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March 03, 2008

Capital Budgeting and Public Financial Management -- Part II

A primer on systems and issues: Capital Budgeting Process

Posted by Bill Dorotinsky

The previous post of February 20,2008, discussed capital budgeting in the context of the over-all PFM system, and addressed defining capital and measuring some aspects of efficiency and effectiveness. This post focuses on the capital budgeting process itself, again drawing directly from a 2006 World Bank Public Expenditure Review for Ukraine.

A stylized capital budgeting process

Captial_budget_cycle_2 Within the over-all budgeting process, robust capital budgeting elements need not be overly technical or sophisticated.  To help orient the reader, the the Figure to the right presents nine key steps in a capital budgeting cycle, covering four phases. Traditional capital budgeting has three distinct phases: planning, budgeting, and implementation. A fourth not commonly included in capital budgeting discussions, ex poste audit, is also an import step in assuring process and information integrity.

The planning phase is often considered the most important because of the long-lived nature of the assets. Whether undertaking government-wide strategic capital planning, ministry planning, or program planning, the planning exercise needs to be kept within the over-all expenditure ceilings or envelopes to help insure more realism in the planning process, and in a multi-year framework to take into account the inter-temporal nature of decisions. Capital planning is not divorced from strategic planning, where strategic planning sets the goals and objectives for government, ministries, and programs. Then capital planning fits as part of consideration of what mix of capital and recurrent spending best meets those needs within available resources. The planning phase should provide the type of investments and size/number of investments (if not specific investments) needed.

The budgeting phase entails selecting specific projects to include in the budget, and may entail trade-offs between specific investments given available resources and government’s relative priorities. It includes identifying specific financing sources.

Implementation is self-explanatory, and entails government monitoring and oversight of the work for quality, time-lines, etc. The bulk of this work is in programs or ministries. Procurement is a critical step in the process, and care  must be taken to assure that costs do not rapidly escalate after contracts signing, and that unit costs are within competitive ranges.

Audit. Ex poste audit of financial and physical records helps insure weaknesses in the process are identified and can be corrected.  The table below goes into more detail on each step of the process shown in the Figure.

Capital_project_filters_2 Capital budgeting processes can be extremely time-consuming and expensive if not properly designed. There is frequently a tendency to require elaborate studies and cost-benefit analysis for all proposed projects, regardless of importance, feasibility, likelihood of being adopted, etc. A better system would seek to use strategic planning and priority-setting to help screen ideas before necessitating more detailed analysis. Much of the planning and budgeting process is a filtering process to arrive at an optimal set of investments with respect to government objectives and available resources. The figure to the right suggests some filters that might be used for screening projects.

A foundation of a robust capital budgeting process is a good inventory of existing capital assets. Basic information needs to be readily available and up to date. The inventory should identify each asset, the ministry owning it, the program it supports, the date it entered service and original construction cost, annual maintenance and repair expense history, current condition, current replacement cost, and similar data. Current asset condition needs a simple but consistent framework for summarizing condition, and should be updated annually.

Asset condition assessment is likely to be the most labor-intensive task in the capital budget process, but is essential to know if the asset is in need of replacement. The condition can be assesses by the owning agency/ministry, by a central agent (a central agent charged with over-all responsibility for capital budgeting or budget generally, such as the Ministry of Economy Capital office, Ministry of Finance capital budget office), contracted to a private firm, or contracted to a university or non-profit organization.





Responsible Agent


1. Update Inventory, Assess Asset Condition

Asset Inventory (including information on date facility entered service, annual maintenance and repair costs, current condition, etc.)

Condition assessment and maintenance cost history should enable better estimation of maintenance budget.

Inventory Database centrally maintained by Central Agent (e.g. MoF capital budget office, Ministry of Economy capital office, or Planning Ministry)


Asset Condition Assessment performed by sector ministry specialists, contracted to third-party.


2. Project identification

Preliminary list of possible projects with cost estimates

Identify need for rehabilitation or replacement of existing facilities, as well as new facilities


Should be tied to sector strategy, service objectives


Valuable to prepare list within over-all multi-year sector/ministry resource ceiling (capital and recurrent)

Sector ministries identify projects, cost estimates


Central agent prepares guidelines, forms for use by sector ministries


3. Project Evaluation

More detailed costing of projects


For revenue producing projects, estimates of revenues


Identification of possible financing sources

More detailed project evaluation should be done only for the top priority projects of ministry and government, projects likely to be funded


Cost-benefit and rate of return analysis can be undertaken, but this can be very expensive and time consuming, and may not add value for many projects

Sector ministry, using expert panels or contracting with consulting engineers


Central agent prepares standard guidelines, forms for use by sector ministries


MoF budget department needs to be involved in revenue estimates, evaluating the quality of the cost estimates


4. Project Ranking


Multi-year list of Approved Projects, ranked in priority


Should be started afresh (zero-based) annually. No assumption that a project approved but unfunded last year is automatically included in subsequent plans or budgets.

Central Agent maintains approved project database, prepares plan


Ranking can be done using formal project ranking sheets, used by a inter-ministry review panel. Including citizens in panel add credibility.


A public hearing can also add credibility before final plan adoption.


Some governments submit CIP/PIP to legislature for review and approval before finalizing plan.


5. Financing

Specific financing arrangements for proposals to be included in the budget

Options include general revenues, debt, users fees, concessions, public-private partnerships, etc.


Must reconcile with debt limits decided in debt strategy.

MoF budget department capital budget office


6. Budget

Include expenditures for projects in the budget, in sector/ministry

In addition to displaying the expenditures with the appropriate ministry and program, the budget might include an annex of those CIP/PIP proposals included in the budget for information

MoF budget department capital budget office




Procurement plans should already have been developed for the projects to be included in the budget, including a schedule of cash requirements for budget execution


Procurement should follow good practices as defined in procurement law

Responsible Ministry


MoE procurement office may provide technical support, and certainly would set standards, provide general guidance


8. Monitoring

Regular monitoring of physical and financial progress in completion

Financial progress can be monitored through Treasury payments


Physical progress should be tied to a database of on-going projects

Responsible Ministry


Central Agent


Treasury could require assessment of physical progress before making payment, and forward to capital database


9. Audit

Ex-poste assessment of financial records and physical completion

Ministry internal audit bodies,  required under the budget code, should monitor accuracy of financial records and efficiency of operations


Central internal auditors and the Accounting Chamber should periodically check on the effectiveness of internal audit and internal control processes.

Budget User internal audit offices


Central internal auditors


Accounting Chamber


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