Public Financial Management: An Introductory

A sound public financial management (PFM) system emphasizing institutional efficiency assumes significance while designing appropriate polices and implementing them to achieve the desired results. PFM system is based on the principles of fiscal discipline, strategic resource allocation, and a result oriented operational management. While the PFM system conventionally related more to the public expenditure and thereby to the budgeting system, it has evolved over the years by incorporating management of all facets of public funds. A robust PFM system helps in successful deployment of fiscal policy instruments to achieve macroeconomic goals.¹

The institutional strengthening process involves improving the environment of the budgeting system, establishing rule based fiscal management, determining resources and expenditure composition through a broad macro framework, instilling comprehensiveness and transparency, putting a hard budget constraint to address populist demands and control aggregate spending level, improving prioritization for allocative efficiency, and improving technical efficiency in the government organizations.²

Reform Initiatives in India

The PFM system in India with established institutional structure like budgeting, accounting, audit and legislative control systems has its root in the constitutional provisions.³ The initiatives to improve the PFM systems and processes over the years, although yielded some enduring changes, there were discontinuities and indifferent implementations.⁴ The expansion of Government programs at both the Central and the State levels makes imperative to identify areas to strengthen the PFM systems and processes. Establishing a performance oriented management structure stretched over levels of Governments in the Indian federation should be the key objective.

Major Historical Interventions Influencing PFM Reforms

• The 14th Report of Second Administrative Reforms Commission (SARC 2009): The SARC emphasized on effectiveness of the public spending and suggested several institutional reform measures.
• Report of the High Level Expert Committee on Public Expenditure Management (2011): The recommendations of the committee played crucial role in removal of plan-non-plan distinction and strengthening of Central Plan Scheme Monitoring System (CPSMS), which further evolved into PFMS platform in later years.
• Recommendations of Central Finance Commissions: The Central Finance Commissions particularly the FC-XII, FC-XIII, and FC-XIV made recommendations that have far reaching consequences towards institutional development in the PFM system.
• PEFA Report (PEFA 2010): The report measured performance of PFM institutions at the Union level and provided areas in need for reforms.

Fiscal federal nature of the country and constitutional assignment relating to finances and functions in which State and local governments bear large functional responsibilities assumes significance in PFM reforms. The tendency of expanding budget size, spreading resources thinly, and inadequacies in designing and implementing the programs persists in budget management process. Positive developments like adopting fiscal responsibility legislations (FRLs) and advances made in utilization of information technology, however, has enhanced capacity to take appropriate decisions. It is increasingly becoming apparent, particularly after the distortions created by Covid-19 pandemic in the public finances, that a sound PFM system is crucial in fiscal management.

Some of the important developments in recent decades in PFM system in the country have been elaborated here.

Outcome Budget and Output Outcome Framework (OOF)

To improve the performance orientation in the budgeting system, the Union government introduced outcome budget, a revised form of the already existing performance budget, in 2005. As a supplemental device, it evinced similar problems like predecessor. The outcome budget, although prepared and presented by all the spending departments regularly since the adoption, proved fragile and its ability to influence the budgetary decisions in both program formulation and resource allocation was limited. The ambitious plan to estimate quantifiable outcomes, inadequacies in costing the outputs/outcomes for planning the expenditure, stretched performance chain with gaps in information with regard to Central schemes, absence of an effective monitoring system to evaluate the results proved to be stumbling blocks.⁵

The government adopted Output Outcome Framework (OOF) from the year 2017-18 as a unified framework by discontinuing preparation of ministry wise outcome budget and NITI Aayog was assigned the responsibility of preparing this assigned document in consultation with the implementing Ministries and Departments. The OOF covers major Central Sector (CS) Schemes and Centrally Sponsored Schemes (CSS) with an outlay of Rs. 500 crore or more. The OOF has the unique advantage of being a unified document of high value CS and CSS prepared by a professional body like NITI Aayog. However, some of the basic issues relating to formulation of performance indicators for the schemes, the costing basis, determining the quality of public services, lack of public scrutiny relating to its impact on budget decisions more or less remain there.

Performance Monitoring and Evaluation System (PMES)

The Government introduced PMES in 2009 to provide a framework in the form of result framework document (RFD) to measure performance of all schemes and projects run by the departments. While outcome budget was already there, the utility of similar type of instrument was doubtful. It was given up after few years of paperwork.

Medium Term Perspective in Expenditure Planning (MTEF)

Medium term expenditure framework (MTEF) is considered as one of the most popular budget innovation in recent times and has many takers both in developed and developing countries. Implementation of MTEF is aimed at providing a perspective of government programs spreading over number of years and adjusting expenditure priorities and links policy making, planning and budget implementation.⁶

Medium term expenditure framework (MTEF) was introduced in India in 2012 as part of the revision of Fiscal Responsibility and Budget Management Act (FRBM Act). The process, however, failed in engaging the spending departments for preparing a medium-term sector plans, negotiate for resources for the budget based on this plan, and prioritize the programmes based on the spending limit. The MTEF process needs to be strengthened to provide robust indication of resource allocation to the ministries and departments and enable them to prioritize their spending plans.

Fiscal Responsibility and Budget Management Act (FRBM Act)

The fiscal rule was adopted in India in 2003 in response to severe deterioration of public finance both at central and state levels. While the country achieved significant fiscal correction during 2001-02 to 2007-08 riding high on higher growth, subsequent fiscal problems due to the financial crisis of 2008-09 derailed the process. The fiscal rules were redesigned with a longer time horizon and were amended in 2012. Since then the timeline to achieve the target remained elusive and the Act has been amended several times. The Covid-19 pandemic brought disruptions in the public finances of the country and the FRBM Act got further extended until 2025-26.

Modified Cash Management System

To reduce unevenness in expenditure pattern during the year and rush of expenditure in the last quarter of the financial year, the Government has introduced a modified cash management system. The system is aimed at reducing the tendency of parking of funds, effective monitoring, and better planning of indicative market borrowing.

Efforts to Change the Budget and Accounting Classification

The existing budget and accounts classification (Chart of Accounts) has problems with regard to providing reports on comprehensive view of central transfers to the states, translating accounting information into plan schemes, showing clarity in functional classification of expenditure, reporting costs incurred by the Government in providing services to facilitate preparation of outcome budget, and finding uniform accounting codes for plan schemes across the States.

The Committee constituted to review the List of Major and Minor Heads of Accounts (LMMHA) in 2010 recommended rationalization and reorganization of the existing account classification and proposed a multidimensional classification framework. Following the recommendations of the Expenditure Management Committee in 2015-16, Government of India has initiated actions to revise the recommendations of the LMMHA Committee. As the Chart of Accounts assumes significance in accounting and reporting structure, there is need to take urgent action.

Efforts to Adopt Accrual Accounting

Most government accounts are kept on cash basis in India. The cash based accounting system is found to be deficient in not being able to provide the complete picture of the financial position of the Government due to lack of complete information on assets and liabilities, which makes it difficult to ascertain the total cost of services provided by the Government departments.

The Government of India has accepted in principle the recommendations of the FC-XII to make a gradual transition to accrual based accounting system. The Government Accounting Standards Advisory Board (GASAB) was entrusted with the responsibility to prepare a detailed roadmap and an operational framework. Despite positive intents and building up institutional structure, much still needs to be done in this direction. Unanimity has not been achieved at political and administrative level due to apprehensions regarding risks and likely costs involved, and requirement of administrative capacity. FC-XIV and FC-XV in their recommendations reiterated the need to adopt the accrual accounting system. The Government needs to lay down the targets considering the administrative capacity and skills required for bringing about such a major reform.

Internal and External Audit Reforms

• Internal Audit Modernisation: The internal audit system in India has not been updated responding to changing times and modern standards emphasizing its role as a management tool and an integral part of both management controls and communication processes. Report of the Task Force constituted to provide roadmap to improve the internal audit in 2006 has not been considered yet.⁷
• External Audit: The external audit by the Comptroller and Auditor General of India (CAG) has played crucial role in India and assisted the Parliament in exercising financial control over the executive. While external audit has been a strong element of Indian PFM system, the follow-up process needs improvement to enable the external audit system to play its desired role.

Digital PFM Systems: PFMS and State-Level IFMIS

Web-Based PFMS System: The Public Financial Management System (PFMS) is a web-based online software application implemented by the Government to facilitate payment & exchequer control, accounting of receipts, accounting and reporting, and integration with financial management systems of states. The primary function of PFMS today is to facilitate sound PFM system for Government of India by establishing an efficient fund flow system as well as a payment cum accounting network.

Integrated Financial Management Information System (IFMIS) at State Level: State Governments in India, aided and encouraged by the Central Government, made considerable progress in adopting IT enabled IFMIS to facilitate improved accounting and budgeting system and manage payment processing, spending, reporting activities. Starting from initial treasury computerisation states have made progress in developing IFMIS, which has improved their information base on financial management and program implementation.

Crosscutting Issues

There were attempts to improve institutional framework of PFM systems that needs to be taken to their logical end:

1. Debt Management Office (DMO): The Government’s attempt to delink debt and cash management from monetary management controlled by the Reserve Bank of India by establishing a Debt Management Office in the Ministry of Finance is an ongoing effort to change the existing debt management system.
2. Fiscal Council: The practicality and usefulness of creating an independent Fiscal Council to pursue sustained dialogue on fiscal policy and independent review and monitoring of the implementation of various measures as recommended by the Central Finance Commissions is another issue which needs to be considered at policy making level.
3. Public Procurement Regulation: In the area of procurement by various ministries and departments, reforms were initiated including a legislation to regulate public procurement. The recommendations given by FC-XV to create strong institutional support for PFM system in India needs to be considered while taking reform decisions.

Concluding Remarks

The initiatives undertaken to strengthen PFM institutions over the decades provides opportunities to build upon them. The contemporary PFM system in the country continues to face challenges to maintain sustainable fiscal position, undertake effective allocation of resources, and provide public services effectively. As the PFM system is complex by nature and individual processes are interlinked, a framework treating them comprehensively will lead to achieving outcomes from intents. Given the challenges faced by the Indian economy in recent years, there is a need to inculcate economy, efficiency and effectiveness (the 3 Es) in Government operations to achieve value for money. There are supportive recommendations by various expert bodies based on the analysis of the performance of the PFM institutions, which should be considered. The involvement of all the stakeholders including the politicians in PFM reform process depends on effective communication with them regarding the benefits of changes that would accrue to the development programmes pursued by the government.

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References

1. Campos Ed, and Sanjay Pradhan (1996), “Budgetary Institutions and Expenditure Outcomes: Binding Governments to Fiscal Performance.” Policy Research Working Paper 1646, World Bank, Washington, DC.
2. Government of India, Comptroller & Auditor General of India (2006), Report of the task Force for Benchmarking the Status of Internal Audit in the Central Government.
3. Government of India, (2020), Report of the Fifteenth Finance Commission.
4. Hemming Richard (2013), “The Macroeconomic Framework for Managing Public Finances”, in (eds.) Richard Allen, Richard Hemming and Barry H. Potter, The International Handbook of Public Financial Management, Palgrave Macmillan, pp. 219-236.
5. Jena, Pratap Ranjan (2013), “Improving Public Financial Management in India: Opportunities to Move Forward” Working Paper 123, National Institute of Public Finance and Policy.
6. Jena, Pratap Ranjan (2016), “Reform Initiatives in the Budgeting System in India”, Public Budgeting & Finance, Wiley-Blackwell, spring, 36(1), pp.
7. PEFA (2016). Public Financial Management Performance Measurement Framework. PEFA Secretariat. Washington DC.
8. Premchand, A. (2008), Trapped in the Comfort Zone of Denial: 50 Years of Expenditure Management in India, National Institute of Public Finance and Policy, New Delhi.
9. Swarup, D (1990), “India: development in Government Accounting and Financial management”, in A. Premchand (ed) Government Financial Management: Issues and Country Studies, International Monetary Fund.
10. World Bank (1998) Public Expenditure Management Hand Book, Washington, D.C.

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Author may be reached at: pratap.jena@nipfp.org.in and eboard@icai.in