Public Financial Management in Latin America : The Key to Efficiency and Transparency

Inter-American Development Bank

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 2016
• eBook ISBN: 9781597822268

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Chapter 1. Public Financial Management in Latin America: The Key to Efficiency and Transparency

Carlos Pimenta and Mario Pessoa

Overview of Public Financial Management Reforms in Latin America

Public financial management (PFM) plays a key role in the sound allocation and use of public resources and macroeconomic management. This is why PFM modernization can have a substantive impact on the effectiveness, efficiency, and transparency of public spending. The call to upgrade institutional, functional, and technological frameworks of PFM systems in Latin American countries has been significant as governments seek to achieve greater coverage, reliability, and timeliness of financial information. There is also pressure to streamline procedures and implement more sophisticated business models and technologies in national treasuries, debt management offices, accounting departments, and budget and procurement agencies.

The demand for modernization has been particularly strong in Latin American countries, as authorities pursue fiscal sustainability in a challenging international economic environment. At the same time, they are responding to increasing demands for transparency and facing tighter fiscal conditions.

This book intends to contribute to the discussion by providing an overview of good practices, as well as the experiences of some countries—with special attention to Latin America—that have implemented PFM reforms in cash and debt management (CDM), government accounting, procurement, and financial management information systems. The book does not cover other PFM areas that include budgeting and planning processes and their interactions; performance-oriented budgeting; public investment systems; Medium-term Expenditure Frameworks (MTEF); or risk analysis. Although these areas have been covered in many other publications, further research is needed to understand how Latin American countries have performed on those issues. The focus of this book, in particular, reflects the findings of the technical dialogue and technical assistance of the Inter-American Development Bank (IDB) and the International Monetary Fund (IMF) with regard to Latin America, representing some of the priorities determined by the countries in the region.

The IDB and IMF have collaborated to support the exchange of experiences of, and dissemination of good practices by, PFM practitioners, particularly in terms of treasury management and public accounting. In addition, since its inception in 2010, the Latin American Treasury Forum (Foro de Tesorerías Gubernamentales de América Latina (FOTEGAL)) has become the primary forum on treasury management in the region, prompting and facilitating discussions on the key topics and challenges that the region faces. These discussions take place through annual seminars, workshops, studies, and training.

FOTEGAL is composed of 16 national treasuries in the countries of Argentina, Bolivia, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Dominican Republic, and Uruguay.¹ The recently created Latin American Government Accounting Forum (Foro de Contadores Gubernamentales de América Latina (FOCAL)) is expected to produce a similar impact with regard to government accounting, influenced significantly by a new wave of reforms relating to the implementation of accrual and cost accounting.

One remarkable trend in the region is the use of information and communication technology (ICT) to facilitate the management of large amounts of financial information. Some of the recent reforms would not be possible without the support of sophisticated integrated financial management information systems (IFMIS). This is reflected in the implementation of comprehensive treasury single accounts (TSAs), electronic systems supporting the procurement and acquisition of goods and services, consolidation and integration of financial management systems, implementation of public sector cost systems, and preparation of consolidated financial statements on an accrual basis.

Although extensive progress on those PFM issues in the region has been made in recent decades, there still remain many challenges to overcome. IFMIS are in the process of modernization aimed at greater functional integration; TSAs—as defined by Fainboim and Pattanayak (per references list) (2010)—have expanded, but coverage remains incomplete (even in relation to central government), and accrual accounting has yet to progress. Public procurement is fundamental to sound public resource management (PRM) and it has achieved great progress in the region during the past two decades; however, there is room for improvement. Cost accounting—also essential for best PRM practices—is still in its infancy and it depends on information that is not fully available. In this regard, it is important to engage decision makers with an appetite to go beyond traditional financial information.

Strong demand for efficiency and economy in the management of financial resources continues. The development of treasury indicators is vital to measure and communicate results simply and directly. This also has a bearing on the close agency coordination of CDM functions to achieve substantive financial impact, resource savings, and transparency.

The above issues are discussed in this book to influence PFM reforms and to contribute to the improved delivery of goods and services by governments. Sound PFM systems are intended to provide the preconditions for the efficient performance of public expenditure. The Latin American experience is unique, since it involves a substantive number of middle-income and emerging market economies that have similar institutional and legal traditions that derive from European countries, such as Spain, Portugal, and France. This experience can be useful for other regions that currently face similar challenges.

Four main pillars of PFM are discussed in this book. The first pillar represents the relationship between PFM and macro-fiscal affairs in general, and it includes fiscal and macroeconomic management, monetary policy, development planning, and other macro-fiscal aspects. The second pillar concerns the improvement of the efficiency and performance of PFM systems, covering the characteristics that relate to the organizational structures, methods and strategies, information systems, and indicators that measure PFM efficiency. The third pillar relates to PFM and PRM, including the use of financial information to improve decision making in the public sector, which contributes to greater efficiency in resource management, and generates value for money in public expenditure. The fourth and last pillar involves PFM and transparency, taking into consideration the quality, timeliness, availability, and public access to financial information.

PFM and Macro-Fiscal Affairs

Within the first pillar of PFM, this publication highlights the relevance of PFM to generate information that is conducive to good fiscal and macroeconomic management. As Allen, Hemming, and Potter (2014) mention, “although the objectives of PFM overlap with the goals of fiscal policy, PFM and fiscal policy are not the same. PFM has more focus on expenditure rather than on taxation and is concerned with achieving aggregate fiscal discipline and efficient government spending, while the goals of fiscal policy are to achieve macroeconomic stability and sustainable economic growth.”

In this context, the concept of PFM, which is discussed here, adopts a comprehensive and overall definition that covers a set of administrative elements, tools, and management systems. These are designed to produce information, processes, and rules that support macro-fiscal policy decisions and to provide the instruments for the implementation of these decisions.

Regarding the legal and regulatory PFM frameworks in Latin American countries, considerable improvement has been attained during the last two decades, although difficulties have been experienced in linking development strategies and plans to medium-term fiscal planning frameworks, as well as budget plans to current in-year appropriation and execution (USAID, 2014). Furthermore, increasing the quality of macro-fiscal management is essential to improve fiscal planning and forecasting capacities.

In terms of monetary policy, the treasury—understood to be the unit responsible for CDM—must communicate and coordinate with the central bank, given the macroeconomic relevance of the volume of resources controlled. As emphasized by Cangiano, Curristine, and Lazare (2013), one of the key objectives of PFM is to maintain a sustainable fiscal position. These macro issues impact economic development and its measurement.

The relationship between PFM and fiscal affairs is not the prime subject for analysis in this publication. Rather, it is a component of the general framework that relates to its importance in macro-fiscal and economic management.

PFM and its Efficiency

A more in-depth discussion is made of the efficiency of PFM—the second pillar—through the identification of common trends and opportunities that can strengthen these systems in Latin America. These include aspects that relate to organizational arrangements, methods and strategies, information systems, and PFM performance indicators.

The book dedicates special attention to the organization and coordination between treasury and debt management functions in terms of the organizational arrangements that structure PFM administration. The traditional objective of government cash management, in general, is to ensure that cash is available to execute the budget efficiently and to meet government obligations when they fall due. Modern cash management, however, has other objectives: cost-effectiveness, risk management, and support to other financial policies. It has been stated that a TSA is a prerequisite for efficient cash management. Most countries in the region have developed, or are in the process of developing, a TSA. By pooling financial resources, millions of dollars can be saved per year, given that centralization of cash liquidity reduces the need to issue treasury bills to finance short-term cash requirements. It also provides the opportunity to invest cash surpluses.

Among the key functions of cash management are the monitoring of cash inflows and outflows, access to cash, development of cash flow forecasting, and entry into the financial market. Government cash management is also related to the coordination between treasuries and central banks in terms of analyses and the management of financial risk (liquidity, credit, and operational). Furthermore, the core function of debt management is to ensure that the financing needs and payment obligations of government are met at the lowest cost in the short, medium, and long terms, consistent with prudent risk levels. Many countries associate a secondary objective to the development of the domestic financial market.

The importance of close coordination between debt and cash management is self-evident. In the first place, to finance the gross borrowing requisites of government, debt management strategies (DMS) need to be developed to enable the selection of the most adequate financial instruments that will minimize cost and risk. Simultaneously, the financial market should be developed as a means to provide stability and a measure of certainty. Good practices dictate that such choices are made by way of medium-term DMS that are supported by debt sustainability analyses, taking into account the appetite and volatility of the market, as well as interest and exchange rate predictions. Cost considerations are relevant, among other criteria, since the development of a consistent yield curve will, in turn, develop the market. Specialists within the treasuries should develop these processes.

On the expenditure side, it is essential to comprehend the significant yearly, monthly, and weekly fluctuations that impact payment flows. Most countries in Latin America have developed quarterly, monthly, and intra-monthly cash flow forecasts with sufficient precision to experience small variations in relation to effective payments, but some continue to operate under severe cash constraints with the need to ration cash, impose budget restrictions, and, ultimately, accumulate expenditure arrears.

Cash flow forecasting at the national and subnational levels tends to be incomplete in many Latin American countries. Opportunities to strengthen cash flow management include expanding the coverage of TSAs, improving its interoperability with debt and financial management systems, and strengthening cash flow forecasting at the national and subnational levels to improve the predictability of funds.

There are only three countries in Latin America that operate under an integrated debt and cash management model: Brazil, Colombia, and Peru. The other 14 countries have different arrangements, whereby the functions are distributed among the treasury office, debt management unit, central bank, and—sometimes—the budget office. There are advantages to integrated units, although there are some constraints, such as the lack, in some cases, of a professional cadre of staff, the fact that remuneration sometimes is noncompetitive, and the need for training, all of which prevent the implementation of a modern debt management unit, as exists in many advanced economies.

In some respects, the functions of debt and cash management perform well in Latin America, despite the various organizational structures in place. The historical tradition of separate units prevails at the expense of a more integrated approach. Whether or not the potential advantages of integration are recognized, reform is challenged by the need to change current legislation and administrative practices. The transition from a separate to an integrated structure takes time and the process can be more complicated than originally foreseen by ministries of finance.

Taking into account the countries that maintain separate units, those that are more effective tend to have better coordination mechanisms and superior integrated accounting and financial information systems. Nevertheless, while countries improve their CDM processes and the domestic financial markets develop, the separation of functions appears to be more disadvantageous than advantageous.

The most important instrument in Latin America that is discussed, in terms of key PFM methods and strategies, is the TSA. This is viewed as an essential tool to efficiently manage cash.

Establishing a TSA is a fundamental step toward modernization of treasury management. There is much empirical evidence to suggest that a TSA can save significant resources by avoiding unnecessary short-term borrowing or by pooling liquidity to facilitate cash management. Moreover, a TSA allows the treasury to shift from concentrating primarily on the payment of obligations (traditional passive behavior) to become more cash management-oriented (active behavior), leading to such actions as investing in the financial market and maintaining minimum liquidity to allow for timely payments. For example, the Treasurer of Guatemala reported savings in 2014 of Q$42 million (US$6 million, or 1.5 percent of interest paid on domestic debt). This was predominantly attributed to the consolidation of central government resources in the TSA. Other countries have experienced similar savings.

Three countries in the region now include the entire central government within their TSA (Argentina, Brazil, and Costa Rica). Brazil, along with Costa RIca, Ecuador, and Mexico, have incorporated their pension funds and have absorbed their external resources into this account. The remuneration of the TSA has yet to be established and, at present, most treasuries maintain their deposits at the central bank although few, in fact, are remunerated.

Most reforms aim to ensure that the TSA has comprehensive coverage to enable active investment and an adequate remuneration of balances, thus reducing the number of bank accounts and maintaining them at zero balance; automating bank reconciliation; and improving the integration of financial and accounting systems. In the case of Latin American countries, specifically, it is important to recognize that most of the advances that relate to the consolidation of the TSA were made possible due to significant enhancements of IFMIS.

Regarding PFM Information Systems, IFMIS is the key instrument to better integrate PFM functions. All countries in Latin America have implemented IFMIS...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Foreword
• Preface
• Acknowledgements
• Contributors
• Latin American Treasury Forum
• List of Abbreviations
• Chapter 1: Public Financial Management in Latin America: The Key to Efficiency and Transparency
• Chapter 2: Treasury Management Efficiency Indicators
• Chapter 3: Cash and Debt Management: Interaction, Coordination, and Integration
• Chapter 4: The Treasury Single Account in Latin America: An Essential Tool for Efficient Treasury Management
• Chapter 5: Public Accounting and Fiscal Credibility
• Chapter 6: Finding the Costs of Public Services: The Experience of the State of São Paulo in Implementing a Cost System
• Chapter 7: Integrated Financial Management Information Systems in Latin America: Strategic Aspects and Challenges
• Chapter 8: Public Procurement in Latin America
• Footnotes