October 2015 | Edition No. 1 Transition amid Risks with a Special Focus on Intergovernmental Fiscal Relations Macroeconomic and Fiscal Global Practice Transition amid Risks with a Special Focus on Intergovernmental Fiscal Relations TABLE OF CONTENTS ABBREVIATIONS ............................................................................................................................................................ i FOREWORD ................................................................................................................................................................... iii ACKNOWLEDGEMENTS ................................................................................................................................................. v MAIN MESSAGES AND KEY RECOMMENDATIONS ....................................................................................................... vi EXECUTIVE SUMMARY .................................................................................................................................................. ix PART I: Social, Economic, and Governance Status ....................................................................................................... 1 1. Context and Objectives ......................................................................................................................................... 2 2. Social and Poverty Status ...................................................................................................................................... 3 2.1 A Young and Rapidly Growing Population ...................................................................................................... 4 2.2 Weak Social Indicators .................................................................................................................................... 4 3. The State of the Economy ..................................................................................................................................... 8 3.1 The Real Sector ............................................................................................................................................... 8 3.2 The Monetary and Financial Sector ................................................................................................................ 11 3.3 International trade a key feature of the Somali economy .............................................................................. 13 3.4 Fiscal Policy ..................................................................................................................................................... 15 3.4.1 Improved revenue mobilization efforts are paying off .............................................................................. 16 3.4.2 Expenditure is concentrated on salary and security and weak budgetary controls and execution have led to buildup of arrears ............................................................................................................................ 20 3.4.3 Arrears in the FGS and Puntland are significant ....................................................................................... 23 3.5 Debt Arrears and Eligibility for Debt Relief (HIPC) .......................................................................................... 24 4. Governance ........................................................................................................................................................... 26 4.1 The Public Financial Management (PFM) System ........................................................................................... 26 4.1.1 The legal and regulatory framework for PFM is inadequate and is being revamped ............................... 26 4.1.2 Procurement rules need strengthening ..................................................................................................... 27 4.1.3 Oversight institutions are being put in place ............................................................................................ 28 4.1.2 Procurement rules need strengthening 4.1.3 Oversight institutions are being put in place 4.2 Anticorruption and Accountability ................................................................................................................. 30 5. The Outlook for 2015–17 ...................................................................................................................................... 32 5.1 The Importance of Security ............................................................................................................................ 32 5.2 Reforms Needed to Spur Growth ................................................................................................................... 32 PART II: Special Focus: Intergovernmental Fiscal Relations in Somalia - Challenges and Lessons from International Experience.................................................................................................................. ............... 35 6. Key Principles Governing Intergovernmental Relations ........................................................................................ 36 7. From Unitary to Federal Government ................................................................................................................... 41 7.1 The Long Road to the Provisional Constitution .............................................................................................. 41 7.2 Municipal and District Governance ................................................................................................................ 43 7.3 Formation of the Federal State ....................................................................................................................... 44 7.4 The State of State Formation .......................................................................................................................... 45 8. Designing Intergovernmental Financing Arrangements for Somalia .................................................................... 49 8.1 Functions and Spending Responsibilities: The Theory .................................................................................... 50 8.2 Functions and Spending Responsibilities: Current Practice in Somalia .......................................................... 52 8.3 Assignment of Revenues: The Theory ............................................................................................................ 53 8.4 Assignment of Revenues: Current Practice in Somalia .................................................................................... 54 8.5 Transfers: The Theory ...................................................................................................................................... 55 8.6 Addressing Interregional Inequity Through Transfers: Scope to Apply theory to Practice in Somalia ............. 57 8.7 Case Study of Oil and Gas ............................................................................................................................... 60 8.8 Conclusion: Choices and Options .................................................................................................................... 61 9. Institutions and Processes ...................................................................................................................................... 64 REFERENCES .................................................................................................................................................................. 67 Annex A: Excerpts of Relevant Articles from the Provisional Constitution .................................................................... 70 Annex B: Revenues of the Federal Government of Somalia and Puntland, 2013 .......................................................... 73 LIST OF FIGURES Figure 2.1: Both the size of the population and life expectancy have been rising in Somalia ..................................... 4 Figure 3.1: Somalia’s GDP amongst the lowest in the region ...................................................................................... 8 Figure 3.2: Somalia’s GDP per capita is the 5th lowest in the World ............................................................................ 8 Figure 3.3: Somalia’s economy remains consumption driven ..................................................................................... 9 Figure 3.4: Consumption is the main contributor to GDP in Somaliland and Puntland ............................................... 9 Figure 3.5: Livestock and Services are the key drivers of Somaliland’s GDP ................................................................ 10 Figure 3.6: The Central Bank recognizes 48 financial institutions in Somalia .............................................................. 12 Figure 3.7: Imports dominate Somalia’s economy ...................................................................................................... 14 Figure 3.8: Somalia exports far fewer goods than it imports ....................................................................................... 14 Figure 3.9: Long-term flows finance Somalia’s current account deficit ....................................................................... 15 Figure 3.10: The Federal Government of Somalia’s efforts to mobilize revenue are paying off .................................... 16 Figure 3.11: Development partners continue to support Somalia’s reconstruction