Financial Planning Part 1 Methodology Tarun Das

Financial Planning Methodology and Policies – Tarun Das

Financial Planning Methodology and Policies Part-1: Methodology ________________________________________________________________

Prof. Tarun Das1, Ph.D. Glocom Inc. (USA) Strategic Planning Expert ADB Capacity Building Project On Governance Reforms

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Ministry of Finance Government of Mongolia Ulaanbaatar, Mongolia. January 2008 . 1

Formerly Economic Adviser, Ministry of Finance and Planning Commission of the Government of India, and Professor (Public Policy), Institute for Integrated Learning in Management (IILM), New Delhi. For any clarifications contact [email protected]

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Financial Planning Methodology and Policies Prof. Tarun Das CONTENTS Part-1: Methodology 1. Introduction and Scope 1.1 Objectives of Financial Planning 1.2 Components of Financial Planning 1.2.1 Reallocation of budgetary resources 1.2.2 Budgetary Planning for the future 1.2.3 Nominal number planning versus ratio planning 1.2.4 Independence of fiscal and financial authorities 1.2.5 Financial control systems and mechanisms 1.3 Status of Fiscal Planning in Mongolia 1.3.1 The larger role of the government 1.3.2 New public sector management 2. Public Finance Management in Mongolia 2.1 Determination of policies and priorities 2.2 Allocation of public resources 2.3 Establishment of mechanisms for financial control 2.4 Uniformity of accounting standards and fiscal statistics 2.5 Internal and concurrent audit system 2.6 Ex Ante Financial Control 3. Relation Between Financial Planning and Budget Planning 3.1 Budget planning and Strategic Planning 3.2 Public Sector Management and Finance Act (PSMFA 2002) 3.3 Progress of Implementation of PSMFA during last five years 4. Methodology for Financial Planning for 2009-2011 4.1 Macro-economic framework 4.1 Methodology for Financial Planning 4.3 Financial Planning for 2009-2011 Annex: Financial Accounting Tables prescribed by IMF GFSM-2001 Selected References

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Part-2: Policies 5. Policies for Financial Planning and Risk Management 5.1 Risk Management for Natural Disaster 5.1.1 The credit system 5.1.2 Risk transfer instruments 5.1.3 Insurance and development bonds 5.2 Management of Contingent Liabilities 5.2.1 Contingent liability- definitions and measurement 5.2.2 Fiscal risk matrix for Mongolia 5.2.3 Lessons from international best practices 5.2.4 Management of contingent liabilities 5.3 Management of Public Debt 5.3.1 Public debt of Mongolia 5.3.2 Debt sustainability and fiscal deficit 5.3.3 Risk management systems for public debt (a) Independent and integrated Public Debt Office (b) Composition and functions of the Public Debt Office (c) Transparency in risk management (d) Basic principles f risk management (e) Risk management framework (f) Assessment of risk 5.4 Management of External Debt 5.4.1 Various risks of external debt 5.4.2 Risks for different modes of capital transfer 5.4.3 External debt sustainability measurement 5.4.4 Risk management policies for external debt 5.4.5 Stress tests (a) Standard stress tests (b) Indicators of debt distress episodes (c) Determinants of debt distress (d) Quality of institutions and policies (e) Indicators of debt and debt service thresholds (f) Debt distress classifications 5.4.6 International best practices or debt management Selected References

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Financial Planning Methodology and Policies – Tarun Das

Financial Planning Methodology and Policies Prof. Tarun Das, Strategic Planning Expert

1. Introduction and Scope As per the Terms of Reference of the ADB Capacity Building Project on Governance Reforms, the International Strategic Planning Expert is required “to develop a methodology for the preparation of ex ante financial planning (for the central government)”. In the broad sense, ex-ante financial planning implies assessment of feasible financial resources and planning revenues and expenditures before the budgetary commitments are made, while ex-post financial planning means management of public finance after the approval of the budget by the Parliament. However, both ex ante and ex post financial planning are integrally related. Therefore, in this paper we deal with methodologies and policies for both ex ante and ex post financial planning and management. 1.1 Objectives of Financial Planning Basic objective of government financial planning is to assess the mobilisation, allocation and management of financial resources keeping in view the Government’s strategic objectives and sustainability of pubic expenditure within the total available resources and cash budget limits. This includes developing, promulgating and implementing financial policies, rules and regulations across the budget entities. It also includes establishing and strengthening institutions and policy planning systems for the better management of investment plans, and development of efficient and vibrant financial, monetary and capital markets. An effective financial planning serves to provide:  Optimal allocation of resources among competing needs and sectors; Sustainability of fiscal deficit over time;  Stability and predictability of government financial resources;  Coherence to diverse fiscal objectives for both short and long term interests. There is of course no universal model, methodology or structure for an effective and efficient financial planning. Like physical planning, government financial planning must satisfy the following characteristics:  ransparency –There should be openness for government’s fiscal, monetary, T budgetary and financial policy formulation and implementation. There should not be any hidden agenda of the government for favoring some particular groups. MOF, Govt. of Mongolia

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 Accountability – Actions and decision-making processes should be open to scrutiny by public agencies, Parliament and civil society;  Responsiveness – It should have the capacity and flexibility to respond to changing national and international circumstances;  Future Orientation – It must have the inherent ability to anticipate future problems and liabilities and to develop policies that take into account future costs and contingent liabilities; Rule of Law and Integrity –It must be subject to equitable enforcement of fair and transparent laws, regulations and codes, so that the basic culture in the public sector supports ethical behavior and strict actions to fight corruption. 1.2 Components of Financial Planning 1.2.1 Reallocation of budgetary resources The reallocation of resources is at the heart of budgeting and financial planning. A change in national and global economic environments leads to a change in strategic business plans with subsequent impact on outputs and outcomes. Financial planning must be able to adjust accordingly for resource flows into various sectors of the economy. However, there could be inherent difficulties to resource reallocation due to resistance by the groups who might be adversely affected. In many cases, support from those, particularly the weaker, poor and vulnerable groups, who would benefit tends to be weak and diffuse, even though this group may be much larger than the vested interest groups. When anticipated resources fall short of budgetary targets due to some internal and external shocks, it is customary for the government to resort to pro-rata reduction in the operating expenditures or to have cross-the-board cuts in the capital expenditure. However, cross-the-board cuts are less desirable than the tougher choice of reallocating among line ministries and budgetary agencies. 1.2.2 Budgetary Planning for the Future Planning by definition deals with the future. But, annual budget and financial plan often ignore the long-term objectives and sustainability. Therefore, financial planning must have the medium term panning horizon, just as the Medium-term or multi-year budget frameworks. Although, multi-year allocations may not be legally binding due to change in government or unanticipated events, mediumterm plans help to overcome the following difficulties:

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t he tendency of the present government to over-estimate future financial prospects and economic growth; the tendency of budgetary entities to view their unrealistic and wishful goals as entitlements to future funding. 1.2.3 Nominal Number Planning versus Ratio Planning It may be emphasized here that in planning one should not focus on absolute magnitudes and nominal numbers. On the contrary, the focus should be on the direction of change and on real numbers (generally expressed as percentages of or ratios to Gross Domestic Product at current market prices), because when nominal economic growth falls or inflation rate accelerates, revenues and expenditure forecasts expressed as ratios to GDP are automatically adjusted. Thus the Fiscal Responsibility Acts of various countries fix targets for fiscal deficit, revenue deficit, outstanding public debt and contingent liabilities, incremental debt or incremental contingent liabilities in terms of percentages of GDP (and not in absolute numbers). 1.2.4 Independence for Fiscal and Financial Authorities It is now generally recognized that the central bank must be independent with adequate power to use monetary instruments for inflation targeting and to sustain growth prospects. Government should not manipulate monetary policy for political purposes. While government will have independence to determine tax rates, impose new taxes and allocate resources, monetary authority should have independence to maintain low inflation rates and stability in real interest and exchange rates. However, certain parameters for financial and fiscal planning, notably forecasting of major economic parameters such as growth rates, inflation, balance of payments, private savings, private investment etc., deserve agreement by both monetary and fiscal authorities. 1.2.5 Financial Control systems and mechanisms Financial planning must be integrally related to financial control, accounting and auditing. All the sectoral development, social security and insurance funds need to be properly managed, accounted and utilized for the purposes for which they were set up. Agencies set up to manage the special funds must fulfill specific minimum standards concerning operating procedures, internal financial controls and audits, procurement rules, adequate technical staffing, etc. Similarly resources from external aids need special accounting and auditing. Financial rules relating to public procurement, financial control and reporting are also required to be framed and strictly enforced.

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1.3 Status of Fiscal Planning in Mongolia 1.3.1 The larger role of government Presently Mongolian government is passing through a stage of governance reforms to improve efficiency and productivity of the public sector. There is greater emphasis on public-private partnership in development of both physical infrastructure and human capital. At the same time inflation has emerged as a major problem, and the levels of taxation and public sector borrowing are growing over time. The public pressure has, therefore, emerged for better planning of public expenditure coupled with a demand for improved management of the public services. 1.3.2 New Public Sector Management The central government in Mongolia is in effect moving to a system of “New Public Sector Management”. It has the following key features: t he separation of policy-making from service delivery and strengthening agencies to deliver services in health, education, employment and social welfare and security; the separation of the provider function and producer function- government has already privatized and withdrawn from activities where private participation including foreign investment is more productive and more efficient;  as required by the Public Sector Management and Finance Law (2002) government is formulating accrual-based output budgets (AOB) and shifting its emphasis from inputs to outputs and outcomes;  Government is emphasizing on the systematic comparison of activities and output costs between various management units (benchmarking); Government is developing performance measures and indicators for efficient budget allocations and for rewarding good performance in achieving set objectives;  Government is also strengthening accounting and auditing standards and systems,  Government is upgrading capacity and skill of personnel engaged in planning, budgeting, accounting and auditing; and strengthening the information technology system to support the budget modernization process and systems.

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2. Public Finance Management in Mongolia Public Financial Management covers the institutions and processes related to the management of public resources. This process consists of three stages.  Determination of policies and priorities  Allocation of public resources in accordance with the specified policies  Establishment of financial control, accounting and audit mechanisms to ensure the economical, effective and efficient acquisition and utilization of public resources 2.1 Determination of the policies and priorities For efficient operations, a government is required to make strategic plans indicating vision, mission, objectives, strengths and weaknesses of the economy and considering resource constraints in the short and medium terms and to prepare financial plan and budget to support these policies and objectives. All the line ministries and budgetary entities in Mongolia are already preparing master plans and strategic business plans indicating desired outputs and outcomes in the medium term. The Public Sector Management and Finance Act (27 June 2002) also requires preparation of multi-year budgeting, output budgeting on the basis of accrual accounting, benchmarks and performance parameters, accountability by General Managers of Budget Entities, fiscal transparency, efficient internal financial control, which are major components of modern financial planning and management. 2.2 Allocation of public resources Annual Budget prepared by the MOF is the  the main allocation instrument of the limited resources.  the instrument of realizing economic plan and policies.  a basic political choice indicating the common public needs  the financial planning of the government policy. Establishment of mechanisms for financial control Financial controls include both Internal Control and External Control, and there could be both ex-ante control (before disbursement of funds) and ex-post control (after disbursement of funds). (a) Internal Control comprises  Ex ante control- Before disbursement of any funds, the internal financial advisers examine the proposed expenditure to satisfy that it conforms the scope and limits approved under the budget.

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 Ex post internal audit- After finances have been spent, internal auditors examine whether the expenditure was within budgeted purpose and limits. (b) External Audit • Another audit mechanism is the statutory financial reporting and the existence of a budget code structure and government accounting principles. • Government of Mongolia is also making attempts to improve the automation and information system of the financial management, accounting and auditing. 2.4 Uniformity of Accounting Standards and Fiscal Statistics The same accounting system and standards are used in all budget entities within the scope of the general government.  The Ministry of Finance determines the accounting and reporting standards and frameworks, Chart of Accounts and the format, period and type of the reports that will be applied by all budgetary bodies within the scope of general government.  MOF provides guidelines for preparation and public announcement of the fiscal statistics.  MOF also determines rules and regulations for Ex ante control over the payments, procurement, control over public revenues and expenditures and mechanism to prevent irregularities and fraud. 2.5 Internal and Concurrent Audit System It is understand that there is no system of internal auditing or concurrent auditing in the budget entities. For efficient auditing system, it is recommended that to start with the major line ministries such as MOF, MOECS, MOSWL, MOH and MOJIA must have a system of internal audit and concurrent audit. It is discussed in more details in the following section on ex ante financial control. 2.6 Ex Ante Financial Control Ex Ante Financial control implies examination of any expenditure proposal before its commitment or execution or disbursement of funds. In many countries, like India, Bangladesh, Nepal and Pakistan, there are Financial Advisers/ Financial Control Officers attached to the Expenditure Department of the Ministry of Finance but working for various budget entities. The same Financial Adviser/ Financial Control Officer may deal with various budget entities. An expenditure proposal approved administratively by any department needs to be examined by the concerned Financial Adviser before actual disbursement of funds. The Financial Adviser examines whether it falls within the scope and limits of the MOF, Govt. of Mongolia

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approved budget for the budget entity. However, budget entities have the power to save finances under certain heads and utilize the surplus for development purpose. But the proposal needs be examined and scrutinized by the Financial Adviser. Thus the Financial Advise/ Financial Control Officer helps the line ministry for the following functions:  allocating appropriations  approving financial commitments  holding tenders and concluding contracts  overseeing purchase of goods or services  overseeing execution of public works  approvals for payment orders Such Ex ante control mechanism is based on the principle that compliance audit is performed before the payment is made at various stages of the spending process. In the event that the transactions not approved are realized, the authorizing officer shall be deemed to have personal responsibility. It is understood that the government of Mongolia does not have a system of Financial Adviser/ Financial Controller/ Internal Auditor. It may be advisable for the Mongolian government to adopt such a system for ex ante financial control. To start with, MOF may appoint Financial Advisers/ Financial Control Officer for the major ministries like MOF, MOECS, MOSWL and MOH. 3. Relation Between Financial Planning and Budget Planning 3.1 Budget Planning and Strategic Planning Financial planning is an integral part of a sound and transparent budgeting exercise. Budgeting techniques have been changed significantly over the years. Modern budgets emphasize independence between fiscal policies and monetary policies and therefore donot make automatic support by the central bank through monetization of deficit. As compared with classical budgeting with more emphasis on sectoral and individual projects budgeting, inputs and expenditure budgeting and cash accounting; modern budgets are based on strategic planning, output budgeting, accrual accounting, benchmarks and performance parameters. In classical budgets, Ministry of Finance used to adopt a top-down approach under which financial resources are first allocated to various ministries which in turn allocate assigned resources among various projects. Under modern budgeting, more emphasis is placed on prior consultation with all stakeholders and a bottom-up approach where outputs and outcomes are given priority and line ministries first prepare their strategic plans and budgets and sends requests for financial allocations to the Ministry of Finance. The MOF then decides allocations for budgetary bodies within budget constraints and to achieve intersectoral and inter-regional equity. Table-1 summarizes the major characteristics of modern budgets as compared with those of classical budgets. MOF, Govt. of Mongolia

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Table-1: Characteristics of Modern Budgets Compared with Classical Budgets Classical Budgets

Modern Budgets

Unbalanced budget with reliance on monetized deficit financed by the monetary authority with creation of additional money supply.

Balanced budget without any monetized deficit. Fiscal deficit is financed by market borrowings from either domestic markets or from external sources including bilateral countries and multilateral funding agencies. Sectoral financial planning focusing Strategic business planning keeping in view basically on short-run or sectoral gains broader objectives, vision, mission, strengths and weaknesses Input based budgeting- Budgeting in terms of Activity based budgeting- costing and wages and salaries, purchases of goods and budgeting of activities required to produce services desired outputs Inputs/ resources budgeting – budgeting for Output/ Outcome budgeting- budgeting for labor, energy, transport, goods and services specific outputs and outcomes Cash accounting- accounting revenues and Accrual accounting- accounting revenues expenditures when cash is received or paid and expenditures when commitments are made or liabilities are created – it does not matter whether cash is received or not. Project budgeting- focusing on completion of Program budgeting- focusing on integrated individual projects program for a specific purpose such as employment generation or poverty reduction Expenditure based budgeting- allocation of Performance based budgeting- allocating money on the basis of expenditures finance on the basis of performance Annual budgeting- budgeting for a year Multiyear budgeting- budgeting for a number of years, generally for the budget year and two forward years Non-Transparent budgeting – budgets are Transparency based budgeting – less prepared in top secretary secretary in preparation of budgets, experts and stakeholders are consulted, government’s objectives are announced. No public scrutiny- does not allow scrutiny by Public scrutiny- allows scrutiny by the media others and the general public No stakeholders’ consultation- stakeholders Multi-stakeholders’ consultationare not consulted stakeholders are consulted before finalizing the budget Top-Down Approach- MOF first allocates the Bottom-up Approach- Line ministries first resources to line ministries who then allocate prepare their budgets and sends requests to funds under various heads MOF who makes adjustments on the basis of resource constraints and inter-sectoral equity Complete secrecy in budget preparation Limited secretary and public consultation

3.2 Public Sector Management and Finance Act (PSMFA June 2002) MOF, Govt. of Mongolia

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It is well known that the Government of Mongolia enacted the Public Sector Management and Finance Act (PSMFA) on the 27 June 2002 in order to modernize budget planning and budgeting systems as per international best practices. The complete implementation of the provisions of the Act requires the following activities on the part of the government: (1)Preparation of “a Strategic Business Plan” for each budgetary body indicating its strategic objectives for the next three years and the outputs to be delivered during the budget year specified by category, quantity, quality and costs. Output costs shall be determined on the basis of accrual cost of production including management overheads and capital charges.2 (2)Signing of output purchases agreement between the “Portfolio Minister” and the budgetary bodies for purchase of goods and services. Output purchase agreement shall specify terms of delivery of outputs and prices to be paid from the budget3. (3)Setting accounting policies for budgetary bodies in conformity with International Accounting Standards and implement these policies4: (4)To prepare Financial Statements containing operating statement, balance sheet, and statements of cash flows, net assets and contingent liabilities5, which are also the requirements of the IMF Government Finance Statistics Manual (GFSM 2001). The details of the Financial Accounting Tables prescribed by the IMF GFSM-2001 and the current situation in Mongolia along with necessary action are discussed in the Annex. (5) To prepare Fiscal Framework Statement including the Government’s medium term objectives, public investment plans, forecast balance sheet and cash flow for the budget year and two forward years6. (6) To conclude Performance Agreement between the Portfolio Minister and the General Managers (GM) of a budgetary body within one month from the date of the approval of the State Budget by the State Great Hural7. The Act also specifies systems for the Assessment of Performance Agreement8 . 3.3 Progress of implementation of PSMFA during last five years 2

Articles 26.1 to 26.3 of the Public Sector Management and Finance Act (27 June 2002). Article 23 of the PSMFA. 4 Article 9 of the PSMFA. 5 Article 37 of the PSMFA. 6 Article 25 of the PSFMA. 7 Article 18 of the PSMFA. 8 Article 47 of the PSFMA. 3

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The government of Mongolia initiated measures to implement the provisions of the PSMFA almost immediately since its inception in June 2002. Good progress has been made with the preparation of Strategic Business Plans in major line ministries; formulation of Medium Term Fiscal and Budgetary Framework, preparation of consolidated financial statement for the general government, time bound execution of budget and improved fiscal reporting on cash basis with some steps towards accrual accounting. MOF is implementing two major capacity building projects being financed by grants and loans from the World Bank and the Asian Development Project. Significant progress has been made in the development of basic concepts, preparation of methodological papers, guidelines, manuals on strategic planning, output costing and output budgeting, accrual accounting, setting benchmarks and performance parameters for the budgetary bodies, improving technical capabilities of the staff engaged in budget formulation, strengthening Information technology (IT) system and creating general awareness of the stakeholders about the usefulness and necessity of modern techniques for output budgeting on the basis of accrual accounting and benchmarks. In addition to the mobilization of the national capacities, valuable assistance and consultancy from experts of the international financial institutions such as ADB, IMF and the World Bank have been extensively used in the implementation of fiscal reforms and enforcing related legislation. Assessment and evaluations made by the international experts facilitated the fiscal reforms process, particularly for strengthening the capacity building for governance reforms. Despite these efforts and good results during the last five years, progress towards full implementation of the PSMFA remains slow due to some structural problems. Assessments made by the IMF and ADB experts have indicated the following constraints: (a) There is absence of a specialized institutional system at various levels of the Government, line ministries and local governments, which have adequate experience and expertise in strategic planning, output costing and accrual budgeting; (b) The issues and activities involved in budget modernization are complex, but the international experiences for transition from the classical budget techniques to the modern framework were not studied carefully and in a timely manner. (c) Assessment of national capabilities for implementation of the law such as outlining of required human resources, suitable organizational structures, and adequate information technology was also neglected. MOF, Govt. of Mongolia

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(d) Thus, a hustled approach was adopted to complete the full implementation of the framework within 1-2 years without adequate capacity building and necessary infrastructure, which is responsible for slow progress and partial success. Above observations lead to the conclusion that the successful implementation of the PSMFA (2002) as regards strategic business plans and output budgeting on the basis of accrual accounting and benchmarks will require the following actions on a priority basis by the present government of Mongolia: (1) To consolidate the progress made until now by proper documentation in both English and Mongolian; (2) To build up necessary institutions for modernizing budgets; (3) To build up capacity and skill of the personnel engaged in planning, budgeting, accounting and auditing; (4) To strengthen and upgrade the information technology system to support the budget modernization process and systems. (5) To conduct all these works in a time-bound systems framework but step by step and in a phased manner. We have already outlined a seven year action program to complete these activities in a phased manner (see Tarun Das and E. Sandagdorj 2008). 4. Methodology for Financial Planning for 2009-2011 4.1 Macro-economic framework In this section we describe a methodology for Financial Planning for the Mongolian Budget. However, it must be kept in view that there is no unique methodology which can be applied at all times. Financial Planning depends on the macroeconomic prospects and on the budgetary and fiscal framework already approved by the Parliament. In recent years Mongolian economy has performed very well. In fact, Mongolian economy is presently in a rebound and resilient mood after successfully tackling the adverse impact of the severe and successive dzuds during 2000-2002. Economy performed very well since 2003 and achieved an average growth rate of 8.4 per cent during 5 years 2003-2007 with peak at 10.7 per cent recorded in 2004 (Table-2). The mining, construction, wholesale and retail trade, financial services, transport and tele-communications served as the main drivers of growth supported by favorable weather conditions. Mongolian economy usually does well when the weather conditions are favorable and commodity markets are buoyant. Consumer prices inflation moderated from 11 per cent in 2004 to 7 percent in 2006, but increased to 8.6 percent due to rise of wages by 30 percent at home and hardening of international prices of petroleum products abroad. MOF, Govt. of Mongolia

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Interest rate on central bank bills declined from 15 percent in 2003 to 5.8 percent in 2006, but was raised to 6.4 per cent in September 2007 by the Bank of Mongolia as a part of policies for inflation targeting. The current account balance on both the government budget and the external sector improved significantly and were in surplus in 2006 and 2007. Net present value of public external debt halved from 64 percent of GDP in 2003 to 32 percent in 2006. External debt service ratio (as percent of exports of goods and services) declined significantly from 34 percent in 2003 to 3.4 percent in 2006. As per World Bank classification, Mongolia is now categorized as a low income and les indebted country. Table-2 Mongolia: Trends of Selected Economic Indicators in 2003-2006 Economic Indicators 2003 2004 2005 2006 1. Real GDP growth (percent) 5.6 10.7 7.0 8.7 (a) Agriculture 4.9 17.7 9.6 7.5 (b) Industry 4.8 15.0 1.2 7.0 (c) Services 6.1 6.3 8.7 10.0 2. Consumer prices inflation rate (percent) 4.7 11.0 9.5 7.0 3. Growth rate of broad money supply (%) 49.7 20.3 37.3 34.9 4. Interest rate on central bank bills (percent) 15.0 15.8 3.7 5.8 5. Revenue and grants (as % of GDP) 37.9 37.3 37.0 36.6 6. Mineral revenue (as % of GDP) 2.8 4.1 4.5 13.5 7. Non-mineral revenue (as % of GDP) 34.2 32.5 29.0 27.0 8. Expenditure and net lending (% of GDP) 42.1 39.4 33.7 33.3 9. Overall budget balance as % of GDP -4.2 -2.1 3.2 3.3 10. Current account balance as % of GDP -7.7 1.6 1.4 5.2 11.Year-End foreign exch. reserves (US$ ml) 178 208 333 626 12. Forn. exch. reserves (months of imports) 1.5 1.6 2.1 3.4 13.Total public debt (as % of GDP) 113 93 68 54 14. External debt (as % of GDP 98 85 64 51 15. NPV of external debt (as % of GDP) 64 52 40 32 16. Domestic debt (as % of GDP) 15 8 4 3 17. External debt service (as % of exports) 34 7.5 2.9 2.1 18. End-period Exchange rate (MNT/US$) 1170 1209 1221 1164 Source: ADB, IMF, Govt of Mongolia 2008 Budget and the Bank of Mongolia. Note: P stands for preliminary and the latest available information.

2007P 9.9 10.0 7.9 11.1 8.6 43.8 6.4 39.5 NA NA 40.5 -1.0 NA 1290 8.0 NA NA NA NA NA 1186

Foreign exchange reserves were rebuilt from their end-2003 low level after the settlement of the pre-1991 Russian debt, and reached US$626 million (equivalent to 3.4 months of imports) at the end-2006 and further to US$1290 million (equivalent to 8 months of imports) at the end-2007. MOF, Govt. of Mongolia

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Mongolian economic prospects in the short and medium term are considered to be bright. Assuming that there would be no major internal or external shocks having destabilizing effects on the Mongolian economy and no monsoon failures, Mongolia would be able to sustain real GDP growth rates around 10 percent in 2008-2011 supported by a growth rate of 5 to 6 percent in agricultural value added, 10 to 11 percent in industry and 11 percent in services (Table-3). Industrial and services production are expected to sustain growth momentum largely driven by cyclical factors and induced by a rise in agricultural income and increased public spending on physical and social infrastructure. Table-3: Projections of real GDP growth by main sectors (in percentage)

Sectors Agriculture Industry Services Total

2007P 9.9 10.0 7.9 11.1

2008 5.0 11.5 11.5 10.1

2009 5.8 10.6 11.1 9.9

2010 6.0 10.0 11.0 9.8

2011 6.0 10.0 11.0 9.8

Source: Government of Mongolia Budget 2008 for the years 2007 to 2010, and the author’s estimate for 2011.

Parliament of Mongolia has earlier approved major macroeconomic and fiscal parameters as medium-term objectives under the Medium Term Budgetary Framework (Table-4). For Financial planning during 2009-2011, we consider major macro-economic and fiscal parameters such that these parameters comply the basic targets under MTBF. Table-4 Compliance with the 2008 MTBF targets (As percentage of GDP unless otherwise specified) Major macro-economic and fiscal parameters

1. Floor on GDP growth rate (%) 2. Ceiling on inflation rate (%) 3.Ceiling on total budget revenue 4. Ceiling on total budget expenditure 5. Floor on current balance 6. Ceiling on budget deficit 7. Floor on capital expenditure

MTBF

Budget for 2008

Financial Plan9 for 2009-2011

8.7 5.0 40.2 43.2 7.9 -3.0 8.0

10.1 5.5 44.0 47.0 7.7 -3.0 8.8

10.0 5.5 43.7 46.2 7.7 -2.5 9.0

Source: Government of Mongolia Budget 2008 for MTBF and 2008 Budget, and the author’s estimate for the Financial Plan for 2009-2011.

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Author’s projections in this report. For details, see section 4.2.

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It may be mentioned here that the Socio-Economic Development Guideline of Mongolia for the year 2008 has an inflation target of less than 10 percent. This is significantly higher than the European Union’s inflation target at 3 percent, and the inflation target of the most of the developing countries at less than 5 percent. Mongolian policy implies a major departure from the neo-liberal macroeconomic framework that has dominated policymaking in many developing countries. The neo-liberal model favors strict fiscal discipline that is pre-occupied with maintaining small fiscal deficits, monetary policy that has low inflation targets and exchange-rate policy that is committed to be fully flexible and market-determined. While the government of Mongolia also supports fiscal discipline (with overall fiscal deficit targeted at less than 3 percent of GDP as in the European Union) and flexible exchange rate, it is more liberal for the target of inflation rate. This is because the overall inflation in Mongolia is highly correlated with global prices of minerals and petroleum products, which had witnessed significant increases over the past few years. Higher inflation rate also implies a more expansionary fiscal policy to encourage work efforts and production, to enhance buoyancy in government revenues and to foster private investment. Monetary policy can be accordingly designed to support fiscal expansion and export promotion by achieving low real interest rates for private investment and the alleviation of public-sector debts. With higher inflation rate prevailing in the economy, monetary authority (i.e. the Bank of Mongolia) could take direct measures (such as selective credit controls and higher cash reserve ratios) to dampen the inflationary pressures resulting from ‘supply shocks’— e.g., sharp increases in food and energy prices. They should not hold back economic growth by raising interest rates and trying to contain inflation at five percent or less. They could move aggressively to provide increased access to affordable credit, through offering loan guarantees for productive activities and reviving development banks. They could also pursue appropriate foreign exchange management policies to reduce volatility in exchange-rates and to maintain stability in real interest rates. 4.2 Methodology for Financial Planning Financial planning means forecasting different components of government’s revenues and expenditures for the financial planning horizon. In this exercise, the current budget year 2008 has been taken as the base year and the three forwarding years viz. 2009-2011 have been taken as the planning horizon. Trends of different revenue and expenditure items are examined during 20062008 and then one of the following methods, depending on the pattern of past trends and underlying relationships, are used for projecting these items for the planning horizon:

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(a) Growth method- Average growth rate of an item during 2005-2008 or growth rate during 2008 or average growth rate in the past excluding extreme values; (b) Stability approach- Stable value for an item over the planning horizon implying attainment of satiety or saturation level; (c) Ratio or intensity approach- Average ratio of an item to GDP at current market prices. (d) Elasticity approach- Elasticity of an item with respect to GDP at current market prices. The methodology for specific items is described in details in Table-5. If larger time series data were available, one could have used the usual trend analysis or multiple regression techniques. Here, very simple but logical techniques have been used for forecasting an item for financial planning. The results are indicated in Tables-6A, 6B, 7A and 7B. Table-5: Methodology for Financial Planning for the Period 2009-2011 ITEMS 1. TOTAL REVENUE AND GRANTS 2. CURRENT REVENUE 2.1 Tax revenue 2.1.1 Income Tax 2.1.1.1 PIT 2.1.1.2 CIT 2.1.1.3 wind fall tax 2.1.2 Social security contributions 2.1.3 Tax on immovable properties 2.1.4 Sales Tax ( VAT ) 2.1.5 Excise Tax 2.1.6 Special purpose revenue 2.1.7 Taxes on foreign trade 2.1.8 Other Taxes and fees 2.2 Nontax revenue 3. CAPITAL REVENUE 4. FOREIGN GRANTS

MOF, Govt. of Mongolia

Methodology 2+3+4 2.1+2.2 2.1.1 to 2.1.8 PIT+CIT+WT Elasticity with respect to GDP Elasticity with respect to GDP GR in 2008 Average GR during 2006-2008 Average GR during 2006-2008 Elasticity with respect to GDP Elasticity with respect to GDP Average GR during 2006-2008 Elasticity with respect to GDP Average GR during 2006-2008 GR in 2008 Average GR during 2006-2008 Stable at 2008 level

18

Value

0.42 1.15 0.16 22.15 19.53 1.10 0.77 17.12 1.15 37.83 7.48 13.91

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Table-5: Methodology for Financial Planning for the Period 2009-2011 ITEMS 5. TOTAL EXP & NET LENDING 6. CURRENT EXPENDITURE 6.1 Goods and Services 6.1.1 Wages and Salaries 6.1.2 Purchase of goods/services 6.2 Interest payment 6.3 Subsidies and transfers 6.3.1 Subsidies 6.3.2 Transfers 7. CAPITAL EXPENDITURE 7.1 Domestic Investment 7.2 Capital Repairs 7.3 Other capital expenditures 7.4 Road fund by project loan 8. NET LENDING 8.1 Domestic (net) 8.2 Foreign (net)

Methodology 6+7+8 6.1+6.2+6.3 6.1.1+6.1.2 Inflation rate Inflation rate Average GR during 2006-2008 6.3.1+6.3.2 GR in 2008 GR in 2008 7.1 to 7.4 Investment/ GDP ratio in 2008 Average ratio of (7.1) Average GR during 2006-2008 GR of GDP 8.1+8.2 Stable at 2008 level Stable at 2008 level

9. Overall Balance 10 Current Balance 11. Mineral balance

Value

0.10 0.10 1.71 15.12 37.78 0.07 0.08 40.38 0.10

(1)-(5) (2)-(6) ----

12. FINANCING: 12.1 Foreign (net) 12.1.1 Project loans 12.1.2 Cash loans 12.1.3 Amortization 12.2 Domestic (net) 12.2.1 Privatization receipts 12.2.2 Repayment of Govt bonds 12.2.3 Long term bond 12.2.3.1 New 12.2.3.2 Amortization 12.2.4 IMF ( Net ) 12.2.4.1 Disbursement 12.2.4.2 Amortization 12.2.5 Banking system net credit 12. 2.5.1 Increase in the DF bal 12.2.5.2 Net changes in C/A 12.2.5.3 Opening Balance 12.2.6 Non-banking system

12.1+12.2 12.1.1 to 12.1.3 Residual after domestic Stable at 2008 level As per debt profile 12.2.1 to 12.2.6 Stabilize at 2008 level As per debt profile New Amortization GR in 2008 As per debt profile As per IMF loan profile As per IMF loan profile As per IMF loan profile 12.2.5.1 to 12.2.5.3 Estimated by Bank of Mongolia Estimated by Bank of Mongolia No balance Preferably nil

18.44

Table-6-A: Financial Planning for the Govt of Mongolia for 2009-2011 (Billion MNT) ITEMS

MOF, Govt. of Mongolia

2005

2006

19

2007

2008

2009

2010

Glocoms Inc. (USA)

2011

Financial Planning Methodology and Policies – Tarun Das

Outturn . 2.

. 3.

. 4.

MOF Final . 5.

.6.

.7.

.8.

1. TOTAL REVENUE AND GRANTS

838

1360

1786

2404

2865

3431

4129

2. CURRENT REVENUE

833

1354

1781

2387

2848

3414

4112

692

1128

1417

1996

2428

2962

3626

2.1.1 Income Tax

179

477

626

800

945

1118

1325

2.1.1.1 PIT

58

77

70

85

92

99

108

2.1.1.2 CIT

121

222

242

352

433

532

655

0

178

314

363

421

487

563

2.1.2 Social security contributions

96

112

135

174

212

259

317

2.1.3 Tax on immovable properties

6

7

8

11

13

15

18

2.1.4 Sales Tax ( VAT )

181

241

237

451

550

672

819

2.1.5 Excise Tax

79

100

119

163

188

217

251

2.1.6 Special purpose revenue

11

11

13

17

20

24

28

2.1.7 Taxes on foreign trade

57

72

98

169

208

255

314

.1.

2.1 Tax revenue

2.1.1.3 wind fall tax

Outturn

Outturn

Forecast

Forecast

Forecast

2.1.8 Other Taxes and fees

84

108

181

211

291

402

553

2.2 Nontax revenue

140

226

364

391

421

452

486

3. CAPITAL REVENUE

1

2

1

1

1

2

2

4. FOREIGN GRANTS

4

5

4

16

16

16

16

5. TOTAL EXP & NET LENDING

765

1237

1832

2569

3037

3622

4363

6. CURRENT EXPENDITURE

600

982

1414

1968

2335

2798

3391

387

692

667

1020

1122

1234

1357

6.1.1 Wages and Salaries

143

197

307

566

623

685

754

6.1.2 Purchase of goods/services

244

496

360

454

499

549

604

6.2 Interest payment

21

18

20

21

22

22

23

6.3 Subsidies and transfers

193

272

727

927

1191

1542

2011

6.1 Goods and Services

6.3.1 Subsidies

8

12

330

380

437

503

579

6.3.2 Transfers

185

259

397

548

754

1039

1432

7. CAPITAL EXPENDITURE

90

176

312

482

584

706

854

7.1 Domestic Investment

67

146

250

375

450

540

649

7.2 Capital Repairs

5

12

19

27

34

41

49

7.3 Other capital expenditures

7

9

18

17

24

34

48

7.4 Road fund by project loan

10

9

26

63

76

91

109

74

79

106

118

118

118

118

8.1 Domestic (net)

-14

-10

19

-44

-44

-44

-44

8.2 Foreign (net)

89

89

87

162

162

162

162

8. NET LENDING

9. Overall Balance

73

123

-46

-165

-172

-191

-234

10 Current Balance

232

372

367

419

513

616

721

11. Mineral balance

-49

-190

0

0

0

0

0

MOF, Govt. of Mongolia

20

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Table-6-B: Financial Planning for the Govt of Mongolia for 2009-2011 (Billion MNT) ITEMS

2005

2006

2007

2008

2009

2010

2011

Outturn

Outturn

Outturn

Forecast

Forecast

Forecast

. 2.

. 3.

. 4.

MOF Final . 5.

.6.

.7.

.8.

-73

-123

46

165

172

191

234

90

74

65

170

201

237

298

12.1.1 Project loans

99

98

112

225

280

336

417

12.1.2 Cash loans

11

6

1

6

6

6

6

12.1.3 Amortization

-20

-29

-48

-62

-85

-105

-125

-163

-198

-19

-5

-30

-46

-64

5

30

32

16

16

15

10

-14

0

0

0

0

0

0

-12

-94

24

-15

-41

-56

-69

.1. 12. FINANCING: 12.1 Foreign (net)

12.2 Domestic (net) 12.2.1 Privatization receipts 12.2.2 Repayment of Govt bonds 12.2.3 Long term bond 12.2.3.1 New 12.2.3.2 Amortization 12.2.4 IMF ( Net )

0

0

56

67

79

94

111

-12

-94

-33

-82

-120

-150

-180 -5

-7

-7

-8

-6

-5

-5

12.2.4.1 Disbursement

0

0

0

0

0

0

0

12.2.4.2 Amortization

-7

-7

-8

-6

-5

-5

-5

-135

-126

-67

0

0

0

0

0

0

317

463

600

600

600

12.2.5 Banking system net credit 12. 2.5.1 Increase in the DF bal

-135

-126

-384

-463

-600

-600

-600

12.2.5.3 Opening Balance

12.2.5.2 Net changes in C/A

0

0

0

0

0

0

0

12.2.6 Non-banking system

0

0

0

0

0

0

0

2267

3715

4526

5464

6557

7869

9442

19

64

22

21

20

20

20

Real GDP GR (%)

7.0

8.7

10.1

10.1

9.9

9.8

9.8

Overall inflation by GDP deflator (%) CPI inflation rate (%)

10.9

50.8

8.2

10.0

10.0

7.0

8.6

12.1 5.5

10.0

9.5

5.5

5.5

5.5

Memo Items GDP at current market prices GR of GDP at market prices (%)

MOF, Govt. of Mongolia

21

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Table-7-A: Financial Planning for the Govt of Mongolia for 2009-2011 Share of GDP (in percentage) 2005

2006

2007

2008

As %

As %

As %

Outturn

Outturn

Outturn

Of GDP

of GDP

of GDP

. 2.

. 3.

. 4.

MOF Final . 5.

.6.

.7.

.8.

1. TOTAL REVENUE AND GRANTS

37.0

36.6

39.5

44.0

43.7

43.6

43.7

2. CURRENT REVENUE

36.7

36.4

39.3

43.7

43.4

43.4

43.5

30.5

30.4

31.3

36.5

37.0

37.6

38.4

2.1.1 Income Tax

7.9

12.8

13.8

14.6

14.4

14.2

14.0

2.1.1.1 PIT

2.6

2.1

1.5

1.5

1.4

1.3

1.1

2.1.1.2 CIT

5.3

6.0

5.3

6.4

6.6

6.8

6.9

2.1.1.3 wind fall tax

0.0

4.8

6.9

6.6

6.4

6.2

6.0

2.1.2 Social security contributions

4.2

3.0

3.0

3.2

3.2

3.3

3.4

2.1.3 Tax on immovable properties

0.3

0.2

0.2

0.2

0.2

0.2

0.2

2.1.4 Sales Tax ( VAT )

8.0

6.5

5.2

8.3

8.4

8.5

8.7

2.1.5 Excise Tax

3.5

2.7

2.6

3.0

2.9

2.8

2.7

2.1.6 Special purpose revenue

0.5

0.3

0.3

0.3

0.3

0.3

0.3

2.1.7 Taxes on foreign trade

2.5

1.9

2.2

3.1

3.2

3.2

3.3

2.1.8 Other Taxes and fees

3.7

2.9

4.0

3.9

4.4

5.1

5.9

2.2 Nontax revenue

6.2

6.1

8.0

7.2

6.4

5.7

5.1

3. CAPITAL REVENUE

0.0

0.0

0.0

0.0

0.0

0.0

0.0

4. FOREIGN GRANTS

0.2

0.1

0.1

0.3

0.2

0.2

0.2

5. TOTAL EXP & NET LENDING

33.7

33.3

40.5

47.0

46.3

46.0

46.2

6. CURRENT EXPENDITURE

26.5

26.4

31.2

36.0

35.6

35.6

35.9

17.1

18.6

14.7

18.7

17.1

15.7

14.4

6.1.1 Wages and Salaries

6.3

5.3

6.8

10.4

9.5

8.7

8.0

6.1.2 Purchase of goods/services

10.8

13.3

7.9

8.3

7.6

7.0

6.4

6.2 Interest payment

0.9

0.5

0.4

0.4

0.3

0.3

0.2

6.3 Subsidies and transfers

8.5

7.3

16.1

17.0

18.2

19.6

21.3

6.3.1 Subsidies

0.4

0.3

7.3

6.9

6.7

6.4

6.1

6.3.2 Transfers

8.2

7.0

8.8

10.0

11.5

13.2

15.2

7. CAPITAL EXPENDITURE

4.0

4.7

6.9

8.8

8.9

9.0

9.0

7.1 Domestic Investment

3.0

3.9

5.5

6.9

6.9

6.9

6.9

7.2 Capital Repairs

0.2

0.3

0.4

0.5

0.5

0.5

0.5

7.3 Other capital expenditures

0.3

0.2

0.4

0.3

0.4

0.4

0.5

7.4 Road fund by project loan

0.5

0.2

0.6

1.2

1.2

1.2

1.2

3.3

2.1

2.3

2.2

1.8

1.5

1.3

8.1 Domestic (net)

-0.6

-0.3

0.4

-0.8

-0.7

-0.6

-0.5

8.2 Foreign (net)

3.9

2.4

1.9

3.0

2.5

2.1

1.7

.1.

2.1 Tax revenue

6.1 Goods and Services

8. NET LENDING

9. Overall Balance

3.2

3.3

-1.0

-3.0

-2.6

-2.4

-2.5

10 Current Balance

10.2

10.0

8.1

7.7

11. Mineral balance

-2.2

-5.1

0.0

0.0

7.8 -

7.8 -

7.6 -

MOF, Govt. of Mongolia

22

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Table-7-B: Financial Planning for the Govt of Mongolia for 2009-2011 Share of GDP (in percentage) 2005

2006

2007

2008

As %

As %

As %

Outturn

Outturn

Outturn

Of GDP

of GDP

of GDP

-3.2

-3.3

1.0

MOF Final 3.0

2.6

2.4

2.5

4.0

2.0

1.4

3.1

3.1

3.0

3.2

12.1.1 Project loans

4.4

2.6

2.5

4.1

4.3

4.3

4.4

12.1.2 Cash loans

0.5

0.2

0.0

0.1

0.1

0.1

0.1

12.1.3 Amortization

-0.9

-0.8

-1.1

-1.1

-1.3

-1.3

-1.3

-7.2

-5.3

-0.4

-0.1

-0.5

-0.6

-0.7

0.2

0.8

0.7

0.3

0.2

0.2

0.1

-0.6

0.0

0.0

0.0

0.0

0.0

0.0

-0.5

-2.5

0.5

-0.3

-0.6

-0.7

-0.7

12. FINANCING: 12.1 Foreign (net)

12.2 Domestic (net) 12.2.1 Privatization receipts 12.2.2 Repayment of Govt bonds 12.2.3 Long term bond 12.2.3.1 New

0.0

0.0

1.2

1.2

1.2

1.2

1.2

12.2.3.2 Amortization

-0.5

-2.5

-0.7

-1.5

-1.8

-1.9

-1.9 -0.1

12.2.4 IMF ( Net )

-0.3

-0.2

-0.2

-0.1

-0.1

-0.1

12.2.4.1 Disbursement

0.0

0.0

0.0

0.0

0.0

0.0

0.0

12.2.4.2 Amortization

-0.3

-0.2

-0.2

-0.1

-0.1

-0.1

-0.1

12.2.5 Banking system net credit

-6.0

-3.4

-1.5

0.0

0.0

0.0

0.0

12. 2.5.1 Increase in the DF bal

0.0

0.0

7.0

8.5

9.2

7.6

6.4

12.2.5.2 Net changes in C/A

0.0

-3.4

-8.5

-8.5

-9.2

-7.6

-6.4

12.2.5.3 Opening Balance

0.0

0.0

0.0

0.0

0.0

0.0

0.0

12.2.6 Non-banking system

0.0

0.0

0.0

0.0

0.0

0.0

0.0

4.3 Financial Planning for 2009-2011 It may be observed from the above tables that the overall fiscal balance as per the fiscal planning is projected to decline to 2.5 percent of GDP during 2009-2011 compared with MTBF ceiling on fiscal deficit at 3 percent of GDP. This implies that the financial planning for the period is consistent with fiscal sustainability over time. Resource mobilizations from individual taxes and duties and expenditures by economic classifications appear to be reasonable and realistic. Government’s financing planning also appears to be feasible. Needs for foreign project loans will continue and the government will be able to repay domestic and foreign loans and make associated interest payments in time without undue pressure on government budgets. Underlying parameters for the real GDP growth rates and the inflation rates for consumer prices are realistic as judged by past trends. Overall, the fiscal planning as indicated in the Tables 6-A, 6-B, 7-A and 7-B appears to be realistic and feasible.

MOF, Govt. of Mongolia

23

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Annex10 Financial Accounting Tables Prescribed by the IMF Government Finance Statistics Manual 2001 A.1 Basic Concepts In this report we describe the financial tables prescribed by the Government Finance Statistics Manual 2001 (GFSM 2001) of the International Monetary Fund (IMF). GFSM 2001 is a major step forward in terms of fiscal reporting. It fully integrates flows and stocks, considers both financial and mom-financial assets and puts emphasis on accrual accounting and preparation of a comprehensive balance sheet of the government. GFSM 2001 financial statements and fiscal indicators help for improved fiscal analysis and policy. Under GFSM, all flows are classified either as transactions or as other economic flows. A transaction is an interaction between two units by mutual agreement or by force of law such as interest payments, tax and non-tax revenues. Every transaction is either an exchange or a transfer. A transaction is an exchange if one unit provides a good, service or asset a second unit and receives something of the same value in return. Compensation of employees, purchases of goods and services, interest expense etc. are exchanges. A transaction is a transfer if one unit provides a good, service or asset to a second unit without receiving anything of any value in return, such as government subsidies, grants, and social assistance benefits to the people. All taxes and duties are treated as transfers. Transactions cover monetary flows and in-kind activity (such as the receipt of commodity grants and non-cash remuneration). Other economic flows are the result of events that affect the value of nonfinancial assets, financial assets, and liabilities but which are not exchanges or transfers. These flows can reflect either price changes (including exchange rate movements) or volume changes due to one-off events such as mineral discoveries and natural disasters.

10

This Annex is primarily based on the Government Finance Statistics Manual 2001 (GFSM 2001) and other papers on GFSM 2001 published by the International Monetary Fund (IMF), Washington, D.C. It may be mentioned here that the author was a Member of the Expert Group Meeting at IMF, Washington D.C. in February 2001 to discuss the Draft GFS Manual 2001 and to incorporate final round changes and conclusions in GFSM 2001 (refer the Preface by Mrs. Carol S. Carson, the then Director, Statistics Department, IMF in the GFS Manual 2001, p.ix).The author was also Country Reporter for India on IMF Government Finance Statistics when he worked as Economic Adviser in the Ministry of Finance, Government of India during 1989-2006. MOF, Govt. of Mongolia

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Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Transactions and other economic flows are recorded on an accrual basis. This means that they are recorded when the economic impact associated with an event occur. However, there are difficulties in identifying revenue on an accrual basis. In practice, a tax liability is normally recorded at the time of assessment. Transactions in nonfinancial assets, financial assets and liabilities are also recorded at the time assets change ownership and liabilities are incurred. A.2 Financial Statements The basic relationships under the GFSM 2001 analytical framework are summarized in three accrual-based statements relating to transactions, other economic flows, and the balance sheet, and one cash-based statement. • The Statement of Government Operations distinguishes between revenue and expense transactions, transactions in nonfinancial assets, and transactions in financial assets and liabilities. Revenue covers all transactions that increase net worth and expense covers all transactions that decrease net worth. Transactions in nonfinancial assets, financial assets and liabilities are not included. The difference between revenue and expense is the net operating balance. Subtracting the net acquisition of nonfinancial assets from the net operating balance yields net lending/borrowing, which in turn is equal to the net acquisition of financial assets less the net incurrence of liabilities. • The Statement of Other Economic Flows presents information on changes in net worth that arise from flows other than transactions. • The Balance Sheet shows the government’s net worth at the end of a fiscal year, which is equal to the stock of nonfinancial assets plus net financial worth (i.e., the difference between financial assets and liabilities). The change in net worth in a year is the sum of changes due to revenue and expense transactions and to other economic flows. The links between the components of the balance sheet and the other accrual-based statements are shown in Table-A.1. • Statement of Sources and Uses of Cash shows cash flows associated with revenue and expense transactions and transactions in nonfinancial assets, and their net impact in terms of the cash surplus/deficit. Adding the cash flow from transactions in financial assets and liabilities to the cash surplus/deficit gives the net change in the stock of cash. A.3 Valuation All flows and stocks are valued at market prices. This is the cash value of inkind transactions or the amount for which goods, services, assets, labor or capital are exchanged. Flows are valued at the current prices on the dates when

MOF, Govt. of Mongolia

25

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

they are recorded. Stocks are valued at the market prices current on the balance sheet date. Table-A.1 GFSM 2001 Analytical Framework Opening Balance Sheet

Statement of Government Operations

Statement of Other Economic Flows

Closing Balance Sheet

Revenue Minus Expense = Net operating balance = Net worth

+

= Nonfinancial assets

+

Change in net worth due to revenue and expense transactions =

+

Net acquisition of nonfinancial assets

+

+ Net financial worth

Net lending/borrowing

= Financial assets – Liabilities

+

+

Net acquisition of financial assets Minus Net incurrence of liabilities

MOF, Govt. of Mongolia

+

+

26

Net worth

=

Change in nonfinancial assets due to other economic flows

=

+

= +

=

=

Plus +

Change in net worth due to other economic flows

Nonfinancial Assets

+

Change in net financial worth due to other economic flows =

=

Change in financial assets due to other economic flows – Change in liabilities due to other economic flows

=

Net financial Worth =

=

Financial assets – Liabilities

Glocoms Inc. (USA)

Financial Planning Methodology and Policies – Tarun Das

Consumption of fixed capital is the economic equivalent of depreciation. It is the decline in the current market value of the stock of fixed assets during the accounting period as a result of physical deterioration, normal obsolescence, and accidental damage. Consumption of fixed capital accrues continuously over the accounting period and is treated as an expense under accrual accounting. Although the balance sheet is to be valued at market prices, provision is made in GFSM 2001 for reporting the nominal value of the debt as a memorandum item. Net lending/borrowing, the net operating balance, surplus/deficit are the main GFSM 2001 fiscal indicators.

and

the

cash

•

Net lending/borrowing is the most important indicator, as it reflects the government’s financing operations.

•

The net operating balance is an indicator of the impact of fiscal policy on net worth.

•

The cash surplus/deficit measures the change in the government’s liquidity position due to revenue and expense transactions, and transactions in nonfinancial assets. A.4 Implementation by Countries

Successful implementation of GFSM 2001 in the first instance involves the reclassification of existing fiscal information, which can be done relatively quickly. The second step relates to developing key institutional set up for a modern public expenditure management (PEM) framework, which provides assurance that government accounting and classification systems are capable of supporting statistical reporting that is fully GFSM 2001 compliant. Key Institutional Features of the PEM Framework Four institutional features of the PEM framework can support a successful changeover to GFSM 2001. These include the following: •

A chart of accounts, which is a hierarchical coding framework for classifying and recording fiscal data that is fully mapped into GFSM 2001.

•

A general ledger which provides a central accounting record of all government financial transactions.

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•

A treasury single account into which all government receipts are deposited and from which all payments are made on the basis of budget authorization.

•

A Government Financial Management Information System (GFMIS), which is an integrated accounting system that can generate detailed information to support budget preparation and execution, commitment control, arrears management, liquidity management and other tasks involved in managing government finances.

Experiences of IMF technical assistance for PEM reforms in many countries suggest that a well-functioning chart of accounts, general ledger, single treasury account and GFMIS constitute a sound institutional basis for meeting a wide range of PEM objectives. A.5 Phased Approach to the Implementation of GFSM 2001 (a) Categories of countries IMF has suggested a phased approach to the implementation of GFSM 2001. To this end, countries are divided into three groups depending on their capacity to build appropriate PEM capacity. •

Group-I countries are those who record revenue, expenditure, and financing transactions mainly on a cash basis, but aim at reporting fiscal statistics on GFSM 2001 basis.

•

Group-II countries are those who report revenue and expense transactions (other than consumption of fixed capital), and transactions in nonfinancial assets, financial assets and liabilities on an accrual basis, and produce a balance sheet for financial assets and liabilities. This method is known as a partial accrual basis or a modified accrual basis.

•

Group-III countries recognize consumption of fixed capital, extend the balance sheet to cover nonfinancial assets, and complete the institutional development required to fully implement GFSM 2001. (b) Implementation and coverage of government

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The focus of GFSM 2001 is the general government. A reasonable objective for Group-I countries is that they achieve comprehensive coverage on a cash basis for the central government and at least the important subnational governments. Group-II countries should routinely expand coverage from central government to general government, and a shift from a cash to a partial accrual basis. Group-III countries should be reporting fully GFSM 2001 compliant fiscal statistics for the whole of general government.

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On the basis of the above described characteristics, in August 2003 IMF categorized Fund member countries into Group I, II, and III countries. Table-A2 shows that, out of 182 Fund member countries, as per the judgment by the Fund staff, 50 countries were in Group II and 13 countries in Group III (excluding seven viz. Australia, Canada, Finland, Iceland, New Zealand, Sweden, and the United Kingdom that had fully, or almost fully, implemented GFSM 2001). The rest of the countries were in Group-I. Mongolia did not appear in either Group-II or Group-III. Therefore, Mongolia was categorized as a Group-I country. Table-A2 indicates further that the countries in Asia and Pacific were far behind the complete implementation of GFSM 2001. None of the Asia and Pacific countries belonged to Group-III and only nine countries viz. Hong Kong, India, Japan, Korea, Malaysia, Nepal, Philippines, Singapore and Thailand belonged to Group-II, and all other countries including Mongolia were in Group-I. Table-A2 Group II and III Countries Group II Countries AFR

APD

Group III Countries 1/

Benin, Burkina Faso, Cameroon, Cote d’Ivoire, Gabon, Mali, Mauritius, Senegal, South Africa Hong Kong, India, Japan, Korea, Malaysia, Nepal, Philippines, Singapore, Thailand

EU1

Bulgaria, Cyprus, Czech Republic, Greece, Hungary, Israel, Malta, Poland, Portugal, Romania, Serbia and Montenegro, Slovak Republic, Slovenia, Switzerland, Turkey

EU2

Armenia, Estonia, Latvia, Lithuania, Ukraine

MED

Morocco, Tunisia

WHD

Argentina, Bahamas, Barbados, Chile, Grenada, Jamaica, Mexico, Panama, Peru, Uruguay

Austria, Belgium, Denmark, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Norway, Spain

Brazil, United States

1/ Australia, Canada, Finland, Iceland, New Zealand, Sweden, and the United Kingdom already report on a full (or close to full) accrual basis as on August 2003.

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IMF observed that in general a country, which is fully committed to GFSM 2001 implementation, could spend 1–2 years in Group-I, 4–5 years in Group-II, and 2– 3 years in Group-III. Thus a country could expect to achieve full implementation in at best 7 years and possibly up to 10 years. Four years have passed since 2003, and now Mongolia has moved to Group-II. Government of Mongolia has already developed chart of accounts and GFMIS and is engaged in upgrading both software and hardware for the Budget Preparation Information System (BPIS). Even then, full implementation of GFSM 2001 is a major task for Mongolia. It requires careful planning and management so that the normal flow of fiscal statistics is not disrupted. Furthermore, there is need to train, recruit, and retain skilled staff to work for the National Statistical Organisation (NSO), the Ministry of Finance, Bank of Mongolia and other government agencies. (c) Links to other reforms The ultimate objective is that fiscal tables in IMF reports will be presented in full GFSM 2001 format. This should be the outcome for Group-III countries. However, systematic steps in this direction should be taken by Group-I and Group-II countries. Tables-A3.1 and A3.2 set out schematically how fiscal tables could be modified to parallel the progress that is made with implementation. While GFSM 2001 involves a shift to accrual reporting, this does not imply an automatic shift to accrual budgeting. Only a few industrialized OECD countries currently prepare budget on the basis of an accrual accounting, while most of the other member countries still prepare budgets on cash basis or on a mixture of cash and accrual accounting. Successful implementation of GFSM 2001, however, can support other best practices for PEM reforms. The introduction of accrual output budgeting (AOB), which involves an explicit focus on the effectiveness of public policy and efficiency of service delivery, provides a good example of governance reforms. We have already indicated in the main report that Mongolia has made significant progress on preparation of output budgets on the basis of accrual accounting, benchmarks and performance parameters.

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Table A3.1 Modifications of Fiscal Tables for Cash Accounting Current Presentation (Cash basis)

Group I Presentation (Cash basis) STATEMENT OF SOURCES AND USES OF CASH Receipts from operating activities (A) = (1)

GOVERNMENT OPERATIONS Total revenue and grants (1)

Payments for operating activities (B) = (2.1) + (2.2.3)

Total expenditure and net lending (2) = (2.1) + (2.2) + (2.3)

Net inflow from operating activities (C) = (A) – (B)

Current expenditure (2.1) Capital expenditure (2.2) = (2.2.1) + (2.2.2) + (2.2.3)

Net outflow from investments in nonfinancial assets (D) = (2.2)

Physical capital (2.2.1) Equity capital (2.2.2) Capital transfers (2.2.3)

Cash surplus/deficit (E) = (C) - (D) Net acquisition of financial assets other than cash (F) = (2.2.2) + (2.3) –(3.3)11

Net lending (2.3) Overall balance (3=1-2)

Net incurrence of liabilities (G) = (3.1) + (3.2)12

Financing (3) = (3.1) + (3.2) + (3.3)

Net change in the stock of cash (H) = (E) – (F) + (G)

Domestic (net) (3.1) External (net) (3.2) Privatization proceeds (3.3) Gross debt Net debt

11

Assuming that all privatization proceeds derive from sales of equity. Proceeds from sales of nonfinancial assets would be netted out of D. 12

Assuming that information on domestic and external financing is available only on a net basis. If information is available on a gross basis, any acquisition of financial assets should be included in F. Financial assets acquired for liquidity management purposes, which are included below-the-line in the current presentation, fall into this category.

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Table A3.2 Modifications of Fiscal Tables for Accrual Accounting Group II Presentation (Partial accrual basis)

Group III Presentation (Accrual basis)

STATEMENT OF SOURCES AND USES OF CASH (AS FOR GROUP I)

STATEMENT OF SOURCES AND USES OF CASH (AS FOR GROUP I)

STATEMENT OF GOVERNMENT OPERATIONS

STATEMENT OF GOVERNMENT OPERATIONS

Revenue (accrual basis) Expense (accrual basis, excluding consumption of fixed capital)

Revenue Expense (including consumption of fixed capital)

Gross operating balance Net acquisition of nonfinancial assets

Net operating balance Net acquisition of nonfinancial assets (Q)

Net lending/borrowing (accrual basis) Net acquisition of financial assets (accrual basis) (I) Net incurrence of liabilities (accrual basis) (J) STATEMENT OF OTHER ECONOMIC FLOWS

Net lending/borrowing Net acquisition of financial assets Net incurrence of liabilities

Other changes in net financial worth (K=L-M) Other changes in financial assets (L) Other changes in liabilities (M)

Other changes in net worth (R=S+L-M) Other changes in nonfinancial assets (S) Other changes in financial assets Other changes in liabilities

FINANCIAL BALANCE SHEET

BALANCE SHEET

Net financial worth (N=O-P) Financial assets (O=Oo+I+L)13 Liabilities (P=P o+J+M) 14

Net worth (T=U+O-P) Nonfinancial assets (U=U o+Q+S) 15 Financial assets Liabilities

STATEMENT OF OTHER ECONOMIC FLOWS

Selected References 13

A ‘0’ subscript indicates beginning of year value.

14

A ‘0’ subscript indicates beginning of year value.

15

A ‘0’ subscript indicates beginning of year value.

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Das, Tarun (1999a) East Asian Economic Crisis and Lessons for External Debt Management, pp.77-95, in External Debt Management, ed. by A. Vasudevan, April 1999, Reserve Bank of India (RBI), Mumbai, India. _______ (1999b) Fiscal Policies for Management of External Capital Flows, pp. 194207, in Corporate External Debt Management, edited by Jawahar Mulraj, December 1999, Credit Rating and Investment Services of India Ltd. (CRISIL), Mumbai, India. _______ (2000) Sovereign Debt Management in India, pp.561-579, in Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C. _______ (2002) Management of Contingent Liabilities in Philippines- Policies, Processes, Legal Framework and Institutions, pp.1-60, March 2002, World Bank, Washington D.C. ______ (2003a) Off budget risks and their management, Chapter-3, Philippines Improving Government Performance: Discipline, Efficiency and Equity in Managing Public Resources- A Public Expenditure, Procurement and Financial Management Review (PEPFMR), Report No. 24256-PH, A Joint Document of The Government of the Philippines, the World Bank and the Asian Development Bank, Poverty Reduction and Economic Management Unit, World Bank Philippines Country Office, April 30, 2003. ______ With Raj Kumar, Anil Bisen and M.R. Nair (2003b) Contingent Liability Management- A Study on India, pp.1-84, Commonwealth Secretariat, London. _______ (2003c) Management of Public Debt in India, pp.85-110, in Guidelines for Public Debt Management: Accompanying Document and Selected Case Studies, 2003, IMF and the World Bank, Washington D.C. _______ (2005) International Cooperation Behind National Borders- A Case Study for India, pp.1-50, Office of Development Studies, UNDP, UN Plaza, New York, 2005. _______ (2006a) Management of External Debt: International Experiences and Best Practices, pp.1-46, Best Practices series No.9, United Nations Institute for Training and Research (UNITAR), Geneva, January 2006. _______ (2006b) Governance of Public Debt- International Experiences and Best Practices, pp.1-23, Best Practices series No.10, United Nations Institute for Training and Research (UNITAR), Geneva, January 2006. _______ (2008) Accrual Accounting Rules for Government Finance Statistics, pp.1-36, ADB Capacity Building Project on Governance Reforms, Ministry of Finance, Govt of Mongolia, Ulaanbaatar, January 2008. Das, Tarun and E. Sandagdorj (2007a) Strategic Business Planning- objectives and suggested structure for Mongolia, pp.1-95, ADB Capacity Building Project on Governance Reforms, Min of Finance, Govt of Mongolia, Ulaanbaatar, August 2007.

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_______ (2007b) Output costing and output budgeting, pp.1-50, ADB Capacity Building Project on Governance Reforms, Ministry of Finance, Govt of Mongolia, Ulaanbaatar, October 2007. _______ (2007c) Transition from Cash Accounting to Accrual Accounting, pp.1-35, ADB Capacity Building Project on Governance Reforms, Ministry of Finance, Govt of Mongolia, Ulaanbaatar, October 2007. ________ (2008) Seven-Year (2008-2014) Action Plan for the Complete Implementation of the Provisions of Public Sector Management and Finance Act (27 June 2002), ADB Capacity Building Project on Governance Reforms, Ministry of Finance, Govt of Mongolia, January 2008. International Monetary Fund (2002) Government Finance Statistics Manual 2001, Statistics Department, IMF, Washington D.C., August 2002. _______ (2003a) The Implications of the Government Finance Statistics Manual 2001 for Country Work in the Fund, GFS Policy Development Taskforce, IMF, Washington D.C., August 2003. _______ (2003b) External Debt Statistics- Guide for Compilers and Users, 2003, IMF, Washington D.C. International Monetary Fund and the World Bank (2003) Guidelines for Public Debt Management: Accompanying Document and Selected Case Studies, 2003, Washington D.C. Ministry of Finance, Government of Mongolia (2007) Government Budget 2008, Ulaanbaatar, December 2007. Keipi, Kari Juhani and Justin Tyson (2002) Planning and financial protection to survive disasters, Sustainable Development Department Tech. Studies series: ENV-139, Inter-American Development Bank, Washington D.C., Oct. 2002. Reserve Bank of India (RBI) (1999) External Debt Management- Issues, Lessons and Preventive Measures, pp.1-372, edited by A. Vasudevan, RBI, Mumbai, April 1999. World Bank (2000) Sovereign Debt Management Forum: Compilation of Presentations, November 2000, World Bank, Washington D.C.

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