EXECUTIVE SUMMARY

 

Rationale and purpose

Ukraine’s macroeconomic growth remained on track from 2016 following the 2014-2015 economic crisis, partly due to the first IMF’s Stand-By Arrangement (SBA) approved in December 2018 and the second 18-month COVID-19 related SBA request of USD5 billion approved in June 2020, coupled with sound fiscal and monetary policies, which culminated into the reduction of public debt. The country was not speared by the global COVID-19 pandemic; the humanitarian and economic crisis have derailed efforts to stronger and all-inclusive growth.

Several years ago, Ukraine adopted a very bold and elaborative decentralisation agenda, which became a top reform priority of the Government. The reform included the shift of fiscal responsibilities to local governments, which was adequately being followed by the decentralisation of the delivery of key public services such as education, health, and social welfare. As decentralisation gains momentum, sub-national government levels are taking up increasing shares of the overall public expenditure.

In accordance with the Budget Code of Ukraine, the main sources of revenue of the Oblast Capitals (OCs) include: 60% of the personal income tax (PIT), excise tax, 10% corporate income tax (CIT) from communal enterprises, and local taxes. On the other hand, the expenditure responsibilities of the OCs include: pre-school education, secondary education, high-school communal establishments, extra curriculum education, healthcare, local fire department, housing and communal services, transport and road infrastructure, mass media, social services, physical education, palaces of culture, libraries, museums, and communal zoos.

The bold decentralisation drive of the government led to the first sub-national PEFA assessment of Starosynyavska Amalgamated Territorial Community in 2019, followed by other SNG PEFA assessments for Khmelnitsky Oblast, Khmelnitsky Oblast Capital, and Iziaslavskyi Rayon between 2019 and 2020. At the national level, three PEFA assessments have been conducted: in 2012, 2016, and 2019.

This PEFA assessment in selected cities (including Chernivtsi City) is part of a preparatory phase of the "Effective Local Public Financial Management in Ukraine" project (ELocFin), which is planned to be implemented between 2022-2025 with the financial support of the Swiss State Secretariat for Economic Affairs (SECO).

Overall Objectives

The overall objectives of this sub‐national PEFA assessment are to:

(i) Contribute to an up‐to‐date picture of the quality of sub‐national PFM system at OC level in Ukraine;

(ii) Enable the relevant central and local governments to identify reform priorities based on the findings of the PEFA assessment;

(iii) Provide the basis for PFM capacity development initiatives in the local governments of Ukraine;

(iv) Inform possible adjustments to relevant ongoing reforms in the country.

Based on this information, the local governments would be in a stronger position to prepare a list of PFM improvement proposals for submission to the Ministry of Finance (the proposals may include amendments to the budgetary legislation or additional reform initiatives/measures to the PFM Strategy and/or its Action Plan). The assessment results will be used for identification of the PFM strengths and Ukraine SNG PEFA Assessment 2021 Chernivtsi City weaknesses in the respective city, and consequently, for determination of the underlying causes of the PFM performance. On the other hand, as the Ministry of Finance is directly involved in this PEFA assessment as both a member of the Oversight Committee and a peer reviewer, the results can be directly used by the MoF for further adjustments (if necessary) in PFM or in decentralisation reforms.

Specific Objectives

The specific objective of this PEFA assessment is to improve public service delivery through supporting PFM reforms at the sub-national level (OC level) in line with Swiss SECO’s ELocFin project. Following an evidence-based approach, in this preparatory stage, the strengths and weaknesses of PFM in the pre-selected OCs will be assessed using the PEFA 2016 methodology, including gender and service delivery modules. On the one hand, the ensuing assessment reports will provide the basis for the final selection of participating OCs as well as for the development of individual reform action plans (including baselines) during the inception stage of the first project phase. On the other hand, they will contribute to an increasingly granular understanding of PFM in Ukraine, which is the basis for the dialogue on PFM reform strategies and priorities both among local stakeholders and with international development partners.

The primary beneficiaries of this PEFA assessment are Ministry of Finance of Ukraine and the Chernivtsi City SNG. The key officials involved in the assessment were trained on the use of the PEFA methodology, gender-responsive PFM, and the service delivery module as part of internal capacity building to facilitate the assessment and communication of results.

Table 1 below provides a summary of PFM performance of each dimension and indicator. Chapter 2 provides a detailed analysis and assessment of PFM performance of each dimension/indicator. Chart 1 shows a graphical presentation of PFM performance at the indicator level.

 

Main strengths and weaknesses of PFM systems

PFM strengths

PFM laws, regulations, and guidelines established by the central government are strong; they form the basis of strong PFM systems. Not only are the laws strong, but also the compliance levels are high.

The good performance of budget classification and documentation included in the budget proposal enhances transparency. Transparency and publication of fiscal data (budget, execution reports, procurement information, performance information for service delivery, etc.) encourage financial accountability. There is also citizen engagement during the budget formulation and preparation process through public consultation, which further improves transparency.

The public procurement system is strong. The Prozzoro provides a lot of information on procurement, including procurement plans, bids, contract awards, procurement complaints resolution, and procurement statistics. This information is made available to the public promptly. Transparent procurement systems contribute to reducing service delivery cost, leading to efficiency and effectiveness.

There is a strong cash management framework coupled with a good revenue reporting mechanism which ensures the timely release of funds to key spending units for payment of expenditure, thereby eliminating expenditure arrears. The effective cash management system is because of TSA, which allows the City Government to properly track its cash/bank balances.

PFM weaknesses

The huge expenditure reallocations for both economic and functional classification, resulting from higher-level government transfers originally not budgeted for, has a negative impact on the execution of planned sub-national government policies and programmes; the good news, however, is that these activities are predetermined by the central government and therefore cannot be altered.

Though annual financial statements are comprehensive, they are not directly comparable with the approved budget; this makes it difficult to properly track the city government budget.

External oversight carried out by the Accounting Chamber of Ukraine (ACU) is partial as far as external audit of SNG is concerned; it fails to provide a comprehensive independent overview of the operations of the City Government. This is because of the limitations of the legal framework that governs the activities of ACU at SNG level, which means that the independence of ACU is severely undermined. The City Council (legislature) also does not scrutinise external audit reports because these reports are not prepared and submitted to the council for scrutiny.

 

Impact of PFM performance on budgetary and fiscal outcomes

Aggregate fiscal discipline

Aggregate fiscal discipline is strengthened by the existence of strong PFM laws promulgated by the state government for all levels of government. There is also high compliance with payment rules and procedures, which strengthens the fiscal discipline. Fiscal discipline is also strengthened by the reliability of aggregate and composition revenues. The expenditure budget is reliable at the aggregate level but unreliable at both economic and functional classification levels because of unpredictable and unbudgeted higher-level government transfers; this has a negative impact on fiscal discipline.

At this stage, revenues and expenditures outside the City Government budget and reports are not a threat to fiscal discipline since they represent less than 3% of City Government operations; they could, however, affect fiscal discipline in future if they exceed 3% - in fact, good practice suggests a threshold of no more 1% of revenue and/or expenditure budget. Now, operations outside the City Government are monitored and reported timely.

The city public corporations are fairly monitored with majority of them been audited annually; this reduces the risk of providing additional funding to unprofitable corporations. That said, about 19% by number of public enterprises are on liquidation list due to poor performance – this could be a pointer in terms of strengthening the oversight responsibilities of public corporations. Payroll controls are satisfactory to the extent that they provide reasonable assurance for strengthening fiscal discipline.

The ineffectiveness of the external oversight roles by the Accounting Chamber of Ukraine and the City Council, mainly due to legal limitations of the former and consequently not auditing and submitting external audit reports of the local government for legislative review, has the potential to weaken the internal control framework with a consequential negative impact on fiscal discipline.

Strategic allocation of resources

The City Government’s budget classification meets international standards. This good practice coupled with comprehensive budget documentation information enhances the strategic allocation of resources. Resources allocated can be easily traced.

The underlying assumptions for forecasting the budget set the tone for resource allocation in a strategic manner. There is, however, a weakness in terms of the City Government’s inability to estimate the fiscal impact of changes in policy proposals. The insufficient time allocation for key spending units to meaningfully prepare their budget proposals reduces KSUs’ ability to effectively prioritise their programmes and expenditure requirements. That said, the approval of the annual budget promptly allows key spending units to commence their annual programmes and activities in time to ensure full utilisation of allocated resources for improved service delivery.

The adequacy of resources available to the City Government for the execution of its policies and programmes, through transfers from higher level government though unpredictable, supports the provision of service delivery. The concern, however, is the frequency and significance of budget reallocations within the year; this defeats the purpose of strategic resources allocation. Nonetheless, this negative effect is minimised by pre-determined activities to be funded – this means that funds can only be used for these activities. Strategic resource allocation is strengthened by a good revenue accounting framework and an efficient cash management system, together with ensuring the availability of resources promptly for improved service delivery.

Efficient use of resources for service delivery

The efficiency in the use of resources for service delivery has been positively impacted by good budget classification, which allows strategic allocation of resources. That said, in-year budget virements are significant and frequent, and this has a negative impact on strategic resource allocation leading to inefficient service delivery. This negative impact is reduced by the availability of cash for payment of expenditures/services.

Procurement management systems are good with most procurement activities going through open tender, leading to cost reduction and consequently improved service delivery. There is good public access to service delivery information, both planned and achieved. This has led to citizen engagement for more accountability, resulting in the efficiency of the use of resources for service delivery. Public consultation is equally satisfactory; more public engagement in the design of public service means improvement in the efficient use of resources for service delivery. The existence of proper accountability for resources received in cash and kind has led to improvements in the delivery of primary service.

The efficiency in the use of resources for service delivery is negatively affected by the low internal and external audit coverage. Improved audit coverage ensures that the performance of service delivery is assessed to evaluate its efficiency and effectiveness. The timely preparation and publication of fiscal data (in-year budget execution reports) has led to improvement in public accountability, thereby leading to efficient use of resources for service delivery. Fixed assets that are needed for the delivery of service are well kept, accounted for and monitored; this has a positive impact on the efficiency of service delivery since resources are not wasted.

Performance changes since last assessment

Since this is the first PEFA assessment, there is no tracking of performance changes. This assessment therefore forms the baseline for future assessments.

Conclusions on service delivery

Even though HLG-1, which assesses the performance of transfers from higher-levels of government, performed averagely (rated ‘C’), service delivery programs were not negatively affected because actual transfers from the state and oblast governments were timely for payment of SDU expenditures. One

setback in the Ukrainian SNG budget planning, formulation, and preparation process is the exclusion of budget estimates of all transfers from higher-levels of government, the result of which is the frequent budget reallocations within the year once actual subventions are received. That said, this setback appears to have had marginal or insignificant negative impact on SDU programs, principally because all SDU activities/programs to be funded have been predetermined.

Fiscal transparency that shows good performance at the city government level cascades to SDU level with the publication of fiscal data, thereby promoting transparency and accountability. SDU budget classification is in tandem with the City Government’s budget classification. Own revenues from SDUs are properly accounted and reported; these elements improve fiscal transparency. SDUs maintain account and report on their respective fixed assets with periodic updates. The involvement of SDUs in public investment management, especially those with direct impact on SDUs, ensures that those investments are made on the basis of value-for-money. The timely approval of the City Government’s budget estimates signals positive impact on SDU service delivery programs.

Actual cashflows to SDUs are timely. Furthermore, cash shortages have not been experienced. These are positive signs for SDU programs. SDUs procurements also go through Prozzoro, ensuring competition as much as possible, thereby leading to efficiency in service delivery. The limited internal audit coverage is a concern to the extent that SDUs are neither covered for internal audit nor are their performances independently evaluated to ascertain the efficiency and effectiveness of their programs. This is further compounded by the absence of external audit coverage.