PFM REFORMS IN YEMEN: BACKGROUND AND WAYFORWARD

Jean-Marc Lepain EU PFM Advisor

1. Introduction and background Attempts to develop a comprehensive PFM system in Yemen started in the late 90s with a number of uncoordinated projects. They were mostly donor driven and addressed what were seen as pressing issues in the areas of budget preparation, budget execution, control and auditing. In the early 2000s, the idea of the implementing an FMIS started to be debated and a conceptual design was adopted in 2005. Meanwhile, the Ministry of Finance adopted a PFM Reform Action Plan to support AFMIS development and to federate a number of donor initiatives. The 2005 Action Plan, covering the years 2005-2008, was mostly focused on preparatory work for FMIS implementation. The Plan suffered from a number of weaknesses which explains its failure to substantially improve PFM functions. It was not based on a proper PFM diagnostic and failed to address the issue of budget credibility. As a consequence it did not take a comprehensive approach of PFM reforms, nor did it address the issue of reform sequencing. The Plan was limited to MOF whereas PFM functions are shared between different ministries (MOF, MOLA, MOPIC) and Agencies (BoY, SFD, COCA, HTB, etc.). For that reason it did not address such issues as budget integration, fiscal policy coordination, or the decentralisation of budget execution functions. Finally, although the plan was useful in identifying priority actions to be taken for FMIS implementation and proposed a number of measures to strengthen budget preparation and budget execution, it was not based on a strategic vision of how a PFM system could be developed in Yemen or reform prioritisation. With the benefice of hindsight, it appears that the launching of AFMIS implementation was probably premature. One of the originalities of the conceptual design was that the budget preparation module was given high priority. However this approach did not take stock of the immaturity of the budget preparation process. The same is true of the budget execution module which was developed without proper business process re-engineering, resulting in the multiple rounds of system revision which account for high development costs and the low level of user acceptance. As a consequence, the 2005 Action Plan had limited impact and did not offer a well-accepted framework for donor intervention. A number of important reforms such as tax collection and tax management were undertaken without being part of the plan. By 2008, a PEFA assessment was conducted. The report underlined the lack of budget credibility, weak budget execution, lack of predictability in budget releases, weak cash management, weak commitment controls and salary expenditure controls and the non-achievement of value-for-money in procurement. It also highlighted the practice of ex-post approval of the supplementary budget by parliament along with the accumulation of arrears without proper and complete tracking. The

report concludes that systemic weaknesses result in undermining the PFM capacity for achieving aggregate fiscal discipline and budget credibility. While the PEFA report shows very little improvement of PFM functions despite all the efforts put into implementing the 2005-2008 Action Plan, the negative outcome was largely blamed on the slow implementation of reforms. The Action Plan was neither updated nor reconsidered but a number of actions were agreed upon with the donors on an ad hoc basis. Emphasis was put on revenue reforms, development of a commitment control system as part of FMIS, implementation of a cash management procedures, development of internal audit, as well as the strengthening of COCA and the High Tender Board. However, five years later most of these items are still at the implementation stage. A Medium Term Fiscal Framework was also introduced but was not linked with budget preparation while investment policy remains largely disconnected from fiscal sustainability. After much discussion with the donors and stakeholders1 it was decided that the new Action Plan

will only take the form of a two year intermediary plan (2014-2015) with the objectives of

addressing some of the most pressing issues faced by the Yemeni Government. Development of a

more ambitious plan is left for 2015 and beyond when a proper PFM diagnostic will be conducted,

the budget deficit reined in and a democratic Government elected. The present plan intends to

focus on the restoration of budget credibility and fiscal sustainability, although planners have

sometimes considered activities that seem out of the scope of the agreed strategy. There was a

strong feeling among all stakeholders that very bold reforms are necessary to revise the legislative

framework, reorganise ministries and agencies involved in PFM management, review the state-

owned enterprises’ oversight mechanism and implement fiscal decentralisation, but that these

reforms will have to wait until an elected Government is in place to support them.

A reform plan is always a compromise between different views and the Yemen PFM Reform Action

Plan 2014-2015 is no exception. It has its strengths and its weaknesses. However if this plan can be

implement it would be good preparation for a more ambitious reform program that could address

structural issues.

1

By “stakeholders” we mean all ministries and agencies involved in public finance management. It also

includes the Ministry of Finance, the Revenue Authority, the Finance Institute, the Ministry of Planning, the

Ministry of Local Authorities, the Social Fund for Development, the Bank of Yemen, the High Tender Board, and

the Central Organisation for Control and Audit (COCA).

2. PFM and the deterioration of the macroeconomic framework

PFM issues are closely related to the deterioration of the macroeconomic framework of the country

that can be summarised as follows:

For the last two decades Yemen has been unable to achieve a sustainable fiscal position and

has remained dependent on donor support.

Alteration of the international environment has had a negative effect on the country's

macroeconomic situation. Due to support to the Iraqi regime during the Gulf War, Yemeni

workers were expelled from Golf states. Since then, although immigration to Gulf States has

resumed, expatriate remittances due to various reasons have ceased to play the stabilising

role they had in the past. Furthermore, recurrent tensions between Yemen and Saudi Arabia

result in the regular expulsion of Shi’a workers from the Kingdom where they are perceived

as a threat.

The recent revolution has aggravated the fiscal crisis by undermining fiscal discipline. The

hiring of thousands of new civil servants has not only raised the wage bill to an alarming

level, but has aggravated the mismatch between the need for skilled employees and the

mass of unqualified civil servants. The same situation is found in the army and in a number

of state owned enterprises.

Subsidies for gas and electricity are consuming a growing share of the budget without any

significant impact on the economy or the poverty level. Although the subsidies benefit

mainly a small number of importers and the middle class, their phasing out appears

politically very difficult.

The fiscal position of the country is prone to further deterioration due to (i) a fast decline in

oil revenues caused by the depletion of reserves that might be exhausted by 2020 (oil

exports still represent 25% of the GDP and 70% of Government’s resources), (ii) pressure on

the wage bill, (iii) increase in security expenditure and (iv) deteriorating fiscal discipline.

All experts agree that a bail-out from either the IMF or Gulf countries will be necessary for

stabilising the economy and easing the liquidity crisis that is affecting budget execution.

However, a bail-out will only be a temporary patch if it does not go along a number of

structural reforms; among which are the phasing out of energy subsidies, the repealing of a

number of tax exemptions, better revenue collection and revenue management, and

stronger fiscal discipline.

4

3. Fiscal sustainability and budget credibility

In this context, fiscal sustainability and budget credibility appear as the main issues to be addressed

by PFM reforms. However, the 2005 PFM Reform Plan while focusing on AFMIS implementation did

little to address such issues. This appeared clearly during the 2008 PEFA assessment, triggering a

number of donor initiatives in the area of macro-fiscal planning, budget preparation, revenue

management, single treasury account management, cash management, debt management,

commitment control, internal control, etc. However, despite all these initiatives in the right

direction, few results have been achieved so far for several reasons:

PFM has two essential components: processes and policies. Improving processes has little

effect as long as policies remain unrealistic. Reforms introduced over the past few years

address mostly processes while the question of policies remains ignored;

Real progress in revenue management has certainly contributed to easing the situation and

remains the most positive result achieved by reforms thus far. However, tax policies remain

incoherent mainly for political reasons. A number of key sectors, such as Telco, remain

largely untaxed and the Tax Authority and Customs remain understaffed and under-

equipped;

Cash management cannot be a substitute for a realistic budget, nor can it correct the effects

of poor fiscal discipline. Cash management is always difficult to implement within a context

of a liquidity crisis and cash rationing; and

Reform Sequencing is ignored with each department or ministry independently conducting

its own set of reforms resulting in poor linkage between them. For example, MOF is

preparing a relatively good Medium Term Fiscal Framework (often wrongly referred to as

Medium Term Expenditure Framework or MTEF), but in the absence of a fiscal policy

document and of sectoral fiscal envelopes, the MTFF is totally ignored during budget

preparation. The Ministry of Planning uses a different fiscal model based on different

indicators and sets of data to prepare its Public Investment Programmes.

Among all the issues mentioned, two emerge as particularly important: the lack of clarity of the

roles between MOF and MOPIC and the lack of budget integration between the different

components of the General Budget.

5

4. Lack of clarity of roles of Ministries, Departments and Agencies

The respective roles of MOF and MOPIC are not well defined, with the consequence that both

ministries claim responsibility for a number of areas such as fiscal policy, expenditure planning and

programme budgeting. As capacity is slightly better at MOPIC, donors tend to provide more

technical assistance to MOPIC and by doing so reinforce the MOPIC claim to have the leading role in

public finance management. This is especially true of fiscal policy and macro-fiscal planning. On the

other hand, when it comes to budget execution MOF has the means of blocking many of MOPIC’s

initiatives.

Discussions about fiscal decentralisation show that a clarification of roles will also be necessary

between MOF, MOLA the Ministry of Interior and the Social Fund for Development. The solution

would probably be to establish a joint committee.

The lack of role clarity is not limited to MOF, MOPIC and MOLA. It is a more general problem that

also exists between departments in ministries, especially MOF. New functions have been created

without very much change in organisational structures. Although there is a department in charge of

the MTFF/MTFF, that department does not have a broad enough mandate to embrace all aspects of

fiscal policy, the responsibility of which is shared between MOF’s budget department and MOPIC.

Accounting and reporting are not separated from budget execution and the delineation between

budget preparation and budget execution is unclear. In the medium term a complete reorganisation

of MOF, MOLA and MOPIC must be considered. However, this issue should be addressed only after

2015 on the basis of a new PFM Reforms Plan and only if there is strong political support. The last

attempt to reorganise MOF failed due to a lack of consensus and rivalries among top management.

5. Budget integration

The lack of integration between the different components of the General Budget has emerged as of

one of the main reasons for the budget's lack of credibility. The disconnection between the

operating budget and the investment budget is a typical problem of countries that separate

economic planning from fiscal management. In such countries the Investment Budget is prepared

independently from the operating budget resulting in a mismatch between investment in

infrastructures and their operational and maintenance costs. In the case of Yemen, the issue goes

beyond dual budgeting. The budget is comprised of four components which are developed

independently: the operational budget, the subsidy budget, the investment budget, and the

economic entities budget.

The Subsidies Budget is seen as a macroeconomic constraint since the budget volume does not

depend on the country’s fiscal capacity but on the price fluctuations of exported oil and imported

6

gasoline. When prices go up, the Government must adjust its subsidies. With energy subsidies

absorbing 30% of budget resources in a context of declining oil revenues, the burden is becoming

unbearable and is one of the main reasons for the lack of sustainability of the country’s fiscal

position. So far, the Transitional Government has resisted all international pressure to phase out oil

subsidies due to the unpopularity of this measure. Beside the fact that energy subsidies primarily

benefit gasoline importers and the middle class, the policy is perceived by the population as pro-

poor and there is no doubt that the removal of these subsidies would impact the cost of food

transport and agricultural products since a great part of Yemeni agriculture requires diesel powered

water pumps for irrigation. This subject is strongly linked to a possible bail-out package by the IMF.

Until financial pressure on the budget becomes unbearable, no change in the policy can be expected

in the immediate future. In any case, the phasing out of energy subsidies will require several years

and will not improve fiscal space immediately as a social safety net would first have to be put in

place.

The Investment Budget is prepared on the basis of multi-year Public Investment Plans (PIP) with the

consequence that the budget is burdened with on-going projects which are neither properly

documented nor monitored. Some projects cannot go beyond the conceptual phase because of the

lack of a feasibility study, imprecise technical requirements, an unrealistic budget, etc. Some new

projects have unrealistic procurement schedules. Other projects have started but are either under

spending or over spending. In the absence on an Investment Management System it is difficult to

assess the state of advancement of Public Investment Programmes and to forecast their financing

needs. Additionally, PIPs are prepared without consideration of MOF’s MTFF, MOPIC macro-fiscal

model which is driven by macroeconomic considerations rather than considerations of fiscal

constraints.

The Economic Entities Budget is a supposedly auto-financed budget. The concept of Economic

Entities is vague and not in line with the principles of modern budgeting. It groups State Owned

Enterprises with a number of budget entities that have a significant volume of own-source revenue.

Problems raised by economic entities are highly specific, and we will come back to them after

discussing other aspects of budget integration.

6. The proposed Action Plan structure

The proposed Action Plan structure as presented in the concept note and the preparatory

documents was far simpler than the one later adopted by the Planning Committee. Initially four

platforms divided into subcomponents were considered:

A. Budget Credibility,

7

B. Streamlining of Budget execution,

C. Accountability and transparency, and

D. Fiscal decentralisation

The Budget Credibility Platform should have been divided into a number of subcomponents:

macroeconomic forecasting, revenue management, cash management, debt management,

etc.

Budget execution streamlining should have focused on making the budget execution more

effective, especially at the provincial and district levels, possibly including some measures of

decentralisation.

Accountability would have covered AFMIS, external control (Audit), procurement, budget

transparency; etc.

The approach to fiscal decentralisation should have been organised by function instead of

by organisation.

Soon it was found that about three quarters of the planned activities were grouped under “budget

credibility”. For that reason Component A was split into two components while several other

components were added.

A. Restoring fiscal sustainability and strengthening the budget formulation

process

B. Strengthening revenue mobilisation and revenue management.

C. Enhancing Control and Accountability.

D. Developing capacity and expanding the role of the Finance Institute.

E. Strengthening risk management, public debt management and development

of the financial sector.

F. Implementing fiscal decentralisation.

G. Institutional reforms and medium term planning.

One reason for the hydrocephalus of Component A was the necessity to integrate the

Harmonisation Project. Reference to “Transparency” was dropped from the Accountability

Component because budget transparency was thought not to be a priority. Firstly, implementing full

budget transparency has little benefit as long as budget credibility is not restored, because the

implemented budget would bear little resemblance with the voted budget. Secondly, implementing

budget transparency would require a debate in the Cabinet and changes in the legislation.

Considering the Government's transitional nature, the difficulty of political parties to agree on the

fiscal policy, and the urgency of other questions, it was thought that attempting such a debate might

be counterproductive and in the end undermine budget reforms.

8

“Streamlining Budget Execution” disappeared as an independent component due on one hand to

the protestation of the PFM Modernisation Project that thought that any change in budget

execution should be done according to the AFMIS Implementation Plan, and on the other hand due

to the mediocrity of the recommendations of the Finance Department that was unable to pinpoint

the reasons for dysfunctional processes. Recommended activities were put either under Component

A or Component C.

Component G “Institutional reforms and medium term planning” was created to group all planned

activities which could not reasonably be undertaken during the following two years, such as result-

based budgeting. This component has in fact two parts. One part is the preparation for a number of

reforms that will take place beyond the time horizon of the Action Plan. Obviously the different

ministries involved in PFM will have to undergo a deep reorganisation and the legislative framework

will need to be revised thoroughly. But medium term planning is as important as the institutional

reforms. Component G integrates the PFM diagnostic that will take place either in 2014 or at the

beginning of 2015 followed by a new planning phase. We expect that this new planning phase will

be more ambitious than the current one and will addressed structural issues that cannot be tackled

now due to the transitory nature of the Government.

As it is, the Action Plan remains a collection of necessary activities with a certain degree of

sequencing and prioritisation. It is not underpinned by a proper PFM diagnostic and even less by a

unity of vision and an agreed strategy.

7. Work plan strengths and weaknesses

The Action Plan, as its stands today, has a number of strengths:

It is the result of an emerging consensus on the necessity of undertaking important PFM

reforms.

The Plan is the product of a joint cooperation between MOF and MOPIC, despite their

rivalries.

The plan addresses important cross-ministerial issues such as budget integration, the linkage

between economic planning and budget preparation and the importance of a centralised

fiscal policy.

The plan (again to a certain extent) takes middle management's views into consideration

while having the support of key ministries' top management.

Budget credibility is now recognised by stakeholders as the first and foremost issue that

needs to be addressed.

9

However, the new Action Plan has also important weaknesses.

The Plan remains too ambitious, loaded with too many activities and objectives. At this

stage the Action Plan remains a compilation of different departments’ plans without a

unifying vision, except for the Harmonisation Project and to some extend budget

integration.

The plan is a plan for “fixing problems”. It is not based on a strategic vision or the conscious

adherence to a specific PFM model toward which the existing system must converge.

Although budget credibility remains the plan's main objective, this is not always reflected in

terms of focus of action and there is a risk that during the implementation phase it will be

forgotten.

Language used for describing activities remains vague and inappropriate, showing a lack of

knowledge of PFM processes and insufficient conceptualisation.

Often, activities are only loosely related to objectives and deliverables are not clearly

identified.

Means of verification are non-existent or unreliable in most cases. Many of them have been

provided by the Planning Secretariat and not by the departments.

Request for technical assistance is too fragmented and not realistic.

Capacity building is not planned systematically.

The Ministry of Local Authorities was only loosely integrated in the planning process

through its Vice-Minister while the rest of the top ministry management remained relatively

unconcerned, mainly due to a lack of PFM process understanding. As a consequence we are

still missing a plan to deconcentrate budget execution processes.

8. Lessons learnt

(1) The most important lesson learnt is that, in Yemen, a six month time frame with only three

months of technical assistance is not enough to prepare even a limited action plan. The next

Action plan will probably have to cover the years 2016-2020 and be strategically important.

Failure to introduce structural reforms during these crucial years will undermine the very

existence of the country. It is important that the next plan be prepared with sufficient

technical assistance. Technical assistance must be relatively continuous as experience shows

that in the absence of the Consultant little progress is made.

10

(2) To consolidate the emerging consensus on reform it is necessary to engage more vigorously

political parties and key politicians close to the Cabinet. Parliament support will also be

necessary. Members of Parliament and politicians in the Presidential entourage have often

an unrealistic view of the country's fiscal position and are insufficiently informed of the

consequences of the current policy's lack of fiscal sustainability. Promoting the right fiscal

policy will require the education of civil society at large.

(3) In order to prepare the next reform plan a proper PFM diagnostic is necessary and its

conclusion should be discussed with the authorities. The diagnostic should be broader than

a PEFA to address issues such as fiscal sustainability, energy subsidies, and fiscal

decentralisation among other questions. It should also include policy issues and

recommendations on the structure budget allocations based on the economic and social

objectives adopted by the Government.

(4) Before starting the planning phase of a new plan, a strong capacity building plan and

communication strategy must be put in place with a number of seminars, firstly to ensure

that all stakeholders understand the plan's purpose and, secondly, to ensure that planners

have a grasp of the most essential concepts.

(5) The success of any PFM Reform Strategy will require a change of fiscal policy. Structural and

organisational issues, including business processes, cannot be divorced from policy issues.

Unless the Government adopts a sound fiscal policy PFM reform cannot succeed. Ideally a

PFM Reform Plan should be presented with a new fiscal policy strategy.

(6) Overcoming the fragmentation of the Action Plan would require a stronger planning

committee whose members would represent more than their departments. Planners, in

order to be able to prioritise activities, most not be chosen among the project's main

beneficiaries.

(7) Considering the importance that fiscal decentralisation will take in the coming years, it is

important to move quickly on that front. The way the new Constitution is drafted will have

considerable importance. Although the political debate focuses on the issue of federalism,

from a fiscal perspective even a federal state can be fiscally centralised. Maintaining

revenue centralisation is essential to ensure that all provinces/states are sustainably

financed by sufficient central transfers. The form of Government chosen must be fiscally

sustainable. For that purpose the politicians involved in the preparation and approval of the

11

new Constitution must have a better idea of the country's fiscal capacity. Important

preparatory work can be done to measure the fiscal capacity of each province, to gauge the

horizontal imbalance by sector in budget allocation, and to measure the size of the fiscal gap

to bring all provinces on par. Without such preparatory work a revision of the revenue and

expenditure assignment will be impossible.

(8) From a fiscal perspective moving to a new decentralised formed of Government will require

several years. Therefore it is unlikely that the fiscal dispositions of a new Constitution will be

implemented. A transition period will be necessary to put the new system of

intergovernmental transfers in place.

9. Way forward

The most important step to be taken is of course the approval of the plan by the Cabinet. This

approval will ensure that there is enough political support for its implementation and that the

emerging consensus on reform policy is consolidated. This will require monitoring on the donor side.

The following step will be the installation of the Steering Committee and of the Governance

structure. Because a committee meets only periodically there is a need for a permanent secretariat.

Ideally this permanent secretariat should be supported by a full time adviser.

It should be understood that the plan should be amendable and will require periodic revision. In

practice, the present plan has so many weaknesses that it would be beneficial if some of them could

be corrected quickly and unrealistic objectives delayed until after 2016.

The Action Plan is not, and should not be, a technical assistance plan. Proper technical assistance

should be developed and costed in a distinct document that needs to be prepared rapidly, probably

by donors. Technical assistance should be aggregated as much as possible to reduce the number of

consultants. Priority should be given to long term consultants responsible for broad functions rather

than short term technical assistance.

A more specific plan should be developed by donors to support fiscal decentralisation.