Baku Engineering University

Economics and Administrative Sciences

Faculty

Budget and Treasury

The budget cycle

Lecture 6
(Part 1)
Samra
Talishinskaya
 Outlin
e

Part 1.
1. Three prerequisites for budget
preparation

2. The budget formulation processes

i. Preparing the macroeconomic
framework
ii. Three stages of budget preparation
iii. Budget preparation calendar
iv. The budget execution

Part 2.
3. The treasury function

4. Cash management
 BEU, 2016-2017 2
 1. Three prerequisites for budget
preparation
Three major conditions are needed for the desired outcome of a budget that is
both technically sound and faithful: taking a medium term perspective, making
early decisions, and
setting a hard constraint.

The Need for a Medium-Term Perspective

To be an effective instrument of financial management, the government budget
must in the first place be credible. To be credible, the expenditure program
must be affordable. Therefore, budget preparation must take as its starting
point a good estimate of revenuealthough the revenue estimate may change
before the budget is finalized in order to produce a consistent revenue-
expenditure package. Thus, fiscal marksmanshipthat is, the accuracy of
revenue forecasts as manifested in closeness of actual revenues to those
estimatedis the linchpin of
the budget preparation system. To meet the governments objectives, the
budgeting system
must provide a strong link between government policies and the allocation of
resources through the budget. Because most of these policies cannot be
implemented in the short term, the process of preparing the annual budget
should take place within a fiscal perspective several years into the future.1 The
future is inherently uncertain, and the more so the longer
the future period considered: the general tradeoff is between policy relevance
and certainty.
Clearly, the feasibility of a multiyear perspective is greater when revenues are
predictable and the mechanisms for controlling expenditure are well
developed.
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 1. Three prerequisites for budget
preparation

The need for early decisions

By definition, preparing the budget entails hard choices. These decisions can
be made, at a
cost, or avoided, at far greater cost. The necessary tradeoffs must be made
explicit when formulating the budget. Doing so will permit a smooth
implementation of priority programs and prevent disruption of program
management during budget execution. Political interference, administrative
weakness, and lack of needed information often lead to
postponing these hard choices until budget execution. This postponement
makes the choices
harder, and the consequence is a less efficient budget process. As repeatedly
noted, an unrealistic budget cannot be executed well.

The need for a hard constraint

Giving a hard expenditure constraint to line ministries from the beginning of
budget preparation. Annual budget preparation must be framed within a sound
macroeconomic framework and should include a top-down stage, a bottom-up
stage, and an iteration and negotiations stage. It is at the top-down stage that
the hard expenditure constraint, or ceiling,
should be communicated by the ministry of finance to all spending agencies; it
is the most
effective way of inducing them to confront the hard choices early in the
process.

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 2. The budget formulation processes

Five generic stages of annual budget processes (see Figure 1) can be identified
as follows:

First the executive prepares a draft budget and submits it to the legislature.
This is usually a two-step process: a Ministry of Finance (or equivalent)
prepares a draft budget that incorporates the governments expressed budget
orientation; the draft budget prepared by bureaucrats is then approved by a
Cabinet of ministers (or the equivalent for countries with
presidential political systems). This budget is submitted to the legislature for
possible
amendment and approval.

Second, at the Parliamentary stage, the budget is generally discussed in

parliamentary committees, which may propose amendments. Once
amendments are agreed in plenary session, the legislature approves the
budget. Legal authority is provided to the executive for raising revenues if this
is not ongoing. Formal adoption of the spending proposals means that legally
binding upper limits are established for many expenditure categories.
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 2. The budget formulation processes

The third stage is the implementation of the approved budget which is

performed by the
executive and/or government agencies. In so doing, a central budget office
(usually in the
Ministry of Finance or the equivalent) monitors budget implementation and
prepares periodic budget execution reports using a well-defined accounting
system. The executive may be provided with the power to change the
approved budget in the case of unforeseen emergencies, including major
deviations in the macroeconomic framework underlying the
budget law. A supplementary budget may be needed to confirm any such
action by the
executive. The executive may also be provided with other powers to modify the
approved budget, including powers to change its composition (e.g. by virement
or by using a reserve fund approved in the annual budget) or to control actual
spending to a level below that approved, should economic circumstances
dictate.
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 2. The budget formulation processes

The fourth stage is parliamentary control of budget implementation. This

takes place both
during and, especially, after the close of the fiscal year. Parliamentary control is
based on
reports provided by the executive. It is Parliaments prerogative to specify the
content and timing of such reports, which may contain both financial data
(annual accounts) and non-financial data (e.g. attainment of performance
targets).

The final stage is when an independent external audit office audits the
financial accounts. It may also have a mandate to assess the results of the
annual budget in terms of efficiency, economy and effectiveness.
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 The Figure
1.
The roles of
Parliament and the
executive in the
budget cycle
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 2.1. Preparing the macroeconomic
framework

In both logical and chronological sequence, the main stages in the budget
preparation process
proceed from the elaboration of the macroeconomic and fiscal framework to
the issue of
budget instructions, preparation of budget proposals, negotiations on those
proposals, and finally presentation to and approval by the legislature.

The starting points for expenditure programming are (a) a realistic assessment
of resources
likely to be available to the government and (b) the establishment of fiscal
objectives. Both
starting points depend in large part on a sound and consistent macroeconomic
framework in pursuit of economic growth, employment, poverty reduction, and
low inflation, by means of fiscal policy, exchange rate and trade policy,
external debt policy, and policies affecting the real economy. For example, the
policy objective of low inflation is influenced by the level of the fiscal deficit,
and he specific instruments can include tax measures and credit policy
measures, among others. Projections should cover the current year and a
forward period of two to four years.

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 2.1. Preparing the macroeconomic
framework

A macroeconomic framework typically includes four interlinked modules on

the balance of
payments; the real economy (that is, production in the various sectors); the
fiscal accounts; and
the monetary sector. It is a tool for checking the consistency of assumptions or
projections concerning economic growth, the fiscal deficit, the balance of
payments, the exchange rate, inflation, credit growth, and the share of the
private and public sectors on external borrowing policies.

The preparation of a macroeconomic framework should be a permanent

activity. The framework needs to be prepared at the start of each budget cycle
to give adequate guidelines to the line ministries. As noted, it must then be
updated throughout the further stages of budget preparation, also to take into
account intervening changes in the economic environment. During budget
execution, too, macroeconomic projections require frequent updating to assess
the impact of exogenous changes or of possible slippage in budget execution.
In addition to the baseline framework, formulating variants under different
assumptions, such
as changes in oil prices, is important. The risks related to unexpected changes
in macroeconomic parameters must be assessed and policy responses
identified in advance,
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 The Figure 2.
Relationships between
major macroeconomic
accounts
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 2.1. Preparing the macroeconomic
framework: Fiscal
component
A key component of the macroeconomic framework is the fiscal framework of
revenues and expenditures, broken down first in the respective major
component categories. For revenue, the categories are direct taxes, indirect
taxes, grants, other taxes, and nontax revenue; for
expenditures, they are salaries, interest, goods and services, subsidies, and
capital
expenditures. The setting of explicit fiscal targets frames the preparation of the
detailed annual budget, calls on government to define clearly its fiscal policy, and
allows the legislature and the public to monitor the implementation of
government policy, ultimately making the government politically as well as
financially accountable. Fiscal targets and indicators should cover fiscal position
(for example, fiscal deficit); fiscal sustainability (for example, debt-to-GDP ratio);
and fiscal vulnerability (for example, future liabilities and fiscal risk).

The summary indicator of a countrys fiscal position used most commonly is

the overall
balance on a cash basis, defined as the difference between actual collected
revenues plus
grants and actual expenditure payments. The cash deficit is by definition equal
to the government borrowing requirements (from domestic or foreign sources)
and is thus integrally linked to the money supply and inflation targets and
prospects. The overall deficit is obviously a major policy target and is used for
international comparisons as well. How the deficit is financed also requires
attention: the same level of fiscal deficit can be manageable or not, depending
on whether it is financed in cost-effective and noninflationary ways.
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 2.1. Preparing the macroeconomic
framework: Fiscal
component
It is essential to underline that the broad objective of fiscal policy is not a specific
level of deficit by any definition, per se, but a fiscal position that is sustainable in
light of policy goals and likely resource availability. A temporary budget surplus,
for example, may mask structural
fiscal problems when the tax base is shrinking, when expenditures are
dominated by rigid
entitlements, and when financing possibilities are limited to expensive foreign
borrowing.

Indicators of fiscal sustainability include the ratio of debt to GDP and the ratio
of tax to GDP. The calculation of the deficit on an accrual basis would in
principle allow a better assessment of liabilities and therefore their impact on
sustainability.

An assessment of fiscal vulnerability is also needed, especially in countries that

benefit from short-term capital inflows and those where loan guarantees have
been given out too
generously and without adequate scrutiny. The standard deficit measures may
indicate a
healthy fiscal situation that is in reality fragile. However, guidelines for
assessing fiscal vulnerabilities are doubtful and unclear. At budget preparation
time, a good judgment must be made of the governments fiscal exposure to
future obligations and contingent liabilities.

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 2.1. Preparing the macroeconomic
framework: Making projections
credible
As noted, a key requirement of a good budget is to be credible. If the budget
preparation is framed by medium-term macroeconomic and fiscal projections,
these must be credible, too. In some countries, the government projections are
submitted to a panel of independent and respected experts to ensure their
reliability while preserving the confidentiality required on a few sensitive
issues.

In other countries, such as the United Kingdom, the projections are validated
by the independent auditor general. In most African developing countries, the
macroeconomic and fiscal projections are developed with the support of
external organizations, which gives them a measure of added credibility.
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 2.1. Preparing the macroeconomic
framework:
Whose fiscal responsibility
Several countries have laws and rules that restrict the fiscal policy of
government and prescribe fiscal outcomes.6 For example, the so-called golden
rule stipulates that public borrowing must not exceed investment (thus in fact
prescribing a current budget balance or surplus, as in Germany). In many
federal countries, the budget of subnational government entities must be
balanced by law. In the European Union, the Maastricht Treaty stipulated
specific fiscal convergence criteria, concerning both the ratio of the fiscal
deficit to GDP and
the debt-to-GDP ratio. EU member countries whose fiscal deficit is higher than
the permitted 3 percent of GDP limit are, supposedly, liable for large penalties.

A frequent criticism of such rules is that they favor creative accounting and
encourage nontransparent fiscal practices by burying expenditures or listing as
regular revenue one-off revenues. Also, when the rules are effectively
enforced, the criticism is that they can prevent governments from adjusting
their budgets to the economic cycle, thus making worse both recessions and
inflationary pressures. The European experience has, unfortunately, also
shown that the Maastricht rules are selectively enforced, with no penalties
exacted for
violation by the largest and most important EU members.

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 2.2. Three stages of budget preparation

In the budget formulation process, close cooperation between the ministry of

finance and the top leadership (presidents office or prime ministers office) is
required. sharp distinction exists between the three stages of budget
preparation: the top-down, bottom-up, and negotiation stages.

The top-down stage

As previewed earlier, the starting points for budget preparation are a clear
definition of fiscal targets and a strategic framework consisting of a
comprehensive set of objectives and priorities. Thereafter, strong coordination
of the budget preparation is required to prevent major departures from the
initial framework.

Generally, the ministry of finance should be responsible for setting the sectoral
ceilings, but it should, of course, coordinate with the center of government,
which must also review the ceilings in detail and approve them. In some
countries, the sectoral ceilings are discussed
within interministerial committees; in other countries, proposed ceilings and
guidelines for
budget preparation are submitted to the cabinet.
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 2.2. Three stages of budget preparation
The bottom-up stage
Line ministries are responsible for preparing their requests within the spending
limits provided. However, the principal request should be consistent with the
notified ceilings or guidelines, and costs of programs included in the additional
requests should be clear and fully adequate for proper implementation, without
any underestimation. Line ministriesbudget
requests should clearly distinguish (a) the amount necessary to continue
current activities
and programs and (b) proposals and costing for new programs. Before deciding
to launch any new expenditure program, the line ministry must assess its
forward budget impact. This step is particularly important for development
projects and entitlement programs, which may generate recurrent costs or
increased future expenditures. This assessment is required whether or not a
formal exercise of multiyear expenditure programming is carried out.

The review, negotiation, and iteration stage

When it receives the requests of line ministries, the ministry of finance reviews
their
conformity with overall government policy and their compliance with the
spending limits.
(Ideally, any submission that exceeds the spending limit by even the smallest
amount should be
returned to the originating ministry forthwith with an instruction to resubmit
one within the
ceiling.) The ministry of finance then reviews performance issues and takes
into account
changes in the macroeconomic environment since the start of budget
preparation. Almost
always, these reviews lead the ministry of finance to suggest modifications in
the line
ministries budget requests. Negotiation follows.

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2.3. Budget preparation
calendar
A pragmatic compromise must be found to
establish a calendar of budget preparation
that fits the realities of developing countries
and the requirements of good budgeting.
If the calendar is not long enough, one or The Table 1.
another Morocco:
phase of budget preparation would be Annual
unduly Budget
constrained, the legislature would not be Preparation
given sufficient time to debate and approve Calendar
the budget, or both.
If the period is too long, changes are likely to
intervene after the issuance of the budget
circular that may invalidate some of the
initial assumptions and targets and require
revision of the draft budget proposals.
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 2.4. The budget execution

Budget execution is the phase when resources are used to implement policies
incorporated in the budget. A well-formulated budget can be poorly
implemented, but a badly formulated budget cannot be implemented well.
Good budget preparation comes first. Budget execution procedures must
ensure compliance with the initial programming, but they are not simply
mechanisms for ensuring compliance. Successful budget execution depends on
numerous
other factors, such as the ability to deal with changes in the macroeconomic
environment, the
implementation capacities of the agencies concerned, and the problems met in
program implementation.

After the budget is approved by the legislative body, spending units are
authorized to spend money through various mechanisms, such as ministry of
finance warrants, decrees, and apportionment plans. This authorization is
generally granted for the entire fiscal year, but in several British
Commonwealth countries it is granted for shorter periods (for example, the
authorization to spend may be granted quarterly for goods and services).
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 2.4. The budget execution

Many countries do delegate authority to the executive to issue decrees or

regulations for the budget execution processes. This is a sign that the
legislature trusts the central budget authority to implement the approved
budget and the audit body to provide reports to the legislature on budget
execution. In Finland, for example, the State Budget Act contains a specific
article to this effect. There are, however, some areas, where Parliament may be
involved during the course of budget implementation. These include the extent
to which the
executive has authority to cancel or transfer budget appropriations which have
been approved by the legislature and, in special circumstances (e.g.
emergencies, from contingency funds), to make expenditures prior to ex post
approval by the legislature. The United States is an example of a country that
has adopted detailed laws in these and other areas of budget execution so that
the legislature can closely monitor and control in-year budget developments.

The constitutions of four OECD countries (Austria, Finland, Germany and Japan)
and the
budget system laws of most other countries contain provisions relating to the
authority of the
executive to spend public money in excess of the approved budget, when there
are specified contingencies. In order to avoid undermining the legislatures
budgetary authority, restrictions necessarily apply.
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 2.4. The budget execution

In Germany, the Constitution authorises the Minister of Finance to consent to

excess spending only in the case of an unforeseen and compelling necessity.
For the federal budget, the Federal Budget Code elaborates: the need shall not
be deemed compelling if a supplementary budget can be adopted in time or if
the expenditure can be postponed until the following year.

In France, in particularly urgent situations, where the national interest is at

stake, the Organic
Budget Law allows the executive to increase Parliaments appropriations by
decree even if it means that the budget deficit target would deteriorate.
However, should the Council of Ministers issue such a decree, it must be
ratified by Parliament as soon as possible. Besides emergency situations, the
executive in France may increase budget appropriations in the event of excess
tax revenues, up to a limit of 1%, provided the budget balance is unaffected
and after notifying parliamentary budget committees.
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 2.4. The budget execution

Budget execution covers both activities related to the implementation of

policies and tasks related to the administration of the budget. Both the central
agencies and the spending agencies are involved in these tasks. The
distribution of responsibilities in budget management should be organized
according to the agencies respective areas of responsibility and accountability.

The ministry of finance should have the following responsibilities:

Concerning the control of budget execution, administering the system of

release of funds (warrants, budget implementation plan, and the like);
preparing the in-year financial plan; monitoring expenditure flow; preparing
in-year budget revisions; managing the central payment system (if any) or
supervising government bank accounts; administering the central payroll
system (if any); and preparing accounts and financial reports

Concerning policy implementation, reviewing progress independently or

jointly with spending agencies, identifying policy revisions as appropriate,
and proposing to the council of ministers reallocations of resources, within
the framework authorized by the legislative body.

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 2.4. The budget execution

The spending units should have the following responsibilities:

Concerning budget administration, allocating funds among their subordinate

units, making commitments, purchasing and procuring goods and services,
verifying the goods and services acquired, preparing requests for payment
(and making payments if the payment system is not centralized), preparing
progress reports, monitoring performance indicators, and keeping accounts
and financial records

Concerning policy implementation, periodically reviewing the

implementation of the relevant program, identifying problems and
implementing appropriate solutions, and reallocating resources among
sector activities within the policy framework of the budget.

In particular, in many countries, coordination between the budget department

of the ministry
of finance, which is responsible for budget preparation, and the treasury, which
is primarily
responsible for budget execution, is often insufficient. The budget department
should be responsible not only for preparing the budget but also preparing
budget revisions and reallocating resources among sectors. The treasury
should provide the department with all the information it needs related to
budget execution.
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 2.4. The budget execution

The principle of separation of duties

The principle of separation of duties is a powerful internal control device. It

states that duties (roles) should be assigned to individuals in such a manner
that no one individual can control a process from start to finish. Everyone
occasionally makes mistakes. Separation of duties
provides a complementary check by another individual. It allows an
opportunity for someone
to catch an error before a transaction is fully executed or before a decision is
made on the basis of potentially erroneous data. In addition, having adequate
separation of duties reduces the opportunity factor that might encourage an
employee to commit fraud or to embezzle.
Thus, according to this principle, the implementation of the budget rests on the
existence of three different functions, which must be performed separately by
the authorizing officer, accountant, and financial controller.

The authorizing officer administers the appropriations. He or she has the power
to commit the
expenditure and to authorize the payment. The authorizing officer is subject to
disciplinary
action and may be held financially liable if he or she fails to comply with
financial regulations or neglects tasks relating to his or her function.

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 2.4. The budget execution

The principle of separation of duties

The accountant makes the payments. He or she is the only person empowered
to handle moneys and other assets and is also responsible for their
safekeeping. The accountant is subject to disciplinary action and may be held
financially liable for payments in which a
procedural error is detected.

The financial controller checks the legality of operations. He or she checks the
commitment and authorization of all expenditure and ensures that revenue, if
any, is properly collected. The financial controller checks whether all
procedures were carried out, all authorizations obtained, and all necessary
signatures obtained. To carry out this task, the financial controller has access
to all the necessary documents and information. The financial controller is
subject to disciplinary action and may be held financially liable if he or she
approves expenditure in excess of the budget appropriations.
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 2.4. The budget execution: monitoring

To keep budget execution under control, a comprehensive and timely system

for monitoring budget transactions is required.

At least every six months, and preferably quarterly, a comprehensive financial

budget execution report, including both expenditures financed from domestic
resources and
expenditures financed from external sources, should be published.

The uses of appropriations need to be systematically registered and tracked.

Budget monitoring (or appropriation accounting) should cover appropriations,
apportionment, increases or decreases in appropriations, commitments and
obligations (including special procedures to monitor forward commitments),
expenditures at the verification and delivery stage, and payments. Such a
system is only one element of the governments accounting system, but it is
the most crucial one for both formulating policy and supervising budget
implementation.
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 Baku Engineering University
Economics and Administrative Sciences
Faculty

Budget and Treasury

The treasury
function

Lecture 6
(Part 2)
Samra
Talishinskaya
 3. The treasury function
Governments need to ensure both efficient implementation of their budgets
and good management of their financial resources. Spending agencies must be
provided with the funds needed to implement the budget in a timely manner,
and the cost of government borrowing
must be minimised. Sound management of financial assets and liabilities is
also required.

Financial management within the government includes various activities:

formulation of fiscal policy; budget preparation; budget execution;
management of financial operations; accounting rules and controls;
maintaining a record of historical and comparative data; and auditing and
evaluating the financial performance and results of government policies and
programmes. Within this broad financial management framework, the treasury
function aims to achieve the set of specific objectives mentioned above. It
covers some or all of the following activities:
Cash management
Management of government bank accounts
Accounting and reporting
Financial planning and forecasting of cash flows
Management of government debt and guarantees
Administration of foreign grants and counterpart funds from international aid
Financial assets management
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 3. The treasury function
To carry out these activities, organisational arrangements and the distribution
of responsibilities vary considerably according to countries. In some countries,
the treasury department focuses only on cash and debt management
functions. In a few countries, debt
management is performed by an autonomous agency. In other countries, the
treasury
performs also budget execution controls and/or accounting activities. Often the
treasury department is a subordinated agency of the ministry of finance, but in
some countries, it is independent of the ministry of finance. In such cases a
very close co-ordination between the ministry of finance and the treasury
department is required, since budget execution must be based on the priorities
stated in the budget. In transition countries (see Annex 1), the treasury should
be preferably part of, or attached to, the ministry of finance, because co-
ordination between government agencies is often weak.

Figure 3 illustrates a possible organisational structure for the treasury, with

separate areas
handling the main functions of cash and debt management, accounting and
reporting and budget execution and financial planning.
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 The Figure 3.
Illustrative treasury organisational
structure
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 4. Cash management
Cash management has the following purposes: controlling spending in the
aggregate, implementing the budget efficiently, minimising the cost of
government borrowing, and maximising the opportunity cost of resources.
Control of cash is a key element in
macroeconomic and budget management. However, for budget management
purposes, it must
be complemented by an adequate system for managing commitments, and it
is not a substitute for sound budget preparation.

For efficient budget implementation, it is necessary to ensure that claims will

be paid according to the contract terms and that revenues are collected on
time; to minimise transaction costs; and to borrow at the lowest available
interest rate or to generate additional cash by investing in revenue-yielding
paper. It is also necessary to make payments on a timely basis by tracking
accurately the dates on which they are due.

Often in the past, governments did not pay sufficient attention to issues related
to efficient cash management. Budget execution procedures and the
management of cash flows focused on issues of legal regularity and
compliance, while daily cash needs were met by the central bank. Spending
units were not concerned with borrowing costs since their interest payments
were already taken account of in the budget prepared by the ministry of
finance.

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 4. Cash management
From a cash management point of view, these modes of centralising cash
balances give identical results. At first sight, the variant that places payment
transactions processing and accounting controls under the full responsibility of
the treasury department might seem more efficient from the viewpoint both of
cash management and expenditure control. However, the centralisation of
accounting controls and the central management of float can lead to
inefficiencies, and even corruption, in countries with poor governance.

Reform of the cash management system must take into account its possible
impact on budget
management within spending agencies and must also be cost-effective.
Implementing a
system that centralises cash management does not pose major problems for
the central departments of line ministries. But for regional departments, the
organisation of the payment system must take into account the system of
public administration and banking infrastructure in the country concerned.
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 4. Cash management: efficiency issues
Tax collection
It is necessary to minimise the interval between the time when cash is received
and the time it is available for carrying out expenditure programmes. Revenues
need to be processed promptly and made available for use. Commercial banks by
virtue of the banking sector infrastructure are often able to collect revenues more
efficiently than tax offices, which should therefore focus instead on tracking
taxpayers, issuing tax assessments, monitoring payments and reporting results.
When revenues are collected by commercial banks, arrangements must be
defined to foster competition and ensure prompt transfer of collected revenues to
government accounts. Systems of bank remuneration through float, which
consists of
authorising the banks to keep the revenues collected for a few days are
inconvenient. Stringent rules to ensure prompt transfers should be established.
Moreover, bank remuneration through fees is more transparent and promotes
competitive bidding. An appropriate system of penalties for taxpayers is also
an important element in avoiding delays
in revenue collection.
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 4. Cash management: efficiency issues
Payment techniques
Payment methods affect the transaction costs of cash outflows. Depending on
the banking infrastructure and the nature of expenditures, various payment
methods may be considered (cheque, cash, electronic transfer, debit card,
etc.). Modern methods of payment for example, payment through electronic
transfer instead of by cheque or cashallow the government to plan its cash
flow more accurately, expedite payments, and simplify administrative and
accounting procedures. However, whether one mode of payment is preferable
to another depends on many factors, such as the degree of economic
development
of the country, the extent and maturity of the banking network, and the level
of
computerisation. For payments within the government sector (e.g. when a
ministry or government agency provides services to another agency), a
number of countries use non-payable checks, while others make accounting
adjustments. Using non-payable cheques has the advantage of avoiding delays
in the preparation of accounts.
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 The Box 1.
Incentives for good cash management in
Sweden
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 Budget and Treasury

Questions and
Comments

Lecture 6
 Annex 1
The main ingredients of the transition process are:
Liberalization: the process of allowing most prices to be determined in free
markets and lowering trade barriers that had shut off contact with the price
structure of the world's market economies.
Macroeconomic stabilization: primarily the process through which inflation is
brought under
control and lowered over time, after the initial burst of high inflation that
follows from liberalization and the release of pent-up demand. This process
requires discipline over the government budget and the growth of money and
credit (that is, discipline in fiscal and monetary policy) and progress toward
sustainable balance of payments.
Restructuring and privatization: the processes of creating a viable financial
sector and
reforming the enterprises in these economies to render them capable of
producing goods that could be sold in free markets and of transferring their
ownership into private hands.
Legal and institutional reforms: These are needed to redefine the role of the
state in these
economies, establish the rule of law, and introduce appropriate competition
policies.
Some of transition economies: Albania, FYR Macedonia; Armenia, Azerbaijan,
Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russia, Tajikistan,
Turkmenistan, Ukraine, Uzbekistan.

Source: IMF, UN
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