Strengthening public financial management in Montenegro

3. Budget execution, control and reporting

The MoF maintains a robust framework for cash management, budget flexibility and execution. Cash management benefits from strong cash flow planning. A legal framework is in place for internal controls and internal audit, but the operational framework is not of the same standard. In this regard, the following recommendations would be beneficial:

• Adopting the ESA2010 definition of general government debt as the measure of public debt.

• Implementing the SAI’s recommendation to improve the credibility of expenditure arrears by consolidating data on outstanding liabilities at the end of the year.

• Tightening the criteria surrounding the use of the current and reserve funds to ensure that they may only be used for policy proposals that comply with budget regulatory provisions.

• Addressing the risk of understating the cost of new polices by strengthening the requirements for fiscal impact assessments.

• Enhancing the monitoring of SoEs by establishing financial planning and performance monitoring frameworks, and performance indicators that are part of the accountability arrangements for SoEs.

• Strengthening internal audit capacities across public sector entities to improve the assurance function and the use of the findings from internal audits.

• Enhance the quality and analysis of reports submitted by public bodies and local government to the MoF to better inform spending decisions.

3.1. Cash and debt management

The LBFR provides for a Treasury Single Account (TSA) into which most though not all revenues are transferred every day. The account is operated by the CB and it is consolidated daily in accordance with the Instructions on State Treasury Operations issued by the MoF. All budget users, including the Health Insurance Fund, the Pension and Disability Insurance Fund, the Employment Institute and municipalities, are included in the TSA. The LBFR also permits public bodies that generate own revenues to use the revenue for operational expenditure without going through the TSA. They can only do this, however, after receiving prior approval from the MoF. The amount is around EUR 40 million (1.3% of total expenditure in the 2024 Budget Law). Suspense accounts for certain payments, including international transfers, are also permitted but they too must be approved by the MoF and cleared in a timely manner.

Revenue and expenditure must be recorded in the general ledger. The general ledger and the TSA are reconciled daily. Cash disbursement is monthly and the finance directorate in each public body is responsible for monitoring compliance with regulatory requirements established by the MoF. This means that public bodies must operate within a framework approved by the MoF, which establishes monthly and quarterly ceilings.

Cash flow projections are developed in January of each year. Public bodies submit monthly forecasts to the MoF and the MoF consolidates the information so that the Treasury can anticipate expenditure will be in each month. This allows anticipated revenue and expenditure to be matched for each month to facilitate cash management. The projections are updated monthly based on actual revenue and expenditure. The published cash flow reports are not detailed by budget organisation but on an economic classification so there is no information on pay, non-pay and capital expenditure by institution.

Data on the stock of expenditure arrears are collected quarterly and are published annually. The LBFR defines arrears as liabilities for which payments are outstanding as of the due date; there is no definition of the number of days past the due date that constitutes a payment in arrears. Arrears are reported as a gross figure broken down by type of expenditure without reference to specific institutions. The reported stock of arrears for both 2022 and 2023 was 0.4% of total expenditure, which is low. However, the SAI audit report on the final accounts of the State Budget 2022 found that some details of expenditure arrears were not reliable. It recommended steps to consolidate data on outstanding commitments in such a way as to show the arrears at the end of the accounting period.

It is not clear whether all institutions, including municipalities and SOEs, report on arrears. There is an annual report from each SOE to the Tax Authority that is shared with the monitoring department in the MoF. However, this means that monitoring on this basis is two years in arrears and lacks relevance. Furthermore, the MoF only provides an opinion on SOE policies when that SOE is under the responsibility of a line ministry.

The MoF is the sole authority for managing debt. There is some debt analysis and debt forecast in the MFPG, including a forecast of debt trajectory for the upcoming four years but until very recently, a stand-alone medium-term debt management strategy had not been published since the one for 2018-2020. In December 2024, the Government adopted the medium-term debt management strategy 2025-2027. This is aligned with the FS.

The MFPG establishes targets for general government debt and there is a limit on the debt to GDP ratio of 60%. While the LBFR requires corrective action in the face of the threshold being exceeded, the debt ratio has exceeded 60% for several years. Although it is projected to remain stable at around 61.5% in the medium-term, the pressures of an ageing population and the lack of long-term forecasting could lead to a relatively sudden and unforeseen deterioration in the trajectory of the public finances. There are also limits on State guarantees which may not be more than 15% of GDP. Local government debt, which comprises less than 1% of general government debt, is strictly controlled. Municipalities may only incur loans or provide guarantees with central government approval.

The MoF publishes a General Government Debt Report annually within 90 days of the end of the fiscal year. However, the definition of public debt in the national report on public debt is not in line with ESA 2010 definitions. The authorities should prioritise using the ESA measure of public debt.

3.2. Budget flexibility and execution

Supplementary budgets towards the end of the year are a regular feature of the budget cycle. This is a normal feature of budgeting in OECD countries. One supplementary budget each year suggests that the planned budget is enough to provide for normal planned spending over a budget year with normal reallocations and adjustments. However, in Montenegro supplementary budgets have been used to give effect to what are essentially new budgets.

In terms of spending, the LBFR allows the reallocation of spending during the year subject to several rules. For example, spending resourced by EU funds cannot be reallocated and reallocations between capital and current spending are prohibited. As is usual in OECD countries, minor changes are allowed with MoF approval while larger transfers require Cabinet approval. With MoF approval, public bodies can make reallocations by programme, subprogramme, activity, project and individual expenditures, as long as the reallocation does not exceed 10% of the programmes, subprogrammes, activities, projects and expenditures that are reduced. Changes of up to 10% but between public bodies require Government approval. Changes in excess of 10% require not only Government approval but also the approval of the Parliament because they are regarded as a new law. The adoption of the new law is outside the supplementary budget process because it is reallocating resources without affecting total spending.

It is notable that public bodies regularly report that new policy proposals will have no additional cost. There is no sanction for this practice so there is no incentive for sponsoring bodies to make a realistic estimate of costs. Proper fiscal impact assessments depend on quantitative analytical capacity and partly on changes in the culture of the civil service. To bring about an improvement will require both technical capacity and buy-in from stakeholders on the importance of fiscal impact assessment.

The level of spending is controlled by the Treasury and each public body is subject to both a monthly ceiling and a quarterly ceiling to make sure that deviations from agreed limits cannot emerge. Any new commitments which a public body wishes to incur will only be permitted if it does not exceed the remaining balance in its annual allocation. However, commitment controls do not apply to the own resources of public bodies. The SAI considers that the commitment control system is not fully operational and liabilities are not tracked or recorded in many institutions.

The LBFR provides for a current reserve and for a permanent reserve. It states that unforeseen or inadequately planned expenditure may be funded from the current reserve. The permanent reserve is supposed to be used only for urgent and unforeseen expenditure. The MoF decides on the use of both the reserves, after it has obtained the approval of the Government. However, the LBFR also states that more detailed criteria for the use of the reserves will be determined by the Government. This has led to the current reserve being used in unusual circumstances on occasion. The criteria surrounding the use of these funds should be tightened.

3.3. Internal control

The 2022-2026 PFM Reform Programme outlines goals for developing internal control and audit systems, with the MoF being primarily responsible for its implementation through the Central Harmonisation Unit (CHU), across the public sector. By the end of 2024, just over half of the planned activities related to internal control and managerial accountability were executed. The reform programme is largely governed by the 2018 LMIC supplemented by various rulebooks and methodologies. A planned amendment to the PIFC Law seeks to address inconsistencies with other laws and update associated by-laws.

The PIFC Law mandates public bodies to establish internal controls, with heads of public bodies holding overall responsibility. Compliance rates for submitting annual governance and control reports are high (over 90% in 2023), and around two-thirds of entities performed a self-assessment over the same period. The CHU uses these reports and self-assessments to make recommendations for updating risk registers and conducting further self-assessments. Despite these efforts, just over one third of entities adopted plans to improve management and controls in 2023.

Risk management practices are improving. However, updates and substantive use of these registers remain uneven. By 2023, most public bodies had risk registers, although only about one third updated them regularly, and there is little inter-institutional co-ordination. Monitoring SoEs by line ministries remains a priority, particularly in financial planning and performance monitoring. Most SoEs do not submit financial plans to the MoF or the supervising ministries, and there are no binding requirements for agreeing performance indicators or monitoring frameworks. Consequently, many line ministries lack consistent oversight or coherent data on SoEs.

The PIFC Law also establishes the framework for internal audit in the public sector, detailing requirements for planning, execution, reporting, independence, and auditor certification and development. It provides for the establishment of internal audit units (IAUs) in public sector entities, either internally or through agreements with other entities, and sets minimum staffing requirements for these units. By the end of 2023, there were IAUs in nearly all public bodies, although most units remain understaffed, with only nine out of 23 central government entities meeting the minimum staffing criteria. The Government has approved CHU proposals, including salary top-ups approved in early 2024, to address retention challenges and bolster internal audit capacity.

Implementation of the internal audit function is progressing steadily. The CHU and the Human Resource Management Authority have professional development and certification programmes for internal auditors, with 83 out of 87 (95%) auditors certified by the end of 2023. Efforts to enhance quality assurance are in early stages, with guidelines for self-assessments and reviews in place. An external quality assessment system is under development, overseen by the CHU.

In 2023, 111 out of 139 (80%) planned audits were completed, reflecting a growing trend since 2021. Despite general compliance with legal and methodological requirements, gaps persist in annual audit planning. Internal audit reports produced 552 recommendations in 2023, with an implementation rate of about 60%. Management’s perception of internal audits is improving, but challenges remain on engagement with audit findings. While most managers accept audit recommendations, not all believe these contribute to organisational improvement. Furthermore, internal audit findings are not consistently discussed with auditees, limiting their impact.

3.4. Financial monitoring and reporting

In Montenegro, the LBFR, the Law on Accounting in the Public Sector and MoF Order No.6 of 2014 "Rules on the method of preparing and submitting the financial reports of the budget, state funds and local self-Government” provide the legal framework for financial analysis and reporting. The framework establishes a reporting format that requires each public body to apply a consistent methodology, which allows public financial information to be presented accurately. Budget execution reports are on a monthly, quarterly and annual basis.

MoF Order No.6 of 2014 defines the accounting standards to be applied. Currently, accounting standards are cash-based. There is no accruals-based methodology in place. The MoF plans to have introduce a new Law on Accounting in the Public Sector by 2027. However, the existing Law on Accounting provides for the recognition and valuation of assets, liabilities, net assets, income, receipts, expenses and expenses and for assets and liabilities to be reported on an accrual basis. Nevertheless, current accounting standards are on a cash basis and while the annual financial report includes data on liabilities, state guarantees, arrears, it lacks data on assets. As reforms must be sequenced, we recommend that the adoption of accruals should follow only after other more fundamental reforms are in place.

Reports on central government revenue, expenditure and borrowing are published monthly and quarterly on the MoF website, within four weeks of the end of the relevant period. The reports show all central government data at the institutional level, programme level and the functional level. The reports show variations from an original spending and revenue profile published at the start of the year. They provide brief explanations for the variations at the aggregate level but not by institution. They show variations in absolute numbers and by percentage. They also show a comparison against expenditure for the same period in the preceding year.

There are quarterly reports on consolidated public spending and they are published on the government website. In addition, these reports show details of both central government and local government revenue and expenditure data separately. They show variations between actual and planned spending in absolute numbers and by percentage. The consolidated quarterly reports are published before the end of the following quarter.

The fundamental requirement for comprehensive reporting to the MoF that allows the financial position of local government bodies to be monitored can be improved. Data on stocks of local government arrears need to be improved. In some cases, this makes it difficult to assess the fiscal health of local governments. The authorities should make reporting a requirement of all municipalities to facilitate more comprehensive monitoring of their finances. Even if the MoF does not have the resources to analyse the reports of all local self-governments, they could focus on a sample every year and identify necessary improvements to the reports; in this way reporting could be improved over a period of years even if resources are limited.

The central government’s annual financial report (final account of the year) is comprehensive, in that the social insurance funds are included and the format mirrors the presentation of the budget. It notes and explains variations from the original budget allocation by spending bodies and on the implementation of capital projects. It includes information on guarantees, borrowing and debt. There is a chapter that provides performance information that links budget appropriations with objectives and results. It is supposed to be published within six months of the end of the financial year but this is not always the case. For instance, the Government submitted the 2022 Annual financial report to the Parliament on 16 November 2023. In recent years, the SAI has issued a qualified opinion on the annual financial report.

The Law on Audit requires the annual financial statements of SOEs to be audited but not all SOEs submit audited annual statements to the MoF or to the sponsoring ministry. A consolidated report on the financial performance of the SOE sector is not published annually. Given the fiscal risk that SOEs can present, the monitoring and reporting process should be strengthened.