89228 A briefing of good practices and lessons learned from the Europe and Central Asia region June 2014 > Volume 72 Capital Expenditures: Making Public Investment Work for Competitiveness and Inclusive Growth in Moldova Authors: Karen Stephanie Coulibaly and Mame Fatou Diagne A recent World Bank Public Expenditure Review for Moldova,1 conducted using BOOST,2 analyzes the inefficiencies in the allocation and implementation of capital expenditures. It provides recommendations for improving their ef- fectiveness and to enhance Moldova’s competitiveness and achieve sustained inclusive economic growth. Introduction Like many countries in the world, Moldova faces the challenge of meeting considerable public investment needs while preserving fiscal sustainability. In recent years, Moldova has experienced rapid poverty reduction, and gains from growth were widely shared. Over the period 2006–12, the national poverty and extreme poverty rates fell from 30.2 and 4.5 percent to 16.6 and 0.6 percent, respectively, and over the period 2006–11, consumption of the bottom 40 percent grew by 5.7 percent. However, with a rapidly aging population, high emigration, structural imbalances, and vulnerability to external shocks, Moldova will need to raise investment, productivity, and exports in order to achieve sustained growth KEY MESSAGES and competitiveness. While convergence with the European • Despite experiencing rapid poverty reduction and Union may anchor growth, infrastructure and investment inclusive economic growth over the past decade, climate upgrades are needed to fully capitalize on emerging Moldova needs to raise investment, productivity, and opportunities. exports in order to achieve sustained growth and At the same time, the prospects for raising overall revenues competitiveness in the long term. in Moldova are limited. Tax revenue is already high as a • A recent World Bank analysis of public investment percentage of GDP (in comparison with other countries in the processes and outcomes using a diagnostic framework Europe and Central Asia [ECA] region), and declining external and a specially-developed BOOST capital expenditure assistance could further reduce general government revenue module reveals significant inefficiencies in the and weigh on capital investment funding. A favorable public allocation and implementation of Moldovan capital debt outlook but high private debt leaves room for modest expenditures. This is largely due to inadequate project borrowing to fund priority projects, provided that borrowing appraisal, spreading of resources over small, fragmented remains prudent and selective. Given these constraints, funding and insufficiently prioritized projects, and long implementation periods. 1 World Bank, “Capital Expenditures: Making Public Investment Work for Competitiveness and Inclusive Growth in Moldova,” Public Expenditure Review, Report 76310 (Washington, DC: World • Better public investment decisions can be achieved Bank, 2013). through the implementation of reforms focused on 2 Support of the Europe and Central Asia (ECA) regional BOOST initiative, financed by trust funds improving project appraisal mechanisms, improving from the Bank-Netherlands Partnership Program and the ECA Public Financial Management Multi-Donor Trust Fund, is gratefully acknowledged. Launched in 2010, the BOOST initiative budgeting processes, and strengthening project is a Bank-wide effort to promote access to, and the effective use of, budget data for improved implementation monitoring systems. decision-making processes, transparency, and accountability. For more information: http://sitere- sources.worldbank.org/INTECA/Resources/KB43onBOOST.pdf. EUROPE AND CENTRAL ASIA KNOWLEDGE &LEARNING public investment objectives will require significant expenditure water and sanitation infrastructure, energy efficiency, power adjustment and rationalization. generation capacity, and physical interconnections with neigh- The World Bank’s recently published Moldova Public boring countries in gas and electricity. Expenditure Review (PER) focuses on capital expenditures Figure 1. Road Fund Spending by Economic Classification, 2006–12 and recommends reforms in public investment management and sector policies to raise cost effectiveness and allocative efficiency. The PER draws on an analysis and review of the structure and classification of the capital budget, recent trends in capital expenditure levels and execution, and the adequacy of resource allocations and utilization across sectors (given investment needs, national priorities, and implementation capacity). It also incorporates a diagnostic of the strength of Moldova’s public investment management system.3 Analyses for the PER were conducted using the BOOST public expenditure database developed by the World Bank. Using BOOST for Public Expenditure Analysis BOOST is a country-specific database of disaggregated govern- ment expenditure data from a national treasury system. BOOST datasets can also be extended into sector-specific modules that Source: Moldova BOOST. link government spending with nonfinancial performance data (e.g., inputs, outputs, and outcome data). BOOST data facilitated simultaneous micro analyses of The Moldova BOOST follows the national fiscal reporting budgeted and actual spending trends. A comparison of these methodology and includes information on the approved, trends with Moldova’s development objectives established revised, and actual budgets broken down by government level, that budgeted spending trends were broadly consistent with administrative units, subnational spending units, economic and strategic objectives, with the exception of the fuel and energy functional classification, and financing source. The Moldova sector. Budget execution performance varied by sector, so that capital expenditure module expands the (core) BOOST actual budget outlays were less aligned with national strategic dataset to include information at the detailed object4 level and priorities (Figure 2). supplements it with performance information monitored by the Figure 2. Changes in the Composition of Spending and Budget Execution Ministry of Finance. Performance by Sector In the Moldova PER, both the core BOOST database and the capital expenditure module were used to flag inconsistencies in budget classifications; analyze the trends, efficiency, and distributional equity of capital expenditure; and suggest improvements in government monitoring of public investment projects. Flagging Inconsistencies in Budget Classifications Comparing selected BOOST data economic, functional, and administrative breakdowns with special funds and sector- specific administrative data revealed inconsistencies in national budget classifications. Expenditures classified as “capital transfers” did not always correspond to expenditures for the purpose of acquiring capital. Specifically, after 2008, spending on road maintenance executed through the Road Fund was Source: Moldova BOOST. classified as “capital transfers within country” (Fgure 1). These maintenance expenditures should have been recorded in the recurrent section of the budget as they had been prior to 2009. Correcting for this classification issue, capital spending as a 3 Based on Anand Rajaram and others, “A Diagnostic Framework for Assessing Public Investment Management,” World Bank Policy Research Working Paper 5397 (Washington, DC: World Bank, share of GDP in Moldova would have been roughly 5 percent in 2010). 2012, rather than 6 percent. 4 In Moldova, public expenditure is understood in terms of discreet “objects,” unlike the more restrictive notion of “projects” in international practice. Whereas a project refers to a planned set Analyzing Allocative Efficiency of interrelated tasks executed over a fixed period and within certain cost (and other) limitations, an object refers to any item for which a cost is compiled. An object can be a product (e.g., “9754 Moldova’s National Development Strategy for 2012–20 outlines Bust of Emil Loteanu in the park of cinema ‘Patria,’ Municipality of Chisinau”), a service, a project seven priority areas for reform and development, including large (e.g., “9248 Project ‘Regional Development and Social Protection in the Republic of Moldova’”), or an activity (e.g., “9814 Construction of Primary School-Kindergarten in Commune Cotul Morii, public investments in national and local road infrastructure, District of Hincesti”). We will, however, refer to projects throughout this brief. KNOWLEDGE BRIEF > www.worldbank.org/eca The gap between budgeted and executed expenditures also sug- and poverty data led to the conclusion that the geographic gested implementation issues (particularly in the transport and distribution of capital expenditures is broadly in line with the utilities sectors). distribution of the population and perhaps redistributive goals, A closer look at the utilities sector illustrates this gap. The as per capita spending is higher in districts with higher poverty allocated budget approved by local governments for utilities rates. increased over 2006–12, while the executed amounts declined Analyzing Cost Efficiency (Figure 3). At the central level, budgeted and actual utilities Analysis of capital projects using the BOOST capital expenditure expenditures moved in opposite directions. This may be due to module demonstrated that an “optimism bias” (a propensity to delays in implementation of the Regional Development Fund and underestimate costs or overestimate benefits) is evident in local externally funded projects for water and sanitation, and is an investment and is more widespread in the education and utilities example of how Moldova has been unable to fully utilize avail- sectors. In recent years, the estimated project cost at inception able external funding in a sector with considerable investment was exceeded in about a third of local investment projects, by and repair requirements. This points to a need for improvements 60 percent on average. There were cost overruns in 20 percent in the general public investment management system, enhance- of local government capital repair projects, and these overruns ments in procurement and administrative skills within local averaged nearly 50 percent. At the central government level, agencies and utility companies, and resource pooling in order to the proportion of projects with cost overruns has also been strengthen implementation capacity. increasing over time. In 2011, there were already overruns in Figure 3. Trends in Central and Local Government Capital Expenditures on three out of 12 projects initiated in 2010. Utilities In parallel, resources are being spread more thinly on local investment projects. The capital budget is characterized by the proliferation of many small projects with low value, particularly at the local level. The average planned expenditure on local projects dropped from 13.5 million lei (Moldovan currency units) in 2001 to 1.7 million lei by 2009, and was as low as 222,000 lei in 2011 (Figure 4). Figure 4. Average Investment Spending per Project (2001–11) Source: Moldova BOOST capital expenditure module. Furthermore, funding for ongoing projects is not continuous Source: Moldova BOOST. and is being spread out over longer implementation periods, Analyzing Equity and Regional Distribution especially at the local level. Since 2006, between 30 and 50 percent of executed expenditure was spent on new rather While capital expenditure is not necessarily to be used for than ongoing projects, and consequently, budget allocation redistributive purposes, public investment can help reduce to ongoing projects is often interrupted. Budget allocations poverty and provide equal opportunities for all. There are large were interrupted for over a third of the investment projects inequalities in access to public services, such as improved water and a fourth of local repair components for which there were and sanitation, education, and health, across Moldova. Invest- multi-year budget allocations, a phenomenon that is, again, ments in local roads are a prerequisite to equal access to these more marked at the local level. Also more evident at the local services. Furthermore, investment in agricultural production and level is a longer implementation period for projects; central resilience, as well as measures to enhance agricultural produc- investment projects tend to stall for a year on average, while tivity and boost exports, can increase the incomes of the most local investment (and repair) projects tend to stall for two years. vulnerable segments of the population. Analysis using BOOST local capital expenditure data, census, KNOWLEDGE BRIEF > www.worldbank.org/eca Evaluating Public Investment Management Processes ABOUT THE AUTHORS An assessment of Moldova’s current public investment management system reveals a lack of regulated project appraisal processes involving systematic analysis. There is no formal requirement to conduct feasibility studies involving analysis of a project’s economic viability, financial sustainability, and environmental and social impacts. There is also no formal appraisal Karen Stephanie Coulibaly stage in which the findings of feasibility studies are assessed and a decision made on whether is a Public Expenditure Analyst in the Poverty or not a project represents good use for public money and thus qualifies to be submitted for Reduction and Economic funding. Management Unit of the Europe and Central Asia Using the BOOST capital expenditure module, the distribution of new central and local Region of the World Bank. investment projects by estimated total cost for each year between 2006 and 2011 was She was a core member of examined. Given the distribution of projects in Moldova, an initial threshold of 30 million the Moldova 2013 Public lei was recommended for requiring full feasibility studies involving cost-benefit or cost- Expenditure Review team. effectiveness analysis. This would mean that a small number (under 10) of fully domestically Mame Fatou Diagne financed projects would be subject to a comprehensive cost-benefit analysis every year. is a Senior Economist in Simpler approaches could be used for less significant investments, such that the sophistication the Poverty Reduction and of the appraisal method is proportional to the scale and complexity of the project and to the Economic Management Unit availability of skills within dedicated agencies. of the Europe and Central Asia Region of the World The Path Ahead Bank and was the Task Team Leader (TTL) for the Moldova In order to address the inefficiencies in the allocation and implementation of capital 2013 Public Expenditure expenditures identified in the analysis, three key areas of reform are recommended: (i) raise the Review. quality of new projects by improving preliminary screening and project appraisal mechanisms; (ii) improve the selection of new projects and ensure continuity of funding for ongoing projects through better prioritization and budgeting processes; and (iii) strengthen the monitoring of project implementation for cost efficiency and timely delivery of public services. A regulation adopted by the Government of Moldova in December 2013 established a framework to reform public investment management. Still, the agenda for improving the efficiency and equity of public investments in Moldova remains large. In addition to implementing the newly adopted regulatory framework, further improvements in monitoring could inform future adjustments to policy. In the short term, the monitoring of capital expenditure could be enhanced by adding up-to-date information on projects (e.g., total estimated cost and estimated completion The findings, interpretations, and date). This data would not only lead to better analytical outcomes, but would also yield better conclusions expressed herein are management of total project costs and earlier identification of implementation problems. those of the author(s), and do not necessarily reflect the views of the International Bank for Reconstruction In most countries, fostering demand for better management processes, including greater and Development /The World Bank transparency and more responsive monitoring systems, may help motivate governments to and its affiliated organizations, or those of the Executive Directors of perform and sustain a results-oriented focus. In Moldova, BOOST has successfully led the The World Bank or the governments they represent. The World Bank way for more related initiatives to follow, including the open data initiative Budget Stories, does not guarantee the accuracy of which helps inform citizens on raw budget and execution data. Such tools can help improve the data included in this work. The boundaries, colors, denominations, transparency and create greater accountability for public expenditures. and other information shown on any map in this work do not imply any judgement on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. “ECA Knowledge Brief” is a regular series of notes highlighting recent analyses, good practices, and lessons learned from the development work program of the World Bank’s Europe and Central Asia Region http:/ /www.worldbank.org/eca KNOWLEDGE BRIEF > www.worldbank.org/eca