Annex 6: Medium-term Expenditure Framework (MTEF)

Institutional issues

The development of a medium-term framework for designing budgets, known as Medium-term expenditure framework (MTEF) increases the feasibility of PRSPs. Where such frameworks do not exist, its introduction should be considered a priority.

Where the MTEF has been introduced, two challenges have to be met:

• aligning measurement and control instruments at the political level (including PRSP) and operational level (budget);
• using the MTEF as a policy discussion tool within and outside government.

Developing a minimum reference framework to gauge public finance management performance seems critical to this process. Such a reference framework should include performance indicators on timely budget design, preparation of budget execution reports, accuracy, appropriateness and tracking of accounts, verification of accounting income.

Opening budget systems to public control by publishing information on budget design, execution and public accounting, may have a significantly influence policy discussions and accountability of public institutions. Aligning the budget system on the PRSP through a participatory and ownership process requires the commitment and resolve of each level of the system. The active support of the Ministry of Finance is vital throughout the process as it lays down the fiscal incentive scheme which guides other bodies in the preparation of their budgets.

Better resource planning is a long-term goal that requires appropriate accounting expenditure management systems, institutional and personnel capacity building. Sound resource planning should hinge on an institutional system that:

• redefines policy options based on available medium-term resources;
• introduces a financial bidding process among programmes and ensures that decisions are grounded on full reporting of medium-term expected impact and costs;
• translates long-term strategic priorities into sustainable programmes.

MTEF is a prioritized resource package consistent with macroeconomic stability and some overt strategic priorities. It ensures a graduated costing of short- and medium-term policies (ongoing and planned) and decision-making based on an iterative process matching costs with available resources.

Phases of the process

Step 1: Costing the resource package

Income estimates may be derived from three- to five-year projections on economic performance and development assistance flows. The MTEF method sets expenditure caps for major sectors of government, economic services, infrastructure, social services and public security. The authorized indicative ceiling for the three-year period covers all expenditure and is broken down into various cost heads (levels where the budget is prepared and run: departments, divisions, services).

The MTEF advocates the amendment of the budgeting method by migrating from an addition system to clear costing of activities and policies to be implemented. The method may be introduced initially into pilot ministries, Health, Education or Infrastructure. Subsequently, the component will be extended to all ministries that will be trained in costing during the three-year period.

Step 2: Setting limits for medium-term sector resources

Trickle down resources depend on current commitments. As much as possible, they should be allocated to sectors prior to the setting of limits. Indicative expenditure limits will then be set in consideration of government and ongoing programme priorities during discussions with the sector-specific ministries. Such indicative limits are subject to the approval of the council of ministers, usually many months before the beginning of the annual budget cycle.

Step 3: Preparing sectoral plans

Sector-specific ministries prepare medium-term strategic plans setting main sector objectives and projecting performance, production and expenditure, in keeping with the limits set by the council of ministers. These plans should factor in the costs of ongoing programmes. Ideally, expenditure should be posted by programme and category (wages, overheads and investments).

Before MTEF enters into force, sector managers should use a strategic planning method to set their objectives, expected outcomes and programme their activities and not on the basis of mere extensions of previous programmes which are clearly inconsistent with the new PRSP guidelines.

Step 4: Revising sectoral plans

The Ministry of Finance revised sectoral programmes to check their consistency with all priorities and expenditure limits. It prioritizes comprehensive strategies at the expense of the envisaged detailed expenditure format. Where a sector’s expenditure is projected to exceed the set limits, the Ministry of Finance helps the said sector to slash expenditure, or requests further information to review the limits.

Step 5: Submitting reviewed limits to the council of ministers

On the strength of such revision, the Ministry of Finance proposes new multi-year spending limits to the council of ministers. Such limits are the basis for designing more detailed budget estimates during the first year of MTEF.

Step 6: Preparing the annual budget and submission to Parliament

The annual budget, based on the MTEF proposal, is prepared by experts and submitted to the Ministry of Finance for compilation and onward presentation to the cabinet. It is later tabled before parliament for adoption. Appropriations of the previous year must be included in the final annual budget tabled before parliament.

Step 7: Review and rollover

Current expenditure projections (fiscal year and MTEF period) are updated as the need arises and according to changes in policy or key variables (inflation or growth). The new budget cycle opens with updated spending projections for the MTEF period, projections for the resource package of the previous year and new government strategic priorities.

MTEF design method

Designing a MTEF is an iterative process

A good number of global resource projections may be generated on the basis of different macroeconomic and fiscal policy options (step 1). Given the uncertainty of economic conditions and priorities, a contingent fund should be created before communicating the medium-term expenditure limits to the sectors. Part of the fund will be reallocated for the sake of adjusting spending limits after designing sectoral programmes (steps 3 to 5).

The expansion of poverty reduction programmes requires reallocation of resources generated by other public sectors. Considering the costs of current medium-term policies, including legal and contractual obligations (step 2), MTEF enables policymakers to assess the real expenditure trickle down margin. It guides sectors in long-term programme resource allocation planning to the extent of reducing gaps to the barest minimum (step 3).

Prerequisites to designing MTEF

Although a significant number of developing countries have embarked on the road to MTEF, most others are still at the preliminary level of the process and a number of sectors need further attention to boost the efficiency of the instrument:

• Improving expenditure forecasting reliability
  Huge income cuts or increased contingent costs may erode the relevance of forecasting, as expenditure limits ought to be dropped substantially at the beginning of each fiscal year. This risk may be mitigated by according sustained attention to stabilizing macroeconomic balances. A contingency fund may be instrumental in cushioning the impact of uncertain revenue and expenditure forecasts of the previous years.
• Identifying key poverty reduction programmes
  Since it is impossible to completely forestall resource flow variations, it is worth identifying priority spending programmes in the context of the PRSP. Existing synergies between programmes also suggest the need for operational collaboration among government agencies.
• Assuring an appropriate analytic period
  Poverty reduction programmes may take years to be launched. While the MTEF is a major stride in annual budgeting on account of its medium-term coverage, extending the life of key programmes beyond the duration of the MTEF may be necessary for their comprehensive costing.
• Extending the scope of policy analysis
  Initially, MTEF forecasts outline global expenditure estimates by sector and programme and classified on economic grounds. Enhanced institutional capacity allows for more detailed forecasts which may include, for instance, regional resource allocation.
• Opening policy discussions
  Forecasts generated by the MTEF also serve as the basis for national policy discussions. In fact, poverty reduction programmes induce long-term commitments that are included in yearly appropriations. This explains why the publication of the MTEF should be considered a real priority.
• Using MTEF to set budget limits
  Clear procedures are needed to ensure sound input of MTEF in budget design. If the MTEF estimates are not used as a base for designing annual budgets (step 6), they immediately become irrelevant. Hence, it is central to incorporate the MTEF as swiftly as possible into the budget process.
• Aligning expenditure forecasts on performance objectives
  Matching the resources with performance objectives should be integrated early in the MTEF process. Initially, the model relation between aggregate expenditure and performance ratings would at best be indicative. Ultimately, however, the model may be detailed and used as a basis for gauging future performance.

Many countries introduced macroeconomic forecasts long ago to determine significant budget cuts. MTEF is a major stride in this method as it lays emphasis on sectoral allocations and matching expenditure with performance.

The budget allocation process starts off with the formulation of the macroeconomic framework by the Ministry of Finance. Typically, the macroeconomic framework helps in estimating overall resource packages based on relevant variables such as GDP growth, inflation rate, money supply growth, etc. In practice, revenue flow allocations are based on growth projections generated by the Ministry of Finance. This narrow-minded interpretation of the macroeconomic framework yielded mixed results in respect of projecting expenditure ceilings for sector-specific ministries.