Strengthening public financial management in Montenegro

2. Budget preparation

The foundations of sound budgeting practices are in place in Montenegro for the preparation of the Government’s budget. This is clear from initiatives for a multi-annual approach, attempts to develop programme and performance budgeting and ongoing reforms to strengthen the capital budgeting framework. The implementation of gender budgeting is in its early stages; green budgeting has not yet been implemented.

Priorities for reform should build on the progress achieved to date to improve the quality of the budget preparation process and the quality of information that informs budget decisions, in particular by:

• Securing political commitment for spending reviews and developing a framework for their implementation.

• Promoting programme-based and performance budgeting for better expenditure planning and alignment with policy goals.

• Ensuring the consistent implementation of programme budgeting across all ministries by capacity building and including a timetable for performance budgeting and annual reports.

• Providing that investment projects are planned and approved within a multi-year budget framework, which permits the carryover of unspent funds within specified limits.

• Building capacity in the agencies responsible for budget execution, specifically through the government’s finance function.

2.1. Structure of the budget

The structure of the State budget is defined by Article 34 of the LBFR and comprises a general and a specific part. The general part of the budget contains an assessment of current receipts and expenditures, the primary budget cash surplus or deficit, and the budget cash surplus or deficit. The specific part presents the detailed allocation of funds.

The budget is prepared on a cash basis according to five classifications: 1) organisational classification; 2) functional classification (COFOG); 3) economic classification; 4) programme classification; and 5) project classification. The entire state budget is presented across these five classifications. A consolidated table of revenues and expenditures by economic classification is also included in the budget documentation.

• Organisational classification identifies the administrative units responsible for spending the funds (e.g. ministries, agencies)

• Functional classification shows the general purpose of allocations (e.g. health, education defence) according to the Classification of the Functions of Government (COFOG) developed by the OECD and UN.

• Economic classification details the nature of the expenditures (e.g. salaries, capital expenditure, social assistance benefits). This classification is consistent with the IMF’s Government Finance Statistics (GFS).

• Programme classification breaks down the budget of individual spending units into programmes, which are further broken down into sub-programmes and activities. For example, the Ministry of the Interior’s budget is organised into four programmes, each detailed with economic classifications.

• Project classification categorises expenditures related to specific capital projects within the budget.

In addition, the annual budget is supplemented with an explanatory part, which provides macro-fiscal forecasts, details budget revenues and expenditures, and includes a chapter on gender budgeting to illustrate the financial impact of budget policies on gender.

The State budget incorporates a medium-term perspective in the Macroeconomic and Fiscal Policy Guidelines prepared by the MoF. The MFPG sets binding expenditure ceilings for the first year and indicative ceilings for the two subsequent years. This medium-term approach promotes fiscal discipline and budget predictability while allowing some degree of flexibility.

2.2. Programme and performance budgeting

Programme budgeting organises public expenditure into programmes, sub-programmes and activities corresponding to specific objectives the Government wants to achieve. This is a significant departure from traditional line-item budgeting, which allocates funding based on inputs such as salaries and capital expenditures. Instead, programme budgeting structures the budget around policy objectives and activities required to achieve them.

Performance budgeting builds on programme budgeting by using performance indicators and targets to inform the allocation of public resources. Programme and performance budgeting are complementary practices and common features of modern PFM systems. Together, they provide a more transparent link between the allocation of funds and policy outcomes, making it possible to evaluate the success of government programmes based on results rather than inputs. Performance budgeting is common among OECD countries (Figure 1).

Montenegro introduced programme budgeting in the central government in 2021. It is still in the early development stages, and the programme structure is prepared in parallel with a traditional line-item budget structure. Montenegro has taken some steps towards performance budgeting, which connects the annual budget to the Government’s public policies and programmes. The legal framework for performance budgeting is established in the LBFR and supplemented by other regulations, including:

• The Budget Circular for the MTBF

• The Manual for the MTBF

• Government decision on the creation of the capital budget and determination and valuation criteria for the selection of capital projects.

Spending units are required to prepare programme budgets outlining programmes, sub-programmes, and activities with corresponding performance indicators and targets. Programme budgets are submitted to the MoF for review and approval as part of the annual budget preparation process.

Reporting on performance budgeting remains of insufficient quality to effectively inform budgetary decision-making. While spending units are required to submit semi-annual reports on budget execution, these reports are often submitted late and do not include measurable goals, relevant indicators, and justifications for expenditure. In addition, the performance information developed by spending units is often not connected to the Government’s strategies and objectives. While some ministries have developed targets and indicators for their activities, others are not required to implement performance budgeting. Inconsistencies also exist within ministries. There is a need to build capacity to enhance the skills and knowledge of spending units for preparing and using performance information.

While the introduction of programme budgeting has facilitated greater transparency and accountability, several challenges remain to fully realise the potential of performance budgeting. To strengthen its performance budgeting framework, the Government of Montenegro should:

• Invest in skills to develop quality performance information: provide training and assist spending units in designing their programme and performance budgets, particularly focusing on developing and using quality performance information (e.g. indicators and targets).

• Enhance the legal framework: amend the Decision on Programme Budget Preparation to include a specific deadline for submitting annual reports on performance budgeting and to ensure the consistent implementation of programme budgeting across all ministries.

Figure 1. Performance budgeting in OECD countries, 2023

Source: 2023 OECD Survey on Performance Budgeting

2.3. Spending reviews

The expenditure baseline for the current year is often the starting point from which a government prepares its budget. Spending reviews look at this stock of expenditure and play a crucial role in helping governments manage public spending through the reallocation of fiscal resources. The purposes of a spending review include:

• Enabling the government to manage the aggregate level of expenditure.

• Identifying savings and reallocation measures.

• Improving effectiveness within programmes and policies.

Spending reviews have become a core instrument for expenditure prioritisation and reallocation and a permanent feature of the budget process in many OECD countries. As of 2023, nearly all OECD countries (97%) had conducted at least one spending review, with 29 countries (82%) carrying out spending reviews on an annual or regular basis (Figure 2).

Figure 2. Spending reviews in OECD countries, 2023

Source: 2023 OECD Survey on Spending Reviews.

While Montenegro has not yet started using spending reviews, such reviews are particularly relevant in the context of the country’s accession to the EU as nearly all EU member states use spending reviews. In the context of PFM reforms, the MoF is looking to introduce spending reviews to improve the efficiency of public spending by regularly assessing baseline expenditure to reprioritise and reallocate spending, identify fiscal space and improve the effectiveness and efficiency of programmes.

Spending reviews can be an instrumental tool to better address fiscal challenges in Montenegro. They can include programmes that have historically presented budgetary challenges and spending areas that no longer relate to key priorities of the Government.

Spending reviews can complement programme and performance budgeting in Montenegro. Information from programme and performance budgeting can help identify spending areas that merit review. Such reviews support the quality of analysis, ensuring the findings are realistic and actionable.

Montenegro should introduce spending reviews gradually. In the short term, the Government should:

• Secure political commitment for spending reviews: highlight the fiscal and policy benefits of conducting spending reviews. Involve key stakeholders early, including line ministries, to create ownership. Create incentives for spending entities to take part in spending reviews.

• Develop a framework for conducting spending reviews: formulate a methodology and define key roles and responsibilities throughout the review process.

• Conduct one pilot review focusing on an area with suspected inefficiencies. The first pilot should target a spending area or programme with high fiscal impact and clear alignment with Government priorities. Areas with good data availability should be selected to reduce complexity and build confidence in the process.

• Engage with external experts to build in-house capacities: learn how to conduct spending reviews from peers, external experts, and international organisations. Use their support and guidance to build lasting capacities for conducting spending reviews in-house.

• Update the spending review framework to reflect lessons learned during the pilot review: continuous improvement of the framework helps maintain its capacity to deliver results and respond to the government’s needs and the evolving fiscal environment it faces.

Box 1 presents examples of spending review practices in two OECD countries. In the Netherlands, spending reviews benefit from political commitment and support, anchored in the Coalition Agreement. The Greek example reflects a broader trend: spending reviews have evolved from a top-down exercise into a more collaborative process between the MoF and line ministries.

Box 1. Examples of spending reviews in OECD countries

Spending reviews in the Netherlands

During the formation of Government, following general elections, the coalition agreement includes a statement on spending reviews. The statement identifies the priority and focus of the new Government’s spending review programme over the four-year term of Government. The coalition agreement is politically binding but is an instrument for the executive of the Government and does not have a legal status through parliament. Political leadership is demonstrated through key stages of the spending reviews:

• The Cabinet determines the topics and/or areas of Government to review based on Government priorities and the politics of the day.

• The Cabinet approves the terms of reference of a spending review and publishes the terms in the Budget Memorandum along with guidance information on the conduct of the review.

• The Cabinet determines which recommendations from the spending review it will approve.

The analysis underpinning a spending review occurs through a non-political working group co-ordinated by the MoF. Both the report by the working group and the Cabinet’s decisions are released publicly.

Spending reviews Greece

Greece began conducting spending reviews in the aftermath of the 2008 financial crisis. The first reviews were a comprehensive, top-down exercise with strong leadership from the MoF that focused on identifying savings to improve fiscal balances. Today, the process has broadened from focusing mostly on savings to include the quality of spending with stronger involvement of line ministries.

Greece has been working on embedding spending reviews as a permanent technical process that produces possible savings options to be included in the Government’s budget process every year. To achieve this, options for savings and reallocations are explored and a portfolio of possible spending review measures is built for each review, and the measures that are to be implemented in the upcoming budget are selected by ministers.

2.4. Green budgeting

Green budgeting is an approach that helps Governments manage public finances with sustainability as a primary consideration. It considers climate and environmental factors and long-term objectives when allocating resources. Many OECD countries have introduced green budgeting into public financial management frameworks, policies and practices to help pursue climate and environmental objectives.

In 2022, two-thirds of the OECD countries surveyed had implemented green budgeting measures (24 of 36 countries). This compares to 14 countries that had implemented green budgeting in 2020. The proportion of OECD countries that were using green budgeting in 2022 demonstrates the growing commitment of Governments to consider climate and environmental goals in budget processes.

Montenegro ratified the Paris Agreement and submitted three Nationally Determined Contributions (NDC) in 2017, 2021 and 2025. In its most recent NDC, the Government of Montenegro committed to a 55 reduction in net greenhouse gas emissions by 2030 and 60% by 2035 compared to 1990 levels. This commitment covers all sectors of the economy.

In addition to its NDCs, Montenegro has developed a National Strategy for Sustainable Development to 2030 (NSSD 2030) in response to the significant climate risks it faces, such as frequent floods, earthquakes, landslides, intensifying droughts, wildfires, and heat waves. The NSSD 2030 focuses on substantial investments in adaptation and renewable energy, structural fiscal reforms, and support for affected communities.

Despite its ambitious climate policies and the significant climate risks that the country faces, Montenegro has not yet started to implement green budgeting. Introducing green budgeting would provide a structured approach to align fiscal planning with Montenegro’s environmental strategies and climate-related objectives. Green budgeting should be integrated into the annual budget cycle to demonstrate the relationship between fiscal resources and policy objectives on climate change and the environment. Montenegro’s approach to green budgeting should be aligned with the NSSD aimed at mitigating climate change, enhancing resilience and achieving sustainable economic growth.

Green budgeting practices vary among OECD countries for a variety of reasons. Each country tailors its approach to green budgeting based on its specific circumstances, policy objectives, and levels of commitment to environmental sustainability. The most prevalent budgetary tools refer to carbon pricing mechanisms (22 countries, an 83% increase compared to 2020), environmental impact assessments (18 countries, a 33% increase compared to 2020), and green tagging (13 countries). However, countries’ experiences with green budget tagging have also shown that there are limitations in terms of what can realistically be achieved from tagging budget data.

2.5. Gender budgeting

Gender budgeting is an approach to PFM that can integrate gender considerations into budgetary decision-making. It is used to identify budget measures that will be effective at closing gender gaps and advancing gender equality objectives (OECD 2023). The benefits of gender budgeting include:

• Strengthening the evidence base upon which resource allocation decisions can be made.

• Improving the effectiveness of the budget in closing gender gaps.

• Eliminating inherent gender biases from key government processes and tools.

• Increasing transparency on the impact of the budget on different groups across the population (OECD, 2023).

Gender budgeting is increasingly practised in OECD countries and is now used to help close gender gaps in 61% of member countries. The number of OECD countries practising gender budgeting has almost doubled in recent years, with 23 countries implementing it in 2022, compared to 12 in 2016 (35%).

Montenegro has made some limited progress in introducing gender budgeting. While the Law on Budget and Fiscal Responsibility does not yet prescribe gender budgeting, elements of gender-budgeting have been introduced in by-laws and guidelines. The Programme Budgeting reform of 2020 requires all spending units to prepare a Statement on Gender Equity, which includes gender-sensitive goals, indicators, and activities.

In 2021, the Manual for the MTBF introduced provisions for assessing the gender responsibility of policy proposals (e.g. how they contribute to reducing inequalities between men and women). In addition, the Annual Budget Circular includes instructions for spending units to provide a short statement on how their programmes and sub-programmes contribute to reducing gender disparities and supporting vulnerable groups.

The lack of clear requirements and guidance on gender budgeting has negatively impacted its systematic implementation and effectiveness. While budget requests must indicate whether achieving a given goal would contribute to reducing gender inequality, budget execution reports do not require spending units to report on how the budget actually contributed to gender equality. In addition, there are wide inconsistencies in the quality and completeness of gender equity statements.

Several steps would help Montenegro align its gender budgeting approach with the OECD Gender Budgeting Framework:

• Enhancing the legal framework: the LBFR should be amended to explicitly mandate gender budgeting. This legal underpinning would help ensure the sustainability and consistent application of gender budgeting across spending units.

• Developing guidelines: provide spending units with guidance on formulating gender-responsive goals and indicators and reporting progress.

• Establishing reporting requirements: focus on results achieved from gender budgeting in budget execution reports across the Government.

2.6. Capital budget

Capital investment has been a primary contributor to budget deficits in Montenegro over the past decade. Under-developed appraisal, evaluation and monitoring procedures have contributed to actual expenditures being well more than planned spending.

The Government has taken some steps to strengthen capital budgeting. The 2024 Decision on Creating the Capital Budget establishes a methodology for consistent appraisal, evaluation and reporting of all investment projects across all public bodies, including local self-governments. This provides an improved legal framework for delivering projects that are within budget and provide better value for money but it is too early to assess its impact on the actual implementation of capital investment.

Under the new procedures, a Project Evaluation Commission has been established, whose objective is to ensure that projects are comprehensively appraised before they can be approved by Cabinet. Proposed projects must be accompanied by justifications and costings. The aim is to have a standardised approach to the selection of capital projects. The Commission is inter-ministerial and includes staff from the Prime Minister’s Office and the MoF. The MoF also provides the Secretariat for the Commission, which maintains its central role in managing the overall capital spending process.

Under the new regulation, all capital project proposals must be accompanied by supporting analysis of the expected impact. Furthermore, any project with a cost above EUR 5 million must include a cost benefit analysis. However, while the Decision prescribes that monitoring is conducted, there are no details of how this is to be implemented other than to say the person responsible for monitoring is to carry out this task and prepare a report. The Decision requires a project risk assessment to be included in the initial project proposal but does not prescribe how this should be done. These gaps can be addressed by preparing procedural requirements, illustrating areas where further measures are needed to support the quality of the public investment management process.

To overcome this problem – and to ensure the quality of the project appraisal and management process – some countries such as Croatia and Ireland have established centralised services that provides expertise for all budget units.

• In Croatia, the Sector for Government Expenditure Analysis within the MoF is responsible for co-ordinating and monitoring all aspects of infrastructure policy and investment decisions. This centralised approach was designed to achieve better value for money in capital projects.

• In Ireland, the Irish Government Economic and Evaluation Service (IGEES) is a cross-Government service established to enhance the role of economics and value for money analysis in public policy making. It provides analysis in many areas including capital investment.

All capital investment proposals must be in line with the Government’s strategic plan. The Commission submits a report to the MoF each year with a list of priority capital projects to be included in the capital budget. In 2024 it submitted 30 projects out of 217 proposals. New projects can only be included subject to available resources in light of the Government’s existing commitments on existing capital projects. Once approved by the Cabinet, the details can then be included in the budget. Responsibility for implementing investment projects remains with the Public Works Administration or the Transport Directorate. The Decision requires these bodies to monitor progress and report monthly to the MoF on the implementation of the projects for which they are responsible.

Two of the issues that remain unresolved in the capital budgeting system is the lack of a multi-annual approach to managing capital projects and the inability to carry-over funds when there is a delay to a project. Neither the LBFR nor the Decision on Capital Budgeting provides a regulation or framework for planning or implementing on a multi-annual basis.

To tackle these two issues, investment projects should be planned and approved within a multi-year budget framework. Without the certainty of multi-year budgeting, the Government risks facing challenges in sustaining consistent funding for critical projects or may be forced to postpone or cancel them due to unexpected budget reductions. The MoF should consider permitting the carryover of unspent funds – within specified limits – when delays occur. The funds carried forward should only be available for the original project. This would enhance the execution of capital projects and associated budgets.

The approach to project assessment and selection could be enhanced by creating a more comprehensive methodology for evaluation and building the capacity of staff in the agencies. The MoF should explore support for a training programme aimed at improving skills in this area. Additionally, the MoF would benefit from examining international best practices from smaller countries, such as the Irish Public Spending Code, which could be tailored to fit the Montenegrin context. (Department of Public Expenditure and Reform of Ireland, 2019[2]).