Budget Execution System and Expenditure Control in Korea May 24, 2005 Tae Sung Lee Director, Investment Management Divis

1. Budget Execution System and Expenditure Control in Korea May 24, 2005 Tae Sung Lee Director, Investment Management Division Ministry of Planning and Budget Republic of Korea

2. Contents • Political and Administrative Structures in Korea • Korea’s Budget Formulation Process • The Significance of Budget Execution • Korea’s Budget Execution Process and Main Characteristics • Improving the Public Expenditure Management System

3. Political and Administrative Structures in Korea

4. Budget Formulation Budget Execution Budget Review Budget Account Settlement Administrative Body Legislative Body Administrative and Legislative Bodies • Korea’s political system: Presidential system • Principle of ‘checks and balances’

5. Administrative Branch Legislative Branch Ministry of Planning and Budget (Central fiscal authority): Budget formulation Ministry of Finance and Economy: Tax revenues, account settlement Board of Audit and Inspection: Account settlement audit, account audit Line Ministries : Budget execution Special Committee on Budget and Accounts: Budget review Standing Committees: Preliminary budget review National Assembly Budget Office: Budget proposal analysis Budget-related Bodies

6. Korea’s Budget Formulation Process

7. MPB sends budget formulation guidelines to government agencies (End of Mar.) Agencies’ budget requests are submitted to MPB (End of May) Agencies’ medium-term program plans are submitted to MPB(End of Jan.) MPB notifies sectoral and ministerial ceilings to agencies (End of Apr.) Compilation ofBudget Proposal (Jun. ~ Sep.) Submission of Budget Proposal to National Assembly (Oct. 2) Budget Formulation Process

8. Review by Special Committee for Budget and Accounts(Nov.) - Presentation of budget proposal by the government - General policy reviews, agency reviews, and subcommittee adjustment - Special Committee plenary session Approval by the National Assembly(Dec. 2) Approval by the National Assembly Preliminary review by standing committees(Oct. ~ Nov.) • The National Assembly may make reductions to the budget proposal, but approval of the government is required to make increments

9. Submission of budget allocation request(ministries and agencies  MPB) Establishment of budget allocation plan (Dec. of the previous year, MPB) Budget execution guidelines (end of Jan., MPB  ministries and agencies) Quarterly Budget allocation(MPB) Monthly Allocation of financial resources(MOFE) Budget execution(ministries and agencies) Budget Allocation and Execution

10. Submission of budget settlement reports (end of Feb. of the following year, ministries and agencies  MOFE) Settlement of the budget account and report to the President (Mar. ~ May, MOFE) Audit of budget account settlement document by the Board of Audit and Inspection (Jun. ~ Aug.) Submission of budget settlementreport to National Assembly(Sep. 2) Review and Approval by the National Assembly(Dec. 2) Settlement of the Budget Account

11. The Significance of Budget Execution

12. The Significance of Budget Execution • Budget execution is realizing policy measures contained in the budget • Inappropriate execution leads to failure in achieving budget formulation objectives • Strict expenditure control is important, but adapting to changes in circumstances is also essential • More people are related with budget execution than with budget formulation • Budget is not only a administrative control mechanism but also a measure for democratic policy making and implementation

13. The Significance ofBudget Execution • Hence, efficient budget execution calls for: • Strict execution in accordance with legal procedures • Flexibility to counteract changes in circumstance • Wise settlement of problems which may occur during the execution process • Managing the purchase and use of resources efficiently

14. Korea’s Budget Execution Process and Main Characteristics

15. Basic Process of Budget Execution Budget allocation (MPB) Allocation of financial resources (MOFE) Acts causing expenditure (Line ministries) • When the budget is settled, MPB formulates quarterly budget allocation plan (Dec. of the previous year) • Line ministries execute the budget according to the plan (Jan. ~ Dec.) • MPB sends budget execution guidelines to line ministries (Jan.)

16. Basic Process of Budget Execution • Budget allocation (MPB) • Allocating budget resources by 3-month terms • Budget allocation is necessary for acts causing expenditure • Allocation of financial resources (MOFE) • Monthly expenditure ceilings are set, taking into consideration the tax revenue circumstances • Financial resources must be allocated for budget execution • Commitment (Line ministries) • Commitment, contract which incurs a future obligation to pay, within Budget allocation • Payment (Line ministries) • Payments within expenditure ceilings

17. Transparency and Accountability in Budget Execution • Institutional mechanisms to ensure transparency, control and accountability • Budget and account settlement reports are publicly announced • Spending of a fiscal year is financed by the year’s revenues • Restriction of spending which do not follow the budget’s purposes or exceed predefined amounts • Restriction of the issuance of government bonds or signing of contracts which cause extra-budgetary burden

18. Flexibility in Budget Execution • Institutional mechanisms to enhance flexibility in budget execution • Reallocation between budget items: transfers between items are possible with the pre-approval of the National Assembly • Diversion between administrative budget items: transfers between administrative items are possible with the approval of MPB • Reserve funds: funds which have been pre-approved by the National Assembly in lump sum, can be used • Multi-year expenses: multi-year spending is possible with the pre-approval of the National Assembly

19. Strengthening fiscal policy functions • Front loading of budget expenditure to provide economic stimulus • In case of subdued economic growth during the first half and rapid growth during the second half, budget expenditures are front-loaded during the first half to support economic growth • Key programs which have greater effect are front loaded • 58%(100 trillion won) of key program spending(170 trillion won) are being front loaded in 2005 • Fiscal Management Inspection Meetings (chaired by the Vice Minister of Planning and Budget and attended by Planning and Management Officers of line ministries) are held every month to check the budget execution situation

20. Supplementary Budget • Formulation of supplementary budgets • In the case of significant changes in circumstances, supplementary budgets are formulated and approved by the National Assembly • In the case of natural disasters, economic downturns, and other serious domestic and external changes • Recent cases of supplementary budgets

21. Total Project Cost Management • Purpose • Strict control of increasing in large-scale project costs to enhance the productivity of budget expenditure and quality of projects • Projects under total project cost management • Projects with total costs exceeding 50 billion won and whose construction period exceeds 2 years • As of March 2005 • 718 projects (totaling 220 trillion won) are subject to TPCM system

22. Total Project Cost Management Guidelines • Requires preliminary consultations with the MPB when making changes to the project size, costs, and implementation timeframe • Excluding inevitable cases such as improved safety and legal changes, increases in project size are disallowed • In cases of exceedingly large increases (more than 20%) in project size, project feasibility is reviewed by external experts • In 2003, 15 reviews were conducted, reducing the size of projects by 650 billion won

23. Countermeasures against imprudent spending • Budget misuse prevention system, participated by MPB and line ministries, is under operation • Formation of the Fiscal Management Inspection Group, and establishment of a Budget Waste Reporting Center (43 institutions) • Strengthening budget misuse prevention training for line ministries • Budget performance award money is given to those who have contributed to budget saving

24. Improving the Public Expenditure Management System

25. Changes in the Fiscal Management Environment • Socioeconomic changes • Population ageing and low fertility rate • % of the population over 65: 7.2 (2000)  14.4(2019) • Total fertility rate: 6.0(1961)  2.1(1982)  1.17(2002) • Rising demand for a better quality of life • Focus on social welfare, education, culture, environment • Possible slowdown in economic growth engines • Input driven  productivity-driven economy • Increased demand for participation and fiscal transparency

26. Changes in the Fiscal Management Environment • Public expenditure management will face future challenges • Increase rate of tax revenues will drop • Spending requirements are continuously increasing • Support for the aged / disabled / low-income bracket, childcare, medical services, unemployment countermeasures • Promoting regional economies, balanced national development, new growth driving factors • Fiscal risk factors such as public pension scheme and unification-related costs

27. Changes in the Fiscal Management Environment • Increased attention of the general public and NGOs in fiscal management • Demand for improved national competitiveness, and transparent fiscal management • Need for the establishment of a system to allow the transparent understanding of the current fiscal situation • Need for improved public announcement of fiscal information

28. Performance Management System Objective evaluation of performance to enhance accountability and transparency Line ministries set performance indicators and goals Yearly evaluation of performance Program effectiveness and implementation problems will be evaluated and the results will be reflected in budget formulation 2004 (Y-1) 2005 (Y) 2006 (Y+1) Budget Execution Performance Reports Performance Plans

29. Performance Management System(example) • Ministry of Environment • Goal: blue sky, clean air • Objective: air quality improvement • Programs ’04 ’05 ’06 ’07 ’08 • LNG vehicles (billion won) 63.5 57.7 117.8 130.9 90.0 • Measures to improve air quality in Seoul Metropolitan Area (billion won) - 15.9 25.0 40.8 81.6 • Expanding automobile certification testing equipment(billion won) 2.6 9.4 6.8 7.2 7.4 • Key indicators • NO2 emission(g/m3) 34 33 31 30 29 • PM10 emission (g/m3) 70 68 65 60 55

30. Digital Budget and Accounting System • Establishment of the Budget and Accounting Reinvention Office (May 2004) • MPB, MOFE, MOGAHA, BAI • Setting implementation tasks and directions (Jul. 2004) • Reform of the budget structure and system • Reform of the accounting system • Integrated fiscal information system • Reform measures will be introduced according to yearly plans with the objective operating the system by 2007 • The system will be established by 2006

31. Digital Budget and Accounting System(Implementation Tasks) • Redefining the scope of public finance • Gradually expanding the scope until 2005 • Preparation of new fiscal indicators • Program-oriented and simplified budget structure • Systematic linkage between policy, organization and program • Simplification of budget structure • Introduction of accrual accounting • Early-warning system of fiscal risks • Supporting performance management • Integrated fiscal information system • Real time analysis and projection capacity • Supporting policy formulation and decision making

32. National Fiscal Act • The current Budget and Accounts Act has maintained the basic framework since its enactment in 1961 • There are limits in effectively supporting the fiscal reform initiatives of the Korean government • The National Fiscal Act will serve as a legal framework for public expenditure management, supporting fiscal reform initiatives • In October, 2004, the National Fiscal Bill was finalized at the cabinet meeting, and submitted to the National Assembly

33. Advanced PEMS Fiscal Transparency Enhanced Efficiency Fiscal Soundness Expanding innovation, autonomy and performance National debt management and sustainable fiscal soundness Promoting participation, transparency and external input National debt management plan Ex-ante consultation for laws accompanying spending Detailed conditions for supplementary budget Extra revenue for debt repayment NFMP Top-down budgeting Performance management Strengthened counter- cyclical function of public finance Early budget account settlement Citizens’ oversight for illegal spending Increased public announcement of fiscal information Consultation bodies National Fiscal Act(Contents and expected effects)

34. Thank You

35. <ANNEX> Total Project Cost Management System May 24, 2005 Lee, Tae-sung Director, Investment Management Div. Budget Management Bureau Ministry of Planning and Budget leeftc@korea.com

36. The TPCM aims to enhance fiscal productivity and to ensure high quality of public construction work by properly adjusting and managing total project costs (TPC) throughout the implementation stages of a project. The Ministry of Planning and Budget (MPB) established the cost monitoring system in 1994, and has revised the “Guidelines for Total Project Cost Management” on an annual basis. It was after the establishment of MPB in 1999 as a leading agency of government reform in the wake of financial crisis of 1997 and 1998 that the TPCM has been effectively implemented as a government expenditure measure. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 1. Overview of TPCM

37. The following construction projects are subject to TPCM system: ① Projects implemented by the central government itself or its agents, or by local governments or private institutions supported by government funding, ② Projects whose construction period exceeds two years, and ③ Civil engineering projects whose TPC exceeds fifty billion Korean won (fifty million USD), or architectural projects whose TPC exceeds twenty billion Korean won (twenty million USD). The TPC includes all the cost items accrued throughout the life cycle of the project, including design, land acquisition, and construction costs regardless of whether the source of funding is from the central government, local governments or private institutions. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System)

38. Project costs should be managed by the construction phase and by construction unit in reference to total construction cost. The construction costs are not arbitrarily inter-changeable between project phases or between construction units. When increases in construction size or construction costs are inevitable, the minister in charge of the project is to consult with the Minister of Planning and Budget concerning TPC adjustment. At the same time, he/she also must consult matters relating to adjusting project duration that will be accompanied by the cost change. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 2. General Principles of TPCM

39. Project Conception phase The minister in charge of the project should make an appropriate estimate of the total cost and duration of the project and request the Minister of Planning and Budget for a PFS if the estimated total cost in the project conception phase is fifty billion won or more. In the case of local government projects, the minister in charge should request the Minister of Planning and Budget for a PFS if the project’s funding relies on the central government subsidy by thirty billion won or more. Phases of PFS and (Detailed) Feasibility Study The Minister in charge should report project size, TPC and project duration to the Minister of Planning and Budget for all the projects that have been evaluated as feasible by PFS and drawn up the budget by the end of January. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 3. Implementation of the TPCM by project phase

40. Detailed feasibility studies should cover the life cycle cost of the projects resulting from all technological, environmental, social, and financial aspects as well as land acquisition. Draft Design phase It is recommended to spend sufficient amount of money and time in the draft design phase to prevent significant and frequent design modifications in the following construction phases. The design team should collect various opinions from target citizens, interests groups and related government authorities to minimize public discontent expected in the construction phase. The minister in charge should consult value-engineering (VE) experts at least once before the end of this phase to prevent overestimation of costs and excessive construction. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System)

41. Blueprint Design phase The construction size should not be modified significantly in this phase. When design modification or change in construction size is inevitable, the minister in charge should discuss the matter with the Minister of Planning and Budget. The minister in charge should also consult value-engineering (VE) experts at least once before the end of this phase to prevent overestimation of costs and excessive construction. Contracting phase The Minister of Planning and Budget informs the Administer of the Office of Supply Administration of the total construction cost that is discussed with the minister in charge. When the contract cost exceeds the informed cost, the Administer of the Office of Supply Administration should discuss the matter with the Minister of Planning and Budget. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System)

42. Construction phase The minister in charge should try to minimize increase in costs except when new construction techniques or new equipment are to be introduced to enhance the quality of the product substantially. When the increase in costs, change in construction size and/or construction duration are inevitable, the minister in charge should submit a written explanation and consult with the Minister of Planning and Budget. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System)

43. Construction Contingencies The line ministry is allowed to set construction contingencies up to 8% of the contract price of a project to cope with inevitable design modification and amendment of the law and so on. The line ministry can change the TPC within the limit of contingencies with its own discretion. Contingencies apply only to construction phase of a project. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 4. Construction Contingencies

44. The RIF aims to check unnecessary cost increase by re-affirming the feasibility of projects under implementation and scrutinizing the adequacy of the cost increase. The MPB conducts the RIF on a project if; ① the PFS has not been conducted although it falls under the PFS coverage, or if ② the TPC has increased by more than 20% (excluding inflationary effects and increase in land acquisition cost) compared to the cost that the Minister of Planning and Budget confirmed at the previous phase of the project. (e.g. if the blueprint design cost estimate exceeds the draft design cost estimate by more than 20%, the project is subject to RIF.) Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 5. Re-inspection of Feasibility (RIF)

45. The line ministries conduct the RIF on a project with miscellaneous changes in construction costs and report to the Minister of Planning and Budget. Guidelines and Contents of RIF The MPB established the RIF guidelines in March 2005 to clarify the procedure and methodology of RIF. The RIF guidelines suggest that the RIF should include, but should not be limited to, the following components: Outline of a project Analysis of background date and newly raised project issues Analysis on adequacy of the plan including size of the project Economic analysis including cost-benefit analysis Policy Analysis Overall Assessment including judgement whether or not to continue a project and if the TPC increase is adequate. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System)

46. In general, an increase in construction size through design modification is not allowed, except for inevitable cases. The base cost for TPCM system is the contract cost determined by bidding, not the cost estimate at design phase. "The indicator adjustment formula" set by the Office of Supply Administration is applied to re-calculate project costs incorporating inflationary effects. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 6. Principles of TPC Adjustment

47. When project under implementation violates the TPCM guidelines, the Minister of Planning and Budget can cut off or suspend budget allocation for the project. The minister in charge can impose sanctions prohibiting invitation to tendering of construction projects on design teams when their work have resulted in substantial cost increase due to unsatisfactory performance or when they intentionally or unintentionally failed to estimate the appropriate construction costs or sizes. The minister in charge can petition to the Minister of Planning and Budget requesting for changes in costs and project duration at any time through the Budget Information Management System, if necessary. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) 7. Other administrative guidelines

48. Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System) <Table 1> Number of projects with substantial change in TPC (Unit: the number of project, %)

49. B/A (%) has decreased and C/A (%) has increased since 1999. It is result of establishment of the MPB and the MPB’s efforts to reinforce the TPCM System. THANK YOU Budget Execution System and Expenditure Control in Korea (Total Project Cost Management System)