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Forward Estimates: the Most Fundamental Tool of Medium-Term Budgeting

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(Originally published in September 2008 on the IMF's PFM Blog)

CABRI has just published the proceedings of a seminar on medium-term budgeting held in Ghana last December, under the title Are We Asking the Right Questions? Embedding a Medium-Term Perspective in Budgeting. It’s an interesting read.

I was particularly struck by comments in the overview paper—by Alta Fölscher from South Africa—on the fundamental importance of good forward estimates for successful medium-term budgeting. Alta stresses that a fundamental obstacle to the success of MT budgeting in African countries has been that:

the quality of forward estimates is poor. They consist far too frequently of the proposed budget for the first year of a multi-year framework, followed by inflation adjusted projections of cost for the outer year ...they pay little attention to, for example, the likely phasing of policy implementation, changes in demand that will effect spending unevenly or the impact of once-off capital spending on the base-year estimates. ...A key aspect of embedding a medium-term perspective therefore is deciding what the rules are for rolling over and adjusting and determining the forward estimates.
 
She is spot on – as I’m sure that anyone who has looked at a representative sample of MTEFs from around the world can attest.

This put me in mind of the stimulating blog mini-debate of the week before last (in reaction to my critique of forward-year expenditure ceilings). It underlines reasons why, in my view, we should indeed distinguish clearly between forward estimates and multi-year ceilings for ministries: namely, that a core problem has been the setting of ceilings which are not underpinned by good estimates. The result is arbitrary ceilings which, as Alta says, do not capture underlying expenditure dynamics—and which can as a consequence either underfund or overfund some ministries significantly.

Forward estimates are just that—a projection or estimate of the spending implied over the coming (say) three years by current expenditure policies (including approved new initiatives). Ceilings, on the other hand, imply an intention or a commitment to provide the ministries concerned with specified levels of funding over the next three years. It is possible to have estimates without setting ceilings, and to set ceilings without having estimates.

Having forward estimates without ceilings is not a problem. Australia, for example, produces forward estimates of ministry expenditure while making it clear that the government reserves fully the right to make change expenditure policy in any annual budget. So all the forward estimates tell ministries is how much funding they could expect in the outer years if the government doesn’t change expenditure policy. (Incidentally, this alone is a considerable help to them in reducing budget uncertainty and letting them improve planning.)

It is setting multi-year ceilings without the benefit of good forward estimates which is the problem. To specify what, say, the ministry of education should receive in three years time without having a reasonable understand of how cost-drivers such as trends in the population numbers of school-age children is to risk getting it significantly wrong.

The catch is that developing reasonable forward estimates of expenditure (and revenue, for that matter) is no simple matter, and there are few LICs or even MICs who seem to do it well. This suggests to me that we should be giving a lot more attention in capacity-building to developing the forward estimates skills of ministries of finance.
 
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