moldova: public economic management...

Report No. 25423-MD

Moldova: Public Economic Management Review February 20, 2003 Poverty Reduction and Economic Management Unit Europe and Central Asia Region

Document of the World Bank

CURRENCY EQUIVALENTS UNITS (Exchange Rate Effective December 31, 2002)

Currency Unit=Moldovan Leu (MDL)

US$1=13.82 MDL

GOVERNMENT FISCAL YEAR January 1- December 31

WEIGHTS AND MEASURES

Metric System

ACRONYMS AND ABBREVIATIONS BCP Budget Concept Paper CFAA Country Financial Accountability Assessment CEE Central and Eastern Europe CIS Commonwealth of Independent States CPI Consumer Price Index GDP Gross Domestic Product ECA Europe and Central Asia EU European Union EBFR Extra Budgetary Funds and Resources FSU Former Soviet Union IDA International Development Association IMF International Monetary Fund IT Information Technology MGs Methodological Guidelines for Annual Budget

Preparation MTEF Medium-Term Expenditure Framework NBM National Bank of Moldova NGO Non-Governmental Organization NSIH National Social Insurance House OECD Organization of Economic Co-Operation and

Development PRSP Poverty Reduction Strategy Paper SACIII Structural Adjustment Credit III SSI State Social Insurance TIMSS Third International Mathematics and Science Study VAT Value Added Tax

Vice President: Country Director: Sector Director: Sector Manager: Team Leaders:

Johannes F. Linn Luca Barbone Cheryl Gray Helga Muller Neil Parison Elena Nikulina

ACKNOWLEDGEMENTS

The report was prepared by a team managed by Elena Nikulina and Neil Parison. Contributions were provided by Jariya Hoffman, Gord Evans, Joao Oliveira, Chandrashekhar Pant, Carolina Revenco, Reema Nayar and Emily Andrews. Dammika Somasundsaram, Lilian Canamaso and Ofelia Miranda formatted the report. The report also makes use of analysis and reports produced in recent years by James Cercone and Liviu Vedrascu (health), and Sue Ellen Berryman, Claude Tibi, and Michael Peleah (education). The report was prepared under the general supervision of Roger Grawe and Luca Barbone, Country Directors (ECC07, ECCU2). Sector Directors were Pradeep Mitra and Cheryl Gray (ECSPE). The Sector Managers responsible for the report were Shekhar Shah and Helga Muller. Allister Moon (ECSPE) and Nick Manning (SASPR) were peer reviewers.

The report is an outcome of more than two years of dialogue with the Government of Moldova in the framework of preparation of a comprehensive public sector reform strategy; and of even longer experience of collaboration in the area of public expenditure management led by the Moldova country office. The team is grateful for the assistance of many Moldovan officials who have been most forthcoming with their time and information, including the representatives of the Prime Minister’s Office, State Chancellery, Ministry of Finance, Ministry of Economy, Ministry of Health, Ministry of Education, Ministry of Labor and Social Protection, and the Academy of Public Administration. The team is especially grateful to the management team of the Ministry of Finance, led by Minister Zinaida Greciani, for their strong leadership and excellent collaboration. Thanks are also extended to the Center for Strategic Studies and Reforms (Chisinau) and its Director, Mr. Anatoly Gudym.

CONTENTS Executive Summary ........................................................................................................... i

Key Recommendations ............................................................................................ i The Reform Agenda ................................................................................................. i Transition Performance .......................................................................................... iii Fiscal Adjustment in the Social Sectors................................................................. iv The Road Ahead...................................................................................................... v

Relaunching Public Sector Reform............................................................. v Center of Government Decision Making ................................................... vi Budget Formulation and Execution...........................................................vii Civil Service Management and Human Resource Management................ ix Sector-Specific Reforms in the Social Sector ............................................ xi

Next Steps .............................................................................................................xii

1. Strategic Setting............................................................................................................ 1

A. Causes of the Disappointing Transition Performance....................................... 1 B. Macro-Fiscal Developments.............................................................................. 5 C. Macro-Fiscal Outlook...................................................................................... 10 D. Key Risks and Constraints .............................................................................. 12 E. Conclusions and Outlook................................................................................. 13

2. The Fiscal Adjustment and Reform Efforts in the Social Sectors ......................... 16

A. The Health Sector............................................................................................ 18 The Fiscal Crisis and the Government’s Response................................... 19 The Impact of Recent Policies and the Remaining Challenges ................ 20 The Road Ahead........................................................................................ 23

B. The Education Sector....................................................................................... 25 The Fiscal Crisis and the Government’s Response................................... 25 The Impact of Recent Policies and the Remaining Challenges ................ 26 The Road Ahead........................................................................................ 30

C. The Social Protection Sector ........................................................................... 33 The Fiscal Crisis and the Government’s Response................................... 33 The Impact of Recent Policies and the Remaining Challenges ................ 35 The Road Ahead........................................................................................ 37

D. Summary ......................................................................................................... 39

3. Strengthening Public Expenditure Management .................................................... 40

A. Budget Management Performance .................................................................. 41 Aggregate Fiscal Discipline ...................................................................... 41 Allocative Efficiency................................................................................. 42 Technical Efficiency ................................................................................. 43

B. The Legislative and Institutional Framework.................................................. 44 The Legislative Framework ...................................................................... 44 Budget Coverage ....................................................................................... 44 Budget Process Participants and their Roles ............................................. 48

C. The Budget Process ......................................................................................... 50 Budget Preparation and Formulation ........................................................ 50 Budget Execution ...................................................................................... 59 Debt Management ..................................................................................... 61 Reporting................................................................................................... 63 Internal Audit ............................................................................................ 65 External Audit ........................................................................................... 65

D. Intergovernmental Fiscal Relations................................................................. 65 Expenditure Assignment ........................................................................... 66 Revenue Assignment................................................................................. 66

E. The Road Ahead .............................................................................................. 67 Key Challenges ......................................................................................... 67 Recommendations ..................................................................................... 68

F. Conclusion ....................................................................................................... 71

4. Building Capacity For Increased Government Effectiveness ................................ 72

A. Present Position ............................................................................................... 74 Center of Government Decision-Making.................................................. 74

Benchmarks................................................................................... 74 Functional Arrangements at Center of Government ..................... 75 Institutional Arrangements ............................................................ 75

Civil Service Management ........................................................................ 77 Benchmarks................................................................................... 78 Institutional Framework ................................................................ 78 Legal and Ethical Framework ....................................................... 80 Pay and Employment Policy ......................................................... 80

Civil Service Human Resource Management ........................................... 86 Benchmarks................................................................................... 86 Merit .............................................................................................. 86 Depoliticization ............................................................................. 87 Training and Career Development ................................................ 88 Accountability and Transparency.................................................. 89

B. The Road Ahead .............................................................................................. 90 Key Challenges for the Government of Moldova ..................................... 90 Short-Term Actions................................................................................... 90

Leadership and Overall Management of Public Sector Reform ... 90 Center of Government Decision-making ...................................... 91 Civil Service Management ........................................................... 91 Civil Service Human Resource Management .............................. 93

Medium-Term Actions.............................................................................. 94 Leadership and Overall Management of Public Sector Reform ... 94 Center of Government Decision-Making...................................... 94 Civil Service Management ............................................................ 94 Civil Service Human Resource Management .............................. 95

C. Conclusion....................................................................................................... 95

List of Tables

Table 1: Summary of Priority Recommendations Table 1.1: Income and Output in CIS countries, 2000 Table 1.2: Aggregate Fiscal Trends (percent of GDP) Table 1.3 Revenue Trends (percent of GDP) Table 1.4: General Government Expenditure Trends by Economic and Functional

Classification (percent of GDP) Table 1.5: Expenditure Trends by Functional Classification (percent of total

discretionary expenditures) Table 1.6: Macroeconomic Framework, 2000-2005 Table 1.7: Debt Sustainability Analysis Table 2.1: Recent Social Expenditure Trends Table 2.2: Distribution of Health Sector Expenditures by Type of Facility (percent of

total) Table 2.3: Distribution of Health Sector Expenditures by Spending Category (percent

of total) Table 2.4: Health Status Comparisons Table 2.5: Distribution of Education Sector Expenditures by Type of Institution

(percent of total) Table 2.6: Distribution of Education Sector Expenditures by Spending Category

(percent of total) Table 2.7: Share of Salaries and Non-salary Operational Expenses in Recurrent

Expenditures by Level of Education in OECD Countries, 1995 (percent) Table 2.8: Social Protection Expenditure Trends (percent of total) Table 3.1: Consolidated Budget – Deviation between Approved and Executed

Budgets (in percent of approved amounts) Table 3.2: Budget Calendar for Preparation of the 2002 Budget Table 3.3: Selected Macroeconomic Indicators, Forecast and Actual Table 4.1: Change in the Number of Central Government Agencies in Moldova since

1985 Table 4.2: Government Employment as a Percentage of Population and Employment

Levels (2000) Table 4.3: Health, Education and Public Administration Employment, 1997-2000 Table 4.4: Civilian Government Wages (monthly average) Table 4.5: Comparison of Civil Service Pay Levels with Market Rates

List of Figures:

Figure 1.1: Budget Deficit Trends (percent of GDP) Figure 1.2: Budget Deficit Financing by Source (MDL million) Figure 3.1: Breakdown of Total General Government Expenditures by Budget

Component (percent of total) Figure 4.1: Private Sector View of the Helpfulness of Government Figure 4.2: Management Time Spent with Government Officials Figure 4.3: Typical Policy Cycle for Complex Reform

Figure 4.4: General Civilian Government Employment as a percentage of population Figure 4.5: Comparison of Civil Service and Private Sector Pay

List of Boxes:

Box 1.1: Moldova’s Debt Profile Box 3.1: Moldova’s Budget System Box 3.2: Strategic Planning in the Budget Cycle: Indicative Timing Box 3.3: MTEF progress Box 3.4: Program Budgeting Pilots Box 3.5: Moldova’s Treasury System Box 3.6: Absorption of Contingent Liabilities Box 4.1: Center of Government Decision-Making Benchmarks Box 4.2: Civil Service Management Benchmarks Box 4.3: Civil Service Human Resource Management Benchmarks

Statistical Annex

Table A1: Moldova - Key Economic Indicators Table A2: Moldova - General Government Budget, 1997-2001 (executed, at current

prices) Table A3: Moldova - General Government Budget, 1997-2001 (executed, at 1997

prices) Table A4: Moldova - General Government Budget, 1997-2001 (executed, percent of

GDP) Table A5: Moldova - General Government Budget, 1997-2001 (executed, in percent

of total) Table A6: Moldova - Consolidated Budget Expenditure Arrears, 1996-2001 Table A7: Moldova - State Budget, 1997-2001 (executed, at current prices) Table A8: Moldova - Local Governments' Revenue and Expenditure, 1997-2001

(executed, at current prices) Table A9: Moldova – State Social Insurance Budget, 1997-2001 (executed, at current

prices) Table A10: Moldova - Extra-Budgetary Funds and Resources, 1997-2001 (executed,

at current prices)

Bibliography

Map

EXECUTIVE SUMMARY Key Recommendations

1. Moldova has experienced a very difficult transition. Initial conditions were unfavorable and vulnerability to external shocks was extreme. This culminated in the 1998 regional financial crisis, which resulted in the need for radical fiscal retrenchment. Expenditures on the social sectors were reduced, with outcomes and quality of services deteriorating, and inequities in service access increasing. While reasonable growth appears to be attainable and sustainable under certain conditions in the medium term, the challenge for the Government in the short term is to begin to improve basic outcomes in the social sectors and address inequities in access to basic social services. This requires improving the ability of the center of government to make and stick to painful decisions, particularly with respect to strategic prioritization in budget formulation; and significantly improving the efficiency of resource utilization within the social sectors. This in turn will require implementing cross-cutting reforms in civil service management and budget execution, together with a number of sector-specific reforms.

2. Key recommendations identified and suggested for consideration by the Government in this report include: (i) launching a major program of public service reform; (ii) strengthening center of government decision-making through introduction of a system of Cabinet Committees and restructuring the State Chancellery into a non-political Government Secretariat; (iii) strengthening strategic prioritization in budget formulation through a structured and prioritized approach to developing and implementing the Medium-Term Expenditure Framework (MTEF); (iv) strengthening the budget process through increasing budget coverage, deepening Treasury coverage, and putting in place a stronger internal and external accountability framework; (v) strengthening civil service management through amending the Civil Service Law to secure the application of the key principles of merit and depoliticization, and launching a program of functional reviews to rationalize the structure of government; and (vi) undertaking sector-specific reforms in the social sectors to accelerate education and social assistance reform while maintaining health and pension reform, and to rebalance intra-sectoral education and health expenditures further in favor of primary and basic secondary education and primary health care and emergency services.

The Reform Agenda

3. Moldova has experienced ten very difficult years of transition. One of the deepest and most prolonged GDP declines among the transition economies (a cumulative decline of 65 percent between 1990 and 2000) has turned Moldova into one of the poorest countries in Europe, with more than half of the population living in absolute poverty.

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Social indicators have deteriorated. The accumulation of huge external debt exacerbates an already very difficult position.

4. A number of factors contributed to the poor transition outcomes experienced: unfavorable initial conditions and shocks at the outset of the transition; the poor quality of governance over the period; a partial stop-and-go approach to reforms by Moldova’s ten governments over this period; a precarious fiscal position resulting from soft fiscal policy until 1998; and a vulnerability to external shocks, culminating in the massive external shock from the 1998 regional fiscal crisis, which resulted in the need for deep and painful fiscal retrenchment.

5. While by 2001 the required fiscal retrenchment had largely been achieved, the quality of adjustment was unsatisfactory due to deep institutional weaknesses in center of government decision-making and an inability and lack of capacity on the part of the government to take decisions on strategic prioritizations and make difficult and painful choices. As a result, fiscal consolidation was achieved through implementing across the board reductions in expenditures. Although the social sectors represented key government priorities, they were not protected during this adjustment. Social expenditures declined over the period 1997 to 2001 from 29.0 percent of GDP to 16.7 percent of GDP. Outcomes and the quality of services deteriorated, and inequities in access to services increased dramatically.

6. The challenge now facing the Government of Moldova is to seek to attain sustainable growth and to significantly reduce poverty and rebuild human capital. The Government of Moldova is, however, particularly constrained in that the resources available for development are (and are likely to remain) extremely limited and the policy-making and implementation capacity of the government and of the public administration remains very weak. The level of growth that is likely to be achievable is such that a significant easing of the severe resource constraint facing the Government can only be expected to be experienced in the medium term. Inefficiency in public spending will need to be reduced significantly, and expenditures on comparatively low priority areas similarly reduced. In this context, the specific challenge facing the government in the social sectors is to seek to protect them so far as is possible from further reductions in overall expenditures through making more effective strategic prioritization of resource allocation in line with government priorities; to achieve reallocations of expenditures within each of the social sectors to ensure that key government priorities for each sector are resourced to the maximum extent possible; and to significantly improve the efficiency with which the social sectors utilize the limited funding which is available.

7. This will require a series of deep institutional reforms: strengthening center of government decision-making, particularly in the areas of strategic prioritization and budget formulation; undertaking some cross-cutting reforms in civil service management and budget execution to improve operational efficiency and efficiency in resource utilization; and undertaking some further sector-specific reforms in the education, health and social protection sectors. Some suggested recommendations for possible reform actions required in these areas are identified in this report for the consideration of the Government.

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8. While the reform agenda may seem daunting, the Government of Moldova should approach this agenda with reasonable optimism given actions which it has already taken and which it plans to take. The ongoing work to develop the full Poverty Reduction Strategy Paper (PRSP) will provided a vehicle for the Government to make strategic decisions about reform priorities for the short to medium term. Similarly, the ongoing work to put in place an MTEF will provide the context to support efforts to strengthen strategic prioritization in budget formulation, while the continuing program of budget reforms should help to deliver improvements in efficiency of resource utilization. Relaunching the Public Sector Reform Strategy and Program will provide the mechanism for tackling the required reforms of the civil service and public administration. And while health sector reform and pension reform are comparatively advanced, reforms of the education sector and social assistance system could now be accelerated.

Transition Performance

9. The complexity of the causes underlying Moldova’s disappointing transition performance should not be underestimated. Initial economic conditions were not favorable. In the Soviet system, Moldova’s major role was to supply agricultural products while being entirely dependent on imports to meet its energy needs. This led to Moldova experiencing a particularly severe terms of trade shock upon the breakup of the Soviet Union, with this being exacerbated by the 1992 conflict in Transnistria. Initial institutional constraints were severe, with weak capacity in the country’s newly-formed civil service right from its beginning. Political instability, the absence of political consensus behind economic reform, and frequent lack of political will have all combined to produce a stop-and-go pattern in the development and implementation of reforms.

10. Overall, Moldova’s quality of governance has remained poor, and is among the weakest in the region. Moldova had the worst performance among twenty transition countries when compared on a governance index by the EBRD (1999 Transition Report). Moldova also rated the lowest among transition countries with respect to perceptions of quality and efficiency of central government services in the World Bank/EBRD Business Environment and Enterprise Performance Survey (BEEPS-1999). This survey placed Moldova toward the top of the scale both on state capture and administrative corruption. Moldova also remains very vulnerable to external shocks, and was one of the countries in the region hardest hit by the regional financial crisis in 1998. Moldova has also experienced a number of severe setbacks over recent years caused by adverse weather.

11. In spite of the above factors and constraints, the Moldovan authorities were able to achieve comparatively good monetary performance until 1998, with inflation maintained below 15 percent from 1996, and the exchange rate stable. However, the comparative success of performance in this area was undermined by severely declining GDP, a soft and unsustainable fiscal policy, and a widening current account deficit. Following the regional financial crisis of 1998, there was a major devaluation in 1998-99 and a temporary surge in inflation. The Government was forced by the regional financial crisis to tighten fiscal policy dramatically and reduce the fiscal deficit sharply. While government revenues dropped from 40 percent of GDP in 1997 to 31 percent of GDP in 2001, expenditures were reduced over the same period from 50 percent to 30 percent of

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GDP. The situation has to some extent recovered over the last two years, with the return of economic growth (2.1 percent in 2000 and 6.1 percent in 2001), the stabilization of the exchange rate, and the reduction of inflation to 6.3 percent in 2001. The current account deficit widened to over 9 percent of GDP in 2000, but shrank in 2001.

12. While the overall outlook suggests that a GDP growth rate of 5 percent a year could perhaps be achievable and sustainable over the medium term, this can only be achieved if the remaining key institutional and structural reforms are developed, approved, and implemented aggressively and effectively, and if external conditions are favorable. Given the heavy burden of debt servicing in coming years, fiscal policy will need to remain very tight, and will need to be designed to maintain a primary budget surplus of about 1.5 percent of GDP throughout the period 2002 to 2005. Even so, Moldova remains heavily dependent on significant external financial support over the short to medium term, which could be jeopardized in the event of policy reversals or slower than expected progress in tackling remaining reforms. Moldova will also continue to remain extremely vulnerable to external shocks, particularly any downturn in the Russian economy or further severe adverse weather conditions.

Fiscal Adjustment in the Social Sectors

13. By far the largest share of public expenditures are in the social sectors - health, education, and social protection. Although all these sectors represented key priorities of the government’s work program, because of weaknesses in center of government decision-making and strategic prioritization in budget formulation, the social sectors were not afforded any protection by the Government during the severe fiscal retrenchment which followed the 1998 regional financial crisis; and efficiency of resource utilization within these sectors remains problematic. Over the period 1998 to 2001, social sector spending remained virtually unchanged at 64 percent of total discretionary expenditures. However, over this period, social expenditures declined from 29.0 percent of GDP in 1997 to 16.7 percent of GDP in 2001. Within social expenditures, health expenditures over this period fell from 5.7 percent of GDP to 3.0 percent; education expenditures from 9.7 percent of GDP to 5.4 percent; and social protection expenditures from 13.5 percent of GDP to 8.3 percent. Outcome indicators show that the quality of service delivery has declined substantially; and that inequities in access to services have at the same time increased dramatically.

14. Public sector funding for health care decreased by about 48 percent in real terms from 1997 to 2001. The government’s response to the fiscal crisis in the health sector focused on consolidating the sector, and on beginning to shift intra-sectoral resource allocation priorities in favor of primary and emergency care. However, much of the restructuring agenda remains incomplete. Major inequities in access to health care services have arisen, the quality of services as experienced by service users is poor, and Moldova demonstrates very poor health outcomes compared to other countries in Europe.

15. Over the same period, public sector funding for education shrank by about 45 percent in real terms. Adjustments in the education sector in response to the reduction in overall resources have been largely ad hoc. The measures undertaken included some

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attempts to begin to shift intra-sectoral financing priorities in favor of primary and basic secondary education, and some specific measures designed to reduce the high levels of expenditure on heating utilities in schools. Though certain efficiencies with respect to utility costs were achieved, the quality of education has deteriorated, and significant inequities in access to education services have emerged.

16. In the area of social protection, expenditures decreased by about 39 percent in real terms between 1997 and 2001. The Government’s response to the fiscal crisis in the area of social protection was fragmented. Structural reform of the public pension insurance system received priority. The only other part of the system that has undergone restructuring to date is utility subsidies, which the Government replaced with targeted “nominal compensations” under energy sector restructuring. Most other social protection programs, including programs which could have been restructured to support targeted poverty alleviation (for example, child allowances and social assistance benefits) have remained unreformed.

17. While the pension reforms implemented so far have produced relatively good results with respect to restoring short-term fiscal balances, the level of pensions remains extremely low, the pension system does not provide pensioners with predictability in terms of maintaining their purchasing power, and the system remains inequitable. The nominal compensations program continues to suffer from weak targeting of the poor.

18. Responding to the present difficult position in the social sectors requires the government to be able to increase the ability of the center of Government to make and stick to tough decisions, particularly in budget formulation. It will also require improvement in the efficiency of resource utilization within the social sectors through making progress on cross-cutting reforms in the areas of civil service management and budget process and execution.

The Road Ahead

Relaunching Public Sector Reform

19. The Government of Moldova developed a comprehensive Public Sector Reform Strategy in November 2000. The strategy was designed to reorient the role of the state away from its current role as universal caretaker and toward a role both consistent with the role of the state in a well-functioning market economy and also appropriate given government work program priorities and resource constraints. The objectives of the three components of the developed strategy are as follows:

(i) Public Expenditure Management: “To build a robust, sustainable, and effective public sector resource management system which provides for high levels of fiscal control (hard budget constraints at all levels of government); strategic prioritization (allocative efficiency in budget formulation and expenditure review and prioritization); and technical efficiency in budget execution.”

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(ii) Public/Private Sector Interface: “To build a public sector which provides a supportive partner for the private sector, and an appropriate framework for private sector development, based on accountable, predictable, transparent, simplified, codified, and arms-length interactions with the private sector.”

(iii) Public Administration Reform: “To build a market-oriented and service-oriented public administration which meets EU “best practice” standards; is affordable and sustainable; and ensures cost-effective delivery of priority goods and services.”

20. This provides an excellent summary of the reform agenda now facing the Government. The strategy, however, has not been enacted and there has been no movement towards its implementation. Perhaps the most critical priority in this area is for the Government to restart the public sector reform process by approving the Public Sector Reform Strategy, reconstituting the high-level Steering Committee for Public Sector Reform (led by the Prime Minister), and setting up an adequately-resourced Public Sector Reform Unit. A detailed Action Plan for Public Sector Reform could then be developed; and a set of monitoring indicators put in place from the outset of the reform process to allow progress in achieving real outcomes from the reforms to be assessed both within government and also externally by civil society.

Center of Government Decision-Making

21. There appear at present to be a number of critical weaknesses in the area of center of government decision-making. In most OECD countries, effective development and implementation of a complex policy reform depends on policy continuity being achieved over an extended period of time. It can often take four years for a major policy reform to move from initial development to the beginning of the implementation stage. Given that the average lifespan of a government in Moldova since 1991 has been around a year, and given also the high levels of staff turnover at change of government, it has clearly been extremely difficult for the Government of Moldova to shepherd major policy reform initiatives from the development stage through to successful implementation.

22. This lack of stability is exacerbated by a number of other serious weaknesses. The most telling is that the ability of Cabinet to take tough decisions on strategic prioritization remains weak. The State Chancellery is not as yet sufficiently strong for it to be able to play a leading role in supporting strategic prioritization in center of government decision-making. The further development of the MTEF will in time lead to the State Chancellery, the Ministry of Economy and the Ministry of Finance having to work much more closely together on strategic prioritization of government policy measures and particularly on supporting and facilitating strategic prioritization in budget formulation. The capacity of the State Chancellery needs to be upgraded significantly to equip it to undertake this role effectively.

23. A system of Cabinet Committees could also be introduced to support efforts to reduce the overall present overload on the Cabinet agenda, to help improve policy

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contestability, and also to strengthen substantive joint inter-Ministerial working. Efforts could be made to strengthen strategic planning and policy analysis across government through developing and introducing a mandatory approach to policy analysis and impact assessment which would be applied to all new proposals to be submitted to Cabinet or to Cabinet Committee. As a first step towards strengthening capacity of the State Chancellery, a functional review of the State Chancellery could be undertaken, with a view to restructuring it over the short to medium term as a non-political Government Secretariat.

Budget Formulation and Execution

24. The Government of Moldova has made progress in improving and streamlining certain technical aspects of public expenditure management. Most of the basic legal framework for the budget system and budget process is in place, a central treasury system has been established, efforts continue to strengthen revenue administration and collection, and attempts to launch a far-reaching fiscal decentralization reform were initiated. The Ministry of Finance is committed to securing further improvements in the quality of the budget process (particularly budget formulation) through the gradual adoption of the elements of an MTEF and building capacity in performance and program budgeting techniques. The Ministry of Finance deserves credit for promoting such an ambitious set of reforms in an extremely difficult fiscal and political context. However, the measures undertaken so far have proven insufficient to assure allocative and technical efficiency. Moreover, the sustainability of the progress achieved in the area of aggregate fiscal discipline remains questionable.

25. The budget process remains particularly weak in allocating resources based on strategic priorities. Further development of the MTEF should provide an appropriate integrating and supporting framework to help underpin the achievement of improvements in this area. Priority areas for attention should perhaps include approaches to determining the aggregate resource envelope and to ensuring greater realism and credibility here; and gradually enforcing tougher top-down prioritization of expenditures across sectors. In parallel, efforts could be made to strengthen intra-sectoral prioritization in support of key government work program objectives for each of the education, health, and social protection sectors. However, it should of course be borne in mind that meaningful, credible and binding intra-sectoral prioritization can only be undertaken once a credible and binding top-down process for overall prioritization within a clearly-determined and enforced resource envelope across sectors is in place.

26. To support ongoing efforts to introduce the MTEF, the Government needs to go beyond the technical aspects of medium-term macroeconomic planning and budget estimates and develop the strategic focus of medium-term resource planning. The key to moving forward in this area may be through improving the quality of the Budget Concept Paper. Amendments to the Law on the Budget System and Budget Process may need to be considered to incorporate the schedule for preparing the Budget Concept Paper into the budget calendar and to reflect the importance of the Budget Concept Paper in setting the strategic direction for budget formulation.

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27. Aggregate fiscal discipline needs to be strengthened further through improving the comprehensiveness of budget coverage. Budget comprehensiveness can be strengthened by: (i) considering the State Social Insurance budget together with the state and local governments’ budgets as part of a Consolidated General Government Budget, which would also include all extra-budgetary funds and resources, and which would be used as the basis for the annual Budget Concept Paper; (ii) including external financing of capital investments and other expenditures funded with donor assistance; (iii) integrating capital expenditures in the preparation of the annual budget proposal; and (iv) including contingent liabilities related to arrears of energy enterprises in the fiscal framework for budgeting.

28. Fiscal reporting and budget transparency could be increased further through the production of more comprehensive, accurate, and timely budget reports designed to support effective and informed management policy-making and decision-making. In particular, comprehensive budget execution data for State and local governments’ budgets should be prepared and published.

29. Both the internal and external accountability framework appears comparatively weak. It is planned that the Ministry of Finance’s internal audit system be restructured in order to ensure increased independence. Donor funding could be sought to support capacity and institution building for the planned Internal Audit Unit within the Ministry of Finance. Similarly, donor funding could be sought to help enable the Chamber of Accounts to develop its objectives, functions and capacities in line with those required for a modern supreme audit institution. The present ongoing CFAA is likely also to produce a number of specific recommendations in both these areas for consideration by the Government.

30. The budget process could be streamlined by adjusting the budget calendar to start the budget process much earlier in the year. The quality of the macro-fiscal framework and the process of its preparation could be improved through strengthening institutional capacity in macroeconomic analysis and defining clear institutional arrangements and responsibilities for this function. Revenue projection methodologies could be reviewed with the purpose of developing more reliable tools for simulating realistic and credible revenue scenarios for all parts of the budget.

31. With respect to budget execution, performance has been disappointing recently with increased budget deviation in execution and some new build up of arrears experienced in 2001. The present expenditure commitment control system and process needs to be tightened, extended and made more effective. Implementation of the Treasury system to local governments needs also to be completed. The main driver though of improvements to budget execution is likely to come from a combination of: (i) more realistic revenue forecasting; (ii) tougher up-front strategic prioritization of expenditures each year within the context of a realistic resource envelope; (iii) line Ministries beginning to regard top-down sectoral allocations as binding and enforceable; (iv) a reduction in policy volatility and in the frequency of amending the budget following its formal approval during the course of its execution within year.

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32. Further strengthening of public debt management and the development of an integrated public debt management strategy should be a priority area to minimize the cost of financing and ensure fiscal sustainability of debt servicing over the medium and long term.

33. Finally, it should be noted that, as concerns intergovernmental fiscal relations, a large share of general government expenditures, especially in areas that impinge directly on the poor, are of course under the jurisdiction of local authorities. The efficiency of budget relations between the state and local budgets, together with the quality of expenditure management by the local authorities, is, therefore, an important determinant of the overall efficiency of public resource management in Moldova. The efficiency of public spending at the local level in Moldova is affected by a broad range of factors, many of which are political in nature. In 1999, the Government initiated a far reaching decentralization reform that progressed more slowly than had been expected. In 2002, Parliament voted for major amendments to the 1999 legal framework, in effect partially reversing the reform. Only some of these amendments, however, were later accepted by the Constitutional Court. The present position with regard to the fiscal decentralization process remains unclear.

Civil Service Management and Human Resource Management

34. Moldova started the transition period with a comparatively low level of institutional capital in its public sector. This situation has worsened considerably since 1991 due to the prevailing chronic political instability and volatility. Moldova has had ten governments over this period. Increasing politicization has led to high levels of turnover in the civil service at each change of government (up to 20 percent turnover at change of government, with turnover down to deputy head of department). This has resulted in chronic policy discontinuity, weakening of institutional capacity, a severe deterioration in operational efficiency, erosion of institutional memory, and very low staff morale. Further, pay and remuneration levels are extremely low.

35. There have been few external pressures on the system for appropriate behavior on the part of public officials. The private sector has not yet been able to form business associations capable of lobbying effectively for business-oriented policies. Less than 10 percent of enterprise managers surveyed in the BEEPS Enterprise Survey felt that the government in Moldova was helpful to their business. At the same time, they spent almost 15 percent of their time in dealings with government officials, compared to a CIS average of 6 percent. Civil society is weak. Citizens have extremely low expectations of the public sector and extremely limited opportunities to participate meaningfully in decision-making processes. External accountability of the system is very low, as are levels of transparency and freedom of information.

36. Unusually perhaps, the overall size of the central civil service and of local government administrations in Moldova is not a key problem: these are comparatively small by international standards, although there are still some areas of over-staffing and many areas where significant efficiency, effectiveness and cost-effectiveness gains could be achieved. The greater challenge is perhaps to build capacity, particularly in central

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ministries, to provide for more efficient and cost-effective implementation of the core medium-term priorities of the government’s work program. While the overall number of ministries in Moldova (at present fifteen) is also in line with international practice, existing ministries need to be significantly streamlined to focus on: (i) policy analysis and development; and (ii) monitoring and evaluation. Taken together, these factors imply a radical restructuring of existing line ministries.

37. A program of functional reviews could be launched to help achieve this reorientation. This review would also aim to identify and eliminate non-core functions and services and provide for the commercialization or spinning off of commercial services at present provided within government structures. Initially, criteria for such a program could be developed, and three pilot functional reviews launched over the first year of implementation of the overall Public Sector Reform Strategy and Program.

38. Civil service human resource management is generally underdeveloped, with no strong central agency setting strategic human resource management policy for the civil service overall. The present Civil Service Law does not provide a sufficiently clear and strong legislative underpinning for a merit-based and depoliticized professional civil service. Key objectives must be to build a career public service; to provide for continuity on change of government; and to differentiate clearly between career civil servants and political appointees.

39. The Civil Service Law, together with supporting legislation and regulations, could be reviewed and amendments developed to strengthen the application of merit and depoliticization. Consideration could also be given to setting up an independent non-partisan oversight body (such as a Civil Service Commission) to afford some protection of the principles of merit and depoliticization as enshrined in the amended legislation. Further, clear criteria could be established for deciding which posts should be filled through competitive external open recruitment. These steps could be accompanied by moves to develop a Code of Ethics for civil servants and to strengthen provisions relating to conflict of interest and to declarations of assets and earnings.

40. Accountability could be strengthened through introducing a system for performance management within the civil service based on the determination of a hierarchy of objectives (for the government overall, next for each ministry, then for each department within each ministry, and finally for individual employees within each department). Such a system would also seek to provide performance data on the work of ministries and government bodies. Such performance data could be linked with budget data as a first step toward allowing for more explicit assessment of efficiency, effectiveness, and cost-effectiveness. This could also lead to the determination and publication of service standards for ministries and government bodies, against which performance could then be assessed and reported on, both internally and externally. In addition, new forms of consultation with, and for providing for participation of, private sector business associations, and NGOs and individual citizens and service users in decision-making and service management could be developed and introduced.

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41. Pay reform could be considered across the public sector to increase the competitiveness of government as an employer and to allow government to be able to recruit and retain sufficient quantity and quality of employees, particularly in managerial and professional areas. This could go a long way towards rebuilding capacity within the public sector. Capacity in the central civil service could also be strengthened through paying increased attention to training and development strategy and programs.

Sector-Specific Reforms in the Social Sector

42. Addressing cross-cutting weaknesses in areas such as center of government decision-making, budget formulation and execution, and civil service management and human resource management appears to be an essential pre-condition for strengthening the government’s ability also to define strategic intra-sectoral priorities; to ensure the optimal allocation of scarce resources in line with the priorities determined; and to increase overall operational efficiency and efficiency of spending at the sectoral level. The present inappropriate incentives and weak institutions continue to make it extremely difficult for government to be able to make and secure the effective implementation of appropriate policy decisions. However, beside paying attention to cross-cutting reforms, there also remain a number of sector-specific areas justifying the attention of the government.

43. In the education sector, the priorities appear to be to strengthen equity in access to primary and basic secondary education through improving enrolment rates, completion rates, and attendance rates, particularly for children from low income families and from rural areas. In the context of the PRSP and the Government’s Public Sector Reform Strategy and Program, a specific Education Reform Strategy could also be developed to articulate these sector-specific priorities and objectives. This could also include the completion of rebalancing of intra-sectoral education expenditures further in favor of primary and basic secondary education; the development of an Education Human Resource Restructuring Plan designed to allow for rebuilding of human resource capacity within the education sector; and an approach to increasing external accountability and strengthening parental and communal involvement in decision-making.

44. In the health sector, the agenda appears to parallel that for the education sector, although restructuring of the health sector is further advanced. Priorities at sector level appear to be to strengthen equity in access to basic services, particularly through defining then implementing the basic health care services package. Also, in the context of the PRSP and the Government’s Public Sector Reform Strategy and Program, the government’s Hospital Restructuring Plan could be finalized and implemented. The rebalancing of intra-sectoral expenditure allocations in favor of primary health care and emergency services could be concluded. A Health Sector Human Resource Restructuring Plan also designed to allow for rebuilding of human resource capacity within the health sector could be developed and implemented; and approaches to increasing external accountability and strengthening community involvement in management of community-based boards for primary health care services developed.

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45. In the social protection sector, the sector specific priorities appear to be to strengthen equity in, and the medium-term sustainability of, the pensions system; and to improve the ability to target social assistance to the most vulnerable and needy groups (including through the restructuring of child allowances and the elimination of compensations for non-energy communal services).

Next Steps

46. As set out earlier in this report, the challenge facing the Government of Moldova is to seek to secure sustainable growth and significantly reduce poverty, while building human capital and improving health and education outcomes. This already challenging agenda has to be achieved in an extremely constrained fiscal position and in the context of weak institutional capacity. This report accordingly presents a set of proposals for consideration by the Government of Moldova which are designed to help secure increases in institutional capacity in a number of key areas, such as center of government decision-making, budget formulation and execution, and civil service management and human resource management. Additionally, a number of sector-specific recommendations relating to the public sector reform agenda in the social sectors have also been suggested. The table attached to the Executive Summary summarizes the recommendations identified and suggested for consideration by the Government in each of these areas.

47. While the challenge facing the Government cannot be over-estimated, the Government has been able to demonstrate considerable progress in some early structural policy reforms, and has for example been able to put in place many of the basics required for a well-functioning public resource management system. The government’s decision to adopt the MTEF approach also provides an excellent integrating framework to strengthen discipline within the system and to support the government’s efforts to secure the desired improvements in institutional capacity. And the PRSP, underpinned by an active Public Sector Reform Strategy and Program, should provide the appropriate policy vehicle for the Government to develop and begin to implement these reforms.

48. Many of the institutional measures suggested for the Government’s consideration may require years before their effects can really be felt both within and outside the system. Yet, making progress on this institutional agenda appears to be a critical precondition for making progress on the Government’s core policy reform agenda and thereby helping to deliver strong and sustainable growth and achieving real and significant reductions in poverty.

Table 1: Summary of Priority Recommendations

OBJECTIVES ACTIONS

Six Months Twelve Months Medium-Term Target (Three to Five Years)

1. Public Sector Reform

1.1 Put in place appropriate arrangements for leadership and management of public sector reform

Approve Public Sector Reform Strategy

Reconstitute high-level Steering Committee for Public Sector Reform led by Prime Minister; together with the three component-level Working Groups on Public Administration Reform; Public/Private Sector Interface; and Public Expenditure Management

Set up Public Sector Reform Unit reporting directly to Prime Minister

Develop and approve detailed and costed Action Plan for Public Sector Reform

Put in place set of monitoring indicators (including statistical and budgetary data as well as results of public officials surveys and service delivery surveys of service users) to support process of monitoring and evaluation by the government and by external stakeholders of the impact of and outcomes from the Public Sector Reform program

Draw up communications and internal and external consultation strategies

Annual reports on work of public service overall and on public sector reform activities and outcomes being published

2. Center of Government

2.1 Strengthen center of government decision-making through seeking to increase both the effectiveness of Cabinet and the ability of Cabinet to reach binding collective decisions

Introduce system of Cabinet Committees to reduce overall load on Cabinet and to improve policy contestability and strengthen substantive inter-Ministerial joint working

System of Cabinet Committees in place and working effectively

OBJECTIVES ACTIONS


2.2 Strengthen capacity for strategic planning, policy analysis and policy coordination at the center of government

Undertake functional review of State Chancellery

Set up Public Sector Reform Working Group on Strategic Planning to develop methodology for policy analysis and impact assessment to be applied to all new proposals to be submitted to Cabinet

State Chancellery restructured into non-political Government Secretariat

Prime Minister’s Office strengthened with those political functions previously exercised by the State Chancellery reassigned to it

Management information systems strengthened to allow State Chancellery to be able more effectively to monitor implementation of the Government’s work-program

3. Public Expenditure Management

3.1 Strengthen strategic prioritization and allocative efficiency in budget formulation

Develop Issues Paper and Budget Calendar for preparation of 2004-2006 MTEF

Prepare sectoral expenditure strategies for each of education, health and social protection (to be attached to the 2004 BCP)

Prepare amendments to 1996 Budget Law to require Cabinet approval of BCP prior to detailed budget preparation starting with 2005 Budget

Develop medium-term plan for strengthening the MTEF framework (determination of aggregate resource envelope; prioritization of expenditure items across and within sectors)

Approve MTEF for 2004-2006 with explicit expenditure ceilings by functional classification, and including the sectoral expenditure strategies for education, health and social protection

MTEF effectively implemented

OBJECTIVES ACTIONS


3.2 Strengthen aggregate fiscal discipline through improving comprehensiveness of budget coverage

Decide to include externally financed investment in capital expenditures for 2004 Budget

Agree to consider capital expenditure together with the recurrent budget proposal for 2004 Budget

Consolidated General Government Budget (including State Budget, local governments’ budgets, State Social Insurance budget, and extra-budgetary funds) developed and used as basis for BCP from 2005 budget onwards

Consideration of contingent liabilities from energy arrears taken proper account of in budget analysis and planning

3.3 Improving fiscal reporting and budget transparency

Budget execution data for State and local governments’ budgets on a commitment and cash basis being published

3.4 Strengthen internal and external accountability framework

“Reorganization of the Ministry of Finance’s internal audit system so as to ensure increased independence and capacity” (SAC III Second Tranche Core Condition)

Mobilize donor support for institution building for newly-established Internal Audit Unit of Ministry of Finance

Mobilize donor support for institution building for Accounting Chamber

Internal audit system restructured

Accounting Chamber objectives, functions, and capacities in line with those required for modern supreme audit institution

Approve action plan to implement CFAA recommendations (CFAA report due to be submitted to Government March 2003)

Implement priority recommendations from CFAA

Implementation of CFAA recommendations completed

3.5 Enhance quality of macroeconomic forecasting

Macroeconomic forecasting model developed and implemented effectively from 2005 Budget onwards

OBJECTIVES ACTIONS


3.6 Strengthen budget preparation Amend budget calendar to start budget preparation in January of each year starting with 2004 Budget

Develop more reliable and robust revenue projection methodologies and tools

Continue building capacity in the area of performance and program budgeting; continue and develop the pilots in education and health for 2004 Budget; initiate preparatory work for pilot in social protection for 2005 Budget

Process of monitoring the performance of budgets includes reviewing outputs and outcomes of spending programs

3.7 Strengthen budget execution Extend coverage and effectiveness of expenditure commitment control system and processes

Borrowing plan consistent with cash inflows and outflows in place

Implementation of Treasury system to control expenditure commitments of local governments completed

Integrated public debt management strategy operational

4. Civil Service Management

4.1 Strengthen legal and ethical framework

Undertake review of Civil Service Law and supporting legislation and regulations and develop amendments designed to strengthen the application of merit and depoliticization

Process of putting in place legislative framework to give the required underpinning for the application of merit and depoliticization completed

Independent non-partisan oversight body (such as Civil Service Commission) to protect both merit and depoliticization principles created

Process under way to strengthen and codify administrative procedures designed to remove inappropriate discretion from individual civil servants

OBJECTIVES ACTIONS


Code of Ethics for civil servants; and provisions relating to conflict of interest and inappropriate political activity on the part of civil servants in place

Requirements for declarations of assets and earnings by managerial-level civil servants and public officials of sub-national units of government strengthened

4.2 Rationalize structure of government and of constituent parts of government

Develop criteria for program of functional reviews of government overall and of individual Ministries and other bodies within the structure of government

Implement three pilot functional reviews Program of functional reviews undertaken across government; and for judets and local governments

Line Ministries re-oriented on role of policy analysis and development, strategic planning, and monitoring and evaluation

4.3 Increase competitiveness of public sector as attractive employer through pay reform

Develop medium-term pay policy and pay position for the public sector as compared to the private sector

Develop medium-term target decompression ratios (ratio of grade level 13 to 23 for basic pay)

Set of targets established for civil service pay compared to the private sector and for decompression ratio achieved

5. Civil service human resource management

5.1 Strengthen external competition in recruitment

Define criteria as to which positions are to be filled on the basis of competitive external open recruitment

Scope of positions to be subject to competitive external open recruitment broadened

OBJECTIVES ACTIONS


5.2 Rebuild capacity through strengthening civil service training and development

Develop overall change management program to support public sector reform

Training and development strategy and program for senior and middle-level managers in place

Training and development strategy and program for strengthening skills in areas such as human resource management, financial management, policy analysis and strategic planning, IT, impact analysis and legislative drafting in place

5.3 Strengthen transparency and external accountability

Develop service standards for number of pilot Ministries and other bodies of government together with process for collecting, analyzing and publishing data on actual performance against standards

Develop new forms of consultation with, and participation of, private sector business associations, and NGOs and individual citizens and service users in decision-making and service management

Performance data and budget data for Ministries and other units of government linked

Application of service standards and publishing of reports on actual performance against standards extended across government

Performance management system based on hierarchy of objectives developed and implemented

New forms of consultation with, and participation of, private sector business associations, and NGOs and individual citizens and service users in place

Processes and procedures to promote freedom of information implemented

6. Education

6.1 Strengthen equity in access to primary and basic secondary education; and to higher education

Define target enrolment ratios, completion rates, and attendance rates : overall; for children from low income

“Government to approve an education reform policy strategy to address emerging inequities in the system,

Implementation of Education Reform Strategy under way; target enrolment ratios, completion rates, and attendance

OBJECTIVES ACTIONS


families; for children from rural areas

Complete study on levels of formal and informal payments for access to higher education overall; for students from low income families; and for students from rural areas

including (a) drop out of poor children from basic education; (b) higher education selection and financial support mechanisms to ensure access of poor students” (SAC III Third Tranche Core Condition)

rates for primary and basic secondary education achieved; satisfactory access of students from low income families and from rural areas to higher education achieved

6.2 Rebalance intra-sectoral education expenditures further in favor of primary and basic secondary education

Define target allocations for intra-sectoral expenditures (as percentage of all public education expenditures) to be achieved for primary and basic secondary education over medium term

Target intra-sectoral allocations for primary education and for basic secondary education achieved

6.3 Rebuild human resource capacity within the education sector

Complete inventory of existing staff levels by type of staff (teachers and support); type of educational institution; location; and subject (for teachers)

Complete assessment of short-term and medium-term staffing needs by type of staff; type of educational institution; location and subject (for teachers) (including allowing for the effects in medium term of falling school rolls)

Education Sector Human Resource Restructuring Plan covering: (i) redeployment of existing staff; (ii) retraining then redeployment of existing staff; (iii) required redundancies; (iv) management training; (v) professional training; (vi) training in policy analysis and development and monitoring and evaluation for Ministry of Education staff; and (vii) pay reform strategy for areas of recruitment and retention difficulty; prepared and being implemented

6.4 Increase external accountability Develop proposals for strengthening parental and community involvement in decision-making relating to primary and secondary education in their local area

Comparative information being provided to local communities and to parents on comparative performance of educational institutions

OBJECTIVES ACTIONS


7. Health

7.1 Strengthen equity in access to basic services

Define basic health care services package

Prepare costed implementation plan for introduction of basic health care services package

Basic package of health care services designed to provide universal free access in place

7.2 Rebalance intra-sectoral health expenditures further in favor of primary health care and emergency services

“Government approval of a time bound Hospital Restructuring Plan for further elimination of excess capacity in Chisinau Municipality Hospital and Republican Hospitals” (SAC III Second Tranche Core Condition)

Define target allocations for intra-sectoral expenditures (as percentage of total public health expenditures) to be achieved in the medium term for primary health care and emergency services

Secure increased intra-sectoral allocations for primary health care and for emergency services within 2004 draft Budget

Implementation of Hospital Restructuring Plan completed

Target intra-sectoral allocations achieved

7.3 Rebuild human resource capacity within the health sector

Complete inventory of existing staff levels by type of staff (doctors, other professionals, nurses, ancillary); type of health care institution; and location

Complete assessment of short-term and medium-term staffing needs by type of staff; type of health care institution; and location

Prepare Health Sector Human Resource Restructuring Plan covering: (i) redeployment of existing staff; (ii) retraining then redeployment of existing staff; (iii) required redundancies; (iv) management training; (v) professional training; (vi) training in policy analysis and development and monitoring and evaluation for Ministry of Health staff; and (vii) pay reform strategy for areas of recruitment and retention difficulty

Implementation of Health Sector Human Resource Restructuring Plan completed

OBJECTIVES ACTIONS


7.4 Increase external accountability Develop proposals for introducing community-based boards on a pilot basis for primary health care services in a small number of primarias

Information being provided to local communities and to health care service users on comparative performance of community-level primary health care services`

8.Social protection

8.1 Strengthen equity and medium-term sustainability of pension system

“Enactment of amendments to the 1998 pension law On the State Social Insurance Pension” which includes :

-Integration of privileges into the general pension law with gradual withdrawal of elements inconsistent with the general pension law

-Specification of a clear financially viable indexation mechanism with which to determine future pension increases (SAC III Second Tranche Core Condition)

Reintegration of “special treatment” professional groups into the general pension system on equitable basis completed

8.2 Improve ability to target social assistance to most vulnerable and needy groups

Further develop household budget survey data and analysis to provide improved analytical base to support more effective targeting of social assistance benefits

Develop strategy and action plan for restructuring of child allowances

More effective targeting of social assistance benefits achieved

Proposals for phasing out of program of nominal compensations developed and implementation under way with beneficiary groups which are not the most in need eliminated and compensations for non-energy communal services also eliminated

Restructuring of child allowances completed

1. STRATEGIC SETTING 1.1 The challenge facing the Government of Moldova is to promote sustainable growth and to significantly reduce poverty, while building social capital. This has to be achieved in the context of a very constrained fiscal position, weak governance, and limited institutional capacity. Following the government priorities as set out in the Interim-Poverty Reduction Strategy, the report argues that the required social sector reform outcomes (restoring equity in access in the health and education and social protection sectors) can only be achieved if public expenditure management arrangements are significantly strengthened and the institutional capacity of government decision-making and of public administration and service delivery is significantly improved.

1.2 To give a context for this discussion, this chapter provides a summary of the causes of Moldova’s disappointing transition performance. Macro-fiscal developments are examined, including an assessment of compositional changes in revenues and expenditures over the last ten years. A macro-fiscal framework for the period to 2005 is presented, together with a discussion of some of the key risks and constraints to the scenario in the framework.

A. CAUSES OF THE DISAPPOINTING TRANSITION PERFORMANCE

1.3 The complexity of the causes of Moldova’s disappointing transition performance should not be underestimated. The main causes can be divided into four groups: (i) unfavorable initial conditions and shocks at the outset of transition; (ii) poor quality of governance; (iii) partial and stop-and-go implementation of market reforms; and (iv) the external shock from the 1998 regional financial crisis. Moldova has experienced ten very difficult years of transition. Over the period from 1990 to 2000, GDP declined by 65 percent. More than half of the population live in absolute poverty.1 External debt increased from virtually zero to above 100 percent of GDP2.

1.4 Transition was accompanied by a dramatic fiscal adjustment, most of which was induced by the 1998 regional financial crisis. The cash budget deficit, which exceeded 10 percent of GDP in 1997, was reduced to 1.6 percent of GDP in 2000 and eliminated in 2001. Government revenues declined from 40 percent of GDP in 1997 to 31 percent of GDP over the same period. This was largely the result of the collapse in tax revenues.

1 According to the most recent available data on regional poverty levels, Moldova’s headcount index for absolute poverty as measured at $2.15/day in PPP terms stood at 55 percent in 1999 and was the second worst after Tajikistan among the transition countries for which data were available (see, for example: World Bank. 2000. Making Transition Work for Everyone. Poverty and Inequality in Europe and Central Asia. The World Bank. Washington, D.C.) 2 At the end of 2001, total external debt, including external energy arrears, was estimated at around 103 percent of GDP. Without energy arrears, external debt amounted to 83 percent of GDP.

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The Government had to cut expenditures from 50 percent of GDP in 1997 to 30 percent in 2001.

1.5 Initial Economic Conditions and Shocks of the Early years of Transition. In the Soviet system, Moldova’s role was primarily to supply agricultural products to the rest of the Former Soviet Union (FSU). Moldova was almost completely dependent on imported energy and had no natural resource base of its own. With the dissolution of the FSU, Moldova experienced one of the strongest terms of trade shocks among the FSU countries, combined with severe disruption of trade links and loss of traditional markets. The 1992 civil war, when the region of Transnistria claimed unilateral secession, considerably eroded Moldova’s industrial base, increased its dependence on imported energy, and made Moldova more reliant on its agricultural output.

1.6 Initial Institutional Constraints. Equally important were the initial institutional constraints. The dissolution of the Soviet Union required the newly independent states to build from scratch the set of institutions which are part and parcel of modern statehood and democracy. Like other CIS countries, Moldova started the transition period with a low level of institutional capacity in its public sector. The situation in Moldova has, however, been exacerbated over the last decade by chronic political instability and volatility, with ten governments over this period. Moreover, increasing politicization has led to high levels of turnover in the civil service at each change of government (up to 20 percent turnover at each change of government, with turnover down to deputy head of department). This has resulted in chronic policy discontinuity, weakening of institutional capacity, erosion of institutional memory, and extremely low staff morale.

1.7 Institutional capacity has, in some limited areas, improved since independence. For example, Moldova has one of the strongest central banks in the FSU. The Ministry of Finance’s technical capacity has also been considerably developed. Both these agencies were the beneficiaries of substantial externally funded technical assistance. However, even in these cases, the sustainability of the improvements will depend on implementing deep public sector reforms to depoliticize the public administration and provide appropriate incentives to be able to retain good quality professionals.

1.8 Quality of Governance. Overall, Moldova’s quality of governance has remained poor, and is among the weakest in the region. Moldova had the worst performance among twenty transition countries when compared on a governance index by the EBRD (1999 Transition Report). Moldova also rated the lowest among transition countries with respect to perceptions of quality and efficiency of central government services in the World Bank/EBRD Business Environment and Enterprise Performance Survey (BEEPS-1999).

1.9 Persistently extremely low compensation levels in the civil service combined with exposure to opportunities for rent-seeking as elements of a market economy developed (the new private sector, emergence of some SMEs, restructuring of existing enterprises, privatization) has led to Moldova experiencing high levels of both state capture and

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administrative corruption.3 At the same time there have been few external pressures on the system for appropriate behavior on the part of public officials. Politicians have been unable to secure discipline within the system. The private sector has not been able to form business associations capable of lobbying effectively for business-oriented policies. Civil society is weak. Citizens have extremely low expectations of the public sector and extremely limited opportunities to participate meaningfully in decision-making processes.

1.10 Stop-and-Go Implementation of Reforms. The transition period has been characterized by a large degree of political instability, with ten governments since independence. The absence of political consensus behind economic reforms over this period, frequent changes of government, and weak institutional capacity all combined to produce a stop-and-go pattern in the implementation of economic reforms.

1.11 In the early years of transition, Moldova ranked among the best achievers of the transition economies with regard to first generation market reforms. The macro stabilization program launched with the introduction of a new currency in 1993 was relatively successful: the leu stabilized within twelve months, inflation declined from above 100 percent per annum in 1994 to 15 percent per annum in 1996, and the cash budget deficit was reduced from 22 percent of GDP in 1993 to under 6 percent of GDP in 1995. These successes were accompanied by a traditional set of price and trade liberalization measures and mass privatization.

1.12 Real restructuring of the economy did not start until 1997, however, and progress to date has been mixed. While consecutive privatization programs have moved many formerly state-owned enterprises into the private sector, many large enterprises perceived to be of strategic importance for the economy, including enterprises in the wine, tobacco, energy and telecommunications sectors, were kept under state control. Moldova made significant progress in land privatization and in agricultural and energy sector restructuring between 1998 and 2000.4 The business and investment climate has, however, remained poor. This has discouraged strategic foreign direct investment, which amounted to a very modest $80 per capita on a cumulative basis for the period from 1994 to 1999.5

1.13 Public sector and social sector reforms have been delayed. Health sector restructuring and pension reform were initiated only in 1999. The first steps in

3 See: World Bank. 2000. Anticorruption in Transition : A Contribution to the Policy Debate. The World Bank. Washington, D.C. 4 Major achievements in the energy sector include tariff rationalization, replacement of unfunded subsidies with targeted nominal compensations to vulnerable groups of the population, establishment of an independent regulatory body, and the sale of three out of five power distribution companies to a strategic foreign investor. Land privatization and farm restructuring are almost completed, with more than 90 percent of all the former collective farms restructured through the national land program. 5 Foreign direct investment in the Moldovan economy was very low in the beginning of transition and has been growing slowly. From 1995 to 1999, annual net foreign direct investment (FDI) flows averaged US$56 million. The sale of part of the electricity distribution grid to Union Fenosa company of Spain increased the average to US$68 million for 1995-2000. The total volume of net FDI into the Moldovan economy reached US$443.7 million (3.7 percent of GDP) by the end of 2000. As a ratio of GDP, however, this was above the average for FSU countries (1 percent of GDP for 1992-1995, and 2.5 percent of GDP in 1996-1999 (Source: World Bank. 2002. Transition. The First Ten Years. Analysis and Lessons Learnt for Eastern Europe and the former Soviet Union. The World Bank. Washington, D.C.)

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improving social assistance targeting were taken that same year, when the government introduced a nominal compensations program for vulnerable population groups to replace the formerly unfunded utility subsidies. Education restructuring has not been initiated. While the Government developed a comprehensive Public Sector Reform Strategy in November 2000, there have been few concrete steps taken to begin implementation of this Strategy.

1.14 The External Shock from the 1998 Regional Financial Crisis. Moldova was one of the countries in the region hardest hit by the regional financial crisis in 1998. The depreciation of the leu against western currencies and its simultaneous appreciation against the Russian ruble resulted in Moldova’s second dramatic terms of trade shock since independence. Exports halved in 1999 compared to 1997, and by 2001 they had recovered to only 70 percent of their pre-crisis level. The incipient positive economic growth in 1997, which followed six years of decline, was reversed. Inflation generated by the leu depreciation reduced real household incomes and savings, leading to an increase in the incidence of absolute poverty from 54 percent of the population at the end of 1997 to almost 74 percent of population at the end of 1999.6 Income per capita plummeted in 1999 to less than 60 percent of the pre-crisis level. External debt as a percentage of GDP increased from 56 percent in 1997 to above 877 percent in 1999.

1.15 The cumulative decline in GDP of 65 percent between 1990 and 2000 (the second worst among the Former Soviet Union (FSU) countries) turned Moldova into the poorest country in Europe, with Gross National Income per capita lower than all other FSU countries except Tajikistan. Poverty is widespread, with more than half of the population having consumption levels below the internationally comparable absolute poverty line of US$2.15 per day,8 and a

6 Murrugara, Edmundo. 2001. “Moldova Dynamic Poverty Study” . Working Paper. 7 Excluding energy arrears. 8 According to the most recent available data on regional poverty levels (see, for example, World Bank. 2000. Making Transition Work for Everyone. Poverty and Inequality in Europe and Central Asia. The World Bank. Washington, D.C.), Moldova’s headcount index for absolute poverty as measured at $2.15/day in PPP terms stood at 55 percent in 1999 and was the second worst after Tajikistan among the transition countries for which the data was available. The Dynamic Poverty Study undertaken by Bank staff in 2001 (E. Murrugara, 2001) suggested the use for Moldova of an absolute poverty line of 89.97 lei per capita per month valued at end 1997 prices (equivalent to about $20 per month at the time of measurement). The use of this poverty line results in an absolute poverty rate above 70 percent for 2000.

Table 1.1: Income and Output in CIS Countries, 2000

GNI per capita, $ at PPP

Real GDP,

1990=100Russia 8010 64 Belarus 7550 88 Kazakhstan 5490 90 Turkmenistan 3800 76 Ukraine 3700 43 Azerbaijan 2740 55 Georgia 2680 29 Armenia 2580 67 Kyrgyzstan 2540 66 Uzbekistan 2360 95 Moldova 2230 35 Tajikistan 1090 48 Source: World Bank. 2002. World Development Indicators 2002, and Transition. The First Ten Years. World Bank. Washington, D.C.

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majority9 falling into the category of chronically poor. Social indicators have deteriorated to among the worst in the region. In 2000, Moldova ranked 102nd of 174 countries on the UNDP’s human development index, the lowest of all transition economies except Tajikistan and Uzbekistan.10 Moldova’s accumulation of one of the heaviest external debt burdens of all the transition countries exacerbates the situation.11

B. MACRO-FISCAL DEVELOPMENTS

1.16 In the last two years, GDP growth turned positive, growing by 2.1 percent in 2000 and 6.1 percent in 2001. The exchange rate stabilized relatively quickly after the major devaluation in 1998-99 and has been depreciating slowly for the last two years. After a temporary surge in 1998-99, inflation was reduced to 18.5 percent in 2000 and to 6.4 percent in 2001. The current account deficit contracted sharply in 1999, widened to above 9 percent of GDP in 2000, but fell to 8 percent of GDP in 2001. Following a dramatic tightening of fiscal policy, fiscal balances have demonstrated strong improvements since 1998, with a cash budget surplus of about 1 percent recorded in 2001 (see Table 1.2).

Table 1.2: Aggregate Fiscal Trends12

(Percent of GDP)

1995 1996 1997 1998 1999 2000 2001

Revenues 39.4 35.9 39.8 39.0 32.0 33.0 31.3 Expenditures 46.2 43.9 50.0 42.9 35.0 34.6 30.3 Deficit -6.8 -8.0 -10.2 -3.9 -3.0 -1.6 1.0

Source: 1995-96 – IMF, 1997-2001 - Ministry of Finance. 1.17 Overall Fiscal Performance. Up to 1998, fiscal performance was mixed. While the fiscal deficit showed a moderate improvement over the period, the deficit remained relatively high (see Figure 1.1).13 Revenues were fairly stable as a share of GDP, ranging between 35 and 40 percent of GDP. Expenditure fluctuated between 44 and 50 percent. The fiscal deficit was financed through a combination of external financing, domestic

9 The Dynamic Poverty Study found that the share of chronic poverty varied between 90 percent and 67 percent of the total in 1997-2000. The study follows the criteria used by Jalan and Ravallion (1998, 2000) to distinguish between chronic and transient poor. 10 UNDP. 2000. Human Development Report 2000. 11 The recent study found that Moldova’s and the Kyrgyz Republic’s debt indicators at end-2000 exceeded the sustainability thresholds under the enhanced HIPC Initiative by modest amounts. (World Bank and IMF. 2002. Poverty Reduction, Growth and Debt Sustainability in Low-Income CIS Countries.) 12 Here and below, if not specified otherwise, fiscal trends are based on the general government budget execution data. The definiton includes the state budget, local budgets, state social insurance budget, other extra-budgtary funds and resources (see Box 3.1 for a more detailed description of Moldova’s budget system). Consistent time series for donor financed investment and other external inflows not channelled through the government budget could not be compiled, and these items are not included. 13 Measured on a commitment basis, the fiscal deficit ranged from 7.2 to 12.6 percent of GDP between 1993 and 1998. On a cash basis, the deficit was smaller, ranging from 5.7 to 10.2 percent of GDP during the same period.

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borrowing, and domestic payment arrears (mostly on social expenditures, including pensions).14 The stock of domestic expenditure arrears peaked at over 12 percent of GDP in 1996 (see Figure 1.2). Heavy recourse was made to external borrowing, which averaged above 6.5 percent of GDP between 1995 to 1997. As a result, total external debt rose from almost zero in the early 1990s to 67 percent of GDP by the end of 1997 (see Box 1.1).

Box 1.1: Moldova’s Debt Profile Moldova’s total external debt increased from near zero at the beginning of the 1990s to over $1.2 billion (83 percent of GDP ) at end-2001, of which 77 percent was public and publicly guaranteed debt. Additionally, the remaining outstanding external arrears on energy imports to foreign suppliers (mainly Gazprom) are estimated at US$298 million (20 percent of GDP). About 60 percent of total public and publicly guaranteed debt is owed to multilateral institutions, including the IMF, the World Bank, and the EBRD. About 27 percent is owed to private creditors, including an outstanding balance from a Eurobond in the amount of US$75 million (issued in 1997 with a bullet repayment in June 2002), US$90 million securities issued to Gazprom of Russia, and a number of direct and publicly guaranteed credits from foreign banks. The remaining public and publicly guaranteed debt (13 percent of total) is owed to bilateral creditors. Private non-guaranteed debt accounted for 22 percent of the total external debt stock in 2001, which has increased in recent years due to increased private sector borrowing from foreign credit markets. A relatively small part of the current government debt portfolio was contracted on concessional terms. Source: World Bank staff analysis based on data provided by the Government of Moldova.

14 For example, the gap between social contributions and State Social Insurance budget expenditures has widened since 1996; it reached a peak of around 4 percent of GDP in 1997. State Social Insurance budget expenditures (including pensions, family allowances, unemployment benefits and other minor social assistance benefits and subsidies) accounted for slightly less than one quarter of total general government expenditures in 1999. Consolidated state and local budgets outlays on the social sphere (including public expenditures on health care, education, and some minor social assistance schemes) ranged between 13 and 17 percent of GDP on a cash basis between 1994 and 1998. These levels are high relative to the average for other FSU countries (8.2 percent of GDP) and even relative to the average for countries in Central and Eastern Europe and the Baltic states (about 10 percent of GDP) in recent years. (Source: Alam, Asad and Sundberg, Mark. 2001. A Decade of Fiscal Transition. The World Bank. Washington, D.C.)

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Figure 1.1: Budget Deficit Trends (Percent of GDP) Source: Based on the Ministry of Finance and IMF data.

Figure 1.2: Budget Deficit Financing by Source (MDL million)

-600

-400

-200

0

200

400

600

800

1995 1996 1997 1998 1999 2000 2001

Net domestic Net foreign Privatization Proceeds Change in domestic expenditure arrears

Source: Based on IMF data.

1.18 Starting in 1998, the Government had to tighten fiscal policy dramatically, in part because of the regional financial crisis. In the aftermath of the crisis, government revenues dropped, and external sources of deficit financing and the market for T-bills both dried up. The urgent need to consolidate the reserve position of the National Bank of Moldova also reduced the Government’s access to National Bank resources to finance its deficit. Deficit financing was limited to those amounts made available by bilateral and IFI creditors, and only after sufficient resources had been allocated to the National Bank to shore up its international reserves and net-credit-to-Government positions. The Government had no option but to reduce the fiscal deficit sharply, in both cash and commitment terms.

-5%

0%

5%

10%

15%

1995 1996 1997 1998 1999 2000 2001

cash deficit commitment deficit

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1.19 In 1999, the fiscal balance on a commitment basis declined to 3 percent of GDP, an improvement by more than 6 percentage points of GDP compared to 1998. The cash deficit fell to the same level. The improvement continued in 2000, when the cash deficit declined to 1.6 percent of GDP, and the stock of expenditure arrears contracted from 9 to 5.2 percent of GDP. In 2001, the dearth of external financing exacerbated by an unexpected shortfall in revenue forced the government to tighten fiscal balances even further. While expenditures were cut during the year, that was insufficient to prevent accumulation of new expenditure arrears, even with an overall cash budget surplus of about 1 percent of GDP. During 1999-2001, the primary cash budget surplus exceeded 4 percent of GDP.

1.20 Revenue Performance. As shown in Table 1.3, general government revenues fell from almost 40 percent of GDP in 1997 to about 31 percent in 2001. Tax revenues declined from 25 percent of GDP in 1997 to below 18 percent in 2001. The continuing economic recession eroded the tax base. The high share of the informal sector15 went hand in hand with widespread tax evasion. Changes in tax policies and enactment of the new tax code also adversely affected some types of revenues: for example, in 2001, the state budget experienced a shortfall of 15 percent of planned VAT revenues because of higher than projected VAT refunds. Direct taxes (personal income tax and profit tax) constituted 21 percent of total tax revenues in 2001, and indirect taxes (VAT and excise) accounted for 65 percent of tax revenues. The balance is composed of foreign trade taxes (7 percent) and other taxes (8 percent), including the land tax, real estate tax, natural resource tax, and state tax.

Table 1.3 : Revenue Trends (Percent of GDP)

1997 1998 1999 2000 2001

Total Revenues 39.8 39.0 32.0 33.0 31.3 Tax Revenues 24.8 23.6 18.4 18.8 17.6 of which: VAT 10.6 12.3 7.6 8.4 7.9 Excises 4.5 4.1 3.6 4.1 3.6 Non-Tax Revenues 5.5 5.4 4.7 5.0 3.9 Social Insurance Contributions 8.2 8.6 6.4 6.3 6.8 Extrabudgetary Revenues 1.4 1.4 1.6 2.1 2.3 Grants 0.0 0.0 0.9 0.8 0.8Source: Ministry of Finance.

1.21 Expenditure Performance. Government expenditures have been cut drastically in response to shrinking revenues, particularly since 1997. General government expenditures were reduced from almost 50 percent of GDP in 1997 to around 30 percent in 2001 (see Table 1.4). Between 1997 and 2001, all categories of discretionary expenditures (that is, all expenditures with the exception of interest payment on domestic 15 The Department of Statistics estimated the share of the shadow economy in 2001 GDP at around 35 percent, and the IMF considered it to be even higher. Independent analysis estimates range between 40 and 60 percent of GDP, depending on the estimation methodology used. (See, for example: Center for Strategic Studies and Reforms. Different years. Moldova in Transition. Chisinau).

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and external debt) were scaled down. Social programs that provide basic health, education, and social protection to the poor were cut sharply. Social expenditures as a share of GDP fell from 29 percent in 1997 to 16.7 percent by 2001. Within the social sectors, expenditures on health dropped from 5.7 percent of GDP in 1997 to 3 percent in 2001; education expenditure declined from 9.7 percent to 5.4 percent; and expenditure on social protection decreased from 13.5 percent of GDP to 8.3 percent.

Table 1.4: General Government Expenditure Trends by Economic and Functional Classification (Percent of GDP)

1997 1998 1999 2000 2001

Expenditures by Economic Classification

Total Expenditures 50.0 42.9 35.0 34.6 30.3 Recurrent Expenditure 38.9 30.9 23.9 23.7 22.3 Interest Payments 4.8 5.5 7.4 6.5 4.3 Capital Expenditures 4.9 5.0 2.6 2.9 2.0 Extrabudgetary Expendituresa 1.1 1.3 1.4 1.7 1.9 Net Lending 0.3 0.3 -0.4 -0.2 -0.1

Expenditures by Functional Classification

Total Expenditures 50.0 42.9 35.0 34.6 30.3 State Security and General Services 5.9 5.0 4.6 4.5 4.6 Social Expenditures 29.0 23.6 18.0 18.2 16.7 Education 9.7 7.1 5.3 5.1 5.4 Health 5.7 4.0 2.8 3.0 3.0 Social Protection 13.5 12.4 9.9 10.0 8.3 Economic Expenditures 3.1 2.2 1.7 1.7 1.7 Other Expenditures 2.0 1.3 1.0 1.1 1.2 Interest Payments 4.8 5.5 7.4 6.5 4.3 External 1.9 2.0 3.6 2.7 2.4 Domestic 2.9 3.5 3.8 3.8 1.9 Capital Expenditures 4.9 5.0 2.6 2.9 2.0 Net Lending 0.3 0.3 -0.4 -0.2 -0.1

a Includes expenditure of extra-budgetary funds (except for the state social insurance budget) and extra-budgetary resources of state budget institutions.

Source: Ministry of Finance. 1.22 Capital expenditures fell from about 5 percent of GDP in 1997 to 2 percent of GDP by 2001 (see Table 1.4). However, budget financed investment was supplemented by external donor-financed capital investment, which is not included in the budget and ranged from 3 percent to 6 percent of GDP in 1998-2000.16

1.23 The relative shares of different sectors in discretionary spending did not change significantly, suggesting that the government was not able to secure appropriate strategic 16 Includes investment loans directly contracted by the government and those guaranteed by the government. Calculations were made on the basis of the disbursement data by project provided by the Ministry of Finance.

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prioritization in budget formulation to protect key government priorities and that expenditures were simply cut across the board proportionately.17 The only activity whose share in discretionary spending registered a rise during the period is State Security and General Services (including public administration and general public services18, as well as external activities, defense, judicial authorities, public order and safety). The share rose steadily from about 13 percent in 1997 to above 17.5 percent by 2001.

Table 1.5: Expenditure Trends by Functional Classification (Percent of Total Discretionary Expenditures)

Source: Ministry of Finance.

1997 1998 1999 2000 2001

Total Expenditures 100.0 100.0 100.0 100.0 100.0 State Security and General Services 13.0 13.2 16.8 15.8 17.6 Social Expenditures 64.1 63.1 65.1 64.7 64.1 Education 21.6 19.1 19.3 18.2 20.7 Health 12.6 10.8 10.1 10.8 11.5 Social Protection 30.0 33.3 35.8 35.7 32.0 Economic Expenditures 7.0 6.0 6.3 6.1 6.5 Capital Investment 10.8 13.3 9.0 10.3 7.6 Other 5.1 4.4 2.4 3.1 4.1

C. MACRO-FISCAL OUTLOOK

1.24 If the government is able to maintain prudent monetary and fiscal policies and accelerate and deepen the implementation of the required structural reforms and if external conditions are favorable, GDP growth rates of 5 percent per year appear sustainable over the medium term (Table 1.6).19 Throughout this period, however, Moldova will continue to face a severe fiscal constraint. Given the heavy burden of debt servicing in the coming years, fiscal policy will have to remain very tight, and will need 17 While the share of social sector spending in total budgetary spending declined from 57.9 percent in 1997 to 55.1 percent in 2001, it remained virtually unchanged at around 64 percent if discretionary spending is taken as a basis. Within social sector expenditures, there was a shift in expenditures in favor of social protection payments at the expense of spending on education and health. Expenditures on health fell from above 12.5 percent in 1997 to 11.5 percent of discretionary spending in 2001. Education oulays fell from above 21.5 percent in 1997 to about 18 percent in 2000, but increased to 20.7 percent in 2001. The share of social protection payments in total discretionary spending rose from about 30 percent in 1997 to almost 36 percent in 1999-2000, before declining to 32 percent in 2001. The share of economic expenditures (in fuel and energy, agriculture, forestry, fishing, environmental protection, manufacturing and construction, etc.) in total expenditures fell marginally from 7 percent in 1997 to 6.5 percent by 2001. Expenditures on capital investment declined from 10.8 percent of total discretionary spending in 1997 to 7.6 percent in 2001. 18 In fact, general public services, including public administration, were the main contributors to the rise in the share of the State Security and General Services expenditure line in GDP and total expenditures. 19 Macroeconomic framework was projected for the base case scenario assuming maintenance of prudent financial policies aimed at lowering inflation and maintaining a competitive exchange rate, as well as continuing deepening of structural reforms to improve the business environment and investment climate supported with the IDA Structural Adjustment Credit III (SACIII). The scenario also assumes no major external shocks. World Bank RMSM-X model was used as a projection tool.

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to be designed to maintain a primary budget surplus of about 1.5 percent of GDP during 2002-05.

Table 1.6. Macroeconomic Framework, 2000-2005

2000 2001 2002 2003 2004 2005

Actual Projected

Real GDP growth rate 2.1 6.1 4.8 5.0 5.0 5.0

Inflation (CPI, end of the year)

18.5 6.4 8.0 8.0 6.0 6.0

Exchange rate (MDL/USD, annual average)

12.4 12.9 13.5 14.4 14.9 15.1

Current account balance (% of GDP)

-9.4 -8.0 -7.4 -8.0 -6.8 -6.0

Fiscal balance a (% of GDP)

-1.6 1.0 -1.7 -1.0 -0.2 +0.5

a General government budget cash deficit, the same definition as used in Table 1.2 above. Source: World Bank staff projections.

1.25 Both fiscal and external liquidity will be significantly constrained through 2005. The debt service burden results in a severe liquidity crunch in 2002, and foreign exchange shortages are expected to characterize later years. The financing gap was estimated at US$62 million for 200220 and an annual average of US$43 million for 2003-2005. Total external debt service to exports of goods and services will remain above 20 percent during 2003-2005, while debt service of public and publicly guaranteed debt will begin declining below 30 percent of central government revenue only in 2006. (see Table 1.7).

1.26 While the debt scenario looks grim in the medium term, debt indicators are projected to become more manageable over the longer term. By 2011, the total debt service is projected to decline to 11 percent of exports of goods and services, while debt service on public and publicly guaranteed debt will be reduced to about 16 percent of central government revenues.

20 Staff estimate as of end-May 2002, assuming that IMF PRGF is on track and disbursements of IDA SACIII take place as scheduled. Without PRGF in place and IDA disbursements, the financing gap was estimated at about $87 million. The financing gap was significantly reduced following successful restructuring by the Government of Eurobond debt obligations in late 2002.

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Table 1.7: Debt Sustainability Analysis21

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total external debt, million USD

1226 1278 1313 1357 1348 1333 1333 1330 1345 1356 1359

Public and publicly guaranteed debt, million USD

961 981 982 995 980 944 909 881 883 883 856

External debt to GDP, percent

83 81 78 75 68 62 58 54 51 48 45

Total debt service to exports of goods and services, percent

21 26 24 22 22 18 15 14 14 13 11

Total debt service of public and publicly guaranteed debt to central government revenues, percent

42 44 38 37 33 27 23 22 20 19 16

Source: World Bank staff projections.

1.27 Given recent revenue performance and existing capacity and administrative constraints, the probability of mobilizing a significantly larger volume of revenues in the short to medium term is low, and the most realistic strategy for the Government on the revenue side appears to be to seek to sustain and slowly increase current revenue levels in terms of GDP share while preventing any further contraction. This requires a continuation and deepening of the ongoing efforts to improve administration and to strengthen the enforcement capacities of the tax and custom authorities in order to improve compliance with tax laws and to expand gradually the tax base.

1.28 On the expenditure side, the availability of resources for domestic needs will directly depend on the size of the debt service obligations, as well as on the availability of external financing for the budget deficit. In the medium term there will be very little room to increase government expenditures in terms of the ratio to GDP. The challenge for the Government is to direct the very limited resources available to its main priority activities, and the emphasis, therefore, needs to be on strengthening the government’s ability to make and enforce strategic prioritizations in budget formulation and on rationalizing expenditures and improving their efficiency.

D. KEY RISKS AND CONSTRAINTS

1.29 The prospects of steady economic recovery outlined above could be jeopardized by a number of risk factors. Not all of those factors are under the Government’s control.

1.30 Vulnerability to External Shocks. Moldova’s economy remains extremely vulnerable to external shocks. The health of the Russian economy is an important source

21 Base case assuming the macro trends in the above presented base case macro scenario and rescheduling of the Eurobond balance and Gazprom promissory notes.

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of vulnerability. Russia is Moldova’s largest market for its exports and supplies most of Moldova’s gas imports. Almost 12 percent of Moldova’s public and publicly guaranteed debt is owed to Russia, apart from the bulk of the energy arrears. As shown by events of the last ten years, any downturn in the Russian economy will have an adverse impact on Moldova.

1.31 Bad weather is also a major risk factor because of its adverse impact on agricultural production, which remains the mainstay of Moldova’s economy, accounting for about 30% of GDP, and more than 50% of exports and employment.

1.32 Availability of External Financial Resources. Moreover, Moldova’s economic prospects could be jeopardized if adequate external financial resources are not forthcoming. As already mentioned, even with extremely tight financial policies, Moldova faces large financing requirements in the short and medium term. If expected external financing does not materialize and additional funds are not secured (for example, if creditors lose faith in the Government’s commitment to reforms and/or its ability to implement them), the macro-fiscal outlook for the economy becomes extremely problematic with the government resource balance even tighter than projected above.

1.33 Political Risks. The political situation remains a key risk factor with regard to the pace and content of the core structural, social and public sector policy reforms. The macro-fiscal framework presented above assumes maintenance of tight monetary and fiscal policy and accelerated implementation of a wide range of remaining reforms. Policy reversals or an inability to pursue and implement the required reforms would seriously jeopardize the chances for recovery and growth and could also be expected to lead to disruptions in external financial support.

1.34 Limited Institutional Capacity. The implementation of the required policy reforms will require substantial capacity on the part of the Government. Creating the required capacity to plan, develop, and implement the required complex policy reforms will require accelerated and deep public sector reform.

E. CONCLUSIONS AND OUTLOOK

1.35 The regional financial crisis forced the Government to undertake a substantial fiscal adjustment. However, reductions in expenditures were implemented without appropriate strategic prioritization, and expenditures on health, education and social protection bore a heavy brunt of the cuts. Outcomes and quality of services deteriorated, and inequities in access to services increased. Since the tight fiscal situation in the upcoming years will not allow any substantial increases in overall expenditures, one of the main challenges will be to improve strategic prioritization in budget formulation so as be able to identify and protect adequate resources for priority activities and to ensure that non-priority programs are cut and inefficiencies in resource utilization are minimized.

1.36 In response to the challenges set out above, in November 2000, the Government of Moldova developed a comprehensive Public Sector Reform Strategy. The strategy was designed to reorient the role of the state away from its current role as universal

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caretaker and toward a role consistent with the role of the state in a well-functioning market economy, and a role appropriate and affordable given Government work program priorities and resource constraints. The strategy acknowledged that: “the deep economic and social crises faced by the country during the last decade questioned the fundamental competence of the Government to administer the economy and of the public sector to provide quality public services.” The objectives of the three components of the prepared Strategy are as follows:

(i) Public Expenditure Management: “To build a robust, sustainable, and effective public sector resource management system which provides for high levels of fiscal control (hard budget constraints at all levels of government); strategic prioritization (allocative efficiency in budget formulation and expenditure review and prioritization); and technical efficiency in budget execution.”

(ii) Public/Private Sector Interface: “To build a public sector which provides a supportive partner for the private sector, and an appropriate framework for private sector development, based on accountable, predictable, transparent, simplified, codified, and arms-length interactions with the private sector.”

(iii) Public Administration Reform: “To build a market-oriented and service-oriented public administration which meets EU “best practice” standards; is affordable and sustainable; and ensures cost-effective delivery of priority goods and services.”

The strategy, however, has not been enacted, and there has been no movement toward implementation to date. The immediate challenge for the Government is to re-launch the reform process.

1.37 While reasonable levels of growth appear to be attainable under admittedly challenging conditions in the medium term, the issue facing the Government in the short term is to begin to improve basic outcomes in the social sectors and to begin to address the present inequities in access to basic social services, particularly in primary and emergency healthcare and primary and basic education. This requires improving the ability of the center of government to make and enforce what are likely to be perceived as painful decisions with respect to strategic prioritization in budget formulation while significantly improving the efficiency of resource utilization. This in turn will require the development and implementation of cross-cutting reforms in civil service management and budget execution together with a number of social sector specific reforms in each of the education, health and social protection sectors.

1.38 Key recommendations identified and suggested for consideration by the Government in this report include: (i) launching a major program of public service reform; (ii) strengthening center of government decision-making by introducing a system of Cabinet Committees and restructuring the State Chancellery into a non-political Government Secretariat; (iii) strengthening strategic prioritization in budget formulation

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through a structured and prioritized approach to developing and implementing the MTEF; (iv) strengthening the budget process through increasing budget coverage, deepening Treasury coverage, and putting in place a stronger internal and external accountability framework; (v) strengthening civil service management through amending the Civil Service Law to secure the application of the key principles of merit and depoliticization, and launching a program of functional reviews to rationalize the structure of government; and (vi) undertaking sector-specific reforms in the social sectors to accelerate education and social assistance reform while maintaining health and pension reform, and to rebalance intra-sectoral education and health expenditures further in favor of primary and basic secondary education and primary health care and emergency services.

1.39 Chapter 2 of this report looks at the experience of fiscal retrenchment in the social sectors and sets out some suggested recommendations for sector-specific reforms for consideration by the government. These reforms need to be accompanied by accelerated and deep public sector reform, designed to secure improvements in budget formulation and execution; and in center of government decision-making, civil service effectiveness and operational efficiency, and in the ability and capacity of ministries effectively and efficiently to develop and implement policies in line with the Government’s core priorities. Chapter 3 sets out a suggested reform agenda in the areas of budget formulation and budget execution; and Chapter 4 sets out a possible reform agenda in the areas of center of government decision-making and civil service management and human resource management.

2. THE FISCAL ADJUSTMENT AND REFORM EFFORTS IN THE SOCIAL SECTORS

2.1 By far the largest share of public expenditures is in the area of social spending – on health, education and social protection. Together these were about 55 percent of all public expenditures in 2001 (and 64 percent of all discretionary public expenditures). These sectors are also all key priorities of the Government, as reflected in the Interim-PRSP.22 What happens in the social sectors has a strong impact on the equity, efficiency and sustainability of public expenditures overall.

2.2 However, because of weaknesses in center of government decision-making and strategic prioritization in budget formulation, the social sectors were not afforded any protection by the government during the severe fiscal retrenchment necessitated by the 1998 regional financial crisis. Expenditures in all the social sectors were slashed: for health by about 48 percent from 1997 to 2001 (from 5.7 percent of GDP to 3.0 percent); for education by about 45 percent (from 9.7 percent of GDP to 5.4 percent); and for social protection by about 39 percent (from 13.5 percent of GDP to 8.3 percent). Social sector spending remained virtually unchanged at 64 percent of total discretionary expenditures between 1998 and 2001. Further, the quality of the fiscal adjustment achieved in these sectors left a lot to be desired: the quality of services deteriorated, and access became more inequitable. Efficiency of resource utilization within the sectors remains problematic.

2.3 Using the reform efforts in the social sectors over recent years as an example, the discussion in this chapter seeks to illustrate how the cross-cutting weaknesses in the areas of center of government decision-making and public expenditure management (and particularly allocative efficiency and strategic prioritization) contributed to the unsatisfactory reform outcomes experienced since 1998. The chapter argues that the Government should: (i) seek to pursue cross-cutting reforms designed to secure significant improvements in Government decision-making, in budget formulation, implementation and accountability, and in policy analysis and strategic planning; (ii) pursue and secure improvements in the efficiency of resource utilization within the social sectors through making progress on cross-cutting reforms in the areas of civil service management and of budget process and execution; and (iii) maintain, and in some cases, accelerate, a number of sector-specific policy reforms. The institutional reform agenda is then developed in more detail in Chapter 3 (budget formulation and execution) and Chapter 4 (public sector reform, center of government decision-making, and civil service management and human resource management reforms). 22 The main pillars underlying the strategy include: (i) sustainable and inclusive economic growth that should provide the population with productive employment; (ii) human development policies emphasizing increased access to basic services such as primary health and education; and (iii) social protection policies targeting those most in need.

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2.4 As discussed in Chapter 1, the adverse fiscal conditions after the regional financial crisis in 1998 resulted in a sharp decline in government spending on health, education, and social protection, both as a share of GDP and in real terms. Table 2.1 presents the recent trends in government spending on the social sectors. Social sector expenditures declined from 29 percent of GDP in 1997 to less than 17 percent of GDP in 2001. In 2001, total spending on health, education, and social protection equaled just 57 percent of its 1997 value in real terms.

2.5 Prior to the fiscal retrenchment, Moldova’s health and education indicators compared unfavorably with other transition economies, despite the country’s comparatively high levels of spending on these sectors. Significant governance and efficiency problems remained to be tackled in all three sectors. Delays in the launching of structural reforms left the social sectors particularly unprepared to cope with a major adjustment.23 The contraction in social spending that followed the regional financial crisis has been accompanied by some indications of worsening social indicators, deterioration in service quality, and growing inequities in access to services.

Table 2.1: Recent Social Expenditure Trends

1997 1998 1999 2000 2001

Percent of GDP

Social Expenditures 29.0 23.6 18.0 18.2 16.7 Education 9.7 7.1 5.3 5.1 5.4 Health 5.7 4.0 2.8 3.0 3.0 Social Protection 13.5 12.4 9.9 10.0 8.3

Percent of Total Public Expenditures Social Expenditures 57.9 55.0 51.4 52.5 55.1 Education 19.5 16.6 15.2 14.7 17.8 Health 11.4 9.4 8.0 8.8 9.9 Social Protection 27.1 29.0 28.3 29.0 27.5

Percent of 1997, in Constant Prices Social Expenditures 100 77.5 57.2 57.2 57.0 Education 100 69.7 50.3 47.7 54.7 Health 100 67.6 45.1 48.8 52.2 Social Protection 100 87.4 67.3 67.5 60.8 Source: Ministry of Finance.

23 Consolidation of the health sector and pension reform were only launched in 1999. The first step towards better targeting of social assistance was made the same year with rationalization of energy subsidies, while restructuring of the education sector and reforms of most non-pension social protection programs remain ahead.

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2.6 To illustrate the effects of the weaknesses in the institutional framework and in budget management, this chapter examines health, education, and social protection in turn. It does not in any way aim to present a comprehensive review of the social sectors. For each sector, the discussion covers: (a) a brief overview of the sector prior to the fiscal adjustment; (b) a description of the Government’s response to the regional financial crisis, including reform efforts; (c) an assessment of the impact of recent reforms; and (d) an identification of key short- and medium-term actions that the Government could take to improve equity and efficiency in the sector. The chapter emphasizes that effective implementation of sectoral policy reforms in a consistent, effective and sustainable manner is not possible without also tackling the cross-cutting institutional reforms required to strengthen public resource management and to build capacity in the country’s public administration at all levels of government.

A. THE HEALTH SECTOR24

2.7 Moldova inherited one of the most extensive healthcare networks in the world in per capita terms as part of its legacy from the Soviet system. In 1998, Moldova had 7.7 hospitals per 100,000 citizens, compared to the EU average of 3.8, and the Central and Eastern Europe (CEE) average of 2.18. Similarly, the number of doctors per 100,000 was above the EU and CEE averages (338 for Moldova against 291 and 238 respectively). Each district had several hospitals, several large polyclinics, and multiple, smaller health posts and feldscher points. Hospitals had been developed under a fragmented model whereby many of the services were separated in independent buildings: pediatrics, obstetrics, surgery, and administration would each have their own building. This increased the operating costs related to heating, electricity, cleaning and maintenance considerably. All towns or sectors with a population over 3,000 were provided with a polyclinic and all populations with less than 3,000 were provided with some combination of health centers, posts, or feldscher points. In total, the delivery network included more than 305 hospitals, 1,011 health posts, and 189 health centers.

2.8 Moldova spent 4.0 percent of GDP on the health sector in 1998. This is slightly higher than the 3.6 percent average among CIS countries, and considerably higher than the averages for low-income countries (1.2 percent) and middle-income countries (2.5 percent). Despite comparatively high levels of public spending on health, Moldova exhibited relatively poor health indicators. The intra-sectoral allocation of resources heavily favored hospital care over primary and emergency care: 75 percent of sectoral resources went to hospital care in 1998. Nearly 30 percent of all resources were directed to the 20 Republic Institutes that provided specialized care. Nearly one-third of all government outlays on health in 1998 were spent on utilities and maintenance, crowding out other essential inputs. Structural reforms had not been initiated when the regional financial crisis occurred. Because of weaknesses in center of Government decision-making and allocative efficiency, these intra-sectoral problems were not addressed as coherently and consistently as was required.

24 The discussion in this section draws heavily from Cercone, James. 2002. Moldova: The Health Sector in Transition. Draft.

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The Fiscal Crisis and the Government’s Response

2.9 As described in Chapter 1, public expenditures on health were reduced significantly in the wake of the regional financial crisis. Public sector funding for health care decreased by 55 percent in real terms from 1997 to 1999 but recovered slightly by 2001, when expenditures stood at 52 percent of the 1997 level. On a per capita basis, budgetary spending on health care in 2001 had dropped by 62 percent in US dollar terms relative to 1997. Public outlays on health care were 3 percent of GDP and 10 percent of public spending in 2001. While this represents a marked drop compared to previous years, if expressed as a share of GDP, total public expenditures on health in Moldova still compare favorably to those in an average middle income country (2.5 percent).25

2.10 The Government’s response to the fiscal crisis in the health sector, while delayed, focused on reducing the role of the state in health care provision, consolidating the sector, and shifting intra-sectoral resource allocation priorities.

2.11 Adjusting the Role of the State. A number of steps were undertaken to adjust the role of the state in the health sector. Private medical practice for selected types of services was officially allowed, and official fees for services at public institutions were introduced. The Government also passed the Law on Free Minimum of Health Care Services Guaranteed by the State in 1999, and subsequently launched efforts to test affordable definition, delivery, and financing schemes for the basic health care package.

2.12 Restructuring the Sector. The Government took politically difficult steps to begin to reduce the number of health care facilities and to close unnecessary infrastructure at the remaining hospital facility complexes. Between 1998 and 2000, the number of hospitals was reduced to 65, and the number of primary care facilities was reduced from 979 to 800 health care clinics and family medicine offices. Significant consolidation was achieved through the closure of rural hospitals serving municipalities and the consolidation of specialties in the judet hospitals. As a result of this process of consolidation, total staff numbers have been reduced by over 22,000, 180 hospitals have been eliminated, 154 polyclinics have been consolidated, and more than 670 obstetrics clinics have been closed. Significant restructuring efforts were also undertaken in the Chisinau municipality. During the period 1997-2002, the number of hospitals was reduced from 22 to 10 and the number of beds was cut from 5,700 to 2,979 (by 47.8 percent).26 In sum, the republican health facilities located in the capital city reduced their capacity from 10,770 to 7,986 beds (by 26 percent).

2.13 Rebalancing Intra-Sectoral Resource Allocation Priorities. The Government has sought to secure some rebalancing of expenditures in favor of primary and emergency care. In parallel with this process, a far-reaching plan for improving the

25 Source: Alam, Asad and Sundberg, Mark. 2001. A Decade of Fiscal Transition. The World Bank. Washington, D.C. 26 This included closure of the Municipal Clinical Hospital for Children No. 2 and the Maternity Hospital “Gh. Marcu” No. 1, as well as the reprofiling of services, reducing beds and duplication in the Traumatology and Orthopedics Clinical Hospital and the Republican Clinical Hospital for Children “Em. Cotaga”.

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quality of primary care and reducing reliance on tertiary care was launched. This was based on the introduction of the concept of the family doctor, with the whole territory divided into sectors of around 1,000 to 1,800 people, and a family doctor position being allocated to each sector.

The Impact of Recent Policies and the Remaining Challenges

2.14 While major fiscal adjustment and consolidation of infrastructure were the right responses to the crisis and helped to prevent the complete collapse of the sector, weaknesses in center of Government decision-making, strategic prioritization and allocative efficiency led to a situation where the required trade-offs were not made at political level and policy analysis, development and implementation remained weak at the technical level. This in turn contributed to outcomes such as inequities in access to services increasing and quality of health services deteriorating.

2.15 Reallocation of Resources Toward Primary Care. As shown in Table 2.2, the share of expenditures on ambulatory/primary care rose from about 25 percent in 1998 to 42 percent in 2001, while there was a corresponding reduction in the share of expenditures on hospital care, from 75 percent to 58 percent. However, while this shift was desirable and brings Moldova closer to the pattern observed in OECD countries, Moldova still spends comparatively considerably more on hospital care.27

Table 2.2: Distribution of Health Sector Expenditures a by Type of Facility (Percent of Total )

a Total covers health expenditures of state and local budgets but does not include expenditures of extra-budgetary funds as well as extra-budgetary resources of health institutions financed from the state budget.

b Includes primary care, or family medicine (27 percent of total health expenditures), emergency medical centers (4 percent), specialized care at polyclinics and diagnostic centers (11 percent).

Source: Ministry of Finance, Ministry of Health. 2.16 Reallocation of Resources Among Inputs. Prior to the 1998 regional financial crisis, Moldova spent an unusually high share of the health sector budget on utilities and 27 The unweighted average for 17 OECD countries in 1998 was 41.1 percent. Only four countries spent more than 50 percent on hospital care in 1998: Denmark (54 percent), Iceland (55 percent), Netherlands (53 percent), Switzerland (50.3 percent). (Source: OECD. 2001. OECD Health Data 2001.)

1998actual

1999actual

2000 actual

2001budget

Republican Hospitals 28 30 22 21 Chisinau Municipal Hospitals 13 11 12 11 Rayon Hospitals 29 28 32 26 Rural Hospitals 5 Total Hospitals 75 69 66 58Total Ambulatory/Primary Care 25 31 32 42b

Total Health 100 100 100 100

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maintenance. The intra-sectoral allocation of resources has become somewhat more balanced in the wake of the consolidation of health care infrastructure and other reforms, with utility costs accounting for a smaller share in the total (see Table 2.3). However, essential inputs remain underfunded and are still crowded out by maintenance and utility expenditures. The high share of utilities in the budget is largely due to energy inefficient buildings and the inability to turn off utility supply in portions of the premises.

Table 2.3: Distribution of Health Sector Expendituresa by Spending Category (Percent of Total)

1996 1997 1998 1999 2000 2001

Salaries and benefits 31 37 40 43 47 42 Food 9 9 10 9 6 6 Drugs 12 14 11 11 12 18 Equipment 3 2 4 3 4 3 Supplies 1 1 1 1 2 2 Repairs 2 2 2 1 2 2 Other, incl. utilities 43 34 33 31 27 27 Total 100 100 100 100 100 100

a Similar to Table 2.2, total covers health expenditures of state and local budgets but does not include expenditures of extra-budgetary funds as well as extra-budgetary resources of health institutions financed from the state budget.

Source: Ministry of Finance. 2.17 In 2000, salaries and social benefits accounted for about 47 percent of total health care expenditures. Salary levels are extremely low. Public sector wages in health are substantially below the relative levels observed in many other countries. Moreover, salaries are not always paid on time: nearly half of health sector arrears in 2000 were for wages and benefits. The extremely low level of salaries does not provide adequate incentives to doctors to provide quality care and has led to high levels of turnover in medical personnel (many of whom have left the country). There are very few trained managers in the sector capable of securing improvements in efficiency, quality and satisfaction.

2.18 Poor Quality of Health Services. There is a widespread perception on the part of service users that the quality of health services has deteriorated severely over recent years. Surveys conducted by the Ministry of Health in 2001 in relation to establishing a baseline for the monitoring and evaluation framework found that over 80 percent of those surveyed felt that quality is a major problem in the health sector.

2.19 Inequities in Access to Health Services. Significant inequities in access to healthcare services have emerged. The introduction of official fees for services at public institutions together with informal payments have put the price of medical care beyond the means of many Moldovans. Analysis of household budget survey data indicates that the poorest 20 percent of the population is 70 percent less likely to receive

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ambulatory care and 33 percent less likely to receive hospital services, relative to the national average.

2.20 High out-of-pocket costs at the point of service given the mix of formal and informal payments required for the service to be provided are one factor that limits the poor’s access to health care. Results from the UNICEF household survey conducted in 2001 found that the out-of-pocket cost of hospital care can be as much as three times the average monthly wage. Nearly 50 percent of the people that require hospital services finance the out-of-pocket payment by selling assets or incurring debt. The same survey also showed that nearly 30 percent of the population requiring medical care over the previous six month period was unable to receive the required services due to the prohibitively high cost of such services.

2.21 Poor Health Outcomes. While there is some evidence that the health status of Moldovans has improved in some ways since the mid-1990s28, health outcomes remain very poor in Moldova compared to those achieved in other European countries. The table below compares key indicators from Moldova with European, CEE and Commonwealth of Independent States (CIS) country averages. In most cases, the outcomes for Moldova are at least 50 percent worse than the European average. Compared to other CIS countries, Moldova lags behind in all but life expectancy, infant mortality, and maternal mortality. Moldova has the second highest incidence of breast and colon cancer of all European and CIS countries. Moldova also has the highest mortality rate related to digestive diseases of any CIS county and the second highest rate of standardized mortality due to strokes.

Table 2.4: Health Status Comparisons

Indicator Moldova (2000)

CEE (1997)

CIS (1997/98)

Europe (1998)

Life Expectancy 67.4a 71.5 65.7 73.6 Male 63.7a n.a. 61.6 69.6 Female 71.0a n.a. 69.7 77.6 Infant Mortality per 1,000 Live Births 18.3 13.8 18.9 11.1 Maternal Mortality 27.1 14.8 39.8 19.0 Standardized Mortality Rate, All Causesb 1132.8 1117 1008.6 961 Standardized Mortality Rate, Cardiovascularb 632.0 n.a. 502.3 476 Standardized Mortality Rate, Digestive Tractb 103.4 50 45.8 38.0 Incidence of Tuberculosis per 100,000 60.9 n.a. 76.6 40.4 Incidence of AIDs per 100,000 0.07 n.a. n.a. 1.4a

a 1999. b Standardized mortality rate per 100,000 population. Source: Cercone, James. 2002. Moldova: The Health Sector in Transition. Draft.

2.22 High Levels of Arrears. The sector continues to be burdened by arrears that totaled 36 percent of the actual consolidated budget spending at the end of 2001, and 28 Life expectancy reportedly increased from 65.9 years in 1995 to 67.4 years in 2000. Maternal mortality was reduced from 50 deaths in 1995 to 27 deaths per 100,000 in 2000. Infant mortality also posted improvements, declining from 22 deaths per 1,000 live births in 1994 to 18 deaths in 1999.

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almost half of the local health budgets spending in the same year.29 These high levels of arrears are a clear indication that the existing oversized infrastructure and human resource base of the sector cannot be financed within available resources and that managers of health services do not apply financial discipline to live within the approved budget.

The Road Ahead

2.23 Moldova has begun to make progress in consolidating the health sector and in shifting from an overly hospital-based system to a more balanced and integrated health system through the strengthening of the primary care network. The Government clearly faces considerable challenges in completing its reform agenda for the health sector. In addition to the cross-cutting institutional constraints, the extremely tight fiscal constraints, growing inequalities in access to care and declining health service quality, and poor health outcomes all present a significant challenge. Most critically, addressing the existing budget management and institutional weaknesses will be crucial for successfully completing the reform process and ensuring access to good quality basic health services for all Moldovans. The required cross-cutting institutional and public expenditure management reform agenda is set out in detail in Chapters 3 and 4. This section presents recommendations for accompanying short- and medium-term sector-specific actions. Priority sector-specific objectives appear to be to strengthen equity in access to basic health care services; rebalance intra-sectoral health expenditures further in favor of primary health care and emergency services; rebuild human resource capacity within the health sector; and increase external accountability.

2.24 Short-Term Actions. The Government should consider accelerating moves to implement a basic package of care with universal access for all. This is estimated to cost US$2.5-3 per person per year and would imply an annual expenditure of roughly $10 million. However, a detailed costed implementation plan for introduction of the defined basic health care services package should be prepared as a short-term action. The basic package of care would guarantee access to services, drugs, and laboratory and support services.

2.25 A time bound hospital restructuring plan to continue progress on the elimination of excess capacity at the Republican hospitals and the Chisinau Municipality hospitals should also be developed and formally approved by the Government. Hospital restructuring should focus on creating Centers of Excellence which would consolidate existing hospital departments, equipment and knowledge to facilitate the further consolidation of the republic and municipal hospital network. The hospital restructuring would also address the large number of patients from the country’s judets that are treated unnecessarily at the republican health facilities30 by strengthening the capacity of lower level facilities and shaping the Centers of Excellence into facilities that deal with the

29 At the end of 2001, local budgets’ arrears amounted to 44 percent of their 2001 actual expenditures on health care. Local governments differ greatly in the extent of their arrears in the health sector. 30 Estimated by the Ministry of Health at about 40,000 patients annually from Judets and 20,000 patients from the Chisinau municipality.

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cases of highest cost and complexity. Efforts should be accelerated to liquidate non-productive assets such as land and buildings that are no longer in use as a result of the consolidation in the sector. Consideration could be given to providing incentives to the Ministry of Health and to local authorities to continue downsizing. Target allocations for intra-sectoral expenditures for primary healthcare and emergency services could also be explicitly defined; and increased allocations for these areas provided for initially within the 2004 budget.

2.26 Moves to rebuild human resource capacity within the sector could be based on firstly, completing an inventory of existing staff levels by type of staff (doctors, other professionals, nurses and ancillary); type of health care institution; and location; and secondly, completing an assessment of short- and medium-term staffing needs also by type of staff; type of health care institution; and location. In the context of the Government’s overall Public Sector Reform Program, a Health Sector Human Resource Restructuring Plan could also then be developed. This would cover: redeployment of existing staff; retraining and subsequent redeployment of existing staff; identification of any required redundancies; a management training and development strategy and a strategy for training of professional staff; and training for Ministry of Health staff in policy analysis and development and in monitoring and evaluation. This could also include a pay reform strategy for areas of recruitment and retention difficulty, designed to provide incentives to stem the loss of professionals particularly in the primary health care sector. The plan could also make provision for the development over the medium term of a performance-based management framework, including performance indicators.

2.27 Efforts could also be considered to strengthen the accountability framework. External accountability could be strengthened initially through the development and introduction of community-based boards for primary health care services in a number of pilot locations.

2.28 Medium-Term Actions. The development of the MTEF and of the Health Sector Human Resource Restructuring Plan will be critical to providing a route-map forward and to generating the basis for building consensus around continuing the medium-term reforms. These should focus on implementation of the Human Resource Restructuring Plan, including achieving staff reductions and redeployment, introducing required changes in medical education, and introducing performance based incentives and training. Once efforts to strengthen the primary care and emergency services have been developed, implementation of the Hospital Restructuring Plan should be completed to remove excess capacity in the Republican and Chisinau municipal hospitals. In addition, excess infrastructure should be liquidated and resources should be used instead to strengthen the delivery network. The planned introduction of health insurance31 offers an opportunity to introduce significant further changes in the sector through introducing selective contracting, accreditation of providers, and innovative payment mechanisms and evaluation. Based on international experience with health insurance, however, it is not recommended to introduce health insurance until key questions on coverage, financial 31 In the spring of 2002, the Government officially announced an intenion to introduce mandatory health insurance from January 2003. Later in the year, after considerable debates in the Government and Parliament, the introduction of health insurance was postponed till mid-2003.

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mechanisms and administrative arrangements are clearly answered. In this context, the Ministry of Health’s plan to introduce health insurance in 2003 is seen as quite ambitious.

2.29 The target intra-sectoral allocations for primary health care and emergency services should be capable of being achieved over the medium term. Finally, extensive implementation of community participation in governance to strengthen the external accountability of the health care system should be achieved. A further possible step in this direction would be to provide information to local communities and to health care service users on the comparative performance of community-level primary health care services.

B. THE EDUCATION SECTOR32

2.30 Moldova entered its transition with nearly universal adult literacy and with high participation and completion rates at all levels of education. The country spent a relatively high share of GDP on education expenditures (9.7 percent in 1997) compared with the CIS average. However, even prior to the regional financial crisis, the education sector was characterized by a number of allocative inefficiencies. Moldova spent less of its education budget on basic education (primary and academic secondary) relative to OECD countries and more on pre-school education. It also spent much more on utilities—20 percent of all education expenditures in 1997 went to heating alone—and very little (less than 1 percent) on textbooks, teaching materials and staff training. The ratio of non-teaching staff to teaching staff was comparatively high.


2.31 Fiscal retrenchment resulted in a significant reduction in public spending on the education sector. Public sector financing for education declined by more than 52 percent in real terms from 1997 to 2000 and recovered only slightly to about 55 percent of the 1997 level in real terms in 2001. In 2001, public sector education expenditures were 5.4 percent of GDP and about 18 percent of total government spending. While overall spending on education as a share of GDP is still on a par with the average of CIS countries, and is indeed more in line with expenditures in high income countries than low or middle income ones,33 significant issues relating to the underfunding of primary and basic secondary education persists.

2.32 Adjustments in the education sector in response to the reduction in overall resources have not so far reflected the Government’s priorities for the sector. Further, education sector arrears rose from 1997 through 1999, both in absolute terms and as a share of total actual education expenditures. The measures undertaken by the Government in response to the regional financial crisis included attempts to reduce the state’s involvement in education financing, moves to shift intra-sectoral financing 32 The discussion in this section draws heavily from Berryman, Sue, Peleah, Mikle and Tibi, Claude. 2001. Moldova’s Education Sector: A Financing Strategy to Leverage System-Wide Improvement. Draft. 33 The average of high income countries in recent years is 4.8 percent, for middle income countries it is 3.5 percent, and for low income countries it is 2.9 percent. (Source: Alam, Asad and Sundberg, Mark. 2001. A Decade of Fiscal Transition, The World Bank. Washington, D.C.)

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priorities, and ad hoc efforts to reduce the high levels of expenditure on heating utilities in schools.

2.33 Reducing the Scope for State Financing. Private schools and universities were officially allowed. All kinds of informal contributions by parents and students to support school budgets were encouraged. The so-called “contract” practice was introduced for public universities, under which a certain quota of places was made available to students who did not pass the qualifying test (but, however, did get marks above a certain threshold) and who could afford to pay for their studies. Universities were allowed to accumulate such fees for their own disposal in extra-budgetary funds.

2.34 Shifting Financing Priorities Toward Primary and Secondary Education. An attempt was made to begin to shift financing priorities in favor of primary and secondary education. Public financing of other levels of education was cut, with many pre-school institutions closed as a consequence.

2.35 Addressing High Utility Costs. The high utility costs (and the associated issue of the build-up of arrears) began to be addressed by changing the education year schedule and closing schools for the cold season.


2.36 The impact of the reforms so far pursued has, however, been that the quality of education has suffered, and inequities in access have increased.

2.37 Reallocation of Resources Toward Primary and Secondary Education. Between 1997 and 2000, resource constraints produced some changes in the intra-sectoral allocation of public education expenditures. (See Table 2.5.) The shares for pre-schools, vocational schools, colleges, and tertiary institutions declined. The drop was significant for pre-schools and tertiary institutions, where the shares fell respectively from 20.7 percent and 14.3 percent of public education expenditures in 1997 to 15.8 percent and 10.4 percent in 2000. The shares for all other levels and types of education increased. However, even with these changes, the shares for primary, general secondary, vocational secondary, and tertiary education remained very low relative to the average for OECD countries. For example, the share for primary and general secondary education was 50 percent in 2000 versus an average of 68.7 percent of public expenditures for these levels in OECD countries in 1997.34

34 Source: S. Berryman, M. Peleah and C.Tibi. 2001. Moldova’s Education Sector: A Financing Strategy to Leverage System-Wide Improvement. Draft.

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2.38 Reallocation of Resources Among Inputs. The economic composition of education expenditures has also undergone some change over the period (see Table 2.6). The share of salaries in total education outlays increased from 42 percent to 54 percent of the total between 1997 and 2000, primarily due to the growth in the share of teachers’ salaries from 21 to 32 percent. Despite this shift, in 2000, total spending on staff salaries remained very low relative to industrialized countries (usually around 60 to 70 percent—see Table 2.7) and developing countries (85 to 95 percent). Moreover, compared to the OECD average, Moldova spends a larger portion of salary expenditures on non-teaching staff salaries (41.6 percent in 2000).

2.39 The share of utility expenses declined between 1997 and 2000 (from 31 percent in 1997 to 16 percent in 2000), mainly due to the reduction in heating expenditures, which contracted from 20 percent to 7 percent of total education expenditures. Despite

Table 2.5. Distribution of Education Sector Expenditures a by Type of Institution (Percent of Total)

Level of Education/ Type of Institution

1997

1998

1999

2000

Pre-school 20.7 18.6 17.0 15.8 Primaryb 1.3 1.2 1.4 1.6 Secondary general 41.6 41.4 43.5 48.4 Secondary boarding 2.6 2.4 3.9 3.6 Boarding handicapped 2.2 2.0 2.9 2.9 Polyvalent schools 6.2 5.8 6.1 4.4 Professional schools 0.2 1.0 1.3 1.0 Collegesc 5.4 4.7 4.4 3.6 Universitiesc 8.2 8.8 7.3 6.4 Other tertiary institutions 1.1 0.7 0.4 0.4 Extra-curricular institutions 2.9 3.5 3.7 4.2 Others 7.2 9.3 6.9 6.1 Central administration 0.4 0.7 1.2 1.5 Total 100.0 100.0 100.0 100.0

a Total expenditures in this table include education expenditures of the state and local budgets but do not include expenditures of extra-budgetary funds as well as extra-budgetary resources of education institutions financed from the state budget. Analysis of the available data indicates that the share of expenditures going to primary and secondary education becomes even smaller, while the share of expenditures going to tertiary education larger if extra-budgetary funds and resources are included.

b “Primary” spending includes budget outlays on schools that only have grades 1 through 4. Expenditures on levels 1 through 4 in schools containing upper grades as well (1 through 9 or 1 through 11) are included under “secondary general.”

c Budget allocations for these institutions do not include resources allocated for tertiary institutions attached to ministries other than the Ministry of Education.


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these changes, utility and maintenance expenses continue to crowd out spending on salaries and essential inputs such as textbooks, teaching materials, equipment, and training.

Table 2.6: Distribution of Education Sector Expenditures by Spending Categorya

(Percent of Total)

Expenditure Item 1997 1998 1999 2000

Teacher salaries 20.9 27.5 29.3 31.6 Non-teaching staff salaries 21.4 25.9 24.4 22.6 Heating 20.4 12.6 11.7 6.8 Electricity 4.4 4.7 5.1 4.6 Water 5.8 6.1 3.8 4.6 Food 8.7 9.8 9.3 7.7 Scholarships 3.0 3.9 4.3 3.0 Textbooks, teaching materials & staff training 0.9 0.4 0.6 0.3 Repairs 4.1 4.0 3.9 5.5 Equipment 1.1 2.1 0.7 0.8 Others 9.3 3.1 6.9 12.4 Total 100.0 100.0 100.0 100.0

a As in Table 2.5 above, total includes state and local budget education expenditures but does not include expenditures of extra-budgetary funds and extra-budgetary resources of state budget institutions.


Table 2.7: Share of Salaries and Non-salary Operational Expenses in Recurrent Expenditures by Level of Education in OECD Countries, 1995 (Percent)

Primary and Secondary Tertiary

Teachers Salaries: OECD Countries Average Minimum Share Maximum Share

69 44 93

44 29 73

Non-teaching Staff Salaries: OECD Countries Average Minimum Share Maximum Share

13 12 27

22 15 40

Total Salaries: OECD Countries Average Minimum Share Maximum Share

82 56 97

69 45 84

Operational Expenses: OECD Countries Average Minimum Share Maximum Share

18 11 44

31 16 55

Source: S. Berryman, M. Peleah and C. Tibi. 2001. Moldova’s Education Sector: A Financing Strategy to Leverage System-Wide Improvement. Draft.

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2.40 Deteriorating Quantity and Quality of Education Services. The quantity and quality of education services has deteriorated over the transition. Measured by enrollment rates, Moldova is building less human capital now than at the beginning of the transition. Excluding pre-school, by 1999/2000, the years of education that the average five-year-old child could expect to complete had declined by almost three years relative to 1990/1991, giving him or her four fewer years of education compared to an average five-year-old child in OECD countries. Most of the decline in enrollment rates occurred prior to the fiscal crisis, with the exception of pre-school enrollments, which continued to drop after 1997.

2.41 The reforms have led to an adverse impact on the amount of instructional time which students receive. Instructional time per year has decreased through formal decree and through informal closures of schools that lacked heat during winter months. While the number of subjects remained the same, the number of weekly lessons (and therefore instructional hours per subject) was reduced. In 2000, Moldova’s instructional time was 92 percent of the average for OECD countries and Ukraine for lower secondary education and only 71 percent of the average instructional time for the same countries for primary education.

2.42 While there is as yet not much statistical evidence of the impact of the fiscal crisis on learning outcomes, results are available from the 1999 Third International Mathematics and Science Study (TIMSS) for eighth graders, in which Moldova participated together with 37 other countries. Moldovan students did not perform well on that test, both compared to OECD countries and 10 other transition economies, with scores in mathematics and science significantly below the average scores of their 8th grade counterparts in all participating countries, all OECD countries, and all other ECA countries.

2.43 Inequities in Access to Education. Access to educational services has become more inequitable. The growing formal and informal private costs for education in combination with increasing poverty levels have acted to limit access to education for the poor. Since real salaries have dropped significantly and key inputs are underfunded, school heads and teachers are now requiring admission fees in most urban schools and various informal and unrecorded contributions. These include payments for heating, maintenance and repairs of premises, extra-curricular activities, and “gifts” for teachers. To compensate for low salaries, an unknown number of teachers “encourage” parents to pay for private tutoring, transactions that increase the opportunities for corruption.

2.44 An analysis of household budget survey data for 199935 found that enrollments at the pre-school and primary school level are not yet affected by family income levels, and enrollment at the lower secondary level is only modestly affected. However, children from the wealthiest quintile are now almost 60 percent more likely to be enrolled in upper secondary education and 350 percent more likely to be enrolled in higher education than children from the poorest quintile. There is also a rural-urban divide. Urban children have

35 Analysis was undertaken on the basis of 1999 data and served as an input to Moldova’s Education Sector: A Financing Strategy to Leverage System-Wide Improvement. 2001. Draft.

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a significant participation advantage at the upper secondary level and especially in tertiary education, where urban youth are seven times more likely to be enrolled than rural youth.

2.45 Benefit incidence analysis based on the 1999 household budget survey data indicates that cumulative public expenditures in education per child are biased toward children from non-poor families and toward children in urban families, mainly due to differences in enrollment rates at the upper secondary and tertiary levels. Major differences in per child subsidies by consumption quintile and residential location were found at those levels of education.36

2.46 Higher education financing appears to be particularly unfair. Competition for entrance into university has encouraged unofficial payments at the secondary and tertiary levels that poor families cannot afford. Pernicious bribery practices are common for entrance to universities,37 and have the effect of excluding intellectually capable youth from poor families. This also undercuts merit as a basis for admission.

2.47 Arrears. At the end of 2001, accumulated arrears were still 34 percent of total education expenditures, having reached a peak of 70 percent at the end of 1999. Arrears are concentrated in the salary, heating, electricity, water, and to a limited extent, food budget lines. In some communities, teachers and non-teaching staff may be unpaid for five to six months.

2.48 Underfunding. While items such as heating and utilities are underfunded, others such as textbooks, teaching materials, and staff in-service training are virtually ignored. The present very low level of investments in maintenance of premises and equipment is also not sustainable.

The Road Ahead

2.49 Both sector-specific structural reforms and cross-cutting institutional reforms are urgently needed in the sector to prevent a further deterioration in the quality of education and a worsening in the inequality in access. Analysis undertaken with the use of the Education Strategic Model38 shows that restructuring and consolidation of the sector is an important prerequisite for improving both outcomes and equity in Moldova’s education system. The timing and sequencing of reforms must take into account the limited

36 Benefit incidence analysis was undertaken as an input to the same paper. The cumulative per child subsidy represents the benefits received by a child during the whole duration of his/her studies from primary through university. The analysis found that the cumulative per child subsidy for children in the richest 20 percent of the population was 30 percent higher than that for the poorest 20 percent. Urban-rural differences were also found: the per child subsidy for the poorest 20 percent in urban areas was 27 percent above that for the poorest 20 percent in rural areas. 37 Moldova’s Education Sector: A Financing Strategy to Leverage System-Wide Improvement gives examples of such practices. A website popular with Moldovan students gives the price list for passing the test for university entrance for some universities, the price varying from US$50 to US$500. A survey by the Center for Transparency and Democracy in 2001 sampled first and second year students in eight colleges and universities. Sixty-two percent said that they had given bribes in connection with the baccalaureate examination and at the university level. 38 See Moldova’s Education Sector: A Financing Strategy to Leverage System-Wide Improvement for a detailed discussion of the model and scenarios.

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resources available and the weak institutional capacity in the sector at all levels. The required cross-cutting institutional and budget management reforms are set out in detail in Chapters 3 and 4. This section suggests short- and medium-term sector-specific actions which the Government of Moldova could take to improve the efficiency, equity, and fiscal sustainability of its educational system.

2.50 Short-Term Actions. Priority sector-specific objectives appear to be to strengthen equity in access to primary and basic secondary education and to higher education; to rebalance intra-sectoral expenditures further in favor of primary and basic secondary education; to rebuild human resource capacity within the education sector; and to increase external accountability.

2.51 In pursuit of the first objective of strengthening equity in access to primary and basic secondary education and to higher education, short-term measures suggested for consideration by the government include explicitly defining target enrolment ratios, completion rates and attendance rates to be achieved in the medium-term overall, for children from low income families, and for children from rural areas; and completing a study on the levels of formal and informal payments made to secure access to higher education overall, for students from low income families, and for students from rural areas. The Government would then be in a position to develop and approve an Education Reform Strategy deigned to address the inequities in the system.

2.52 As concerns the objective of rebalancing intra-sectoral education expenditures further in favor of primary and basic secondary education, the priority short-term measure suggested for consideration by the Government would be to define target allocations for expenditures in these areas to be achieved over the medium term.

2.53 As suggested above, in the case of the health sector meeting the objective of rebuilding human resource capacity within the education sector could perhaps initially best be pursued through completing an inventory of existing staff levels by type of staff (teaching and support); type of educational institution; location; and, for teachers, by subject taught; and a parallel assessment also made of short- and medium-term staffing needs by type of staff; type of educational institution; location; and, again for teachers, by subject taught (and including allowing for the medium-term effects of falling school rolls).

2.54 With respect to the objective of increasing external accountability, a possible short-term measure suggested for consideration by the government is to develop proposals for strengthening parental and community involvement in decision-making relating to primary and secondary education in their local area.

2.55 Medium-Term Actions. Implementation of the approved Education Reform Strategy could be pursued as an objective for the medium term, with appropriate progress being made to meet the target enrolment ratios, completion rates and attendance rates defined for primary and basic secondary education; and to secure satisfactory access of students from low income families and from rural areas to higher education. Similarly, the objective for the medium term of rebalancing intra-sectoral allocations would simply

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be for the target allocations identified for primary and basic secondary education to be achieved.

2.56 To increase equity, the Government should develop approaches to securing increased enrollments of students from poor families and in rural areas. Reforms of the financing of pre-tertiary and tertiary education should be designed to reduce the pressures on schools to levy informal payments. At the very least, informal payments should be made formal and public, and schools held accountable for their use. Universities could be encouraged to levy fees on all tertiary students at levels below those now paid just by “contract” students. However, such a reform would need to be coordinated with the development of mechanisms to assist students from poorer families to be able to pay the determined fees.

2.57 The main priority here would probably be to begin implementation of the school rationalization strategy. The Education Strategy Model, for example, indicates that sustainable reform scenarios require consolidation of 10 to 20 percent of schools, integration of 20 to 60 percent of pre-school children into general education schools, introduction of multigrade teaching in small schools to increase class sizes without diminishing quality, and reduction of energy costs by 20 percent (through measures such as introduction of metering, providing incentives to secure energy savings at the level of each educational institution, undertaking building modifications and introducing specific energy efficiency measures).

2.58 In the context of the Government’s overall Public Sector Reform Program, an Education Sector Human Resource Restructuring Plan could also be developed building on the staffing and needs assessments undertaken as short-term priority measures. This could cover: redeployment of existing staff; retraining and subsequent redeployment of existing staff; identification of any required redundancies; a management training and development strategy and a strategy for initial professional education and subsequent in-service training of teachers; and training for Ministry of Education staff in policy analysis and development and in monitoring and evaluation. A pay reform strategy for areas and subjects of particular recruitment and retention difficulty could also be developed.

2.59 With respect to increasing external accountability, a possible medium-term approach could be for information to be provided to local communities and to parents on the comparative performance of educational institutions both locally and nationally.

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C. THE SOCIAL PROTECTION SECTOR

2.60 Like all the FSU economies, Moldova inherited from the Soviet times an extremely costly, untargeted social protection system. Social protection expenditures in Moldova include pensions, non-pension social insurance benefits (unemployment, maternity, and sick leave benefits), energy subsidies and compensations, child allowances, and other social assistance and social services. Prior to the regional financial crisis in 1998, Moldova’s social protection system was already under severe strain, with arrears mounting in all parts of the system and most programs deteriorated to the state of bankruptcy.

2.61 The most immediate problems emerged in the pension system, demonstrated through the surge in social insurance contribution arrears, delays in pension payments, lack of funds for indexation of pensions, and growth in in-kind transactions. Poverty had also emerged as a major new phenomenon, and the deficiencies of the social protection system in coping with poverty were becoming clearer. 39 The severity of the fiscal crisis in the pension system and the energy sector had motivated the Government of Moldova to focus on designing restructuring strategies for the pension system and energy subsidies, but restructuring itself had not taken place by the time of the regional financial crisis.


2.62 Social protection expenditures decreased from 13.5 percent of GDP in 1997 to 8.3 percent by 2001, which represented a 40 percent reduction in real terms. The share of social protection spending in total public expenditures fluctuated between 27 and 29 percent over the same period. Within social protection, the share of pension expenditures declined from around 70 percent in 1996 to 60.5 percent in 1998, but had recovered to 67 percent by 2001 (see Table 2.8). At 6 percent of GDP, Moldova’s level of pension expenditures was similar to that of many countries in the region, but noticeably higher than that of other low income transition economies, such as Armenia, Azerbaijan, Georgia, and Tajikistan.40 Total non-pension expenditures increased because of the rationalization of energy subsidies and compensations, while all other types of non-pension spending, including child allowances, were reduced.

39 Poverty analysis was launched in Moldova in 1997, simultaneously with the introduction of the new household budget survey, and as part of the background analysis for the World Bank. 1999. Moldova Poverty Assessment. Washington. D.C. 40 In 1999, Armenia spent 3.8 percent of GDP on pensions; Azerbaijan, 4.2 percent; Georgia, 2.6 percent; and Tajikistan, 1.8 percent. [Source: World Bank and IMF. 2002. Poverty Reduction, Growth and Debt Sustainability in Low-Income CIS Countries.]

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2.63 The Government’s response to the regional financial crisis in the area of the social protection sector was fragmented and focused primarily on rationalization of social protection financing. There has been no overall strategic prioritization across the social protection area; nor any accompanying realignment of budget resources to reflect the main priorities of the Government’s work-program. Weaknesses in center of Government decision-making and in allocative efficiency in the budget formulation process meant that the required difficult prioritizations and trade-offs were not made. Pension system reform was given priority. Utility subsidies were the only other part of the system that underwent restructuring: these were replaced with targeted nominal compensations (under energy sector restructuring). Most of the other programs, including non-pension insurance (unemployment, maternity and sick leave benefits), non-energy related social assistance benefits, child allowances, social services and residential care remained unrestructured.

2.64 Pension Reform. Structural reform of the pay-as-you-go pension system was launched in January 1, 1999, after the passage of the new Law on State Social Insurance Pensions (October 1998). This laid a solid foundation for transforming the pension system into a sustainable pension insurance program. The structural changes introduced were medium to long term in nature. The main features of the new pension law include a new benefit formula that bases future pensions on individual contributions rather than on reported wages and years of service; the elimination of most early retirement privileges; a gradual increase in retirement age by five years for both men and women at a speed of six months per year; and a synchronized increase in the minimum required contribution record.

2.65 Rationalization of social protection financing was implemented through transferring all the non-insurance programs to the state budget and limiting spending from the State Social Insurance budget to pensions and other insurance programs. Concerted efforts were undertaken to clear pension arrears through various measures, including through the freezing of pension increases and the allocation of additional state budget funds in the most severe years to cover the pension fund deficit. Also, annual

Table 2.8: Social Protection Expenditure Trends (Percent of Total)

1996 1997 1998 1999 2000

Pensions 69.3 74.6 60.5 62.2 66.9 of which: general pensions 63.9 67.4 54.4 55.1 57.7 privileged pensions 5.4 7.1 6.1 7.1 9.2Energy subsidies and compensations 2.5 3.6 15.9 18.6 11.7Non-pension social insurance benefits 8.4 6.5 6.6 6.1 5.7Child allowances 3.3 2.9 2.9 2.5 2.4Other 16.5 12.5 14.0 10.6 13.2Total 100.0 100.0 100.0 100.0 100.0

Source: Ministry of Finance and National Social Insurance House.

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targets were used to gradually eliminate the previously widespread phenomenon of non-cash payments in the system.

2.66 Nominal Compensations. The surge in social assistance spending in recent years arose mainly out of the introduction of the “nominal compensations” program that replaced a broad range of unfunded utility privileges for numerous categories of individual energy consumers.41 The introduction of the program was dictated by the increase of energy tariffs to cost-recovery levels as part of energy sector restructuring implemented in stages during 1997-1999. On July 31, 2000, legislation was enacted to replace the unfunded privileges with limited benefit payments to assist the vulnerable categories of the population42 to pay for increased utility costs. Compensations range from 25 to 50 percent of the cost of the service. For most categories, compensations are set at 50 percent of the official norm of the corresponding type of utility expenditures, including heating, electricity, gas and other communal services.43 In 2001, compensations for heating accounted for the lion’s share (69 percent) of government expenditures on this program, and electricity amounted to 24 percent of the total.


2.67 Fiscal Balances Restored. Overall, the social protection reforms produced relatively good results with regard to restoring fiscal balances. As far as the pension system is concerned, while it is still too early to assess the full impact of the reforms, Government efforts did help to stabilize the system, transforming it into a relatively well-functioning system which now pays benefits in cash on a timely basis. Pension arrears, which equaled 4.5 months of pension payments in 1997-1999, were totally eliminated by April 1, 2001. Furthermore, the use of in-kind payments, which peaked at about half of all pension payments in 1998, ceased. However, the pension system still faces serious challenges.

2.68 Very Low Pensions. The level of pensions, however, remains very low and does not satisfy basic needs in old age. The percentage of pensioners receiving the minimum pension increased from 4.6 percent in 1997 to 11.4 percent in 2000. Even after a 50 percent increase over 2001,44 the average old age pension was around $11 per month last year, well below the national poverty line.45 This low benefit level discourages

41 Thirty-seven beneficiary categories were identified and documented in 1999. See, for example, the working note by Sandu, Maya. 1999. “Subsidies for Energy Consumption by the Population.” 42 At the moment, ten categories of the population are entitled to nominal compensations: five categories of disabled persons, participants of World War II (WWII) and individuals associated with them, families of deceased Chernobyl liquidators, single pensioners, and families with four or more children under age 18. 43 These include water supply, sewerage, elevator service, garbage removal, and general communal services. 44 At the end of 2000, with surpluses beginning to appear in the pension fund, pensions were raised by 16 percent in December 2000, by 34 percent in December 2001, and by another 17 percent from May 1, 2002. Those increases were undertaken through a complex and untransparent recalculation exercise, because the existing legislation lacks a clear and implementable indexation mechanism. 45 Even though Moldova does not have an official poverty line, the Department of Statistics of Moldova uses 50 percent of the official subsistence minimum as an absolute poverty line when calculating poverty indicators. In 2001, this averaged 235 lei per person per month ($18.30). In the same year, the average monthly pension was 140 lei.

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participation in the system and does not enable the pension system to meet its basic objective of providing a source of living in old age.

2.69 Pension Indexing Cancelled. The system does not provide pensioners with predictability in terms of maintaining the purchasing power of their modest pensions: indexing was canceled because of budgetary constraints. The replacement rate (the ratio of the average pension to the average wage) declined from 39.2 in 1997 to 21.3 in 2000 and was the third lowest in CIS countries.46

2.70 Pension Inequities Remain. The system remains inequitable. Although the elimination of most early retirement privileges was a positive development and went some way towards improving the pension system’s fairness and equity, important inequities remain and are, in fact, growing. While expenditures on pensions have been declining as a share of GDP, pensions for certain privileged groups have been increasing. Special pensions are in effect for eleven professional groups in the population, including the military, prosecutors, civil servants, Chernobyl liquidators, members of Government and Parliament, customs employees, and local elected officials. These pensions are considerably higher than those received by general pensioners; special pensions are received by only 2 percent of old-age pensioners but amount to about 14 percent of total pension expenditures.

2.71 Inequalities in contribution rates also still exist, as evidenced by preferential rates for the agricultural sector, the self-employed, and several other categories of contributors. The pension system is particularly biased in favor of agricultural workers, for whom the pension contribution rate has remained fixed at a very low level in nominal lei terms for the last five years.47 As a consequence, agricultural workers contribute less than 15 percent in revenue to the pension scheme, while their pensions amount to about a half of all old-age pension expenditures, and their minimum pensions are fixed at 85 percent of the general minimum.

2.72 Fiscal Sustainability of the pension system needs to be strengthened. While short-term financial stability of the pension system has been restored, the future affordability of the pension system will depend on how well the Government implements and further develops its initial reform strategy. In the long run, fiscal sustainability of the pension system will depend on the ratio of the eligible pensioner population to working contributors. Given the expected scenario of an increasingly aging population together with increases in longevity, Moldova’s pension system will be out of balance without increases in retirement ages and improvements in contribution collection.

2.73 The Government of Moldova deserves credit for taking on the task of rationalizing utility subsidies. The transparency of energy and housing subsidies was 46 According to Ministry of Labor calculations, Moldova’s replacement ratio was the third worst among the CIS countries, after Georgia and Armenia. (Source: Ministry of Labor and Social Protection of Moldova. 2002. 2001 Annual Social Report. Chisinau. ) 47 While the standard social insurance contribution rate is set as a percentage of the contributor’s wage, contributions for agricultural sector contributors are calculated by applying a fixed rate in lei to the factor measuring the size of the land plot and its quality as determined by the special point scale.

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greatly increased through linking them directly to the payment process; in many CIS countries, subsidies are still provided directly to utility companies and municipal housing authorities, thus subsidizing these enterprises without linkages to consumer families. Also, the processing of these funds through the banking system48 provides for much better monitoring of benefit users and the flow of funds for the compensations program relative to other cash benefit programs in Moldova.

2.74 The reduction of the number of privileges appears to have had a positive impact on the budget, although the full costs cannot yet be precisely evaluated. Nonetheless, it appears that while subsidies in 1999 represented 2.1 percent of GDP, they declined to 1.2 percent in 2000.

2.75 Targeting Issues. Given that most privileges have now been eliminated, the objective of housing and energy subsidies is ostensibly the provision of affordable heating and electricity to poorer or more vulnerable groups in the population. The current system narrowly meets these objectives. Certainly, it is generally agreed that the aged, disabled, and survivor families are among the most vulnerable. The question is the extent to which housing and energy subsidies are needed given limited resources and alternative uses for these funds. The World Bank’s 1999 Poverty Assessment for Moldova found that poverty was highest among the rural population, families with children, and the unemployed. Consequently, while energy subsidies do focus on vulnerable groups, they do not necessarily focus on the most needy.

2.76 On the other hand, the recipients of energy subsidies are now clearly specified, as are the amounts of benefits to be received. Thus, in terms of design, the benefits are likely to be going to eligible recipients. Further, the process appears to be transparent and the interactions between the NSIH, the Ministry of Finance and the Banca de Economii smooth. As such, this is perhaps the most efficient social program in Moldova, despite its targeting deficiencies. Moreover, given the extent of in-kind and informal income in Moldova, income-based targeting is likely to lead to substantial errors of inclusion, so some type of categorical targeting may remain necessary for some time.

The Road Ahead

2.77 This section suggests short- and long-term actions aimed at improving the social protection system’s efficiency and equity for the government’s consideration.

2.78 Short-Term Actions. The key objective in the area of pension reform appears to be to strengthen equity in, and the medium-term sustainability of, the pension system. Areas for improvement include strengthening the capacity for developing long-term financial projections to model the future development of the pension system. A transparent and affordable indexation rule for pensions should also to the extent possible be introduced in the main pension law. Consideration could be given to integration of privileges into the general pension law with gradual withdrawal of elements inconsistent with the general pension law. 48 These compensations are paid through Banca de Economii (Savings Bank), which invested in information technologies to establish a link with the NSIH information system.

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2.79 Social assistance and its targeting to the really needy is an area which requires urgent attention. The main objective here appears to be to improve the ability to target social assistance to the most vulnerable and needy groups. In the short term, available household budget survey data need to be improved and used more efficiently to develop an analytical basis for improved targeting of social assistance benefits. As a first practical step, child allowances should be prioritized for restructuring.49 One of the sources to improve financing of the program once it is restructured could be through reducing the costs of the nominal compensations program over time.

2.80 The transitional nature of the nominal compensations program has to be recognized, and the Government needs to develop a strategy aimed at ensuring its costs are kept under control. The present categorical targeting of nominal compensations should be reviewed to ensure that these benefits are indeed targeted to the most vulnerable groups. As some benefits are extremely low, these could perhaps be removed relatively painlessly, e.g., compensations for non-energy communal services: these subsidies are relatively small, ranging from 1 lei per month to 18 lei per month, and yet their administrative costs are comparatively high.

2.81 The State Social Insurance budget preparation process could perhaps also appropriately be strengthened, and would benefit from being integrated in the overall sectoral budget as well as the government budget. A revenue projections model based on the existing extensive information base of the Tax Inspectorate and National Social Insurance House could be developed and introduced.

2.82 Medium-Term Actions. A comprehensive and financially sustainable strategy of reforming the social protection system needs to be developed in the medium term, taking into consideration the interlinkages between various social protection programs and prioritizing those that are most efficient for poverty alleviation. This will require significant enhancement of analytical capacity in both the Ministry of Labor and Social Protection and the National Social Insurance House. It will also require the establishment of effective mechanisms for cross-agency coordination on social protection issues.

2.83 The key action suggested in the area of pension reform for the medium term is for professional groups to be reintegrated into the general pension system and for the size of their benefits to be reduced to more equitable levels, with clear and justified eligibility criteria. Recent surpluses resulting from economic growth have been used to increase pension payments and to increase average replacement rates. However, it could be more appropriate to allocate surpluses first to fund three months of payments in a reserve fund for contingencies, as is international practice. Such reserves should be invested in low-risk assets, as established under the basic social insurance law. The regulatory framework for such investments would also need to be developed. In the longer run, given economic growth, the Government of Moldova might also wish to consider the development of a

49 The Government has reached an agreement with the EU on the progam including, among other components, the support of the budget financing of child benefits in 2002-2003 through the EU Food Security Program grants. The program envisages restructuring of child benefits and strengthening their administration.

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funded pillar for the public pension system to help ease the burden of public pensions on the pension fund and consolidated government budget.

2.84 With respect to social assistance, in the medium term, the government might wish to consider amending the current legislation to reduce nominal compensations, remove non-poor groups from program coverage, and/or place clear sunset provisions on some current entitlements. One option to keep costs down would be to reduce the subsidy amount over time for categories of recipients currently receiving 50 percent subsidies down to 25 percent. Based on 2001 figures, such a reduction combined with the removal of subsidies for communal services would have reduced program costs by 15 percent. The rationale behind a phased-out reduction of this type is that with continued economic growth, over time most families should be able to afford to pay for full-cost heating charges. An even more effective strategy, however, would be to remove all the beneficiary groups that are not vulnerable, including disability categories II and III and veterans not serving in WWII. With the exclusion of these groups from the program and the elimination of subsidies for communal services, expenditures on the nominal compensation program would have been 41 percent lower in 2001. If, in addition, all benefits had been paid at a 25 percent rate, expenditures would have been 56 percent lower.

D. SUMMARY

2.85 While the reform efforts precipitated by the regional financial crisis had some positive effects, overall the fiscal adjustment has had negative consequences on service quality and on equity and access to services in the social sectors. Deficiencies in strategic prioritization, budget management and processes and in public administration contributed to the poor quality of the fiscal adjustment. These weaknesses also present serious obstacles to completing the necessary remaining structural reforms in health, education, and social protection. They also hinder the government’s ability to achieve its key goals, including reducing poverty and improving access to good quality basic social services and social protection for those in need. In this context, Chapter 3 discusses specific institutional and process-related reforms for improving public expenditure management in Moldova. Chapter 4 addresses issues of center of government decision-making and civil service management and human resource management and suggests a reform agenda to establish an efficient and effective system of Government decision-making, and a merit-based, de-politicized, corruption-resistant public administration.

3. STRENGTHENING PUBLIC EXPENDITURE MANAGEMENT

3.1 Effective implementation of the Government’s work program and priorities needs to be based not only on appropriate macroeconomic policies and sectoral structural reforms, but also on well-functioning institutions and on a trained and capable public administration able to formulate and implement policies and programs in line with the Government’s strategic priorities. Nowhere is this more important than in the planning and management of public expenditures. Rules, procedures, and organizational arrangements which govern the budget process and shape the incentives that influence the size, allocation, and use of budgetary resources need to be in place and be able to deliver a high degree of fiscal discipline, strategic prioritization, and efficiency in the management of public resources.

3.2 Most of the reforms pursued by the government to date have focused on the preparation and implementation of the budget. Key reforms include the adoption of a new organic Law on Budget System and Budget Process in 1996, the introduction of a new budget classification system (conforming to GFS standards) in 1997 to strengthen the targeting and monitoring of public expenditures, the establishment of a central treasury system (launched in 1997), and the adoption of a Law on Local Public Finance (1999). The Government has also recently committed to introduce a medium- term expenditure framework (MTEF). In 2000 the Ministry of Finance introduced the MTEF concept for planning and formulating the 2001 budget and prepared a medium- term macro-fiscal framework. This was updated during formulation of the 2002 budget. In 2002, an MTEF for 2003-2005 was for the first time officially approved by the Government. Program budgeting is also being introduced on a pilot basis in three program areas. Taken together, these represent a significant set of reforms and provide a strong basis on which to build for the future. The Ministry of Finance deserves credit for having been able to implement such a set of reforms in a consistently difficult fiscal context.

3.3 This chapter provides: (i) an assessment of budget management performance; (ii) a description and assessment of the existing budget management framework and budget process; and (iii) specific recommendations for consideration by the government for improving the system of public expenditure management. The discussion in this chapter focuses on the central government budget. It should, of course, not be forgotten that a large share of social sector spending (in health, education, social security) is implemented at the level of local governments.

3.4 The assessment of the effectiveness of Moldova’s budgetary system is undertaken at three levels: (i) achievement of aggregate fiscal discipline; (ii) strategic prioritization in budget formulation; and (iii) delivering cost effectiveness in specific expenditure

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programs. Examples from the social sectors, particularly education and health, are used to build further on the analysis set out in Chapter 2.

3.5 Based on this assessment and the review of the budget system and process that follows, recommendations are made concerning suggested priority actions designed to support the achievement of a strengthened public expenditure management system. These recommendations include: strengthening strategic prioritization and allocative efficiency in budget formulation; strengthening aggregate fiscal discipline through improving comprehensiveness of budget coverage; improving fiscal reporting and budget transparency; strengthening the internal and external accountability framework; enhancing the quality of macroeconomic forecasting; strengthening budget preparation; and strengthening budget execution. Completion of the implementation of a strategic approach to expenditure planning in the context of a medium-term expenditure framework is the unifying conceptual approach to achieving the specific recommendations identified.

A. BUDGET MANAGEMENT PERFORMANCE

3.6 This section assesses Moldova’s budget management performance along three dimensions: aggregate fiscal discipline, allocative efficiency, and technical efficiency. While good progress has been made in achieving and maintaining aggregate fiscal discipline, there is a concern that institutional arrangements are not yet robust enough to sustain this. At the other two levels, there appear to be particular issues relating to the government’s ability to allocate resources based on strategic priorities and to ensure that public spending is efficient and cost-effective.

Aggregate Fiscal Discipline

3.7 While impressive progress has been made in strengthening aggregate fiscal discipline since the 1998 regional financial crisis, recent fiscal outcomes provide grounds to question the quality and sustainability of the discipline achieved. As shown in Chapter 1, while the cash deficit of the general government budget has been virtually eliminated (a cash surplus was registered in 2001), the sustainability of the downward trend in commitment deficits is under question, as evidenced by the growth in consolidated state and local budget arrears by 81 million lei by the end of 2001.

3.8 Analysis of divergences between the budget as approved (and amended) and as executed also calls into question the sustainability of the improvements (Table 3.1). Over the years, actual budget outcomes have deviated substantially from the approved budgets without any apparent clear pattern. The noticeable reduction in deviations between the approved and executed budget achieved in 2000 was not sustained in 2001.

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Table 3.1: Consolidated Budgeta

Deviation between Approvedb and Executed Budgets (in Percent of Approved Amounts)

1997 1998 1999 2000 2001

Total Revenuesc 13.6 -5.4 4.3 1.6 -9.0 of which : Tax Revenues 8.7 -9.1 -2.2 3.6 -11.5 Total Expenditures 10.9 -4.8 -6.1 -2.0 -10.7 of which: State Security and General Services 5.6 0.7 14.9 1.6 -7.1 Education 12.4 -13.8 -15.0 -4.4 -9.6 Health -1.6 -24.4 -19.3 -4.7 -15.5 Social Protection -0.9 -26.5 -18.4 3.1 -21.8 Economic Expenditures 7.5 20.3 -2.1 2.5 -13.4 Deficit 3.5 -0.9 -47.2 -32.7 -53.3

a Government definition of “consolidated budget”, refers to the state budget plus local budgets. b “Approved” stands for the latest version of approved budget (reflecting amendments during the year). c Including grants and excluding privatization proceeds Source: Ministry of Finance. 3.9 An important feature of Moldova’s fiscal adjustment to date which might have important implications for its sustainability is that it was to a significant extent induced by external restraints. As discussed in Chapter 1, the Government had no option but to enforce aggregate fiscal discipline starting from 1998 given the difficulty in accessing external resources in the wake of the 1998 regional financial crisis. This led also to increased dependence on the IMF program and on World Bank adjustment lending (in 1999-2001, 75 percent of total external inflows for budget financing were provided by World Bank adjustment lending). The need under these programs to meet specified quantitative performance criteria related to fiscal performance was a key factor in enabling the Ministry of Finance to exercise strict control on government spending.

Allocative Efficiency

3.10 The way that resources are allocated between and within sectors and expenditure categories does not facilitate the implementation of the Government’s strategic priorities. As discussed in Chapter 2, given weaknesses in strategic prioritization, recent expenditure cuts in the social sectors led to reduced access to basic social services, particularly for the poor. Survey results indicate that a significant part of the population requiring medical care is now unable to receive the required services due to their prohibitively high cost. The increasing formal and informal private costs for education have acted to limit access to education for poor children. Higher education financing appears to be particularly inequitable.

3.11 A key question is to what extent the Government is able to protect expenditure allocations to priority sectors such as the social sectors when it is forced to reduce overall expenditures. As seen in Chapter 1, when faced with resource cuts, the Government

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reduced expenditures more or less across the board; social sector expenditures were not afforded any particular protection. The share of social sector spending (of drastically reduced total expenditures) remained virtually unchanged at 64 percent of total discretionary expenditures (excluding interest payments) between 1998 and 2001. At the same time, the share of expenditures on state security and general services in total discretionary expenditures increased, for example, from 13 percent to above 17.5 percent.

Technical Efficiency

3.12 Technical efficiency refers to the capacity of line ministries and agencies to use allocated resources in the most cost-effective way so as to ensure the efficient delivery of public goods and services. As seen in Chapter 2, Moldova’s performance on health and education indicators compares poorly with other transition economies. At the same time, Moldova spends as much or more on health and education as a share of GDP compared to similar countries. Between 1997 and 1999, public expenditures on education averaged 6.7 percent, much higher than the 4.6 percent average for CIS and CEE countries. Even after substantial cuts, the share remained at 5.4 percent in 2001. In the case of health, Moldova’s average level of expenditures as a percent of GDP between 1997 and 1999 was about 4 percent, which is slightly higher than the 3.6 percent average among CIS countries (and considerably higher than the 1.2 percent average among low-income countries and the 2.5 percent average among middle-income countries.) As was the case with respect to education spending, Moldova’s expenditures on health remained relatively high even after the fiscal adjustment, equaling 3 percent of GDP during 2001.

3.13 This combination of relatively poor outcome indicators with comparatively high levels of spending suggests weaknesses in strategic prioritization and inefficiencies in program delivery. The IMF undertook an analysis of the efficiency of social spending in Moldova using a non-parametric method called Free Disposal Hull analysis. This found that Moldova’s performance in the public provision of social services compares unfavorably with other transition economies for a wide range of standard health care and education indicators. 50

3.14 Two widely used indicators of management efficiency in the health sector are the turnover rate of patients in hospitals and occupancy rates. Moldova’s efficiency with respect to turnover rates is between 50 and 70 percent lower than for comparator countries, while the average occupancy rate of 68 percent in hospitals is still about 20 percent below the rate achieved in comparator countries. Inefficiency in the health sector is characterized by excessive capacity in health services infrastructure. It is also evidenced by high utility bills that crowd out spending on drugs and other essential medical supplies.

3.15 In the education sector, while class size (number of students per class) and school size (number of students per school) appear unexceptionable, inefficiencies are reflected in the high bills for heating, an excessive number of non-teaching staff, and low external efficiency of professional/polyvalent schools and vocational colleges. This inefficiency

50 Source: IMF. 2001. “The Efficiency of Social Spending In Moldova: Recent Economic Developments”..

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affects learning outcomes: teachers’ salaries, learning materials, laboratory facilities, and in-service training for teachers are underfunded.

B. THE LEGISLATIVE AND INSTITUTIONAL FRAMEWORK

3.16 This section provides an overview of the legislative framework and institutional arrangements that underpin Moldova’s budget system and processes. It first discusses the key legislation that underpins budget management in Moldova. Budget coverage is then examined from the point of view of comprehensiveness and fragmentation. Finally, the section identifies the various budget process participants, describes their respective roles, and highlights aspects of these institutional arrangements that either support or hinder effective budget management.

The Legislative Framework

3.17 The present legal framework for the budget system and budget process is reasonably recent. The most important elements of the framework are two organic budget laws, namely the Law on Budget System and Budget Process approved in 1996, and the Law on Local Public Finance approved in 1999. These two laws provide the general procedural rules for the preparation of annual budgets for the central and local governments. The Law on Budget System and Budget Process sets out the objectives of the budget, its composition, the division of responsibilities among government agencies, the associated budget procedures, and the timetable for budget preparation. The Law on Local Public Finance sets out the budget process for local governments, establishes revenue and expenditure assignments for local governments, and mechanisms for inter-governmental resource transfers and borrowings.

3.18 Other relevant laws include the Law on State Debt and State Guarantees (1996), which establishes a ceiling on public debt and a constraint on government guaranteed loans and provides procedures and guidelines for issuing state guarantees. The Tax Code (1997-2001) establishes tax rates and tax bases. Import tariffs have been fixed in a separate organic law since 2000. The Law on State Social Insurance (1999) defines the scope and coverage of the state social insurance budget. Gradual implementation of the above legislation has introduced more stability and transparency into the system.

Budget Coverage

3.19 The general government budget is still fragmented and appears to be insufficiently comprehensive in its coverage. This presents an important obstacle to improving aggregate fiscal discipline and allocative efficiency. Under the Budget System and Budget Process Law, Moldova’s budget system includes the central government budget (state budget), budgets of administrative-territorial units (local governments’ budgets), the State Social Insurance Budget (SSIB), and extra-budgetary funds (EBFs). Box 3.1 describes the coverage of each of the budget system components, while Figure 3.1 presents the relative shares of the different budget components in the general government budget.

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3.20 Moldova’s general government budget remains fragmented partly as a consequence of the provision in the 1996 Budget System and Budget Process Law which requires Parliamentary approval to be obtained only for the state budget and not for the overall national public expenditure framework. Only the state budget and local governments’ budgets are consolidated into the official “consolidated budget” for the presentation of the annual state budget law and for subsequent reporting. The State Social Insurance budget and extra-budgetary resources are not consolidated for reporting purposes.

3.21 A further aspect of fragmentation concerns the incomplete integration of capital expenditures in the budget. The 1996 Budget System and Budget Process Law requires the inclusion of a line item for expenditure for capital investments in the annual budget proposal, but without integrating this into line items of the functional classification. The present practice is that expenditures for new constructions/investments are presented as a separate single line item, while capital repair and maintenance expenditures are incorporated in the lines of functional classification. The breakdown of expenditures for new construction/investment is often made after the approval of the annual state budget, pending the approval by Parliament of the list of new capital construction objects through a separate resolution. This approach could be construed as leading to the development of a separate public investment program (PIP) and the institutionalization of a dual budget. This can lead to the risk of serious imbalances between investment and recurrent spending occurring.

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Box 3.1: Moldova’s Budget System. The State Budget. The State Budget covers the operations of central government institutions, including their deconcentrated structures in the territories. The central government is responsible for providing publicgoods (defense, security, foreign relations, research, justice, environment, and infrastructure), delivery of social services (higher and vocational education, specialized hospital care, and social safety net), thepayment of debt service, and supporting other government operations. In 2001, the state budgetexpenditures net of transfers to local governments and the SSIB accounted for 39 percent of total actual general government spending (see Table A7 of statistical annex for more detailed numbers on statebudget execution for 1997-2001). The state budget is approved through the annual state budget law.

Local Government Budgets. Based on the 1998 Law on Administrative and Territorial Reform, territorial-administrative units are organized in two levels. The first level of territorial administrative division isrepresented by 10 judets (counties), the autonomous territorial unit of Gaguazia and the municipality ofChisinau with a special status. The second and lowest level of territorial administrative division isrepresented by 55 towns and municipalities, and 594 communes (villages). Each municipality, village, town and commune in a judet has a local council that approves its own local budget, and their combined localcouncil budget forms the budget of that judet. Local government budget expenditures (inclusive of statebudget transfers) accounted for 31 percent of the total actual general government spending in 2001(see Table A8 of statistical annex for more detailed numbers on local budget execution for 1997-2001). The Law on Local Public Finance stipulates that the local budgets cannot be approved with deficits. If revenue collection (including “own taxes and fees” for local governments, tax sharing with the judets, and “gap fill’transfers) is insufficient to cover expenditures, local governments must reduce their expenditures (includingestablished obligations and payments) in order to balance the local budget. The Law on Local PublicFinance allows local governments to borrow from the central government (the state budget), upper levellocal governments and from domestic commercial banks; however, they are prohibited to contract external loans/credits and to issue treasury bills.

The State Social Insurance Budget (SSIB). The SSIB covers expenditures for pensions, non-pension social insurance programs (unemployment, sickness, and maternity benefits), and most social assistance benefits. Pension spending accounts for the largest share of total expenditure of the social insurance budget(86 percent in 2000). In 2001, state social insurance budget expenditures (inclusive of state budgettransfer) accounted for about 24 percent of total actual general government expenditure (see Table A9 of statistical annex for more detailed numbers on SSI budget execution for 1997-2001). The SSIB is financed by revenues from social insurance contributions of legal and physical persons. It also receives a transfer from the state budget to cover non-insurance program spending. The SSIB is approved through anannual state social insurance budget law and administered by the National Social Insurance House (NSIH). Extra-Budgetary Funds and Resources (EBFRs). Generally, these refer to accounts of government activities that are normally excluded from budget documents and do not follow the standard rules for budgetexecution procedures. In Moldova, extra-budgetary funds include those earmarked by specific taxes or fees corresponding to their end uses (e.g., road fund, ecology fund, school text book fund). Extra-budgetary funds are incorporated in the budget. Extra-budgetary funds of the central government are approved byParliament as annexes to the annual state budget Law, while extra-budgetary funds of local government are approved as annexes to local budgets. In contrast, extra-budgetary resources of state budget institutions, referring to special funds of institutions financed from the state budget and originating from official user charges and fees (e.g., fees charged by education and health care institutions for their services), are notexplicitly included in the budget. Similar resources of institutions financed from local budgets make an integral part of local budgets. Line ministries, responsible for the sectors where state budget institutions areauthorized to accumulate extra-budgetary resources must submit forecasts of revenues from these resourcesand expenditures to be financed with such resources, together with their annual budget requests. Theseforecasts are used for analytical purposes in the course of budget preparation. Both extra-budgetary funds and extra-budgetary resources are administered through the treasury system. In 2001, EBFRs accounted for approximately 6 percent of total actual general government expenditures (see Table A10 of statistical annex for more detailed numbers on EBFRs for 1997-2001).

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Figure 3.1: Breakdown of Total General Government Expenditures by Budget Component

(Percent of Total)

Note: State budget expenditures exclude transfers to local budgets and state social insurance budget. Source: Based on data provided by the Ministry of Finance.

3.22 A number of important expenditures are also not incorporated in approved budgets in any meaningful way. These include: (i) external financing of capital investments and other expenditures funded with “tied” donor assistance; and (ii) repayment of expenditure arrears. In the case of donor assistance supplementing recurrent expenditures (for example, drugs supplied to public hospitals in the form of humanitarian assistance), this is a particularly important omission in Moldova’s situation; the country receives significant amounts in various kinds of external assistance supplementing budgetary expenditures.

3.23 Annual disbursements under donor financed investment projects averaged 3 percent of GDP over the last seven years, of which 1.4 percent of GDP was in the form of disbursements under loans directly contracted by the Government, and the rest from disbursements under loans guaranteed by the Government. The magnitude of this assistance was close to total public investment expenditures reflected in the budget (3.5 percent of GDP on average over 1997-2001), and the proper reflection of this in the budget would provide a much more accurate picture of Moldova’s public investment situation. Moreover, the real impact of those funds on the integrity of the budget process is considerably greater given that some two-thirds of domestically financed public investment is currently allocated as domestic counterpart funding on externally financed projects.

3.24 Arrears accumulated over previous years are also not adequately reflected in Moldova’s budgets, and no explicit allocations are made for their repayment, even though in practice a sometimes significant part of expenditures is expected to be used to clear past arrears. The official explanation for this is that budgets are prepared on a cash basis,

0%

20%

40%

60%

80%

100%

1997 1998 1999 2000 2001

extrabudgetaryfunds andresourcesstate socialinsurance budget

local budgets

state budget

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and therefore any reflection of past commitments is inappropriate. This is an important issue since in many sectors, particularly health and education, stocks of arrears accumulated during the past years are still significant and amount to important shares of the annual allocation. The 2002 state budget law stipulates that the past year’s arrears would be cleared within the limits of current year allocations, implicitly indicating that arrears would be maintained at the level of the previous year. In the past, and on a few occasions only, the state social insurance budget law and state budget law have included a provision freezing pension arrears as of a certain date and including cross-references to a specific budget allocation to clear those past arrears. This practice proved to be very useful in strengthening aggregate expenditure discipline in the pension system and made an important contribution to successful clearance of pension arrears in Moldova.

3.25 Although noticeable progress has been achieved in streamlining the annual budget law in the last few years, it still contains some provisions that perhaps could more appropriately be included in the organic laws governing specific areas (Tax Code, Law on Privatization), e.g., provisions on tax regulation, exemptions, and on other aspects of revenue and expenditure, on privatization, transport of goods and services across customs borders, debt restructuring, leasing, and mandatory state insurance.

Budget Process Participants and Their Roles

3.26 Within the central government, the Ministry of Finance is responsible for the general management of the nation’s finances, including budget policy and planning, budget preparation, and budget execution. Once the Government approves the state budget, the Minister of Finance presents it to Parliament and reports on its execution.

3.27 The responsibilities for budget planning and elaboration are primarily located in the budget block of the Ministry of Finance, which includes the Budget Synthesis Department and the sectoral budget departments which all report to the same Deputy Minister of Finance. Separate divisions within the Budget Synthesis Department are responsible for macro-economic and fiscal analysis, and revenue forecasting. Sectoral budget departments are responsible for overseeing the expenditure programs of particular sectors and work in close collaboration with the Budget Synthesis Department. However, responsibilities for certain aspects of the budget are currently located outside the budget block of the Ministry. These include the budgeting of certain real sector programs (agriculture, trade and industry, which are managed by the National Economy Finance Division of the Ministry of Finance) and of public sector investment (managed by the Capital Investment Division of the Ministry of Finance), both of which are located in the Department of Financial Analysis and Regulation of the Ministry of Finance and report to a different Deputy Minister. These organizational arrangements hinder the integrity of the budget and its preparation process.

3.28 The Budget Department has deconcentrated structures at judet level in the form of general finance divisions which form part of the local public administrations. Recent changes have occurred with regard to the status of those divisions. Until July 2001, they had dual subordination to judet councils and the Ministry of Finance but were funded by the judet budgets. Recently, they were transferred into subordination of the prefects’

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offices, and their funding was transferred to the state budget. This move has introduced uncertainty and ambiguity as concerns the relationship of these departments with the local authorities.

3.29 Line Ministries participate in budget elaboration and execution and are accountable for the allocation of resources of their own budgets. All the line ministries are also responsible for managing their extra-budgetary funds and resources and reporting on them to the Ministry of Finance. However, the capacity of line ministries to participate meaningfully in the national budget process is severely constrained given that their technical capacities in the areas of budgeting and financial management are relatively weak compared to the Ministry of Finance; and given also that they have very limited capacity in policy analysis and formulation.

3.30 The Ministry of Labor and Social Protection is responsible for preparing and executing the State Social Insurance Budget (SSIB) through the National Social Insurance House.51 The Minister of Labor presents the SSI budget to the Government, and after its approval, to Parliament.

3.31 The revenue collection function is divided between the State Tax Service and the Customs Department. The former is responsible for collection of taxes on domestically produced goods and all other domestic taxes, as well as social insurance contributions. The Customs Department is responsible for collection of taxes on imported goods, including VAT on imports, as well as customs duties. Both organizations are represented in the territories by networks of deconcentrated units. The importance of revenue collected by Customs has been increasing during recent years. For example, in 2001, more than 60 percent of the state budget revenue was collected at the border by Customs. The strategic importance of the customs function was quoted as the main reason behind the recent transfer of the Customs Department from subordination to the Ministry of Finance to direct subordination to the Cabinet. Currently, the head of the State Tax Service reports to the Minister of Finance, while the head of the Customs Department reports to the Prime Minister. This tends to create certain operational problems between the two revenue-collecting agencies in terms of their effective collaboration and integration and also with respect to their coordination with the treasury system.

3.32 Responsibility for budget execution falls under the Treasury Department of the Ministry of Finance, whose functions include budget execution, cash management, accounting, and system development. The goals of the Treasury are ensuring that sufficient cash is available to meet the day-to-day execution of the budget, that fiscal targets are met, that spending is within available revenues, and that the budget is executed as approved through the annual budget law. The fiscal operations of the state budget are executed through the Treasury System. State budget revenues are collected to a single treasury account maintained at the National Bank of Moldova. State budget expenditures are made from the same account. Since 2001, local governments’ revenues and expenditures are administered through the territorial treasury branches. Expenditures of 51 The National Social Insurance House was established in 2001 as a semi-autonomous agency that on the one hand reports to the Minister of Labor, who chairs its supervisory board, but on the other hand has a quite independent status granted to it by the Law on State Social Insurance and tends to operate correspondingly.

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the State Social Insurance Budget, however, remain outside treasury operations and are administered by the National Social Insurance House.

3.33 Internal government controls over budget execution are carried out by the Department of Financial Revision and Control reporting to the Ministry of Finance, and external audit of the public budget is undertaken by the Court of Accounts which reports to Parliament.

C. THE BUDGET PROCESS

3.34 Moldova’s budget process has been developing under the constraint of an ongoing fiscal crisis. So far, the Government has focused on strengthening the technical aspects of budget formulation and execution and has achieved the most progress in these areas.

Budget Preparation and Formulation

3.35 The Budget Calendar. The budget preparation calendar is approved annually at an early stage of the budget cycle. The calendar is driven by the requirement of the Law on Budget System and Budget Process to present the annual budget to Parliament by October 1. The calendars for preparation of the state and local budgets are summarized in Table 3.2. The calendar for the preparation of the state social insurance budget coincides with that for the state budget.

3.36 The Ministry of Finance recognizes that the budget calendar does not allocate sufficient time for budget planning. It has recently proposed to modify the calendar by launching preparations for the annual budget cycle much earlier in the year, in the context of the movement towards gradual introduction of the MTEF.

3.37 Planning. Perhaps the major shortcoming of the current budget preparation process is the lack of strategic focus together with the absence of a strategic planning phase. The budget exercise remains largely an arithmetic routine of balancing the numbers. Comparatively little attention is paid to analysis and budget policy formulation. As a result, the later stages of budget formulation are dominated by bargaining about the “shares of the pie”, with such bargaining not informed by adequate analytical and policy foundation. This undermines allocative efficiency, reduces the ability of the Ministry of Finance to promote rationality in budget policy, eases the way for lobbyism, and negatively affects budget outcomes. Annual allocations mainly follow the pattern of the previous years, and strategic prioritization to ensure that allocations match the developing and changing priorities of the Government’s work program remains weak.

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Table 3.2: Budget Calendar for Preparation of the 2002 Budget

State Budget Local Government Budgets

Mid April MoE begins updating macroeconomic indicators.

Ministry of Finance issues Methodological Notes to line Ministries.

Methodological Notes issued by Ministry of Finance to judets.

Judets forward the notes to villages, communes and cities.

Early May Council of Ministry of Finance approves budget calendar.

Early June MoE finalizes macroeconomic forecasts.

Line Ministries submit their budget requests. Villages, communes, and cities prepare draft budgets submitted to judets. Judets develop draft budgets submitted to Ministry of Finance for review.

Mid-June to end July

Ministry of Finance finalizes macro-fiscal framework.

Budget negotiations between Ministry of Finance and line Ministries.

Early-mid August PM/State Chancellery resolve budget disputes.

Local governments discuss divergences from the draft budget with Ministry of Finance.

Mid-end August Ministry of Finance finalizes draft budget.

October 1 Government submits the Draft Annual Budget Law to Parliament.

November 1 Villages, communes, and cities revise and submit draft budgets to local councils for approval.

November 15 Judets’ budgets submitted to judet councils for approval.

December 5 Parliament approves the state budget.

December 10 Village, commune and city councils approve their budgets

December 20 Judet councils approve judet budgets

Source: Based on the Law on Budget System and Budget Process and Government Decision No. 303 of May 7, 2001. 3.38 The fundamental constraint to strengthening the strategic planning phase of the budget preparation process is the absence of incentives to force strategic prioritization in budget formulation in line with key government work program priorities. This is exacerbated by a weak strategic planning function across government and poor strategic analysis and planning capacity. This is true for the center of government, as well as for the line ministries. The current government structure assigns the strategic planning function primarily to the Ministry of Economy, which, however, lacks adequate capacity and expertise in many areas, including budgetary and social sector analysis.

3.39 Medium-Term Expenditure Framework. Recognizing these shortcomings, the Ministry of Finance has started to move towards a more strategic approach to the budget preparation process through the gradual introduction of the Medium-Term Expenditure Framework (MTEF). The first steps in this direction included preparation of medium-

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term macroeconomic forecasts for the 2001 and 2002 budgets. In 2002, a strategic budget planning phase was added to the budget calendar approved in February 2002 (see Box 3.2 for a summary of the activities which were added to the 2003 budget calendar and for indications of desirable timing for their implementation in future years). Work is now also ongoing to turn the traditional budget note that used to accompany the submission of the draft annual state budget law to Parliament into a Budget Concept Paper (BCP). In May 2002, the Government for the first time considered and formally approved a medium-term Budget Concept Paper (for 2003 to 2005)

3.40 Experience over the last few months with the BCP exercise has highlighted institutional weaknesses in the budget preparation process. The main conclusion is that the BCP would benefit from being more analytical and from presenting more discussion of underlying assumptions and policy choices. The analysis would also need to become comprehensive and integrated; the 2003-2005 BCP covers only the consolidated budget and does not incorporate the state social insurance budget. An important operational lesson from the BCP exercise relates to the need to create institutional mechanisms for intra-agency coordination. The Ministry of Finance is committed to move further with the gradual development of the MTEF and is seeking to attract more extensive and longer-term technical assistance to support it in this task. Box 3.3 summarizes experience with the MTEF to date and also indicates the Ministry of Finance’s development plans in this area.

Box 3.2: Strategic Planning in the Budget Cycle: Indicative Timing

The following activities were already incorporated into the budget calendar for the 2003budget approved in February 2002, but the approved timing was sub-optimal because of technical delays. The list below indicates the desirable timing for these key strategic planning activities. � January. Presentation to Cabinet of the MTEF Issues Paper and Budget Calendar setting

out a preliminary framework and identifying the analysis to be undertaken for the MTEF. � February-March. Elaboration of the MTEF analysis revision and updating of the macro-

fiscal framework; analysis of cross-cutting issues; preparation of sector expenditure strategies; and elaboration of sector expenditure plans.

� Early April. Review of the initial MTEF analysis at an inter-ministerial Budget Options Workshop, followed by finalization of the draft BCP.

� Late April. Review and approval of the draft BCP by Cabinet and the issuing of the BudgetMethodological Notes to line ministries and local governments.

Source: Based on Bird, Andrew. 2001. “Moldova: Introduction of a Medium-Term Expenditure Framework”. Consultant report for the Ministry of Finance of Moldova.

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Box 3.3. MTEF progress The Ministry of Finance is aware that preparation of a full MTEF is a demanding undertaking and views the gradual introduction of MTEF as a medium-term project. At the initial stage, the primary focus would be on the strategic content of the MTEF. In 2002, an interministerial MTEF working group wasestablished, and its composition and terms of references were approved by the Government together withthe revised budget calendar. In May, the Government officially approved the first Moldova MTEF for2003-2005. The analysis required for the preparation of the full MTEF falls into four main elements: (i) preparation of the macro-fiscal framework; (ii) analysis of cross-cutting expenditures issues; (iii) preparation of the sector expenditure strategies; and (iv) preparation of the sector expenditure plans. ◊ Medium-term macro-fiscal framework was the only element of MTEF that was present in Moldova’s

budget preparation process prior to 2002.

◊ Analysis of Cross-Cutting Issues. It is planned that each year’s MTEF would analyze a number ofspecific cross-cutting issues selected for that year. The aim would be to develop specific recommendations on key public expenditure issues and policies that could then be incorporated intothe MTEF. Examples of the type of topics that might be covered include: (i) an assessment of theimplications of the Government’s poverty reduction strategy for expenditure allocations; (ii) ananalysis of inter-governmental finance issues leading to proposals for change in sharing of taxrevenues between central and local governments; and (iii) a review of payroll and wagebill issues leading to recommendations regarding the level of total wagebill expenditures as well as of wagelevels for specific groups within the public service. No cross-cutting issue was selected for the 2003-2005 MTEF because of the compressed schedule of its preparation and the complexity of analysis that would need to be undertaken. It is planned to undertake such type of analysis for the first time forthe 2004-2006 MTEF. It is recommended to select for such analysis the central government payroll and wage bill.

◊ Sector Expenditure Strategies are required to inform the decisions on expenditure allocation. It isplanned that sector strategies would initially be developed only for a few major sectors. Health andeducation were the pilot sectors for the first year of MTEF and it is planned to add social protectionto the pilot sectors for the 2004-2006 MTEF.

The initial draft of the pilot sector expenditure strategies was prepared by the line ministries and thensubsequently reviewed together with the Ministry of Finance prior to being incorporated into theMTEF. For the future, the Ministry of Finance needs to develop detailed guidelines for line ministrieson the analysis to be undertaken and the format for its presentation.

◊ Expenditure Plans. Drawing together the macro-framework, analysis of cross-cutting issues and the sector expenditure strategies, the final stage of the MTEF analysis involves the development ofexpenditure plans. In developing these expenditure plans, the sector expenditure strategies should be used to determine: (i) the strategic shifts in resource allocation between sector, identifying whichsectors justify a greater share of public expenditure resources; (ii) budget priorities within sectors,identifying which programs justify a greater share of sector resources; and (iii) the key measures tobe taken to improve operational performance, identifying priority items within sector and programbudgets. These expenditure plans should then be used to develop resource ceilings, broken down by sector and spending agency.

The 2003-2005 MTEF identifies the expenditure priorities between sectors and within the two pilotsectors as well as incorporates sectoral expenditure ceilings. However, significant amounts of technicalanalysis and organization will need to be undertaken in the next few years to gradually develop theprocess for setting expenditure priorities, elaborating expenditure plans and establishing expendituresceilings in an informed way. Source: Partially based on Bird, Andrew. 2001. “Moldova: Introduction of a Medium-Term Expenditure Framework”. Consultant Report for the Ministry of Finance of Moldova.

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3.41 Macro-Fiscal Framework. A critical element in the budget preparation exercise is the preparation of the macro-fiscal framework. The macro-fiscal framework (focused on the overall fiscal deficit and the level and composition of government revenues and expenditures) forms the basis for the Ministry of Finance to determine preliminary targets for total revenue and expenditure of the state budget, to review budget requests submitted by line Ministries, and to make recommendations on changes or revisions.

3.42 Preparation of the macro-fiscal framework is perhaps particularly problematic in Moldova given that the economy is highly dependent on external factors and vulnerable to various external shocks. The Government of Moldova develops three-year macroeconomic forecasts and has achieved certain progress in improving such forecasts in the last two years, as reflected in Table 3.3.

Table 3.3: Selected Macroeconomic Indicators, Forecast and Actual

1997 1997 1998 1998 1999 1999 2000 2000 2001 2001 Forecast Actual Forecast Actual Forecast Actual Forecast Actual Forecast Actual

GDP Growth, % 9 1.6 6 -6.5 4 -3.4 2 2. 1 5 6.1 CPI, annual

average, % n.a. 12 12 8 6 39 28 31 15 10

Exchange Rate, annual average, MDL/USD

n.a. 4.6 n.a. 5.4 7 10.5 13 12.4 14 12.9

Exports, USD million

n.a. 874 955 632 795 463 630 472 600 570

Imports, USD million

n.a. 1171 1121 1024 1200 586 750 776 830 897

Source: Ministry of Economy. 3.43 However, significant weaknesses remain both with regard to the quality of macroeconomic framework and the process of its preparation. While the Ministry of Economy is formally assigned to coordinate the development of medium-term macro-forecasts with the National Bank, the Ministry of Finance, the Department of Statistics and the line Ministries, in reality, it does not have sufficient capacity to develop forecasts of monetary and fiscal aggregates, and its main substantive contribution is to forecast GDP and other real sector and external sector indicators. The monetary framework is projected by the National Bank, and the fiscal framework is projected by the Ministry of Finance. The existing econometric macroeconomic model developed with external technical assistance a few years ago began to be applied by the Ministry of Economy only in 2001. However, it is perceived as of limited use by other agencies participating in the process, and they do not employ this tool. In particular, the linkages between the GDP projections and fiscal and monetary sector projections are not in-built properly in the methodology used by the Ministry of Economy. This leads quite often to inconsistencies between the projected macro indicators. During the last two years, in response to the needs generated by the gradual introduction of the MTEF concept in the budget preparation process, some limited progress was achieved in developing consultative mechanisms for coordination of macroeconomic projections. The analytical foundation of macroeconomic framework, however, remains quite weak and affects its overall quality.

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3.44 Revenue Forecasting is perhaps another area of comparative weakness in Moldova’s budget planning and formulation process which affects the quality of aggregate fiscal discipline. Forecasting state budget revenue is the responsibility of the Ministry of Finance, while the National Pension House is responsible for the Social Insurance Budget revenue forecast, and local authorities are responsible for projecting their budget revenues. Weaknesses in the analytical foundation and the use of simplistic forecasting techniques affect the quality of revenue projections across the government. The methodology used currently by the Ministry of Finance and recommended to the local authorities basically links tax revenue to projected GDP, adjusted for changes in tax laws and tax administration. No computerized revenue forecasting models exist to project revenue from individual taxes. Besides, individual tax forecasts are determined with limited inputs from the tax enforcement and collection units (State Tax Service and Customs Department). Social Insurance Budget revenue projections suffer from the same problems as state budget revenue projections, including undeveloped forecasting tools and poor coordination with the tax inspectorate responsible for the social insurance contributions collections.

3.45 Methodological Guidelines. The Ministry of Finance has been putting a lot of effort into improving the methodology for budget formulation. This is summarized in the budget circular Methodological Guidelines for Annual Budget Preparation (MGs). These methodological guidelines are issued by the Ministry of Finance at the initial stage of the annual budget cycle and provide a framework and methodology for annual budget formulation. This includes estimation of revenues, expenditures, and financing, which allows for greater transparency in the allocation of public funds and provides policy-makers with the information necessary to enable them to review the draft budget. The methodological guidelines for the state and local governments’ budgets are issued separately every year, and both contain detailed information on the projections of economic indicators including salaries, prices of products, outputs (by types), social indicators, and so on. Compilation of the social insurance budget, however, is not guided by any methodological documents.

3.46 Until recently, an important shortcoming of the MGs was that no explicit expenditure ceilings were specified by the Ministry of Finance before individual budget requests were made by line ministries. Expenditure ceilings were, however, established for certain items of expenditures and certain sector activities. The overall ceilings were also implicitly set through the calculation methodology based on past year’s expenditure outturns adjusted by inflation and tariff growth. Sometimes, there were provisions for specific policy changes in the sectors. The parameters for calculating the ceilings were distributed to line ministries together with MGs for elaborating their budgets. In practice, the line ministries did not recognize such implicit ceilings as binding and often submitted budget requests significantly exceeding them. 2002 was the first year when explicit expenditure ceilings were introduced by the Ministry of Finance at an early stage of budget preparation process as part of the 2003-2005 MTEF.

3.47 Moldova’s incremental budget approach tends to encourage budget managers to demand additional resources for new programs rather than to encourage the reallocation of resources from existing programs in support of greater effectiveness. The argument is

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that reallocation could lead to reduced resources for the following year if amounts are to be based on (re-allocated) current year outlays. The effect is that spending agencies project forward their existing budget lines rather than try to review them within a policy framework consistent for the sector and proactively producing planned shifts in expenditure allocations within an overall resource ceiling.

3.48 Quality of Budget Submissions. The quality of line ministries’ budget request submissions represents a further obstacle to improving allocative and technical efficiency of the budget in Moldova. Initial budgetary proposals by line ministries have to reach the Ministry of Finance by the end of June. In compliance with MGs, these proposals must include: (i) recorded revenues and expenditures for the prior fiscal year; (ii) estimated revenues and expenditures for the current fiscal year; (iii) estimated revenues and expenditures for the next fiscal year; (iv) projected revenues and expenditures for at least one year beyond the next fiscal year; and (v) justifications of the expenditure requests with regard to the preliminary revenue and expenditure targets distributed by the Ministry of Finance and the expected results of the programs included in these requests.

3.49 In practice, line ministries have experienced particular difficulties with meeting these requirements. The submissions which the Ministry of Finance receives tend to be overburdened with exceptionally detailed information by institutions, but contain very weak analysis and justification of requests, as well as lacking clear statements on sectoral policies, expenditure priorities and the rationale behind them. The main spending agencies, such as the Ministries of Education and Health, tend to submit budget requests that exceed the implicit ceilings provided to them from around 50 to even 200 percent.

3.50 At present, sectoral submissions by line ministries are designed to serve the purpose of providing the required input into the state budget law and are limited therefore to state budget expenditures only. This restricts, for instance, the scope of the Ministry of Education submission primarily to the tertiary education program, leaving the bulk of primary and secondary education expenditures, which are in theory the priority for the sector, outside the focus of the ministry. This situation results from the specific modality of fiscal decentralization that has been implemented in Moldova since 1999, where local authorities were granted substantive freedom in utilization of local budget resources, including the transfers from the state budget, which are provided in the form of unconditional grants.

3.51 Recent Efforts to Improve Budget Preparation Methodology. The ongoing efforts to strengthen the strategic focus of the budget preparation promoted by the Ministry of Finance has put additional pressure on line ministries to strengthen their policy analysis and strategic planning functions. In 2002, as part of the preparatory work for the MTEF, the Ministries of Health and Education were requested to make a first attempt at drafting overall sectoral expenditure strategies as inputs to the budget concept paper.

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3.52 The estimation methodologies prescribed in the MG are still however significantly driven by the use of norms which translate physical requirements into monetary amounts through the application of average standardized costs for services. This is especially the case in estimating budgetary resources for expenditures on health, education, and energy. The Ministry of Finance realizes the shortcomings of the norms-based approach, and has been making efforts to improve the methodologies underlying the derivation of norms. It also realizes the problems related to the use of average norms for the whole country that do not take into account regional disparities.

3.53 The budget methodology is at present also purely input based, and does not link budget requests to performance information or expected program outcomes. The Ministry

Box 3.4: Program Budgeting Pilots Under the USAID financed Moldova Fiscal Reform Project, the Ministry of Finance was assisted with the introduction of program budgeting. During 2001, the system was developed and tested with the preparation of the 2002 budget in three pilot areas: (i) higher education; (ii) hospital services; and (iii) the Ministry of Finance. The initial plan envisaged moving to full-scale implementation for the preparation of the 2003 budget, with the aim of having it operational throughout Government in 2003. That plan had to be scaled down based on the modest outcomes of the pilot. Social protection was added to the pilots for 2003 budget. The social protection pilot was supported by the technical assistance through the EU Food Security Program. The preparation of a program budget requires substantial details of activities in each sector, including their scope, objectives, strategy, estimated cost of inputs for three years, total cost of activities, and financing sources (budgetary versus extra-budgetary). Preliminary assessment of the program budgeting implemented in the areas of higher education and hospital services is mixed. The Ministry of Finance considered the program budgeting a useful exercise for identifying efficiency of sector activities and thus facilitating prioritization. The hospital care program budget submitted by the Ministry of Health was satisfactory as the Ministry carefully reviewed, analyzed and prioritized activities of hospital services based on the cost of providing services and their outputs/outcomes. Consequently, it was able to recommend measures to reduce the cost of service provision in order to match a given resource allocation. However, the interviewed staff of the Ministry of Health involved in the 2002 program budget exercise raised concerns about the pilot’s limitations with regard to the choice of the program and the resulting exaggerated attention paid to the hospital care program, that, as was shown in Chapter 2, is in fact not the priority for the health sector budget at the moment. During the interviews, the same staff voiced concerns about substantive technical difficulties they anticipated with future extension of the approach to the whole health care budget, given the level of details required from them by the Ministry of Finance guidelines, against the background of the gaps in the existing information available to the Ministry as well as the limited capacities for its processing and analysis. The 2002 program budget exercise at the Ministry of Education brought less advanced outcomes. The Ministry faced technical difficulties in implementing the exercise, was unable to integrate the submissions made by institutions, and subsequently failed to come up with a prioritization of activities. To be able to move forward with further implementation of program budgeting, the Ministry of Finance considers that intensive capacity building needs to be made available for staff in the Ministry of Finance and for finance departments in line Ministries through formal and rigorous training.

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of Finance monitors and controls input items, not the cost of a program or outcome. Recognizing the limitations of this approach in measuring cost effectiveness, the Ministry of Finance launched in 2001 a program budgeting pilot for the 2002 budget (see Box 3.4). This involved preparation of supplementary methodological guidelines for program budgets and their circulation to the pilot Ministries of Health and Education. The Ministry of Finance itself also participated in the pilot. The ministries involved were required to submit program-based budgets for selected programs (hospital care, tertiary education, and tax collection) in parallel with the traditional budget presentation. The documentation had to include the description of those selected programs, including a clear set of program goals and objectives, as well as performance measures for evaluation of efficiency of inputs and effectiveness of outputs.

3.54 The main lesson learned so far from the pilots is not surprising: namely that capacity weaknesses of the line ministries are an important constraint to the speedy introduction of program budgeting in Moldova. If the decision is taken to continue and extend the experiment, more extensive and, at the same time, focused technical assistance in this area may be necessary.

3.55 Budget Scrutiny and Negotiations. Given the absence of substantive discussion of strategic priorities at the onset of the budget cycle, budget scrutiny and negotiations at present represent an unnecessarily lengthy and intense phase of annual budget preparation. The Ministry of Finance reviews the sectoral proposals received from line ministries and may recommend cuts to adjust sectoral budgets in line with forecast resources. Intense bilateral negotiations between the Ministry of Finance and line ministries are held in order to agree on the sectoral budgets. State budget transfers to the SSI budget are separately negotiated between the Ministry of Finance and the Ministry of Labor. Weak analytical capacities in the line ministries reduce their ability to defend their budget proposals. By default, the negotiations are dominated by the Ministry of Finance. Bilateral disagreements are resolved at a political level through the interventions of the Cabinet and the Prime Minister.

3.56 As for local government budgets, the judet administration and the Ministry of Finance need to agree on the overall local budget (including tax revenues, expenditure, and transfers to local governments’ budgets) before the state budget is submitted to Parliament. Once agreement is reached with local governments and line ministries, the Ministry of Finance prepares the draft proposal for the state budget and the “consolidated” budget. The draft budget is then submitted to the Cabinet along with the Budget Note, which sets out the underlying macroeconomic parameters, the resource framework, and the policies within which the draft budget has been prepared.

3.57 The proposed annual Budget Law is approved by Parliament in three readings: the first reading approves the main budget policy direction and the Government’s policy and objectives; the second reading approves total revenues, expenditures and the overall deficit; and the third reading examines in detail the budgetary expenditures of state bodies and settles expenditure appropriations that are financed on a priority basis. The State Social Insurance Fund budget is simultaneously approved after the approval of the

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annual budget law. After Parliament approves the state budget, local governments must adjust their budgets in line with the annual budget law within 15 days.

Budget Execution

3.58 Treasury. During the last decade, Moldova has made reasonable progress in establishing a treasury system (see Box 3.5) to execute national budget. State budget operations were transferred under treasury execution in stages during 1993 - 1997; and territorial treasury branches started to service local governments budgets revenues and expenditures in 2001. A system has been developed to register contracts concluded by public institutions for procuring goods, works and services to support effective control of expenditure commitments. The system is operational at the level of state budget and is being rolled over to the local budgets. The implementation of the treasury system to date has contributed to improved control over cash and over unauthorized expenditures. The Treasury now validates all expenditure transactions requested by line ministries against budget appropriations and the availability of funding prior to payment authorization. It also facilitates monitoring of budget execution and timely reporting of the state and local budgets, as well as extra-budgetary funds (except for the social insurance budget) and resources, thus contributing to improved fiscal transparency and accountability. The central treasury system is now able to provide information on the execution of the state budget at the end of each day.

Box 3.5: Moldova’s Treasury System Moldova’s treasury system is a two-tiered structure consisting of a central treasury (state treasury) and a network of 37 regional offices (territorial treasuries) subordinated to the central treasury. The central treasury became fully operational in 1997 and is responsible for executing all state budget revenues as well as state budget transfers to local budgets and certain other state budget expenditures. The territorial treasury branches launched in 1998 aimed initially to ensure control of spending of state budget funded institutions located in the regions. In 2000, the extension of the treasury coverage to local budget operations was initiated with the objective of improving the transparency of local government revenues and expenditures, and improving the availability, reliability, and timeliness of information on the local governments’ budgets. All fiscal operations of local governments are conducted through territorial treasury branches since 2001. The central treasury is organized around a single revenue account maintained at the National Bank of Moldova where all central government revenues are collected and government operations are recorded. Several additional accounts in various foreign currencies are maintained at the National Bank, as well as a separate account for the revenues of the State Social Insurance Budget. Territorial treasury branches operate with four standard types of treasury accounts including state budget accounts, local budget accounts, accounts for extra-budgetary resources of state budget institutions, and foreign currency accounts. State budget revenues collected by tax and customs bodies (including the revenues shared between the state and local budgets) are deposited at commercial banks, and transmitted to the single treasury account at the National Bank of Moldova. On the payments side, the Treasury utilizes the banking system to transfer funds from the Treasury state budget account at the National Bank to state budget accounts at territorial treasury offices and to make payments to suppliers of state budget institutions located in the territories. Local budget revenues and expenditures are routed through the local budget accounts at territorial treasury branches. Public institutions are not allowed to have accounts at commercial banks and perform their financial operations through the treasury accounts at respective territorial branches. Payments of salaries and pensions are made in cash.

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3.59 The significant decline in state budget expenditure arrears during 1998-2000 (from 440 million lei in 1998 to 234 million lei in 2000) appears largely attributable to the strengthening of controls over commitments. In contrast, expenditure arrears of local governments’ budgets increased from 526 million lei in 1998 to 693 million lei in 2000. The majority of expenditure arrears (about 75 percent of total expenditure arrears in 2000) accumulated by local governments reflects, in part, weak control of expenditure commitments and the lack of coverage of local budgets by the treasury system prior to 2001.

3.60 Further modernization and institutional development of the treasury is a priority for the Ministry of Finance. It will, for example, take at least several years for the territorial branches to become fully operational and integrated in the overall system. Significant investment is likely to be required to upgrade the system’s technology and infrastructure. The Ministry is particularly concerned about the sustainability and security of the treasury information system and is producing a treasury information technology (IT) development plan to be further circulated to the donors with the purpose of attracting external financing for further investment in technology and capacity building.

3.61 Appropriations. After the state budget is approved, the Ministry of Finance distributes monthly allocation limits to central public authorities and requests to submit them their financial plans and those of subordinate institutions, drafted in conformity with the approved annual budget law and following the existing budget classification and monthly allocation limits. Financial plans are drafted by primary budget executors, examined by line ministries’ financial divisions, approved by the Ministry of Finance and registered by the Budgetary Synthesis Department. After registration, financial plans are forwarded to the Ministry of Finance Treasury Department and further to the State Treasury for execution. The Treasury accepts for processing the expenditures of public institutions only within the limits of allocations approved for the respective period and only for the categories of spending provided for in financial plans. Financial plans may be amended within the budget year with approval of the Ministry of Finance. These plans also provide necessary information for Government cash management, for management at the level of the spending agencies, and for ensuring that budget execution conforms to appropriation and budget classification as indicated in the plan.

3.62 However, in practice because of institutional capacity weaknesses, the system of monthly allocation limits and financial plans is compromised in that the response to unexpected deviations in budget execution has turned out to be very slow (as was the case in 2001) and takes a long time to be reflected in monthly allocation limits and financial plans. In practice, therefore, there is only limited in-year adjustment to reflect new dynamics in revenues, changes in debt service, and other expenditures throughout the year, nor any adjustment for an over-estimated budget.

3.63 Control of Expenditure Commitments. The introduction of the treasury system also led to improvements in strengthening controls over expenditure commitments. Previously, expenditure controls became effective only when bills had to be paid, after goods were already received and services rendered. Starting in 2000, the central treasury system ensures the registration of contracts concluded by state budget funded institutions

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for delivery of goods, works and services. In conformity with the annual budget law, contracts that are not registered in the units of the State Treasury are void. The Treasury Office verifies each submitted contract against the agency’s financial plan as well as the Treasury’s cash position, and if accepted, the contract value is registered. The balance of resource allocation for the respective expenditure item is calculated after the payment under the contract is processed. Following the extension of treasury coverage to local budgets in 2001, the extension of the contract registration system to local budgets is being implemented. Once completed, it will enable the Treasury to exercise better control of expenditure commitments of local governments.

3.64 Execution of Revenues. Revenues collected by officials of the State Tax Service and Customs Department are deposited directly to the Central Treasury Account at the National Bank. Taxpayers make tax payments through commercial banks by depositing a check together with submission of a payment form. In the case of shared taxes, the full amount of tax shared between the state and lower level budgets goes initially to the central treasury revenue account. The respective share of the collected tax is further transferred to the lower level budget by the treasury system. Similar procedures apply to the taxes shared between the judet and lower level budgets.

3.65 Cash Planning. The unstable fiscal environment and chronic shortages of public funds until recently led to significant and frequent instances of cash rationing during budget execution. Under this, cash was released by the Treasury in order of priorities depending on the availability of funds each day. This resulted in considerable uncertainty for the budget executors. Consequently, spending units could not implement their budgets correctly and were forced to accumulate arrears even when strictly following the budget law. Inadequate analysis of cash flow requirements made it very difficult for debt offices to prepare and implement a cohesive borrowing plan to meet the demand for cash.

3.66 To improve the cash management process, the Government approved the establishment of a new Cash Management Unit in 2001 as part of the new organization structure of the Ministry of Finance. The new unit’s responsibilities include developing and enhancing cash forecasting, implementing the cash flow plan to allocate budgetary resources, and coordinating with other Divisions in the Ministry of Finance, State Tax Service, the Customs Department, the National Bank, and commercial banks. Once fully operational, the unit is expected to contribute to prevention of the situation experienced in 2001, when because of institutional capacity constraints, new state budget arrears were allowed to accumulate as a consequence of a very slow response during the year to unexpected shortfalls experienced both in revenues and in external financing.

Debt Management

3.67 Strengthening debt management has been high on the agenda of the institutional reforms promoted by the Ministry of Finance for several years. As Moldova’s debt service burden has increased since the 1998 regional financial crisis, the Government has given priority to the formulation of a concise medium-term government debt strategy that incorporates all types of government liabilities—external and domestic, direct and contingent, revealed and hidden. More recently, the Government has approved a decree

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to establish a new Department of Public Debt outside the Treasury Department to be responsible for all public debt issues; the Department’s responsibilities will include the management of public debt, assets and liabilities, debt sustainability analysis, formulation of a comprehensive debt strategy, and loan contracting and negotiation.

3.68 The challenges facing the Government in debt management are evident in the area of contractual contingent liabilities, such as guarantees and energy arrears (see Box 3.6). Following the establishment of the legal arrangements for the issuance of guarantees, during the past few years the Government has abstained from providing guarantees on loans contracted by state enterprises; however, it still honors debt service obligations resulting from loan guarantees. Although contractual contingent liabilities have benefited from the existence of a clear rule-based approach, the realization of various implicit liabilities, particularly energy arrears incurred by budget institutions and enterprises, in an ad hoc manner resulted in rapid accumulation of public debt. During the past few years, the Government repeatedly absorbed various liabilities of other economic agents, mainly energy arrears of enterprises. These were transformed into direct government debt.

3.69 Recent reforms have made a major contribution to bringing a strategic perspective to Moldova’s public debt management. Moldova’s debt managers have managed to cope with a number of difficult repayment situations in the last few years, and the Ministry of Finance has been successful in rescheduling and restructuring several bilateral loans, notably with Russia, Germany, and Romania. Despite these significant achievements, capacity in the area of debt management needs to be further enhanced. In particular, individual borrowing decisions do not yet fully take into account debt sustainability forecasts, and the ability of the Ministry of Finance to prepare such forecasts could be strengthened further.

3.70 Fiscal risks associated with energy arrears and contingent liabilities need also to be integrated into budget planning. As mentioned in Chapter 1, the increase in the debt burden after 1998 was partially due to the Government’s absorption of contingent liabilities associated with government-guaranteed loans (explicit contingent liability) and energy arrears of state energy enterprises to suppliers (implicit contingent liability) into direct public debt (Box 3.6). This action created the expectation that current and future energy arrears would also probably be absorbed into direct public debt, and this expectation, in turn, generated expenditure commitments with immediate fiscal impacts. Such commitments, therefore, should be fully accounted for when formulating a comprehensive budget framework in order to support accurate overall assessment of fiscal risks.

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Box 3.6: Absorption of Contingent Liabilities Despite Parliamentary approval of the Law on State Debt and State Guaranties as of July 18, 1996, absorption of contingent liabilities associated with energy arrears and state-guaranteed debt has continued as a result of a weak juridical framework regarding management of state external guaranties and slow implementation of structural reforms in the energy sector. Absorption of energy arrears and state-guaranteed debt increased the stock of external debt by US$260.4 million during 1996-2000, and therefore, future debt service payments beginning 2002 onwards. Debt services associated with absorption of contingent liabilities are estimated at about US$30 million per year. Energy Arrears. The Government has absorbed arrears on energy imports accumulated by a state-owned enterprise (MoldovaGaz) as well as by Transnistria. It assumed arrears on gas delivered to Moldovagaz in the amount of US$140 million in 1996 (7 year maturity, 2 year grace, and 7.5 percent interest rate) and US$90 million in 2000 (7 year maturity, 2 year grace, and 7.5 percent interest rate). Also in 2000, the Government absorbed Transnistria’s arrears to Russia in the amount of US$30.39 million in the process of restructuring the external debt with the Government of Russia (US$74.4 million) and commercial debt with Oneximbank (US$17.27 million). A new debt agreement was signed with the Government of Russia totaling US$122.06 million (15 year maturity, 5 year grace, and 7 percent interest). State Guaranteed Debt. During 1996-98, the Government issued ten guarantees on loans from commercial creditors to seven state enterprises (including four guarantees on EBRD loans), and the amount of guaranteed issue totaled US$80 million. The stock of external guaranteed debt increased from US$73.3 million in 1996 to US$86 million in 1999 and declined thereafter. However, no loan guarantees were issued after 1998 as the EFF and PRGF programs agreed with the IMF prohibited the Government from issuing new loan guarantees. If an enterprise receiving state guarantee declares bankruptcy, its debt will be assumed by the Government, increasing the stock of public debt. For example, the joint stock company "Perfuzon" contracted credit from the German joint stock company "AKA Bank" in the amount of DM12.74 million for purchasing pharmaceutical equipment in 1994. Since the state failed to finance a part of expenses, "Perfuzon" had to sign the agreement on the additional credit in the amount of DM5 million with "Drezdner Bank" under the Government guarantee due by 1999. As "Perfuzon" declared bankruptcy, the Government had to liquidate the credit. If an enterprise defaults on debt servicing payments, the Government will have to absorb the payment, thus increasing public debt service. Source: Based on Ministry of Finance data.

Reporting

3.71 The Law on Budget System and Budget Process requires the Ministry of Finance to prepare a report on the implementation of the state budget and its relationship with local budgets at the end of each fiscal year (December 31) and to present this report to the Government and Parliament by May 1 of the following year. The implementation of the treasury system for central and local governments has helped to improve the timeliness and accuracy of fiscal reporting. The Ministry of Finance compiles cumulative year-to-date data on the execution of the state budget, local governments’ budgets and the “consolidated budget” at the end of every month, quarter and fiscal year. It also compiles data on the revenues and expenditures of extra-budgetary funds as well as of the extra-budgetary resources of budget institutions. Fiscal data on the execution of the state budget, local governments’ budgets, and State Social Insurance budget cover transactions in cash, in kind, netting operations, and arrears. However, no data are compiled for the

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consolidated central government (the state budget and the SSI budget) or for the consolidated general government (the state budget, SSI budget, and local governments’ budgets). Moreover, cumulative year-to-date data are prepared rather than monthly flow data, which would be useful to have for budget monitoring purposes.

3.72 The state budget’s monthly, quarterly, and annual data are generated directly from the Treasury’s computer system, while the local governments’ data are generated from reports received from each of the judets. These data cover the cash operations (including revenue and expenditure netting operations) of the central and local governments. More detailed reports containing information on commitments and arrears52 of the spending agencies at both central and local government levels are provided at the end of every quarter. These reports are included in the Ministry of Finance’s quarterly and annual reports. On an annual basis, completely separate reports are also compiled on transactions in kind.

3.73 The reports prepared by the Ministry of Finance are primarily designed for budget monitoring purposes and are, therefore, not always particularly useful for macroeconomic analysis or policy making purposes. The Ministry of Finance produces a “standard” set of monthly and quarterly data on revenues, detailed functional and economic classification of expenditure for the individual state and local governments’ budgets, and the consolidated budget for its own analytical purposes. These monthly and quarterly reports contain cumulative information on budget execution during the period (though the quarterly reports provide additional information on commitments and arrears). The National Social Insurance House compiles cumulative year-to-date data on the execution of the SSI budget at the end of every quarter and at the end of each fiscal year.

3.74 The approved annual state budget, the local governments’ budgets, and the consolidated budget are published in Monitorul Oficial (the Official Gazette)53and the local press, and are also posted on the government web-site. The Statistics Department disseminates budget execution data for all levels of government operations through its official publications on a monthly and quarterly basis. The cumulative quarterly fiscal data provided by the Ministry of Finance are published in the Statistics Department’s quarterly bulletin on Social-Economic Situation in Moldova, while annual cumulative fiscal data are published in the annual Statistical Bulletin. The published data are compiled in tables showing the consolidated budget’s revenue by main category, expenditures by main function, net lending, the deficit/surplus, and total domestic and foreign financing. The Ministry of Finance also disseminates the data directly through the media, providing monthly fiscal data on tax collection, budget executions, and financing of the state and local government budgets.

52 Arrears are calculated as arrears at the beginning of the period, plus commitments during the period, less payments (in cash, in kind, and through netting operations) during the period. 53 The multi-volume Annual Report on budget execution for these levels of government is only for internal Government use.

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Internal Audit

3.75 The audit of public funds is a relatively new concept for the FSU countries. At present, the bodies with responsibilities in this area are charged under legislation, starting with the Constitution, to undertake “control” of the use of public funds rather than audit. Understanding of the concept of public audit as well as of the purposes and differentiation between internal and external audits appears also to be at an early stage of development.

3.76 The State Tax Inspectorate and the Department of Financial Revision and Control in the Ministry of Finance are responsible for implementing financial and administrative control over, respectively, budget revenues and expenditures.

3.77 However, a number of changes are planned with regard to the configuration of the bodies responsible for internal financial control. The Department of Financial Revision and Control attached to the Ministry of Finance is to undergo a reorganization, and an internal audit unit was recently established within the Treasury Department of the Ministry of Finance; similar units were also created within the Tax Inspectorate, Customs Department and the National Social Insurance House. The Department of Financial Revision and Control was originally established in 1991 and charged with ensuring that budgetary resources are used in compliance with the budget law. The checks undertaken by the Department focused on cases of misconduct (without reviewing procurement processes or management of personnel) and on verifying whether cost-savings measures designed to reduce budget outlays in areas such as energy consumption were actually achieved. It appears though that sanctions in cases of misconduct and mismanagement were not felt to be particularly effective. The initial assessment under the CFAA is that if this Department is to serve as the basis for the government’s internal audit function then major changes would be required and significant capacity building would be essential.

External Audit

3.78 The responsibility for external financial review of the government’s revenues and expenditures falls under the jurisdiction of the Chamber of Accounts (CoA), which reports directly to Parliament. The CoA was established in 1994 to control management of public resources so as to ensure maximum efficiency in the use of public money and to control public property. The CoA scrutinizes the end-of-year accounts of the Government and prepares an annual report submitted to Parliament. In practice, the CoA has not yet been able to develop into an independent, credible and effective modern supreme audit institution. As confirmed by the recent CFAA mission, significant institutional strengthening is still required.

D. INTERGOVERNMENTAL FISCAL RELATIONS

3.79 A large share of general government expenditures, especially in areas that impinge directly on the poor, are under the jurisdiction of local authorities. In 2001, state budget expenditures (net of transfers to local governments and the SSI budget) accounted for 39 percent of total actual general government spending, while local government

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budget expenditures accounted for 31 percent. The efficiency of budget relations between the state and local budgets, together with the quality of expenditure management by the local authorities, is therefore an important determinant of the overall efficiency of public resource management in Moldova.

3.80 The efficiency of public spending at the local level in Moldova is affected by a broad range of factors. In 1999, the government initiated a far reaching decentralization reform that progressed more slowly than had been expected. In 2002, Parliament voted for major amendments to the 1999 legal framework, partially reversing the reform. Only part of those amendments, however, were validated later by the Constitutional Court. The overall direction with regard to the decentralization process remains unclear.

Expenditure Assignment

3.81 Moldova has two levels of subnational government—the districts (judets) and the municipalities (primarias), with the latter subordinate to the former. The Government has altered this structure several times in recent years. The 1998 territorial reform reduced the number of districts. More recent legislation has allowed for an increase in the number of municipalities

3.82 Subnational governments devote the majority of their revenues to social services. Data for 1997-2001 show 40 percent of spending allocated to education, 22 percent to health, and 4 percent to social welfare. The division of management responsibilities between the Government, districts and municipalities, is not well defined. Responsibility for setting policy, day-to-day management, and financing is not clearly fixed.

Revenue Assignment

3.83 Districts and municipalities derive a majority (70 percent) of their revenues from specific taxes collected by the central government: the corporate income tax, the VAT on domestic sales and road taxes. In principle, local governments are to receive fixed shares of each of these taxes on a derivation basis. In fact, during the budget preparation process, the expenditure needs of each jurisdiction are calculated. Estimates of revenues from shared taxes (and other resources) are then made. If projected revenues exceed projected expenditures, the tax sharing ratios of the municipality are reduced until the two match. If projected revenues fall short of projected expenditures, the difference is financed by a lump sum transfer from the central government.

3.84 This approach succeeds in reducing disparities in per capita revenues among jurisdictions (compared to the levels that would result from distributing funds on a derivation basis). However, the calculation of expenditure needs and expected revenues is subject to extensive bargaining and negotiation. Revenue levels are therefore unpredictable and are perceived to reflect political favoritism. This is particularly true at the second stage of distribution—from districts to municipalities. It also seems to deprive local governments of any means to respond to demands for higher levels of local services or lower taxes. Since the majority of taxes are imposed at nationally uniform rates, local governments have little ability to increase (or decrease) local tax rates to reflect local

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priorities. The municipalities do in fact have control over the rate of the local property taxes and local fees and charges. But these account for a minor proportion of local revenues at the present time.

E. THE ROAD AHEAD

Key Challenges

3.85 This review and assessment of the budget system suggests that the government has been relatively more successful in strengthening fiscal discipline than in ensuring that public expenditures conform to strategic priorities and are efficiently utilized. With respect to aggregate fiscal discipline, sustainability of the progress is not yet assured; and aggregate fiscal discipline is weakened by fragmentation in the budget and inadequate external auditing capacity

3.86 Expenditure allocation decisions across (and within) sectors do not reflect Government priorities. Expenditure cuts necessitated by shortfalls in revenue and increasing debt service payments were made across the board. Within the social sectors, inadequate attention is paid to the relative contribution and effectiveness of different programs in terms of alleviating poverty, with social protection expenditures which target the poor and primary education and health care receiving insufficient priority and shares of the budget allocations.

3.87 Allocative efficiency is also adversely affected by weak center of government decision making and lack of strategic planning capacity within the Government. Within a sector, allocation of resources is based on incremental budgeting, which encourages line ministries to demand more resources to implement a new program rather than reallocating from within the old program. In addition, budget managers are not given incentives to prioritize rigorously across their area of responsibility; and also lack adequate information on the cost effectiveness and on outcomes when seeking to determine the effectiveness of programs.

3.88 Both budgetary and non-budgetary arrangements fail to promote the efficient use of scarce resources (especially in the social sectors), thereby adversely affecting operational and technical efficiency. The budgetary institutional arrangements, including norm-based expenditure estimates, an input-control budget management approach, unpredictability of cash releases, and limited availability of equipment and technology, do not provide sufficient incentives for budget managers to use resources efficiently. Non-budgetary institutional arrangements, including the efficiency of the tax and customs administration and human resource management policy, also contribute to limited technical efficiency. Introduction of the elements of a medium-term expenditure framework into the budget preparation process reflects the Government’s commitment to improve the performance of its budget system. However, the Government needs to go beyond the technical aspects of the medium-term macroeconomic and budget estimates by emphasizing the strategic focus of medium-term resource planning. This includes establishing a budget forum to ensure a systematic link between budgeting and the Government’s strategic policy and priorities to foster greater allocative efficiency and

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linking budget inputs to outputs and outcomes to strengthen technical efficiency. This will require significant enhancement of institutional capacities at all levels of government.

Recommendations

3.89 This section sets out for consideration by the Government a number of short-term and medium-term recommended actions designed to secure achievement of the following objectives: strengthening strategic prioritization and allocative efficiency in budget formulation; strengthening aggregate fiscal discipline through improving comprehensiveness of budget coverage; improving fiscal reporting and budget transparency; strengthening the internal and external accountability framework; enhancing the quality of macroeconomic forecasting; strengthening budget preparation; and strengthening budget execution.

3.90 Strengthening Strategic Prioritization and Allocative Efficiency in Budget Formulation. The key short-term recommendation suggested for consideration by the government is to develop an Issues Paper and Budget Calendar for preparation of the 2004-2006 MTEF. The 1996 Budget Law should also be amended to take account of key features of a strategic approach to budget management. The amendment should require Cabinet’s approval of the BCP prior to budget preparation each year, starting with the 2005 budget. The Cabinet discussion of the BCP would establish a forum where Government strategic policy could be linked to budgeting.

3.91 The ongoing introduction of the MTEF elements could be strengthened so that they are fully integrated into the budget process and the BCP’s analysis provides the direction for budget formulation. This could be supported through developing the BCP at the onset of the budget cycle and improving its analytical content. This early development of the BCP would allow a more realistic budget ceiling to be set. In order for it to be a more analytical and useful document for budget decision makers, the BCP should entail sensitivity analysis that outlines policy impacts, associated fiscal risks, and alternative options of expenditure policy initiatives to provide information for policy makers.54 This would change the Ministry of Finance’s role from input control to ensuring effective budget allocation (in line with Government priorities and program effectiveness) and monitoring of budget outcomes.

3.92 It is suggested also that the government develop and approve a medium-term plan for strengthening the MTEF framework, focusing particularly on the determination of the aggregate resource envelope; and on effective prioritization of expenditure items across and within sectors. For the 2004 BCP, it is suggested that sectoral expenditure strategies for each of education, health and social protection be prepared and attached to the BCP.

3.93 Successful gradual introduction of the MTEF will require complementary measures to strengthen the institutional capacities in the Ministry of Finance and line

54 The Ministry of Finance benefited from World Bank technical assistance in introducing the MTEF elements in the budget process for the 2003 Budget, and technical assistance from DFID was secured to support preparation of the 2004-2006 MTEF.

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ministries over the medium term. The Ministry of Finance will need to strengthen its capacity in macroeconomic and fiscal analysis in its respective divisions within the Budget Synthesis Department; in project analysis and cost-benefit analysis for the Capital Investment Division; and in financial analysis for expenditure planning divisions. The Departments of Policy and Budget in line ministries will need to strengthen their capacity in policy analysis, program development, and financial analysis

3.94 Strengthening Aggregate Fiscal Discipline Through Improving Comprehensiveness of Budget Coverage. Strengthening aggregate fiscal discipline will require improving budget comprehensiveness. Key elements in the short term include considering the social insurance budget together with the state and local governments’ budgets as part of the comprehensive budget framework at the strategic budget planning phase; including foreign financing in project loan spending; integrating capital expenditures in the preparation of the annual budget proposal; and, for the medium term, including contingent liabilities related to arrears of energy enterprises in the fiscal framework for budgeting. The medium-term target could be for a Consolidated General Government Budget, including the state budget, local governments’ budgets, the State Social Insurance Budget, and all extra-budgetary funds, to be developed and used as the basis for the BCP from the 2005 budget onwards.

3.95 Improving Fiscal Reporting and Budget Transparency. The suggested medium-term target is for budget execution data for state and all local governments’ budgets on both commitments and cash basis to be prepared and published in a timely manner. The provision of accurate and timely information to support effective and informed policy decision making is key. It is also recommended that timely and comprehensive reports on execution of the State Social Insurance budget based on economic and functional classifications, and which also present the state social insurance budget together with the state and local government budgets, should also be produced.

3.96 Strengthening Internal and External Accountability Framework. Suggested short-term recommendations are to reorganize the Ministry of Finance’s internal audit system so as to ensure increased independence and capacity; and to seek to mobilize donor support for institution building both for the newly-established Internal Audit Unit of the Ministry of Finance and also of the Chamber of Accounts. The medium-term target could be for both the internal audit function and the Chamber of Accounts to have objectives, responsibilities, functions, capacities and accountability frameworks in line with those required for modern internal audit and external supreme audit institutions, and in line with the recommendations from the CFAA.

3.97 Enhancing the Quality of Macroeconomic Forecasting. It is suggested that the Government should seek to improve the macro-fiscal framework and to secure strengthened institutional capacity in, and institutional arrangements for, macroeconomic analysis. As a medium-term target, it is suggested that a comprehensive macroeconomic forecasting model be developed and used initially during preparation of the 2005 budget.

3.98 Strengthening Budget Preparation. The budget process could be streamlined by starting the budget process earlier and initiating budget preparation at the beginning of

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the year (January). Proposed revisions to the budget calendar, however, should be reviewed carefully to ensure they are realistic and do not place further demands on the limited capacity of the Ministry of Finance and line ministries at a time when other budget-related reforms are being implemented.

3.99 Revenue projection methodologies could also be reviewed with the purpose of developing more reliable and robust tools for simulating revenue scenarios for all parts of the budget. These efforts would need to be supplemented with well-designed internal capacity-building efforts.

3.100 The Ministry of Finance should continue its efforts to gradually shift away from using norm-based budget estimates to approaches based on demand-based inputs, program costing, and monitoring of outputs and outcomes. This approach would enable budget managers in line ministries to make tradeoffs among sectoral programs, given limited resources, based on sector strategies, cost effectiveness, and outputs and outcomes. It would also allow budget managers to monitor the outcome of a program to ensure technical efficiency of resource deployment. Budget proposals should outline the inputs required for a program activity and identify anticipated outputs and outcomes, in order to facilitate monitoring of budget performance at the levels of allocative and technical efficiency. In the short term, attention should continue to be devoted to building capacity in the area of performance and program budgeting, with the pilots in education, and health continued and developed further for the 2004 budget.

3.101 Strengthening Budget Execution. To improve accountability and transparency in the use of public resources, the Government needs to extend the coverage and effectiveness of expenditure control systems and processes in order to limit spending within available resources and to minimize the generation of new expenditure arrears. A well functioning treasury system serving local governments’ budgets should play an important role in enhancing the control of commitments. A medium-term target would be to have in place a borrowing plan consistent with real cash inflows and outflows.

3.102 Strengthening public debt management should be a priority area to ensure least cost financing of the fiscal deficit in the short run and fiscal sustainability of debt service over the medium and long term. The Government’s medium-term target should focus on the development of a comprehensive public debt strategy and ensuring prudent implementation of the strategy.

3.103 The Ministry of Finance should further strengthen the budget execution process, in particular cash flow planning and management to ensure the predictability of cash release. Realistic cash planning could begin with a more realistic forecast of cash inflows and outflows prepared in close coordination with other departments (NBM, Budget, Tax, Customs, and Debt Departments). In addition, a borrowing plan consistent with forecasts of cash inflows and outflows should be prepared as a part of a cash plan. The plan should be updated weekly and monthly, and it should be communicated to line ministries to provide predictability of funding and allow them to effectively plan their spending.

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F. CONCLUSION

3.104 This chapter has sought to identify a reform agenda for the deep institutional reforms required in the area of public expenditure management, particularly strategic prioritization and allocative efficiency in budget formulation and aggregate fiscal discipline and technical efficiency in budget execution. In the next chapter, the parallel required reforms in the areas of center of government decision-making and strengthening operational efficiency of the public administration are identified for consideration by the Government.

4. BUILDING CAPACITY FOR INCREASED GOVERNMENT EFFECTIVENESS

4.1 In Chapter 3 an assessment of the effectiveness of Moldova’s budgetary system at the levels of aggregate fiscal discipline, allocative efficiency, and technical efficiency was presented. Recommendations were put forward for consideration by the Government of Moldova in order to: (i) strengthen budget management through improving comprehensiveness of budget coverage and improving fiscal reporting and budget transparency; (ii) improve the budget process through strengthening execution processes; and (iii) accelerate the adoption of the MTEF as an integrating mechanism to promote better allocative efficiency. However, this mixture of institutional and technical changes in budget management itself cannot be implemented effectively without the implementation also of deep institutional changes to significantly enhance the capacity of Moldova’s center of government decision-making system; radically streamline government structures; fundamentally shift incentives and begin radical pay reform; and rebuild the civil service system as a merit-based and depoliticized professional career civil service. These are the challenges examined in this chapter.

4.2 Moldova is at the beginning of a complex and long-term process to rebuild its public administration at all levels of government. While most OECD countries have been pursuing active public sector reform programs over the last ten to fifteen years (and in some of these countries, radical reforms have indeed been developed and implemented over decades), the challenge for Moldova at the start of this process is particularly severe given the weakness of the existing public service and the Government’s limited ability to make the required investments to support the development and implementation of reforms.

4.3 Data from the 1999 BEEPS Enterprise Survey shows that from the perspective of the enterprise sector in Moldova, less than 10 percent of enterprise managers surveyed felt the Government in Moldova was helpful to their business (Figure 4.1). At the same time, they had to spend almost 15 percent of their time in dealings with Government officials, compared to an FSU average of 6 percent (Figure 4.2). Sixty percent of Moldovan enterprise managers surveyed felt corruption was problematic for the operation and growth of their business. Less than 10 percent gave a positive evaluation of the quality of central Government services.

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Figure 4.1 : Private Sector View of the Helpfulness of Government

Source: World Bank/EBRD Business Enterprise Survey (BEEPS - 1999).

Figure 4.2 : Management Time Spent with Government Officials (CIS Average is 6 Percent)

Source: World Bank/EBRD Business Enterprise Survey (BEEPS - 1999).

What percentage of management time per year is spent in dealing with government officials about the application and

interpretation of laws and regulations?

0%

5%

10%

15%

20%

Moldova Romania Russia Latvia Poland Ukraine Armenia

Perc

enta

ge o

f Tim

e

How helpful do you find central and local governments toward businesses like yours?

0%

10%

20%

30%

40%

Moldova Romania Russia Latvia Poland Ukraine Armenia

Perc

enta

ge o

f Firm

s Who

Fin

d

the

Gov

ernm

ent H

elpf

ul

Central Government Local Government

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4.4 Unusually perhaps, the overall size of the central civil service and of local government administrations in Moldova is not a key problem. These are comparatively small by international standards, although there are still some areas of over-staffing and many areas where significant efficiency, effectiveness and cost-effectiveness gains could be achieved.

A. PRESENT POSITION


4.5 This section presents an assessment of the functional and institutional arrangements for center of government decision-making in Moldova against a set of international benchmarks that seeks to summarize present practice in EU member states.

Benchmarks

4.6 The set of international benchmarks is set out in Box 4.1 below.

Box 4.1: Center of Government Decision-Making Benchmarks

A. Functional Arrangements at Center of Government: - Center of government demonstrates ability to manage the logistics of supporting Cabinet and Cabinet

committees. - Cabinet office restricts cabinet agenda to items of strategic significance, and avoids Cabinet agenda getting

clogged up with second-order issues, while ensuring that items of strategic significance are not kept fromconsideration by the cabinet.

- Center of government contains capacity to subject proposed agenda items for Cabinet to rigorous scrutiny andevaluation.

- System is in place and operational for monitoring the timeliness and substantiveness of implementation ofCabinet decisions by ministries.

- Ministry of Finance provides full and timely reporting on actual expenditure against planned to Cabinet.

- Ministry of Finance is able to ensure that allocations required to implement agreed cabinet decisions arereflected in budget and that allocations in the budget are in fact reliably delivered to spending ministries.

- Ministry of Finance is able to provide alternative macroeconomic scenarios to Cabinet to illustrate implications of varying policy and fiscal stances and provide context for evaluation of specific policyproposals.

B. Institutional Arrangements for Making Decisions at Cabinet Level Binding on all Ministers: - Cabinet decisions are taken in the context of detailed supporting information available on costs and benefits

and impact of proposals, including alternative options where appropriate. - Cabinet takes strategic decisions between different policies and spending areas which are in line with overall

government program and reflect government priorities. - Cabinet takes decisions which can be contained within overall fiscal/resource constraints. - Cabinet office ensures ministers have scope for giving real consideration to policy proposals and ensures that

full and appropriate consultation is undertaken.

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Functional Arrangements at Center of Government

4.7 In Moldova, the key central agencies supporting the Government’s decision-making process are the State Chancellery, the Ministry of Economy and the Ministry of Finance. The State Chancellery in Moldova does not currently play a sufficiently strategic role. While it provides feedback on ministry proposals, assesses their legal implications, participates in budget deliberations, attempts to coordinate policy across ministries, manages a control system of line ministry actions, and meets with stakeholders to resolve contentious issues, it does not, as yet, play a strong role in supporting strategic prioritization. This can be illustrated by the fact that, at present, the Cabinet receives many proposals which are presented without alternatives, do not present a consideration of the fiscal impact, do not reflect a real agreement between all concerned ministries, and focus overly on short-term measures, not all of which may be aligned with the medium-term priorities as set out in the Government’s overall program.

4.8 The State Chancellery could usefully assume a stronger role with respect to strategic planning (assisting the Government with linking policy priorities to the medium-term expenditure framework), horizontal policy coordination, and policy analysis. Consideration could be given to depoliticizing the management positions within the State Chancellery, and perhaps the director’s position, in tandem with broader efforts to create a professional depoliticized civil service. Introduction of the MTEF should give increased prominence to the Ministry of Finance’s role in supporting center of government decision-making; and should lead to the State Chancellery and the Ministry of Finance having to work more closely together on integrating strategic planning, development and monitoring of implementation of the Government’s work program, and strategic prioritization of policy and reform measures.

4.9 At present, Moldova does not have an effective system of Cabinet committees in place. Such a system often allows for deeper discussion of alternative policy options, helps to improve the quality of final decisions; and allows Cabinet meetings to be more streamlined and effective, thereby allowing the Cabinet to focus more on the achievement of the medium-term objectives from the government work program. All OECD countries now use some form of Cabinet committee system.

Institutional Arrangements

4.10 Policy Management Capacity. The Public Sector Reform Strategy developed in 2000 identified frequent changes of laws and regulations governing entrepreneurial activity as a major impediment to the development of the private sector. In a recent survey, among seven transition countries (also including Armenia, Latvia, Poland, Romania, Russia, and Ukraine), Moldova rated the highest (over 90 percent) with respect to the percentage of businesses that considered policy instability/uncertainty to be a problem.55

55 World Bank/EBRD Business Enterprise Survey (BEEPS - 1999).

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4.11 As can be seen from Figure 4.3 below, effective implementation of a complex policy reform depends on policy continuity being achieved over an extended period of time: for a major policy reform in an OECD country, it can require four years to move from strategy development to the beginning of the reform implementation process.

Figure 4.3: Typical Policy Cycle for Complex Reform

4.12 The average duration of governments in Moldova since 1990 is around a year. Thus, to move from strategy to implementation for a major policy reform would require a fully consistent approach to the development of a new policy together with continuity in key staffing across the lifespan of four governments. So many changes of government and the associated political volatility as experienced in Moldova leads inevitably to policy discontinuity. Given also the high levels of turnover experienced in Moldova at change of government, with new staff also requiring training and orientation, it is clear that it is likely to be extremely difficult for the Government of Moldova successfully to carry through to implementation major policy initiatives. In some countries, a counterbalance to unpredictability at the political level is the stability of a depoliticized professional civil service. However, the high degree of politicization in Moldova’s public administration precludes its civil service from playing such a role.

4.13 Government Decision-Making Processes and Structures. The effectiveness of Moldova’s government decision-making process can be assessed at two levels: first, the strategic level indicates how well the Government aligns policy priority-setting with resource allocation, especially as part of the annual budget process; second, the policy development level assesses the quality of government deliberations on the detailed policy choices that are made on a week-to-week basis.

4.14 At the strategic level, a fundamental determinant of effective public sector management is the capacity of governments to undertake effective strategic prioritization. This requires that governments integrate policy and budget deliberations, recognizing that policy priorities need to be set within a realistic, medium-term fiscal framework. In Moldova, there are several key documents that reflect the Government’s strategic policy commitments. These include:

• Government Program

• Activity Program of the Government

hire staff, implement

develop strategy

obtain budgets

develop programs

secondary legislation

framework legislation

1 year 2 years 3 years 4 years

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• Government Decision on Implementing the Activity Program of Government

• Budget Concept Paper

• Broad Policy Strategies (e.g., Interim PRSP).

4.15 Only one of the above strategic documents (Budget Concept Paper) attempts to integrate policy and fiscal planning (see Chapter 3). The most recent Government Program (from the 2001 election) and the related Government Activity Program outline the major policy commitments and the ensuing Government Decision and assigns ministerial responsibility and deadlines for each commitment. There is, however, a fundamental disconnect between the list of policy commitments in the Activity Program and the fiscal planning that takes place as part of the budget. The initiatives for each policy sector are not framed within any overarching policy objectives. Expected policy outcomes are not identified. Although one section of the Activity Program does set out macroeconomic assumptions (including targets for growth, inflation, deficit reduction, and current account deficit), there is no analysis of how these targets will be achieved or of their relationship to the numerous economic initiatives listed elsewhere in the document. In the subsequent decision designed to secure the implementation of the Activity Program, 189 commitments are listed, but none of these are costed. Most of these would have some resource implications, and several would have significant fiscal implications.56

4.16 At the policy development level, the primary decision-making forum is the weekly Government meeting. Few explicit standards exist with respect to the quality of analysis that needs to be reflected in proposals (usually draft legislation) submitted to the Government meeting. As a result, full consideration of policy options and of the fiscal and policy impacts of the recommended option often does not take place. Some brokering and coordination of policy items between line ministries does occur through the Deputy Prime Ministers, who are responsible for broad policy sectors (for example, economic, social). In addition, ministerial sub-committees do meet to deal with issues that may not be reviewed at the weekly Government meeting. However, these structures do not address the need to provide the Prime Minister and Ministers with a sufficiently effective forum for ensuring meaningful consideration of major policy items before their consideration at the Government meeting.

Civil Service Management

4.17 This section assesses the present position in Moldova in the area of civil service management against benchmarks derived from present practice in EU member states.

56 For example, the concessional lending program for agricultural producers; commitments to provide sufficient funding to maintain the minimum level of healthcare; mandatory medical insurance; to increase the scope of free higher education; to provide for continuous growth of budget allocations in education; to provide for an indexing mechanism for wages and pensions; to reduce the gap between the minimum wage and the subsistence level; to correlate the family allowance with the average wage, etc.

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Benchmarks

4.18 The set of international benchmarks in this area is set out in Box 4.2 below.

Institutional Framework

4.19 Civil Service Human Resource Management. The Personnel Policy Division (PPD), now part of the State Chancellery but until recently reporting directly to the Government, has the lead responsibility for development and promulgation of personnel policy across government. In practice, the division has encountered difficulties in implementing its role and has not been able to assume a strategic role in government-wide human resources management or to exercise any effective authority over ministry personnel departments. PPD was successful in developing a human resource management information system, but this was never implemented across the whole of government.

4.20 At the ministry level, the Single Regulation of the Personnel Service (1998) delineates the responsibilities for personnel services in line ministries and agencies. These responsibilities cover a wide range of human resources functions, including

Box 4.2: Civil Service Management Benchmarks A. Legal and Ethical Framework - Specific legislation governing the civil service, with subsidiary legislation and/or regulation that

elaborates rules/procedures/systems for personnel management is in place. - Behavior of civil servants and political appointees is governed by a Code of Conduct. - Merit-based rules for civil service management are established in law and are enforced. - Scope of the civil service is clearly defined. - Civil service political neutrality is provided for and is respected in practice. - Civil service operations and policies are transparent, with statutory rights of access for outside

parties to civil service standards, performance targets, and actual performance. B. Institutional Framework - Effective, dedicated institutions for civil service policy, management and oversight with clearly

established legal status are set up and fully operational. - Accountability and recourse mechanisms for citizens, employees, the legislature and the executive

are in place and operating effectively. C. Pay and Employment Policy - Numbers of public servants and of civil servants are in line with international and regional best

practice and needs. - Civil service wage bill is affordable and contained within overall fiscal framework. - Remuneration is sufficiently competitive to recruit, retain and motivate sufficient qualified staff at

all levels. - Compensation system is simple, monetized and transparent, with rule and market-based approaches

for determining actual compensation. - Establishment control system is in place and linked to computerized payroll and personnel

information system to provide adequate budget control of personnel expenditure.

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participating in restructuring decisions; preparing 5-year staffing plans; advising on developmental assignments, recruitment and promotions; and organizing training. Implementation of this regulation varies widely among ministries. Ministries with well-managed personnel sections appear able to provide effective leadership in human resources management. In other ministries, however, the personnel function remains exclusively administrative.

4.21 Structure of Government. The issue of whether Moldova’s current array of government functions and structures is appropriate needs to be linked to the related questions of whether they are affordable; whether (and how well) they support the Government’s policy priorities; and to what extent they provide value for money. In seeking to tackle such questions, most advanced transition countries have initiated restructuring programs. Many of these have been based upon a program of functional reviews of ministries and other government bodies. The term “functional review” can cover a wide range of approaches to reshaping government. As observed in Manning and Parison (2001),57 many functional reviews have failed to meet expectations. Complex government restructuring initiatives are beyond the capacity of the Moldovan civil service at present. A gradual implementation pace will need to be maintained that links functional reviews to the MTEF and which gives initial priority within the functional review program to those areas that support the Government’s social and economic policy priorities.

4.22 Central Government Structure. Although there is no general optimal number of ministries, OECD countries have over recent years had an average of twelve to fifteen ministries (and members of Cabinet). This average has been reasonably stable over recent years. The more noteworthy trend has been for line ministries to become much smaller in size. The trend among transition countries has been towards consolidation. At independence, Moldova had sixteen ministries, rising to twenty by 1993. In 2001, the number of ministries, as shown in Table 4.1 below, stood at fifteen.

Table 4.1: Change in the Number of Central Government Agencies in Moldova since 1985

Ministries Departments/State Committees

Total

1985 30 14 44 1989 15 17 32 1991 16 13 29 1992/3 20 8 28 1997/8 17 8 25 1999/2000 14 6 20 2001 15 13 26 OECD average 12-15

57 Manning and Parison identify five broad types of functional reviews: pure policy/program, pure efficiency, upstream, intermediate, and downstream. The typology looks at the organizational breadth of the review, its drivers and objectives, its linkages to the budget, and the way efficiency versus effectiveness are addressed as the key variables in determining which type applies.

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4.23 The Government also contains several departments as well as the State Chancellery. While the overall number of ministries in Moldova seems in line with OECD and regional practice, a number of concerns remain: duplication of functions; provision of unnecessary or low priority functions; existence of priorities in the government work program which are not appropriately resourced; presence of remaining commercial activities; and issues concerning the allocation of responsibilities and functions between levels of government.

4.24 Finally, there is also a need to rebuild line ministries as smaller units which focus on policy analysis and development and on monitoring and evaluation, for which the prime client group is politicians. This implies a radical restructuring of existing line ministries (particularly sectoral line ministries).

Legal and Ethical Framework

4.25 The principal laws and regulations governing the management of the civil service include: Law on Civil Service (1995); Regulation on the Organization of Selection to Fill Vacancies in the Public Administration (1997); Single Regulation of the Personnel Service (1998); Direction for Personnel Policy within Government (1998). In terms of ethics, an oath of service is signed by all new public servants. The present Civil Service Law does not provide as clear a legislative underpinning for a merit-based and depoliticized professional civil service as is perhaps required. In addition, there is a need to address the issue of the public service ethos having severely eroded over recent years. This needs to be rebuilt and perhaps also underpinned with a Code of Conduct or Ethics for civil servants, together with regulation of conflicts of interest.

Pay and Employment Policy

4.26 Pay and Employment Numbers and Expenditures, 1990 to 2000. When compared to other transition countries, the total general civilian employment in Moldova appears to be in the middle range. Table 4.2 ranks Moldova third out of eight transition countries in terms of the size of the civilian public workforce as a percentage of the population.

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Table 4.2 : Government Employment

as a Percentage of Population and Employment Levels (2000)

General Civilian Government Employment

Country

Central Government

Subnational Government

Education

Health

Total Civilian

Moldova [2000] 0.02% 0.03% 3.1% 1.6% 5.2% 8 10 112 59 189

FYR Macedonia 2.1% 0.1% 1.0% 0.8% 4.0% 43 1 21 17 82

Hungary 1.5% 1.6% 2.4% 2.2% 7.6% 148 158 237 225 768

Lithuania 1.3% 0.5% 4.0% 2.5% 8.3% 47 18 146 93 304

Poland 0.4% 0.3% 1.2% 0.9% 2.7% 163 113 452 330 1,058

Romania 0.5% 0.5% 1.1% 0.6% 2.7% 114 114 239 141 608

Russian Federation 0.02% 0.7% 1.5% 1.3% 3.5% 36 1067 2,169 1901 5,173

Slovenia 1.4% 0.2% 1.3% 0.9% 3.7% 28 3 25 18 71

Australia 0.8% 2.0% 2.3% 1.5% 6.6% 150 389 427 276 1,242

Canada 1.1% 2.0% 2.7% 2.3% 8.1% 331 622 814 708 2,475

Sweden 2.3% 9.4% 1.3% 2.4% 15.4% 204 832 113 215 1,364

United Kingdom 3.1% 3.4% 1.4% 1.6% 9.5% 1,804.0 1,989 813.0 968.0 5,574

United States 1.0% 5.8% 3.3% 0.5% 10.6% 2,634 15,812 9,011 1,256 28,713

Notes: Government employment figures are from the World Bank’s updated database for An International Statistical survey of Government Employment and Wages and refer to the mid to late 1990s. Individual data for a given country may not be for the same year. Total civilian employment is the sum of data in this table, and may differ from employment totals for any given year. Population figures refer to 1999 and are from the World Bank Live Database. Some discrepancies may arise due to the use of multiple sources. Police employment is excluded.

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4.27 As shown in Figure 4.4,58 the most striking characteristic of public sector employment in Moldova compared to other transition economies is its low number of state administration employees relative to total population, both at central government and local government levels. There are relatively small administrative staffs in ministries in Chisinau, with the majority of central government employees working in deconcentrated units of the tax inspectorate, customs, and statistics. Although central government staffing needs to be closely scrutinized in terms of its effectiveness and capacity, the greater challenge is to rebuild capacity so as to support timely, effective and cost-effective implementation of the Government’s work program.

4.28 General civilian government employment in Moldova has been declining throughout the second half of the 1990s, with the trend significantly accelerating after 1997 (see Table 4.3). In 2000, total civilian employment dropped by almost 20 percent. State administration employment has been reasonably stable, while significant reductions have been made in education and health employment. This decline arose mainly out of: (i) health sector reform accompanied by health facilities closing down and dismissal of personnel; (ii) fiscal constraints leading to enforced downsizing; (iii) outflow of specialists due to low pay, particularly in the education and health sectors. Table 4.4 presents the average monthly salaries for government employees working in the state administration, education and health. While the salary of employees working in the state administration increased in nominal terms about 2.5 times over the last 3 years, salaries in the social sectors registered a relatively modest rise of 35 to 40 percent. As a result, in 2000, the average salary in the education and health sectors was almost four times lower than that in the state administration. At the same time, due to inflation and local currency devaluation, salaries in education and health had deteriorated significantly in real terms.

58 CEE includes all the former socialist countries of East and South Europe, exclusive of Baltic countries.

Figure 4.4: General Civilian Government Employment as a Percentage of Population

0

2

4

6

8

10

Moldova CISaverage

Balticcountries

Hungary Bulgaria CEEaverage

OECDaverage

Central Government Local Government Education Health

Source: As for Table 4.2.

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Table 4.3: Health, Education and Public Administration Employment, 1997-2000

1997

1998

1999

2000 Average Annual

Growth Rate ‘97

Average Annual

Growth Rate ‘94

in thousands in percent General Civilian a 275.4 253.4 235.0 190.4 -11.6 n.a. Health and Social Protection 89.4 83.5 75.4 62.0 -11.5 -2.1 Education, Culture and Sport 167.1 151.0 141.8 110.9 -12.8 -2.7 Public Administration 18.9 18.9 17.7 17.6 -2.4 n.a. a Excludes power structures, police, judiciary. Note: End year data. Source: Ministry of Finance and the Department of Statistics for pre-1997 data only.

Table 4:4: Civilian Government Wages (Monthly Average)

1998 1999 2000

in MDL Administration 310 497 767 Central ministries 435 667 937 Decentralized units and agencies 240 371 755 Local administration 325 545 756 Education (excl. administration) 144 156 196 Health (excl. administration 135 154 189

in USD Administration 58 47 62 Central ministries 81 63 75 Decentralized units and agencies 45 35 61 Local administration 60 52 61 Education (excl. administration) 27 15 16 Health (excl. administration) 25 15 15


4.29 Moldova’s level of public employment in the social sectors is generally comparable to that of the other transition countries. After a period of decline, in 2000, employment in the health sector reached a level comparable to that in OECD and CEE countries and indeed slightly lower than in other CIS countries. Employment in education on the other hand is somewhat higher than in OECD and CEE countries, but lower than in other CIS countries. Moldova tends to have comparatively too many support staff and not enough professional staff in these key sectors.

4.30 High staff turnover remains a serious problem for a number of Moldovan central government ministries and agencies. Although low salaries relative to those paid by some segments of the private sector is one of the factors inducing turnover, the large differences among ministries suggest that other issues may also play an important role.

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One possible explanation is the large difference in market demand for skills of employees working in different ministries. For example, the Ministry of Health has enjoyed very low turnover rates, basically limited to staff retiring, while turnover at the Ministries of Economy, Finance, and Foreign Affairs is significantly higher. It seems that often instances of high turnover can be accounted for primarily by staffing changes made consequent to change of minister and change of government.

4.31 Compensation Policy. The most extensive regulation governing compensation policy in Moldova is the Government Decision 139, On Remuneration of Public Officers and Individuals Performing Technical Services to Ensure the Functioning of Public Authorities on the Basis of the Unified Tariff Grid (1998) and the 1999 amendment (Government Decision 766).

4.32 Beyond base salary, the regulation identifies several additional payments, including:

• increases of up to 80 percent to reward tasks of major importance or requiring a high degree of qualifications;

• bonus of up to 30 percent to offset additional work owing to the absence of colleagues;

• bonus of up to 1.5 times wages to be paid monthly or quarterly depending on job level;

• raises for qualification based on a multiple of the minimum salary (3.5 to 5.0 for the nine classes of the three civil service ranks);

• 15 – 40 percent increase for work experience (five levels from 2 to 20+ years); and

• up to 25 percent language allowance, depending on how additional languages are used on the job.

4.33 In addition, at senior levels there are additional non-cash benefits such as cars that substantially increase the overall value of the compensation package. The bonus and allowance payments, which can be several times the base salary, remain very high in comparison to other countries, where 10-20 percent of base salary is the norm. For instance, at grade level 23, the total pay is 4.6 times the base salary; at grade level 13, it is 3.7 times base salary.

4.34 Compensation Levels. Like most transition countries, Moldova’s compensation levels in the public sector are very low when compared with compensation which could be obtained in the private sector or from working with an international organization. However, in Moldova’s case the gaps are extreme (see Table 4.6 and Figure 4.5). At senior management levels, an equivalent job at the lower end of the market (domestic private sector) will pay more than six times the civil service salary (Grant, 2000). The key conclusion appears to be that civil servants in Moldova are underpaid compared to the private sector at all levels; but that the middle management and senior management levels are extremely comparatively underpaid (not surprising given that the recruitment

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and retention problems appear particularly acute at management levels, as well as for some professional skill areas). Not surprisingly, in the recent public officials survey (2000), low salaries were cited as both the main cause of turnover (88.2 percent) and a leading cause of corruption (56.2 percent).

Figure 4.5: Comparison of Civil Service and Private Sector Pay

Source: Grant, Hugh. 2000. “Moldova Salary Survey Report”..

Table 4.5: Comparison of Civil Service Pay Levels with Market Rates

Benchmark Job Level Pay

Category Total

Salary Market Low*

Market High*

Specialist Entry 13 458 779 1470 Specialist 1 year 14/15 548 1305 3545 Principal Specialist 16/17 635 2410 5570 Section Head 18/19 789 2948 9358 Head of Division 18/19/20 948 4090 14360 Head of Department 21/22/23 1199 6960 18653 “Market Low” represents lowest quartile (primarily domestic private sector), while “Market High” represents highest quartile (primarily international organizations)

Source: Grant, Hugh. 2000. “Moldova Salary Survey Report”.

4.35 Salary Decompression. A recent salary survey undertaken for the Government (Grant, 2000) that examined total average compensation for grade levels 13 to 23 (from specialists up to First Deputy Minister) established that the decompression ratio is 2.76

02000400060008000

100001200014000160001800020000

13 14/15 16/17 17/18 18/19/20 21/22/23

Civil Service Job Category

Tota

l Lei

per

mon

th, G

ross

C.S.Salary25th %-ileMedian75th %-ile

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for total compensation (excluding non-monetary benefits) for grade levels 13 to 23.59 By comparison, OECD levels range from 6 to 9.60 This indicates that there is a very low level of pay differentiation in Moldova between a junior specialist and a Deputy Minister.

Civil Service Human Resource Management

4.36 This section assesses the present position in Moldova in the area of civil service human resource management against benchmarks derived from present practice in EU member states.

Benchmarks

4.37 Box 4.3 summarizes international benchmarks in this area.

Merit

4.38 OECD countries have long focused on the merit principle as a key cornerstone for maintaining effective and professional civil services. Meritocratic recruitment has been shown also to be a key determinant of bureaucratic performance in the public sector in

59 The total pay at level 13 was 443.87 lei per month gross verus 1223.83 lei at level 23. 60 From World Bank. 2000. Ready for Europe: Public Administration in the EU Accession Context.

Box 4.3: Civil Service Human Resource Management Benchmarks A. Human Resource Management - Planning capacity for reviewing and forecasting current and projected staff resource

requirements is operational. - Personnel information system is in place, integrated with budget, accounts, payroll and

establishment management systems. - Recruitment is undertaken on the basis of merit after a competitive process; promotion is based

on open and transparent merit-based procedures. - Performance appraisal system is operational with hierarchy of objectives (ministry to

department to work unit to individual employee), focused on performance improvements. B. Training and Career Development - Training system provides for systematic identification of training needs. - Training budget is determined in light of affordability, international best practice comparators,

and training needs. C. Accountability and Transparency - Decision-making is placed at lowest appropriate level to ensure effective management, service

delivery, and client responsiveness. - Explicit service delivery standards are determined and made available to citizens and reported to

legislature, together with assessment of performance against these targets.

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developing countries.61 It is also clear that poorly performing public administrations can have far-reaching adverse economic impacts62.

4.39 There appears to be a broad consensus within the stakeholder groups for public sector reform in Moldova that merit needs to be re-established as a core defining principle of the civil service, enshrined through appropriate provisions in amended civil service legislation, protected through the setting up of an independent oversight body such as a Civil Service Commission, and respected by all political parties, factions, and groupings.

Depoliticization

4.40 The 2000 Public Sector Reform Strategy states that public administration should be “client-oriented and based on merit, corresponding to the best European practices depoliticized and corruption resistant.” Notwithstanding these stated intentions, Moldova has yet to take any substantive measures to constrain the practice of placing political appointees deep into the civil service. Although it is not possible to establish precise numbers, there is strong anecdotal evidence that Moldova’s civil service is highly politicized and that the level of political appointees varies significantly between ministries. One ministry reported that as many as 30 percent of its employees are removed at change of government, whereas another reported turnover of approximately 5 percent.

4.41 This echoes the range from the 2000 public officials survey where positive responses to the assertion that elected officials often influence promotions and employment ranged from 10 to 50 percent among ministries. In the same survey, 50.5 percent of the senior managers interviewed had been in their positions less than one year. Interestingly, although the Civil Service Law makes specific provision for the hiring of political appointees, this approach is seldom followed. It appears that the unchecked ability for ministers to place appointees of their choice in positions that would normally be career civil service posts has reduced incentives to use the legally sanctioned route.

4.42 This phenomenon relates directly to the policy continuity problem identified earlier, where constant changes of government, accompanied by widespread turnover of staff, damage the public administration’s capacity to implement medium-term policy reforms. Chronic politically-motivated turnover at senior levels not only raises the issue of competence, but places new managers in jobs where their likely tenure will not outlast the learning curve for the new position. This problem is further aggravated when these new managers are expected to leave their posts, without pay, to assist in the re-election campaign of their minister once an election is called.

61 Rauch and Evans study (2000) reviewed data for 35 less developed countries and tested bureaucratic performance against competitive salaries, internal promotion and career stability, and meritocratic recruitment. This last factor was found to be a statistically significant determinant of bureaucratic performance. 62 See for example: Nizzo. 1999.

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4.43 The apparent high level of politicization, and the negative consequences of this practice on civil service performance, suggest that an enforceable framework that clearly differentiates political and administrative roles and designates those positions that will be subject to political appointment should be highlighted as a key priority area of public administration reform in Moldova.63 Given the ongoing high level of political volatility, serious consideration should be given to drawing the line at which the professional civil service begins at the highest level possible (for example, the most senior post in the ministry).64

4.44 In choosing the best route to de-politicize its public administration, Moldova can draw upon the experiences of EU accession countries, all of which have implemented, or are in the process of implementing, a professional civil service. Key objectives must be to build a career public service, to provide for continuity on change of government and/or change of minister, and to provide for clear, distinct, and enforceable differentiation in recruitment and human resource management arrangements for career civil servants as opposed to political appointees.

4.45 Even if an appropriate legal distinction is made between political appointees and professional public servants, compliance problems will arise unless a credible organizational framework can be established to exercise an oversight function. Although the Personnel Policy Department has some very limited powers with respect to hearing appeals on recruitment issues, these are not much used in practice. Accordingly, any efforts to create and enforce an appropriate legal distinction between political and administrative levels must be accompanied by the creation of an effective oversight organization that can enforce these provisions. The approach of setting up a body such as a Civil Service Commission is a common one, with senior, experienced, and generally credible practitioners appointed as commissioners on a non-partisan basis. Clearly, in highly politicized contexts and highly volatile political environments, the challenge of preserving the independence and credibility of such an oversight body is an extremely difficult one.

Training and Career Development

4.46 The Civil Service Law identifies “upgrading the qualifications of civil service employees” as one of the main tasks of public administration. A Government decision in 1991/92 stipulated that 2 percent of each ministry’s wage bill be allocated to training. In practice, however, budget constraints have significantly reduced the availability of training. Although accurate data do not exist on training expenditures, anecdotal evidence indicates that this is a growing area of concern. Beyond the issue of the amount or cost of actual training is the relevance of that training to the country’s priorities. Currently, no 63 There is wide variety in terms of the level of politicization in OECD countries. At the higher end, the ratio of political to professional staff in the US is 1 to 400, while at the lower end, the ratio is 1 to 2000 in Sweden (Manning and Parison. 2001). 64 This would likely involve the creation of a state secretary position that would be part of the permanent civil service (UK model). This would not preclude the minister from hiring political advisers (already permitted under the existing Civil Service Law) or from working out some mechanism for addressing situations where the minister-state secretary relationship becomes dysfunctional.

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national or civil service training strategy or plan exists. A needs analysis of civil service training needs has not been conducted.

Accountability and Transparency

4.47 The link between positive performance and effective accountability underpins modern systems of policy, financial, and human resource management in the public sector. In Moldova’s case, there are already extensive, albeit prescriptive target setting, tracking, and reporting systems in operation covering a wide range of inputs and outputs. In one respect, these are remnants of Soviet-style command and control planning systems. They do, however, represent an existing process and a discipline that may be constructively reshaped. The challenge will be to evolve a system that appropriately balances the need for stronger and publicly reported accountability for policy outcomes with the need for sufficient flexibility to determine how best to achieve these outcomes at the line ministry level.

4.48 The elaborate control system managed by the State Chancellery tracks hundreds of items for which line ministries are responsible. These items are drawn from numerous sources, including the Government’s Action Program, Government decisions taken at the weekly Cabinet meeting, and budget execution. Regular reporting against these targets occurs, and ministry performance against these targets may be raised during budget deliberations. At this point, the control system clearly over-prescribes ministry actions and is not pitched at the outcome level. It does, nonetheless, provide a potential basis for developing a more outcome-based policy monitoring system. This would dovetail with the gradual introduction of the medium-term expenditure framework. It needs to be recognized, though, that building strong accountability systems is a long-term undertaking.

4.49 Because the control system is so detailed, its results can also often be used as the basis for assessing individual performance. In fact, some ministries use these results as a factor in determining the allocation of bonuses to individual employees. The frequency of bonus distributions ranges from monthly to quarterly, depending on the nature of the bonus and how frequently ministry management meets.

4.50 Although employee performance contracts do not exist per se in Moldova, an extensive system of attestation does operate whereby every three years, a ministry or agency attestation committee is formed to review each employee’s potential for promotion. Individual performance is taken into account in making that determination. Job descriptions are in place for most positions.

4.51 Transparency has both internal and external dimensions. Within government, it is strengthened by the open and full provision of information to decision-makers. Externally, it is supported through expanding the range and quality of information available to the public. Civil society groups can play an important role in holding the government to account for its commitments, but will only be able to do so if they have access to the necessary information (strategic goals, objectives, service standards and expected results, budgets, and actual service, financial performance, and results).

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4.52 The gaps in information made available to decision-makers have been discussed earlier in this chapter. With respect to external access to information, Moldova has yet to develop a tradition where civil society groups routinely participate in public policy. In countries with weak institutional capacity, stimulating external pressures on the civil service system to display more effective and appropriate behaviors and operations can be one of the most effective ways of accelerating change.

B. THE ROAD AHEAD

4.53 This section presents for the Government’s consideration recommendations for priority short- and medium-term actions in the area of public sector reform.

Key Challenges for the Government of Moldova

4.54 As Moldova initiates public sector reform, it needs to take into account the linkages of public administration reform with several other key areas of reform, particularly public expenditure management reform, social sector reform, and anticorruption efforts. Capacity building must focus on those skills that will be most needed to ensure that the state plays a proactive and innovative role in fostering the conditions for private sector development and economic growth. Likewise, improvements in administrative capacity in the social sector must support key priority reforms.

Short-Term Actions

4.55 The immediate challenge is to relaunch public sector reform. Additionally, it will be important for the reform team to apply an early focus on functional reviews so as to identify savings and resources which can be re-applied as investments in other reform areas (including pay reform).

Leadership and Overall Management of Public Sector Reform

4.56 It is essential that a signal be sent throughout the civil service that public administration reform is supported at the highest levels and represents a critical government priority. The immediate priority should be for the Government of Moldova to restart the public sector reform process through considering, amending as required, and then formally approving the Public Sector Reform Strategy. This would include reconstituting the high-level Steering Committee for Public Sector Reform, led by the Prime Minister; together with the three component-level Working Groups on Public Administration Reform, Public/Private Sector Interface, and Public Expenditure Management.

4.57 The Steering Committee, based on the work of the three Working Groups, could then develop and submit to Government for formal approval a detailed and costed Action Plan for Public Sector Reform. It would also be necessary to set up a Public Sector Reform Unit, reporting directly to the Prime Minister and the Public Sector Reform Steering Committee, which would act as the policy secretariat and support unit to the Prime Minister and Steering Committee, and which would develop specific proposals and monitor progress on implementation of the reforms. The Steering Committee would also

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need to draw up and have approved by Government a communications strategy and an internal and external consultation strategy and program.

4.58 To support the process of monitoring and evaluation by the Government and by external stakeholders of the impact of and outcomes from the reform program, it would be desirable from the outset of the reform process to have in place a set of monitoring indicators (including statistical and budget data, as well as results of public officials surveys, enterprise surveys, and service delivery surveys of service users).


4.59 To strengthen the system of government decision-making, it is recommended that consideration be given to restructuring the State Chancellery into a non-political Government Secretariat which would focus on strategic planning, policy analysis, and horizontal policy coordination across the Cabinet of Ministers and the Government overall. As a first step to achieving this, a functional review of the State Chancellery could be undertaken using criteria and terms of reference drawn up by the Public Sector Reform Steering Committee.

4.60 It could also be appropriate for the Public Sector Reform Steering Committee to set up an additional Working Group on Strategic Planning, drawing on members of both the Public Administration Reform and Public Expenditure Management Working Groups. This could propose a methodology for introducing policy and fiscal impact assessment of major policy proposals and for requiring mandatory costing, using fiscal impact assessment, of all policy proposals to be submitted to the Cabinet. All policy proposals submitted to Cabinet should provide answers to the following questions: what are the options; what are the costs of the options; what criteria are suggested for evaluating and ranking the options; what are other countries doing; who are the winners and losers from what is proposed; who will oppose the proposal and why; how will the public react and how should the proposals be presented to the public; what internal and external consultation has taken place; and what will the recommended option really cost, both in the short term and in the medium term.

4.61 This Working Group could also consider what changes are required to core legislation (Budget Law, Law on Government) to institutionalize an integrated strategic/fiscal planning process in the context of the MTEF. This Working Group could also draw up proposals for introducing a system of cabinet committees, to improve the quality of policy analysis and of inter-ministerial coordination, to strengthen policy contestability, and to reduce the overall load on Cabinet itself, thereby freeing Cabinet up to take a more strategic view on management of implementation of the overall Government work-program.


4.62 Legal and Ethical Framework. The main recommendations in this area are for the Public Sector Reform Steering Committee and the Public Administration Reform Working Group to undertake a fundamental review of the existing Civil Service Law and

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supporting legislation and regulations and to develop amendments designed to strengthen the application of merit and depoliticization. This could include proposals to set up a Civil Service Commission to function as an independent, non-partisan oversight body with respect both to merit (open, external competitive recruitment and promotions together with an appeals process) and depoliticization. Approaches in this area could include producing recommendations on measures to depoliticize the senior management levels of the civil service and to protect the mid and lower job levels from politically-motivated hiring or dismissal; revising the current legislated distinction between political and professional employees, so that senior ministry management positions, including those in the State Chancellery, are designated as professional, including possible introduction of the position of State Secretaries; and acting as the guardian of the depolitization provisions of the revised law.

4.63 The revised law could be accompanied also by a Code of Ethics for civil servants and provisions to define and enforce requirements and standards relating to conflict of interest for civil servants, and specifying appropriate political activity for different groups of civil servants.

4.64 Structure of Government. The immediate priority in this area could be for the Public Sector Reform Steering Committee to develop criteria for a comprehensive program of functional reviews of Government overall and of individual ministries and other bodies within the structure of Government. Initial review priorities could be the State Chancellery, as discussed above, and also an integrated functional review of Government economic ministries and agencies. Such a program would be designed to: (i) identify and eliminate non-core functions and services; (ii) provide for the commercialization and potentially also privatization, of direct commercial services presently provided within Government structures; (iii) and support the process of re-orienting the role of line ministries on policy analysis and development, strategic planning, management of those parts of the overall Government work-program falling within their remit, and monitoring and evaluation.

4.65 Pay and Employment Policy. The most immediate priority could be for the Public Sector Reform Steering Committee to develop a medium-term pay policy for the public sector. This would include developing a target pay position for the public sector as compared to the private sector that would be monitored through a series of annual comparative pay and benefits surveys. It would also entail developing a medium-target decompression ratio (the salary ratio of grade level 13 to grade level 23). The Steering Committee could also propose a medium-term target for monetization for pay and benefits, with the target to be expressed as what percentage base pay should be of total cash and non-cash pay and benefits. The first step toward the medium-term positions identified could also then be taken, both in terms of overall pay reform, and in terms of increasing the decompression ratio by a certain percentage for the next fiscal year (for example, so that the decompression ratio for grade level 13 to grade level 23 would move from 1:2.76 to reach 1:3.5 by end 2003).

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4.66 As well as reviewing the legislative underpinning for the merit principle, short-term approaches which could be considered to accelerate its application include: (i) the consideration of the creation of a senior executive service, which would unite in a single service the higher grade officials from all bodies of central executive power; and (ii) generating merit-based competition within the system by making greater use of competitive external recruitment, including the use of secondments from the private sector, academia, judets and local government.

4.67 Immediate priorities for the Public Sector Reform Steering Committee and the Public Administration Reform Working Group to consider in the area of training and development include: (i) proposals for a program for change management across the public administration as one of the building blocks to support the overall reform process; and (ii) designing a development strategy and program for senior and middle-level managers within the system. An overall training strategy for strengthening skills within the civil service in areas such as human resource management, financial management, policy analysis, economics, IT, and legislative drafting would also be important for building capacity to allow easier implementation of the overall reform program.

4.68 Immediate priorities for the Public Sector Reform Steering Committee and the Public Administration Reform Working Group in the area of accountability and transparency could be to move towards internal and external reporting of performance against objectives. An approach toward this could include developing proposals for the introduction of a scheme for performance management within the civil service based on a hierarchy of objectives being determined (at the level of Government overall, then for the individual ministry within Government, then for the unit within the ministry, and finally for the individual civil servant of the work team within the unit). Such a scheme would seek also to provide performance data on the work of ministries and other bodies of Government and to begin to seek to link such performance data with budget data, as a first step to allowing more explicit assessment of efficiency and cost-effectiveness issues.

4.69 Service standards could be determined for a number of pilot ministries or other bodies of Government, with the service standards (timescales, user fees and charges, contact details, appeals) then published, and provisions made to assess actual performance against the standards and for monitoring reports of actual performance against standards also to be published. The Steering Committee could also seek to develop suggestions for new forms of consultation with, and participation of, private sector business associations, NGOs, and individual citizens and service users in decision-making and service management (budget hearings, discussion of draft laws, formation of user groups and consultative bodies, as so on), and for developing freedom of information entitlements for citizens. MIS systems at the center of Government could also be strengthened to enable the State Chancellery to monitor the implementation of the Government’s work-program more effectively.

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Medium-Term Actions

Leadership and Overall Management of Public Sector Reform

4.70 Medium-term recommendations in this area could include for the Government to prepare and publish an annual report on the work of the public service and central civil service, and on the overall public service reform process activities and outcomes, together with a presentation of the public sector reform monitoring indicators.


4.71 The next stage of actions in this area could be expected to include the actual restructuring of the State Chancellery into a Government Secretariat; the strengthening of the Prime Minister’s Office and the reassignment to the Prime Minister’s Office of political functions previously exercised by the State Chancellery; and the launching of the agreed Cabinet Committees. A further priority area would be to seek to upgrade capacity in legal drafting (establishing standards, providing for improved success in recruitment and retention of legal resources within the civil service, and ensuring compatibility of new laws and regulations with EU standards and acquis communautaire.) Management information systems could be developed over the medium term to allow the State Chancellery more effectively to monitor the implementation of the government’s work-program.


4.72 Priority medium-term recommendations could be to build on the short-term actions taken through: (i) completing the process of putting in place the primary and secondary legislation and regulations to give the appropriate legislative underpinning for the application of merit and depolitization; and (ii) creating the independent oversight body, the Civil Service Commission, which would have the task of protecting and ensuring the appropriate implementation of this legislative framework. Further measures in the anticorruption area would be to strengthen the requirements for assets and earnings declarations by managerial-level civil servants and public servants at subnational levels of government, and to launch a process to strengthen and codify administrative procedures to remove unnecessary requirements while also removing inappropriate discretion from individual civil servants.

4.73 As regards the structure of Government, medium-term priorities would be to complete the application of the program of functional reviews to all central Government ministries and other bodies of Government and proceed with implementation of the recommendations of such reviews, and to begin a similar process at the level of judets and primarias.

4.74 Medium-term priority actions in the area of pay and employment would be to achieve the set of targets established by the Government for civil service pay position compared to the private sector, the decompression ratio, and base salary as a percentage of total cash and non-cash pay and benefits.

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4.75 Medium-term actions in the area of merit could be the implementation of a senior executive service and the broadening of the class of positions requiring competitive external recruitment. For training and development, medium-term priority actions would be to secure implementation and delivery of the strategies established earlier for change management and management development, and also for training and retraining in key skills areas as set out in the section on shorter recommendations above. In the area of accountability and transparency, medium-term priority actions would be: (i) the production and submission to Parliament of the first annual reports on the effectiveness of the public service overall; and (ii) broadening and deepening the process of determining service standards and publishing the standards determined, together with the introduction of processes and systems for monitoring actual performance and results against standards and for publishing such performance evaluations. The Chamber of Accounts could also be developed to begin undertaking value for money/effectiveness audits.

C. CONCLUSION

4.76 This chapter has set out for consideration by the Government of Moldova a number of steps which can be taken to launch a major program of public sector reform. Taken together with the recommendations from Chapter 3 on strengthening aspects of public expenditure management, implementation of this package of measures should help create much greater capacity within the system to allow the Government to secure implementation in an effective and cost-effective manner of the key priorities from the Government’s work program, including in the social sectors of health, education, and social protection.

4.77 The main recommendations identified above and suggested for consideration by the Government include: (i) launching a major program of public service reform; (ii) strengthening center of government decision-making through introduction of a system of Cabinet Committees and restructuring the State Chancellery into a non-political Government Secretariat; (iii) strengthening strategic prioritization in budget formulation through a structured and prioritized approach to developing and implementing the Medium-Term Expenditure framework (MTEF); (iv) strengthening the budget process through increasing budget coverage, deepening Treasury coverage, and putting in place a stronger internal and external accountability framework; (v) strengthening civil service management through amending the Civil Service Law to secure the application of the key principles of merit and depoliticization, and launching a program of functional reviews to rationalize the structure of government; and (vi) sector-specific reforms in the social sectors to accelerate education and social assistance reform while maintaining health and pension reform, and to rebalance intra-sectoral education and health expenditures further in favor of primary and basic secondary education and primary health care and emergency services. These recommendations are summarized in the detailed table attached to the accompanying Executive Summary.

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4.78 While the reform agenda may appear somewhat daunting, the Government of Moldova should nevertheless approach this agenda with reasonable optimism given actions which it has already taken and which it plans to take. The ongoing work to develop the full PRSP will provide an appropriate vehicle for the Government to make strategic decisions about reform priorities for the short to medium term. Similarly, the ongoing work to put in place an MTEF will provide the context to support efforts to strengthen strategic prioritization in budget formulation, while it is also the case that the ongoing program of budget reforms should help to deliver improvements in the efficiency of resource utilization. Relaunching the Public Sector Reform Strategy and Program should provide the mechanism for tackling the reforms identified for the civil service and public administration. Finally, health sector reform and pension reform are comparatively advanced and can be continued, while reforms of the education sector and of the social assistance system could now be accelerated.

moldova: public economic management...

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