Public Financial Management Systems—Sri Lanka

Key Elements from a Financial Management Perspective

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• Publisher: Asian Development Bank
• Year: 2018
• Print ISBN: 9789292610708
• eBook ISBN: 9789292610715
• Topic: Economics
• Subtopic: Auditing
• Index: Economics

This report documents Sri Lanka's financial management systems covering budgeting, funds flow, accounting and reporting, and auditing systems. It provides insights into Sri Lanka's internal control systems, staffing resource capacity, and information technology structure. The intent is to give project teams and consultants a better understanding of the country's financial management systems to improve project preparation. Find out how high-quality financial management assessments support projects by identifying key risks and enabling the implementation of appropriate actions and reforms to mitigate those risks.

III. Budgeting

A. Project Finance System

Under the Foreign Loans Act No. 29 of 1957 (as amended), the government may contract foreign loans and issue guarantees relating to foreign loans to public corporations and public enterprises. All foreign loan agreements entered into, and guarantees given, by the government must be signed by the President or a specifically authorized representative. All sums payable under those agreements and guarantees are charged to the Consolidated Fund. Loan and grant agreements with foreign donors, including ADB, are signed by the secretary of the Treasury on behalf of the government.

All government spending programs, including donor-funded projects, must be included in the central budget and have proper clearance from the DNP and the Cabinet of Ministers. The government’s Financial Regulation No. 3 requires a two-stage approval process for project plans (Figure 1).

Figure 1: Project Planning Stages Based on Government Financial Regulations

Source: Authors’ compilation based on the government’s Financial Regulations.

Each project proposal, which must be based on an assessment of needs and conform to sector and national development strategies, is submitted to the DNP for preliminary feasibility evaluation. The DNP then conducts a detailed analysis of the proposal in consultation with the relevant line ministry. Preliminary and final approval by the Cabinet is required before the project is included in the national budget. Once the prefeasibility report is approved by the Cabinet, the project owners and the sponsoring ministry prepare the feasibility report and have it reviewed by the DNP before the Cabinet of Ministers grants final approval.

Under Ministry of Finance Circular No. MoF/ERD/2011/1 of 21 April 2011 (Streamlining Mobilization of Foreign Resources) issued to development partners, government spending programs must be properly recognized and approved by the DNP and the Cabinet before funding sources are sought. The ERD is the government agency responsible for obtaining foreign assistance for development projects recommended by DNP; no other agency is authorized to deal directly with foreign donor agencies. The ERD channels potential projects into the lending pipeline of the various lending agencies during the annual consultations between the government and donors.

Ministry of Finance Circular No. MoF/ERD/2014/1 of 26 June 2014 (Acceptance of Donor Assistance), notes that the assessment of foreign funding proposals for development projects is based not only on the financial terms but also on the expected use of the funds and the return on investment. Foreign funding is to be mobilized mainly for large-scale strategic infrastructure development projects, particularly in energy, roads and highways, ports and aviation, and irrigation and water supply, to increase the return on investment. On the other hand, official development assistance on concessionary terms will continue to be invested in soft sectors including health and education. Foreign funds are not to be used for projects where funds can be allocated from the Consolidated Fund and where local expertise is available.

The government may be either a recipient or a guarantor of foreign aid. If the government is the recipient, the central government provides subgrants to central or provincial government agencies or state enterprises, or onlends to state enterprises, depending on whether the investment capital can be fully recovered or can be recouped only partially. Subgrants may go to infrastructure development projects and social projects where the capital cannot be recovered, such as rural development, health, education, and public service projects. Partial subgrants and partial onlending may support projects where the capital can be partly recovered. For example, most infrastructure development projects in the water sector that are implemented with central government support have an onlending component. Loans generally make up a greater share of funding than grants in urban sector development projects, considering the greater capital recovery potential of such projects compared with development projects in the rural sector. Full recovery of investment capital favors onlending. The government is increasingly encouraging revenue-generating public corporations and boards (such as the Water Board and the Ceylon Electricity Board) to operate on a commercial basis. It is urging these entities to borrow on the strength of their balance sheet, with a government guarantee.

At the moment, all loan and grant agreements with ADB are signed by the government. But if ADB were to lend directly to public corporations and boards, it must consider the fact that these entities are subject to the Finance Act No. 38 of 1971. Public corporations that have not adopted their own comprehensive financial rules and regulations must also comply with the government’s Financial Regulations. ADB would need to consider this aspect if and when lending directly to public corporations.

The specific terms and conditions of onlending are discussed and agreed on during project preparation, appraisal, and approval, in light of government regulations and donor agreements. The project approval process is generally lengthy and time consuming.

B. Consolidated Fund

The Consolidated Fund, established under the Constitution, allows for unforeseen government expenditures, which require the submission of supplementary estimates to Parliament. Payments made under annual appropriation acts are sourced from the fund. The special statutory funds created under parliamentary statutes and not included in the national budget are other sources of government funds. Certain activities of government are financed through advance accounts. Appropriations made for advance account activities are distinct from the general appropriations and go into a separate fund for each activity.¹⁰ All transactions affecting foreign funds are recorded under the Consolidated Fund.

Government funds raised through taxes, imposts, rates, and duties, as well as all other government revenues and receipts not allocated for a specific purpose, all flow into the Consolidated Fund. The fund contains all monies belonging to the government that are not allocated to other funds, and monies of various ministries and departments, funds, and investments, including those in bank accounts. Foreign loans received by the government, including ADB loans, are held in individual or pooled bank accounts at the central bank in the name of the deputy secretary of the Treasury and forms part of the Consolidated Fund.

Government expenditures met through the Consolidated Fund require prior provision through an appropriation act or specific provision in the Constitution or other laws. Withdrawals from the Consolidated Fund must be covered by a warrant from the minister of finance and planning. The warrant is issued only for sums previously approved under a parliamentary resolution or under the law. The minister of finance and planning signs separate warrants for general services, special law services, and advance account activities, following parliamentary approval of the budget. The DNB then issues an annual circular to all spending agencies authorizing expenditure, and guidelines for public expenditure management.

The monies in the Consolidated Fund are managed by the TOD and kept at the CBSL or at two state banks, the Bank of Ceylon and the People’s Bank. The provincial councils and local authorities maintain deposit accounts at local branches of the same two state banks.

C. Budget Recording and Reporting

For several years, the government has been using a modified cash-based accounting system conforming to generally accepted accounting principles and practices, as defined by the Sri Lanka Accounting Standards (SLAS) and the International Public Sector Standards (IPSAS). In 2004, the government took steps to shift to accrual accounting, and in 2013, on a pilot basis, it instructed the various ministries and departments to prepare accrual-based annual accounts in addition to cash-based appropriation accounts. By the end of 2014, however, only around 15% of the institutions had complied. Modified cash-based accounting still prevails.

Under the modified cash-based accounting system, unspent budget allocations at the end of the financial year (31 December) are canceled and do not carry over into the next year. Exceptions to this rule, according to Financial Regulation No. 215(3b) and 215(3c), are: provision intended for the payment of grants or loans to statutory corporations and other institutions, if the sum is not immediately required by the corporation or institution; and committed expenditure under special circumstances based on the nature of expenditure, such as for shipment delays on import bills due for immediate payment after the end of the year. Funds for such expenses are reserved in the Treasury system, through an allocation to a special deposit account. These transfers should be indicated by means of footnotes in the appropriation account. An agency seeking such an allocation must send a request to the TOD through the secretary of the relevant line ministry, with justification for the payment to be made within the time schedule prescribed in a Treasury circular in 2015 (Closing of Accounts for the Financial Year 2015).¹¹ Allocations to the special deposit account will be made only after they are approved by the TOD director general, and must be used before the state accounts are finalized in February of the next year. Such allocations may also be made for donor-funded expenses if warranted by the nature and urgency of payment. These exceptions allowed for special payments make up only a very small proportion of total expenses.

D. Budget Process

Budget preparation in Sri Lanka derives its legal framework from the Constitution (articles 148–150), the annual appropriation act for the financial year, the Fiscal Management (Responsibility) Act No. 3 of 2003, applicable Financial Regulations, and other relevant circulars and guidelines issued by the Treasury.

Under the 13th Amendment to the Constitution (1987) and the Provincial Council Act No. 42 of 1987, part of the administrative decision-making authority and financial functions have been transferred from the central government to elected lower-level bodies. The 13th Amendment (9th Schedule) lists the powers transferred exclusively to the provincial councils (List 1: Provincial Council List), those retained by the central government (List 2: Reserved List), and subjects and functions where both the central government and the provincial councils are involved (List 3: Concurrent List).

Sri Lanka has a three-tier administrative structure: central, provincial, and local government (Figure 2). The central government comprises a 225-seat Parliament, which has full control over public finances. There are nine provincial councils in the second tier, and 335 local authorities categorized into municipal councils, urban councils, and pradeshiya sabhas (legislative bodies for third-tier municipalities), in the third.

Figure 2: Administrative Structure of the Government of Sri Lanka

Source: Authors’ compilation.

All activities of the government are predetermined and are set out in plans and programs. The annual estimates of expenditure detail the financial commitment of the government for the next year’s program of activities. There are three budget areas—national, provincial, and local—corresponding to the three levels of government. The Constitution requires the central government to allocate adequate funds from the annual budget to the provincial councils to meet their needs. The Finance Commission is the intermediary between the central government and the provincial councils in finance matters. As a result of the devolution of power to local government under the 13th Amendment, all financial transfers to local authorities are channeled through the provincial c...

Table of contents

• Front Cover
• Title Page
• Copyright Page
• Contents
• Tables, Figures, and Boxes
• Acknowledgments
• Abbreviations
• I. Introduction
• II. Key Players
• III. Budgeting
• IV. Onlending Arrangements
• V. Foreign Exchange and Interest Rate Risks
• VI. Funds Flow Arrangements
• VII. Accounting and Reporting
• VIII. Auditing Arrangements
• IX. Summary of Risks and Issues, and Proposed Mitigating Actions and Improvements
• Appendix: Useful References and Suggested Readings
• Footnotes
• Back Cover