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Public Finance Management Strengthening Programme
EVALUATION OF THE MACRO-FISCAL IMPACT
OF BUDGET NORMS AND EQUALIZATION
NEEDS ON THE GENERAL BUDGET
March 2009
Jean-Marc Lepain
Public Finance Specialist
Intergovermental Fiscal Advisor
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EVALUATION OF MACRO-FISCAL IMPACT OF BUDGET NORMS AND EQUALIZATION
NEEDS ON THE GENERAL BUDGET
EXECUTIVE SOMMARY
The introduction of a budget norm system integrated with the intergovernmental fund transfer
system is an important component of the public finance reform launched through the Public Finance
Management Strengthening programme. The introduction of budget norms over a period of time of
three years, with six year transition period, will have an important impact on the budget structure
and will bring more fiscal equality between provinces.
The present survey is based on the development of a macro-fiscal model that analysis disparities in
the allocation of funds between provinces and measure the fiscal gap likely to appear as a result of
the introduction of budget norms. Data generated by the model strongly support commendation
made in the “Budget Norm Policy Framework” which in the final phase of its development was
drafted in parallel with this report.
Disparities in funds allocation per capita are extremely high in Lao PDR and can easily reach 300% in
some sectors. As shown by the analysis, these disparities are not linked to any objective criteria such
as population structure, human poverty index, life expectancy, etc. Excessive pro-poor policies have
in some cases aggravated the imbalance when low population density provinces are compared with
high density provinces because these policies have not been applied uniformly across the country.
One vital question that we have tried to answer is the affordability of budget norms, considering the
equalization effect that they are likely to generate. The survey concludes that based on FY 2007/08
the fiscal gap required for equalization will be equal to 4.78% of that year budget. As the introduction
of budget norm will be progressive, the cost of closing the fiscal gap resulting from equalization will
be less than 1% of the budget per year. The conclusion is that the country will have no difficulty in
absorbing the equalization cost resulting from budget norms.
However the task remains complex and will require careful monitoring. Based on the Work Plan
presented in November 2008, designing budget norm formula for each sector and testing them on a
Medium Term Expenditure Framework and Macro-fiscal Model is a task requiring around 290 days of
work. The implementation phase will be complex as well and will require dedicated human resources
in the Fiscal Policy Department as well as in the Budget Department. For that reason we recommend
an implementation in three phases: year one for Education and Health; year two for Agriculture,
CTPC and general administration (line-ministries not delivering direct services to the population) and
year three for provincial administration. The implementation of budget norms, as already envisaged
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in the World Bank’s Aide Memoire of September 2007 should go hand in hand with a reform of
budget formulation at the provincial level and a better linkage between planning and budgeting.
An important finding of the survey is that provincial administration is the sector that will require the
most important fiscal effort with a total cost representing 38% of the fiscal envelope required for
budget norm implementation. The reason is that level of spending for local administration in the
provinces does not seem to be directly linked to population, service delivery or poverty. Introducing
budget norms in that sector will require a complete review of budget allocation by province to the
district and municipal level.
The main constrain on the implementation of budget norms is not the lack of fiscal resources at the
central level but the absorption capacities of the provinces. Equalization needs representing 30% of a
sectoral provincial budget are frequent but some provinces should see a doubling of their budget.
This raises two problems. The first problem is that some provinces have low sectoral budget not
because of a lack of resource but because of poor management. The new system should avoid
compensating provinces which have diverted resources from education and health to other sectors.
The second problem is that the capacity of absorption must be created before the budget is
increased. For example, for justifying an increase of the recurrent budget of education and health,
schools and clinics must be built and teachers and doctors trained and recruited. Then only the
budget for goods and services can be increased. Obviously this will require careful planning. Our
recommendation is that each of the three phases of the budget norm implementation plan must go
through a four years transition period. During that period increase in sectoral budget allocation will
be conditional and based on a local implementation plan approved by all relevant authorities at the
provincial and central level.
Tables which are appended to that reports gives all the details on the overall equalization cost, the
equalization model chosen, and the most likely scenario for a three phases implementation of four
years each, resulting in a total implementation plan of six years. Although than implementation
period might seem long, we expect that most of the benefits will appear during the third year and by
that time 80% of equalization needs will have been covered, as the cost of equalization is likely to be
reduced by inflation from one year to the other.
Last but not least, we would like to stress the fact that accounting data entered in GFIS do not reflect
the reality of provincial expenditures, making the introduction of budget norms very difficult. This
due to several factors: (a) some investments recorded centrally are in fact local investments and
should be recognized are part of provincial budgets; (b) a lot of small investments recorded at the
local level are in fact maintenance expenditures, (c) according to data from MPI, most of the
provinces have built important arrears which do not appear as such in accounting but are disguised
as ongoing projects. MPI is trying to keep the payment of arrears under 35% of the investment
budget, but it can reach 70% in some cases. (d) Governors might make fund transfers from one
sector to another sector which are not recorded in accounting. These facts highlight the need for the
reform budget formulation procedures to go hand in hand with a reform of budget execution
procedure and stricter implementation of accounting rules.
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1. Introduction
The introduction of a budget norm system integrated with the intergovernmental fund transfer
system is an important component of the public finance reform launched through the Public Finance
Management Strengthening programme. The introduction of budget norms over a period of time of
three years, with six year transition period, will have an important impact on the budget structure
and will bring more fiscal equality between provinces.
The success of this reform will depend on seven factors:
(1) The implementation of a new fiscal strategy required for absorbing the impact of budget
norms over a period of time of six years
(2) The successful integration of the budget norm system with the Intergovernmental Fund
Transfer System based on a number of grants;
(3) The successful integration of budget norms in new the multi-year planning and budgeting
process under development with the Assistance of ADB;
(4) The completion of the treasury centralization reform and the implementation of the Single
Treasury Account that will ensure that provincial budget are correctly implemented and that
no fund move from one sector to another or from one project to another;
(5) The deepening of other reforms such as the introduction of programme budgeting and a
better integration of the investment budget and the recurrent budget,
(6) The modernization of the budget formulation process at the Ministry of Finance, and
(7) A complete reformulation of the planning and budgeting process at the provincial level with
sufficient capacity building. This reformulation process should clarify various levels of
responsibilities between the central government and the provinces for planning and budgeting
as well as
Overall, the introduction of budget norm should lead to a number of very positive outcomes:
A better equalization of expenditures between provinces and better predictability of
provincial budget;
A better balance between centralization and decentralization in budget formulation;
A better linkage between provincial budgeting and the National Growth and Poverty
Reduction Strategy objectives;
A strengthening of macro-fiscal planning and a better integration between planning and
budgeting at the national level
A better alignment of provincial budgets with national objectives and increase efficiency in
provincial spending
Improved service delivery at the provincial and district level
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I. METHODOLOGY AND GENERAL OUTCOME OF THE SURVEY
1. Objectives of this report
As indicated in the Work Plan prepared in November 2008, the calculation of the budget norm fiscal
envelop is the first step toward the design of the budget norm and intergovernmental transfer
system. The sizing of the fiscal envelop requires two things:
(a) An evaluation of the budget gap when current budget is compared to a prospective budget
calculated with an equalization formula reproducing the likely impact of the introduction of
budget norms.
(b) A fiscal strategy that will determine the ways and means of absorbing the equalization cost,
presumably by assigning part of the future revenue increase to various fiscal envelopes.
This report is primarily concerned with the first point: the evaluation of the budget gap and the cost
of equalization induced by the introduction of budget norms. The fiscal strategy required for
absorbing that cost will only be broached in the last section of that report with the objective to
identify the different options in terms of definition of the different fiscal envelops in competition,
and of the time frame required for absorbing the cost.
As a consequence of the methodological requirements, the objectives of the present survey have
been identified as follows:
to ensure that the introduction of a budget norm system with its equalization function is
affordable;
to make a first assessment of the fiscal enveloped required for the system implementation
along with the outline of a fiscal implementation strategy;
to define more precisely the sectors to which the budget norm system will apply;
to define fiscal target zones, or pre-norms, that will help defining budget norms by sector; for
example minimum spending per capita for sectoral recurrent budget, arithmetic relation
between the minimum investment budget and the recurrent budget, non-wage expenditures
as a percentage of salary, maintenance cost as percentage of investment. In the tables that
have been appended to this report, these fiscal target zone for budget norms appear as
“equalization norm”. However, it should be noted that those equalization norms will not
become part of the budget norm system. They only indicate a level of spending with which
budget norm must be compatible.
to determine the outline of a fiscal strategy for absorbing the cost of budget norm and for
determining a comprehensive approach of the evaluation of budget needs as part of an
interim strategy until the new Medium Term Fiscal Framework linked Medium Term
Expenditure Framework under development is put in place.
to prepare the way for sectoral expenditure need assessment by defining each sector
equalization needs and making a first assessment of the balance required between recurring
expenditures and investment.
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2. Outline of the Budget Policy Framework
The draft of the Budget Norm Policy Framework is now completed and awaiting approval by MoF’s
management. Although the possibility exist that the document might be amended changes are
unlikely to affect to general principles on which the document is based.
The policy framework envisaged is a two tiers system with two types of budget norms:
-Budget norms defining the size of the intergovernmental transfer to the provinces;
-Sector budget norms to allocate funds between economic categories at the local
level.
Budget norms for intergovernmental transfers will be based on equalization principles
Salaries will remain unaffected by sector budget norms at the local level but will be
nevertheless included in the formula for intergovernmental transfer.
What will be available for non-wage spending will be calculated after deduction of salaries
Provinces with expenditure above the equalization norms will
3. New definition of sectors
A few changes have been made in the definition of sectors compared to what was presented in the
November 27th version of the Budget Norms’ Policy Framework and have been consolidated in the
final version of the document.
Education, Health and Agriculture remain as the core sectors of the budget norm system
Transport and Telecommunication has been added to the list of core sector because (a) the
ministry is responsible for district roads, (b) investment for the lay-off of landlines and other
telecommunication infrastructures will play a role in the country development strategy.
A sector called “General Administration” has been created to cover at the provincial level the
ministries of Industry & Commerce, Information & Culture, Justice, Finance, and Planning
Provincial Administration has been added as an independent sector
Energy and Mining so far remains outside of the scope of the budget norm system
Labour has not been integrated in “General Administration” due the importance of social
transfers for that ministry. The expenditure need assessment for General Administration will
determine if the Ministry of Labour should be integrated in that sector or not.
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“Other organizations” thar covers the Ministry of Foreign Affairs, Police, Defence, etc.,
remain out of the scope of the budget norm system.
The question of access to clean water will be probably treated under provincial administration with
the possibility of having specific budget norms for sanitation.
4. Methodology
In the absence of figure for FY2008-09 budget, we have used figures of FY2007-08 budget for the
macro-fiscal model. The assumption is that the budget structure is relatively stable and the cost
expressed in relative terms (percentage) should not be very different, as horizontal imbalance in
sector spending across provinces is structural.
The survey covers only funds administrated by the provinces. Cost of the possible introduction of
budget norms at the central government level should be very limited because there will be very few
budget norms and no need to integrate them in a fund transfer formula. The cost for recurrent
expenditures should no exceed 0.5% of the general budget. The 0.5% will mostly apply to
maintenance costs.
Assumptions for equalization have been formulated for each sector. The level of equalization has
been determine in a way that minimize cost without leaving more than 5 to 6 provinces above the
equalization line set by budget norms. It is assumed that provinces above the equalization threshold
will beneficiate from ad hoc grants during a transition period necessary for integrating all provinces
in the system.
For the recurrent budget, the main criteria for determining the optimum level of equalization have
been the number of provinces above the equalization line combined with affordability. The objective
has been to have no more than 6 provinces above the equalization line, with an average of 5 (see
table below).
A total equalization of investment spending across provinces is neither possible nor desirable as large
investments in infrastructure are always exceptional in nature. The equalization line for investment
has been defined as a minimum envelope for investment either based on population or on a
percentage of the recurrent budget. As a consequence, the number of provinces above the
investment equalization line fluctuates between 4 and 12, depending on sectors. Equalization of
investment is easy for Agriculture, Provincial Administration and General Administration, because
those sectors are not dependent on large infrastructure investments. Equalization is nearly
impossible for Health and CTPT, and problematic for Education. Our first recommendation is to
introduce a distinction between small and large investments and to exclude large investments from
the budget norm system. This raises several issues that MoF will need to address. Some sectoral
investment budgets are so small that they can hardly qualify as investment at all, especially if we
consider that the budget must be spit between several line-items. This is the case of the investment
budget of Justice which is 20 millions kips in Atapeu, 50 millions kips in Phongsaly and 60 millions
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Bolikhansay. Some investment budget can be as small as 10 or 20 millions kips. The Accounting
Department should determine a minimum threshold for expenditure to be recorded as investment
with depreciation rules set accordingly.
There are three good reasons to include at least partially investment norm in the budget norm
system:
Any significant increase of any local budget will require some new investments (It is
impossible to increase significantly the number of teachers without increasing the number of
school).
Any investment has an impact on the recurring budget because it raises the maintenance
cost of fix assets and therefore impacts directly the provision of goods and services.
Funds for investment should be included in the intergovernmental fund transfer system
either as unconditional grant or as ad hoc grant.
However we agree that budget norm cannot cover large investments. Budget classification needs to
distinguish between “national investment”, “provincial investment” and “district investment”. In a
distant future, when local planning will improve, the MTEF will be made by province, defining fiscal
envelopes for local investments.
Recurrent Investment
Budget Budget
Education 5 8
Health 6 12
Agriculture 4 5
CTPT 5 8
Provincial Administration 6 5
General Administration 6 4
NUMBER OF PROVINCES ABOVE THE EQUALIZATION LINE
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5. Integration with the medium term fiscal policy
Usually the introduction or the modification of budget norms is done within the context of the
general fiscal policy of the country and required to be integrated with the Medium Term
Expenditure Framework (MTEF), itself the reflect of macro-economic and macro-fiscal policies
decided at the highest level of the self.
ADB / Maxwell Stamp team in charge of the development of the MTEF has come to the conclusion
that due to important methodological issues and capacity limitation the development of a full-fledge
MTEF would be impractical. The first methodological issue is that the MTEF must be based on a
Medium Framework Macro-Economic Framework (MTMF) and a Medium Term Fiscal Framework.
ADB / Maxwell Stamp team has suggested replacing the MTEF by a Medium Term Budget Framework
(MTBM) that would combine the MTMF, the MTFF and the MTEF in one simplified document.
Because of this issue, a close cooperation between the Intergovernmental Fiscal Adviser and the ADB
/ Maxwell Stamp team has been put in place with almost daily short meetings and frequent
discussion of the macro-fiscal model. The ADB project inception report has been prepared in close
consultation with consultant; even minor areas of disagreement might subsist. The new team leader
is also promoting cooperation with the two projects.
Although, most of the data for the MTMF are already collected by the Fiscal Policy Department and
used for revenue forecasting, it does not appear that there is a multi-year formal MTMF. The main
consequence is that assessing the impact of the current economic crisis on revenue collection
becomes very difficult. However determining this impact is critical for assessing the timeframe
required for the absorption of the budget norm cost and absorbing new budgetary needs.
Usual budget norm methodology requires the use of an MTEFF to ensure consistence between
sectoral fiscal envelopes, programmes and projects. In the absence of the MTEF, there is no other
solution that conducting an Expenditure Need Assessment as described in the work plan. Like the
MTMF, the MTFF faces methodological issues, one being the lack of integration between the
recurrent budget and the expenditure budget, the other being the absence of programme budgeting
resulting in lack of accounting data for programmes. The Expenditure Need Assessment and planning
process for budget norms will face the same issues. Additionally the Expenditure Need Assessment
will be confronted to the lack of data on programme and project by province.
The Sectoral Expenditure Need Assessment can be an important step in the development of the
MTBF and the MTEF. It has been already been decided that ADB / Maxwell Stamp team will be
associated to this project phase. However it is not yet clear if the MTBF will general additional
requirements for the expenditure survey. Requirement for budget norms will be clearly identified in
the Project Strategy. The ADB / Maxwell Stamp team will need to identify its own requirements and
synergies, because the Budget Norm timeframe does not allow any delay that might be required for
extending the expenditure survey requirements.
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6. Other policy and regulatory issues
The introduction of budget norms for investment is always difficult when there is no complete
budgeting autonomy at the provincial level. On the other hand, having no norm for investment
would cause even more serious problems as we need a mechanism that link the growth of the
recurrent budget to improvement of service delivery impossible without a additional investments.
The result could be that the increase in spending on the recurrent side would be waisted due to the
lack of proper level of investment or that the level of investment would be too high, resulting in
infrastructures that cannot be maintained. As complete budgetary autonomy is not desirable, it has
been proposed to define budget norms for investment as a minimum level of investment. In theory
this could mean that the province will be authorised to spend freely that fiscal envelope with
possible contraction with the with the investment plan developed at the central level. The use of
investment fund will require additional clarification that should reflected in regulation issued by MoF
and the Ministry of Planning. A reinforcement of cooperation between the MoF and the Ministry of
Planning would be necessary. That level cooperation could be achieved through a joined Macro-
Economic Planning Committee as already recommended by ADB / Maxwell Stamp team.
7. Introduction of budget norms at the level of the Central Government
The introduction of budget norms at the level of the Central Government is an issue that has been
tackled only superficially in the Policy Framework but that is not expected to cause major problems.
This section will address partially the problem through the angle of the potential cost of the different
systems under consideration.
The allocation of funds to line-ministries can be based on different budget norm systems:
a) A resource sharing formula that will split resources between the Central Government and the
provinces
b) Budget norm that define fiscal envelopes by sector
c) Budget norms that defined the relation between the recurrent budget and the investment
budget
d) Budget norms that allocate fund between different economic categories of the budget
It should be remarked that the transfer of funds to the Central Government’s agencies does not have
the same constrains that the transfer of fund to provinces that require an equalization formula. As a
consequence there is no need to integrate budget norms for the central government to any fund
transfer system. This gives the Government a lot of freedom in the way that funds are assigned and
our view is that the Government should keep as much flexibility as possible by limiting the number of
budget norms.
A. Expenditure Assignment Formula
As we will see in the next section, in fiscal year 2007/08 the spit between central government and
provincial expenditures was 51.62% / 48.38%. This resource assignment seems to have been fairly
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stable along the years and that raise the possibility to have an Expenditure Assignment Formula that
will assign for example 52% of all resources to the Central Government and 48% to the provinces and
that possibility has been suggested by some members of the Budget Norm Committee.
However Expenditure Assignment Formulae do not work as well as Revenue Sharing Formulae
because the total budget ceiling of the state does not depend only on revenue collection but also on
borrowing and borrowing decisions takes many factors in consideration such as debt service, macro-
economic stability and ad hoc financing of large investment.
The second thing that we need to take into consideration is that the expenditure split of 51.62% /
48.38% that we see in accounting does not represent reality. In practice a number of investment and
maintenance contracts are signed in the capital by line ministries but benefit the provinces. This is
certainly the case of health and telecommunication infrastructures, national roads, airports, power
generation and distribution, and mining. Our accounting coding system for the past years did not
allow the clear identification of provincial expenditure and although progress have been made by the
introduction of the new accounting system the problem has not been solved completely.
Another issue is the rigidity that such system will introduce. According to a 2006 survey 87% of civil
servants works in the Provinces against 13% in the central government. With the recentralization of
the state, capacity of the central Government will need to be strengthened and probably more staff
recruited. It would be dangerous to freeze expenditure assignment between the centre and the
provinces when the Central Government is such a need of expanding its outreach, strengthening it
planning and monitoring capacity and developing new services and function.
B. Sectoral Budget Norm
In a few countries we can find systems that allocate resources to sectors using budget norms. Those
norms are either expressed as a percentage of budgets or more frequently as a percentage of GDP.
However most governments prefer using non mandatory objectives that are expressed in fiscal policy
terms and can become binding if endorsed by a Parliament.
The main objections which have been raised against expenditures assignment systems can also be
used against sectoral budget norms.
Such an approach appears impracticable in Lao PDR due to low revenue collection and past distortion
in sectoral fund allocation. Education is likely to keep absorbing a large portion of revenue growth.
Investments in roads and transports will probably slow down and more efforts must be made in
proving health services. Such a situation requires year by year fine tuning. Sectoral Budget Norm
would create a straight jacket that would put counter productive constrains on Government’s policy.
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C. Relation between the recurrent budget and the investment
As already said, the question of the relationship between the recurrent budget and the investment
budget is made more difficult by the fact that line-ministries may sign contracts that are
implemented in the provinces. There is not a strong stance for implementing budget norms in that
areas but something can be done to avoid under investment and, even more important, over
investment.
There is a strong tendency in the Lao DPR to inflate the investment budget in the hope of boosting
GDP growth. Investments are often in competition with improvement of Government’s service
delivery. Maintaining the right balance between the investment budget and the recurrent budget is
critical for sound public finance. The size of the fiscal envelop available for investment should be
determined in function of a number of factors such as the maintenance cost of existing investments,
the cost of expending or improving Government’s service delivery
D. Budget norms for economic categories
The new chart of account is based on three economic categories
Salaries
Goods and Services
Capital Expenditures
Capital Expenditures have already been discussed in the previous section.
Regarding salaries, their structure and the level of compensation is determined by the Civil Service
Commission and the number of civil servants is approved by the Prime Minister Office. The
Expenditure Need Assessment will have to check if the same horizontal imbalance that we see in
financial resource allocation does not exist for human resource allocation. Equalization of financial
resources should go hand in hand with the equalization of human resources. The Expenditure Need
Assessment will have to determine the strategy to reach that objective.
Goods and Services is the economic category on which budget norms are expected to have the
greatest impact. Each sector will have different norms to ensure that (a) operating expenditures are
covered, (b) there is enough budget for fix asset maintenance.
8. Main Outcomes of this Survey
The six sectors under consideration (Education, Health, Agriculture, CTPC, General Administration,
and Provincial Administration) represent 48.38 % of the general budget. The two main constrains of
the budget norm system will be (a) its affordability and (b) the absorption capacity of the provinces.
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a) Preliminary results from the macro-fiscal model show that the impact of the budget norm
system on the budget will be minimum; therefore affordability does not appear to be an
issue. The total fiscal envelope required is estimated to be around 4.36% of the budget over
six years for provinces. The cost will be minimum during the first year (0.39%) and will pick
during the third year (1.31%) before starting to decline after. Additionally, the cost of budget
norm at the central level of government might generate an additional increase of 0.5% of the
general model. This is only a guestimate, as the macro-fiscal model, in the absence of a
budget for FY2008/09 based on the new chart of account and budget classification cannot
tell us much about that. The old chart of accounts does not allow a clear distinction between
salaries and social transfers and between investments and maintenance costs.
b) Absorption capacity, define as the capacity of the poorest provinces to bring there
expenditure average national level set by budget norms appear to be a more crucial
problem. According to initial projections, that need to be discussed with the Ministry of
Education, it will take four years for the less advance provinces to reach the national average.
c) Budget adjustments must be incremental. Some provinces have under-invested in sector like
education, health and agriculture. Having large year to year increase of their sectoral budget
will not help them because there will be bottleneck to raise rapidly their level of spending.
Bolikhamxay spent half of the nation average per capita (41,000 kips against 81,000 kips) on
education. Raising suddenly the level pending of Bolikhamxay to the national level would not
produce any result, because schools need to be built and teachers need to be recruited and
trained before the province can spend the money. The Expenditure Need Assessment that
will be undertaken during the second phase of the design of the Budget Norm System
d) One of the major finding of the survey is that provincial administration is the sector that will
require the most important fiscal effort with a total cost representing 38% of the fiscal
envelope required for budget norm implementation. The reason is that level of spending for
local administration in the provinces does not seem to be directly linked to population,
service delivery or poverty. Because tacking the issue of provincial administration might be
difficult, we have isolated sector as a distinct phase of budget norm implementation that will
not start before the third year of the implementation plan. It does not mean that the
problem should be ignored. On the contrary we think that the two first years of the
implementation must be used for preparing a comprehensive plan that will address the
major issues of the delivery of government services at the provincial level, the strengthening
of provincial planning and budgeting, and the rationalization of provincial administration. It is
clear that without an important effort to make provincial administration more efficient,
efforts made by line-ministries for improving their service delivery in the provinces might fail.
9. Budget Norms Fiscal Envelope
The Work Plan prepared in November 2008 was based on the assumption that the
introduction of budget norm could be completed in three years and that most of the cost
could be absorbed during the first year The present studies shows that budget norms will
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need far more time than initially anticipated, not so much because of budgetary restriction
but because of the limited absorption capacity of the provinces. However the fiscal envelope
required is very affordable. Contrary to what was thought in November 2008, there will be
no need to earmark funds for sectoral budget norm implementation. Over the next three
years we can expect that inflation will remain around the present level of 8-10% and that
economic growth will remain substantial. As a consequence the nominal budget will grow at
a minimum rate of 15% to 20%. The 1% required for budget norm will be easily absorbed by
inflation. As for provinces above the equalization line, if their allocation grows at half the rate
of other provinces, that should be enough to solve the problem of horizontal imbalance.
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II. SECTOR ANALYSIS
1. Education Sector
The national education budget represents 12.8% of the general budget, a very low rate compare to
other ASEAN countries or to countries with a similar level of development.
The provincial budget of 546,214 M kips represents only 47.9% of the total education budget.
However that figure might be misleading because some investments are finance centrally.
Budget Economic Categories Amount % %
Total Provincial Budget 546 214,62 100,00%
Investment Budget 90 102,76 16,50%
Recurrent Budget 456 111,86 83,50% 100
Salaries 379 075,71 69,40% 83,11%
Com. & Allowances 56 438,76 10,33% 12,37%
Salaries + Com. & Allow. 435 514,47 79,73% 95,48%
Goods & Services 20 597,39 3,77% 4,52%
EXPENDITURE BY ECONOMIC CATEGORIES: EDUCATION
Out of a provincial budget of for FY2007/08, 83.5% goes to the recurrent budget and 16.5% to the
investment budget. The level of investment is low compared to the need and experience in other
countries with similar level of development. By it has been impossible precisely how much of the
central investment budget is allocated to provincial projects.
Out of the recurrent budget 95.48% goes to salaries and compensation and allowance, leaving only
4.52% for good and services. However there are important fluctuations of that ratio across provinces.
This ratio suggest no only that there is not enough funding for books and teaching material which are
paid by the families, but that no money is left for basic building maintenance, casting a doubt on the
viability of the present investment policy. Only investments made in FY2007/08 would require a
maintenance budget representing 1% of that year recurrent budget. As a consequence we can
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estimate the real maintenance need between 15% and 20% of the present recurrent budget; a level
consistent with international experience.
The national average spending per capita on education is 79k kip, with important variations across
provinces. There is no linkage between education expenditure per capita and the poverty level.
Houaphan, the poorest province with a Human Poverty Index (HPI) of 1.52, spend 89 k kips per
capita, reasonably above the national average, but well below Xekong (91k kip per capita with a HPI
of 1.51) while Saravanh with HPI of 1.54 spent only 54k kips. The highest level of spending (129k kips
per capita) is found in Vientiane province which has one of the lowest level of poverty (HPI = 1.19),
but paradoxically, that level of spending fall to 65k kips in Vientiane Capital (HPI = 1.17). The lowest
level of spending is found in Bolikhamxay (HPI = 1.29).
More disparities are found in the investment budget. The ratio Investment/recurrent expenditure
fluctuates between 5.81% (Louang Prabang) and 65.32% (Houaphan). Despite a low level of recurrent
spending, Vientiane Capital has a high level of investment. Houaphan with 5% of the country total
population has an investment budget representing 140% of Savannakhet with 14.7% of total
population.
For the purpose of macro-economic simulation of expenditure equalization, we have selected a level
of equalization of 85 m kip per capita for recurrent expenditure. This level of equalization leaves six
provinces above the equalization line. Eleven provinces will require an increase of their budget
representing 5.6% of the total education budget and 0.77% of the general budget.
Regarding the investment budget, it has been decided that the equalization approach was not
possible as the central government must keep the control of large investment programmes. Instead
we have defined a minimum investment envelope representing 7% of the corrected recurrent
budget. This minimum investment envelope leaves ten provinces above the line but require only
minor budget adjustments for four provinces representing only 0.5% of the sector budget and 0.06%
of the general budget. During the expenditure need assessment and after consultation with the
Ministry of Education and the Ministry of Planning we will see if it is a valid approach for budget
norm. In that case we will introduce a budget norm for small investments, and large investments will
be financed by ad hoc grants.
Education is the sector which, after provincial administration, will require the more adjustment for
equalization of expenditure, mostly in the recurrent budget. However the present approach is purely
macro-fiscal and is not based on an expenditure need assessment. It does not take into consideration
efforts that must be made independently from the introduction of budget norms if the Lao PDR
wants to meet it millennium development goals. The Expenditure Need Assessment, due to start
shortly, will tell us more of the real needs of the sector. However we can already see a contradiction
emerging between the need for increasing the recurrent budget for financing maintenance cost and
teaching materials, and the need for investing more in construction of teaching facilities.
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2. Health Sector
The total health budget represents 3.85% of the national budget. The provincial budget of 546,317 M
kips represents 47% of the national budget, but like education some investments might be financed
centrally.
Budget Economic Categories Amount % %
Total Provincial Budget 160 845,56 100%
Investment Budget 54 677,92 34%
Recurrent Budget 106 167,64 66% 100
Salaries 62 224,32 39% 58,61%
Com. & Allowances 28 188,56 18% 26,55%
Salaries + Com. & Allow. 90 412,88 56% 85,16%
Goods & Services 15 754,76 10% 14,84%
EXPENDITURE BY ECONOMIC CATEGORIES: HEALTH
The provincial budget represents 47% of the national budget. Investments at the consolidate level
(central + local) represent 56% of the national budget and only 34% of the provincial budget,
suggesting that some major investments made in the provinces might be financed centrally. In any
case, the level of investment appears too high in relation to the recurrent budget.
34% of the central budget is earmarked for goods and services, against only 14.8% of the provincial
budget. Here again the possibility exists that some goods and services (such as vaccine) are
purchased centrally, but for the purpose of transparent information it appears important to correct
the accounting. In any case, the 14.8% recorded at the provincial level appear too low for a proper
functioning of medical facilities. A well equipped hospital in a developing country can have an
operating budget representing 50% to 100% of the initial investment, depending on the technology
level of the equipments.
Expenditure per capita fluctuate from 11k kips in Vientiane Capital to 36k kips in Xekong, but that
province appears to be an exception. In general, recurrent expenditures per capita tend to be low in
most populated provinces such as Vientiane Capital, Savannakhet and Champassak. The national
average is 18k kips per capita, but raise to 19.5k kips if we exclude Vientiane Capital.
With a average spending per capita of 18 m kips for the recurrent budget, we have put the
equalization line at 21k kips per capita. That level of equalization still leaves eight provinces above
the line. Xiengkuang and Bokeo spent 22 k kips, and there is of course the possibility to consider 22 m
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piks a better level of adjustment. However we have taken a conservative approach. Only discussion
with the Ministry of Health will tell us what the correct level of equalization is.
With 17 provinces, the Lao PDR cannot expect delivering all medical services in all provinces.
Regional centres covering certain medical specialities and serving several provinces will have to be
created. Within that context, it is impossible to equalize investment across provinces. Like education,
we have only defined a minimum level of investment which temporarily has been put at 12% of the
recurrent budget. It leaves 11 provinces above the equalization line, but as already said large
investments in the health cannot be based on equalization or budget norms. What is important is to
define a minimum level of investment that will allow the renewal of medical equipments.
3. Agriculture Sector
The agriculture budget represents only 4.4% of the national budget. A very low amount for a sector
that represents nearly 50% of the GDP, employs 80% of the work force and has been growing at 5%
per year during the last decade.
The main characteristic on the agriculture budget is that investments take the lion share with 81,3%
of all funding. 55.8% of the investment budget is executed centrally and 44.2% locally.
Local budgets represent 49% of the sector budget. Recurrent spending in provinces fluctuate
between 4k kips per capita (Houaphan, against 6k kips in Vientiane Capital where agriculture is not a
priority) and 23k kip in Xekong. At the national level, the average level per capita is 9k kips but should
not be considered as significant considering that the State deliver few direct services to the
agriculture sector.
The agriculture recurrent budget is the easiest budget to equalize. We have put the equalization line
at 11 kips per capita, representing only an increase of 0.38% of the national budget.
The situation is very different for investments. On average, the State spent 25k kips per capita on
agricultural investments, with fluctuations going from 4k kips in Louang Prabang and 112k kips in
Attapeu. Paradoxically, Xekong which has one of highest recurrent budget has also one of the lowest
investment budgets. We have put the equalization line at 23k kip per capita and we have excluded
Vientiane Capital from the budget norm system as we do not expect any need for major investment
there. It leaves only five provinces above the equalization line.
Budget norms for agriculture will need to distinguish geographic areas by the type of dominant
agriculture, such as irrigated land and non irrigated land, plain agriculture and mountain agriculture,
etc. Mountain agriculture has a strong link with poverty.
4. CTPC
The Ministry of Construction, Transport, Post and Communication has very disparate activities that,
for the most part, should not enter in the budget norm system. Part of the activities of the
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telecommunication branch should be excluded from the budget norm system and most probably the
postal activity. That will leave only provincial and district roads. However, only the Expenditure Need
Assessment will allow defining more precisely the perimeter of budget norms in that sector.
Because the budget data that we have received do not allow distinguishing between the different
activities of the ministry we have made only a rough estimate of the impact of budget norm on the
system.
The CTPC Budget is the largest economic sector budget. Representing 14.16% of the national budget
it is larger than the education budget. The sector is mostly driven by investment financed by foreign
capital. The investment budget represents 97.2% of the sector budget. 79.6% of the investment
budget is financed by foreign capital. That level of investment is probably unsustainable in the long
term and raises the question if budget norm can apply to that sector.
The recurrent budget represents 2.84% of the sector budget, with 55.2% of the recurrent budget
going to the provision of goods and service. Considering the very high level of investment in the
sector, those figures appear impossible. Even if infrastructures are poorly maintained, their
maintenance should represent a minimum of 10% of the value of existing investments. The
conclusion is that most maintenance costs are probably entered in the accounting system as new
investments.
In that context only the Sector Survey and the Expenditure Need Assessment will allow us to cost the
maintenance needs and the cost of equalization can be only a guess. We have put the equalization
cost at 0.72% of FY2007/08 budget with 0.07% going to the recurrent budget and 0.66% going to
the investment budget. As there might either no investment norm for that sector, or a norm that will
apply only to the transport budget, we expect the 0.66% to go mostly to maintenance of existing
investments.
5. General Administration
As explained earlier, we have decided to aggregate the local budgets of the ministries of Industry &
Commerce, Information & Culture, Justice, Planning and Finance in one sector that we have name
“General Administration” and that comprise mostly the representative offices of those line ministries
in the provinces, with the exception of Justice that has a more extensive presence.
The budget of that sector remains very small in comparison with other sectors with only 2.12% of the
national budget. 70% of that budget goes to recurrent expenditures and 30% to investment.
However, when we look more in details to the investment budget of the provincial offices of the
ministries, a large number of line items are so small that they do not qualify as investment per se but
should be rather considered as the provision of goods and services.
The national average spending per capita for the recurrent budget is 22k kips, against 9k kips for
agriculture, and 18k kips for health. However we should keep in mind that the sectoral budget must
be split between five ministries. However, putting most of the general administration under one roof
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would certainly generate important saving and facilitate the introduction of a single window for most
government services.
The introduction of budget norms in that sector should be relatively easy and could be based mostly
on population. We have put the equalization line for the recurrent budget at 11 m kip with only four
provinces above the line.
Regarding investments, we have put the minimum budget at 6 m kip per capita that leaves only five
provinces above the equalization line.
The cost of equalization represent only 0.40% of the general budget, with 0.28% going to the
recurrent budget and 0.12% going to the investment budget.
6. Provincial Administration
Provincial Administration is the sector where the introduction of budget norms will be the more
difficult but also the more needed. Local budgets for provincial administration show wide disparities
between provinces and there is no obvious link between spending and population, service delivery or
poverty. For these reason we have isolated the introduction of budget norms for provincial
administration as a separate project phase taking effect on the third year on the implementation
plan. However, we consider that preparation of the reform should start much earlier, probably in the
last quarter of 2009 or in early 2010.
The introduction of budget norms for provincial administration should be linked to the reform of
local budget formulation which is also part of the Intergovernmental Fiscal Advisor’s Terms of
Reference, but also to the reform of civil service, the introduction of Operational Expenditure Block
Grants and the creation of District Development Funds (DDF), although DDF block grants might have
more impact on key ministries’ local budget.
On average, the Lao PDR Government spend 163 k kip per capita for provincial administration,
compared to 80 k kips for education, 18 k kips for health or 9 k kips for agriculture. Recurrent
expenditures for provincial administration represent 33.35% of all provincial expenditures and
investment budget 5%. The weight of provincial administration in provincial administration explains
the impact that equalization will have.
However there are considerable disparities in spending between provinces. The lowest level of
spending is found in Savanaketh with 100k kips per capita and the highest level of spending is in
Attapeu with 420k kips per capita. In general, the most populated provinces have a level far below
the national average. This can suggest two things: either in densely populated provinces the
provincial administration is under represented or important economies of scale are made in those
provinces. The truth is probably a combination of the two explanations. It does not appear that there
is any correlation between poverty and the cost of provincial administration and we do not think that
any one should be made.
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Several factors should be taken into consideration for the introduction of budget norms. One is the
share of provincial services in the local budget. Part of the activity of provincial administrations is
directed at managing the province relations with the central government and that activity is not
directly affected by land area or poverty and is directly proportional to the size of the population.
Delivery of provincial services is affected by factors other than poverty such urbanization rate and
population density. The more the population is scattered the more the delivery government services
is difficult.
Following this analysis we have decided to divide provinces in three categorises
1. Provinces with population less than 270.000 inhabitants
2. Provinces with population from 270.000 to 500.000 inhabitants
3. Provinces with population more than inhabitants
We have taken a very conservative approach keeping the equalization norm as close as
possible to the category average.
Equalization norms and target zone for budget norms have been defined as follow:
Average Equalization Average Equalization
Spending Norm Spending Norm
Up to 270.000 inhabitants 0,255 0,250 0,037 0,040
From 270.000 to 500.000 inhabitants 0,171 0,170 0,032 0,032
Above 500.000 inhabitants 0,114 0,134 0,010 0,010
Recurrent Expenditures Capital Expenditures
For the three most populated provinces, the equalization norm is equivalent to raising Vientiane
Capital and Savanakhet to the same level of spending as Champasak. The expenditure need
assessment will tell us if it is justified.
Despite the fact that the equalization norm is very close to the category average except for the
smallest provinces which are also the poorest, the impact on the national budget is important. The
equalization need is estimated at 1.77% of FY 2007/08 budget,1.24% going to the recurrent budget
and 0.53% going to the investment budget.
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7. Equalization Model
The Equalization model defines the “equalization line” which is the level of spending that equalizes
the level of spending per capita for the majority of provinces. Budgets of provinces under the
equalization line need to have their budget increased. Budget of Provinces above the equalization
line will increase more slowly than other provinces. However complete equalization of spending per
capita for all sectors is neither possible nor desirable.
The Equalization Model gives us indicative equalization norms that represents target zones for
budget norms. For example the Equalization Model tells us that all budget norms for the education
sector should result in a level of expenditure per capita “around” 85,000 kip. That number will be
adjusted to take into account the poverty level of each province and other factors such as population
density, urban zones and rural zone, etc., and specific local conditions such as teachers receiving
special compensation for teaching several grades in poor provinces.
Education Sector
Recurrent Budget : 85,000 kips per capita
Investment Budget: 7% of recurrent Budget as minimum investment envelope
Maintenance cost: 5% of investment
Health Sector
Recurrent Budget: 21,000 kips per capita
Investment Budget: 12% of recurrent Budget as minimum investment envelope
Maintenance cost: 10% of investment
Agriculture & Forestry Sector
Recurrent Budget: 11,000 kips per capita
Investment Budget: 26,000 kips per capita
Maintenance cost: 8% of investment
CTPC Sector
Recurrent Budget: 4,000 kips per capita
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Investment Budget: 35, 000 kips per capita
Maintenance cost: 10% of investment
General Administration Sector
Recurrent Budget: 25,000 kips per capita
Investment Budget: 6,000 kips per capita
Maintenance cost: 5% of investment
Provincial Administration
Recurrent Budget
For provinces with population less than 270,000 inhabitants: 255,000 kips per capita
For provinces with population between 270,000 and 500,000 inhabitants: 171,000 kips per capita
For provinces with population more than inhabitants: 134,000 kips per capita
Investment Budget
For provinces with population less than 270,000 inhabitants: 40,000 kips per capita
For provinces with population between 270,000 and 500,000 inhabitants 32,000 kips per capita
For provinces with population more than inhabitants: 10,000 kips per capita
Maintenance cost: 5% of Investment
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III. FINANCE AND IMPLEMENTATION STRATEGY
1. A three phase approach
For practical and financial reasons the budget norm system cannot be implemented at once. After
analysis of the financial and technical constrains, we recommend implementing the budget norm
system in three phases:
Phase 1: Health + Education
Phase 2: Agriculture + CTPC + General Administration
Phase 3: Provincial Administration
Phase 1 will start with the preparation of FY 2010/11 budget. Il will last four years for the recurrent
budget and three years for the investment budget.
Phase 2 will start with the preparation of FY 2011/12 budget and will last four years.
Phase 3 will start with the preparation of FY 2012/13 budget and will last four years.
Although all phases have an implementation duration of four years, the majority of provinces are
expected to make the transition in two years, except for provincial administration which is facing
deep structural problems.
2. Fiscal impact
The total fiscal enveloped required for budget norms has been estimated at 4.78% of FY 2007/08
budget. Assuming that the budget structure is relatively stable that means that the introduction of
budget norms at the national level, based on equalization needs will require an increase in resources
representing 4.78% of any year budget but spread over a period of six years.
The three phases and four years implementation strategy will minimize the impact of the budget
norm system on the budget structure. The total impact will represent an amount equivalent at 0.39%
of FY2008/09 budget for year 1; 0.82% of FY2008/09 budget for year 2; and 1.31% of FY2008/09
budget for year 3 and will decline sharply after.
With an inflation rate between 8 to 10% during that period, the total impact of the system could be
absorbed by inflation. If this strategy is adopted, it means that the implementation of the budget
norm will not require additional resources as it was feared before and that the economic crisis and
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the expected decline in revenue collection should not be an obstacle to the introduction of the
budget norm system.
In a context of a decline in revenue collection there is a risk that competition between provinces for
limited resources might exacerbate political tensions. The budget norm system will offer alternative
by promoting clear and transparent rules for expenditure assignment. It will strengthen budget
disciple at the provincial level
The full fiscal implementation strategy is presented in table 1 of this report under the title “Budget
Norm Consolidated Strategy. This table is reproduced below.
(expressed in percentage of FY2007/08 budget)
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 YEAR 6 Total
PHASE 1
Recurrent Budget 0,33% 0,26% 0,21% 0,20% 1,00%
Investment Budget 0,05% 0,02% 0,01% 0,08%
PHASE 2
Recurrent Budget 0,00% 0,20% 0,18% 0,17% 0,07% 0,63%
Investment Budget 0,00% 0,35% 0,34% 0,32% 0,25% 1,26%
PHASE 3
Recurrent Budget 0,00% 0,00% 0,41% 0,34% 0,33% 0,19% 1,28%
Investment Budget 0,00% 0,00% 0,17% 0,14% 0,12% 0,11% 0,53%
TOTAL 0,39% 0,82% 1,31% 1,18% 0,77% 0,30% 4,78%
BUDGET NORMS CONSOLIDATED FISCAL STRATEGY
The same numbers are presented in table 2 for all sectors (see annexes), but those numbers do not
include the impact of new investments on the recurrent budget. The cost of maintenance of new
investment has been estimated at 0.20% of the budget.
Tables 3, 4 and 5 show the breakdown of budget adjustments required for equalization by province
(see annexes). Those numbers include the impact of new investment on the recurrent budget.
3. Linkage with fiscal policy
Although the introduction of budget norms will be painless fiscally-wise, it does not mean that it will
be effortless. High fiscal discipline will be required at the central and provincial level. During the first
year of implementation, budget norms will put more strains on the recurrent budget. It means that
the level of investment should integrate this new constrains.
Generally speaking, budget norms will make more funds available for maintenance of buildings and
for other operating expenditures such as books for education or small equipments for hospital. This
will require an investment level compatible with the size of the recurrent budget. This objective can
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only be achieved through the implementation of a Medium Term Expenditure Framework (MTEF)
that is under development and should be ready when implementation of budget norms starts.
4. Way forward
Attention must be given to the following tasks:
Conclusions of this survey have already been integrated in the Budget Norm Policy
Framework that needs to be approved by the Minister to meet PRSO5 requirements.
Budget Execution issues have not been considered in the Policy Framework and must be
addressed before the implementation of phase 1 starts.
Budget norms will affect the way budget is prepared at all level (provinces, line-ministries
and MoF) attention must be paid to capacity building.
Both MoF and line-ministries have insufficient data on budget executions to be able to pilote
the project effectively. The Budget Norm System will require the full implementation of the
new budget classification and chart of account. At the moment there is no matching
between concept used for budget formulation and concept used for accounting.
Managing the system of intergovernmental transfers based on equalization grants, budget
norms and ad hoc grants will require dedicated human resources in the Fiscal Policy
Department and in the Budget Department.
It should be remembered that what has been presented in this report is only a macro-fiscal approach
of the impact of budget norms based on equalization need. It is a bottom up approach that integrate
existing fiscal constrains at the macro level and therefore does not say if the current level of spending
in the sector is compatible with the Government’s objectives for public service delivery. Before
budget norm formula for each of the six sectors can be tested two main tasks must be completed:
The expenditure needs assessment that will tell us if expenditure need exceed equalization
need and what are the main objective indicators of needs.
The cost driver analysis that will us what are the main factors that affect service delivery in
the provinces.
The approach that we are taking will start for a notional minimum spending per service users
adjusted for needs and cost.
If:
STr. = Sectoral Transfer
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NEN= Notional Expenditure Norm (example: 28.000 kips per capita)
N = Need Indicator
C = Cost Indicator
STr.= (NEN x N) + (NEN *C)
