67,457,977; Education Subvention 2018 P* 29,399,487; Balance 2018 P* -38,058,489 - Aggregate projected deficit 2018 P* would be 38,058,489 (UAH million), three times larger than the 2016 deficit. ### Revenue-sharing instability and transferred expenditures - Between 2015 and 2017 continuous transfers of expenditures and removal of assigned resources imply an increase of 66 (UAH) billion in local self-governments’ expenditures according to the Association of Ukrainian Cities. Annual totals reported: 2015 -> 34 UAH billion; 2016 -> 52.7 UAH billion; 2017 -> 66 UAH billion. - The text documents multiple specific transferred expenditures (e.g., Kindergartens 14.9; Vocational Education 5.8; Communal services and energy (Education) 9.3; Salary for non-teaching staff 9.2; etc.) and identifies removed additional sources of coverage (e.g., Basic Grant 10% CIT; Excise Tax; Subventions; Additional dotation for institutions of education and health care (Oblast and Rayon budgets) 14.9; Financing vocational education as the expense of educational subvention 2.2). ### Recommendations on revenue-sharing continuity (Recommendation 2.6) - Ensure greater continuity in policies affecting the revenue sharing-arrangement and expenditure assignments by: - Calculating the real costs associated with the expenditures intended to be covered by subventions; - Reviewing, every three years, whether the subvention formulas still allow the full coverage of assigned expenditure and adjusting the formula accordingly; - Minimizing ad hoc legal changes that may impact SNGs finances during that three-year period; when changes are inevitable, develop rules and procedures to estimate the medium-term impact on revenue and expenditure of subnational governments of all levels that have a direct financial relationship with the State. ### SNG deposits with the State Treasury and cash balances - As of January 1, 2017 total SNG deposits with the State Treasury: 36,152 (UAH million), equivalent to 1.5 percent of GDP. By September 2017 total deposits: 51,780 (UAH million) equivalent to 1.9 percent of GDP. - Treasury deposits by tier (selected dates, UAH million): - Oblasts Jan 2017: 7,212; Sept 2017: 11,710 - Kyiv city Jan 2017: 4,023; Sept 2017: 11,302 - Cities of Oblast Significance Jan 2017: 10,207; Sept 2017: 8,891 - Rayons Jan 2017: 12,750; Sept 2017: 16,495 - Amalgamated hromada Jan 2017: 1,959; Sept 2017: 3,382 - Total Jan 2017: 36,152; Total Sept 2017: 51,780 - Total (percent of GDP): Jan 2014 1.2; Jan 2015 1.1; Jan 2016 1.3; Jan 2017 1.5; Sept 2017 1.9 - GDP (UAH billion) figures: 2014 1,465; 2015 1,587; 2016 1,989; 2017 2,383 (Jan) and 2,734 (Sept estimate noted). - Ratio of cash balance to average monthly expenditures (as of January 2017): - Oblasts: Deposits 7,212 (UAH million); Expenditure Turnover 2016 48,525 (Months) Deposits as months of expenditure 1.8 - Rayons: Deposits 12,750; Expenditure Turnover 2016 107,545; Deposits as months of expenditure 1.4 - Kyiv: Deposits 4,023; Expenditure Turnover 2016 33,482; Deposits as months of expenditure 1.4 - Cities (OS): Deposits 10,207; Expenditure Turnover 2016 130,125; Deposits as months of expenditure 0.9 - Amalgamated hromada: Deposits 1,959; Expenditure Turnover 2016 6,026; Deposits as months of expenditure 3.9 - Total: Deposits 36,152; Expenditure Turnover 2016 325,703; Deposits as months of expenditure 1.3 - Average monthly SNG revenue, expenditure, and balance snapshots (UAH million): selected year-end and Jan values: - Total Revenues year-end 2015: 24,538; Year-end 2016: 30,503; Aug 2017: 39,928 - Transfers (component of revenues) year-end 2015: 14,498; year-end 2016: 16,283; Aug 2017: 21,966 - PIT year-end 2015: 4,933; year-end 2016: 7,071; Aug 2017: 9,181 - Total Expenditures year-end 2015: 23,339; year-end 2016: 29,201; Aug 2017: 36,133 - Payroll year-end 2015: 8,809; year-end 2016: 9,693; Aug 2017: 10,217 - Balance year-end 2015: 1,199; year-end 2016: 1,302; Aug 2017: 3,795 - The report notes that appropriateness of accumulated deposits should be assessed case by case and calls for a standard policy. ### Recommendations on SNG cash balances and budget structure - Recommendation 3.1: The MoF, in consultation with SNG representatives, should develop a standard policy for an appropriate cash balance for SNGs, accompanied by guidance requiring that SNGs: - Apply these policies to evaluate the adequacy of their cash balance, and - If required, prepare a practical plan to bring the balance into conformity with the policy. - Recommendation 3.2: Amend the Budget Code to simplify the SNG budget structure and provide more room to reflect local needs and priorities by: - Replacing the distinction between General and Special Fund with separate appropriations for operating and capital expenditure based on international standards; - Reducing the number and scope of earmarked revenues; and - Reducing or eliminating entirely the concept of protected expenditure items, other than those arising from contractual obligations, notably payment of interest on outstanding debt obligations. ### Issues with budget rigidity, earmarking, and fiscal rules - Protected expenditure items (2016): Total Protected Items 260,333 (UAH million) equal to 74.3 percent of total SNG expenditures. Total Expenditure Outturn 350,413 (UAH million). Main protected items include wages and social contributions 116,313 (UAH million) (33.2 percent of total expenditure) and transfers to households 99,802 (UAH million) (28.5 percent of total expenditure). - Earmarked revenues have accounted for more than half of total SNG revenues each year from 2015 to 2017 (58.1 percent in 2015; 52.9 percent in 2016; 56.4 percent in 2017 (as of August)). Subventions represented 56.3 percent of revenues in 2015, 51.3 percent in 2016, and 54.2 percent in 2017 (general fund subventions). - The Budget Code’s limit on the “working balance” (2 percent of the planned expenditures of the general fund) is unclear and does not preclude an SNG ending the fiscal year with a deficit; SNGs can carry accounts payable into the next year’s budget. *Source: IMF staff estimates and State Treasury data as presented in the source document.* ### Box 3.1. Key Features of the SNG Budget Structure and Process ### Box 3.1. Key Features of the SNG Budget Structure and Process ### SNG budget architecture - Two main funds: - General Fund - Revenues: 93 percent - Own taxes and fees - Shared tax revenues - Expenditure: all current - Education, health and social assistance - State budget subsidies (Earmarked - 55 percent) - Protected items, among others: - Compensation of public employees - Debt service - Certain utility costs - Certain medical and social assistance costs - Certain training and research related costs - Transfer of surplus to the Development Budget for capital expenditures (cannot be reversed) - Special Fund - Revenues: 7 percent (Earmarked – 100 percent) - Proceeds of various land and urban development programs - Proceeds of repayment of loans made by local government - Transfers from other Special Funds (including State Budget) - Revenues of the Development Budget - Expenditure: current & capital - As mandated by earmarked funding - Transfers to other Special Funds - Development Budget expenditures, among others: - Debt service - Capital expenditures - Appraisal of land subject to sale - Town planning expenditures ### Rules and procedures for adopting and amending the budget - Initial General and Special Fund budgets must be adopted by December 25 of the preceding fiscal year. - Amendments of the budgets: - At any time to move items between line items without changing the total, subject to respecting earmarking and protected items. - At the beginning of the fiscal year to incorporate funds balances in the State Treasury. - Quarterly based on revenue overruns (shortfalls) as reported by the State Treasury. - Upon amendment of the State Budget. - Rules regarding the budget balance: - The initial General and Special Fund budgets must be balanced. - Subsequent amendments: - One scenario: amendment of the General Fund budget that appears to be in surplus to transfer that surplus to the Special Fund for investments. A change in national policy (e.g., minimum wage or the price of energy) that increases current expenditures might move the General Fund into a deficit. By law, there are no transfers from the Special to the General Fund, thus leaving the Special Fund in surplus and the General Fund in deficit at year end. - The General Fund may be in deficit subject to incorporating surplus funds in the State Treasury account (as financing below the line). - The General Fund may be in surplus to: - Provide for the transfer of funds to the Special Fund for investments - Pay accounts payable inherited from the prior fiscal year - The Special Fund may be in deficit subject to incorporating as financing below the line: - The transfer of funds from the General Fund for investments - Proceeds of loans - The Special Fund may be in surplus to provide for: - Debt service on outstanding loans (does not specify if just amortization of principle) *Source: Budget Code of Ukraine.* ### Revenue forecasting and PIT performance - Current forecasting arrangements: - The Ministry of Economic Development and Trade (MEDT) prepares the annual forecast of revenues from the PIT, transmitted by the MoF to each SNG beneficiary of PIT shares. - SNGs subsequently modify the forecast based on local circumstances (registration of new firms, formalization of workers). - Empirical performance: - In 2015 and 2016, SNGs adjusted the revenue forecast upward throughout the year but still underestimated the final outturn by 11 and 8 percent, respectively. - SNGs have insufficient time to execute expenditures to absorb this overrun in the final months of the year, resulting in an end of year surplus and growth of idle deposits in the State Treasury. - Assessment: - Accumulation of balances in the State Treasury may be preferable to poorly planned “last-minute” spending. - Conservative revenue assumptions and resulting accumulation of deposits have lowered overall general government spending pressures and contributed to meeting fiscal targets. ### Recommendation on revenue forecasting - Recommendation 3.4: The MoF coordinate with the MEDT to improve forecasting of SNG revenues by: - Analyzing recent over performance primarily of the PIT and refining forecasting techniques; and - Disclosing and explaining the new forecasting techniques to SNG officials. ### SNG capital expenditure planning: context and trends - Pre-reform situation: - SNGs had no incentive or need to adopt investment plans or pipelines; heavily dependent on State investment grants. - In 2014, State investment grants were barely UAH 500 million (0.03 percent of GDP). - Investment rates by SNGs pre-reform were well below regional peers; levels in oblasts and cities were below 10 percent of total expenditure. - Capital expenditure by tier (percent of total expenditure): - 2014: Oblasts 2.8; Cities 9.1; Rayons 1.3; Hromada 16.1 - 2016: Oblasts 14.3; Cities 20.0; Rayons 4.2; Hromada 29.2; Amalgamated Hromada 31.4 - Capacity constraints: - After reform most SNGs started with no pipeline of investment-ready projects and limited capacity to design and obtain permits. - Technical design issues (e.g., capital repairs to bridges) require specialized professionals; SNGs often lacked specialized staff. - Example: City of Kyiv only began to put in place a pipeline of major investment projects consistent with needs and priorities late in fiscal year 2017. - Cross-country context: - By 2016 SNG investment surpassed 2014 low levels but remained low compared with other European countries; hromada and amalgamated hromada were exceptions. ### State investment grants: amount, programs, and effects - Growth and programs: - State investment grants doubled from 2015 to 2016 and doubled again in 2017. - Major 2017 allocations: - Subvention for Social and Economic Development (SSED): UAH 5 billion (new in 2017). - State Fund for Regional Development (SFRD): UAH 3.5 billion. - MRD fund for amalgamated hromada infrastructure: UAH 1.5 billion. - Allocation to develop health system in rural areas: UAH 4 billion in 2017. - SFRD as of 2017 has earmarked 30 percent of the funding for specific project types (e.g., sports facilities). - Project pipeline and quality concerns: - Over 7,600 investment projects have been approved for the SSED and subvention for amalgamated hromada infrastructure. - Concerns: - Selection processes (e.g., commission composition) risk politicization. - Competition for grants may detract local administrations from focusing on local needs and priorities. - Quality of some approved projects is a concern. - Recommendation 3.5: The MoF should consider implementing multi-year capital budgeting by SNGs in advance of a planned MTBF at that level. Pilot programs (as early as 2018) should develop local multi-year capital expenditure budgets that: - Reflect local community and regional development priority needs; - Include investment ready capital projects consistent with these priorities; - Include projections of the impact on the local budget of operating and maintaining, and staffing as appropriate, the new networks and facilities once construction has been completed; and - Are taken into account when setting the criteria and approving financing for State investment subsidy funds and donor financing of SNG investment projects. ### Intergovernmental fiscal coordination and fiscal risks - Persistent weaknesses (areas previously identified and still unresolved): - Oversight of subnational borrowing and PPPs. - In-year monitoring of local government budgets. - Internal and external audit of SNGs’ financial performance. - State Treasury management of SNG cash and liquidity. - Need for coordination: - Local governments need clear understanding of likely transfers from the State budget for the budget year and medium term, and opportunities to comment on national policies affecting them. - The State needs to monitor SNG finances to ensure they do not threaten general government fiscal targets. - Gaps in practice: - Local authorities find it difficult to get timely notice of State government policies that affect responsibilities or revenues; few opportunities to voice concerns. - Fiscal risks from SNG deposits and carryovers: - Legislation requires SNGs to balance annual operating revenues and expenditures but allows for a general fund deficit in the event of use of an idle balance of budget funds. - SNGs can carry over leftover special fund balance from one year to another. - Accumulated financial surplus estimated at 1.9 percent of GDP by end-September 2017 could translate into sizable SNG deficits in coming years. - No fiscal rule in place to limit expenditure growth, ex post deficits, or scope of carry-overs. ### Comparative and institutional examples - Table excerpt: Subnational fiscal rules in selected European countries (summary descriptions preserved) - Italy: Budget balance (LG); Nominal Expenditure growth rate (RG). Internal Stability Pact provides RG with measures to limit expenditures and LG with measures to limit financial balances. Golden Rule: local and regional bodies are allowed to carry on deficits only to finance investments. - France: Budget Balance. Golden Rule: voted budget must be in balance; ex post deficits cannot exceed 5 percent of current revenues (10 percent for small municipalities). - Slovenia: Debt Ceiling: limit on repayment as percent of revenue in previous budget year. Total payment of principal and interest in each year must not exceed 8 percent of revenues of the previous year. LG cannot borrow abroad. LG approval needs the approval of the MoF. - Ireland: Budget balance in nominal terms. For any given year, LG must have a net total deficit of no more than a fixed nominal amount. ### Recommendations to strengthen intergovernmental fiscal coordination - Recommendation 3.3: Amend the Budget Code to preclude recurring negative outturns that could undermine SNG financial sustainability. Options include: - A requirement for SNGs to take steps to return to a balanced or positive outturn within two or three years at most. - Sanctions for recurrent deficits above a certain magnitude or for longer periods, ranging from withholding of transfers, compelled merger with a neighboring authority, or direct State administration. - Recommendation 4.1: Strengthen the intergovernmental fiscal coordination framework with subnational-specific fiscal rules to ensure the general government meets its fiscal objectives. Possible rule forms: - A limit on expenditure growth rate (example: impose annual growth rate of total expenditures not to exceed the average annual growth rate of revenue excluding central government transfers over the previous three years). - A limit on the overall deficit of subnational governments. - Until SNG fiscal rules are established, the MoF should establish a reserve at the State Budget large enough to accommodate any SNG overspending arising from use of accumulated idle balances. - Institutional recommendation: - Establish a common formal platform for intergovernmental coordination including representatives of all government levels to ensure collaborative fiscal objectives and fiscal sustainability. Consider interaction with the legislative powers of the Verkhovna Rada and relevant parliamentary committees. *Source: Budget Code of Ukraine; Box and accompanying IMF staff analysis.* ### 76. Recommendation 4.2: Establish an Intergovernmental Commission to ensure ### Recommendation 4.2: Establish an Intergovernmental Commission to ensure collaborative approach on common fiscal objectives ### Intergovernmental Commission — mandate and composition - Be chaired by the Minister of Finance or its Deputy. - Include representatives of all levels of government, local elected officials as well as representatives of the State (including Oblast and Rayon representatives). It would be important for the Ministry of Regional Development, the Ministry of Education, the Ministry of Health and the Ministry of Social Policy to be represented. - Meet at least twice a year. - Mandated to provide strategic guidance for fiscal policy formulation and coordination among the different spheres of governments with a view to meet fiscal policy targets, set at the government general level, and ensure long-term macro-fiscal stability. - In particular, mandated (based on MoF inputs) to monitor SNG finances and to suggest fiscal targets for the various levels of government and for the largest subnational units. - Be consulted on all draft laws, amendments, or regulations which have an impact on local finances (including any reforms recommended in the remainder of this report that are launched after the establishment of the Commission). The MoF would be in charge of providing the necessary analysis for those elements of the state budget which affect local governments. - Be consulted on matters relating to borrowing and the framework for State loans and guarantees provided to subnational units. - Participate in all major discussions about on-going fiscal decentralization reform. ### Local government financial position — key observations (end-2016) - The consolidated SNG financial position masks significant disparities across jurisdictions. - By end-2016: - More than half of the villages recorded a deficit. - About a fourth of the cities and rayons recorded a deficit. - A fifth of the oblasts recorded a deficit. - Up to 2016, only 11 out of 160 of the amalgamated community displayed a deficit but this situation is likely to change with the tendency of rural and poor villages to amalgamate among themselves. - Among the 453 villages that remained to be amalgamated by end-2016: - 251 recorded a deficit. - 286 spent more than 50 percent of their operational revenue on remuneration. ### Table 4.2: Selected Financial Stress Indicators of SNGs, 2016 (highlights) - Oblasts (24): Rev. UAH 53.1 million; Exp. UAH 48.5 million; Balance UAH 4.6 million; # in deficit 4; # with basic and stab. subs./Current rev.>10 1; # with Personnel exp. / op. exp.>50 percent 13; # with Dev. Exp./Rev.< 10 percent 13; # with Dev. Exp./Rev. < 20 percent 20. - Rayons (457): Rev. UAH 111.6 million; Exp. UAH 107.5 million; Balance UAH 4.0 million; # in deficit 110; # with basic and stab. subs./Current rev.>10 3; # with Personnel exp. / op. exp.>50 percent 2; # with Dev. Exp./Rev.< 10 percent 446; # with Dev. Exp./Rev. < 20 percent 457. - COS (148): Rev. UAH 170.5 million; Exp. UAH 163.6 million; Balance UAH 7.0 million; # in deficit 40; # with basic and stab. subs./Current rev.>10 4; # with Personnel exp. / op. exp.>50 percent 3; # with Dev. Exp./Rev.< 10 percent 74; # with Dev. Exp./Rev. < 20 percent 126. - Villages (453): Rev. UAH 20.9 million; Exp. UAH 22.1 million; Balance UAH -1.2 million; # in deficit 251; # with basic and stab. subs./Current rev.>10 1; # with Personnel exp. / op. exp.>50 percent 286; # with Dev. Exp./Rev.< 10 percent 49; # with Dev. Exp./Rev. < 20 percent 186. - AH (160): Rev. UAH 7.1 million; Exp. UAH 6 million; Balance UAH 1 million; # in deficit 11; # with basic and stab. subs./Current rev.>10 39; # with Personnel exp. / op. exp.>50 percent 135; # with Dev. Exp./Rev.< 10 percent 8; # with Dev. Exp./Rev. < 20 percent 57. - Source: State Treasury and IMF staff estimates. ### Reporting and monitoring gaps - Legal framework requires performance reports on local budgets to be presented quarterly and annually, within two months of the end of the budget period, and approved by relevant local council (Art 80). - Local agencies of the State Treasury must submit monthly, quarterly and annual information on local budget execution to the VR, MoF, CMU, and ACU (within 15 days of the reporting month, within 35 days of the reporting quarter, and within 3 months of the end of the fiscal year). - Despite availability of execution reports, there is no regular analysis or tracking by MoF of key financial stress indicators for individual local governments (overall and operating balance, accounts payable, debt and debt service). - Monitoring of revenue shortfalls or expenditure overruns to identify chronically distressed local governments and potential State intervention is missing. ### Heat map (Table 4.3) — oblasts and City of Kiev (number of oblasts in each situation) - Debt service coverage ratio (available revenue/annual debt service): - Low risk: 25 [More than 2.5 times] - Medium risk: 0 [1.5-2.5 times] - High risk: 0 [Less than 1.5 times] - Debt service/Current revenue: - Low risk: 25 [Below 10 percent] - Medium risk: 0 [10-15 percent] - High risk: 0 [Greater than 15 percent] - Total debt/ Current revenue: - Low risk: 25 [Less than 100 percent] - Medium risk: 0 [100-150 percent] - High risk: 0 [Greater than 15 percent] - Personnel expenditure/operating expenditures: - Low risk: 1 [Less than 35 percent] - Medium risk: 2 [35-50 percent] - High risk: 13 [Greater than 50 percent] - Development expenditures: - Low risk: 4 [Greater than 20 of revenue] - Medium risk: 7 [10-20 percent] - High risk: 13 [less than 10 percent of revenue] - Source: State Treasury and IMF staff estimates. ### Legal and institutional concerns on borrowing, PPPs, and audits - Legal limits and ambiguities: - Local debt service limited to 10 percent of the expenses of the general fund of the local budget during any budget period when servicing is planned. - Limit on total amount of local debt (including guaranteed debt) of 200 percent of forecast revenues of the development budget (400 percent for the City of Kiev). The annual local budget sets a limit on total local debt and local guarantees on a yearly basis. - Lending between local budgets expressly prohibited (Art 73 of the BC). - Local governments required to seek approval from the MoF to issue guarantees but not to contract PPPs. - Article 73 provides for loans to cover temporary cash gaps on the general fund and development fund; Article 74 stipulates local borrowing should be limited to financing development budgets, financed by the special fund. - Article 73 extends borrowing powers to all local budgets, while Article 74 only refers to city budgets. - MoF oversight: - Budget Code requires the “scope and conditions of local borrowing and the provision of local guarantees” to be agreed with the MoF but lacks specification. - Automatic granting of MoF approval of subnational borrowings request on a one-month lapse-of-time basis raises questions about the nature of controls exercised by the MoF. - PPPs and concessions: - Not a large source of fiscal risk currently; many projects take the form of concession contracts requiring no explicit government funding. - No central database recording total fiscal commitments under PPPs. - MoF approval required only for explicit government funding (direct payments or loan guarantees). - Audit framework: - Internal audit and control conducted under State Audit Service (SAS) and internal audit units (IAU) of each budgetary spending unit. Mandate of SAS extends to compliance audits of local budgets (CMU Resolution no.43 On the Charter of the State Audit Service, Article 4(4)). - SAS procedure includes sending audit reports to local government and authorizes local SAS branches to take measures for implementation. - Accounting Chamber of Ukraine (ACU) can carry out audit of local budgets “at their request,” but this does not include audit of own revenues and frequency is not defined. ### Recommendation 4.3: Improve monitoring and management of fiscal risks arising from local government finances - The department of Local Budgets in the MoF should set up a monitoring system to track local government finances, including: - Tracking indicators of fiscal stress including overall balance, operating, accounts payable, debt and debt service to revenue ratios. - Monitoring revenue shortfalls and expenditure overruns. - Identifying hromada with persistent deficits. - Compelling those local authorities to raise taxes, reduce spending or merge with more financially viable authorities. - Reconfigure subnational borrowing rules to require explicit MoF approval for domestic borrowing above a threshold value or any borrowing in foreign currency in lieu of having them approved automatically on a lapse-of-time basis. - Require all PPP contracts to be reported to the MoF and require MoF approval for all PPP contracts worth more 10 percent of local operating revenue. - Strengthen the requirements for external audit and increase their frequency to ensure that each major local government unit undergoes such an audit at least every two years. The law should provide for external audit as a requirement rather than as a permission to audit. These audits could be conducted by an approved list of private audit firms to complement the ACU controls. ### Cash Management ### Three primary pillars for modern government cash management - (i) A consolidated and comprehensive treasury single account (TSA) system of banking arrangements. - (ii) Reasonably accurate, updated cash flow forecasts and projections. - (iii) Active financial cash management transactions based on a dynamic cash buffer level. ### Current TSA arrangements and issues - Article 43 BCU establishes a Treasury Single Account (TSA) structure held with the National Bank of Ukraine; all revenues must be paid into the TSA. - Coverage of the TSA is comprehensive, incorporating all general government revenue (State and Local) and the social funds. - State Treasury Service (STS) responsible for managing the TSA per the Budget Code and procedures approved by the CMU (see Article 2 CMU Decree of 15 April 2015 On Approval of the STS “STS Decree”). - STS granted extensive powers to open, close and manage government bank accounts and generally control public revenues consolidated into the TSA (Art 43(1) and (6) BCU, and Art 4 STS Decree). ### Idle local balances and fragmented liquidity management - Local authorities have accumulated idle balances at State-owned commercial banks, preventing more active cash management across general government. - The State Treasury Service does not remunerate these funds when deposited in the TSA. - Local authorities allowed to deposit idle balances exclusively with state-owned commercial banks during the course of the year; these funds must be returned to the budget accounts from which they were transferred no later than 10 days before the end of the fiscal year. - STS provides short-term unremunerated loans to cover local authorities’ in-year financing shortfalls: - Two types of loans: short-term loans repaid within the fiscal year; medium-term loans that may be outstanding past the end of the year. - Example of liquidity mismatch: - Stock of Treasury Bills issued by the State has increased by UAH 30 billion since the beginning of the year; during the same period, accumulated idle local government funds deposited at commercial banks reached around UAH 16 billion (Figure 4.1). - Source: National Bank of Ukraine. ### Recommendation 4.7: Establish an attractive treasury arrangement for local authorities - MoF actions to implement an attractive treasury arrangement with deposit-taking and lending facilities offering market rates: - Decide on the location of the new treasury arrangement. Within the current framework, the Debt Policy Department would be well equipped to perform this function given their existing financial market capacity and the linkages of debt management to broader cash management objectives. - Develop a concept note explaining the proposed new function, its objectives and the roles of the key stakeholders. This will include identification of the universe of local authorities to be targeted; selection of the authorities most likely to be of interest (i.e., those with the most surplus cash); preparation of a series of road shows with these authorities to discuss their needs and to explain the benefits to them of investing in instruments developed for general government treasury services. - Design the types of instruments to be offered to local authorities for lending and borrowing purposes. Build trust with local authorities to ensure contractual assurances of repayment on maturity date. Analysis of possible legislative changes will be needed. - Analyze systems needs and implement a technical solution for front office and back office processing similar to government debt management operations. - Recruit and train required staff; potential secondment from the financial sector initially. - Improve management of operational and market risks; develop and implement a risk management strategy with appropriate oversight/governance/systems and internal controls prior to launch. - Launch the treasury services, potentially supported by a marketing campaign aimed at local authorities. ### Strengthening the legal framework for fiscal risk management and MTBF ### Planned reforms and objectives - Ukrainian authorities planning to update the Budget Code in two important PFM areas—fiscal risks oversight and MTBF—addressed in previous Fund TA. - Objective: provide a legal foundation for the MoF to be responsible for a fiscal risk oversight function and for the introduction of a fully-fledged MTBF in Ukraine. - Reforms to be incorporated by amending specific provisions of the Budget Code. The MoF has shared a preliminary version of draft amendments with the mission. - Findings and recommendations with respect to the draft amendments are further illustrated by draft legislative suggestions included in Annex III and build upon advice given in previous missions. *Source: State Treasury and IMF staff estimates.* ### 94. The draft amendments to the Budget Code could be made more prescriptive and ### 1ukrea2019004 - 94. The draft amendments to the Budget Code could be made more prescriptive and ### General findings on draft Budget Code amendments - The MoF’s efforts to amend the legislation are commended as an adequate legal basis in the primary law is necessary to ensure the effectiveness of the fiscal risks oversight function and of the MTBF (paragraph 94). - The language of the draft amendments is often generic and lacks detail; more prescriptive provisions would strengthen the MoF’s mandate for fiscal risk oversight and enhance legitimacy and credibility of the MTBF (paragraph 94). - Introducing surgical amendments to the Budget Code is a sub-optimal solution; the MTBF impacts a much broader array of aspects (e.g., removal of the distinction between general and special fund) and requires a more comprehensive revision and operationalized strategy (paragraph 95). - Ukraine’s legal framework for PFM exhibits complexities, inconsistencies, and ambiguities; loose provisions accompanied by many implementing regulations can lead to overlapping or duplicative rules, underscoring the need for a clear and enforceable legal foundation in the Budget Code and high-quality legislative drafting (paragraph 96). ### A. Fiscal Risks Monitoring — Mandate and scope - Clarify the legal nature of the MoF mandate for fiscal risk oversight by defining: - objectives (e.g., mitigation of fiscal risks), - functions (e.g., collection of information, analysis, monitoring, disclosure), - powers (e.g., preparation and submission of a fiscal risk statement) (paragraph 97). - Clarifying mandate along these lines would strengthen MoF position when requesting information from other government agencies or SOEs and ensure a clear line of accountability (paragraph 97). - Timeframe for implementation of the MoF mandate should be clarified in legislation; phased implementation is envisaged (initial focus on SOEs, then broader sources of fiscal risks) and may be addressed by: - including a specific list of fiscal risks with a transitional clause excepting certain sources (e.g., sub-lending or pensions) from immediate entry into force; or - authorizing the CMU to determine the timeframe (paragraph 98). ### A. Fiscal Risks Monitoring — Definition and fiscal risk statement - Broaden the definition of “fiscal risks” to include all factors that may lead to deviation of fiscal outcomes (i.e., revenues, expenditures, deficit and public debt) from expectations or budget forecasts (paragraph 99). - Revise “contingent liability” to include liabilities arising from non-contractual obligations, not only contractual commitments; include an enabling provision authorizing the CMU to further detail the contents of the fiscal risk statement (paragraph 99). - Enhance institutional cooperation and transparency by adding an enabling provision requiring the CMU to adopt a resolution specifying roles and responsibilities of the MoF, ministries, and government agencies in preparing, submitting, and publishing the fiscal risk statement; explicitly require publication of the fiscal risk statement (paragraph 100). - Align provisions on the timeframe for preparation and submission of the fiscal risk statement with any changes to the MTBF calendar, because the fiscal risk statement is included in the budget declaration (paragraph 101). ### A. Fiscal Risks Monitoring — Information gathering powers and compliance - Draft amendments contain useful provisions on information exchange but should be fine-tuned and tightened to enable MoF to gather necessary information from agencies and entities (paragraph 102). - MoF should be authorized to request information directly from SOEs as well as line ministries; information requested from SOEs should be limited to financial performance data for fiscal risk monitoring (paragraph 102). - To safeguard SOE functional independence, information requests to SOEs should be addressed to supervisory boards with copies to shareholding line ministries and executive agencies exercising ownership rights; returned data should be sent to the shareholding ministry concurrently with the MoF (paragraph 102). - Given legal difficulties in designing sanctions against non-compliant line ministries and SOEs, refer in the Budget Code amendments to relevant sanctions under budgetary and administrative law where applicable (e.g., for SOEs receiving budgetary funds) and require MoF reporting (e.g., to the CMU) on non-compliance cases (paragraph 103). - Consider legally feasible specific sanctioning mechanisms allowing MoF to set a reasonable deadline for information provision, after which sanctions can be imposed; possible measures include: - additional reporting requirements, - imposition of additional controls (e.g., over staff recruitment, pay, or major investment decisions), - administrative measures (e.g., steps to dismiss or suspend members of the management board), - government imposition of direct control over a public corporation’s operations; - coordinate sanctions affecting corporate governance with shareholding ministries; sanctions may also be applied to management board members or government officials charged with oversight of public corporations (paragraph 104). ### A. Fiscal Risks Monitoring — Recommendations (Recommendation 5.1) - Amend the Budget Code, revising the draft amendments prepared by the MoF, to: - strengthen the mandate of the MoF and its power to collect information related to fiscal risks; - broaden the definition of fiscal risks; - prescribe that a CMU resolution will specify roles and responsibilities of the MoF, ministries and government agencies in the preparation, approval and publication of the fiscal risk statement, and can further detail the contents of the fiscal risk statement (paragraph 105). ### B. Medium-term Budgetary Framework — General - Draft amendments on the MTBF should be fleshed out in more detail to ensure transparency and build credibility; gradualism and flexibility should not lead to soft implementation—amendments should clearly spell out rules and processes for CMU, MoF, line ministries, and KSUs (paragraph 106). - The absence of an “organic” Budget Code that ranks higher than other laws in Ukraine means MTBF provisions can be superseded by other laws, including the annual budget law; this increases the case for prescriptive amendments specifying process, incentives, and transparency for changes to medium-term fiscal objectives during the budgetary year (paragraph 107). ### B. Medium-term Budgetary Framework — Budget Declaration - Draft Article 33 would define the “Budget Declaration” as the “state strategic document that defines the basic principles of budget and tax policy in the medium term,” with “medium-term period” defined to encompass “the planning period and the next two budget periods following the planning period” — anchoring macro-fiscal projections, budgetary objectives, expenditure ceilings (aggregate and KSUs), strategic goals and performance indicators for KSUs over a three-year horizon (paragraph 108). - Article 33 should be expanded to include: - Consolidated general government sector perspective to foster coordination between central and sub-national governments (paragraph 109, bullet 1). - Requirement to include not only aggregate and KSU-specific expenditure ceilings but also the specific criteria used for their determination and rules governing any possible deviation from the ceilings (paragraph 109, bullet 2). - An enabling provision authorizing a CMU resolution to further specify contents of the Budget Declaration (paragraph 109, bullet 3). - The form and timing of approval of the Budget Declaration should be specified in amendments to the Procedural Rules of the Verkhovna Rada; authorities envisage initial approval via Verkhovna Rada resolution with eventual conversion to approval by law after several years (paragraph 110). - The draft amendments should specify the legal form of approval (i.e., a resolution of the Verkhovna Rada) and the date when such resolution is expected to be adopted (e.g., June 30) (paragraph 110). - Amendments to procedural rules should be submitted or coordinated with the draft amendments to the Budget Code (paragraph 110). ### B. Medium-term Budgetary Framework — Budget calendar and ceilings - The MTBF calendar provisions should be revised to provide adequate rules on discussions over expenditure ceilings and ensure proper sequencing, logic, and early strategic involvement of key stakeholders (paragraph 111). - The draft calendar differs from previous Fund TA recommendations by not providing for a staged CMU first approval (e.g., end of the first quarter) of the expenditure envelope and KSU ceilings; instead CMU intervenes only after MoF and KSUs begin negotiations, reconciling differences before Budget Declaration approval on June 1 — this timing may weaken top-down incentives and MoF’s negotiating position with KSUs (paragraph 111). - Consider reviewing draft calendar provisions to strengthen the strategic role of the CMU, MoF, and line ministries in ceiling negotiations (paragraph 111). *Source: IMF staff report text (paragraphs 94–111) from the provided PDF content.* ### 112. The draft amendments to the Budget Code provide for a quite fluid and flexible ### The draft amendments to the Budget Code provide for a quite fluid and flexible framework on expenditure ceilings ### Expenditure ceilings framework (paragraphs 112–113) - The draft amendments to Article 33–1 of the Budget Code allow aggregate ceilings to be revised in the draft annual budget law upon two circumstances: - (i) “in case of deviation from key macro indicators for economic and social development of Ukraine from the forecast which was considered when compiling the Budget declaration; - (ii) in case of “approval of legislation... which impact the indicators of the government budget during the mid-term period.” - The draft amendments do not distinguish between fixed and indicative ceilings; authorities consider any mention to “indicative ceilings” would not contribute to the credibility of the MTBF process, particularly in the first phase of its gradual introduction. (paragraph 112) - Aggregate and KSU ceilings are defined in the draft amendments as follows (footnote 35): - “aggregate expenditure ceiling and lending—total expenditures and loans from the state budget, which corresponds to the financial resources of the state budget in the corresponding year of the medium-term period”; - “ceiling of expenditures and lending to key spending unit of the state budget funds means the amount of expenditures and provision of loans from the state budget for the corresponding year of the medium-term period, within which the key spending unit plans and carries out its activities, in order to achieve strategic goals in the corresponding sphere of activity (sector).” - Under the proposed draft amendments, “amounts of government capital investments to develop and implement government investment projects for mid-term period are stipulated by the Budget declaration within the range of aggregated expenditure ceilings and loan facilities.” These amounts do not seem therefore to be included within KSU ceilings. (footnote 35) - Identified weaknesses and potential improvements (paragraph 113): - Definitions and Approval - Draft amendments could explicitly provide that the ceilings will be approved by the CMU. - The definition of expenditure ceilings could be clarified to state ceilings represent an explicit commitment of the government or the KSU over a maximum level of expenditures. - General and special fund - Different regimes for KSU expenditure ceilings for the general and special fund: - For the general fund, ceilings may be changed, in addition to the general circumstances noted above, in case of transfer of responsibilities from one KSU to another and in case of “allocation of expenditures which were not allocated between the [KSUs] during approval of the budget declaration.” - For the special fund, deviations can occur at any time given the balance rule between revenues and expenditures provided for them. - Interaction between KSUs, MoF, and the Verkhovna Rada - After the Budget Declaration is submitted to the Verkhovna Rada, the KSUs report to the Verkhovna Rada on the strategic goals and performance indicators over the medium-term period. It is unclear how this provision would interact with discussion at the Verkhovna Rada of the expenditure ceilings, including in the context of the annual budget law. - Draft legislative suggestions in the annex delete this provision, as the strategic goals and performance indicators are included in the Budget Declaration. - Criteria for deviation - Criteria for any deviation from the ceilings are broad and include the approval of legislation that would expand programs or introduce new policies. The report notes it does not seem appropriate to include such criterion as a ground for deviation from expenditure ceilings, whose key purpose is to instill fiscal discipline. - Transparency in case of deviation from ceilings - Draft amendments do not require an explicit explanation for changes to expenditure ceilings, beyond inference from draft annual budget documentation. The report recommends an explicit requirement that any change to expenditure ceilings be adequately explained in the annual budget documentation and any other relevant laws. ### Recommendation 5.2 (paragraph 114) - Amend the Budget Code and Procedural Rules of the Verkhovna Rada, by revising the draft amendments prepared by the MoF, to: - Prescribe that additional contents are included in the Budget Declaration, such as information on the consolidated general government sector and on the criteria for the determination of the expenditure ceilings; - Modify the budget calendar relating to the approval of the Budget Declaration to provide for a stronger strategic involvement of the CMU; and - Strengthen the legal provision on expenditure ceilings by, among other things, removing the distinction between general and special fund with respect to the legal regime for expenditure ceilings and providing for transparency requirements in case of deviation from ceilings. ### Annex I — Distribution of Powers to Local Government: Introduction (Annex I, paragraphs 1–2) - Analysis basis - The analysis is based on the main decentralization-related legal instruments in Ukraine: the 1996 Constitution, 1997 Law on Local Self-Government (LSG), related legislation (as amended), and the Budget Code provisions relating to fiscal decentralization. - Reforms to the administrative and fiscal subnational structure were introduced in 2015 (inter alia, under the Law on Voluntary Amalgamation of Territorial Communities and the Law on Cooperation of Local Communities). - Scope and caveats - Other legal instruments may affect fiscal decentralization; this is a preliminary analysis. - A detailed review of the Tax Code was outside the scope of the current TA; follow-up work should include this analysis. - The mission is aware of proposed amendments awaiting approval in parliament (examples listed), and stands ready to update analysis upon receipt and review of draft amendments. ### Distribution of Powers to Local Government — Rights, Obligations, Competences, and Powers (paragraphs 3–6) - “Rights” of local government (paragraph 3) - The right of local self-government is specifically granted to “hromada” (communities), or amalgamated hromada where amalgamation has taken place. - Hromada are defined as either: - (1) residents of a village; or - (2) a voluntary association of residents of several villages, settlements or cities into one community. - Hromada of the second type (associations of villages and settlements) are not separately recognized under the Constitution as an administrative-territorial subdivision of Ukraine. - Hromada can exercise powers directly or through “local self-government bodies” (councils and executive bodies of the hromada’s constituent villages, settlements and cities). - If hromada have amalgamated, they can elect a separate local council and executive body for the newly amalgamated community (NAC). - Oblast and rayon councils and their executive bodies manage matters of common interest to multiple hromada; city councils manage matters relating to organization and administration of city rayons. - Footnote highlights: - The right of local self-government includes inter alia the right to own, use and manage property, land, revenues of local budgets, other funds, and natural resources; defined as a “right to communal property” (Articles 1, 16(3) and 60 LSG). - Voluntary amalgamation governed by the Law on the Voluntary Amalgamation of Territorial Communities 2015 with restrictions on contiguity and oblast borders (Articles 3(1), 4(2), 4(3)); ambiguity noted about amalgamation restriction in Article 4(1). - “Obligations” of Local Government (paragraph 4) - Constitution (Articles 142 and 143) defines obligations relevant to public financial management: - For hromada: approve budgets of respective administrative and territorial units and control execution of such budgets; establish local taxes and levies in accordance with law; approve and control implementation of programs of socio-economic and cultural development; settle other issues delegated by law. - For oblast and rayon councils: approve rayon and oblast budgets formed from State budget funds for distribution among territorial communities or joint projects; control execution of such budgets; approve and control programs of socio-economic and cultural development; settle other issues delegated by law. - For the State government: obligation to “participate in the collection of revenues for budgets of local self-governments.” - “Competences” of Local Government (paragraph 5) - Village, settlement and city councils are given exclusive competence to: - approve programs of socio-economic and cultural development of corresponding administrative-territorial units, and target programs on other local self-government issues; - approve and amend the local budget; approve the report on the implementation of the corresponding budget; - establish local taxes and fees, and their amounts, within the limits determined by law; - adopt decisions on receiving loans from other local budgets and sources, and on the transfer of funds from the corresponding local budget; - adopt decisions on providing local tax and fee privileges, in accordance with effective legislation. - “Powers” of Local Government (paragraph 6) - Exclusive powers include: - ensure the balance of financial and labor resources, monetary revenues and expenditures necessary for managing socio-economic and cultural development of the corresponding territory; - submit to rayon and oblast councils necessary indicators and proposals on programs of socio-economic and cultural development of corresponding rayons and oblasts; - draft the local budget, submit the draft to the corresponding council for approval, ensure implementation of the budget; submit quarterly written reports on the course and results of the budget's implementation; prepare and submit to rayon and oblast councils the necessary financial indicators and proposals on drafting rayon and oblast budgets; - execute, in the established procedure, the financing of local budget expenditures. - Delegated powers include: - exercise control over payment by enterprises and organizations to the local budget in accordance with their obligations; - exercise control over compliance with prices and rates. *Source: Extract from the provided IMF TA document content (paragraphs 112–114 and Annex I, paragraphs 1–6).* ### Annex II. Subnational Fiscal Rules in Selected European Countries ### Annex II. Subnational Fiscal Rules in Selected European Countries ### Overview - The annex catalogs subnational fiscal constraints across selected European countries, classifying rules by: Type (BBR: budget balance rule; DR: debt rule; ER: expenditure rule; RR: revenue rule), Sector (CG: central government; RG: regional government; LG: local government), Target/constraint (e.g., budget balance in nominal terms, debt ceiling), Accounting system (ESA: ESA95/2010; BA: budgetary accounting system), Time frame (A: annual; M: multiannual), Statutory base (C: constitution; L: legal act; PC: political commitment), Monitoring body, and Enforcement body. - Source noted at table end: European Commission, Fiscal Rules database. ### Rule types and common targets - Budget balance rules (BBR): - Widely applied to local government (LG) and regional government (RG) in multiple countries (examples: Belgium, Germany, France, Italy, Portugal, Romania, Sweden, Poland, Netherlands). - Described targets include "Budget balance in nominal terms", "Budget balance (règle d’or)", "Structural Budget Balance, in % of GDP". - Debt rules (DR): - Frequently specify ceilings as percent of revenues or current net revenue (examples: Estonia, Spain, Portugal, Romania, Latvia, Slovakia). - Examples of numerical ceilings preserved exactly: - Bulgaria: municipal debt payments may not exceed 15 per cent of the annual average amount of own revenue and the total balancing subsidy for the past three years. - Bulgaria: guarantees issued during the current budget year may not exceed 5 per cent of the total revenue amount and the total balancing subsidy. - Estonia: local governments are not allowed to increase their debt over the 60 per cent of their budget revenue (allocations from the state budget for a specific purpose deducted). - Spain: indebtedness exceeds 75% of its current revenues triggers authorization requirement. - Portugal (LG DR): debt at the end of the year cannot exceed 1.5 times on average the current net revenue collected in the previous 3 years; total debt can only increase each year by 20% of the margin available at the beginning of each financial year. - Portugal (RG PT DR): floating debt cannot exceed 0.35 times the average net current revenue collected over the past 3 years. - Romania (DR): annual public debt service including the loan to be contracted cannot be higher than 30% of their own revenue. - Slovakia (DR): total debt cannot exceed 60% of current revenue in the previous budget year; annual instalments to reimburse debt cannot exceed 25 % of revenue in the previous budget year. - Expenditure rules (ER): - Examples include nominal expenditure ceilings or limits on nominal expenditure growth (France: Odedel nominal growth of local expenditure; Italy: expenditure ceilings for pharmaceutical products with ceilings 16,4% (2008); 16% (2009)). - Other quantitative constraints: - Poland (DR): debt service ratio defined by a three-year arithmetic mean formula for revenues and allowable debt service. ### Selected country-specific summaries (preserving original phrasing and numeric values) - Belgium - Type: BBR; Sector: LG; Target: Budget balance in nominal terms. - Description: Balanced budget rule for LG: mandatory balance of budgetary accounts. - Accounting system: BA; Time frame: M; Statutory base: L. - Monitoring body: GS (RG); Enforcement body: GS (RG). - Bulgaria - Multiple entries (DR, BBR, ER) for LG with targets and limits: - DR: municipal debt payments may not exceed 15 per cent of the annual average amount of own revenue and the total balancing subsidy for the past three years. - DR: nominal value of municipal guarantees may not exceed 5 per cent of the total revenue amount and the total balancing subsidy. - BBR: medium-term balance objective on a cash basis to maintain a balanced budgetary balance. - ER: average growth rate of expenditure for local activities for the forecasted medium-term period shall not exceed the average growth rate of reported expenditure for past four years. - Accounting system: BA; Time frame: M or A as listed; Statutory base: L; Monitoring: IND; Enforcement: No body. - Cyprus - Type: BBR; Sector: LG; Target: Nominal balance, in absolute terms. - Description: Local authorities should only prepare balanced annual budgets. - Accounting system: M; Time frame: L; Monitoring: MF, IND; Enforcement: MF, GS. - Czech Republic - Type: DR; Sector: LG; Target: Indicator of total liquidity (current ratio). - Description: MoF calculates short term assets/short term liabilities; liabilities/debts / total assets ratio for municipalities annually. - Accounting system: National accounting standards; Time frame: A; Statutory base: L; Monitoring & Enforcement: MF. - Germany - Multiple rules across CG, RG, LG: - CG, RG: BBR in % of GDP — structural net borrowing must not exceed 0.35 % (CG) and 0.0 % (RG) of GDP. - LG: BBR balanced budget rule for 'administrative' and capital accounts. - RG: Golden rule: credit volume must not exceed investment volume, except for dealing with adverse macroeconomic developments. - Accounting: BA or ESA as noted; Time frame: A; Statutory base: C or L; Monitoring: CoA; Enforcement: NP, CoA, Lander Parliaments, GS as listed. - Estonia - Type: DR; Sector: LG; Target: Debt ceiling as percent of budgeted revenues. - Description: Not allowed to increase debt over the 60 per cent of their budget revenue (state allocations for specific purpose deducted). - Accounting system: BA; Time frame: A; Statutory base: L; Monitoring & Enforcement: MF. - Spain - Type: DR; Sector: LG; Target: Debt ceiling as % of current revenue. - Description: LG must register balanced budget or surplus; negative net saving or indebtedness exceeds 75% of current revenues triggers authorization for long-term credit operations by Central Government or Autonomous Community. - Accounting system: BA; Time frame: A; Statutory base: L; Monitoring: MF, RG; Enforcement: MF. - RG (ES DR): RG need authorization of central Government to take loans. Accounting: ESA; Statutory base: A; Monitoring & Enforcement: MF. - France - BBR for LG described as "Budget balance (règle d’or)": voted budgets must be in balance; ex post deficits cannot exceed 5% of current revenues (10% for small municipalities). - ER (FR ER) for LG: Nominal growth of local expenditure (Odedel) — target on growth of nominal spending expressed as annual percentage change; Programming Law of Public Finances (PLPF) for 2014-2019 distinguished total expenditure vs operating expenditure. - Accounting: BA; Time frame: A or M as listed; Statutory base: L; Monitoring: GS (préfet) and IND (Chambre régionale des comptes); Enforcement: GS (préfet) and IND; in some cases No body. - Ireland - BBR LG: For any given year, LG must have a net total deficit (in EDP terms) of no more than a fixed nominal amount. - Accounting: ESA; Time frame: A; Statutory base: PC; Monitoring: MF, GS; Enforcement: MF, GS. - Italy - ER RG: Nominal expenditure ceiling — example for pharmaceutical products with ceilings: 16,4% (2008); 16% (2009). - IT ER/BBR RG, LG: Budget balance (LG); Nominal expenditure growth rate (RG) — regional spending ceiling computed both on accrual basis and euro-compatible accrual one. - IT BBR RG, LG: Golden rule: local and regional bodies allowed to carry on deficit only to finance investments (article no. 119 of the Italian constitution). - Accounting: BA, ESA as listed; Time frame: M; Statutory base: L or C; Monitoring & Enforcement: MF, CoA, Board of Performance Assessors, GS as listed. - Lithuania - BBR LG: Rule allows deficit not to exceed expenditure from borrowed funds for capital expenditure within borrowing limits approved by Parliament. - Accounting: BA; Time frame: A; Statutory base: L; Monitoring: GS; Enforcement: GS, NP. - Luxembourg - BBR LG: Local governments current budget must be balanced; extraordinary expenditure can be financed by debt but repayment costs must be financed by current budget. - Accounting: BA; Time frame: A; Statutory base: L; Monitoring & Enforcement: GS. - Latvia - DR LG: LG can only increase borrowing and loan guaranties up to certain limits set by CG. - Accounting: BA; Time frame: A; Statutory base: PC; Monitoring: GS; Enforcement: MF. - Netherlands - BBR LG: Structural Budget Balance, in % of GDP (multiannual macro norm) applies to all local governments combined; a correction mechanism triggers when the sum of all deficits exceeds the allowed joint deficit. - Accounting: ESA; Time frame: M; Statutory base: L; Monitoring: MF, other GOV body, IND; Enforcement: MF, IND. - Poland - BBR LG: Planned and executed current expenditures rules; current deficit allowed only under specified execution circumstances. - PL DR LG: Debt service ratio defined by a three-year arithmetic mean formula; monitoring by Regional Chamber of Audit, self-gov. legislative body and management board; enforcement by Regional Chamber of Audit, self-gov. legislative body. - Accounting: BA or NA as listed; Time frame: M; Statutory base: L; Monitoring & Enforcement: CoA, regional bodies. - Portugal - PT DR LG: debt at end of year cannot exceed 1.5 times average current net revenue collected in previous 3 years; total debt annual increase limit 20% of margin at beginning of year. - PT DR RG: liabilities not higher than 1.5 times average current net revenue collected in last 3 years; floating debt cannot exceed 0.35 times average net current revenue over past 3 years. - PT BBR RG: current balance minus average amortization must not be a negative value higher than 5% of the current net revenue collected. - PT BBR LG: collected current revenue should at least be equal to current expenditure plus average medium and long-term loans amortization. - Accounting: BA; Time frame: A; Statutory base: L; Monitoring & Enforcement: Court of Auditors, Directorate General of LG, IND, Financial Policies Monitoring Council, GOV, CoA, GS as listed. - Romania - BBR LG: LG budgets, excluding loans to finance investment and debt refinancing, have to be balanced. - RO DR LG: LG cannot contract or guarantee loans if annual public debt service including the loan would be higher than 30% of their own revenue. - Accounting: BA; Time frame: A; Statutory base: L; Monitoring & Enforcement: MF, GS as listed for respective rules. - Sweden - BBR LG: Local Government Act obliges LG to balance budgets. - Accounting: BA; Time frame: A; Statutory base: L; Monitoring: GS; Enforcement: No body. - Slovakia - DR LG: Borrowing limits — total debt cannot exceed 60% of current revenue in previous budget year; annual instalments cannot exceed 25 % of revenue in previous budget year. - SK BBR LG: LG's current budget must be balanced or in surplus; capital budget can be in deficit if financed by unspent funds, loans or current budget surplus. - Accounting: BA; Time frame: A; Statutory base: L; Monitoring & Enforcement: IND, MF, CoA, MF, IND, or No body as listed. ### Monitoring and enforcement modalities (patterns) - Monitoring bodies frequently include: Ministry of Finance (MF), Court of Auditors (CoA), government structures (GS), independent bodies (IND), and national parliaments (NP). - Enforcement bodies cited include: MF, GS, CoA, Lander Parliaments, Court of Auditors, Regional Chamber of Audit, Financial Policies Monitoring Council, and in many entries "No body" where no specific enforcement entity is listed. - Accounting base varies between BA (budgetary accounting system) and ESA (ESA95/2010) with some countries using national accounting standards. *Source: European Commission, Fiscal Rules database (table reproduced in Annex II).* ### 3. The central body of the executive power which develops the government policy in the ### 1ukrea2019004 - 3. The central body of the executive power which develops the government policy in the ### Budget preparation calendar and institutional roles - The central body of the executive power which develops the government policy in the area of economic and social development: - submits to the Ministry of Finance, to key spending units and to the Cabinet of Ministers of Ukraine, prior to or on March 1, estimated projected key macro indicators for economic and social development of Ukraine for the mid-term period. - The Ministry of Finance of Ukraine: - on the basis of the key projected macro indicators for economic and social development of Ukraine for the mid-term period and the analysis of the execution of the budget during previous budget periods, projects the amount of revenues, defines the amount of funding for the budget and repayment of loans, and: - (i) prior to or on March 15, determines the draft aggregate expenditure ceilings and lending, including the technical amendments to the aggregate expenditure ceilings and lending approved in the Budget Declaration of the previous year; - (ii) prior to or on March 31, determines and submits for approval of the Cabinet Ministers the ceilings of expenditures and lending of key spending units. - The Cabinet of Ministers of Ukraine: - prior to or on April 15 and based on strategic priorities and size of any fiscal adjustment that may be required based on the information submitted to it under paragraphs (2) to (4) above, examines and approves the aggregate expenditure ceilings and lending and the ceilings of expenditures and lending of key spending units. - Further to the approval under paragraph (5) above, the Ministry of Finance of Ukraine: - submits the ceilings of expenditures and lending of key spending units, as approved by the Cabinet of Ministers of Ukraine [and together with an updated macro-economic forecast], to the key spending units; - the Minister of Finance submits to the key spending units also the guidelines for the provision of information regarding new policies that may be relevant for the ceilings of expenditures and lending of key spending units. Such guidelines will require the submission of information on savings regarding existing policies, reallocation between existing policies and the costing of brand new policies. - The Ministry of Finance: - prior to or on May 31, submits the draft Budget Declaration to the Cabinet of Ministers, with an explanatory note on any pending disagreements with key spending units regarding the ceiling of expenditures and lending of key spending units. - The Cabinet of Ministers of Ukraine: - not later than June 15, reviews and approves the Budget Declaration and submits it to the Verkhovna Rada of Ukraine. - The Verkhovna Rada of Ukraine: - reviews the Budget Declaration and adopts a resolution by June 30, according to the [Procedure of the Verkhovna Rada of Ukraine]. ### Contents of the Budget Declaration - The Budget Declaration includes provisions on: - (a) [key projected macro indicators for economic and social development of Ukraine (including the indicators of nominal and real gross domestic product, consumer price index and prices of manufactures, unemployment level, assumptions on UAH/US$ rate average for the year and by the end of the period, as well as other indicators considered during the development of the Budget Declaration); - (b) main tasks of the budget policy, in particular: - a. deficit (surplus) of the government budget; - b. share of the projected annual amount of the gross domestic product which is [appropriated] through the aggregated budget of Ukraine, - c. marginal amount of state debt and marginal amount of state guarantees, - d. amount of minimum salary, - e. subsistence minimum and level of its coverage, - f. marginal amount of state debt and marginal amount of general amount state capital investments to develop and implement government investment projects indicating the priority areas for such capital investments; - (c) priority task for the tax policy; - (d) Information on consolidated general government sector perspective and on the interaction of government budget with local budgets; - (e) a summary assessment of fiscal risks and their impact on the government budget; - (f) general indicators of revenues, finance, expenditures and loans of the government budget for each year of the mid-term period; - (g) indicators per key types revenues to the government budget for each year of the mid-term period; - (h) indicators per key types of finding of the government budget for each year of the mid-term period; - (i) the aggregate expenditure ceilings and lending, the ceilings of expenditures and lending of key spending units, the detailed criteria used for their determination and for any possible change of such ceilings; - (j) strategic goals and performance indicators of the key spending units achieved during the previous year, expected during the year previous to the planned one, and planned during the mid-term period; - (k) other issues as may be determined by a resolution of the Cabinet of Minister of Ukraine, including those necessary to develop the draft law on the Government budget of Ukraine. ### Explanatory note accompanying the Budget Declaration - The Explanatory note is submitted together with the Budget declaration approved by the Cabinet of ministers of Ukraine, and it includes the following: - (a) information on considerations over the Budget Declaration approved during the previous year; - (b) projected indicators of the aggregated budget of Ukraine for the mid-term period (including the government budget and local budgets); - (c) information on other issues necessary to develop the draft law on the Government budget of Ukraine. ### Drafting comments on Budget Declaration provisions - The proposed amendment revise the authorities’ proposal by aligning the timeframe and contents of the Budget Declaration to previous TA advice (see in particular TA Report “Medium-term Budget Framework and Fiscal Risk Statement,” June 2017). - They do not focus on the interaction between the approval process of the Budget Declaration and the annual budget law, which is regulated in different provisions of the Budget Code. - With respect to the prescribed contents of the Budget Declaration, while they generally draw from the text of the authorities’ proposal the proposed amendments focus on certain key provisions, such as those regarding the criteria for the determination of the ceilings. - In reviewing the authorities’ proposal, a number of further aspects would warrant clarification, such as the deletion of a provision on the judiciary and the reference to the concept of “strategic government document” mentioned under Section (1) of this article. - Lastly, it is important to have a clear and consistent definition, throughout the Budget Code, of “key spending unit” (sometimes referred in the translation also as “key government budget owners”). ### Article 33–1 (Expenditure Ceilings) - The aggregate expenditure ceilings and lending and the ceilings of expenditures and lending of key spending units approved in the Budget Declaration may be revised only in case of deviation from key macro indicators for economic and social development of Ukraine from the forecast which was considered at the time the Budget Declaration has been approved. - In addition to the circumstances set out under paragraph (1) above, the ceilings of expenditures and lending of key spending units approved in the Budget Declaration may be revised in case of (i) transfer of responsibilities to execute tasks and functions from one key spending unit to another; (ii) allocation of expenditures which were not allocated between the key spending units at the time the Budget Declaration was approved. - Drafting comment: the proposed amendments simplify the provisions on expenditure ceilings, in line with the recommendations made in the report. ### Article 33–2 (Mandate of the Minister of Finance over the Monitoring of Fiscal Risks) - Paragraph 1: - In order to mitigate their impact on fiscal outcomes, the Minister of Finance shall be responsible for monitoring fiscal risks, by identifying and analyzing such risks, as well as by preparing, submitting and publishing a fiscal risk statement together with the Budget Declaration and the annual budget law, in accordance with this law. - Paragraph 2: - The Minister of Finance may require any financial statements, data, and other information that the Minister of Finance reasonably deems it is necessary for the fulfilment of its responsibility under paragraph (1) above, from any state government bodies, bodies of local self- governance, bodies of social insurance established by the Law, the National Bank of Ukraine, enterprises, institutions and organizations, provided that information requested from state-owned enterprises shall be limited to financial performance data required for the monitoring of fiscal risks. Such request must be in writing and state the date by which, and the manner in which, the information requested must be provided, and in the case of state-owned enterprises, should be addressed to the relevant supervisory boards with copies to the government body(ies) that that exercise ownership rights over the enterprise. - Paragraph 3: State government bodies, bodies of local self- governance, bodies of social insurance established by the Law, the National Bank of Ukraine, enterprises, institutions and organizations must cooperate with the Minister of Finance on matters concerning the fulfilment by the Minister of Finance of its responsibilities under paragraph (1) above, including by: - a) Submitting to the Minister of Finance the information requested by the Minister of Finance under the terms of paragraph (2) above; - b) In the case of state-owned enterprises, sending the requested data to the shareholding government body at the same time it is sent to the Minister of Finance; - c) Providing to the Minister of Finance, on their own initiative or at the request of the Minister of Finance, explanations, comments, recommendations on any actions that could mitigate the impact of fiscal risks, and on the implementation of any such actions; - d) Holding regular meetings with the Minister of Finance, participate in working groups, commissions and other joint forums on issues related to the monitoring of fiscal risks. - Paragraph 4: - In case of failure to provide information or to cooperate with the Minister of Finance in accordance with paragraphs (2) and (3) above, and without prejudice to the applicability of Articles [..... of the Budget Code / the Administrative Code], the Minister of Finance informs the Cabinet of Minister for appropriate follow-up action. - Paragraph 5: - State government bodies, bodies of local self-governance, bodies of social insurance established by the Law, the National Bank of Ukraine, enterprises, institutions and organizations shall remain responsible, in accordance with their respective powers and scope of activity, for taking any action that may mitigate fiscal risks. - Paragraph 6: - The fiscal risk statement is published on the website of the Minister of Finance, upon its submission with the Budget Declaration and with the draft annual budget law. - Paragraph 7: - The Cabinet of Ministers shall set out, by one or more resolutions: - (a) the methodology for the identification and assessment of fiscal risks, and the timeframe for the exercise by the MoF of its responsibility to monitor different sources of fiscal risks; - (b) the detailed roles and responsibilities of state government bodies, bodies of local self- governance, bodies of social insurance established by the Law, the National Bank of Ukraine, enterprises, institutions and organizations state government bodies, relevant for the information exchange and cooperation with the Minister of Finance under Sections (2) and (3) above. - (c) the detailed contents of the fiscal risk statement. - Drafting comment: - The provision on the MoF mandate, which in the authorities’ proposal is added to the text of Article 32, would fit better elsewhere, as Article 32 sets out the framework for the “Organizational principles of creation of the draft of the Government budget of Ukraine”. - Moreover, the heading of the draft article should not refer to the “Fiscal risk department,” which is an internal division of the MoF, but to the MoF. The fiscal risk mandate lies with the MoF and how the MoF would carry out the fulfilment of its mandate is not a matter to be provided under the law. - Lastly, having the MoF fiscal risk function in a specific, stand-alone article in the Budget Code (rather than mixed with other provisions) would enhance clarity. ### Article 38 (Material Enclosed to the Bill on the Annual State Budget of Ukraine) - In addition to the bill on the annual state budget of Ukraine, the Cabinet of Minister submits: - (xxx) A detailed statement on fiscal risks and their impact on the state budget in the planned budgetary period, as well as on measures that may minimize such risks. - Drafting comment: This provision has been finetuned to distinguish the summary fiscal risk statement prepared for the Budget Declaration from the more detailed statement prepared for the draft annual budget law. A CMU resolution would further detail the contents of both types of fiscal risk statement. ### Transitional provision - Article XX – Transitional Provision: - [A transitional provision may be added here providing for a date after which the Budget Declaration will no longer be approved as a resolution but through a different procedure (e.g. law).] *Source: 1ukrea2019004* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1ukrea2019004.pdf_