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June 11, 2020

Expenditure Arrears and the COVID-19 Pandemic

Covid
Posted by Paul Seeds and Suzanne Flynn[1]

During the global financial crisis (2008) and the Ebola crisis in West Africa (2014) spending arrears presented significant problems. In Sierra Leone, after the Ebola crisis, arrears rose from 1 percent of expenditures to over 17 percent in 2016[2]. The 2008 crisis demonstrated that the accumulation of arrears can be a problem in advanced economies, such as Portugal, Greece, Spain, and Italy. Similar issues arise today. As the COVID-19 pandemic develops and downturns in economies deepen, many countries are setting their budgets for the upcoming fiscal year without fully recognizing the risk of substantial revenue shortfalls and escalating spending arrears. Enhanced diligence on the part of Ministries of Finance can mitigate the risk of burgeoning arrears.

Potential escalation of arrears

In some countries, arrears are likely to recur and escalate for a number of reasons. Spending measures in health and social protection to mitigate the impact of the pandemic, and the need for expedited disbursement in certain sectors have placed additional burdens on scarce budget resources. Another risk is that budget funds allocated for clearing arrears are diverted to meet COVID-related spending needs. The economic downturn may result in defaults on loans and calls on existing guarantees that will also impact governments’ budgets. Arrears may accumulate both at central government and subnational government level as well as in extrabudgetary funds and state-owned enterprises. Cross-indebtedness between government entities may compound the problem creating a domino effect — when the liquidity dries up, settlements are not made between entities.

These additional calls on the budget come at a time when fiscal measures are being implemented to soften the impact of the pandemic on the economy, for example through tax deferrals. There can be great uncertainty about the timing of cash inflows in the immediate term, and the tightening of credit lines may impact countries’ ability to borrow. These issues are intensified by systemic weaknesses, including:

  • Weak commitment controls that do not cover all categories of expenditures and the timely recording of commitments (as soon as they are incurred) being undermined by too-short a time-horizon of budget releases.
  • Inadequate reporting and monitoring arrangements, with many governments only compiling the stock of arrears at the end of each year.
  • Manual compilation of arrears data, which can be prone to error and abuse and the concealment of liabilities.

What can be done to manage arrears during the crisis?

Breaking the continuous cycle of arrears during the crisis will be extremely challenging. Lessons can be learned from the present crisis and previous ones. The focus should remain on immediate short-term actions, namely “firefighting” the problem rather than addressing the root causes. Indeed, such actions are critically important if the situation is not to become too acute to resolve. Potential solutions include:

  • Close coordination with spending agencies and active monitoring of and reporting of arrears, at least quarterly, with analysis by spending unit, institution or sector, expenditure category, and the age structure of outstanding payments.
  • Identifying areas of discretionary spending where cuts can be made – capital projects yet to start are often a casualty, and cutting projects where mobilization has started may lead to legal action and exacerbate arrears, discussed further here.
  • Speedy amendment of spending ceilings to reflect reprioritized budgets in automated financial management information systems (FMIS), and closer coordination with spending units, particularly in critical sectors where spending authority may have been temporarily delegated to service delivery units.
  • Strengthening cash management practices, updating projections of cash requirements, and identifying additional cash resources which may be temporarily borrowed, such as from SOEs or pension funds, and subsequently repaid, further discussed here.
  • Increasing the oversight of critical entities and extrabudgetary funds, including health and social welfare funds to ensure arrears are not allowed to compromise relief efforts and interrupt the supply chain.
  • Active monitoring of the government’s portfolio of loans and guarantees including those issued under the present emergency.

Longer-term actions should be considered whilst the severe constraints of the crisis are fresh in the mind. Will governments be caught out again by a second wave of the pandemic or unanticipated future shocks? Or can the foundations be laid now which will help alleviate the fiscal impact of future crises? Actions include:

  • Introducing or expanding commitment controls to cover all expenditure categories.
  • Automating the collection and reporting of data on all accounts payable through the FMIS using an invoice registry function.
  • Developing and implementing an arrears prevention strategy with a plausible, affordable and timebound clearance plan.

To conclude, comprehensive measures for the active monitoring and management of spending arrears are critical to ensuring that vital public services are delivered, the private sector is supported, tax systems are preserved, and trust in the government is promoted.

This article is part of a series related to the Coronavirus Crisis. All of our articles covering the topic can be found on our PFM Blog Coronavirus Articles page.

 

[1] Paul Seeds is the IMF’s PFM regional advisor based at AFTRITAC East in Dar Es Salaam, and Suzanne Flynn is the IMF’s PFM regional adviser based at the Center of Excellence in Finance in Ljubljana.

[2] Project Performance Assessment Report: Sierra Leone Integrated Public Financial Management Reform Project. World Bank, 2018, available here.

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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