World Bright College, Faculty of Business and Economics, Department of Accounting and Finance

CHAPTER THREE
PUBLIC FINANCE IN ETHIOPIA
3.1. Features of Ethiopian Federal Finance
Federalism is a system of government in which there is division of powers and functions between federal government and
several regional governments, each of which in its own sphere coordinates with the others and each of which acts directly on
the people through its administrative machinery. Federal finance refers to the system of assigning the source of revenue to the
central as well as state governments for the efficient discharge of their respective functions i.e. clear-cut division is made
regarding the allocation of resources of revenue between the central and state authorities.

Ethiopia is a federal state which comprises of a central government and 12 (twelve) Regional Governments namely; Tigray,
Afar, Amhara, Oromiya, Somali, Benishangul Gumuz, Sidama, South West Ethiopia, Southern Ethiopia, Central Ethiopia,
Gambela, and Harare. There are also two city administrations Addis Ababa and Dire Dawa. As a federal country, the
functions and duties of the government are divided between central and state governments and they are generally defined in
the constitution.

The form of government is parliamentary having both federal and state governments with legislative, executive, and judicial
powers. Federalism requires decentralization of government decision making and implementation involves delegating more
power to the decentralized divisions of the government. The goal of this strategy is to speed up government action and to
deliver a more suitable package of services needed by the locality.

One component of federalism is fiscal federalism (federal finance) which gives local governments some taxing power and
expenditure responsibility, and allows them to decide on the level and structure of their expenditure budgets. The main goal
of fiscal decentralization is to move governance closer to the people, and this does requires strengthening local government
finances. Fiscal decentralization requires local governments with some autonomy to made independent fiscal decisions.

Principles of Federal Finance

1. Principle of Independence
2. Principle of Equity
3. Principle of Uniformity
4. Principle of Adequacy
5. Principle of Fiscal Access
6. Principle of Integration and Co-ordination.
7. Principle of Efficiency
8. Principle of Administrative Economy
9. Principle of Accountability

In the case of federal system of finance, the following main principles must be applied:

1. Principle of Independence: Under the system of federal finance, a Government should be autonomous and free about the
internal financial matters concerned. It means each Government should have separate sources of revenue, authority to levy
taxes, to borrow money and to meet the expenditure. The Government should normally enjoy autonomy in fiscal matters.

2. Principle of Equity: From the point of view of equity, the resources should be distributed among the different states so
that each state receives a fair share of revenue. The allocation of resources should be made in such a way as to give equitable
treatment to the individuals and business firms in different places.

3. Principle of Uniformity: In a federal system, each state should pay equal tax payments for federal finance. But this
principle cannot be followed in practice because the taxable capacity of each unit is not of the same. Since this principle of
uniformity emphasis on the uniformity of pattern of expenditure in all the states, equality of contribution imposes heavy
burden on backward states.

4. Principle of Adequacy of Resources: The principle of adequacy means that the resources of each Government i.e. Central
and State should be adequate to carry out its functions effectively. Here adequacy must be decided with reference to both
current as well as future needs. Besides, the resources should be elastic in order to meet the growing needs and unforeseen
expenditure like war, floods etc.

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
5. Principle of Fiscal Access: In a federal system, there should be possibility for the Central and State Governments to
develop new source of revenue within their prescribed fields to meet the growing financial needs. In nutshell, the resources
should grow with the increase in the responsibilities of the Government.

6. Principle of Integration and Co-ordination: The whole financial system of a federation should be well integrated. There
should be a perfect co-ordination among different layers of the financial system of the country. Then only the federal system
will prosper. This should be done in such a way to promote the overall economic development of the country.

7. Principle of Efficiency: The financial system should be well organized and efficiently administered. There should be no
scope for evasion and fraud. No one should be taxed more than once in a year. Double taxation should be avoided.

8. Principle of Administrative Economy: Economy is the important criterion of any federal financial system. That is, the
cost of collection should be at the minimum level and the major portion of revenue should be made available for the other
expenditure outlays of the Governments.

9. Principle of Accountability: In a federal set up, the Governments both Central and States enjoy financial autonomy. Thus,
in such a system each Government should be accountable to its own legislature for its financial decisions i.e. the Central to
the Parliament and the State to the Assembly.

Modes of Allocation of Revenue Resources in Federal Government

In a federal Government, allocation of financial resources between the Centre and the states is of great importance. While
allocating the resources, the principles of uniformity, adequacy, autonomy, transference, administrative economy and federal
control are to be followed. These principles are not exclusive. They are interdependent.

Modes of Allocation

There are two types of allocation. They are as follows:

1. Independent System

Under this system, the units in a federation are deriving their revenue from absolutely different sources. There would be no
concurrence or contact between the center and the units.

2. Mixed System

Under this system, there would be concurrence and contact between the center and the units. This system is divided into two
viz., concurrent mixed system and the contact mixed system. In the concurrent mixed system, both center and the states have
concurrent powers of taxation regarding certain sources. There would be no transfer of resources from the center to the states.
In the contact mixed system, contact between the center and the states is created. There would be assignments, subsidies,
subventions or contributions.

Balancing Factors of Allocation

Prof. Adarkar points out that it would be impossible to think about an independent system. The most desirable system of
federal finance must ensure large measure of independence and adequacy. If either the center or the states are not able to
meet their requirements, it should be made good by certain balancing factors.

The balancing factors are those, which would make good the financial inadequacy of either the center or the states in a
federation. They are as follows:

1. Assignments

Usually the Federal Government levies and collects certain taxes. But it is shared on an agreed basis with the states. Of
course the distribution of this share between the states is very difficult. The basis of distribution may be as follows:

 On the basis of actual collections from different states.

 On the basis of population, and
 On the basis of economic backwardness of the states.

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
2. Subsidies

The states very often find themselves with financial stringency. They are granted certain subsidies by the center on account of
the transfer of certain sources like customs or excises to the center.

3. Subvention

Subventions are grants-in-aid to redress certain inequalities between states. They are made for specific purposes. They should
be spent for the purpose for which they are made. The spending of the amount would be under the supervision of the granting
authority.

These are the bases and modes of allocation of funds between the center and the states. The distribution of financial sources
in Ethiopia is based on the recommendations of the Ministry of Economic Development.

Fiscal federalism has four components:

i. Revenue Assignment
ii. Expenditure Assignment
iii. Intergovernmental Transfer, and
iv. Borrowing

3.2. Revenue Assignment

The distribution of revenues between the center and states is followed on the basis of constitution of Ethiopia and
Proclamation No. 33/1992-Proclamation to define sharing of revenue between the central government and the regional
governments.

The Articles 96, 97, 98, 99 and 100 of the constitution of Ethiopia make a clear demarcation of areas where the Central alone
or State alone have authority to impose taxes. It contains a detailed list of the functions and financial resources of the center
and states.

3.2.1. Objectives of Revenue sharing

The sharing between the central government and the Regional Governments has the following objectives:

 To enable the central Government and the Regional Governments efficiently carry out their respective
duties and responsibilities.
 To assist Regional Governments, develop their regions on their own initiatives;
 To narrow the existing gap in development and economic growth between regions;
 To encourage activities those, have common interest to regions.

3.2.2. Basis for Revenue Sharing

The sharing of revenue between the central government and the national/ regional governments takes in to consideration the
following principles:

 Ownership of source of revenue;

 The National or Regional character of the sources of revenue;
 Convenience of levying and collection of the tax or duty;
 Population, distribution of wealth and standard of development of each region;
 Other factors that are basis for integrated and balanced economy.

3.2.3. Categorization of Revenue

According to constitution of Ethiopia revenues are categorized as central, regional and joint. The sources of revenue are
given under federal/central list are as follows;
a. Duties, tax and other charges levied on the importation and exportation of goods;
b. Personal income tax collected from the employees of the central Government and the International Organizations

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
c. Profit tax, Personal income tax and sales tax collected from enterprises owned by the Central Government. (Now sales tax
is replaced with VAT and Turnover taxes).
d. Taxes collected from National Lotteries and other chance winning prizes;
e. Taxes collected on income from air, train and marine transport activities;
f. Taxes collected from rent of houses and properties owned by the central Government;
g. Charges and fees on licenses and services issued or rented by the central Government;

The following shall be Revenues for the Regions

1. Personal income tax collected from the employees of the Regional Government and Employees other than those covered
under the sources of central government.
2. Rural land use fee.
3. Agricultural income tax collected from farmers not incorporated in an organization.
4. Profit and sales tax collected individual traders.
5. Tax on income from inland water transportation.
6. Taxes collected from rent of houses and properties owned by the Regional Governments;
7. Profit tax, personal income tax and sales tax collected from enterprises owned by the Regional Government:
8. With prejudice to joint revenue sources, income tax, royalty and rent of land collected from mining activities.
9. Charges and fees on licenses and services issued or rented by the Regional Government;

The following are Joint Taxes

 Profit tax, personal income tax and sales tax collected from enterprises jointly owned by the central Government and
Regional Governments;
 Profit tax, dividend tax and sales tax collected from Organizations;
 Profit tax, royalty and rent of land collected from large scale mining, any petroleum and gas operations;
 Forest royalty

3.2.4. Collection and Allocation of Joint Revenues

The federal government collects both the federal and joint revenues. The joint revenue is shared based on a decision made by
a committee appointed by the prime minister and consisted of representatives of both levels of governments.

Table 3.1: Share of the joint revenue between the federal government and regional government

Jointly Established Enterprises Federal Government Regional Government

Profit Tax In proportion to their respective capital contribution
Employment Income Tax 50% 50%
Value-added Tax (VAT) 70% 30%
Turnover Tax (TOT) 70% 30%
Excise Taxes 70% 30%
Companies
Profit Tax 50% 50%
Dividend Income Tax 50% 50%
Value-added Tax (VAT) 70% 30%
Turnover Tax (TOT) 70% 30%
Excise Taxes 70% 30%
Mineral, Petroleum and Operation
Profit Tax 50% 50%
Royalty 60% 40%

3.3. Expenditure Assignment

The federal structure of Ethiopia allocates functions and responsibilities, and hence expenditure, to federal government and
regional governments. Art 51 of the Constitution entrusts the federal government with power subject to national defense,

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
international or foreign relations, citizenship, immigration and naturalization; interstate commerce, postal and
telecommunication services, weights and measures, domestic currency coinage and foreign currency usage, banking, patents
and copyrights, operation of air, rail and water transports and highways linking two or more states, enacting labor, electoral,
procedural, criminal, and commercial codes.

Art 52 (2) assigns to regional governments such power and functions as enacting and executing the state constitutions;
establishing state police, maintaining public peace and order; administration of land and other natural resource within the
region; and formulating and executing economic and social development policies, strategies and plans of the state.

The states also have power over areas of education, health and agriculture. Both regional governments and federal
government are required to cover expenditure to be incurred in connection with their respective functions and responsibilities.

3.4. Intergovernmental Transfer (Subsidy)

As can be evidently observed from the revenue and expenditure assignments addressed in the Constitution, the lucrative
(profitable) sources of revenue in Ethiopia are assigned to the federal government while a wide range of expenditure
responsibilities are reserved to the regions. This resulted in significant vertical fiscal imbalance between the federal and
regional governments. Besides, the adoption of the federal system has created autonomous regions that vary enormously in
area, population size, infrastructure, human and institutional capacity and socioeconomic status. As a result, there is an
extensive difference in the fiscal capacities of these regions.

Recognizing the inevitability of fiscal imbalances resulting from the division of powers in the constitution, the disparities in
population, natural resources as well as human and institutional capacities among regions, the Constitution lays down legal
basis for fiscal transfer-the transfer of money from central government to regional governments. Annually there is a formula-
based unconditional transfer of money from the federal government to regional governments.

3.5. Borrowing
Regional governments are not allowed to borrow from abroad. It is the federal government that has the power to borrow from
abroad. They can, however, borrow internally from banks to meet the cash flow timing problem.

Borrowing internally from banks requires the permission of MOFED. When regional governments experience budget
shortfall in any fiscal year the federal government may give them loan in the form of advance to be charged to their
budgetary subsidy of the following year.

3.6. Budgeting and its process in Ethiopia

3.6.1. The Concept of Budgeting in Ethiopia

The government budget represents a plan/forecast by government of its expenditures and revenues for a specified period.
Commonly government budget is prepared for a year, known as a financial year or fiscal year. In Ethiopia the fiscal year is
from July 7 of this year to July 6 of the coming year (Hamle 1-Sene 30 in Ethiopian calendar).

Budgeting involves different tasks on the expenditures and revenues sides of government finance. On the side of expenditure,
it deals with the determination of the total size of the budget (i.e. total amount of money for the year), size of expenditures on
different functions, and the extent of outlays on various activities. On the revenue side, it involves the determination of the
size of the overall revenue and foreign aid. Furthermore, budgeting also address the issue of the budget deficit (i.e. the excess
of outlays over domestic revenues), and it‟s financing.

Budgeting is not solely a matter of finance in the narrow sense. Rather it is an important part of government‟s general
economic policy. Budget is not solely a description of fiscal policies and financial plans, rather it is a strong instrument in
engineering and dynamiting the economy and its main objectives are to devise tangible directives and implement the long
term, medium term, and annual administrative and development programs”.

3.6.2. Budget Structures in Ethiopia

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
Budget structures are the formats that organize budget data. Budget data could be classified in different ways and for
different purposes. In the early days, for instance, budget classification basically focused on providing a better understanding
of the intentions and purposes of government for which funds were planned and to be spent.

Later on, the budget structures started to be influenced largely by the issue of accountability. That is in addition to providing
information on what the government proposed to do, the budget structures indicate the full responsibility of the spending
agency. To this end the budget head or nomenclature of the budget are mostly mapped to each spending agency. This should
not, however, imply unnecessarily extended and detailed structure (or mapping). Perhaps, due consideration must be taken to
make the structure manageable and appropriate. The first classification of the budget is between revenue and expenditure.

Revenue Budget

It represents the annual forecast of revenues to be raised by government through taxation and other discretionary measures.
The amount of revenues raised this way differs from country to country both in magnitude and structure, mainly due to the
level of economic development and the type of the economy.

In Ethiopia, the revenue budget is usually structured into three major headings: ordinary revenue, external assistance, and
capital revenue. Hence, the funds expected from these three sources are proclaimed as the annual revenue budget for the
country. The revenue budget is prepared by the Ministry of Finance (MoF) for the federal government and by Finance
Bureaus for regional governments.

Ordinary revenues include both tax and non-tax revenues. the tax revenues being direct taxes (personal income tax, rental
income tax, business income tax, agricultural income tax, tax on dividend and chance wining, land use fee and lease); indirect
taxes (excise tax on locally manufactured goods, sales tax on locally manufactured goods, service sales tax, stamps and duty);
and taxes on foreign trade (customs duty on imported goods, duty and tax on coffee export). Non-tax revenues include
charges and fees; investment revenue; miscellaneous revenue (e.g. gins); and pension contribution.

The second major item in revenue budget is external assistance. It includes: cash grants, these are grants from multilateral
and bilateral donors for different structural adjustment programs; and technical assistance in cash and material form.

The third item is capital revenue. This could be from domestic (sales of movable properties and collection of loans),
external loan from multilateral and bilateral creditors mostly for capital projects, and grants in the form of counterpart fund.

Expenditures Budget

Government expenditures for administration and developmental activities are handled through the expenditures budget.
These expenditures are categorized into recurrent and capital expenditures. This categorization gained acceptance since the
Great Depression of the 1930s. The recurrent budget which covers the current expenditures is financed in principle by
taxation (more broadly by domestic revenue from tax and non- tax sources), and the capital budget which covers the
acquisition of newly produced assets of the economy is financed through external borrowing and grants. The Expenditure
Budget includes the following two types of Budgets:
1. Recurrent Budget, and
2. Capital Budget.

1. Recurrent Budget

Financial proclamation 57/1996 and financial regulation 17/1997 defined only the capital budget, implicitly defining the
recurrent one as a residual. To common practice, however, is to include in the recurrent budget expenditures of recurrent
nature (like salaries of civil servants) and fixed assets with a multi-year life.

The recurrent budget is structured by implementing agencies (public bodies) under four functional categories: administrative
and general services, economic services, social services, and other expenditures. All public bodies then fall under one of
these functional categories. The budget hierarchy will then be down to sub agencies.

2. Capital Budget

Capital budget is budget for capital expenditures. Financial proclamation 57/1996 defined capital expenditure as “an outlay
for the acquisition of improvements to fixed assets, and includes expenditures made for consultancy services.” Financial
regulations 17/1997 further provided a detailed definition of capital expenditures to mean:

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
a. The acquisition, reclamation, enhancement as laying out of land exclusive of roads, buildings or other structures;
b. The acquisition, construction, preparation enhancement or replacement of roads, buildings and other structures;
c. The acquisition, installation or replacement of movable plant, machinery and apparatus, vehicles and vessels;
d. The making of advances, grants or other financial assistance to any person towards him/her on the matters mentioned in (a)
to (c) above or in the acquisition of investments; and
e. The acquisition of share of capital or loan capital in anybody corporate;
f. Any associated consultancy costs of the above.

Capital budget could thus broadly be described as an outlay on projects that result in the acquisition of fixed assets and the
provision of development services (Ministry of planning and Economic Development, 1993:4). It should therefore be need
that, capital budget as a wider coverage than simple outlays in fixed investments, since it includes expenditure on
development services like agricultural research and transfer payments related to a project.

The capital budget is presented into three functional groups such as economic development, social development, and general
development. Economic development includes production activities (agriculture, industry, etc.), economic infrastructure
facilities (mining, energy, road etc.), commerce, communication, and so on. Social development includes education, health,
urban development, welfare and so on. General development includes services like cartography (the act of drawing map),
statistics, public and administrative buildings, and the like.

3.6.3. Budget Deficit

A budget is considered as surplus or deficit according to the position of the revenue accounts of the government. Thus, a
surplus budget is one in which revenue receipts exceed expenditure charged to revenue account regardless of the gap in
capital accounts; while a deficit budget is one in which expenditure is greater than current revenue receipts. Budget deficit is
the excess of total expenditure over total revenue of the government.

The deficit financing denotes the direct addition to gross national expenditure through budget deficits whether the deficits are
on revenue or capital accounts”. It implies that the expenditure of the government over and above the aggregate receipt of
revenue account and capital account is treated as budget deficit of the government.

The meaning of deficit financing is different in different countries. In western countries, the budget gap, that is covered by
loans is called deficit financing because, if the government borrows from the banks rather than from individuals the idle
funds will be activated and there will be an increase in the total public expenditure and thus there will automatically be a
deficit financing has been used in a different sense,. Here it is used to denote the direct addition to gross national expenditure
as a result of budget deficit. Thus, deficit financing can be defined as “the financing of a deliberately created gap between
public revenue and public expenditure”. The government of Ethiopia has used deficit financing for acquiring funds to finance
economic development. When the government cannot raise enough financial resources through taxation, it finances its
developmental expenditure through borrowing from the market or from other sources.

Methods of Financing Deficit

There are four important techniques through which the government may finance its budgetary deficits. They are as follows:
i. Borrowing from central bank
ii. The running down of accumulated cash balances
iii. The government may issue new currency
iv. Borrowing from market or from external sources.

Under the first method, government borrows from central bank as per budgetary policy. In the second source, government
spends from available cash balance. In the third measure, government issues new currency for financing deficit. The last
method is that government borrows from internal and external sources to finance its deficit.

Objectives of Deficit Financing

a. Deficit financing has generally been used as a method of meeting the financial needs of the government in times of war,
when it is considered difficult to mobilize adequate resources.

b. Keynes advocated deficit financing as an instrument of economic policy to overcome conditions of depression and to raise
the level of output and employment.

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
c. The use of deficit financing has also been considered essential for financing economic development especially in under
developed countries.
d. Deficit financing is also promoted for the mobilization of surplus idle and unutilized resources in the economy.

Effects of Deficit Financing

1. Inflationary (rise in prices) effect: The most serious disadvantage of deficit finance is the inflationary (rise of prices).
Deficit financing increases the total volume of money supply. Unless there is proportional increase in production this can
lead to inflation. When deficit financing goes too far it becomes self-defeating. There was inflationary pressure during the
decade due to deficit financing.

2. Effects on distribution of wealth and income: The real income of wage earners gets reduced and that of entrepreneurs/
businessmen increased, leading to distribution of wealth in favor of business class.

3. Faster growth: Country is able to implement the developmental plans through deficit financing thereby attaining faster
growth.

4. Change in pattern of Investment: Deficit financing leads to encouragement for investment in certain fields like
construction, luxury consumption, inventory holding and speculation. This may lead to investment in undesirable fields.

5. Credit creation in banks: Inflationary forces created by deficit financing are reinforced by increase credit creation by
banks. Among various fiscal measures, deficit financing has been assigned an important place in financing developmental
plan and various developing countries including Ethiopia resort to deficit financing to meet budgetary gaps.

Deficit financing in Ethiopia

Deficit financing in Ethiopia was mainly resorted to enable the government of Ethiopia to obtain necessary resources for the
plans. The levels of outlay laid down were of an order, which could not be met only by taxation or through a revenue surplus.
The gap in resources is made up partly through external assistance. But when external assistance is not enough to fill the gap,
deficit financing has to be undertaken. The targets of production and employment in the plans are fixed primarily with
reference to what is considered as the desirable rate of growth for the economy. When these targets cannot be achieved
through resources obtained from taxation and external borrowing, additional resources have to be found. Deficit financing is
the easier option. It is important to emphasis the fact that deficit financing cannot create real resources which do not exist in
the economy.

3.6.4. The Budget Process in Ethiopia

Budgeting from the initial stage of forecasting the annual revenues and expenditures, to the final stage of approval of the
annual budget by the Council of Peoples Representatives, passes through a sequential and an iterative process. This
budgeting process includes:

 Preparation of the macro-economic and fiscal framework;

 Revenue forecast and determination of expenditure budget ceiling:
 Allocation of expenditure budget between Federal and Regional governments;
 Allocation of Federal government expenditure budget between recurrent and capital budgets:
 Budget call and ceiling:
 Budget review by MoF and MoED;
 Budget hearing and defense:
 Review and recommendation:
 Submission of the budget to the council of Ministers:
 Submission of the budget to the Council of Peoples‟ Representatives:
 Notification and publication of the budget; and
 Allotment.

The budget process thus includes all these stages, which obviously are sequential (one after the other) and iterative. Peterson
summarized the budget process into three phases: analyzing, fitting, and implementing. The analysis phase is the assembly
and integration of financial data which might include processes from the formulation of macro-economic and fiscal
framework to the allocation of expenditure budget between Federal and Regional governments. The fitting phase is the
process of prioritizing activities to fit with policy and reducing a budget to a ceiling.

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
Referring to the budgeting processes outlined above this might range from the processes of allocation of Federal government
expenditures budget between recurrent and capital budget down to the submission of the budget to the council of peoples‟
Representatives. The final phase, implementing, is distributing and using the allocation, i.e. the notification and publication
of the budget, allotment and the monitoring processes.

Budget being a one-year plan prepared for the coming fiscal year it requires a time schedule (deadlines) for each and every
process that should strictly be adhered to. The time schedule is usually handled through the budget calendar. In effect the
budget calendar is the major instrument to manage the budgetary process. Thus far we don‟t have an authoritative and
binding budget calendar that could force all public bodies involved in the process of budgeting. The only dates proclaimed by
law are the final approval and notification dates of the budget.

Financial proclamation 57/1996 states that “the budget appropriation shall be approved by the council of peoples‟
representatives by sine 30th (July 6) and all public bodies shall be notified by Hamle 7 (July 13). “The other deadlines in the
process of budgeting will be set by the MOF and MOED who are responsible for the preparation of the recurrent and capital
budgets, respectively.

The MOF and MEOD will notify the spending public bodies well ahead of time about the important deadlines, the budget
ceiling and other information through the budget circular. The budgeting process usually took between six to eight months,
and the MOF and MOED will release the budget circular around November to December.

The Budgetary Process at the Federal Level

The budget processes at the Federal level follows sequential and iterative the steps. These steps can be explained with the
help of the following Chart. Let us briefly explain these steps one by one here under:

Step one - Macro-Economic and Fiscal Framework:

The preparation of the macro-economic and fiscal framework is basically a component of the recently initiated public
investment program (PIP). It is a planning practice and as stated in Ministry of Economic Development, the macro-economic
and fiscal framework determines the overall level of government expenditures based on policies related to the role of
government in the economy, government deficits, and priorities for resource allocation between regions and sectors. For the
Federal government the framework is three years forecast and will be updated each year.

The framework is composed of macro-economic forecast and fiscal forecast. The macroeconomic forecast gives the forecast
of Gross Domestic product based on past performance and estimates for future years, and provides base line information in
preparing the fiscal forecast.

Financial Regulation 17/1997 gave the responsibility of preparing this framework to the Ministry of Economic development
(MoED). Whereas; the later, establish the level of total resources available for expenditure. It provides a more detailed
forecast of revenue (both Federal and Regional), end projection of expenditure. Given the policy of no borrowing from
domestic banks to finance budget deficit the level of expenditure mainly depends on the amount of resources to be raised in
the form of domestic revenues and external fund that include counterpart funds. Once prepared by the concerned coordinating
ministries, i.e. MoF and MoED, it will be reviewed and approved by the Prime Minister‟s Office (PMO).

Step Two - Determination of Federal Government Expenditure and Subsidy to Regional Governments

After the revenue and expenditure of the government are estimated through the fiscal framework, the PMO will decide on the
shares of Federal government expenditures and subsidies Regional governments. It is known that, following the
decentralization policy, Regional governments took grants from the Federal government in the form of subsidy. Once the
amount of subsidy is known, the allocation among regions is determined on the basis of a formula. Initially the formula was
composed of five parameters (population, level of development, revenue generating capacity, utilization capacity, and land
area). At present, however, the formula takes account of three parameters: population, the level of development, and revenue
generating capacity of each region which are given a relative weight of 60%, 25% and 15% respectively. This allocation will
first be prepared by MoED, then reviewed by the PMO and finally approved by the Council of peoples‟ Representatives.

Step three - Allocation of Federal Expenditure between Recurrent and Capital Budget

The practice in the allocation of recurrent and capital budget is to consider the latter as a residual. That is, first the amount of
budget necessary to cover such recurrent expenditures like pensions, debt servicing, wages and non-wage operating costs will

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
be determined. The balance will then be allotted to capital expenditures. This will be performed by the PMO in consultation
with MoF and MoED.

Step Four - Budget Call and Ceiling Notification

a. Recurrent budget: MoFD will release the budget ceiling to the line ministries in a budget call. The budget call provides
each ministry such information as the macroeconomic environment, an aggregate recurrent budget ceiling, and priorities to
budget.

b. Capital Budget: MoED issues detailed capital budget preparation guidelines to spending public bodies along with the
ceilings provided to each line institution. MoED will set the ceiling for each sector.

Step Five - Budget Review by MoF and MoED

1. Recurrent Budget: Prior to a formal budget hearing, spending public bodies will submit their budget proposals to the
MoF-Budget Department. In consultation with spending public bodies, MoF will prepare an issue paper on Major issues at
each head level in the proposed budget. Here, spending public bodies can submit above the ceiling but need to have a
compelling justification.

2. Capital Budget: The sector departments of MoED review the capital budget requests from different public bodies. At this
stage projects will be screened. If there is a discrepancy between the respective sector department and the public body, a
series of discussions will be held to reach agreement. After such a process the various sector department of MoED will
submit their first-round recommendation to the Development Finance and Budget Department of MoED. Then it will be
consolidated and prepared for the capital budget hearing and defense.

Step Six - Budget Hearing and Defense

1. Recurrent Budget: Spending public bodies defend their budget submission in a formal hearing with the MoF. The issue
paper will be the basis of the hearing. The hearing focuses on policies, programs and cost issues, when necessary it might
involve discussion down to line item. Spending public bodies could also challenge the ceiling. Presenting the hearing will be
ministers and/or vice ministers, heads of public bodies and the MoFD.

2. Capital Budget: Spending public bodies will be called to defend their projects to a budget hearing convened by the PMO
which will be chaired by the prime Minister or the deputy Prime Minister or their economic advisers. The hearing
customarily includes a review of status of the project, implementation capacity of the institution, compatibility with the
countries development strategy and policy, cost structure, and regional distribution. A project description will be presented
which includes objectives of the project, main activities of the project, status of the project, total cost, past performance of the
project, source of finance, and whether the project is accepted or rejected by MoED. On the basis of the discussion the
respective sector departments of MoED in consultations with the spending public body will further refine the capital projects.

Step Seven - Review and recommendation

1. Recurrent budget: After the hearing is over, the budget committee of the MoFD will review the discussion and make a
recommendation. If there is an increase (over ceiling) this will go to the PMO for approval.

2. Capital budget: After the hearing and defense with the PMO and MoED, sector departments of MoED will give a final
recommendation to the development finance and budget department of MoED. This will then be compiled and put in
appropriate formats for submission to the council of ministers.

Step Eight: Submission to the council of Ministers

At this stage the two budgets (recurrent and capital) will be consolidated, and MoFD will prepare a brief analysis of the total
budget.

1. Recurrent budget: The recommended budget will be submitted to the deputy Prime Minister for economic affairs. This
will first be reviewed by ministers and vice ministers in economic affairs, and then presented to the Prime Minister along
with a brief. The Prime Minister may or may not make amendments and then the budget will be sent to the council of
Ministers for discussion.

Prepaired By; Aman Ous. (MSc) 10 | P a g e

 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
2. Capital Budget: A brief analysis of the capital budget will be prepared by MoED on the final recommended budget and,
along with the consolidated capital budget, will be submitted to the council of ministers. MoED will defend the budget in the
council. The council of ministers may make some adjustment and the draft capital budget will pass the first stage of approval.

Step Nine - Submission to the Council of Peoples’ Representatives

Once approved by the council of ministers, the Prime Minister will present both the recurrent and capital budget to the
council of peoples‟ representatives. The budget will then be debated based on the recommendation of the budget of the
committee.

Step Ten - Notification and Publication

The approved budget will then get the legal status through the publication in the „Negaret gazeta.‟ Spending public bodies
will then formally be notified of their approved budget by line items from MoF and MoED for recurrent and capital budgets,
respectively. MoFD will notify spending public bodies through Form 3/1. Likewise, MoED will inform through Form 3/2.
Both Forms will be copied to the Treasury Department of the MoFD which disburse funds to spending public bodies.

Until Form 3/1 is released spending public bodies are authorized to spend one-twelfth of the previous year‟s budget with no
provision for new expenditures (e.g. new staff posts) in the case of recurrent budget. For capital budget spending public
bodies are authorized to use approved budget for ongoing projects even when Form 3/2 is not released. The final stage of the
budgetary process is to request spending public bodies to prepare adjusted work plan and cash flow for the approved budget.
The adjusted work plan and cash flow will be verified by MoFD-for the recurrent budget-and by MoED-for the capital
budget, and then will be sent to the treasury Department of the MoFD.

Step Eleven - Supplementary Budget

In the course of the budget year supplementary (additional) budget will be proclaimed when necessary, following almost the
same process as the initial budget preparation. Likewise, budget reallocation will be made mainly based on performance.

The Budgetary Process at the Regional Level

It is quite difficult to present the budget process at the Regional level in the way discussed for Federal Budgeting. At present
the budget process followed by regions is not uniform. Hence, let us discuss the process of budgeting in a more general terms
without referring to a particular region. The process is more or less a mirror image of the Federal budget process. In place of
MoFD the Regional Finance Bureau (RFB) is responsible for the preparation of the recurrent budget. While the Regional
planning and Economic Development bureau (RPEDB) is responsible for the capital budget. At the higher level the Regional
council is the one responsible for the appropriation of the region‟s budget. One significant deviation is, the regional budget
process starts at the woreda level and goes up to Zone and Region levels.

1. Pre-ceiling Budgeting

Pre-ceiling budgeting is the budgeting practice at the woreda and zone levels before the region receives its subsidy/grant from
the Federal government. The process is as follows: the woreda prepares a budget with no indicative or final ceiling from the
Zone or the Region. The Finance Office will consolidate the budget of the sectoral offices and submit to the woreda council.
The woreda executive committee will then form a budget committee to review the budget. This budget will be sent to the
zone through two channels: one, the woreda counsel submit the budget to the zone executive committee: second, the woreda
sectoral offices send to the zone sectoral departments. The zone executive committee will then form a budget committee that
will be chaired by the head of the Finance Department, to review the woredas‟ and zones‟ budget proposal. In passing the
budget to the region it will again be through two channels. The zone executive committee submits to the Region executive
committee and the zone sectoral departments will submit to the region sectoral bureaus. The sectoral bureaus then prepare a
budget submission to the Region Finance Bureau.

2. Post-ceiling Budgeting

Following the notification of the subsidy from the Federal government, the regional public expenditure envelope will be
determined based on the Federal subsidy, local revenue and local borrowing. Once the expenditure envelope is set, then it
will be split up between recurrent and capital expenditures. The practice is similar to the Federal government, i.e. the
allocation begins with recurrent expenditures and the balance of the envelope will be reserved for capital expenditures. After
this stage, different regions may follow different approaches to allocate recurrent expenditure between salary and

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 World Bright College, Faculty of Business and Economics, Department of Accounting and Finance
organization and management, and to allocate capital expenditure among the different sectors. In some regions the budget
will be prepared up to line items at the region level, where as in some regions a lump sum will be allotted to zones that will
be in turn allocated to woredas. At last, the budget will be published in the region‟s „Negarit gazeta‟.

Prepaired By; Aman Ous. (MSc) 12 | P a g e