China Liuyang City 2020
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 Liuyang, 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 the design of 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 Liuyang City can be measured.
The assessment covers the city of Liuyang, 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 in Liuyang City, the social security fund is managed separately from the core budget system—general public budget and government fund budget, and thus is classified as extrabudgetary operation in this assessment. Following China’s legislative classification, state owned enterprise (SOE) is assessed as a public corporation. China 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 quasifiscal 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 Liuyang. At the time of assessment, there were two LGFVs in Liuyang that are still in the process of transformation to commercial entities.
The field work for the assessment was undertaken from December 8 to 14, 2019, with a follow-up mission from January 14 to 17, 2020. The fiscal years (FYs) covered for indicators that require an assessment of a three-year period, are FY 2016 to FY 2018.
Impact of PFM systems on the three main budgetary outcomes
Overall, the PFM systems of Liuyang 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 Liuyang sets its budget is important. Liuyang generally complies to the PFM practices mandated by the central and provincial governments.
The budget fails to impose much fiscal discipline in Liuyang. The variation between outturn and budget estimates for both aggregate expenditure (PI-1.1) and expenditure composition (PI-2.1) is rated D, and there are significant budget adjustments for expenditures with information shortage (PI-21.4, rated D) within the fiscal year. The main factor is the lack of predictability of higher-level government (HLG) transfers (HLG-1, rated D+) and land revenues (PI-3, rated D+). The in-year resource allocation is frequent and unpredictable (PI-21, rated C+), and monitoring of expenditure arrears is missing (PI-22.2, rated D).
Effective control over expenditures by budgetary units helps to maintain fiscal discipline. All government operations are included in financial reports (PI-6, rated A). Liuyang made an effort in cash management, including the consolidation of cash balances (scored A) and cash forecasting and monitoring (scored B). Payroll control is effectively 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 of non-salary expenditure (PI- 25, rated B+) and an internal audit system (PI-26, rated B+) have ensured strict control over spending during budget execution. Moreover, there is good reporting and recording of debt (PI-13.1, rated C) and contingent liabilities (PI-10.3, rated A).
Liuyang City recognizes the role of enhanced management over SOEs to the success of imposing fiscal discipline. It has taken the initiative to establish a double-control system to enhance scrutiny of the financial transactions and operations of a broad range of SOEs, including local government financing vehicles (LGFVs).
The system has enhanced the government’s monitoring of contingent liabilities. However, there is no evidence that the Liuyang Finance Bureau makes use of this information to assess the implication that the financial performance of public corporations (PCs) has for fiscal sustainability, or to impose discipline on aggregate public investment.
Strategic allocation of resources
The main PEFA indicator concerned with medium-term budget strategy (PI-14) is rated C. 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, with respect to the budget preparation process and legislative scrutiny of the budget, are assessed as reasonable (PI-17, rated B and PI-18, rated C+).
Other indicators that relate to the strategic allocation of resources are rated at a satisfactory level. Clear rules for prioritizing major investments are in place (PI-11.2, rated A). Budget documentation (PI-5, rated C) meets all basic requirements, though economic classification is not fully adopted in the budget accounting (PI-4, D).
Efficient use of resources for service delivery
The PFM systems of Liuyang encourage the efficient use of resources for service delivery. While the share of budgetary units that publish performance targets is not high (PI-8.1, C), they conduct performance evaluation regularly (PI-8.4, C), and they report on available resources (PI-8.3, A). However, both low budget reliability and predictability of in-year resource allocation (PI-21, C+) adversely affect the capacity of service delivery units to make efficient use of resources.
Required mechanisms are in place to reduce the possible leakage of funds, such as the asset management system (PI-12, B) and internal controls on payroll (PI-23, B+) and non-salary expenditure (PI-25, B+). With regard to procurement management, strong monitoring exists for big value contracts – to which mostly competitive bidding methods are applied. However, no monitoring takes place for small-value contracts (PI-24.1, D*) and procurement methods in general (PI-24.2, D*). Information disclosure is reasonable (PI-24.3, C), and the complaint solving regime sound (PI-24.4, A).
The ratings of the existing oversight arrangements are mixed (C+ for PI-30 and B for PI-31). Audit coverage is high, and audit reports are submitted to the People’s Congress within nine months. The required follow-up actions are taken by the respective entities effectively and timely. However, the audit reports and hearings are not accessible to the public.
In summary, the Liuyang PFM system performs well given the context in which it operates. 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 the Annex 7 shows, LGFVs carry out sizeable quasi-governmental activities while operating outside of the PFM system (Annex PI-6, D). The Liuyang government has basic monitoring authority over the investment project that LGFVs implement (Annex PI-11.4, C) and their liabilities (Annex PI-13.1, A). A comprehensive assessment for LGFVs is warranted to reveal the impact of LGFVs on the PFM performance of Liuyang 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 mediumterm 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 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.