EXECUTIVE SUMMARY

The purpose of this PEFA assessment is to provide an objective analysis of the present performance of the public financial management (PFM) systems in the city of Liling, using the new 2020 Subnational PEFA Framework. The results of this assessment will inform the design of the Hunan Subnational Governance and Rural Public Service Delivery Program-for-Results lending operation and local specific PFM reform initiatives and appropriate technical support from development partners, as well as provide a baseline against which the future developments of PFM systems of Liling City can be measured.

The assessment covers the city of Liling, more specifically its government administrative units (GAUs, 行政单位) and public service units (PSUs, 事业单位), including budget-funded service delivery entities such as schools, hospitals, or agricultural service centers. While there is no extra-budgetary unit (EBU) in Liling City, the social security fund is managed separately from the core budget system— that is, the general public budget (GPB) and government fund budget (GFB), and thus is classified as extrabudgetary operation in this assessment. Following China’s legislative classification, state owned enterprises (SOEs) are assessed as public corporations (PCs). China’s laws and regulations prohibit any SOE including local government financing vehicles (LGFV) from financing government investment projects, on behalf of the government. LGFVs that have been undertaking quasi-fiscal operations are required to be transformed into commercial entities, operating according to market rules, producing goods and services at market price and bearing risks on their own. The government does not have a legislative obligation to bail out any SOE. Considering that they may present potential fiscal risk to the government, Annex 7 provides complementary information on the financial management performance of LGFVs in Liling. At the time of assessment, there were two LGFVs in Liling that are still in the process of transformation to commercial entities.

The video conferences for the assessment were undertaken in March of 2020. The fiscal years (FYs) covered for indicators that require an assessment of a three-year period, were FY 2016 to FY 2018.

Impact of PFM systems on the three main budgetary outcomes

Overall, the PFM systems of Liling perform well in budget execution, budget reporting and internal control. The main weaknesses pertain to budget reliability, medium-term budgeting, transparency, fiscal risk control and legislative scrutiny. The context in which Liling sets its budget is important. Liling generally complies to the PFM practices mandated by the central and provincial governments. Improvement in the county’s PFM perform requires enhanced predictability of information on transfers to be received from higher-level governments (HLGs).

Fiscal discipline

In Liling, fiscal discipline was imposed only partially. The variation between budget outturn and budget estimates for aggregate expenditure (PI-1.1) is rated B, while expenditure composition (PI-2.1) scores D+; there are significant budget adjustments for expenditure with information shortage (PI-21.4, rated C). The lack of predictability of HLG transfers (HLG-1 rated D+) and land sales revenues (PI-3.2 rated C) are the main factors. In-year resource allocation is frequent and unpredictable (PI-21, rated D+), and monitoring for expenditure arrears is missing (PI-22.2, rated D).

Effective control over expenditures by budgetary units helps to enhance fiscal discipline. No government operation takes place outside the financial reports (PI-6, rated A). Payroll control is effective and supported with centralized payment arrangements and auto-reconciliation through an IT system (the first three dimensions of PI-23 are rated A). Strong internal control for non-salary expenditure (PI-25, rated B) helps ensure strict control over spending during budget execution. There is a good reporting and recording system for debts (PI-13.1, rated C) and contingent liabilities (PI-10.3, rated B). However, Liling made insufficient efforts in cash management, including consolidation of cash balances (PI-21.1, score C) and cash forecasting and monitoring (PI-21.2, score D). And the internal audit system is not satisfactory (PI-26, rated D+).

Liling City recognizes the role of enhanced management over SOEs to the success of imposing fiscal discipline. There is a fiscal investment evaluation center in FB to conduct assessment of the fiscal implication of major government investment projects, but it failed to effectively monitor the actual cost during the project implementation. There is no evidence that the Liling Finance Bureau assesses the implications that PC finance may have for fiscal sustainability or impose any discipline on aggregate public investments.

Strategic allocation of resources

The main PEFA indicator concerned with medium-term budget strategy (PI-14) is rated D+. During budget preparation, estimates are provided for revenues, expenditures and transfers, but no forecasts are contained based on macroeconomic or demographic indicators. In addition, costing information of major investment projects is not included in the budget documents (PI-11.3, rated D).

The oversight arrangements, including those related to the budget preparation process and legislative scrutiny over the budget, have been assessed as reasonable (PI-17, rated B and PI-18, rated C+).

Other indicators that relate to the strategic allocation of resources are satisfactory. While no clearly defined and published standard criteria for investment project selection exist, the government executive selects and prioritizes major projects (PI-11.2, rated C). Budget documentation is considered to meet three basic requirements (PI-5, rated C). However, costing information of major investment projects is not included in the budget documents (PI-11.3, rated D); and budget classification is not in accord with international standards (PI-4, D).

Efficient use of resources for service delivery

Liling’s PFM system encourages the efficient use of resources for service delivery. However, the share of the budgetary units which publish performance targets is low (PI-8.1, rated D), performance evaluation is not regularly conducted and not published (PI-8.4, rated C) and only available resources are reported on (PI-8.3, rated A). Both the low budget reliability and predictability of in-year resource allocations (PI-21, rated D+) may adversely affect the capacity of service delivery units in making efficient resource use.

Required mechanisms are in place to reduce the possible leakage of funds, such as the asset management system (PI-12, rated B), the internal controls over payroll (PI-23, C+) and non-salary expenditure (PI-25, B). As for the procurement management system, there is monitoring of large value contracts, but there is no monitoring of, and no procurement methods for, small-value contracts (both PI-24.1 and PI-24.2 are rated D*).

Ratings of the oversight arrangements are mixed (C+ for PI-30 and B for PI-31). Audit coverage is high, and the audit reports are submitted to the People’s Congress within six months. Effective and timely required follow-up actions are taken by the concerned entities. However, the representatives of the budgetary units, with issues disclosed by the auditors, are not required to attend the hearings, and hearings on audit reports are not accessible to the public.

In sum, the Liling PFM system performs at sub-optimal level, but there is great potential for improvement if the regulatory framework of the CG and provincial government allows. The ongoing reforms, promoted by the CG and fully embraced by Hunan Province, provide a good opportunity and foundation for the City Government to carry out the necessary PFM reforms.

The assessment results are to be interpreted with an important caveat in mind. As Annex 7 shows, LGFVs carried out sizeable quasi-governmental activities while operating outside of the PFM system (Annex PI-6, D). The Liling Government has basic monitoring obligations over the investment projects that LGFVs implement (Annex PI-11.4, C), and their liabilities (Annex PI-13.1, A). A comprehensive assessment of LGFVs is warranted to reveal the impact of LGFVs on the PFM performance of Liling City.

China has launched ambitious fiscal and taxation reforms since 2014. The revised landmark Budget Law and its associated directives have laid out a solid foundation for a modern fiscal framework. The main motivation has been to better serve the transformation of the government functions from boosting growth, more toward delivering quality public goods and services. The major changes mandated by the revised Budget Law fall into five areas: 1) making the budget comprehensive and transparent; 2) improving credibility and medium-term perspective of the budget; 3) allowing provinces to borrow on budget within the regulatory framework; 4) making transfers transparent, fair and pro-equalization; and 5) hardening budget constraint. The recently released Government Investment Decree in 2019, if effectively implemented, could enhance the discipline and scrutiny around government investment projects and contain contingent liabilities associated with their financing.

The reforms that are currently being pushed by the Central Government (CG), and fully embraced by Hunan Province, provide a good opportunity and foundation for the city government to carry out the needed PFM reforms. PFM in China is a long-term endeavor, requiring the concerted effort of all tiers of government and coordinated adaptation of all public-sector institutions.