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December 21, 2011

Designing “virementally”-friendly budgets

Posted by Sami Ylaoutinen

If you didn’t get the joke in the title, you’re probably part of the 99.99 percent of the population whose favorite topic is not public financial management. If you did, congratulations!, that’s why you’re reading this blog. Virements, the authority to reallocate budget appropriations, are important tools to introduce flexibility in government budgets. Why this flexibility is necessary, and why increasingly countries are moving to a situation where virements are less needed, I will discuss in this post.

A budget is a mechanism though which governments try to achieve several objectives simultaneously: spending the right amount of money (maintaining aggregate fiscal discipline), spending it where politicians want it to be spent (facilitating a strategic allocation of expenditure), and spending it to achieve maximum benefit for the population (using resources to most efficiently produce the desired outputs).

As has been painfully clear during the past few years, we live in a world filled with uncertainties. Budgets are clearly not isolated from the effects of this uncertainty, and therefore there is often a need to make adjustments to the budget approved by the parliament in order to achieve the objectives, or at least some of them, mentioned above.

There are different ways to deal with these uncertainties and resulting expenditure variations. One of such techniques is virements. Virements refer to transfers or reallocations between appropriations during the implementation of the budget. Accordingly, virement rules refer to restrictions that have been imposed for making such transfers.

Irrespective of whether a country still uses input-based budgeting or has adopted an output-based budgeting system, legal rules on virements need to be in place. Certain degrees of flexibility are needed, but within limits.

Typically, virement rules prohibit reallocations between ministries (without parliamentary approval) and between operating and capital expenditure. In some countries it is possible for the government to reallocate certain percentage of total approved ministerial budget between programs or policy-areas. Some virements can be authorized by the line ministry itself, others need authorization from the ministry of finance. In many developing countries the number of virements approved annually by the budget office ranges in the thousands (a time-consuming activity that provides the finance ministry political power, but in the end is more a distraction than that it improves overall budget management). In contrast, in some countries virements are almost completely banned; all changes to the budget have to be approved through supplementaries.

Is it possible to identify best practice in the area of virements? As typically is the case with budgets, there are almost as many practices as there are countries. Turkey, for example, has some 34,500 line items in their budget with quite flexible virement rules whereas in the Netherlands the number of line items is around 170 without possibilities to reallocate appropriates during the year without parliament’s approval. Which practice is the better one or does the optimum lie somewhere in between? The answer, not atypical coming from an economist, is “it all depends”. At least to some extent.

As one can note from our two-country sample above, there seems to be a correlation between the number of line-items in the budget and the flexibility of virement rules. Indeed, the appropriate degree of virements depends on how detailed or aggregated the budget is.

With a very detailed budget, including thousands of lines limiting how much can be spent on economic categories for each spending unit, there will be a justified need for the executive to do reallocations during the course of the budget implementation. Involving parliament or the cabinet in each one of these reallocations could be too cumbersome. Larger reallocations (in percentage terms) can therefore be allowed, without being a sign of a poorly prepared budget, or a lax control over funds.

If, on the other hand, the budget is more aggregated, there should be much less need for reallocations. Among the OECD countries there seems to be a general trend towards fewer, more flexible appropriations which reduces the need for virements in the first place.

Different practices exist but whatever degree of flexibility regarding virements and level of aggregation in their budgets countries choose to employ, the overall structure of budgets should be conducive to reinforcing accountability for expenditure (being an argument for prohibiting virements across ministries, and limiting the virement across programs) while providing certain level of flexibility and incentives for efficient use of resources (being an arguments for allowing some virements across policy-areas).

Virement rules are an important aspect of efficient budget-making which cannot be studied in isolation from overall appropriation structure of the budget, and of the stage of development of budget planning and management systems. FAD is planning to do further work on this issue in the new year with a view of providing more concrete guidance on virement policies.

But meanwhile, and also to the other 99.99 percent, Happy Holidays!

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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Comments

I agree with your statement in the penultimate paragraph that "Virement rules are an important aspect of efficient budget-making which cannot be studied in isolation from overall appropriation structure of the budget, and of the stage of development of budget planning and management systems."

The Budget Office/Ministry of Finance must be sensitized to this issue and the need to provide some greater degree of flexibility to MDAs in managing their budgets. This may not be applicable in all jurisdictions but where virements are permitted, efficiency in the processing/approvals of such warrants can go long way in improving the budgetary outcomes.

I have never forgotten reading a paper by Allen Schick in the OECD Journal on Budgeting Volume 1-No.1 in which he spoke of the "The Changing Role of the Central Budget Office". He cited the changing role of the budget office in light of the management changes within the OECD Countries.

It therefore means that the there is greater need to allow Public Sector managers to manage the resources entrusted to them by parliament, but yet to hold them accountable.

Virements is one such area which warrants further dialogue and I am heartened that FAD will provide further guidance in this matter.

Happy Holidays

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