1. Reform of the Public Financial Management System in Korea
May 2005
Youngsun Koh
Korea Development Institute

2. Contents Introduction Background of the Reform
Limitations of the Previous System
Main Characteristics of the Reform
National Fiscal Management Plan
Top-down Budgeting
Main Contents of NFMP
Improvements Required

3. - 1 -
Introduction
The Korean government strengthened its efforts to overhaul the financial management system after the crisis of 1997
The new government introduced a medium-term expenditure management framework (MTEF) together with a top-down budgeting system in 2003
MTEF provides for a mechanism to reflect policy priorities in budgeting and facilitate a strategic decision-making.
The budget for FY 2005 was prepared under the new system.
The introduction of “program budgeting” and “performance management system” is in progress

4. Background of the Reform
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Background of the Reform
Changing environment
The size of the government spending increased from 57 billion won in 1960 to 118 trillion won in 2004.
The structure of budget is getting more complicated.
There is an increasing emphasis on “autonomy and devolution” and “accountability and performance” as the guiding principles of government.
Limitations of the previous system
Centered on a single budget year
Relied excessively on a bottom-up approach in budgeting
Focused on the general account

5. Limitations of the Previous System
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Limitations of the Previous System
Centered on a single budget year
Little consideration is given by the central budget office and the parliament to the out-years beyond the budget year.
Medium- to long-term planning is also quite weak in line ministries.
As a result, it is difficult to identify and cope with the trend increase in spending.
Without a medium-term strategy for fiscal management, public spending has been on a rising trend since the mid-90s.

6. Limitations of the Previous System
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Limitations of the Previous System
The counter-cyclical role of fiscal policy is constrained.
The current principle of “balanced budget in each year” has the potential to produce a pro-cyclical fluctuation in spending.
The so-called “automatic stabilizer” can be strengthened when spending increases at a pre-determined, constant rate and the balanced budget is pursued over the medium term.
Surplus
Surplus
Expenditure
Revenue
Revenue
Expenditure
Deficit

7. Limitations of the Previous System
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Limitations of the Previous System
Excessive reliance on a bottom-up approach
At the initial stage of budget preparation, the central budget office makes rough estimates of the total size and the sectoral allocation of the next year’s budget.
But the estimates are not transmitted to line ministries and therefore cannot guide line ministries in preparing their budget requests.
In reviewing the budget requests by line ministries, the central budget office focuses on the microscopic spending control of individual programs.
The sectoral allocation and the total size of the budget are determined at the last stage of budget preparation by aggregating the expenditures on individual programs.

8. Limitations of the Previous System
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Limitations of the Previous System
As a result, the control of inputs assumes the major importance in budget discussions and little attention is paid to outputs or outcomes.
The central budget office has little scope to review and analyze policies themselves, and the linkages between budgeting and policy-making are very weak.
The accountability and autonomy of line ministries in preparing and managing their budget is severely limited.
Line ministries usually request unrealistically large amount of budget, and massive cuts are inevitable.

9. Limitations of the Previous System
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Limitations of the Previous System
Centered on the General Account
The central budget office spends most of its time on reviewing and preparing the budget of the General Account.
Less attention is paid to Special Accounts and Funds.

10. Main Characteristics of the Reform
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Main Characteristics of the Reform
A medium-term perspective
“National Fiscal Management Plan,” covering the current year, the budget year, and three out-years.
Top-down budgeting
Line ministries given greater discretion in the preparation of budget requests within the ceilings set by MPB.
Performance management
Introducing a system similar to the Program Assessment Rating Tool (PART) of the U.S. federal government.
Program budgeting
Adopting a program structure in budget accounts.

11. National Fiscal Management Plan
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National Fiscal Management Plan
Main features
Covers 5 years on a rolling basis.
Includes the General Account and various special accounts and funds.
Sets out major policy directions, fiscal aggregates, and the sectoral resource allocation.
Prepared through an intensive policy dialogue involving line ministries and other interested parties.
Closely linked to annual budgeting.

12. National Fiscal Management Plan
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National Fiscal Management Plan
Timetable
Setting out the framework (Jan. - early Apr.)
Line ministries submit medium-term spending projections to MPB by the end of January.
Sectoral taskforces (composed of staff from MPB and relevant line ministries and private-sector experts) are organized to discuss sectoral policy directions and spending priorities.
Taskforces present their results in a series of public hearings in March - April.

13. National Fiscal Management Plan
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National Fiscal Management Plan
Timetable
Preparing the draft (Apr. - early May)
MPB prepares a draft NFMP, which includes among others the tentative ceilings on sectoral spending.
At the end of April, a two-day cabinet meeting is held to discuss and finalize the ceilings.
In May - June, line ministries prepare their budget requests for the next year based on the ceilings.
Finalizing the NFMP (May - early Oct.)
In July - September, MPB negotiates with line ministries on their budget requests, prepares the draft budget, and revises the NFMP.
After approved by the cabinet, the NFMP is tabled at the National Assembly together with the draft budget in early October.

14. Top-down Budgeting Main features
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Top-down Budgeting
Main features
Line ministries prepare their budget requests within the ceilings set out in NFMP.
Ceilings are set for 14 spending areas such as social infrastructure, agriculture, education, and environment and then disaggregated into 56 programs.
For example, social infrastructure has 7 programs, including roads, railways, subways, ports, airports, housing, and water resources.
Separate ceilings are also set within each program for the general account and various special accounts and funds.

15. Top-down Budgeting Progress to date
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Top-down Budgeting
Progress to date
Pilots on four agency-level organizations for FY 2004
Government-wide implementation for FY 2005
A smaller increase in budget requests by line ministries above the previous year’s budget: 11.7% for FY 2005 vs. 30.8% for FY 2004
Larger reallocation of budget across programs: cutting back 2.7 trillion won on existing ones and introducing new ones worth 3.0 trillion won for FY 2005
The same numbers for FY 2004 were 1.6 and 1.5 trillion won, respectively.

16. Main Contents of NFMP 2004-2008 Fiscal aggregates
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Main Contents of NFMP
Fiscal aggregates
In , the economy is expected to grow 5% p.a. in real terms and 8% p.a. in nominal terms.
The total revenue grows by 7.4% p.a. and the total spending by 6.3% p.a.
The target balance will record a small deficit (within 1% of GDP) in but the deficit will be eliminated by 2008.
The target balance refers to the consolidated budget balance excluding the social security funds and the transformation of financial-sector restructuring bonds into treasury bonds.
The debt-to-GDP ratio will increase slightly in but stay at the 2006 level afterwards.

17. Main Contents of NFMP 2004-2008 Resource allocation Priority areas
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Main Contents of NFMP
Resource allocation
Priority areas
Improving the growth potential: R&D and education
Strengthening the social integration: Welfare
Meeting the challenges for national security: Defense
Areas that needs readjustment
Social infrastructure: Greater use of public-private partnership
Agriculture: Promote structural changes following the market opening
Industry and SMEs: Focus on R&D and human resource development

18. Improvements Required
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Improvements Required
Clarifying the medium-term targets
Presently, it is not clear which variable the government is targeting in the medium term; the budget balance, the total spending, or the debt-to-GDP ratio.
An ideal target would be “a balanced budget over the business cycle,” given the low level of debt-to-GDP ratio in Korea.
In this scenario, a lower-than-expected growth will produce deficits and a higher-than-expected growth surpluses, with deficits and surpluses averaging out over the cycle.
And the debt-to-GDP ratio will decline slowly over the years.

19. Improvements Required
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Improvements Required
Setting out the annual operational targets
There are two types of operational targets commonly employed -- budget balance and total spending.
Total spending is a superior choice because
it is less influenced by the cyclical position of the economy and therefore easier to target; and
it assists in a counter-cyclical management of fiscal policy by leaving the balance to fluctuate over the cycle.
Presently, the Korean government intends to keep the annual spending totals unchanged in successive NFMPs, and thus appears to have the total spending as annual targets.

20. Improvements Required
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Improvements Required
Analyzing the risk factors
Risk analysis is being called for that studies the impacts of
the projected medium-term growth rates and other macroeconomic variables on the government financial position;
the various contingent liabilities of the government; and
the changing demography on the long-term fiscal sustainability and on the public pension system.

21. Improvements Required
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Improvements Required
Introducing “program budgeting”
The Korean government is currently redesigning the structure of its budget accounts around functions, administrations, and programs.
The resulting program structure will make it easier to allocate resources according to the national priorities and set ceilings on sectoral spending.
“Programs” will also act as the basic units of performance management in the future.