## 1. An Illustrative Example of the Structure of a Capital Budget ## Source details **Canonical URL:** [1. An Illustrative Example of the Structure of a Capital Budget](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08160.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08160.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08160.pdf.json) --- ### Introduction - Capital budgets in governments have multiple roles: as instruments of fiscal policy, to improve the net worth of government, and—as vehicles for economic development—particularly in the area of economic infrastructure. - Governments often rely more on debt than conventional financing such as taxation to fund capital budgets. - Objectives served by capital budgets vary by context; in some cases they are used to reduce deficits caused by an excess of recurrent expenditures versus revenues. - Debate about the utility of capital budgets persists, especially in the developing world where many governments operate on the edge of financial instability. - Key challenges: - Defining an appropriate balance between current and capital expenditures. - Integrating budgeting for government investment into the formal budget preparation process. - Common problems when capital budgeting is weak or absent: - Borrowing without due consideration of sustainability aspects. - Assets inadequately maintained. - Major projects suffer from poor management and performance. - The paper revisits whether capital budgets improve allocation, use, and accounting for resources and whether they promote decision making and a management culture that maintains government net worth. - Scope note: The paper focuses mainly on public investment and will not address public-private partnerships, earmarking arrangements and extrabudgetary funds, procurement and project management, or asset management strategies and their link with the budget. ### Defining Capital (Box 1) - Capital spending is generally about physical assets with a useful life of more than one year. - Capital includes capital improvements or rehabilitation of physical assets that enhance or extend useful life (distinct from repair or maintenance which assures that the asset is functional for its planned life). - Capital spending is sometimes equated with investment or development spending, where expenditures have benefits extending years into the future. - Under this definition, governments may include: - physical assets for government use (for example, office buildings), - physical assets of a public good nature that also enhance private sector development (for example, roads, water systems), - intangibles (for example, education, research). - Distinguishing investment from noninvestment expenditures can be difficult; if investment receives favored treatment, nearly all spending may be classified as investment. - Governments establish arbitrary cut-off points to distinguish capital from current (operating) expenditures. - For budgeting purposes, current expenditures are purchases of assets to be consumed within one year, regardless of expenditure size. - Small expenditures (for example, less than US$25,000) are regarded as current, regardless of the period over which they might be consumed. - Note: The term “investment in human capital” should be distinguished from investment in social infrastructure (schools, hospitals, etc.). ### Distinction Between Capital and Current Expenditure - For some purposes, capital and current expenditures need to be considered separately (for planning, monitoring, management, and disposal of capital assets). - For other purposes, capital and current expenditures need to be considered together (for example, when investment proposals need appraisal in terms of both capital and operating costs). - Capital spending within the budget needs to be clearly identified separately. - Capital-specific procedures are needed for asset procurement and for project management and maintenance of assets. - Planning and budgeting for capital and current spending should be developed together; investment proposals must be appraised for both capital and operating costs. ### An Illustrative Structure of a Capital Budget (Table 1) - The funding of a capital budget can be more than borrowing; sources of funds may include: - Taxes levied on property (considered levies on capital and included in capital receipts). - Income from natural resources earmarked for capital projects. - Surpluses from the current budget. - Depreciation allowances (accounting contra or balancing items). - Capital transfers from external sources and proceeds from the sale of property and privatization. - Receipts 1. Estate and death duties 2. Surpluses from the current account 3. Proceeds of borrowing: - Domestic - Trust and captive accounts maintained by government - External 4. Depreciation allowances 5. Sales of property - Regular - Privatization - Also listed: Taxes and property; Earmarked revenues for capital projects; Capital transfers from external sources and proceeds from the sale of property and privatization. - Expenditures 1. Acquisition of existing assets - Plant, property, and equipment - Financial 2. Acquisition of new assets - Plant, property, and equipment - Financial (other than capital transfers) 3. Capital transfers - Transfers to other levels of government - Transfers to state-owned enterprises 4. Repayment of loans 5. (Implicit in structure) Asset maintenance and project-specific costs associated with procurement and management - Institutional practice note: - In developed economies it is normal for the ministry of finance section familiar with a spending unit’s activities to deal with both capital and current spending; budgeting for both is developed together. *Source: _wp08160 - 1. An Illustrative Example of the Structure of a Capital Budget* ### 6. Capital grants ### Overview - Annual government budgets in most developed countries are broken down into several hundred headings for parliamentary approval, with each heading usually wholly capital spending or wholly current spending. - Parliaments often require capital expenditures to be specifically identified in the budget documentation, but presentation and debate focus on expenditure programs as a whole. - Program budgets frequently have capital and current components with limited (if any) freedom to vire between them. - Development of capital investment plans is typically an internal management issue for line ministries or agencies; specific ministry of finance approval may be needed for some large capital projects. ### Golden rules, balanced budgets and limits on borrowing - Some countries establish explicit links or rules between net public investment and public debt, including “the golden rule,” which specifies that increases in the stock of public debt should not exceed net public investment. - There has been increasing interest in rules limiting the budget balance and the total level of public debt; reinforced in the European Union in the 1990s by conditions for membership of the Monetary Union and succeeded by the Stability and Growth Pact. - Historical examples and dates: - A law was passed in 1967 allowing exceptions to the golden rule in Germany. - The Netherlands applied the golden rule between 1927 and 1958. - In 1997, the U.K. government introduced a policy of balancing the budget over the economic cycle and set a target for government debt. - Control of public debt is equally important in low-income countries; priority is to develop reliable measures of public assets and liabilities and to monitor information on capital assets and liabilities. Some countries have found it helpful to establish some form of the golden rule. ### The evolution of capital budgeting practices - Six discernible stages of changes in capital budgeting practices are identified. - Stage 1 (Great Depression years): focus on economic recovery; Sweden introduced a capital (investment) budget to be funded by public borrowing to finance durable and self-financing assets. - Stage 2 (late 1930s): colonial government in India introduced a capital budget to reduce the budget deficit by shifting items from the current budget; dual-budget system justified borrowing. - Stage 3: capital budgets as vehicles for development plans; many low-income countries formulated five-year plans and used capital budgets (or development budgets) as impetus for economic development. - Stage 4 (1960s–1970s): quantitative appraisal techniques applied more widely, leading to more rigorous investment appraisal and financial planning. - Stage 5: revival of debate about capital budgets (particularly in the United States); 1999 president’s commission concluded a capital budget could lead to greater outlays on bricks and mortar and advocated accrual accounting instead. - Stage 6 (late 1990s onward): renewed push for accrual budgeting and accounting (influenced by Australia and New Zealand experiences); emphasis on dividing outlays into current and capital to ensure proper asset maintenance and creation. - Additional historical notes: - In the 1960s and 1970s, systems such as PPBS and ZBB were believed to render budget allocation “scientific,” but critiques highlighted practical, informational, and governance limitations. - Sweden’s early 1970s review found that credibility and creditworthiness of government depend more on macroeconomic policy stance than on a government’s net worth, contributing to a decline in popularity of capital budgets until the late 1980s. ### Current capital budgeting practices in developed countries - Dual budgeting originated in European countries in the late 1930s to ensure borrowed resources were used for capital expenditures; after WWII budgets were integrated due to reconstruction, increased recurrent expenditures, Keynesian macroeconomic approaches, and recognition that returns apply across all government spending. - Most OECD countries have achieved a high degree of integration of current and capital budgets through long-term development of public administration and budget systems. - A unified budget is judged by the extent to which current and investment spending decisions are “well-balanced” and mutually supportive of policy objectives; imbalances can appear in sectors such as education and health (examples: many teachers but too few classrooms; large new hospitals but insufficient trained staff or inadequate maintenance). - Key features of budget systems with high integration between current and capital expenditures: - a single (combined) annual budget law and appropriation process; - clear, and unified, responsibilities for budgetary preparation and implementation within the relevant public sector institutions; - the existence of effective and widely employed investment appraisal techniques; - a unified budget presentation, with supporting classification and accounting systems; and - budget planning and management techniques within individual spending agencies that encourage and enable good use of financial resources. - Full benefits of a unified budget require all of the above conditions; the most challenging reforms and greatest gains are often in budget planning and management within spending agencies. ### A medium-term approach to public investment - Public investments are primarily meaningful in a medium- to long-term perspective; an annual-only focus tends to emphasize short-term macro-economic effects and political considerations, leading to under-funding of capital budgets and prioritization of high-visibility, fast-track projects rather than projects with highest net benefits. - Allocation of resources across sectors and projects should ideally be based on efficiency: - Short-term focus: static efficiency—expected results based on current delivery capacity for public goods and services. - Longer-term perspective: dynamic efficiency—resource allocation should consider possibilities for improving sector capacity over time; investment projects play a critical role. - Cost-effectiveness considerations: - Short-term: focus on cost minimization without fundamental changes in production processes. - Longer-term: pursue modernization and re-engineering of government operations, which often requires investments. - Many efforts to extend the time horizon for investment planning include medium-term approaches to public investment. *Source: _wp08160 - 6. Capital grants* ### introduction of medium-term budget frameworks (MTBFs) ### Characteristics of effective MTBFs - The ministry of finance develops a medium-term macroeconomic forecast, which forms the basis for multi-year spending ceilings by organizations or programs. - The line ministries develop policy-based, three-year budget estimates for their activities. These estimates should reflect ministries’ strategies and policies. - The ministries’ budget estimates distinguish clearly between the costs of existing policies and programs, and the costs of new proposals, including investments. - The budget preparation process gives a formal status to the out-year estimates. On a rolling basis, the first out-year estimates of expenditures should become the basis of preparation of the following year’s budget. - Note: Currently, the majority of OECD countries prepare comprehensive MTBFs. Few low-income countries have been able to introduce full-fledged MTBFs so far. ### Stages of budgetary management of public investment - Pre-commitment / planning/detailed objectives: - Strategic objectives/strategies - Option appraisal - Financing - Budgetary allocation - Post-commitment: - Procurement - Project management - Budget monitoring and control - Post-completion: - Asset management - Performance measurement - After any stage: - Ex post evaluation - Source of stages: Spackman, 2001: p. 215. - Observation: Degree of overall success depends on the maturity of the public financial management system; in more developed countries most activities are well integrated into budgetary processes. ### Appraisal of capital projects - Investment appraisal is an economic analysis of national costs and benefits of the proposed investment or alternative options (including not undertaking the investment). - The appraisal should: - Include all costs, including costs of using the asset throughout its lifetime. - Preferably include a sensitivity analysis where costs or benefits are uncertain. - Consider legislative impact, environmental impact, and impacts on other sectors. - Spackman’s crucial requirements: - Well-informed and open-minded consideration of alternative options, against well-defined policy objectives. - Taking proper account of opportunity costs (e.g., recognizing the use of labor as a cost, not a benefit). - Consideration of factors which cannot be explicitly valued in money terms as well as those which can. - Contrast: Project appraisal in many low-income countries is often a cost analysis of an already well-defined proposal; capacity for economic analysis to question initial proposals is usually weak. ### Capital budgeting in low-income countries (LICs) — historical drivers and problems - Origins and persistence: - Separate current and capital budgets (“dual budget”) have origins in colonial administrations and persisted after independence. - Development ministries or planning ministries often took responsibility for identification, appraisal, budgeting, and accounting of investment budgets, reinforcing dual budgeting. - Donor preferences for funding “development” activities reinforced the separation. - Institutional dynamics: - Finance and planning/development ministries frequently issued separate budget circulars and presented separate budget documentation and classifications to parliament. - Special bank accounts, extrabudgetary funds, and trust accounts were used for donor-financed projects and counterpart funds, often outside central treasuries and accountants-general. - Special project management units in line ministries handled accounting and banking of external loans and grants, further fragmenting accounting and reporting. - Recurring issues: - Recurrent spending needs arising from capital projects were often under-projected or ignored; finance ministers were uninformed or unable to fund recurrent costs. - Double or overlapping budgeting occurred when line ministries negotiated separately with finance and planning ministries to receive funds for the same recurrent activities. - Lack of coordination led to weaker reporting, delays in closing government accounts, and difficulties reconciling accounting records with banking transactions. - Evolving donor practices: - Since the late 1990s, PRSPs, monitoring of poverty-reducing expenditures, sector-wide approaches, and budget support have increased donor financing of recurrent expenditures and pushed for more integrated approaches. - Public expenditure reviews (PERs) have shifted to combine recurrent and development expenditures in intra- and inter-sectoral analyses. - Current state: - Most LICs have at least begun using medium-term expenditure frameworks (MTEFs) to replace five-year national plans and public investment programs, but annual programming and budgeting of recurrent and development operations still tend to be carried out by separate organizations. - Organizational issues: - Some LICs have merged finance and planning ministries; many have not due to political, institutional, and remuneration incentives. - Staff of planning or development ministries have tended to be better paid and advantaged, reflecting externally financed project opportunities. ### Rationale for integrating recurrent and development budgets in LICs - Drivers for integration: - Government borrowing is no longer limited to capital expenditures. - Only an integrated analysis of recurrent and development expenditures can identify poverty-reducing expenditures with immediate or indirect impacts. - Part of external concessional credits, and the bulk of donor grants, are used for recurrent expenditures, supplementing the government recurrent budget. - Recurrent costs of capital projects continue to be ignored due to lack of coordination. ### Benchmarks and practical recommendations for budgeting for public investment in LICs - Determining the resource envelope: - Capital expenditure decisions should be based on a consolidated budget approach, incorporating all revenues and expenditures, in particular foreign-financed projects and extrabudgetary funds with investment activities. - Capital expenditure decisions should be based on a medium-term budget perspective. - Decisions regarding capital expenditures should be taken in the context of a hard budget constraint. There should be explicit ceilings for guarantees and commitments beyond the budget year. - Governments should have clear policies regarding which capital expenditures should be financed by the budget, which may be realized through public-private partnerships and which should be handled by public or private enterprises; policies should reflect cost structure and possibilities for user-financing, as well as political priorities. - Efficient prioritization and selection: - The budget calendar and procedures for integration of capital expenditures in the budget must be clear, transparent and stable. Development and analysis of capital investment proposals should largely be completed before the budget preparation process starts. - All projects should be subject to cost-benefit analysis. If subjecting all projects to cost-benefit analysis is too costly, focus could first be on the larger projects, using a simplified methodology for smaller projects. - A public investment agency, with strong links to the Ministry of Finance, should prepare guidelines for project development and analysis, review proposals to ensure adequate preparation and analysis, and have the authority to reject projects that do not meet established technical standards. - The Ministry of Finance should give the cabinet recommendations for which investment projects should be realized within the available resource envelope. Ministries should compete for investment funds based on net social value and political priority of proposals. - The decision to implement an investment project should be independent of the financing and procurement modalities. PPPs can improve risk allocation, but benefits must be substantial to compensate for increased financing and transaction costs. Decisions regarding PPPs should be an integral part of the budget process, and PPP arrangements should be fully disclosed in budget documents. - Efficient implementation: - Rules for budget adjustments should give incentives for realistic initial capital cost estimates. Cost overruns during project implementation should be partly covered by reallocation within ministry’s existing budgets. In the case of real cost reductions, ministries should be allowed to retain part of these. - Capital investment project proposals should only be considered when they include a detailed disclosure of the expected operating costs, indicating how these will be accommodated within existing resource envelopes or proposing additional financing for operating costs. - Capital investment project proposals should only be considered after the ministry has explained how it will fully cover the maintenance of its existing capital stock. - Governments should avoid excessive targeting of capital expenditures for budget cuts. Decisions on budget cuts should be based on the medium-term budget and take full account of future expenditure pressures as a result of under-funding. - There should be project completion reports for all capital expenditure projects; these should form the basis for cross-sectoral analysis, methodology development, and continuous improvements in the investment process. ### Conclusion - An effective capital budgeting process should be an integral component of a sound overall budgeting system. - A well-designed public financial management system supports capital spending through: - Good multi-year planning, supporting overall fiscal balance and more stable spending patterns. - Good budget execution and procurement, enabling timely, within-budget completion of projects (assuming good program and project management). - Financial management information systems that support financial and program management needs of the executive, ministries of finance and economy, spending ministries and program managers. - LICs should continuously aim to improve both capital budgeting processes and public financial management systems overall, recognizing that attaining these benchmarks will often take several years and that reforms may need to focus initially on a few key areas. *Source: _wp08160 - introduction of medium-term budget frameworks (MTBFs).* ### 1. An Illustrative Example of the Structure of a Capital Budget ...............................................6 ### 1. An Illustrative Example of the Structure of a Capital Budget ...............................................6 ### Introduction - Capital budgets in governments have multiple roles: as instruments of fiscal policy, to improve the net worth of government, and—as vehicles for economic development—particularly in the area of economic infrastructure. - Governments often rely more on debt than conventional financing such as taxation to fund capital budgets. - Objectives served by capital budgets vary by context; in some cases they are used to reduce deficits caused by an excess of recurrent expenditures versus revenues. - Debate about the utility of capital budgets persists, especially in the developing world where many governments operate on the edge of financial instability. - Key challenges: - Defining an appropriate balance between current and capital expenditures. - Integrating budgeting for government investment into the formal budget preparation process. - Common problems when capital budgeting is weak or absent: - Borrowing without due consideration of sustainability aspects. - Assets inadequately maintained. - Major projects suffer from poor management and performance. - The paper revisits whether capital budgets improve allocation, use, and accounting for resources and whether they promote decision making and a management culture that maintains government net worth. - Scope note: The paper focuses mainly on public investment and will not address public-private partnerships, earmarking arrangements and extrabudgetary funds, procurement and project management, or asset management strategies and their link with the budget. ### Defining Capital (Box 1) - Capital spending is generally about physical assets with a useful life of more than one year. - Capital includes capital improvements or rehabilitation of physical assets that enhance or extend useful life (distinct from repair or maintenance which assures that the asset is functional for its planned life). - Capital spending is sometimes equated with investment or development spending, where expenditures have benefits extending years into the future. - Under this definition, governments may include: - physical assets for government use (for example, office buildings), - physical assets of a public good nature that also enhance private sector development (for example, roads, water systems), - intangibles (for example, education, research). - Distinguishing investment from noninvestment expenditures can be difficult; if investment receives favored treatment, nearly all spending may be classified as investment. - Governments establish arbitrary cut-off points to distinguish capital from current (operating) expenditures. - For budgeting purposes, current expenditures are purchases of assets to be consumed within one year, regardless of expenditure size. - Small expenditures (for example, less than US$25,000) are regarded as current, regardless of the period over which they might be consumed. - Note: The term “investment in human capital” should be distinguished from investment in social infrastructure (schools, hospitals, etc.). ### Distinction Between Capital and Current Expenditure - For some purposes, capital and current expenditures need to be considered separately (for planning, monitoring, management, and disposal of capital assets). - For other purposes, capital and current expenditures need to be considered together (for example, when investment proposals need appraisal in terms of both capital and operating costs). - Capital spending within the budget needs to be clearly identified separately. - Capital-specific procedures are needed for asset procurement and for project management and maintenance of assets. - Planning and budgeting for capital and current spending should be developed together; investment proposals must be appraised for both capital and operating costs. ### An Illustrative Structure of a Capital Budget (Table 1) - The funding of a capital budget can be more than borrowing; sources of funds may include: - Taxes levied on property (considered levies on capital and included in capital receipts). - Income from natural resources earmarked for capital projects. - Surpluses from the current budget. - Depreciation allowances (accounting contra or balancing items). - Capital transfers from external sources and proceeds from the sale of property and privatization. - Receipts 1. Estate and death duties 2. Surpluses from the current account 3. Proceeds of borrowing: - Domestic - Trust and captive accounts maintained by government - External 4. Depreciation allowances 5. Sales of property - Regular - Privatization - Also listed: Taxes and property; Earmarked revenues for capital projects; Capital transfers from external sources and proceeds from the sale of property and privatization. - Expenditures 1. Acquisition of existing assets - Plant, property, and equipment - Financial 2. Acquisition of new assets - Plant, property, and equipment - Financial (other than capital transfers) 3. Capital transfers - Transfers to other levels of government - Transfers to state-owned enterprises 4. Repayment of loans 5. (Implicit in structure) Asset maintenance and project-specific costs associated with procurement and management - Institutional practice note: - In developed economies it is normal for the ministry of finance section familiar with a spending unit’s activities to deal with both capital and current spending; budgeting for both is developed together. *Source: _wp08160 - 1. An Illustrative Example of the Structure of a Capital Budget* ### 6. Capital grants ### 6. Capital grants ### Overview - Annual government budgets in most developed countries are broken down into several hundred headings for parliamentary approval, with each heading usually wholly capital spending or wholly current spending. - Parliaments often require capital expenditures to be specifically identified in the budget documentation, but presentation and debate focus on expenditure programs as a whole. - Program budgets frequently have capital and current components with limited (if any) freedom to vire between them. - Development of capital investment plans is typically an internal management issue for line ministries or agencies; specific ministry of finance approval may be needed for some large capital projects. ### Golden rules, balanced budgets and limits on borrowing - Some countries establish explicit links or rules between net public investment and public debt, including “the golden rule,” which specifies that increases in the stock of public debt should not exceed net public investment. - There has been increasing interest in rules limiting the budget balance and the total level of public debt; reinforced in the European Union in the 1990s by conditions for membership of the Monetary Union and succeeded by the Stability and Growth Pact. - Historical examples and dates: - A law was passed in 1967 allowing exceptions to the golden rule in Germany. - The Netherlands applied the golden rule between 1927 and 1958. - In 1997, the U.K. government introduced a policy of balancing the budget over the economic cycle and set a target for government debt. - Control of public debt is equally important in low-income countries; priority is to develop reliable measures of public assets and liabilities and to monitor information on capital assets and liabilities. Some countries have found it helpful to establish some form of the golden rule. ### The evolution of capital budgeting practices - Six discernible stages of changes in capital budgeting practices are identified. - Stage 1 (Great Depression years): focus on economic recovery; Sweden introduced a capital (investment) budget to be funded by public borrowing to finance durable and self-financing assets. - Stage 2 (late 1930s): colonial government in India introduced a capital budget to reduce the budget deficit by shifting items from the current budget; dual-budget system justified borrowing. - Stage 3: capital budgets as vehicles for development plans; many low-income countries formulated five-year plans and used capital budgets (or development budgets) as impetus for economic development. - Stage 4 (1960s–1970s): quantitative appraisal techniques applied more widely, leading to more rigorous investment appraisal and financial planning. - Stage 5: revival of debate about capital budgets (particularly in the United States); 1999 president’s commission concluded a capital budget could lead to greater outlays on bricks and mortar and advocated accrual accounting instead. - Stage 6 (late 1990s onward): renewed push for accrual budgeting and accounting (influenced by Australia and New Zealand experiences); emphasis on dividing outlays into current and capital to ensure proper asset maintenance and creation. - Additional historical notes: - In the 1960s and 1970s, systems such as PPBS and ZBB were believed to render budget allocation “scientific,” but critiques highlighted practical, informational, and governance limitations. - Sweden’s early 1970s review found that credibility and creditworthiness of government depend more on macroeconomic policy stance than on a government’s net worth, contributing to a decline in popularity of capital budgets until the late 1980s. ### Current capital budgeting practices in developed countries - Dual budgeting originated in European countries in the late 1930s to ensure borrowed resources were used for capital expenditures; after WWII budgets were integrated due to reconstruction, increased recurrent expenditures, Keynesian macroeconomic approaches, and recognition that returns apply across all government spending. - Most OECD countries have achieved a high degree of integration of current and capital budgets through long-term development of public administration and budget systems. - A unified budget is judged by the extent to which current and investment spending decisions are “well-balanced” and mutually supportive of policy objectives; imbalances can appear in sectors such as education and health (examples: many teachers but too few classrooms; large new hospitals but insufficient trained staff or inadequate maintenance). - Key features of budget systems with high integration between current and capital expenditures: - a single (combined) annual budget law and appropriation process; - clear, and unified, responsibilities for budgetary preparation and implementation within the relevant public sector institutions; - the existence of effective and widely employed investment appraisal techniques; - a unified budget presentation, with supporting classification and accounting systems; and - budget planning and management techniques within individual spending agencies that encourage and enable good use of financial resources. - Full benefits of a unified budget require all of the above conditions; the most challenging reforms and greatest gains are often in budget planning and management within spending agencies. ### A medium-term approach to public investment - Public investments are primarily meaningful in a medium- to long-term perspective; an annual-only focus tends to emphasize short-term macro-economic effects and political considerations, leading to under-funding of capital budgets and prioritization of high-visibility, fast-track projects rather than projects with highest net benefits. - Allocation of resources across sectors and projects should ideally be based on efficiency: - Short-term focus: static efficiency—expected results based on current delivery capacity for public goods and services. - Longer-term perspective: dynamic efficiency—resource allocation should consider possibilities for improving sector capacity over time; investment projects play a critical role. - Cost-effectiveness considerations: - Short-term: focus on cost minimization without fundamental changes in production processes. - Longer-term: pursue modernization and re-engineering of government operations, which often requires investments. - Many efforts to extend the time horizon for investment planning include medium-term approaches to public investment. *Source: _wp08160 - 6. Capital grants* ### introduction of medium-term budget frameworks (MTBFs). ### introduction of medium-term budget frameworks (MTBFs). ### Characteristics of effective MTBFs - The ministry of finance develops a medium-term macroeconomic forecast, which forms the basis for multi-year spending ceilings by organizations or programs. - The line ministries develop policy-based, three-year budget estimates for their activities. These estimates should reflect ministries’ strategies and policies. - The ministries’ budget estimates distinguish clearly between the costs of existing policies and programs, and the costs of new proposals, including investments. - The budget preparation process gives a formal status to the out-year estimates. On a rolling basis, the first out-year estimates of expenditures should become the basis of preparation of the following year’s budget. - Note: Currently, the majority of OECD countries prepare comprehensive MTBFs. Few low-income countries have been able to introduce full-fledged MTBFs so far. ### Stages of budgetary management of public investment - Pre-commitment / planning/detailed objectives: - Strategic objectives/strategies - Option appraisal - Financing - Budgetary allocation - Post-commitment: - Procurement - Project management - Budget monitoring and control - Post-completion: - Asset management - Performance measurement - After any stage: - Ex post evaluation - Source of stages: Spackman, 2001: p. 215. - Observation: Degree of overall success depends on the maturity of the public financial management system; in more developed countries most activities are well integrated into budgetary processes. ### Appraisal of capital projects - Investment appraisal is an economic analysis of national costs and benefits of the proposed investment or alternative options (including not undertaking the investment). - The appraisal should: - Include all costs, including costs of using the asset throughout its lifetime. - Preferably include a sensitivity analysis where costs or benefits are uncertain. - Consider legislative impact, environmental impact, and impacts on other sectors. - Spackman’s crucial requirements: - Well-informed and open-minded consideration of alternative options, against well-defined policy objectives. - Taking proper account of opportunity costs (e.g., recognizing the use of labor as a cost, not a benefit). - Consideration of factors which cannot be explicitly valued in money terms as well as those which can. - Contrast: Project appraisal in many low-income countries is often a cost analysis of an already well-defined proposal; capacity for economic analysis to question initial proposals is usually weak. ### Capital budgeting in low-income countries (LICs) — historical drivers and problems - Origins and persistence: - Separate current and capital budgets (“dual budget”) have origins in colonial administrations and persisted after independence. - Development ministries or planning ministries often took responsibility for identification, appraisal, budgeting, and accounting of investment budgets, reinforcing dual budgeting. - Donor preferences for funding “development” activities reinforced the separation. - Institutional dynamics: - Finance and planning/development ministries frequently issued separate budget circulars and presented separate budget documentation and classifications to parliament. - Special bank accounts, extrabudgetary funds, and trust accounts were used for donor-financed projects and counterpart funds, often outside central treasuries and accountants-general. - Special project management units in line ministries handled accounting and banking of external loans and grants, further fragmenting accounting and reporting. - Recurring issues: - Recurrent spending needs arising from capital projects were often under-projected or ignored; finance ministers were uninformed or unable to fund recurrent costs. - Double or overlapping budgeting occurred when line ministries negotiated separately with finance and planning ministries to receive funds for the same recurrent activities. - Lack of coordination led to weaker reporting, delays in closing government accounts, and difficulties reconciling accounting records with banking transactions. - Evolving donor practices: - Since the late 1990s, PRSPs, monitoring of poverty-reducing expenditures, sector-wide approaches, and budget support have increased donor financing of recurrent expenditures and pushed for more integrated approaches. - Public expenditure reviews (PERs) have shifted to combine recurrent and development expenditures in intra- and inter-sectoral analyses. - Current state: - Most LICs have at least begun using medium-term expenditure frameworks (MTEFs) to replace five-year national plans and public investment programs, but annual programming and budgeting of recurrent and development operations still tend to be carried out by separate organizations. - Organizational issues: - Some LICs have merged finance and planning ministries; many have not due to political, institutional, and remuneration incentives. - Staff of planning or development ministries have tended to be better paid and advantaged, reflecting externally financed project opportunities. ### Rationale for integrating recurrent and development budgets in LICs - Drivers for integration: - Government borrowing is no longer limited to capital expenditures. - Only an integrated analysis of recurrent and development expenditures can identify poverty-reducing expenditures with immediate or indirect impacts. - Part of external concessional credits, and the bulk of donor grants, are used for recurrent expenditures, supplementing the government recurrent budget. - Recurrent costs of capital projects continue to be ignored due to lack of coordination. ### Benchmarks and practical recommendations for budgeting for public investment in LICs - Determining the resource envelope: - Capital expenditure decisions should be based on a consolidated budget approach, incorporating all revenues and expenditures, in particular foreign-financed projects and extrabudgetary funds with investment activities. - Capital expenditure decisions should be based on a medium-term budget perspective. - Decisions regarding capital expenditures should be taken in the context of a hard budget constraint. There should be explicit ceilings for guarantees and commitments beyond the budget year. - Governments should have clear policies regarding which capital expenditures should be financed by the budget, which may be realized through public-private partnerships and which should be handled by public or private enterprises; policies should reflect cost structure and possibilities for user-financing, as well as political priorities. - Efficient prioritization and selection: - The budget calendar and procedures for integration of capital expenditures in the budget must be clear, transparent and stable. Development and analysis of capital investment proposals should largely be completed before the budget preparation process starts. - All projects should be subject to cost-benefit analysis. If subjecting all projects to cost-benefit analysis is too costly, focus could first be on the larger projects, using a simplified methodology for smaller projects. - A public investment agency, with strong links to the Ministry of Finance, should prepare guidelines for project development and analysis, review proposals to ensure adequate preparation and analysis, and have the authority to reject projects that do not meet established technical standards. - The Ministry of Finance should give the cabinet recommendations for which investment projects should be realized within the available resource envelope. Ministries should compete for investment funds based on net social value and political priority of proposals. - The decision to implement an investment project should be independent of the financing and procurement modalities. PPPs can improve risk allocation, but benefits must be substantial to compensate for increased financing and transaction costs. Decisions regarding PPPs should be an integral part of the budget process, and PPP arrangements should be fully disclosed in budget documents. - Efficient implementation: - Rules for budget adjustments should give incentives for realistic initial capital cost estimates. Cost overruns during project implementation should be partly covered by reallocation within ministry’s existing budgets. In the case of real cost reductions, ministries should be allowed to retain part of these. - Capital investment project proposals should only be considered when they include a detailed disclosure of the expected operating costs, indicating how these will be accommodated within existing resource envelopes or proposing additional financing for operating costs. - Capital investment project proposals should only be considered after the ministry has explained how it will fully cover the maintenance of its existing capital stock. - Governments should avoid excessive targeting of capital expenditures for budget cuts. Decisions on budget cuts should be based on the medium-term budget and take full account of future expenditure pressures as a result of under-funding. - There should be project completion reports for all capital expenditure projects; these should form the basis for cross-sectoral analysis, methodology development, and continuous improvements in the investment process. ### Conclusion - An effective capital budgeting process should be an integral component of a sound overall budgeting system. - A well-designed public financial management system supports capital spending through: - Good multi-year planning, supporting overall fiscal balance and more stable spending patterns. - Good budget execution and procurement, enabling timely, within-budget completion of projects (assuming good program and project management). - Financial management information systems that support financial and program management needs of the executive, ministries of finance and economy, spending ministries and program managers. - LICs should continuously aim to improve both capital budgeting processes and public financial management systems overall, recognizing that attaining these benchmarks will often take several years and that reforms may need to focus initially on a few key areas. *Source: _wp08160 - introduction of medium-term budget frameworks (MTBFs).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp08160.pdf_