Executive Summary

Background

1. Knjaževac is a relatively less-developed municipality in South-East Serbia, with about 30,000 inhabitants spread over a large and partly mountainous area. Its main industry is agriculture, and there is also some light manufacturing and a major ski resort. More than four-fifths of annual municipal revenue accrues from the municipality’s share of nationally collected taxes and from central government transfers, with the remainder coming from local property and other taxes, from the exploitation of municipal property, from charges for goods and services and from the sale of assets. This repeat PEFA assessment reflects the situation in 2018, and is based on data for the three years 2015-17. Where applicable the cut-off date is end-December 2018. Where appropriate it takes into account changes since the previous 2014 assessment which was based on 2011-13 data, using the then current (2011) PEFA criteria; the new assessment uses the revised (2016) criteria, and thus provides a baseline against which future changes in public financial management can be measured.

The assessment has been commissioned by the State Secretariat for Economic Affairs (SECO) which has supported efforts to improve public financial management (PFM) in sub-national governments (SNGs) through the “Implementation of the SECO Local Government Finance Reform Program in Serbia” (RELOF). The management of the assessment has been undertaken by RELOF. The assessment has been coordinated by RELOF and was overseen by a team co-chaired by SECO and RELOF. The other members of the Oversight Team were representatives of the Ministry of Finance, the State Audit Institution, the six Subnational Governments, the Standing Conference of Towns and Municipalities and UNDP. The assessment is conducted in six Serbian sub-national governments – Knjaževac, Osečina, Paraćin, Sremska Mitrovica, Vranje and Užice. All Performance Indicators as set out in the 2016 PEFA criteria have been evaluated apart from PI-7, which is Not Applicable because there are no government units subordinate to the Knjaževac municipality.

A. Integrated analysis of PFM performance

2. The findings from the assessment of each Indicator are summarised in terms of each of the seven Pillars of the PFM performance measurement framework.

1. Reliability of the Budget

3. About half of central government funding for Knjaževac takes the form of budget transfers, with a further third coming from the municipality’s share of income and other CG taxes. Total actual CG transfers (including income tax share) were close to or even above budget in all three years 2015-17 ( -3.7 per cent, -0.2 per cent and +11.0 per cent respectively). Own revenue fell far short of budget in all three years (actual revenues were 40.1 per cent, 48.0 per cent, and 58.9 per cent of budget for the three years respectively), mainly because of completely unrealistic forecasts of property tax revenue. Because of this actual expenditure fell 19.3 per cent below budget in 2015, 15.4 per cent below in 2016, and 7.9 per cent below in 2017 (Score D for PI-1). The functional breakdown of expenditure showed relatively low variance (as measured by the PEFA criteria) in 2016 (5.1 per cent) but much higher variances in 2015 and 2017 (17.6 per cent and 19.2 per cent respectively) (Score D for PI-2.1). Variances by economic classification were also substantial: 17.7 per cent, 15.3 per cent, and 11.4 per cent for the three years 2015-17 (Score D for PI-2.2). No expenditure was charged to contingency during 2015-17.

2. Transparency of public finances

4. The Treasury system through which all municipal revenue and expenditure pass contains enough information to enable comparisons between budget and out-turn by reference to administrative, functional and economic classifications (PI-4). (However, the Government does not produce such  

comparisons for local government spending as a whole.) Information given to the Assembly as part of budget proposals needs supplementing in order to meet PEFA standards (Score D for PI-5). Reporting of performance against targets established for each of the programmes into which SNG expenditure has to be fitted has been initiated, but the formulation of the objectives requires improvement. There have been no independent evaluations of public service performance, although it should be acknowledged that the limited nature of SNG responsibilities makes performance difficult to measure and evaluate (PI-8). Information for the general public is satisfactory (Score B for PI-9).

3. Management of assets and liabilities

5. Full financial reports are published for the municipality’s utility and other service companies, but no consolidated reports, or analyses of the fiscal risks faced by the municipality, have been published (PI-10). Investment is planned within the framework of the municipal development strategy 2009-20, and progress is regularly monitored and reported (PI-11). MOEs are effectively monitored, as are the municipality’s holdings of nonfinancial assets, but the asset register is incomplete and valuations are lacking. Asset disposals were insignificant (PI-12). Knjaževac currently has no outstanding borrowing (PI-13).

4. Policy-based fiscal strategy and budgeting

6. Knjaževac has been unable to allocate the staff resources necessary to undertake medium-term fiscal and expenditure planning (PI-15 and PI-16). Budget preparation is orderly, although central government guidance on economic assumptions is only provided months after the statutory deadline; as a result, time is very limited for the administration to finalise its proposals and the Assembly to consider them in time for enactment before year-end (PI-17 and PI-18).

5. Predictability and control in budget execution

7. Good progress has been made in expanding the property tax base, and arrangements are in place to encourage compliance and to check the validity of tax declarations. Tax arrears remain a problem, much of it inherited in 2009 when responsibility was transferred from central to local government, with write-offs discouraged by the need to maintain the municipality’s claims in bankruptcy proceedings (PI-19). Aggregate revenues are reported and reconciled monthly, and individual taxpayer accounts updated as revenue is received (PI-20). New IT software ensures that commitments cannot be undertaken without the assurance of available funds (PI-25.3), while the municipality’s financial reserves enable budget users to make commitments within their budget allocations at any time during the year (PI-21). There are no expenditure arrears (PI-22). Payroll controls are effective, and there is an annual external inspection to ensure that all staff positions are authorised, and all employees correctly paid according to their qualifications, responsibilities and length of service (PI-23). The management of procurement by the municipal administration (including indirect budget beneficiaries) appears satisfactory, but there are doubts about the completeness of information and the extent to which procurement is subject to competition (PI-24). Internal control arrangements are stretched because of the fall in staff numbers, while internal audit is not yet fully operational (PI-26).

6. Accounting and reporting

8. Bank reconciliations arising from budgetary operations are undertaken daily. No use is made of suspense accounts, and advances are cleared promptly and reconciled at year-end. Arrangements are in place to ensure the integrity of financial records (PI-27). In-year and end-year financial reporting are satisfactory, and annual financial statements comply fully with national standards (PIs 28 and 29).

7. External scrutiny and audit

9. Serbian SNGs are subject to a thorough audit to international standards by the State Audit Institution (SAI) every three or four years. In other years, a limited financial audit is undertaken by a commercial audit firm, which does not result in significant audit findings. MOEs are also within the ambit of the SAI, but coverage of them is more limited. Knjaževac was not audited by the SAI for 2015-17, so there are no significant audit findings to take into account in this report. The resources available to the SAI are controlled and restricted by the Government (PI-30). There has been no involvement of the Assembly in audit follow-up (PI-31).

B. Effectiveness of the internal control framework

10. The internal control system should contribute towards four objectives: (1) the execution of operations in an orderly, ethical, economical, efficient and effective manner; (2) fulfilment of accountability obligations; (3) compliance with applicable Laws and regulations; and (4) safeguarding of resources against loss, misuse and damage. The analysis of the performance of the internal control system looks at the five control components: (1) the control environment; (2) risk assessment; (3) control activities; (4) information and communication; and (5) monitoring.

11. The control environment depends on the legal and regulatory framework, and the way it is applied in practice. The Budget Systems Law (2009) sets out how internal audit and internal financial control (including inspection) should operate (Articles 80-89). Other relevant legislation is the Law on local self-government (2007), the Public Debt Law (2005), the Public Procurement Law (2013) the Law on Determining the Maximum Number of Employees in the Public Sector (2015), and the State Audit Institution Law (2005). In the local government context, the performance of the municipality will depend on the integrity of management and staff, the management styles of the organisation, the organisational structure (including appropriate segregation of duties and reporting arrangements), the management of human resources, and the professional skills of the staff. It is the responsibility of the Mayor to set the tone of the municipal organisation, and to adopt a strategy to minimise the risks of damage to the provision of good services.

12. The main risks faced by Knjaževac are that revenue from the municipality’s own taxes will not be collected, that revenue producing developments will not take place, and that procurements will not secure best value. A continued focus on maximising local revenues will be important in sustaining the services which are the responsibility of the municipality.

13. Internal controls in the municipal administration appear to work satisfactorily, but internal audit is not fully operational. There has been no recent external audit by the SAI. Monitoring the performance of service delivery is still in process of development, with the first (unpublished) reports of performance against targets having been submitted to central government in September 2018.

C. PFM strengths and weaknesses

Aggregate financial discipline

14. The restraints on borrowing, and the sanctions against local authorities failing to pay invoices within 45 days, mean that the risks of uncontrolled overspending are low. But budget estimates have been poor predictors of actual and own revenue during 2015-17, with capital investment falling far below amounts originally envisaged.

Strategic allocation of resources

15. Knjaževac has yet to introduce medium-term fiscal and expenditure planning, while public investment planning is adversely impacted by central government control and the absence of any medium-term planning of targeted transfers on which much SNG investment depends. New arrangements at central government level to improve the planning of public investment have yet to be finalised, but will have little impact at SNG level because most SNG projects will fall below the threshold costs above which the new arrangements are to apply.

Efficient use of resources for service delivery

16. The presentation of all SNG (and central government) expenditure in terms of 17 programmes represents the first step towards results-oriented budgeting. However, it appears that the definition of the programmes may need to be reconsidered, so that they fit more readily into the responsibilities and circumstances of SNGs. It should be recognised, moreover, that the services for which SNGs are responsible – local infrastructure, urban planning, recreational and cultural facilities - do not very readily lend themselves to measurement of the standard of services delivered. Analysis of the costs of standard operations (e.g., road maintenance, public lighting) may over time provide indications where greater efficiency could be achieved, although differences in local circumstances are likely to mean that comparisons of cost need to be treated cautiously.

Performance changes since 2015

17. Knjazevac in common with other SNGs faced a more difficult fiscal climate in 2015-17 than in 2011-13, so there were no improvements in the scores concerning budget reliability. There was progress in other areas: new commitment controls were introduced, a start was made in installing internal audit, consolidated reports were made about the operations of municipal enterprises, and tax administration procedures were substantially improved. The property tax base was considerably enlarged, offering the prospect of additional revenues in the future. Aggregate financial discipline has been maintained despite the difficulties encountered, and a start has been made on performance reporting which should contribute to the efficiency of service delivery. A deliberate approach has been adopted to public investment planning which should contribute to the strategic allocation of resources. But the absence of progress in medium-term fiscal planning, the limited advance in internal audit and the absence of regular external audit are all negative factors in relation to the strategic allocation of resources and the efficiency of service delivery. A bare comparison of Indicator and Dimension scores risks being misleading because of inconsistencies in the application of the criteria as between the 2015 and 2019 assessments.

Approach to PFM reform

18. Serbia is engaged in an ambitious and wide-ranging Public Administration Reform (PAR) programme with the objective of meeting the standards required for admission to the European Union. Different elements cover the functioning of the economy and the working of the judicial system, as well as government operations and the provision of public services. Within this framework, the Government is implementing a PFM Reform programme, with technical assistance from OECD/SIGMA, IMF, SECO and others. The specific objectives are (1) to improve the quality of economic and fiscal projections; (2) to improve medium-term fiscal planning and budgeting; (3) improvements in public procurement legislation and practice; (4) the embedding of Public Internal Financial Control (PIFC) arrangements on the EU model (through a development strategy and action plan for the period 2017-20); the further development of TSA business practices and reporting: and (5) enhancement of the work of the SAI. The SECO-supported RELOF initiative is contributing to these efforts, which are led by the Ministries of Finance, Economy, and Public Administration and Local Government. The focus has been on changes at central government level; relatively little attention seems to have been paid by central government to the needs and interests of subnational governments which have been adversely affected by limits on staffing and a reduction in the share of income tax accruing to them.

19. RELOF is supporting the corresponding PFM improvements also at local government level, focusing on (1) improvement of Financial Management and Control (FMC); (2) the introduction and development of Internal Audit: (3) improvements in budget planning, execution and reporting, including the medium-term dimension; and (4) improving tax administration and tax yields. RELOF is also supporting the improvement of financial management in utility and other companies owned by local authorities on which much of the delivery of public services depends.