37141 The World Bank notes MARCH PREM 2006 NUMBER 108 PREM POVERTY SECTOR Pro-Poor Public Spending Reform-- Uganda's Virtual Poverty Fund Can governments and donors ensure that the World Bank, which concluded that 15 out of resources are effectively targeted to poverty re- 24 HIPC countries needed substantial upgrad- ducing programs? The question raises difficult ing of public expenditure management (PEM) issues both regarding the anticipated effect of systems. Typically such countries demonstrate: a specific spending policy on poverty and the · An inability to identify Poverty Reduction quality of budget management. The Heavily Strategy Paper (PRSP) priorities within the Indebted Poor Countries (HIPCs) program at- existing budget classification system tempted to earmark resources released by debt · Budget allocations and out-turns that do relief to programs that would benefit the poor. not reflect PRSP priority programs Various developing countries with weak public · Unpredictability in budget allocation/ Donors want expenditure management systems--such as implementation processes and the inability Tanzania, Ghana, Chad, Honduras, and Zam- to track expenditures during budget imple- to ensure that bia--have established special poverty funds, mentation. debt relief is along the lines or similar to Uganda's Poverty There was, therefore, an inherent conflict Action Fund. There are, however, key lessons between the capabilities of recipient budget used to benefit from Uganda's experience, both regarding the systems and the expectation of HIPC donors. the poor in design of Virtual Poverty Funds (VPFs) and the Given such problems, the temptation to ad- recipient definition of pro-poor programs, that deserve dress the immediate pressure from donors to careful consideration in similar initiatives else- account for the use of HIPC resources was to countries. where. The issue assumes particular significance introduce a dedicated poverty fund with special in light of the recent decision of the G-8 to ex- implementation and reporting arrangements. pand the scope of debt relief significantly. But such a short-term remedy would create a parallel financial arrangement that would divert Introduction scarce capacity and undermine the integrity of The provision of debt relief to HIPCs commenc- the overall budget management system. ing in the late 1990s, and the growing interest The alternative was to create a VPF as a among donors in providing direct budget sup- bridging mechanism for tracking pro-poor port, increased donor focus on national budget expenditures in the budget, whilst budget- systems. Given that debt relief and aid resources wide mechanisms were being established and are fungible, donors were concerned that such strengthened (call out for Box 1 here). A well debt relief be verifiably used to benefit the poor designed VPF would, in principle, allow for: in the recipient country. In effect, the World Bank · Maintaining the integrity of budget man- and the International Monetary Fund (IMF), act- agement and systemic reforms ing on behalf of donors, asked that HIPC govern- · Adapting the existing budget classification ments put in place systems to track the use of re- system to "tag" pro-poor programs (hence sources freed up by debt relief and show that these "virtual" poverty fund) were in fact used to finance pro-poor programs. · Linking specific (e.g., HIPC) resources to This required governments to have the capacity to these budget allocations identify policies and programs that would benefit · Protecting budget disbursements to these the poor and to effectively channel and track programs resources to such programs. · Monitoring of performance of these expen- Budget systems are notoriously weak in ditures. most low income countries. Just how weak was This note considers the Uganda VPF to un- made evident by the 2002 HIPC assessment of derstand how well it served to allocate resources budget systems conducted jointly by the IMF and FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK to pro-poor programs and what weaknesses were local governments. Expenditures on PAF pro- observed that may need to be corrected as other grams grew from 19 percent to 36 percent of a countries employ mechanisms similar to the VPF. rapidly expanding government budget between 1997/8 and 2002/3 (see table 1). The Poverty Action Fund--Uganda's VPF Mobilizing donor resources and harmo- Uganda was the first country to benefit from nizing conditions: Over time, the PAF has also debt relief under the original HIPC and en- contributed to the mobilization of sector-spe- hanced HIPC initiatives. In 1997, prior to receiv- cific donor resources through budget support, ing HIPC, the Government of Uganda (GOU) which increased from $20 million in 1998/9 to developed its own comprehensive strategy to more than $130 million in 2001/2. By providing tackle poverty, the Poverty Eradication Action donors with a level of comfort in terms of alloca- Plan (PEAP). Subsequently, the government in- tion, implementation, and transparency, the PAF troduced the Poverty Action Fund (PAF) in 1998 enabled the donors' shift from project to budget to reorient government expenditures towards and sectorwide approach (SWAP) support. More implementing its PEAP as well as to account for recently as governance concerns have emerged HIPC resource use (see box 2). in Uganda, the PAF has proved important in Successes of the PAF justifying continued provision of budget support Over time the scope of the PAF budget in- by demonstrating orientation of the budget to creased. Explicit criteria for programs to qualify for pro-poor expenditures. inclusion were developed. The focus of attention Improved budget predictability, transpar- moved to the actual performance of PAF programs. ency, and accountability: The government guar- Although the predictability of disbursements anteed that all budgeted resources would be facilitated better performance, the guarantee was made available in full for disbursement to PAF qualified, that is, only those programs account- programs, regardless of resource shortfalls. The ing for funds and performing satisfactorily were PAF provided a platform for establishment of an guaranteed funding. Unless the performance of open and transparent process of budget report- programs was put under scrutiny, it was felt that ing and review, and improved the focus on the there would be little incentive to perform. results of government's programs. A system of Reorienting budget allocations towards pro- activity-based budget reporting was introduced poor service delivery and demonstrating the ad- in local government for PAF conditional grants. ditionality of debt relief: The PAF ensured that Five percent of all PAF resources were set aside additional HIPC debt relief and donor direct for oversight institutions and local government budget support were channeled into specific to improve monitoring and accountability. PEAP priority programs, helped reorient allo- While a number of the achievements can cations within sectors towards pro-poor expen- be directly attributed to the PAF, it must be em- ditures, and increased the funds channeled to phasized that broader reform initiatives such as the medium term expenditure framework (MTEF), Box 1: Tracking Pro-Poor Spending SWAPs, and the PRSP combined with a supportive The performance of a country's public financial management (PFM) political, institutional, and policy environment system in terms of its ability to allocate and execute budgets and to have played a major part. But equally, by maintain- track and report on poverty reducing spending is monitored annually ing the integrity of the budget whilst channeling as part of oversight of the HIPC Initiative. One of the indicators re- HIPC resources, the VPF contributed to the suc- lates to the existence of effective pro-poor tracking mechanisms for cess of the PRSP and budget reforms. the HIPC funds channeled through the budget. The definition of what Negative Aspects of the PAF qualifies as a poverty reducing expenditure is determined by country Some aspects of the PAF are problematic and authorities and varies from country to country, but generally includes could potentially be undermining the achieve- social sector spending, sometimes water, and in a few cases other ment of Uganda's poverty reduction goals: infrastructure needs. Unbalanced budget allocations: The PAF may Of the 27 HIPC countries that were monitored in 2004, only 14 (Cam- have skewed budget allocations too far towards eroon, Democratic Republic of Congo, Ethiopia, The Gambia, Gha- the direct provision of basic social services to the na, Guyana, Honduras, Malawi, Mali, Niger, Rwanda, Sierra Leone, poor, illustrated by the movement from point A Tanzania, and Uganda) had satisfactory tracking mechanisms for to point C in figure 1. This reflects the difficulty pro-poor spending. Of these, Honduras, Sierra Leone, and Uganda of predicting the ex-ante impact of a chosen have established a virtual fund and protected them against budget budget allocation. Government's commitment cuts. Rwanda and Tanzania have resorted to mechanisms similar to to the size of the PAF and donor preference a virtual fund. The remaining countries used existing budget classi- for the social sectors has limited the ability to fications to identify pro-poor expenditures, but have no mechanisms reallocate away from established PAF sectors. to protect these expenditures from budget cuts. Thus more than 70 percent of additional PAF PREMNOTE MARCH 2006 Table 1: PAF Reorienting National and Box 2: The Key Elements of the Uganda Poverty Action Fund Sector Allocations towards the PEAP The PAF identifies and gives special treatment to specific pro-poor sec- 1997/8 1998/9 2002/3 tors/subsectors/programs in the budget. (pre-PAF) · PAF criteria--PAF programs are defined as only those that are in the PAF Programs as % of National Budget PEAP or PRSP, are directly poverty reducing, delivering a service (excluding interest) to the poor, and have a well developed plan. The five major areas Social Services1 17 21 27 are primary education, primary healthcare, water and sanitation, Productive Sectors2 1 2 4 rural roads, and agriculture extension. Others 1 2 5 · Matching resources to expenditures--A PAF table matches specific Total 19 25 36 resources from HIPC, donors, and the government to the budget allocations for PAF programs. PAF Expenditures 163 267 692 · Additionality of resources--PAF resources were shown as additional (Uganda shillings 2002/03 prices) to the government's own budget allocations to PAF programs in the 1 Primary education, primary healthcare, and water. 1997/8 budget. Since 2000, the GOU has made a commitment that 2 Agriculture, rural roads, and strategic exports. PAF will consistently grow as a proportion of the overall budget. resources were spent on basic social services · Protection of disbursements--Government guarantees that PAF between 1998/9 and 2002/3, despite the budget programs are protected from budget cuts during implementation, already being oriented towards those services. provided that performance is on track. It can be argued, retrospectively, that there has · Reporting and transparency--There are specific requirements for lo- been underinvestment in areas such as roads, cal governments (LGs) and other government departments to report rural electricity, and agriculture that may have disbursements on PAF programs, and progress in implementation. had a larger impact on income poverty. Con- Reports are made public and discussed in open quarterly meetings, ceptually, a budget allocation such as B rather where civil society, the press, and donors are present. than C may have had a greater positive impact · Monitoring--Five percent of PAF funds are earmarked for enhanced on the poor. This has been compounded by the monitoring and accountability. difficulty government encountered in develop- spending had a similar social sector bias (see ing appropriate public sector programs that figure 2). promote the private sector, exports, and more Biased budget implementation: The bias generally economic growth. What is required in budget allocation has been magnified by is a more balanced approach so as to provide a similar bias in budget execution. With the greater flexibility within the budget to allocate growth of the PAF, other sectors have borne resources to pro-poor issues. The Tanzanian the brunt of budget adjustments to resource model has some useful features that provide shortfalls. The protection of disbursements greater budget flexibility in future, (see box 3), under PAF is required only because the major although early approaches to poverty reducing causes of underdisbursement, such as the serial overspending of some govern- Figure 1: Earmarking HIPC and Budget Support ment institutions, have not been to the PAF May Actually Distort Budget addressed to date. Allocations Partial monitoring and evalu- ation: The PAF added a layer of monitoring and evaluation (M&E) and external verification processes that has diverted atten- tion away from the overall budget and led to unbalanced scrutiny of government expenditures. Al- though initially an improvement, currently these systems have not been mainstreamed into govern- ment systems, and the coverage of the budget M&E improvements remains partial. No exit strategy: While the Ministry of Finance has expressed a desire to phase out PAF, govern- ment agencies within priority sectors and donors supporting PREMNOTE MARCH 2006 Figure 2: Social Service Bias in Uganda and Tanzania Priority Poverty Reducing Expenditures (total public expenditure excluding interest) those sectors want the preferential PAF treat- not solely the meeting of VPF commitments. ment continued, making it politically difficult Protection of VPF budgets may be necessary, but to remove PAF protection, especially given it would be important to control overspending that it was not clearly designed as a temporary in other parts of the budget to limit the shocks mechanism with a sunset clause at the outset. to unprotected sectors. A VPF does not bypass the need to have Key Lessons a PRSP and an effective budget process that Given weak initial PEM capabilities, VPFs al- identify priority pro-poor expenditures to be low priority poverty reduction programs to be included in the VPF as part of a broader policy implemented without undermining reform framework for growth and poverty reduction. of public expenditure management systems This represents the greater challenge in the (PEMs). To be effective, a VPF should be simple context of countries with weak policy, planning, and limited to the identification of PRSP prior- and budgeting processes. The danger of a VPF ity expenditures in the budget classification sys- is that it can create incentives for development tem. A VPF should be introduced in a way that partners to predominantly fund social sectors supports rather than replaces the implementa- that can distort the implementation of more bal- tion of such comprehensive improvements in anced and appropriate strategies for improving budget preparation and implementation. Do- poverty outcomes. nor dialogue and conditions should be based This note was written by Sudharshan Canaga- on achievement of such improvements, and rajah (scanagarajah@worldbank.org) of the World Bank and Tim Williamson (t.williamson@odi.org.uk) Box 3: Tanzania--Different Approaches to Pro-Poor Spending of the Overseas Development Institute, London. Tanzania originally adopted a more flexible approach for allocating expenditures to priority PRSP areas by including all spending on the Key Reading seven broad priority sectors. A system of reporting on pro-poor prior- Williamson, Tim, and Sudharshan Canagarajah. ity expenditures was also introduced. The broader definition allowed 2003. Is There a Place for Virtual Poverty greater flexibility in budget formulation and execution, whilst neither Funds in Pro-Poor Public Spending Re- creating an artificial enclave nor undermining the flexibility necessary form? Lessons from Uganda's PAF. Develop- to complement priority expenditures with other activities. However, ment Policy Review Volume 21: 4, July. the disadvantage was that it treated all lines of expenditures within IMF (International Monetary Fund) and IDA a priority sector as equally important. Since the 2004/05 budget, the (International Development Association). priority sectors have been replaced by an allocation system that aims 2002. Actions to Strengthen the Tracking of to make a more comprehensive link between the second PRSP and Poverty Reducing Expenditures in Heavily budget allocations by requiring all spending agencies to identify how Indebted Poor Countries. Washington DC: their expenditures are contributing to PRSP objectives. IMF and IDA, March. This note series is intended to summarize good practices and key policy findings on PREM-related topics. The views expressed in the notes are those of the authors and do not necessarily reflect those of the World Bank. PREMnotes are widely distributed to Bank staff and are also available on the PREM Web site (http://prem). If you are interested in writing a PREMnote, email your idea to Madjiguene Seck. For additional copies of this PREMnote please contact the PREM Advisory Service at x87736. This PREMnote was edited and laid out by Grammarians, Inc. Prepared for World Bank staff