REPUBLIC OF ALBANIA
MINISTRY OF FINANCE
MEDIUM-TERM EXPENDITURE FRAMEWORK
2002-04
Tirana, June 2001
Contents
Executive Summary......
A.Introduction......
B.Macroeconomic Outlook......
Overview of Recent Macroeconomic Performance......
Prospects for 2001-04......
C.Public Expenditure Resource Framework 2002-04......
Revenue Performance During 2000......
Outlook for 2001......
Financing of the Budget Deficit......
Consolidated Resource Framework......
D.Expenditure Issues and Projections......
Interest Payments......
Discretionary Recurrent Expenditure......
Public Investment......
E.Fiscal Decentralisation......
Functions to be Financed by Local Governments......
Financing Instruments......
Implications for Ministry and Local Government Budgets......
F.Sector Resource Allocations......
Recent Trends......
Strategic Priorities......
General Issues Identified......
Resource Allocation Recommendations......
Proposed Resource Ceilings......
Ministry Resource Ceilings......
Annex: Summary Fiscal Tables......
Boxes
Box 1: The Medium-Term Expenditure Framework - Aims......
Box 2: Subsidies – Summary of MTEF Recommendations......
Box 3: Functions of Local Government......
Box 4: Resource Allocation Recommendations – Key Sectors......
Tables
Table 1: Recent Economic Performance......
Table 2: Projected Revenues 2002-04......
Table 3: Comparison of Tax Rates and Revenues......
Table 4: Financing of the Budget Deficit......
Table 5: Summary Indicators of Budget Resources......
Table 6: Consolidated Expenditure Framework......
Table 7: Projection of Wagebill Allocations......
Table 8: Share of Resources Allocated to Operations and Maintenance......
Table 9: Social Protection Transfers......
Table 10: Projection of Public Investment Expenditure......
Table 11: Projection of Local Government Financing......
Table 12: Implications of Decentralisation on Ministry Budgets in 2002......
Table 13: Total Public Expenditure – Breakdown by Function (excluding debt service)......
Table 14: Public Expenditure 2001-04 - Breakdown by Function (excluding debt service).....
Table 15: Ministry Resource Ceilings 2002-04......
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Executive Summary
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Macroeconomic Outlook
During 2002-04, the main aim of macroeconomic policy will be to maintain the strong performance of the last two years. Real GDP is projected to grow by around 7% annually with inflation remaining at around 3% annually. Growth will be facilitated by an accelerated programme of structural reform in key sectors, by improved governance necessary to facilitate private sector investment, and by continued high levels of investment in public infrastructure. This will provide a robust framework for implementation of the GPRS and for reorienting public expenditure towards GPRS objectives.
Resource Framework for Public Expenditure
Government revenues are expected to continue to show strong growth increasing from 22.4% of GDP in 2000 to 24.4% in 2004 (Chart A). This growth will be driven by increases in tax collections (excluding customs revenues) from 6.5% to 8.4% of GDP, and collection of social insurance contributions from 3.7% to 4.4% of GDP. Local government revenues are projected to increase from 0.2% of GDP in 2000 to 0.6% in 2004 following introduction of the agricultural land tax in the second half of 2002. Customs revenues are expected to fall from 8.7% of GDP in 2001 to 8.4% in 2004 following implementation of WTO provisions.
Achievement of these revenue targets will depend on further measures being taken to strengthen tax administration and to improve collection of social insurance contributions. Selective reductions in higher tax and contribution rates will also be introduced where these can be expected to lead to increased revenues collections through improved compliance.
Further reduction in the budget deficit, particularly the domestic financed deficit, is crucial to achieving fiscal sustainability. The total budget deficit is projected to decline from 9.1% of GDP in 2001 to 7.9% in 2004, with the domestically financed deficit falling from 5.0% to 3.1% of GDP over the same period. Privatisation revenues will continue to be a significant source of financing in 2002 and 2003, but are expected to fall off sharply in 2004. External financing will increase significantly over the period as major investment projects enter full-scale implementation.
Table A shows the overall budget framework for 2001-04. Total resources are projected to grow at 11% per annum over the period.
Expenditure Issues and Projections
Total expenditure is projected to increase from 31.4% of GDP in 2000 to 32.3% in 2004. Chart A shows the planned distribution between the main budget items:
Interest payments fell from a peak of 7.8% of GDP in 1998 to 5.5% in 2000, and are projected to fall further to 3.1% of GDP by 2004. This will release substantial resources for additional spending on public services and investment.
Personnel expenses fell from 8.2% of GDP in 1996 to 6.2% in 2002 and are estimated at 6.7% in 2001 reflecting recent wage increases. During 2002-04 the total wagebill is planned to increase by 10% annually allowing substantial increases in real wage levels. It is proposed that in health and education, where average salaries are lower, wagebill expenses should increase by 12% annually and in all other staff cadres by 8% annually. Additionally it is proposed that two-thirds of these increases should be used to finance pro-rata increases in salaries and one-third used to support pay restructuring measures necessary to attract and retain key skills. The scope for further reductions in public service staffing is limited, and is expected to be confined primarily to activities, such as road maintenance, which can be contracted out to the private sector (resulting in a shift in spending from wagebill to operations and maintenance). Around 10,000 staff are expected to be transferred from central government to local government payrolls in 2002.
In the 2001 Budget increases in operations and maintenance allocations were targeted towards education, health and road maintenance. Nevertheless operations and maintenance spending remains substantially inadequate, accounting for less than 15% of total recurrent spending in some services. During 2002-04 it is proposed that increases in operations and maintenance allocations will be targeted towards health, education and infrastructure maintenance consistent with GPRS objectives. In other sectors spending will increase by an average of 10% annually.
Subsidies have increased rapidly, rising from 0.5% of GDP in 1999 to an estimated 1.2% in 2002. This increase is entirely driven by subsidies on imported electricity which now exceed spending on higher education. This has resulted in considerable diversion of resources from spending on public services and emphasises the importance of tariff and management reform measures necessary to ensure the commercial viability of KESH. On this basis electricity subsidies are projected to fall by 25% annually during 2002-04. Elsewhere, the policy will be to eliminate subsidies that are no longer appropriate or effective. Specifically, it is planned to eliminate the subsidy on the production of school textbooks reallocating the resources to school and university budgets, and to transfer the subsidy on urban transport services to the local government conditional grant. Total spending on subsidies is expected to fall back to 0.5% of GDP by 2004.
Social protection transfers are planned to remain at around 6.9% of GDP during 2002-04. Over 80% of social protection transfers relate to social insurance benefits, the remaining 20% being poverty and disability related social assistance benefits. Social insurance benefits (pensions subsidy and unemployment benefits) account for two thirds of budgetary spending on social protection transfers. The main strategic issues to be addressed during 2002-04 are:
- to reduce the general subsidy to the pension scheme linked to a series of measures aimed at improving compliance in contributions, reducing the subsidy on rural pensions and raising the retirement age to bring it into line with other European countries; and
- to improve the administration and targeting of social assistance benefit programmes requiring more appropriate criteria for determining entitlements and improved inspection.
A substantial increase of 15% for Ndihma Ekonomike and 30% for disability benefits is proposed for 2002.
Public investment is projected to increase from 6.5% of GDP in 2000 to 8.3% in 2004, although part of this increase will reflect the better recording of externally financed public investment, much of which at present falls outside of the Budget. Investment in energy, transport and local infrastructure is expected to account for around two-thirds of all public investment. In order to improve the budgeting of public investment expenditures the following measures are proposed: (i)requiring additional details on project cost, expenditures to date and projected expenditures in line ministry budget submissions; (ii)increasing allocations for infrastructure maintenance under the recurrent budget so that maintenance expenditures no longer have to be met from the capital budget; and (iii)ensuring that line ministries make more adequate provision for local costs and VAT coverage on externally financed projects.
Fiscal Decentralisation
Chart C shows the projected growth in spending from the general budget of local governments in 200204.
In the 2001 Budget a number of exclusive functions of local governments continued to be financed as conditional grants from line ministry budgets. In 2002, these functions will be transferred to the general budget of local governments and financed by the unconditional grant from central Government. Exceptions are veterinary services, residential social care, and water supplies where outstanding issues about the appropriate role of local governments still have to be addressed. This will result in the unconditional transfer to local governments increasing to from Lek4.9 billion in 2001 to Lek10.3 billion in 2002. The MoLG will develop new criteria for the distribution of the general transfer to be introduced with the 2002 Budget.
Local government revenues from land taxes and fees are expected to increase rapidly during 2002-04 as a result of measures to improve collections and the introduction of the agricultural land tax. Collection of the small business tax will continue to be undertaken by central government and transferred through the unconditional transfer. Proposals for tax sharing have still to be defined and this will not be introduced until at least 2003. No borrowing by local governments is envisaged during 2002-04.
Sector Resource Allocations
The strategic priorities identified for the 2002-04 MTEF are:
- to increase the share of GDP allocated to spending on health and education;
- to maintain, as a share of GDP, spending on social protection linked to a shift towards poverty reduction related expenditure programmes;
- to continue to allocate substantial real increases in resource allocations for public order;
- to maintain the high level of investment in public infrastructure while addressing those constraints that have resulted in slow project implementation;
- to increase allocations for infrastructure maintenance.
Chart D shows the planned growth in recurrent spending on major sector programmes during 2002-04 and shows the very rapid increase in planned spending on operations and maintenance in health, education and transport.
Chart E shows the distribution of recurrent spending (excluding interest) between sectors during 2002-04. Health, education, and social security and welfare are expected to account for 63% of total recurrent spending over the period with the share of health and education increasing from 25% in 2001 to 29% in 2004.
Chart F shows the planned distribution of public investment over the 2002-04 period. However, there remain considerable difficulties in projecting public investment expenditures. This reflects both the lack of forward projections of planned disbursements of external financing and the absence of adequate procedures for project planning and resource allocation.
The work done with line ministries in developing expenditure strategies and plans for 2002-04 identified requirements for ensuring more effective budget planning and implementation. These included: (i)better prioritisation of resource allocations between programmes; (ii)detailing and timetabling of specific reform actions; (iii)review and updating of resource allocation criteria within major programmes; (iv)development of proposals for management decentralisation; (v)assessing the implications for sector budgets of proposed financing reforms, such as those in the health sector; and (vi)establishing a clear “pipeline” of planned public investment projects.
The MTEF sets out proposed ministry resource ceilings for the 2002-04 period (main text Table15) that reflect these sector priorities. These ceilings provide the framework for the preparation and evaluation of line ministry budgets for 2002. In the case of the Ministry of Public Works and the Ministry of Local Government, the ceilings show a fall in budget allocations in 2002. This is due to the transfer of exclusive functions to local governments.
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MEDIUM-TERM EXPENDITURE FRAMEWORK
2002-04
A.Introduction
1.Last year, the Government introduced a medium-term expenditure framework (MTEF). The initial MTEF, which covered the 2001-03 period, achieved considerable success in providing a stronger framework for the preparation of the 2002 Budget (Box 1). Building on this base, the analysis for the 200204 MTEF has been considerably extended in its scope and depth. This has involved a more detailed assessment of payroll and wagebill reform issues, and of the implications of fiscal decentralisation. The analysis of sector expenditure programmes has been extended to include agriculture and has involved a more detailed analysis of expenditure priorities and allocations at the programme level. Resource projections have been developed for sector and ministry level, and will provide the ceilings against which budget requests for 2002 will be evaluated. Preparation of the 2002-04 MTEF has taken place within the framework of the Growth and Poverty Reduction Strategy (GPRS) and the GPRS priorities have provided the strategic direction for the allocation budgetary resources under the MTEF. In the line ministries the same working groups have been given responsible for the preparation of both the GPRS and MTEF.
Box 1: The Medium-Term Expenditure Framework - Aims
The MTEF provides a comprehensive analysis of public spending. Thus it covers both investment and recurrent spending and includes both budgetary expenditures and expenditures financed from the social insurance and health insurance contributions. The MTEF aims to:- promote fiscal discipline by ensuring that public expenditures are planned within a realistic macroeconomic and fiscal framework;
- facilitate the strategic prioritisation of public expenditures by linking more explicitly government policies to expenditure plans;
- encourage greater technical efficiency in the allocation and use of budgetary resources; and
- bring greater predictability to the budgeting process, allowing ministries to plan their expenditure programmes over the medium-term.
2.The MTEF document is divided into a main report and an annex containing the summary fiscal tables. The main report comprises four sections:
Section B: summarises the macroeconomic outlook for 2002-04 and its expected impact on the resources available for the budget and on public expenditure demands;
Section C: analyses the resource framework for 2002-04 covering projections of government revenues and of domestic and external financing;
Section D: reviews expenditure issues and set out projections for each of the main economic categories of public expenditure;
Section E: provides an analysis of sector expenditure priorities and resource allocations for the 2002-04 MTEF focusing on five main sectors: agriculture, health, education, labour and social protection ,and transport.
3.Additionally, two sets of working papers are available in a separate volume. These provide:
- more detailed analysis of specific public expenditure issues covering payroll and wagebill reform, fiscal decentralisation and external financing of public investment; and
- the summary sector expenditure strategies that were prepared for education, agriculture, health and social protection.
B.Macroeconomic Outlook
4.Public expenditure policies are closely linked to developments in the wider economy. The level of economic growth is a significant factor influencing the level of public revenues. At the same time the Government has an important role in ensuring that the conditions for sustained economic growth are present, and in preventing excessive spending by government from crowding out investment by the private sector. The Government also has responsibility for ensuring that poor and disadvantaged groups can share in Albania’s economic growth and development.
5.This section sets out the macroeconomic outlook and supporting policies against which the 2002-04 MTEF has been prepared. During this period public expenditures priorities will be increasingly be determined by the policies set out in the Growth and Poverty Reduction Strategy (GPRS).
Overview of Recent Macroeconomic Performance
6.The macroeconomic and structural reform measures that were taken following the social-political crisis of 1997 initiated a period of sustained economic growth and improving macroeconomic performance (Table 1). Growth in real GDP has averaged 7% to 8% annually, inflation fell from 42.1% in 1997 to 4.2% in 2000 while the domestically financed budget deficit has been reduced from 10.5% to 4.6% of GDP. The economy has continued to undergo significant structural change driven by high rates of growth in the construction, transport and service sectors. Agriculture and industry have also recorded significant real growth - agriculture remaining the largest sector in the economy. The greatest increases in industrial production were recorded in those enterprises in which production had restarted following privatisation.
7.Remittances from Albanians living and working abroad continue to play an important role in driving domestic demand and economic growth. In 2000, remittances increased by an estimated 46% to US$531 million. Direct foreign investment increased by over 300% to US$143 million following the privatisation of a number of large-scale enterprises. Disbursements of foreign aid financing on public investment projects totalled US$162 million.
8.Severe energy shortages that occurred towards the end of 2000 had a damaging effect on business confidence, and were only partially mitigated by increased energy imports. While low water levels in the main hydropower dams was the immediate cause, the crisis highlighted the need to accelerate reform in the power sector in order to attract substantial new investment. Effective measures taken to resolve continued problems of energy theft and payment arrears, resulted in early 2001 in the unfreezing of a substantial amount of foreign aid financing for development of power transmission and distribution networks.
9.One of the consequences of the economic crisis that culminated in early 1997 has been the relatively high level of domestic debt. At the end of 2000 this stood at 41.5% of GDP. Servicing this debt has necessitated the diversion of budgetary resources to meet interest payments. In 2000 these payments fell substantially as interest rates eased.
Table 1: Recent Economic Performance