## _cr1630

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### Preface and Executive Summary — mission scope and priorities
- Mission dates: July 15-29, 2014.
- Purpose of the mission:
  - (i) review the overall status of public financial management;
  - (ii) provide recommendations on urgent measures in the areas of cash management, expenditure controls, and fiscal oversight of SOEs;
  - (iii) outline a strategy for medium-term PFM reforms;
  - (iv) carry out preliminary analysis for a Fiscal Safeguards Assessment.
- Principal counterpart meetings: MoF, NBU, State Property Fund, State Treasury, Accounting Chamber, Kiev City State Administration, Naftogas, State Financial Inspection, World Bank, European Commission.
- Context: compiled against a backdrop of political uncertainty and heightened security concerns.
- Focus: immediate PFM reforms to alleviate short-term budget pressures and medium-term reforms to address long-standing PFM weaknesses.
- Determinants of reform: the authorities’ IMF supported economic program and the EU-Ukraine Association Agreement, which proscribe an expenditure based fiscal consolidation program and a medium-term budget planning process.

### Budget planning and MTBF — findings, preconditions, and sequencing
- Key findings:
  - FAD’s previous recommendations on developing a medium-term budget framework (MTBF) have not been implemented to date.
  - The current MTBF approach fragments the budget process, undermines the top-down framework, and increases the possibility of political interference in macro forecasting.
  - Forecasting error for revenue, expenditure, fiscal balance, and GDP remains significant and was adversely affected by the ongoing economic and financial crisis.
- Preconditions for a successful MTBF (four main preconditions):
  - (i) a credible and predictable annual budget;
  - (ii) accurate medium-term macroeconomic projections;
  - (iii) established fiscal objectives and rules;
  - (iv) a comprehensive, unified, top-down budget process.
- Short-run required actions:
  - Fully align annual budget projections (including for 2014 and 2015) with fiscal projections under the IMF-supported program.
  - Approve with the 2015 MTFF binding expenditure ceilings covering all expenditures for 2015 and indicative expenditure ceilings for 2016 and 2017.
- Medium-term required actions:
  - Ensure independent oversight of the fiscal forecasting process.
  - Consider introducing fiscal rules through the Budget Code and enforce them following the expiration of the IMF-supported program.
- MTFF and Fiscal Strategy Document:
  - MTFF defined as a rolling plan for multi-year limits/targets for debt, financing, primary balance, revenues, and expenditures.
  - Recommendation: replace Budget Policy Guidelines with a Fiscal Strategy Document that includes (i) an MTFF and (ii) aggregate expenditure ceilings for KSUs.
- Implementation sequencing:
  - Adopt MTFF and expenditure ceilings for 2015-17 in context of 2015 budget preparation.
  - Update MTFF in early 2015 and release expenditure ceilings for line ministries to guide 2016-18 submissions.
  - Integrate MTBF development into the budget calendar starting with the 2017 budget and aim for a full MTBF by the 2018 budget.

### Budget planning — explicit short-term recommendations (0–6 months)
- Recommendation 2.1:
  - Adopt a government resolution on preparing budget projections for 2015, including: (i) an MTFF for 2015-17; and (ii) expenditure ceilings for KSUs (binding for 2015, and indicative for 2016 and 2017).
- Recommendation 2.2:
  - Issue new budget instructions to KSUs to identify in their budget submissions the impact of changes in current policies, as defined in the supplementary budget, on future years and the cost-efficiency gains of new policies.
- Recommendation 2.3:
  - Ensure the work on 2015–17 budget projections is closely coordinated with the comprehensive plan for structural reforms and rationalization of expenditure in key sectors planned to be prepared by end-September.
- Recommendation 2.4:
  - Amend the existing PFM action plan to center budget preparation reforms on introducing an MTBF.
- Operational steps:
  - Abolish the early-July instruction to line ministries and other spending units because it does not reflect the updated macrofiscal framework nor supplementary budget measures.
  - MoF should issue a new budget instruction aligned with the updated fiscal framework and supplementary budget measures.
  - MoF should enforce that budget submissions are strictly within released ceilings to prevent accumulation of expenditure arrears.

### Cash management strategy — government banking arrangements and sweeping
- Key findings:
  - TSA structure in the NBU is comprehensive covering all of general government and the social funds and is tightly controlled by the STU in accordance with the BCU.
  - Sweeping arrangements consolidate the vast majority of sub-accounts into a consolidated account, but sweeping is not carried out for all entities.
  - STU’s chart of accounts includes an NBU account (Account 1122) that contained balances of just under UAH 16 billion (US$ 1.3 billion) as at June 10, 2014; purpose unclear and may indicate STU accounts outside the TSA.
- Social and pension fund balances:
  - Unified social fund balances not swept into consolidated TSA and held idle; as at June 1, 2014 the balances was UAH 6.6 billion or US$ 553 million.
  - Government not legally entitled to borrow these funds for liquidity purposes; suggested option: formal lending contracts with safeguards.
- Commercial bank accounts and foreign currency balances:
  - Average central government deposits in commercial banks: around UAH 4 billion (US$341 million) between June 2013–May 2014.
  - Foreign currency accounts in commercial banks: UAH 1 billion (US 85 million) as at April 1, 2014.
  - Commercial bank balances: UAH 3.6 billion (US$ 306 million) as at end March 2014.
  - STU account 1222: UAH 1.4 billion (US$ 123 million) as at June 10, 2014.
  - STU account 1224 balances: UAH 527 billion (US$62) million as at June 10, 2014.
- Foreign currency accounts in the NBU:
  - As at end June 2014 foreign currency deposits were sufficient to finance two month’s worth of foreign currency debt redemptions.
  - These funds earn no interest in the NBU while cash rationing takes place; suggested approach: review ring-fencing and consider converting FX receipts to UAH for TSA use subject to strengthened cash forecasting.
- Local government financing:
  - Medium-term loans outstanding to LGs: approximately UAH 9.5 billion (US$ 810 million or 0.6 Percent of GDP) outstanding as at mid-2014.
  - LGs’ own revenues deposited in TSA but STU frequently unable to reimburse LGs when they seek to use OR to pay obligations; impacts LG revenue incentives and budget execution.
- Recommendation short term (1–6 months):
  - Recommendation 3.1: STU to survey central government agencies for commercial bank accounts and rationalize.
  - Recommendation 3.2: Eliminate foreign currency accounts of spending units in commercial banks; STU to purchase FX on behalf of spending units and credit UAH equivalents to TSA accounts.
- Recommendation medium term (6 months to 2 years):
  - Recommendation 3.3: Put in place formal arrangements to borrow balances of the Social Security Funds in the TSA once cash planning capacity is strengthened.
  - Recommendation 3.4: Review large FX balances in NBU and consider automatic conversion to UAH for TSA use once adequate cash forecasting exists.
  - Recommendation 3.5: MoF to assess impact of lack of liquidity on LGs’ ability to provide legally mandated services.

### Cash planning — forecasts, capacity, and institutional placement
- Findings on current practice:
  - STU produces a weekly forecast of cash balances for the following month.
  - Monthly financial plans of line ministries produced at beginning of year but not updated; no unit responsible for longer-term forecasts.
- Recommended forecast horizon:
  - Forecast period should extend for at least six months, ideally at least twelve months.
  - Some governments project daily flows for one year ahead.
- Capacity and design elements:
  - Create a database of actual daily cash flows, set up information flows from revenue and spending units, and identify key departments accounting for majority of spending.
  - Practical approach: start with rough monthly projections, progress to weekly then daily forecasts.
  - Capacity needs: a cash management team of at least six full-time staff to perform cash planning and active cash management effectively.
- Institutional location:
  - STU could be mandated to produce longer-dated forecasts but may lack information networks.
  - Recommendation 3.6: Establish a cash planning unit in the MoF or the STU to produce detailed cash plans for key stakeholders.
  - Recommendation 3.7: Reduce volatility of TSA balances through alignment of dates for major receipts and expenditures (medium term).
- Integration with debt management:
  - Finding: Debt management operations are not coordinated with cash needs; borrowing plan focuses on redemption schedule rather than funding needs.
  - Recommendation 3.8: Integrate cash and debt management by making the Debt and International Financial Policy Department responsible for managing balances on the TSA (medium term).

### Budget execution, commitment controls, and arrears — problems and remedies
- Key weaknesses:
  - Practices releasing cash in the absence of an appropriation (TSA loans) and allowing KSUs to borrow for capital expenditures in excess of appropriations breach PFM principles and should be discontinued.
  - Accumulation of payment arrears indicates weaknesses in budget execution and control processes.
  - Current allotment process ineffective at restraining the rate of expenditure obligations; protected/unprotected distinction contributes to cash rationing and rigidity.
- Arrears statistics:
  - As at June 2014, arrears totaled 4,180.8 million UAH (0.3 percent of GDP) recorded in STU system (Table 7).
  - Total arrears, including unpaid VAT refunds, is 7.8Bn UAH.
  - Table 7 breakdown (mln. UAH):
    - State Budget 1,715.7
      - General fund 378.1
      - Special fund 1,337.6
    - Local budgets 2,430.9
      - General fund 941.7
      - Special fund 1,489.2
    - Social Welfare Funds 34.2
      - Employment fund 31.7
      - Industrial accident and occupational disease social insurance fund 2.1
      - Temporary disability social insurance fund 0.4
    - Total Payment Arrears 4,180.8
- Commitment control rationale and benefits:
  - Commitments should be recorded at the stage just prior to procurement to prevent incurrence of obligations beyond allocations.
  - Benefits: improves budget execution control, helps avoid arrears, assists cash forecasting, and allows managing incurrence rate of liabilities.
- Recommendations:
  - Short term: Recommendation 4.1: STU to introduce commitment controls to budget execution framework for 2015 requiring commitments be recorded when procurement commences.
  - Short term: Recommendation 4.2: MoF to consider developing an arrears clearance strategy consistent with IMF TNM 14/03 if arrears cannot be cleared from existing appropriations.
  - Medium term: Recommendation 4.5: Provide managers greater flexibility by controlling budgets by program and summary level economic classification (Schedule 3 approach).
  - Medium term: Roll out internal audit functions across budget entities and make managers accountable for internal control results; Recommendation 4.8: continue internal audit roll-out aiming for functioning IA in all national and oblast level spending units by end of 2015.
  - Medium term: Recommendation 4.9: Introduce certification regime granting greater flexibility once unqualified external audit of AFS is achieved by an agency.

### Protected vs unprotected items and control regime
- Finding: The distinction between protected and unprotected items is not appropriate in the medium term.
- Rationale:
  - Once fiscal stability and modern cash management/commitment controls are in place, cash rationing can be avoided.
  - Deliberate non-payment of “unprotected” items undermines PFM, harms private suppliers, inflates procurement costs, and encourages entities to seek separate STU operations.
- Recommendation (medium term):
  - Eliminate the distinction between protected and unprotected items from the 2016 budget onwards and commit to making all payments included in the budget within 30 days of being due. (Recommendation 4.3)

### Treasury operations, IFMIS, and reporting
- STU and IT context:
  - STU operates E-KAZNA; major revenue and spending agencies have separate accounting software (around 40 different systems in key spending agencies).
  - IFMIS procurement under Public Finance Modernization Project (PFMP) has faced delays; inability to acquire functioning IFMIS is a substantial barrier to PFM reform.
- Desired IFMIS features: online transactions, automatic reconciliation, internal control support, general ledger supporting accounting and reporting, interfaces with other systems, robust security/audit.
- Recommendation (medium term):
  - Recommendation 4.4: In cooperation with development partners, produce a strategy for expanding functionality of systems available to STU to support internal control, accounting, and reporting.
- Reporting and timeliness:
  - STU produces monthly, quarterly, and annual budget execution reports; timelines: monthly within 15 days, quarterly within 35 days, annual by April 1.
  - No distinction currently between annual budget execution reporting and financial reporting.
- Accounting basis and transition to accrual:
  - STU uses cash basis; budgetary institutions use modified cash basis; social funds and SOEs use accrual.
  - Government ambition: transition to accrual accounting with 19 new public sector accounting standards based on IPSAS accrual standards and COM resolution for adoption from January 1, 2015; report states full adoption in 2015 is unrealistic.
- Systems options and sequencing:
  - Two options: deploy common accounting package across agencies with data warehouse, or introduce IFMIS supporting STU and agencies on a common platform (preferred).
  - Sequencing (Box 2 — illustrative):
    - Stage one (Years 1–3): general ledger, purchasing and commitment management, payments/accounts payable, revenue/receipts/accounts receivable, banking and cash management, fund management, data collection and consolidation, financial reporting.
    - Stage two (Years 3–4): investment management, debt management (if applicable).
    - Stage three (Years 3–10): fixed asset management, inventory management.
- Recommendations and timelines:
  - Short-term (0-6 months): Recommendation 5.1: STU to develop an implementation plan for accrual accounting standards to be introduced from 2015.
  - Medium term (6 months to 2 years): Recommendation 5.2: STU to include Public Non-Financial Corporations sector (SOEs) in AFS separately from 2016 and consolidated from 2018; develop reporting format and chart of accounts in 2015.
  - Long term (2 years plus): Recommendation 5.3: Consolidated reporting on a whole-of-government (GFS Public Sector) basis including central government, SOE sector, off-budgetary agencies and sub-national governments.

### State assets portfolio — size, fiscal impact, and governance challenges
- Portfolio scope:
  - Almost 20 thousand entities: more than 5,600 owned at central government level and more than 13,800 at sub-national level.
  - Two large state-owned banks: State Export-Import Bank of Ukraine (Ukreximbank) and State Oschadnyi Bank (Savings Bank).
- Valuation proxies:
  - Financial and non-financial assets together represent some 60 percent of GDP or USD 72 billion.
  - Financial assets: some 18 percent of GDP or USD 22 billion.
  - Nonfinancial assets: some 42 percent of GDP or USD 50 billion.
- Fiscal impact and contingent liabilities:
  - Net cost to the state in 2013 amounted to 1.8 percent of GDP.
  - Contribution from state assets to the budget through dividends was around 0.2 percent of GDP.
  - Fiscal support through transfers of budgetary resources amounted to 2 percent of GDP.
  - Issuance of public guarantees for state enterprise debt amounted to 8.4 percent of GDP, as of May 2014, of which around 77 percent are foreign exchange denominated.
- Naftogaz and energy sector:
  - Energy subsidies amounted to more than 7.5 percent of GDP in 2012.
  - Naftogaz arrears to Gazprom by end-March 2014: about USD 2.2 billion, or 1.5 percent of GDP.
  - Naftogaz related subsidies to households through underpriced gas and heating almost 5 percent of GDP per annum.
  - Naftogaz financial statements latest audited available from 2011.
- Governance challenges:
  - Ownership and management framework is decentralized, fragmented, legally complex and often contradictory.
  - Unitary enterprises lack corporate governance structures and legal title to assets, impeding privatization and efficient management.
  - SPF lacks capacity and mandate to implement a coherent portfolio strategy and professional sales processes.

### State assets — reform priorities, sequencing, and transparency
- Three main reform pillars:
  - Strengthen Legal Structure: reduce overlapping structures, align laws (Commercial Code, State Property Law, BCU), delegate clear ownership responsibility.
  - Ownership Management: move from decentralized to consolidated ownership model; short-term create MoF unit to manage consolidated fiscal risk; medium-term merge SPF and MoF SOE unit; long-term consider independent ring-fenced holding company.
  - Transparency Policies: publish consolidated annual reports, create single database including real estate, audit consolidated reports by internationally recognized firms.
- Short-term recommendations (1–6 months):
  - Recommendation 6.1: Establish MoF unit to manage consolidated fiscal risk related to state assets.
  - Recommendation 6.2: Separate commercial and non-market based assets and transparently report subsidies and policy interventions.
  - Recommendation 6.3: Issue government decree identifying value maximization as sole objective for commercial assets.
  - Recommendation 6.4: Carry out stock-take of consolidated portfolio including value, yield and risk; establish single comprehensive database including real estate.
  - Recommendation 6.5: Publish an annual review of state assets in English on the government web site.
- Medium-term recommendations (6 months to 2 years):
  - Recommendation 6.6: Appoint government review group to conduct legal review to streamline legal structure and unify under value maximization objective.
  - Recommendation 6.7: Consolidate ownership function within MoF as intermediate measure and study route for independent arms-length ownership vehicle.
- Transparency and reporting standards:
  - Reporting policies should be analogous to a publicly listed vehicle: publish annual consolidated reports and quarterly portfolio reviews, require large state assets to publish audited annual reports in Ukrainian and English.
  - Apply reporting requirements to state-owned companies with annual turnover in excess of UAH 50 million.
  - Stock take and periodic external valuations for real estate recommended.

### Legal and Budget Code changes to support PFM reforms — high-level inventory
- Suggested changes to BCU and related regulations include:
  - Article 2: New definitions such as MTBF.
  - Article 21: Strengthen MTBF provisions to require aggregate and sectoral expenditure ceilings.
  - Article 33-38: Amend budget calendar to align MTBF and annual budget.
  - Article 43, 46, 47: Strengthen commitment control and virement provisions; require commitments be verified against appropriations prior to contractual obligations.
  - Article 55: Abolish protected and unprotected expenditure categories.
  - Articles 26, 113-118 and Chapter 10: Strengthen internal financial control, reporting (AFS), and accrual accounting guidance.
  - New provisions: fiscal responsibility and potential fiscal council, fiscal rules insertion.
- Organizational implications:
  - MoF responsibilities may be broadened to include greater oversight of SOEs and creation of a cash planning unit in the Debt and International Financial Policy Department to manage the end-of-day TSA balance.

*Source: IMF Technical Assistance mission report: Preface and Executive Summary; IMF staff report excerpts contained in content unit _cr1630.*

### Preface ................................................................................................................

### _cr1630 - Preface

### Preface: mission scope and participants
- Mission dates: July 15-29, 2014.
- Purpose of the mission:
  - (i) review the overall status of public financial management;
  - (ii) provide recommendations on urgent measures in the areas of cash management, expenditure controls, and fiscal oversight of SOEs;
  - (iii) outline a strategy for medium-term PFM reforms;
  - (iv) carry out preliminary analysis for a Fiscal Safeguards Assessment.
- Principal counterpart meetings:
  - Mr. Lisovenko (Deputy Minister of Finance) and senior staff in the Ministry of Finance;
  - Mr. Udovychenko, Deputy Governor of the National Bank of Ukraine;
  - Mr. Dniprov, Deputy Minister of Education and Science;
  - Mr. Myroniuk, Deputy Head of the State Property Fund;
  - Ms. Shamrai, Head of Consolidated Accounts in the State Treasury;
  - Mr. Pylypenko, General Comptroller of the Accounting Chamber of Ukraine and their officials;
  - Mr. Kramarenko, Deputy Head of the Kiev City State Administration and his officials;
  - Mr. Konovets, Deputy Chairman of the Board of Naftogas;
  - Representatives of the State Financial Inspection;
  - Representatives of the World Bank and the European Commission.
- Acknowledgements: IMF office staff support and interpretation/translation by Mr. Shpak, Ms. Mendelenko, Ms. Rubashova, and Ms. Shulga.

### Executive Summary — context and overall focus
- Context: compiled against a backdrop of political uncertainty and heightened security concerns.
- Focus: immediate PFM reforms to alleviate short-term budget pressures and medium-term reforms to address long-standing PFM weaknesses.
- Determinants of reform: the authorities’ IMF supported economic program and the EU-Ukraine Association Agreement, which proscribe an expenditure based fiscal consolidation program and a medium-term budget planning process.

### Budget planning — findings and recommendations
- Key findings:
  - FAD’s previous recommendations on developing a medium-term budget framework (MTBF) have not been implemented to date.
  - Full implementation of MTBF may not be immediately possible; specific measures are needed to introduce realism and a medium-term outlook to support consolidation and prevent arrears.
- Recommended actions:
  - Introduce medium-term expenditure ceilings on Key Spending Units (KSU), binding for the first year and indicative for the following two, together with the introduction of forward budget estimates.
  - Budget projections should reflect measures proposed under the IMF supported program and spending units should take these into account when preparing budget proposals.
  - Prioritization of performance budgeting reforms should not be pursued in the short-term given resource constraints.
  - Over the medium-term the legal framework should be revised to integrate the MTBF with the budget process.

### Developing a cash management strategy — findings and recommendations
- Key findings:
  - Government banking arrangements including a Treasury Single Account (TSA) largely meet international good practice but can be improved for efficiency.
  - All cash balances of general government including the social funds and balances held in foreign exchange accounts in the National Bank of Ukraine (NBU) and commercial banks should be made available for liquidity management, subject to safeguards ensuring access when entities need resources.
  - Foreign exchange and Hyrvina bank accounts in commercial banks should be reviewed with a view to closure; balances in foreign exchange accounts in the NBU should be used for liquidity management purposes.
  - Existing cash planning is extremely short-term and not conducive to efficient liquidity management.
- Recommended institutional measures:
  - Establish a cash planning unit in the Ministry of Finance supported by a high level cash management committee to ensure timely information flows from stakeholders.
  - To reduce volatility of cash balances and better integrate cash and debt management, the Debt and International Financial Policy Department should be given responsibility for managing the end-of-day balances on the TSA.

### Budget execution and internal control — findings and recommendations
- Key findings:
  - Practices releasing cash in the absence of an appropriation through issuance of loans from the TSA and allowing KSUs to borrow to fund capital expenditures in excess of budget appropriations breach fundamental PFM principles and should be discontinued.
  - Accumulation of substantial payment arrears indicates weaknesses in budget execution and control processes.
  - Existing expenditure controls are rigid, making it difficult for program managers to manage threats to service delivery.
  - A comprehensive ex-ante and ex-post control framework exists; expansion of ex-ante control by bodies such as the Accounting Chamber risks role conflict and should be resisted.
- Recommended actions:
  - Introduce commitment controls earlier in the expenditure cycle to prevent arrears and support cash management.
  - Offer KSUs greater flexibility to transfer their budget within certain economic categories.
  - Abolish protected and unprotected expenditures as part of introducing greater realism in budget planning.
  - Roll out internal audit functions across all budget entities and place responsibility for internal control processes with managers in their ministries.
  - Grant greater budget flexibility and more relaxed external controls to KSUs once adequate control processes are demonstrated (medium term).

### Accounting and fiscal reporting — findings and recommendations
- Key findings:
  - Extensive cash-based reports on budget execution are produced and published.
  - The government’s ambition to transition to an accrual based system by the beginning of 2015 will be hampered by weaknesses in current systems, the existing focus on cash-based reporting, and lack of accountancy capacity.
  - Existing IT systems are inadequate to support accrual accounting implementation.
  - State-Owned Enterprises and other public entities outside general government are major sources of fiscal risk; existing reporting structures do not adequately capture their activities.
- Recommended approach:
  - Prepare a realistic implementation plan for transition to accrual accounting.
  - Acquire IT systems to support accrual implementation.
  - Expand fiscal reporting coverage to the wider public sector through a phased approach to achieve consolidated reporting.

### Management and oversight of state assets — findings and recommendations
- Key findings:
  - The portfolio of state assets is a source of significant value and fiscal risk.
  - State ownership brings conflicting objectives: maximize portfolio value, regulate industries, implement social policy.
  - The ownership and management framework is decentralized, fragmented, and legally complex and often contradictory, hampering transparency and privatization efforts.
- Priority reform areas:
  - Legal framework reform.
  - Ownership structure reform.
  - Transparency policies to disclose size and value of the portfolio.
- Recommended sequencing and institutional measures:
  - Short-term emphasis: establish institutional structures to identify the consolidated portfolio size, fiscal risks, and implement a transparency policy.
  - Establish a unit in the Ministry of Finance to: determine and manage risks associated with the portfolio; oversee all financial flows; and establish the portfolio’s value.
  - Publish an annual report on the portfolio of state assets including potential values.
  - Medium-term: review the legal framework and consider consolidating responsibility for active ownership, financial control, and privatizations within a single arms-length entity.

### Selected entries from Table 1. Ukraine: Summary of Recommendation and Action Plan (excerpt)
- Budget Planning
  - Rec 2.1: 2015 Budget projections to include MTFF and expenditure ceiling for KSUs — Responsibility: MoF.
  - Rec 2.2: Issue new budget instructions to KSUs — Responsibility: MoF.
  - Rec 2.3: Coordinate budget projections with structural reform and rationalization plans — Responsibility: MoF and KSUs; TA needs: FAD STX.
  - Rec 2.4: PFM action plan to center budget preparation reforms on developing MTBF — Responsibility: MoF and donors.
  - Rec 2.5: Revise the Budget Code to provide a legal backing for the MTBF reform — Responsibility: MoF, COM, VR; TA needs: FAD STX.
- Cash Management Strategy
  - Rec 3.1: Survey central government commercial bank accounts and rationalize — Responsibility: STU.
  - Rec 3.2: Eliminate foreign currency accounts of spending units in the commercial banks — Responsibility: STU and MoF; TA needs: FAD STX.
  - Rec 3.3: Put in place formal arrangements to borrow balances of Social Security Funds — Responsibility: STU, MoF, SSF; TA needs: FAD STX.
  - Rec 3.4: Review foreign currency accounts in the NBU with a view to rationalization — Responsibility: MoF; TA needs: FAD STX.
  - Rec 3.5: Identify impact of lack of liquidity on LGs ability provide legally mandated services — Responsibility: MoF, STU.
  - Rec 3.6: Establish a cash planning unit in the Ministry of Finance or STU — Responsibility: MoF, STU; TA needs: FAD STX.
  - Rec 3.7: Reduce volatility of TSA through alignment of major receipts and expenditures — Responsibility: MoF Budget Dept.
  - Rec 3.8: Debt Department responsible for managing the balance on the TSA — Responsibility: MoF, STU; TA needs: FAD STX and HQ.

*Source: IMF Technical Assistance mission report: Preface and Executive Summary.*

### 4.1 Introduce commitment controls to the budget execution framework for 2015    STU FAD STX

### 4.1 Introduce commitment controls to the budget execution framework for 2015    STU FAD STX

### Context and immediate fiscal concerns
- Political uncertainty and heightened security concerns in the eastern part of the country affect PFM reform priorities.
- Immediate areas of concern identified:
  - Cash Management: Government cash balances in the Treasury Single Account are precarious; a cash management strategy is needed to ensure continued provision of essential services and availability of cash to meet ongoing obligations.
  - Expenditure Controls: Expenditure controls need strengthening to guard against further accumulation of payment arrears as fiscal consolidation pressures budgets.
  - Fiscal Reporting: Reporting capacity needs strengthening to improve timeliness, accuracy, and coverage so fiscal reports provide a complete overview of government operations and better oversight of the wider public sector, especially SOEs.
- Many problems in budget execution and cash management stem from lack of realism in the budget planning process.
- Fragmented ownership, management, and monitoring of state assets contribute to lack of transparency about fiscal risks and the value of the state asset portfolio.

### Key analytical findings relevant to commitment controls and budget execution
- The supplementary budget for 2014 focuses on cutting spending (freezing wages and pensions; limiting new hiring; cutting goods and services, transfers to SOEs, and investment projects), targeting social assistance to the most vulnerable, and providing additional defense funds. It is important the supplementary budget is adopted as a priority and followed by MoF resolutions and detailed instructions to key spending units (KSUs) to ensure implementation and to prevent accumulation of arrears.
- Expenditure ceilings for KSUs should:
  - cover all primary expenditure;
  - be an integral part of the macro-fiscal framework; and
  - be binding for 2015 and indicative for 2016 and 2017.
- MoF must ensure expenditure ceilings are effectively enforced; budget submissions of spending units should be made strictly within released ceilings and the practice of avoiding ceilings (including via unfunded addenda) should be eliminated.
- Discussions between MoF and KSUs for 2015 should focus on reforms to underpin achievement of medium-term expenditure ceilings rather than annual bargaining for additional resources.
- The forward estimates in budget submissions should identify the impact of changes in current policies (as defined in the supplementary budget) on future years and the cost-efficiency gains of new policies.
- Given current pressures, prioritizing a full program and performance budgeting (PPB) rollout may not be prudent; instead, focusing on a medium-term budget framework (MTBF) is recommended as a key instrument to support expenditure-based fiscal consolidation.

### Short-term (0-6 months) recommendations relevant to budget execution and commitment controls
- Recommendation 2.1:
  - Adopt a government resolution on preparing budget projections for 2015, including: (i) an MTFF for 2015-17; and (ii) expenditure ceilings for KSUs (binding for 2015, and indicative for 2016 and 2017).
- Recommendation 2.2:
  - Issue new budget instructions to KSUs to identify in their budget submissions the impact of changes in current policies, as defined in the supplementary budget, on future years and the cost-efficiency gains of new policies.
- Recommendation 2.3:
  - Ensure the work on 2015–17 budget projections is closely coordinated with the comprehensive plan for structural reforms and rationalization of expenditure in key sectors planned to be prepared by end-September.
- Recommendation 2.4:
  - Amend the existing PFM action plan to center budget preparation reforms on introducing an MTBF.
- Operational steps:
  - Abolish the early-July instruction to line ministries and other spending units because it does not reflect the recently updated macroeconomic and macrofiscal framework nor the impact of expenditure measures in the 2014 draft supplementary budget.
  - MoF should issue a new budget instruction aligned with the updated fiscal framework and supplementary budget measures.
  - MoF should enforce that budget submissions are strictly within released ceilings to prevent accumulation of expenditure arrears.

### Institutional and procedural points affecting implementation
- Article 21 of the Budget Code of Ukraine (BCU) requires medium-term budget forecasts for the two budget periods following the planned one and designates MoF, MoEDT, and the NBU as main actors.
- Medium-term budget projections have not been approved by government since 2012, allegedly due to lack of an agreed medium-term macroeconomic framework, despite KSUs preparing three-year submissions for formality.
- According to Article 21, projections for the outer two years should be approved by government after parliamentary approval of the annual budget law; historical practice showed government resolution on budget projections for 2013 and 2014 were approved subsequent to approval of the Law on the State Budget for 2012.
- Some previously recommended technical measures remain unimplemented (as summarized in Table 2), and full implementation may not be feasible short-term given economic, political, and security conditions.

### Sector example illustrating reform priorities (Education)
- The education sector is overstaffed and oversupplied with buildings despite a declining student population. Potential reform options to achieve cost-efficiency gains include:
  - increasing the teaching load of public school teachers;
  - aligning class and school sizes with average European levels;
  - reducing excessive staffing on the basis of performance reviews; and
  - means-testing of free services provided to students while protecting vulnerable groups.

*Source: IMF staff report excerpt (sections I–II, and summary action list) contained in the supplied PDF content.*

### 20.      There are significant problems with the existing approach to preparing the MTBF.

### _cr1630 - 20.      There are significant problems with the existing approach to preparing the MTBF.

### Key problems with the existing MTBF approach
- The current approach fragments the budget process and undermines the credibility of both the annual budget and medium-term budget projections.
- It undermines the top-down process in which projections set the framework for budget decisions.
- It increases the possibility of political interference in the macro forecasting process.
- These factors help explain significant forecasting errors in the macroeconomic and fiscal projections for 2012-13, which led to significant deviation between the planned and actual fiscal balance (illustrated in Figure 1, covering 2009–2013).

### Preconditions for a successful MTBF
- Four main preconditions are identified:
  - (i) a credible and predictable annual budget;
  - (ii) accurate medium-term macroeconomic projections;
  - (iii) established fiscal objectives and rules;
  - (iv) a comprehensive, unified, top-down budget process.
- Current status (as indicated in Table 3):
  - Forecasting error for revenue, expenditure, and the fiscal balance remains significant and was further adversely affected by the ongoing economic and financial crisis.
  - Forecasting error for GDP remains significant, was further adversely affected by the ongoing economic and financial crisis, and is not insulated from political interference.
  - A debt rule setting a debt-to-GDP ratio of 60 percent is included in the existing Budget Code, and specific fiscal targets are defined in the annual budget guidelines, but they are not effectively used as an anchor of fiscal policies in the mid-term.
  - MoF releases expenditure ceilings limited in coverage only to current expenditure and they are not binding.
- Short-run required actions (from Table 3):
  - Fully align the annual budget projections, including for 2014 and 2015, with the fiscal projections under the IMF-supported program.
  - Fully align the existing macro projections with the macroeconomic framework agreed under the IMF-supported program.
  - Define fiscal objectives and targets in line with the IMF-supported program.
  - Approve with the 2015 MTFF binding expenditure ceilings covering all expenditures for 2015 and indicative expenditure ceilings for 2016 and 2017.
- Mid-term required actions (from Table 3):
  - Ensure independent oversight of the fiscal forecasting process.
  - Consider introducing fiscal rules through the Budget Code and enforce them following the expiration of the IMF-supported program. Technical assistance to design the rules may be required.
  - In the mid-term: ensure independent oversight of the fiscal forecasting process.

### Role of the IMF-supported program
- The IMF-supported program provides a framework to meet preconditions in the short run:
  - Includes macroeconomic and fiscal projections subject to regular reviews; these should be fully incorporated in internal forecasting processes.
  - Provides fiscal objectives and targets to anchor fiscal policies, and to introduce binding expenditure ceilings with the 2015 budget.
  - Specific actions include adoption of a supplementary budget for 2015, and adoption of a new government resolution and new budget instruction of the MoF on the preparation of the 2015 budget.

### Insulating macro forecasting from political interference
- Options to explore:
  - (i) establishing a fiscal council following relevant experiences in the EU member countries (not necessarily appropriate at the moment but could be considered in the future);
  - (ii) publishing the model used to make forecasts (possibly in the context of the preparation and approval of the Fiscal Strategy Document) to allow other stakeholders (banks, think tanks etc.) to review methodologies;
  - (iii) publishing comparisons of government forecasts to those of other independent forecasts (IMF, EC).

### Medium-term fiscal framework (MTFF) as foundation for MTBF
- MTFF definition: a rolling plan that establishes integrated multi-year policy-based limits or targets for key fiscal aggregates—debt, financing, primary balance, revenues, and expenditures—consistent with and supportive of the overall macroeconomic framework.
- The Budget Policy Guidelines (usually issued in April) do not include an MTFF; they focus on the upcoming fiscal year and provide only key macroeconomic assumptions and broad fiscal targets.
- Recommendation: replace Budget Policy Guidelines with a Fiscal Strategy Document that includes:
  - (i) an MTFF;
  - (ii) aggregate expenditure ceilings for KSUs.
- A first Fiscal Strategy Document could be prepared in the context of the recommended government resolution on the 2015 budget. Government should also approve expenditure ceilings by KSUs.

### Possible contents and information status for a Fiscal Strategy Document (summary of Table 4)
- A. Macroeconomic Section
  - Brief narrative on recent developments and challenges; set out targets and major policies; note track record of achieving objectives or forecast errors — Done partially in the Budget Policy Guidelines; more needed.
  - Table with projections for key indicators in the real, external, monetary sectors — Derive from the MEFP.
  - Note on major forecast risks and sensitivity analysis — Prepare on the base of the MEFP and MoEDT forecasts.
  - Brief write-up of “optimistic” and “pessimistic” scenarios — Use the MEFP and consult IMF-supported program staff.
  - Note on internal consistency of macroeconomic framework — Use the MEFP and consult IMF staff.
- B. Fiscal Section
  - Narrative on recent developments with focus on track record — To be prepared by the Budget Department of the MoF.
  - Statement on fiscal sustainability and a complete set of fiscal targets (including debt and primary balance ratios), and targets for revenue structure, capital investment to GDP, wage bill, and other key fiscal targets — Done only partially in the Budget Policy Guidelines; needs extension beyond the upcoming fiscal year.
  - Tables and write-up on baseline projections — Use the MEFP and consult IMF staff.
  - Note and table on magnitude of gaps with respect to targets — To be prepared by the Budget Department to show gaps for the last three years.
  - Main elements of fiscal strategy and detailed measures — Derive from the MEFP and the draft supplementary budget for 2014.
  - Annotated charts juxtaposing baseline and active scenarios — May be introduced from 2016.
- C. Fiscal Risks
  - Assessment of macroeconomic risks and sensitivity of fiscal forecasts — Derive from the MEFP and MoEDT risk statement.
  - Assessment of specific risks (contingency fund claims; asset and liability management; state guarantees; PPPs) — MoF and MoEDT; done only partially.
  - Assessment of political and security risks — Derive from MoEDT risk statement.
  - Assessment of public enterprise risks — Disclose transfers between government and public corporations; account of State Property Fund and sectoral ministries work.
  - Assessment of fiscal risks associated with local governments — Requires input from MoRD, the Association of Ukrainian Cities, and selected municipalities.
  - Fiscal risks related to pensions or demographic factors — Requires input from the Pension Fund.

### Implementation strategy and sequencing
- MTBF introduction objectives:
  - Strengthen sustainable macro-fiscal development (priority in short term).
  - Promote more effective allocation of resources via a comprehensive budget process.
  - Encourage more efficient use of resources by creating predictable conditions for KSUs and supporting multiyear planning.
- Phased approach recommended:
  - Short term (including 2015 budget): focus predominantly on strengthening macro-level public finance sustainability; ongoing PPB performance management work to be phased in later.
  - Certain MTBF design features (special treatment of expenditure items, budget margins, carryover rules, accountability mechanisms) need further technical work and regulatory support; may take more time (see 2011/2012 FAD reports and Table 5).
- Specific implementation steps (explicit actions listed in paragraph 31):
  - Adopt in the context of preparation of the 2015 budget an MTFF and expenditure ceilings for 2015-17, as an initial step and foundation of the MTBF. The MTFF should be based on the fiscal objectives defined in the MEFP.
  - Update the MTFF in early 2015 in the context of preparation of the Fiscal Strategy Document, and release expenditure ceilings for line ministries to guide budget submissions for 2016-18.
  - Integrate the development of the MTBF in the budget calendar starting with preparation of the 2017 budget.
  - Develop the design features of the MTBF, as recommended in the 2011 and 2012 FAD reports and further discussed in this section, in order to introduce a full-fledged MTBF with the 2018 budget.

### Design features of an MTBF (summary of Table 5)
- Budget Preparation
  - Aggregate expenditure ceiling: Implement an aggregate ceiling for 3 years and make them binding when the fiscal position stabilizes.
  - Expenditure ceilings by KSUs: Implement comprehensive ceilings covering all primary expenditures which are binding for the first year and indicative for the outer two years.
  - Special treatment of expenditure items mitigating uncertainty: Limited budget items for special treatment should be identified and allocation mechanism defined.
- Budget Process
  - Incorporate a strategic budget phase: Start the budget calendar with issuance of a Fiscal Strategy Document and KSU expenditure ceilings in April.
  - Macroeconomic framework: Integrate it with the preparation of the Fiscal Strategy Document.
- Budget Execution
  - Tight and regular controls: Focus on ceilings and shift away from line-items.
  - Regular updates of medium-term expenditure projections: Mid-year update or two times a year.
  - Budget margin: Analyze circumstances during the initial phase to establish rules for size, level of budget, and use of the margin.
  - Carryover rules: Analyze carefully concerning adverse effects.
  - Multiyear expenditure commitments: Establish commitment registration system for non-capital expenditure.
- Reporting and Accountability
  - Reporting on achievement of the ceilings in budget execution: Prepare an annual report on ceilings displaying deviations between multiyear plans and expenditure outcomes.
  - Mechanisms for accountability: Analyze experience in the initial phase and decide on appropriate mechanisms.

### Institutionalization and legal backing
- The MTBF process will need further institutionalization, requiring changes to the Budget Code (BCU) to provide legal backing for the MTBF reform.
- The introduction of an MTBF may also require strengthening the macro-fiscal forecasting capacity of the MoF.
- Recommendation (Medium term (6 months to 2 years)):
  - Recommendation 2.5: Revise the Budget Code to provide a legal backing for the MTBF reform.

### Cash management: overview and government banking arrangements
- Cash management objective: ensure cash is available at the right time to meet government obligations; currently difficult due to limited access to capital markets and disturbances in the East affecting predictability of revenues and expenditures.
- Areas to strengthen: government banking arrangements, cash planning, integration of cash and debt management operations.
- Government banking arrangements status:
  - The Treasury Single Account (TSA) structure in the NBU is comprehensive covering all of general government and the social funds and is tightly controlled by the State Treasury of Ukraine (STU) in accordance with the provisions of the BCU.

*Italic: Source: IMF staff report content unit _cr1630 - 20.      There are significant problems with the existing approach to preparing the MTBF.*

### 37.      The sweeping arrangements for TSA balances work well, although it is unclear as to

### _cr1630 - 37.      The sweeping arrangements for TSA balances work well, although it is unclear as to

### Sweeping arrangements and TSA coverage
- The vast majority of sub-accounts of general government budget entities established in the TSA are swept into a consolidated account so that they can be used in managing the overall liquidity of the general government.
- Sweeping arrangements are not carried out for all entities.
- The STU’s chart of accounts includes an NBU account (Account 1122- Titled “Other STU accounts with NBU”) that contained balances of just under UAH 16 billion (US$ 1.3 billion) as at June 10, 2014; the mission was unable to determine the purpose of this account. It may relate to foreign exchange accounts but the balance does not fully correspond with Treasury data on foreign exchange balances on the same date.
- The presence of this account seems to indicate that the STU has accounts outside the TSA.

### Management of social and pension fund balances
- Some earmarking of balances held on sub-accounts in the TSA is currently practiced, mainly relating to unified social fund balances.
- These unified social fund balances are not swept into the consolidated TSA but contain substantial balances that could be used for government liquidity management purposes, provided strict rules on reallocation and strong cash flow planning are in place.
- As at June 1, 2014 the balances was UAH 6.6 billion or US$ 553 million.
- The mission understands the government is not legally entitled to borrow these funds for liquidity management purposes and therefore their balances tend to lie idle unremunerated in the TSA.
- It is possible that some central government commercial bank deposits identified in the monetary survey may be the result of the social funds seeking to earn a return on their cash balances.
- Suggested option: enter into contracts with the social and pension funds that allow surplus funds to be lent to the STU for cash management purposes in return for an agreed rate of interest; formal rules would be needed requiring the STU to return the funds as required by the social funds, and detailed cash plans by the social funds would be required.

### Commercial bank accounts of central government entities
- Monetary survey evidence indicates some central government deposits are in commercial banks, averaging around UAH 4 billion (US$341 million) between June 2013–May 2014.
- Footnote: Source NBU Monetary Statistics.
- As at April 1, 2014, balances of foreign currency accounts in commercial banks amounted to UAH 1 billion (US 85 million).
- Balances in the commercial banks amounted to UAH 3.6 billion (US$ 306 million) as at the end of March 2014 (Table 6).
- The STU indicated amounts may relate to foreign exchange accounts held by spending units in the commercial banks, as the TSA is a domestic currency system and KSUs need foreign currency accounts for spending operations; this does not fully explain the amounts on deposit.
- The STU’s chart of accounts indicates account number 1222 contained balances of UAH 1.4 billion (US$ 123 million) in cash accounts in the commercial banks as at June 10, 2014.
- Account number 1224 appears to have balances of UAH 527 billion (US$62) million in the commercial banks as at June 10, 2014.
  - Note: A/C 1222 is described as Treasury of Ukraine other account in Banks, while account 1224 is described as accounts of institutions and organizations that are financed from the state budget in the banks. STU number 326 as of August 11, 2008.
- Recommendation: STU should conduct a review of its accounts with a view to consolidating remaining government accounts in the TSA.

### Foreign currency accounts in the NBU
- Current practice of “ring-fencing” foreign currency denominated deposits in the NBU should be reviewed to improve daily liquidity management needs.
- Large foreign currency denominated cash balances in the NBU are earmarked to pay off foreign currency obligations and foreign currency denominated debt repayments.
- As at end June 2014 foreign currency deposits were sufficient to finance two month’s worth of foreign currency debt redemptions.
- These funds earn no interest in the NBU while cash rationing takes place during budget execution.
- Suggested approach: sell foreign exchange to the NBU so the NBU can include them as part of reserves and use part to contribute to government liquidity management.
- Any conversion of foreign exchange balances must be accompanied by significant strengthening of cash forecasting capacity and close communication with the NBU to ensure repurchase capacity when required.

### Local Government accounts in the TSA and LG financing
- Local Government (LG) accounts are for the most part maintained in the TSA; LG own revenues (OR) are deposited in TSA accounts and used by the ST to finance ongoing liquidity needs in the consolidated account.
- The STU is frequently unable to reimburse LGs when they seek to use OR to pay obligations.
- Impacts of lack of availability of LGs OR:
  - (i) limits incentives of LGs to collect OR;
  - (ii) reduces LGs ability to plan and execute budgets based on their own forecasts and contributes to arrears accumulation.
- Better cash planning and commitment control could alleviate this problem.
- LGs have been offered short-term and medium-term loans from the STU; currently approximately UAH 9.5 billion (US$ 810 million or 0.6 Percent of GDP) outstanding as at mid-2014 in medium-term loans.
- Loans are frequently granted to compensate for underfunding of legally mandated devolved competencies reliant on central government transfers.
- Issuance and repayment dropped significantly in 2014 following rapid accumulation in 2013; lack of resources to grant loans contributed to the drop but underfunding problem remains.
- Urgent review required to ensure grants to LGs are commensurate with expected level of service delivery.

### Reducing volatility in government balances
- Government cash balances on the TSA are volatile and frequently approach or reach zero in the middle of the month when many expenditures fall due; revenues are largely received at the end of the month.
- Mismatch in timing of receipts and payments could be reduced by aligning revenue and expenditure patterns, e.g., aligning large ticket items (such as wage payments) with large revenue receipts.
- Aligning expenditure and revenue items is a medium-term strategy and would reduce volatility on the TSA and lessen NBU market interventions to sterilize government activity.

### Key statistics and time series (selected)
- Account 1122 balance: just under UAH 16 billion (US$ 1.3 billion) as at June 10, 2014.
- Unified social fund balances: UAH 6.6 billion or US$ 553 million as at June 1, 2014.
- Average central government deposits in commercial banks: around UAH 4 billion (US$341 million) between June 2013–May 2014.
- Foreign currency accounts in commercial banks: UAH 1 billion (US 85 million) as at April 1, 2014.
- Commercial bank balances: UAH 3.6 billion (US$ 306 million) as at end March 2014.
- STU commercial bank cash account (1222): UAH 1.4 billion (US$ 123 million) as at June 10, 2014.
- STU account 1224 balances: UAH 527 billion (US$62) million as at June 10, 2014.
- Medium-term loans outstanding to LGs: approximately UAH 9.5 billion (US$ 810 million or 0.6 Percent of GDP) outstanding as at mid-2014.
- As at end June 2014 foreign currency deposits sufficient to finance two month’s worth of foreign currency debt redemptions.

### Recommendations
Short term (1-6 months)
- Recommendation 3.1: The STU should survey all central government agencies to determine whether they have commercial bank accounts and act to rationalize them if it is found that they exist to manage own source revenues or other funds. The STU should also review its own accounts to determine whether they are required.
- Recommendation 3.2: Eliminate foreign currency accounts of spending units in the commercial banks. The STU should be tasked with purchasing foreign currency on behalf of spending units to finance any foreign currency obligations that they may have and credit the UAH equivalent against their UAH accounts in the TSA.

Medium term (6 months to 2 years)
- Recommendation 3.3: Once cash planning capacity has been strengthened the STU should put in place formal arrangements to borrow the balances of the Social Security Funds in the TSA for liquidity management purposes. This would require formal agreements for making funds available as required by the social funds and the development of detailed cash plans both for the state budget and the social funds.
- Recommendation 3.4: The MoF and STU should review the practice of maintaining large balances in foreign currency accounts in the NBU to finance future debt redemptions. Foreign exchange receipts, including drawdowns of debt, should be automatically converted to UAH and placed on the TSA to be used for cash management purposes. This policy should only be enacted once adequate cash forecasting capacity has been developed and in conjunction with a formalized process to inform the NBU of upcoming foreign exchange purchase requirements of the government so that the NBU can be in a position to provide the foreign exchange when required.
- Recommendation 3.5: The MoF should identify the extent to which lack of liquidity in the STU and subsequent inability to provide loans to LGs will impact on LGs ability provide legally mandated services. Prevention of a rapid accumulation of arrears will require a review of services provided by LGs funded by transfers from central government to ensure the level of services match the available resource envelopes (i.e., available transfers).

### Cash planning: findings and recommended capacity building
- Current practice:
  - STU produces a weekly forecast of cash balances for the following month.
  - Monthly financial plans of line ministries are produced at the beginning of the budget year but are not updated over the course of the year.
  - No unit is responsible for the production and updating of longer-term forecasts.
- Recommended forecast horizon:
  - Forecast period should extend for at least six months, ideally at least twelve months.
  - Some governments project daily flows for one year ahead.
- Design elements for forecasting and monitoring capability:
  - A database of actual daily cash flows for identifying patterns and monitoring; actual cash flows should be tracked against departments’ profiles and major divergences investigated.
  - Information flow to cash managers from revenue and spending units; short-term cash flow forecasts require input from budget agencies.
  - A network of contacts, voice and electronic, with main spending and revenue departments to develop forecasts and monitor current flows.
- Practical approach:
  - Start with rough monthly projections, build towards weekly and then daily forecasts.
  - Examine patterns by plotting individual time series year-over-year to reveal seasonality.
  - Identify key working-level contacts in revenue and spending departments and set formal requirements to ensure profiles are supplied and updated; back with informal arrangements for early notice of major changes.
  - Focus on sums that are large in size, most variable and most unpredictable.
  - Example practice: more detailed information collected from just 15 departments who account for over 80 percent of government spending (U.K. example).
- Capacity needs:
  - MoF should build capacity to construct and analyze cash flow plans; technical assistance can help set up modeling and provide initial training.
  - A cash management team of at least six full-time staff would be needed to ensure that cash planning and active cash management could be performed effectively.

*Italic: IMF mission report excerpt (text provided).*

### 58.      The location of a cash management unit needs careful consideration. At present, as

### 58.      The location of a cash management unit needs careful consideration. At present, as

### Location and role of a cash planning unit
- The STU produces very short term cash forecasts and in theory could be mandated to produce longer-dated forecasts over a six-month to one year period for use by key stakeholders including the Budget Department and the Debt and International Financial Policy Department.
- The STU may not have the information networks needed to receive detailed data from line ministries and revenue collection agencies on the evolution of their cash receipts and expenditures over the course of the year.
- It may make sense to establish a cash planning unit in the MoF where such information can be requested and a cash planning network more easily developed.
- The decision on organization should depend on the capacity of the agency to develop such a network.

### Recommendations — short term (1-6 months)
- Recommendation 3.6: Establish a cash planning unit in the MoF or the STU to produce detailed cash plans to be used by key stakeholders including the STU, Budget Department, and the Debt and International Financial Policy Department.

### Recommendations — medium term (6 months to 2 years)
- Recommendation 3.7: Reduce volatility of TSA balances through alignment of dates for major receipts and expenditures.

### Integration with Debt Management — coordination issues and proposals
Findings
- Debt management operations are currently not coordinated with cash needs.
- The borrowing plan focuses on the redemption schedule of existing debt rather than on the funding needs of the government.
- Government cash management and debt management objectives often appear to conflict: cash managers seek liquidity at lowest cost; debt managers seek orderly borrowing and fulfillment of annual borrowing plans.
- In periods of liquidity shortage, debt issuance must be coordinated with cash needs.
- Short-maturity debt instruments (e.g., short-term T-bills) are usually connected with cash management operations; longer maturities are reserved for debt management operations.
- The existing T-bill issuance program is not fully coordinated with the cash flow profile of government operations, largely due to absence of accurate cash plans with sufficient horizon.
- Management of government resources is fragmented between MoF (debt manager) and ST (cash manager) with potentially conflicting objectives.
- Many advanced countries have a single integrated manager of government financial resources (examples noted: France, Ireland, UK, Sweden).
- A CoM resolution permits the STU to purchase T-bills to invest idle government balances, which is not optimal: it is inefficient for one arm to issue T-bills and another to purchase them given transaction costs (footnote reference: COM Resolution 65 of 201l; Article 12 of the 2010 Budget code also provides for surplus balances to be invested in government securities).
- A more rational approach would be to give responsibility for managing the balance on the TSA to a single manager, in this case the debt manager, making T-bill issuance plans reflect cash needs and optimize TSA balances.
- An integrated manager would ensure a minimal balance is maintained allowing the STU to carry out payment and allocation functions.
- Integrating cash and debt management will incentivize the debt manager to seek better and longer dated cash information and will require commitment to improve forecast quality and access to STU system for daily monitoring.

Recommendation — medium term (6 months to 2 years)
- Recommendation 3.8: Integrate cash and debt management by making the Debt and International Financial Policy Department responsible for managing balances on the TSA.

### IV. BUDGET EXECUTION AND INTERNAL CONTROL — Current situation and systems
Key facts and systems
- The State Treasury of Ukraine (STU) oversees budget execution; STU is an independent body operating within MoF administration.
- STU performs budget execution transaction services and control, and produces budget execution reports.
- STU structure: head office in Kiev, 27 main departments in each of the 24 regions (plus Kyiv, Sevastopol, and Crimea), and 633 local administrative centers with 16,000 staff in total.
- STU’s IT system is E-KAZNA (developed with World Bank assistance and implemented with IMF assistance); previously separate revenue and expenditure systems have been combined into a “unified” system.
- Software is operated on a de-concentrated basis by STU offices at three levels with data transfers between district, regional, and central databases.
- Major revenue and spending agencies have separate accounting software not directly connected to E-KAZNA; historically all transactions had to be initiated and recorded at a STU site; manual data interchange mechanisms have begun to be introduced.
- STU has a direct connection to the payments system managed by the NBU and access to interbank clearing; almost all revenues are collected via transfers from commercial banks acting as collection agents and almost all payments are made by electronic funds transfer: 96 percent.
- Budget classification: administrative unit, program, and economic classification; functional classification used in preparation and reporting but not for execution control.
- Economic classification is detailed, equivalent to a 4-digit GFS economic classification (but not fully compliant with GFSM 2001).
- Budget execution is controlled at detailed economic line item level (example: “purchase of electricity” as subset of “utilities”).
- Virement controls limit movement within budget structure; MoF must approve transfers between recurrent economic categories; CoM and Budget Committee of the Rada involved for other transfers; adjustments between spending units require changes to annual budget law.
- Allocation process: approved budget allocated according to monthly breakdown ("Rozpys") provided at start of year; STU releases monthly allotments based on Rozpys; sub-units provide proposed allotment splits.
- Protected items (Article 55 of the BCU): salaries, payroll, utilities, debt servicing, transfers to households, transfers to local government, purchase of medicines, tertiary education — released monthly according to Rozpys.
- Unprotected items: allotment not automatically released per Rozpys; release depends on short-term TSA liquidity and is released on weekly basis.
- Distinction between General Fund and Special Funds: Special Funds tied directly to earmarked revenues and their timing affects allotments.
- Agencies are required to record invoices (obligations) in the STU system; STU performs budget control and will not record commitments in excess of allocated budget.
- Expenditure initiation: spending units present paperwork to Treasury office which validates documents, authority, classification, and budget availability; obligations recorded in Treasury system control expenses against commitments.

### Issues to be addressed — key weaknesses and arrears
- Financing control against the budget is weak. CoM Resolution 404 appears to allow borrowing by agencies to fund capital expenditure in excess of appropriations.
- Treasury lending to sub-national governments involves release of cash in absence of appropriation.
- These practices violate principle that all cash flows out of National Government funds should be covered by an appropriation and breach sound public financial management and the Constitution of Ukraine.
- Payment arrears have accrued during the fiscal imbalance due to low TSA balances and STU not paying all invoices presented by spending agencies.
- As at June 2014, arrears totaled 4.18Bn UAH (0.3 percent of GDP). These arrears represent invoices recorded in STU system as obligation but not paid.
- The amount in Table 7 includes only arrears in unprotected expenditure and may underestimate true arrears; anecdotal evidence suggests possible unpaid invoices for protected items not recorded in STU system.
- Total arrears, including unpaid VAT refunds, is 7.8Bn UAH.
- A core STU function is to ensure sufficient cash to pay budget-approved expenditures; long-term solution is realistic expenditure consistent with accurate revenue forecasts (see Chapter III).
- Enhance cash management practices to ensure sufficient liquidity so payment obligations can be met (see Chapter III).
- Need greater capacity to manage the rate at which expenditure obligations are incurred during the year.

Table 7. Ukraine: Accumulated Payment Arrears at June 28, 2014 (mln. UAH)
- State Budget 1,715.7
- General fund 378.1
- Special fund 1,337.6
- Local budgets 2,430.9
- General fund 941.7
- Special fund 1,489.2
- Social Welfare Funds 34.2
- Employment fund 31.7
- Industrial accident and occupational disease social insurance fund 2.1
- Temporary disability social insurance fund  0.4
- Total Payment Arrears 4,180.8

### Budget execution process weaknesses and proposed controls
- Current allotment process ineffective at restraining the rate of expenditure obligations; during crisis, internal directives reduced certain purchases and non-payment of invoices for unprotected items, but a more systematic approach is needed to avoid arrears during poor TSA liquidity.
- Commitment control should be introduced to support effective budget execution control and cash management.
  - A “commitment” is an action by a program manager to earmark budget funds for a specific purpose (e.g., issuance of a purchase requisition).
  - Many modern Treasury/IFMIS systems record commitments at time incurred; purchasing modules automatically register commitments when purchase requisitions are prepared.
  - Some regular payment types (e.g., salaries) should automatically register commitments when funds are allocated.
- Current recording of obligations occurs after contracts are signed or goods purchased — too late to prevent arrears; agencies already required to record accounts payable as soon as invoices are received (although often outside STU system).
- Practical solution: convert obligation recording to commitment recording by having spending agencies record obligation/commitment in the treasury system at the stage just prior to commencement of procurement.
- Benefits of commitment control:
  - Improves budget execution control and helps avoid arrears during poor liquidity.18
  - Commitment information assists cash forecasting as it signals timing of future expenditures.
  - Commitments can be controlled against budget allocations so managing release of budget allocation controls incurrence of liabilities.
  - Where forecast cash shortfall exists, restricting allocations will constrain commitments agencies can enter and thus constrain incurrence of obligations, helping manage spending rate without incurring arrears.

### Arrears clearance strategy — guiding factors
- Comprehensiveness: apply to all outstanding payments across central government, sub-national governments, and state-owned enterprises.
- Transparency: clearance should follow a public timetable with transparently stated and adhered prioritization criteria.
- Credibility: include measures to avoid new arrears; penalize ministries/agencies that fail to implement measures.
- Realism: annual budget and medium-term fiscal projections should make adequate provision for cash cost of arrears clearance.
- Verification: arrears should be verified to ensure only valid claims are cleared.19

*Source: IMF staff report content provided in the supplied document.*

### 83.      The distinction between protected and unprotected items is not appropriate in the

### _cr1630 - 83.      The distinction between protected and unprotected items is not appropriate in the

### Distinction between protected and unprotected budget items
- Finding: The distinction between protected and unprotected items is not appropriate in the medium term.
- Rationale:
  - Once fiscal stability is restored, advanced cash management tools are implemented, and commitment controls introduced, it should be possible to avoid cash rationing.
  - Deliberately holding back payment of “unprotected” items:
    - undermines the whole system of public finance;
    - impacts on the revenues of private sector suppliers;
    - inflates the costs of government purchasing;
    - encourages local government and semi-autonomous agencies (such as universities) to seek approval to establish their own STU operations.
- Recommendation (medium term): Eliminate the distinction between protected and unprotected items from the 2016 budget onwards and commit to making all payment of items included in the budget within 30 days of being due. (Recommendation 4.3)

### Budget execution flexibility and control regime
- Finding: Seeking to control expenditure at a highly detailed level (by program and detailed economic classification) creates severe rigidity in budget execution and prevents managers from responding to changing contexts, contributing to payment arrears.
- International practice:
  - Two approaches to increase flexibility:
    1. Give spending agencies flexibility to transfer their budget between economic categories without higher-level approval, often with limits (e.g., caps on total transfers or restrictions on transfers involving salaries).
    2. Record transactions at the detailed CoA level but control/limit spending at a higher summary level (roll-up). Example: roll up detailed “purchase of gas” into a single “utilities” control.
  - Schedule 3 of the annual budget law includes summary level detail appropriate for control (as shown in Table 8 for the general fund and special fund programs).
- Recommendation (medium term): Provide managers with greater flexibility in budget execution control rules by controlling the budget by program and summary level economic classification (as per Schedule 3 of the 2013 budget law). (Recommendation 4.5)
- Recommendation (short term): The STU should introduce commitment controls to the budget execution framework for 2015, requiring that a commitment be recorded in the STU system at the point at which procurement commences. Use control over commitments as a last resort should cash management processes fail to provide liquidity in the TSA. (Recommendation 4.1)

### Treasury operations, STU, and IFMIS
- Finding: Future enhancement of Treasury operations is dependent on the capacities of its IT system.
- Context:
  - Under the Public Finance Modernization Project (PFMP) supported by the World Bank, the Government has been pursuing purchase of an Integrated Financial Management Information System (IFMIS).
  - The IFMIS is intended as a web-based solution supporting STU transactions and services and supporting budget preparation, debt management, procurement, donor assistance management, and human resource management.
  - Successive unsuccessful procurement actions and pending completion of the PFMP put acquisition of the FMIS at risk.
  - The inability to acquire a functioning IFMIS poses a substantial barrier to future PFM reform and STU efficiency enhancements.
- Desired STU/IFMIS features:
  - Available to both STU and spending units.
  - Supports online transactions through the interbank clearing system.
  - Enables automatic reconciliation of accounts.
  - Supports appropriate internal controls.
  - Has robust security and audit functions.
  - Has a general ledger that supports accounting and reporting in accordance with accounting policy.
  - Interfaces with other financial management systems.
- Implementation note: While expanding functionality of the existing STU is technically feasible, acquiring an off-the-shelf IFMIS package may be less complicated and potentially a more efficient way to quickly acquire required functionality while supporting other key PFM functions.
- Recommendation (medium term): In cooperation with development partners, produce a strategy for expanding the functionality of the systems available to STU for supporting the internal control, accounting, and reporting functions of budgetary agencies and the STU. (Recommendation 4.4)
- Recommendation (short term): The MoF should consider developing an arrears clearance strategy directed at clearing all arrears in a timeframe consistent with IMF program and developed having regard to the principles outlined in IMF TNM 14/03 if existing arrears cannot be cleared utilizing existing appropriations of budget users. (Recommendation 4.2)

### Internal control framework and audit institutions
- Overall finding: Ukraine’s financial control framework is extensive, comprising:
  - Ex ante controls by the STU;
  - Ex ante and ex post controls by the State Financial Inspection Service (SFI);
  - Ex post control and audit by the Accounting Chamber (ACU) and Internal Auditors in Budgetary Institutions; and internal control frameworks within each institution.

- Accounting Chamber of Ukraine (ACU)
  - Role and mandate:
    - ACU is Ukraine’s external audit institution and reports directly to the Verkhovna Rada.
    - Established by Section 98 of the Constitution of Ukraine to undertake “control over the receipt of finances to the State Budget of Ukraine and their use on behalf of the Verkhovna Rada of Ukraine.”
    - Recent constitutional amendments clarified ACU’s broad role in auditing both revenue and expenditure.
  - Governance and procedures:
    - ACU is governed by a Chamber comprising a Chairman, two deputies, a Secretary and Chief Controllers.
    - Members are elected by a majority secret vote of the Verkhovna Rada and have a seven-year term.
    - ACU undertakes ex post audit of budget execution; an audit plan is independently developed each year.
    - ACU can perform broader examinations of program effectiveness and efficiency and provides audit findings and recommendations to the Verkhovna Rada, the COM, and the President.
    - ACU provides an audit opinion on the Annual Report on Compliance with the Budget Law and quarterly reports on debt, revenue and expenditure as required under Article 110 of the Budget Code and Article 27 of the Law on the Accounting Chamber.
    - ACU is a member of EUROSAI and INTOSAI and is working toward full implementation of INTOSAI standards with international assistance.
  - Legislative proposals and independence:
    - ACU prepared a new draft legislative framework seeking protection from inadequate funding by presenting its budget directly to the Verkhovna Rada and seeking mandate for limited ex ante control (e.g., verify validity of revenue administration rulings) and to advise on macrofiscal forecasting.
    - Assessment: Completely avoiding the budget preparation process is not ideal; a preferred approach is for ACU to submit a draft budget in the usual way but have the legal right to brief CoM, Budget Committee, and Verkhovna Rada to justify its request, improving transparency.
    - Concern: Engaging in ex ante control and policy development functions might undermine ACU independence and objectivity; the ACU should remain focused on independent ex-post audit activities consistent with INTOSAI standards.
  - Recommendation (short term): Do not expand the mandate of the ACU to include engagement in ex-ante controls and/or administrative decisions or policy making activities. The focus of the ACU should be on performing independent ex-post audit activities consistent with INTOSAI standards. (Recommendation 4.6)
  - Recommendation (medium term): Amend the Budget Code to provide a mechanism for ACU to place a submission explaining their original budget request before the CoM and the Budget Committee of the Verkhovna Rada at the time that the budget is being considered. (Recommendation 4.7)
  - Concern: The ACU is concerned about the implications of the 2014 Supplementary Budget Law as it is understood to place a limit on external audit activities during the remainder of that year; the Government should not seek to limit ACU powers via legislative instruments.

- State Financial Inspection of Ukraine (SFI)
  - Role and governance:
    - SFI is an executive body undertaking ex post review and audit of budget execution.
    - Executive authority directed and coordinated by the Cabinet of Ministers through the Minister of Finance.
    - Key appointments are made by the CoM based on proposals of the Minister of Finance.
    - SFI reports to the Verkhovna Rada, the CoM, and the MoF.
  - Staffing: SFI has a central office with 390 staff and regional offices with a combined staff of over 6,000.
  - Functions:
    - Inspection: ex post fiscal control checking compliance after transactions are processed; where non-compliance is observed, SFI imposes administrative sanctions, makes referrals to law enforcement and the prosecutor, and directs redress actions. These inspection activities reportedly added value with a return to the state budget misappropriated funds and implementation of the agreements in the amount of 370 million. UAH since the beginning of 2014.
    - Financial auditing: performance-type audits identifying ineffective and inefficient use of public funds; audit findings are non-binding and do not apportion responsibility.
  - Expanded scope to include ex ante control:
    - Resolution 214 of the COM provided SFI a mandate to undertake operational audits of the 36 largest SOEs with selective ex ante control over operations, focusing on procurement.
    - Risk-based approach with initial intent to undertake ex ante control over purchases of goods with a value of more than 300,000 UAH and any procurement of works with a value of more than 1 million UAH.
    - SFI tasked with a one-off audit of all payments of budgetary institutions recorded as being in arrears in the Treasury system.
  - Internal audit rollout:
    - Since 2005 SFI has pursued a reform to introduce an internal audit (IA) function in all budgetary institutions with substantial international assistance.
    - Legislation, regulations, and training delivered; 75 ministries and central executive bodies now have IA units in place, and internal audit units have been formed in all regional administrations.
  - Recommendation (medium term): Continue the roll-out of internal audit, with the objective of having a functioning IA in all national, oblast level spending units by end of 2015 and make managers accountable for results. The staff and resources of the SFI should be shifted into budgetary institutions to support strengthening the internal control regime within these agencies. (Recommendation 4.8)
  - Recommendation (medium term): Introduce a certification regime, where freedom from all ex-ante controls and greater flexibility in budget execution (more relaxed virement rules) is granted once unqualified external audit of AFS is achieved by an individual agency. (Recommendation 4.9)

### Key elements of a strong modern internal control regime
- (i) Enhanced flexibility for managers in executing their budgets.
- (ii) A shift away from control over inputs toward attainment of outcomes, reflected in budget process and reporting.
- (iii) A clear legal requirement for senior managers in budgetary institutions to establish a sound internal control regime, including functioning internal audit, separation of duties, delegation of authorities, and risk based controls.
- (iv) Strengthened reporting regime, requiring agencies to produce a publicly released annual report with Annual Financial Statements (AFS) produced according to accounting standards as well as reporting on outputs produced, efficiency indicators and reporting on outcomes achieved from use of public resources.
- (v) External audit of the annual reports of all agencies, including an audit opinion (according to INTOSAI standards).
- Transition approach: A structured certification process can manage the move to decentralized control, granting greater flexibility only after agencies demonstrate strong internal control via unqualified external audits of their AFS.

*IMF staff report excerpt (content unit: _cr1630 - 83.      The distinction between protected and unprotected items is not appropriate in the)*

### 105.      The STU produces monthly and quarterly budget execution reports and an annual

### _cr1630 - 105.      The STU produces monthly and quarterly budget execution reports and an annual

### Budget execution reporting: scope and content
- The STU produces monthly and quarterly budget execution reports and an annual report on enforcement of the Budget.
- Reports are submitted to the Verkhovna Rada, the President of Ukraine, the COM, the Accounting Chamber, and the MoF and all are published on the STU website.
- There is no distinction between annual budget execution reporting and financial reporting; a single report serves both purposes.
- The content of the annual budget execution reports includes:
  - a report on financial position (balance sheet) of the State Budget of Ukraine;
  - a statement of financial result of the State Budget execution;
  - cash flow statement;
  - execution of the State Budget of Ukraine;
  - budget arrears;
  - usage of the reserve fund;
  - public debt and government guaranteed debt status;
  - issuance, balances and payments relating to execution of government guarantees;
  - explanation of progress in achieving the targets of the State Budget of Ukraine and local budgets for the reporting period, including indicators by the key spending units within the budget programs; and
  - information on compliance with the articles of the Law on the State Budget of Ukraine.

- To supplement quarterly and annual general budget execution reports, the revenue administration agency submits to the Verkhovna Rada, the COM, and the MoF a report on tax expenditures, tax write-offs, and data on revenue agreed to be deferred or paid by installment.

### Timeliness, audit, and institutional interaction
- Timeliness requirements (per the Budget Code):
  - Annual reports are produced by April 1 each year.
  - Quarterly reports within 35 days of the end of the period.
  - Monthly reports within 15 days of the end of the month.
- All reports are submitted to the Accounting Chamber; quarterly and annual reports are subject to a published audit opinion.
- The STU undertakes reporting for State and sub-national government both separately and on a consolidated basis.
- The STU prepares budget execution reports but relies on data (e.g., stock of accounts payable) from budgetary institutions.
- The STU has authority to agree to appointment or dismissal of the Chief Accountant of each budgetary agency and issues instructions to agencies regarding accounting and reporting.

### Current accounting arrangements and limitations
- Accounting arrangements:
  - STU: cash basis accounting.
  - Budgetary institutions: modified cash basis accounting.
  - Social funds and SOEs: accrual basis accounting.
- Key difference: STU records cash expenditures while budgetary institutions record accounts payable.
- Individual budgetary institutions perform their own accounting on their own systems (parallel system); the STU performs transactions on behalf of budgetary institutions and accounts for these within the Treasury system using a common classification for common chart of accounts elements.
- Because each agency has a separate accounting system and no direct access to the STU system, much manual data interchange is required for reconciliation and reporting.
- At the time of this assessment, there were 40 different accounting systems in place in key spending agencies.

### Transition to accrual accounting: commitments, gaps, and sequencing
- Government commitment: transition to accrual accounting with 19 new public sector accounting standards developed and adopted based on IPSAS accrual standards.
- A COM resolution would see these accounting standards adopted from January 1, 2015, with 2015 annual financial statements produced on the basis of these accrual standards.
- The report states it is not realistic that accrual accounting will be fully adopted during 2015.
- Progress and remaining weaknesses hindering full accrual adoption:
  - Weaknesses in the accounting systems;
  - The budget execution focus of reporting;
  - Lack of capacity for accounting for the use of assets, liabilities and inventories;
  - Lack of coverage of all controlled entities in the accounts.
- The current Treasury (IFMIS) system:
  - Not yet procured as a new IFMIS; ongoing enhancements to the current system.
  - Designed to track movement in cash deposit accounts and to control and report against cash based budget appropriations.
  - Does not support transactions in nonfinancial assets, nor does it record non-cash balances such as accounts payable or receivable.
- Current workaround: STU supports reporting of some accrual data (e.g., accounts payable) by requiring these be recorded in systems maintained by budgetary institutions.
  - Two key issues:
    - Existence of many different accounting systems in budgetary agencies (40 systems) will become problematic as accrual reporting complexity grows.
    - STU will need new systems for gathering and consolidating accrual data from budgetary institutions.

### Systems options and practical sequencing
- Two solutions to address accounting systems requirements for accrual accounting:
  - Deploy a common accounting package in budgetary institutions and develop a data warehouse and consolidation tool for compiling reports.
  - Introduce an IFMIS system that supports accounting and reporting requirements of the STU and budgetary institutions using a common platform.
- The report indicates the IFMIS/common platform approach is more desirable because it avoids difficulties of managing data interchange and supports budget control and reporting through a common system.
- Perceptions and reconciliation between accrual AFS and cash-based budget:
  - Budget will continue to be prepared on a cash basis; accrual AFS will have operating statement as main indicator of financial performance.
  - Building understanding among budget stakeholders of the relationship between accrual indicators in AFS and the cash-based budget is a major challenge.
  - One mitigation: publish a separate budget outcomes statement within the AFS and amend the budget code to distinguish the AFS and the budget outcomes report.
- Key challenge: accounting for movements in balances of assets and liabilities that do not result from transactions (market-driven changes, depreciation, actuarial changes in pension liabilities).
  - Requires new business processes, data, expertise and systems largely not in place within Ukraine’s budgetary institutions.
- IMF technical note guidance: suggest phasing implementation—initially focus on financial assets and liabilities (e.g., accounts payable, accounts receivable, debts) and defer complex valuation of nonfinancial assets to later stages.

### Expanding reporting coverage: SOEs and sub-national governments
- IPSAS consolidated reporting requires inclusion of all entities under government control; this would include SOEs and non-budgetary operations of social welfare funds.
- Fiscal rationale: including these entities is desirable because they are instruments for delivery of public policy, recipients of significant government support, and sources of fiscal risk.
- Challenges in including SOEs:
  - Need an SOE reporting regime aligned with national government accounting policy and classification scheme.
  - Challenges for SOEs and STU in enforcing compliance.
  - Requirement for highly accurate reporting of all flows between SOEs and government to enable consolidation and avoid double counting.
- Practical data gathering option: require periodic provision of aggregated accounting data by SOEs to the STU based on a common chart of accounts at a high level to support key aggregates (operating statement, cash flow statement, balance sheet).
- STU consolidation will require SOEs to provide precise data on transactions where a budgetary agency is the counterpart; many SOEs may initially be unable to provide this due to system weaknesses, inconsistent accounting policies or incomplete data sets.
- Reasonable objective timeline stated:
  - Include data of the SOEs separately in the AFS for 2016.
  - Include SOEs on a consolidated basis from 2018.
- IPSAS control criteria would exclude sub-national governments from the reporting entity; however, the report recommends continuing to include sub-national governments within consolidated AFS for fiscal policy relevance.

### Sequencing guidance and implementation stages
- Box 2: Illustrative guidance on sequencing accrual accounting reforms
  - Stage one implementation (Years 1–3):
    - General ledger—management of the government’s central financial data repository, including COA, ledger structure, and journal structure
    - Purchasing—management of the full procurement cycle, including commitment management
    - Payments and accounts payable—management of all supplier and grantee payments, including management of accounts payable (arrears)
    - Revenue—management of all invoicing and related processes (excluding taxation revenue—this will be managed by the central tax agency)
    - Receipts and accounts receivable—management of receipts and receivables functions (excluding taxation revenue—this will be managed by the central tax agency)
    - Banking management—including management of banking deposits, bank transfers, bank accounts, and bank reconciliation
    - Cash management—including management of cash budgeting, cash forecasting, cash accounting, and cash reporting
    - Fund management—including accounting for and reporting all transactions and balances of trust accounts, extra-budgetary accounts, special accounts, hypothecated funds, etc
    - Data collection and consolidation—including automated elimination of intrasector transactions and balances. Note that data collection may not be required if the accounting function is centralized
    - Financial reporting—including production of full range of management reports, GAAP financial reports, GFSM 2001 reports, SNA reports, ESA reports, etc.
    - Management of estimates, projections and budgets (if the government has decided that these should be integrated with the accounting functions)
  - Stage two implementation (Years 3–4):
    - Investment management (if applicable)
    - Debt management (if applicable)
  - Stage three implementation (Years 3–10):
    - Fixed asset management—including registration, revaluation, depreciation management, maintenance, etc.
    - Inventory management (if applicable)—including recording, valuation, stocktaking etc

### Recommendations (preserved phrasing and timing)
- Short-term (0-6 months)
  - Recommendation 5.1: An implementation plan should be developed by STU for achieving compliance with the accrual accounting standards to be introduced from 2015.
- Medium term (6 months to 2 years)
  - Recommendation 5.2: The STU should include the Public Non-Financial Corporations sector (SOEs) in the annual financial statements both as a separate sector (from 2016) and also on a consolidated basis (from 2018) onwards. A reporting format and a suitable common chart of accounts should be developed and trialed during 2015 for introduction for data gathering in 2016.
- Long term (2 years plus)
  - Recommendation 5.3: In the long term, consolidated reporting by the STU should be done on a whole-of-government (GFS Public Sector) basis showing each of the budgetary central government, the SOE sector, the off-budgetary agencies and the sub-national governments both separately as well as on a consolidated basis. This implies continuing to report sub-national sector separately and on a consolidated basis—including after the accrual standards are adopted despite this not being required by IPSAS.

*Source: _cr1630 - 105.      The STU produces monthly and quarterly budget execution reports and an annual*

### 123.      The Ukrainian government is the owner of a large portfolio of commercial assets

### _cr1630 - 123.      The Ukrainian government is the owner of a large portfolio of commercial assets

### Portfolio overview and composition
- The portfolio of public assets includes almost 20 thousand entities of which more than 5,600 are owned at the central government level and more than13,800 at sub-national level.
- Two of the largest banks in Ukraine, the State Export-Import Bank of Ukraine (Ukreximbank) and the State Oschadnyi Bank (Savings Bank), are fully state-owned.
- The real estate component is highlighted as potentially the most valuable and the least transparent part of the portfolio; no current information is available on the size and value of this portfolio without a stocktaking effort using the electronic State Land Cadaster and the State Register of Property Rights to Real Estate.

### Valuation proxies and key statistics
- Using financial assets and non-financial assets as a proxy:
  - Together they represent some 60 percent of GDP or USD 72 billion.
  - Financial assets represent some 18 percent of GDP or USD 22 billion, including shares in corporate assets and banks.
  - Nonfinancial assets represent some 42 percent of GDP or USD 50 billion, comprising mostly structures such as roads and real estate.

### Fiscal impact and contingent liabilities
- Public assets continue to have a negative fiscal impact:
  - The net cost to the state in 2013 amounted to 1.8 percent of GDP.
  - Contribution from state assets to the budget through dividends was around 0.2 percent of GDP.
  - Fiscal support through transfers of budgetary resources amounted to 2 percent of GDP.
- Crisis-related fiscal pressures:
  - Nationalization and state recapitalization of banks carried an additional supplementary budget of 1 percent in case additional capital will be needed for the banks.
  - Privatization receipts stalled, representing less than 0.2 percent of GDP in 2013.
  - Issuance of public guarantees for state enterprise debt amounted to 8.4 percent of GDP, as of May 2014, of which around 77 percent of these guarantees are foreign exchange denominated bearing significant exchange rate risk.

### Energy sector liabilities and Naftogaz case (Box 3)
- Energy subsidies in Ukraine, on-and off-budget, amounted to more than 7.5 percent of GDP in 2012.
- Ukraine is one of the most energy intensive countries in Europe, with use of energy per unit of GDP 10 times above the OECD average and with extremely low prices on sales of gas to households and district heating companies.
- By end-March 2014, Naftogaz had built up arrears of about USD2.2 billion, or 1.5 percent of GDP to Gazprom and significantly depleted its stored gas reserves.
- Naftogaz related subsidies to households through underpriced household gas and heating costs almost 5 percent of GDP per annum.
- Institutional and governance issues for Naftogaz:
  - Naftogaz is a government owned, vertically integrated oil and gas company with wide and conflicting objectives, and nominally a commercial company while legal title to assets remains in State ownership.
  - The company has been subject to state audits concluding operations were non-transparent and financial reporting contradictory.
  - The latest available audited financial statements of Naftogaz are from 2011.
- Reform actions underway:
  - Government has begun to establish fair tariffs and started an unbundling process, splitting Naftogaz into four separate business areas: Exploration, Transportation, Storage and Wholesale Distribution.
  - The government is considering partial privatization of some assets (transportation and storage), while noting strategic/geopolitical links that affect asset value.

### Governance challenges and reform priorities
- Persistent challenges despite prior reform efforts by IFIs (IMF, The World Bank, IFC) include the need to:
  - update and modernize the legal framework;
  - separate policy and commercial objectives;
  - introduce clear financial objectives and a transparent reporting process; and
  - consolidate ownership management within an independent vehicle.
- The absence of political insulation, a clear objective, and transparency undermines efficiency, service delivery, fiscal position, and creates vulnerability to corruption and vested interests.
- Three components required to manage commercial assets while remaining within the government sphere:
  - Political insulation — separate ownership management from other policy functions and ring-fence commercial assets from short-term political influence.
  - Clear objective — implement and communicate value maximization as the sole objective for commercial assets and publish and quantify costs when companies carry out policy objectives.
  - Transparency — apply international standards for accounting and financial reporting, external annual audit, and transparent flows between government and SoEs, including funding for “community service obligations.”

### Ownership management systems and international models
- Two broad systems exist: decentralized (unitary/dual governance) and consolidated models.
- The decentralized/unitary approach:
  - Historically practiced in planned economies; regulatory and ownership functions were indistinguishable and managed within the same ministry.
  - Liberalization revealed the need to separate commercial objectives from policy objectives to avoid conflicts that lead to abdication of ownership and rent-seeking.
- The dual governance approach:
  - Introduces a partnering ministry (e.g., Ministry of Finance) for monitoring; improves oversight but leaves gaps in management capacity and alignment with commercial interests.
- The consolidated model:
  - Consolidates ownership rights and financial monitoring in a single ownership management entity, either as a government unit or an independent ring-fenced holding company (National Wealth Fund, ‘NWF’).
  - Government entity approach: dedicated unit within MoF or reporting to Prime Minister’s office; improves capacity but constrained by civil service recruitment and pay.
  - National Wealth Fund approach: ring-fenced holding company at arm’s length from short-term political interference, enabling integrated portfolio management, scale effects, and more efficient privatizations.
- Temasek (Singapore) as an illustrative NWF example:
  - Wholly owned by the government and reporting directly to the prime minister’s office.
  - Increased assets under management from S$354 million at inception to S$223 billion in 2013, with a shareholder return of around 17 percent compounded annually.
  - Corporate credit ratings of "Aaa" by Moody's and "AAA" by Standard & Poor's.
- Economic benefits of consolidation include the ability to develop a fully integrated business plan, set priorities for loss-making assets, identify opportunities for raising finance, and choose optimal timing for disposals.

*Source: _cr1630 - 123.      The Ukrainian government is the owner of a large portfolio of commercial assets*

### 143.      The basic legal framework for management of state assets is provided for in the

### _cr1630 - 143.      The basic legal framework for management of state assets is provided for in the

### Legal and regulatory framework
- Primary legal instruments:
  - Commercial Code of Ukraine (“CCU”).
  - Law on the Management of State Objects (“State Property Law”).
  - Resolutions of the Council of Ministers of Ukraine (“CoM”), regulations, procedures, and rules issued by the Ministry of Economy, Ministry of Finance, the State Property Fund (SPF) and various line ministries.
- Consequence: A complex web of overlapping and sometimes contradictory legislation contributes to absence of clarity and visibility and can create opportunities for vested interests and corruption.

### Governing bodies — structure and roles
- Two broad categories:
  - Bodies directly managing assets: CoM, line ministries, SPF, MoF, Ministry of Economy, Ministry of Industrial Policy, and other agencies.
  - Bodies coordinating monitoring and oversight: CoM, SPF, Corporate Rights Agency, MoF, Ministry of Economy, State Fiscal Service.
- Result: Highly decentralized system with overlapping and sometimes contradicting responsibilities creates an “overwhelming governance vacuum.”

### Legal authority and sectoral rules
- CoM authority governed by the Constitution, CCU, State Property Law, and the Law on the Cabinet of Ministers.
- State Property Law lists and authorizes state bodies’ responsibilities without distinguishing between commercial and regulatory responsibilities or commercial and policy objectives.
- Special laws exist for certain sectors (railways, utilities) and specific assets (pipelines, seaports, inter-city road infrastructure).

### Types of legal entities for state assets
- Two entity types:
  - Unitary enterprises:
    - Not subject to many corporate legal requirements applicable to private sector governance, transparency, or auditing.
    - Two subtypes: “Kazenni” (policy-controlled, “operational management rights”, no full ownership) and “Commercial Entity” (for-profit, “business management rights”, but without legal ownership).
    - Unitary enterprises cannot be privatized in their current legal form without substantial legal reform due to lack of corporate governance structure and proper title.
    - Not required to have board of directors, independent directors, supervisory board, or annual general meeting; governed in practice by a single civil servant — resulting in absence of political insulation and separation between policy and commercial objectives.
  - Joint-stock companies:
    - Can issue shares and are subject to general corporate legal framework unless wholly government-owned when specific rules may apply.
    - Also do not have legal title to the assets they operate (example: Naftogaz).
- Consequence: Most physical assets are directly owned by the state and not by the managing legal entity, leaving asset care at risk of neglect and short-term management focused on cash needs rather than value generation. Regulatory and managerial functions are combined without incentives to care for the asset.

### Management selection and incentives
- Managers of unitary enterprises are meant to be selected competitively with competitive remuneration, but:
  - Government not effective in attracting top candidates despite legislation for adequate remuneration.
  - Evaluation system does not appear to affect company performance or management turnover; underperformers are not routinely replaced.

### The State Property Fund (SPF)
- SPF established as the agency for privatization and is assigned an annual privatization proceeds target by the CoM.
- Limitations:
  - Lacks capacity to formulate coherent portfolio strategy or consolidated financial data.
  - CoM sets targets from political and budgetary perspectives without capacity for realistic or strategic analysis.
  - SPF lacks mandate/resources to hire professional private-sector advisers for sales processes.
- Practices and risks:
  - Asset selection for privatization left to governing body discretion, often leading to less attractive assets being sold and valuable assets retained.
  - Assets not sold timely are transferred back to line ministries or subjected to “fire sales,” with SPF acting as liquidator; opens potential for collusion and transfer of state assets below market value.

### Ministry of Economic Development and Trade (MoEDT)
- Responsible for evaluating governing bodies and “the efficiency of state property management.”
- Methodology focuses on compliance-like scoring (three categories: positive, satisfactory, negative) rather than market performance.
- MoEDT reviews governing bodies’ evaluations of managers, but reviews are carried out without validation or audit; evaluations do not affect remuneration or performance significantly.
- MoEDT itself is owner of 48 state entities — apparent conflict of interest.

### Ministry of Finance (MoF)
- Solely authorized to monitor fiscal impact of state assets; does not directly evaluate individual assets.
- Government lacks transparency capacity to evaluate consolidated portfolio financial performance or fiscal risk.
- State Financial Inspection recently mandated to perform direct operational audit (ex ante control) over selected activities in the 36 largest SOEs.
- MoF enforces compliance with dividend targets based on political/budgetary requirements defined as a percentage of planned net profit in the Financial Plan, creating incentives to minimize profits and undermining value-maximization objectives.

### Accounting Chamber
- Audits use of budgetary resources of state assets; does not attest to reliability of financial statements but may review use of budget funds.

### Need to introduce a clear financial objective
- Current financial indicators established by MoEDT are limited to fiscal and compliance monitoring.
- Performance management will only be meaningful with an explicit financial objective such as value maximization harmonized with private-sector practice.
- The inherent conflict between regulatory, political, and ownership roles is unaddressed at policy, organizational, and practical levels.

### Transparency considerations
- Legal basis: Constitution, Law on the Law on Information, Law on Access to Public Information; information classified as open or limited access, with limited access categorized as confidential or state secret governed by Law on State Secrets.
- Current oversight emphasizes approval of financial plans and comparison of actual versus budgeted performance with little focus on transparency, preventing operational benchmarking and understanding of fiscal risk.

### Privatization history
- From 1992 to June 30, 2009:
  - Ukraine raised more than UAH 40 billion in privatization receipts.
  - Divested more than 120 thousand assets (around 28 thousand from central government and more than 90 thousand from local government).
- Since 2009 privatizations have largely stalled; attracting foreign direct investment has been a challenge.

### Managing State Assets — The Way Forward (three main areas)
- Strengthen:
  - Legal Structure
  - Ownership Management
  - Transparency Policies

Legal reform (recommendations)
- Aim: Reduce/eliminate overlapping structures and conflicting objectives; create clear responsibility and accountability unified under single objective of value maximization.
- Delegate responsibility to boards of directors capable of managing assets and vest ownership responsibility with a consolidated ownership vehicle.
- Requires comprehensive reform to existing laws and subsidiary regulations, specifically the Code and Property Law, and alignment of other legislation.
- Seek to eliminate differences in legal framework between state assets and private-sector equivalents; may require corporate law reform for whole economy.

Ownership rights management (recommendations and sequencing)
- Long-term aim: Centralized ownership model with clear mandate to maximize value once prerequisites (legal, governance, accounting, reporting) are in place.
- Short-term feasible steps:
  - Build capacity to manage fiscal risks and centralize oversight via a dedicated unit within the MoF.
  - Primary objective: transparent and comprehensive assessments of financial plans and identification/proposal of measures to mitigate fiscal risks.
  - Prepare and publish a consolidated annual report for the portfolio of state assets functioning as a virtual holding company.
- Essential actions:
  - Separate commercial and non-market assets; define and quantify subsidies or policy objectives transparently.
  - Procure policy costs under competitive tender, centrally or by the relevant entity, relieving entities of policy duties to focus on core commercial activity.
- Medium-term:
  - Merge SPF and MoF oversight unit to consolidate ownership, financial control, and privatizations through an independent division within the CoM or the MoF; unit to be accountable for asset selection, preparation, and sale to maximize shareholder value.
- Long-term:
  - Convert Ownership Management Unit into an independent, ring-fenced holding company reporting directly to the CoM when capacity and political conditions permit.

Transparency policy (recommendations)
- Ensure stakeholders, including international investors, understand nature and status of state-held assets; information must be credible to support marketable initiatives, including independent auditing and valuation.
- Short-term objectives (can be achieved quickly):
  - Compile and publish an Annual Review of the state asset portfolio (aggregate by sector, including real estate). With proper resources this annual review can be compiled and published within six months from commencement.
  - Establish a single comprehensive database of all state assets including real estate to enable independent valuations, dividend policy establishment, and overall risk management.
  - Implement a comprehensive Transparency Policy obliging the government to publish a consolidated Annual Report of all state assets, audited by an internationally recognized auditing firm, consolidating annual reports of individual state assets. Each Annual Report should include business description, risks and risk management, major investments, R&D, board work and composition during the year, compensation to leading executives, and description of incentive programs.
  - Subsidies directly attributable to state assets resulting from requirement to charge non-market prices should be separately identified.

*Source: _cr1630 - 143.*

### 172.      Reporting polices should be analogous to those of a publically listed vehicle and

### _cr1630 - 172.      Reporting polices should be analogous to those of a publically listed vehicle and

### Reporting, disclosure, and publication standards
- Reporting polices should be analogous to those of a publically listed vehicle and regular communications to the public should be issued in the form of published annual consolidated reports and quarterly portfolio reviews.
- The operational objectives of each corporate asset should be published in the annular report of each respective holding together with financial targets and operational goals, to ensure that the invested capital is managed to the benefit of the shareholders and within the limits of the core business.
- The boards of the state-owned commercial assets should be made responsible for compliance with accounting and reporting standards.
- Larger holding or holdings of strategic importance should, in addition to current accounting legislation and generally-accepted accounting principles, also comply with international practice of listed companies.
- State-owned companies should also be required to submit their reports in an appropriate format to the MoF to enable consolidated reporting of the SOE sector and consolidation in public sector reports as required by international accounting standards.
- Large state assets should be required to publish their annual reports and financial statements audited by a reputable company, in Ukrainian and in English.
- The ownership vehicle should also have a dedicated website in English, as well as in Ukrainian publishing its annual report and audited financial statement, as well as quarterly financial data aiming for the best international practice.
- This requirement should apply for all state-owned companies with annual turnover in excess of UAH 50 million.
- To assess the potential value of state-owned real estate, a stock take should be performed and all information consolidated in a database ensuring harmonization and transparency of data.
- Real estate information should be published in the annual report of the ownership vehicle, including periodic external valuations by independent appraisers.

### Short-term recommendations (1–6 months)
- Recommendation 6.1: Establish a unit within the MoF with the sole responsibility for managing the consolidated fiscal risk related to state assets, including value, dividend, and cost of subsidies and policy objectives.
- Recommendation 6.2: Separate commercial and non-market based assets and transparently report on the cost of subsidies and policy based interventions in commercial assets.
- Recommendation 6.3: Issue a government decree identifying value maximization as the sole objective for commercial assets.
- Recommendation 6.4: Carry out a stock-take of consolidated portfolio of state-assets, including value, yield and risk, and establish a single and comprehensive database of all state assets, including the real estate, enabling independent valuations of each asset, establishing relevant dividend policy, as well as overall risk management.
- Recommendation 6.5: Publish an annual review of state assets in English on the government web site.

### Medium-term recommendations (6 months to 2 years)
- Recommendation 6.6: Appoint a government review group, consisting of public and private sector experts to conduct a legal review that will assess the reforms needed to:
  - Streamline the legal structure governing the portfolio of public assets, to eliminate overlapping structures and conflicting objectives unified under the single objective of value maximization.
  - Harmonize the legal framework and eliminate differences between what is applicable to state assets and private sector equivalents in order to attract even international investors.
- Recommendation 6.7: Consolidate the ownership function within the MoF as an intermediate measure to gain control of state assets, including:
  - Merging the SPF and the MoF SOE financial management unit to consolidate full responsibility for active ownership, financial control, and privatizations.
  - Appointing a sub-group under the government review group, consisting of predominantly private sector experts to conduct a study of the optimal route for implementing an independent, arms-length ownership vehicle for state assets.

### Legal and fiscal framework changes required (high-level inventory)
- The BCU, the primary legislation supporting the budget process, will need to be reviewed in light of the changes proposed.
- Other legislation and secondary regulations and resolutions may also need review to ensure conformity with the amended BCU; new regulations may be needed to introduce more stringent medium-term budget planning provisions in the BCU and to implement fiscal rules and new budget execution controls.
- Table 9 (Ukraine: Potential Changes Needed to BCU to Support PFM Reforms) identifies required changes and rationale, including:
  - Inclusion of new or amended Definitions — Article 2 — New definitions need to be included such as a definition of a MTBF.
  - Abolishment of general and special categories of expenditure — Article 57 — To reduce the current practice of earmarking revenues the current categorization of general and special budgets needs to be removed with all revenues treated equally as sources of funding for all budgetary expenditures.
  - Strengthening provisions surrounding the MTBF — Article 21 — Existing provisions need to be strengthened to include the need for aggregate and sectoral expenditure ceilings.
  - Amending the Budget calendar — Articles 33-38 — The budget calendar needs to be revised to support the alignment of the MTBF and the annual budget.
  - Strengthening and introducing commitment controls earlier in the expenditure cycle — Article 46 — The article needs to explicitly require commitments to be verified against budget appropriations prior to entry into contractual obligations.
  - Virement provisions — Articles 43 and 47 — The articles need to be redrafted to reduce the level of control and allow greater flexibility for KSU’s in the execution of their budgets.
  - Protected expenditures — Article 55 — Remove the concept of protected expenditures as a move towards developing a realistic budget that ensures there is adequate fiscal apace to meet all expenditures approved in the budget.
  - Internal Financial Control — Articles 26, 113-118 — Provide a mechanism for relaxing external controls for those agencies that meet required standards of internal control and reporting.
  - Reporting — Chapter 10 — Require production of annual reports by every major budgetary institution, including AFS and report on outcomes.
  - Accrual Accounting — Chapter 10 — Provide guidance on the distinction between budget execution reporting and accrual AFS.
  - Fiscal Responsibility provisions and introduction of fiscal rules — New — Need to insert new fiscal responsibility provisions (fiscal Council?) and provisions for the establishment and implementation of fiscal rules.

### Organizational responsibilities and institutional arrangements
- The MoF responsibilities may need to be substantially broadened to include a greater oversight role for management of SOE’s through the establishment of the SOE oversight unit mentioned in Chapter V.
- New responsibilities for managing the cash balance on the TSA will require the creation of a cash planning unit in the Debt and International Financial Policy Department with new staff and broadening the responsibilities of the Directorate to manage the end of day balance on the TSA.

*Source: Provided IMF PDF content (pages 172–178).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr1630.pdf_