PFM Background

The Royal Government (RG) has long been recognized the fundamental importance of improving its public financial management policies and systems and some necessary measures have been set out and implemented since the 1980s especially in the area of revenue mobilization and budget expenditure management. The Ministry of Economy and Finance (MEF) has set out and implemented many activities to strengthening economic and public financial management and establishing good governance system including (i) macroeconomic policy framework management, (ii) improving budget system, (iii) modernization tax system, (iv) improving public accounting system, (v) developing audit system, (vi) privatizing public enterprises, and (vii) strengthening state property management.

While remarkable efforts have been devoted and significant achievements have been made, especially in some important areas such as budget management including fiscal framework; budget system management; budget formulation and execution; and treasury operation, tax policy and administration, customs policy and administration, and non-tax revenue collection, considerable challenges and lessons have been faced and learnt. This section provides a summary review of recent progress and challenges in public financial management especially the three core areas of public financial management (revenue policy and administration, public expenditure policy, and public expenditure and financial management) and program implementation and management issues, which has been addressed by the recent Integrated Fiduciary Assessment and Public Expenditure Review (IFAPER) and the Technical Cooperation Assistance Program (TCAP) evaluation report.

Revenue Policy and Administration

Since 1999 fiscal policy and management has been central to the reform efforts. The critical element of the strategy was to increase revenue to meet expenditure needs. As a result, government revenue strengthened from 8.3 percent of GDP in 1998 to a projected 11.9 percent in 2004. The increase in revenue was mostly due to growth in the tax base. The replacement of the turnover tax and consumption tax on imports with a 10 percent value added tax (VAT) in 1999 also contributed positively to the revenue increases. At the same time, the VAT enhanced the efficiency of the tax system by simplifying the tax structure, widening the coverage, and reducing cascading. Overall, tax policy has improved considerably.

However, there has been some limited progress in customs and tax administration and non-tax revenue policy and administration. Efforts focused on ensuring a more efficient use of pre-shipment inspection services, and increased transparency to reduce hidden costs in customs procedures. Moreover, anti-smuggling operations were strengthened through enhanced inter-agency cooperation and the establishment of anti-smuggling units in key border provinces. A large taxpayer unit was set up in 2001 and tax payments through banks were introduced for large and medium taxpayers. The Tax Department recently introduced a number of tax revenue-enhancing measures, such as: improved auditing, strengthened arrears management, strengthened enforcement actions (e.g., seizures of delinquent taxpayer bank and treasury accounts, cessation of import-export operations, disallowance of import permits, etc.), and improved taxpayer registration. As a result of these initial steps, collection of tax arrears has begun. However, the recent experience suggests that administrative capacity, in terms of systems; legal framework and regulations; and human resources, is acting as the binding constraint on efforts to improve tax and non-tax revenue collection. The core concern are the delays in re-organizing the tax department along functional lines, an inadequate number of professional tax and customs collectors, and the poor incentive structure throughout the revenue collection system.

Public Expenditure Policy

Since 1998, the Government has significantly improved the alignment of resources with its developmental objectives by increasing allocations for priority sectors, notably education and health. Government-executed spending on the priority sectors increased from 1.4 percent of GDP in 1998 to 3.2 percent in 2001. Furthermore, as indicated in the National Poverty Reduction Strategy (NPRS) the Royal Government of Cambodia (RGC) intends to continue this strategy, presenting ambitious targets for growth in priority sector spending. The reallocation to the priority sectors was financed through increased growth and revenues, and reduced expenditures in defense and security.

Challenges linking policy and expenditure have resulted in significant sectoral differences in the effectiveness of expenditures in improving social welfare outcomes, thus pointing to expenditure management as the key constraint. In education steady progress has been made since 1999, in expanding educational opportunities by growing total enrolment.

However, net enrolment ratios and the completion rate at the primary level are relatively low. Moreover, quality continues to be a concern. There have also been some significant achievements in the health sector, including a decline in the level of some communicable diseases and expansion of physical coverage of the system. However, the sector needs to improve access to services, which remains low and uneven, and rectify the imbalance in the incidence of spending. In the roads sector, though a start has been made on reconstruction and rehabilitation, the state of the road network remains poor. Significant increases in maintenance expenditure are required. A critical first step is to strengthen management of the Fund for the Repair and Maintenance of Roads (FRMR) by enabling it to carry out financial and performance audits of its expenditures and by requiring a formula-based maintenance expenditure program. In the agricultural sector the lack of both clear sector policy and output information makes evaluation of impact difficult.

Recent experience suggests that in order to reach stated poverty reduction goals, it will be necessary to improve the effectiveness of spending by linking it more closely to priority outcomes. Increased effectiveness can be attained by improving the pro-poor targeting of resources through more tightly linked sector plans and budgets. Public expenditure and financial management have thus emerged as the first priority of the reform program. Without expenditure management reform, the impact of further improvements in expenditure policy will be limited.

Public Expenditure and Financial Management

The RGC has placed public expenditure and financial management reform squarely on its development and poverty reduction agendas. Recent initiatives have built on a previous round of reforms, launched after the promulgation of the Organic Budget Law in 1993, which established the institutional architecture for budgeting, planning and budget execution. Priority was given to the development of systems that guaranteed budgetary
discipline, through a process of commitment control and centralized payments system. These reforms achieved their objective in delivering—with the exception of a period of fiscal instability following the disturbances of 1998—budgetary restraint, reflected in current balances of over 1.2 percent of GDP in each the last four years. They have also been instrumental in increasing expenditures on the priority sectors of education; health; agriculture; and rural development, while reducing spending on defense and security.

It has become increasingly apparent, however, that weaknesses in the public expenditure and financial management system not only have high costs in terms of allocative and operational efficiency, but also create unacceptably high levels of fiduciary risk to public funds. The cash-based payments system has emerged as a major constraint. Increasingly, budget execution has suffered from delays and an unpredictable release of funds, due to cash constraints, undermining operational planning, and leading to the build-up of arrears. The system is plagued by gate-keeping and deficient accounting and reporting systems, thus leading to a weak control environment and increasing opportunities for corruption. Indeed, in comparative perspective, Cambodia’s system ranks below average (as compared to the low income countries assessed by a joint World Bank-IMF diagnostic tool).

Attempts have been made to address these problems by implementing pilot initiatives, notably the Accelerated District Development and Priority Action Programs, together with a sector-wide approach in aid coordination, first in education and health. This has improved the alignment of resources with policy objectives and helped channel funds to operational units, but their impact has been muted by liquidity constraints and concerns over the adequacy of control arrangements. Within MEF, attention has recently turned to the improvement of treasury operations, cash management, and public accounting so as to address these concerns. At the same time, MEF has made progress in the development of a medium term expenditure framework, which hopefully will improve resource allocation and the predictability of resources over the medium term.

Improving the management of external assistance to ensure greater alignment with RGC priorities is also critical, given the sheer volume of external assistance in total Government expenditure. The bulk of this assistance has been channeled off-budget, both in the sense that resource allocations are not reflected in the Government’s budget documents and that funds are not disbursed through Treasury. Lack of information and the absence of effective instruments to guide the allocation of external financing seriously undermine the integrity and effectiveness of the budgetary system. At present, it is impossible to assess the impact of external project financing on overall resource allocations, let alone its implications for future patterns of on-budget expenditures, as regards provision for operation and maintenance costs for new investments. There is a risk that the proliferation of donorfinanced projects—by financing investments that are only tangentially related to ministries’ development strategies— has led to policy drift in some instances.