Tuesday, June 22, 2021

Government urged to improve public investment management framework

In 2017, the International Monetary Fund (IMF) commissioned a study to assess public investment management (PIM) in Botswana culminating in a production of a country report that shed light on strengths as well as weaknesses in the country’s PIM system.

The study observed that Botswana’s public investment “has been consistently high for the past 25 years coupled with prudent fiscal policy and moderate debt at around 10 percent of gross domestic product (GDP)”.

Prudent management of public finances was found to have allowed enough fiscal space for public investment at levels of around 11 percent of GDP which has outpaced peer countries and emerging market economies.

The country report explained that public investment has been a key element of Botswana’s fiscal policy for the last three decades. From 1990 to 2006, public investment averaged 11.4 percent of GDP, almost doubling the average real GDP growth during those years (4.6 percent). Public investment peaked in 2009 at 17 percent of GDP, on account of economic stimulus measures, and gradually declined to 8.4 percent of GDP in 2014.

The report further notes that despite strong public investment during this period, GDP remained highly volatile driven mostly by the impact of the mining industry. In second half of 2015, a new economic stimulus programme was implemented to counteract the economic slowdown resulting from lower mineral revenues.

“Although capital spending is primarily funded through domestic sources – more than 90 percent of the total investment budget – the level of spending is somewhat volatile from year to year. Execution of capital budget used to be volatile, but has been improving recently – execution ranges between 73 and 97 percent”, states the IMF Country Report No. 17/188.

The report further notes that the relatively high public investment spending has contributed immensely to steady accumulation of capital stock – almost three times more per capita than peers and emerging market averages.

It is also recognized by the IMF that more than 60 percent of investment is spent on economic affairs, while social infrastructure accounts for about 25 percent and the remaining 15 percent is on general services. The bulk of investment is concentrated in central government, with state-owned enterprises (SOEs) contributing a quarter of spending and local government less than 10 percent.

While Botswana has received accolades from the IMF on its PIM, on the flip side, the international lender laments that despite the relatively high public investment spending, “the quality of infrastructure has fallen sharply in recent years”.

The IMF decries that while Botswana performed better than peer and emerging market averages up to 2010, more recently, indicators of infrastructure quality, both survey based and physical indicators of access and service delivery suggest significant bottlenecks, particularly in access to electricity supply and railways.

According to the IMF, “around one third of investment does not result in the level or quality of infrastructure of countries which manage their resources efficiently. The efficiency gap for Botswana is 37 percent – which is higher than emerging economies, and the average for all countries”.

The IMF reckons that large inefficiencies in the provision of public infrastructure underscore the need to improve Botswana’s public investment management framework and to fully recognize economic growth from public investment spending, a number of areas require further attention. In general, Botswana has strong planning institutions, investment funding is predictable, debt levels are sustainable, but there is a need to improve project appraisal, selection and monitoring.

It is also acknowledged by the report that the fiscal rule on debt provides separate caps on domestic and external borrowing, each 20 percent of GDP, limits which have not been breached to date. A guideline for total expenditure to GDP is 30 percent while the development to recurrent ratio of spending guideline is set at 30/70.

According to the country report, prudent fiscal policy combined with formal debt limits allowed the government to build fiscal buffers during good times and spend them judiciously during bad times. As a result, between 1990 and 2006 the government fiscal surplus averaged 4.8 percent of GDP, with public debt ratios at 10 percent of GDP, on average. Since 2007, the fiscal position deteriorated reaching a fiscal deficit of  negative14.3 percent of GDP by 2009, in part due to fiscal stimulus measures in response to the 2008 global financial crisis. Public debt peaked at 20.3 percent of GDP in 2012, and has declined to 15.6 percent of GDP by end of 2016.

“There is limited competition within each sector of the economic infrastructure sectors, which could contribute to increasing government support to loss-making entities. The telecommunications sector has been regulated, while the energy and water sectors are not yet competitive. In the water and electricity sectors, the government approves all tariffs – often below operating costs – requiring subsidies to cover operations”, reveals the IMF country report.

The IMF also laments that the economic classification, which distinguish between capital and recurrent expenditure, does not apply to the development budget, which makes it “difficult to accurately quantify the capital stock component of the development budget. Recurrent costs related to capital projects are based on a rule of thumb and often result in under-funding of maintenance expenditure”. 

Up to 2010, Botswana spent on average about twice as much on public investment compared to the average of emerging market economies and peer countries, even though this differential has subsequently narrowed. As a result, Botswana’s public capital stock is estimated at 125 percent of GDP by year end 2015, stands above the average of its peers. Similar results are observed on a per capita basis, where Botswana has almost doubled its public capital stock since 1990.

It is also revealed by the IMF country report that inadequate appraisal of projects have contributed to inaccurate costing, sometime understating costs as much as 60 percent, which can have significant implications for the medium-term fiscal framework.

Poor costing and appraisal also undermine project selection and could lead to funding projects that are not financially viable proving a significant risk for mega projects. Project appraisals include some elements of financial and exchange rate risks, but do not address risks related to engineering complexity.

The IMF commissioned study also found that inadequate project management often undermined project implementation. “The current project development management system, which is meant to tackle progress in implementing projects, is not functional and reports are generated manually – sometimes with significant delay. Project managers for mega projects are not identified at the design stage, which could contribute to implementation delays and possibly costs overruns during implementation”, bemoans the report adding that the mission has learnt that in some line ministries, recently qualified and inexperienced engineers are managing large projects that require significant skills and knowledge. The lack of experienced engineers could put government at risk of developing infrastructure which needs to be replaced or repaired at significant cost.

It is also decried by the country report that a number of agencies are responsible for monitoring project implementation, but their roles are not clearly identified in policy documents leading to duplication and uncertainty. The National Strategy Office (NSO) monitors all mega projects, while the Government Implementation Coordination Office (GICO) monitors implementation of priority projects. There is currently no definition of mega projects and it is not clear how the Ministry of Finance and Economic Development plays a role in monitoring the financial aspects of large or mega projects.

“Although Botswana uses a cash-based accounting system, plans are underway to value fixed assets and apply depreciation in preparation for accrual accounting”, states the report.

It is observed in the report that between 2010 -2015 the allocation of public investment to economic infrastructure (e.g. roads, ports, airports, electricity) was much higher in Botswana relative to emerging market economies. On the other hand, social infrastructure (e.g. housing, hospitals, schools, recreation, social protection) accounts for a similar share in both cases, representing approximately one fourth of total capital expenditure.

On the efficiency and impact of public investment the report states that up to 2010, survey based indicators of perception of infrastructure quality suggested that Botswana compared favourably to regional peers and emerging market economies in the perception of overall infrastructure quality. Later on, indicators suggest that structural bottlenecks in electricity, and rail roads are the drivers of the sharp deterioration in the perception infrastructure quality observed in the last five years.

According to the report, while Botswana generally performs better than its peers in access to social infrastructure (i.e. schools, water, and to a lesser extent hospitals), service delivery of economic infrastructure in the electricity sector is quite poor. By contrast, Botswana scores much better than peers, and even emerging market economies in the delivery of roads.

Another worrying aspect in the public investment set up is the significant efficiency gap, which underscores the need for improved public investment management as Botswana scores below the most efficient countries with considerable levels of public capital stock per capita. Public investment efficiency is lower than the average in emerging market economies.

Based on the methodology outlined in the IMF Board Paper, the efficiency gap for Botswana is calculated at 37 percent compared to an average of 27 percent for the world and emerging market economies. The results suggest that about one third of Botswana’s public capital stock did not result in the maximum level or quality of infrastructure assets or service delivery (i.e., efficiency loss). Therefore, there is significant scope for improving public sector investment efficiency to take full advantage of its impact on economic growth.

The report also underscores the fact that under the current fiscal policy framework, improving public investment efficiency could potentially create additional fiscal space for addressing existing infrastructure bottlenecks, without jeopardizing debt sustainability.

A targeted approach to address existing infrastructure weaknesses would reduce pressure on the government balance. Going forward, achieving the authorities’ infrastructure goals and tackling bottlenecks in the implementation of public investment projects will require addressing key drivers of public sector inefficiencies. Developing a robust public investment framework, and strengthening the institutions will be crucial in addressing these inefficiencies as earlier discussed.

Another concern raised in the paper relates to poor costing which ultimately undermines project selection and budget planning in that if costs are not estimated correctly, the conclusion of cost-benefit analysis will be distorted, possibly resulting in inefficient projects going forward. Contingencies are typically not included in project costing. In addition, supplementary budgets may be required if funds are insufficient to meet the programmed scope of work.

Inadequate costing of capital and recurrent costs of large projects can have significant fiscal consequences, both in the construction phase and after operations begin.

The report recommends a three phase appraisal process covering prefeasibility, feasibility and independent review. Prefeasibility studies for a specific large or mega project should be identified as a project in the development of the budget. This ensures that there are sufficient funds to conduct a proper study and ensures at least one year of study before the project is commenced. Costing should also be verified through the use of international unitary costs by type of project.

RELATED STORIES

Read this week's paper