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 Guidong County, 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 Guidong County can be measured.

The assessment covers the county of Guidong, 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 are no extra-budgetary units in Guidong County, the social security fund is managed separately from the core budget system—the general public budget (GPB) and the government fund budget (GFB), and thus is classified as an extrabudgetary operation in this assessment. Following China’s legislative classification, state owned enterprises (SOE) 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 any legislative obligation to bail out SOEs. Considering that they may present potential fiscal risk to the government, Annex 7 provides complementary information on the financial management performance of the LGFV in Guidong. At the time of assessment, there was one LGFV in Guidong still in the process of transforming toward a commercial entity.

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

Impact of PFM systems on the three main budgetary outcomes

Overall, the PFM systems of Guidong perform well in in-year budget reporting, public asset management, and internal controls. The main weaknesses pertain to budget reliability, transparency, and scrutiny; performance and medium-term orientation of the budget; public investment management; the predictability of in-year resource allocation; the monitoring of expenditure arrears; annual financial reporting; auditing; and public access to fiscal information. The context in which Guidong sets its budget is important. Guidong generally complies with 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

The budget fails to impose much fiscal discipline in Guidong. The variation between outturn and budget estimates for aggregate expenditure (PI-1.1) and expenditure composition (PI-2.1) are both rated D, and there are significant budget adjustments for expenditures within the fiscal year (PI-21.4 is rated C). The uncertainty caused by HLG transfers (HLG-1 is rated D+) certainly contributes much to the SNG’s poor estimation of its expenditures. In-year policy change also makes it challenging for the SNG to project its own-source revenue (PI-3 is rated D). In-year resource allocation is frequent and largely unpredictable (PI-21, rated D+), modern cash management is missing (PI-21.2 is rated D), and monitoring for expenditure arrears only started in 2018 for project expenditures ( PI-22 is rated D).

However, Guidong do have some important control mechanisms over expenditures by budgetary units, which helps to maintain fiscal discipline. All government operations are included in financial reports (PI-6, rated A). Payroll control is effectively supported with centralized payment arrangements and auto-reconciliation through an IT system (the first three dimensions of PI-23 rated A). Strong internal control of non-salary expenditure (PI-25, rated B) and an internal audit system (PI-26, rated C+) have ensured strict control over spending during budget execution. Moreover, there is a sound reporting and recording system for debts (PI-13.1, rated C) .

A major threat to fiscal discipline is that some important control and monitoring functions lay outside the PFM system. System weaknesses that allow for this threat include the entanglement of government units and the local government financing vehicle (LGFV); the fact that investment financing is delinked from the government budget; that large procurements and contracts are supervised by the Bureau of Development and Reform, not by the Finance Bureau; that expenditure arrears and small procurements are not monitored; that there is no effective supervision of public corporations (PCs); and that, while the Finance Bureau monitors financing by the LGFV, there is no fiscal risk assessment or monitoring of the operations of other PCs. In combination, this suggests a lack of institutional mechanism for ensuring hard budget constraints. Consequently, off-budget borrowing may arise. The lack of public scrutiny of financial assets, liabilities, PCs and investment projects is seen as an additional threat to fiscal discipline.

Another issue that undermines the fiscal discipline lies in the weak external auditing system. Both the internal audit (PI-26) and external audit (PI-30) are rated D+.

Strategic allocation of resources

The main PEFA indicator concerned with medium-term budget strategy, PI-14, was rated D+. There is no evidence that macroeconomic indicators have been considered for budget preparation, there is no medium-term budget strategy, and the fiscal impact of policy changes is not regularly estimated. In addition, costing information of major investment projects is not included in the budget documents (PI-11.3, rated D) and clear rules for prioritizing major investments are missing (PI-11.2, rated D).

The budget preparation process was assessed as reasonable (PI-17, rated C+) and legislative scrutiny of the budget was good (PI-18, rated B+).

Budget documentation was considered to be satisfactory, meeting three basic and two additional requirements (PI-5, rated C). However, the budget classification system is not fully in accord with international standards (PI-4, D).

Efficient use of resources for service delivery

Many required mechanisms are in place to reduce the possible leakage of funds, such as the asset management system (PI-12, B) and the internal control mechanisms for payroll (PI-23, C+) and non-salary expenditures (PI-25, B).

However, weak performance management system may undermine the efficient use of resources for service delivery. Less than 20% of the budgetary units in Guidong have a framework of PIs relating to the outputs or outcomes (PI-8.1, D), the information on activities performed in relation to service delivery in FY 2018 covered 18.88 percent of total service delivery expenditures (PI-8.2, D), and independent evaluations of the efficiency or effectiveness of service delivery have not been carried out (PI-8.4, D) , though good reporting on resources received by service delivery units is in place (PI-8.3, A). In addition, low budget reliability and predictability of in-year resource allocation (PI-21, D+) may further adversely affect the capacity of service delivery units to make efficient use of resources.

As for the procurement management system, data are not fully available to evaluate procurement monitoring (PI-24.1, D*) and procurement methods (PI-24.2, D*), and there is no reasonable information disclosure (PI-24.3, D), though the complaint solving regime is pretty good (PI-24.4, A).

Audit reports were submitted to the People’s Congress within six months (PI-30.2, B) and the county People’s Congress completed scrutiny of audit reports within one month (PI-31.1, rated A). The required follow-up actions were taken by related entities effectively and timely (PI-30.3, A). However, coverage of external audit is very low (PI-30.1, D), and audit reports and their hearings were not open to the public (PI-31.4, D).

In sum, the Guidong PFM systems perform at sub-optimal level. With the right regulatory framework set by the central and provincial government, there is great potential for improvement.

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

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, 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 Guidong County Government to carry out the needed PFM reforms. PFM in China is a long-term endeavor, requiring concerted effort of all tiers of government and coordinated adaptation of all public-sector institutions.