Sharing borders with four European Union (EU) member states—Hungary, Poland, Romania, and Slovakia—Ukraine is now a participant in the European Neighbourhood Policy and the Eastern Partnership, and thus a priority partner of the EU. Yet the ratification of the Ukraine-EU Association Agreement, begun in 2012 and concluded five years later, turned out to be a fraught process. Indeed, the 2014 Ukrainian Revolution, or Euromaidan, started when pro-Russian President Viktor Yanukovytch suspended it.

Later that year, with the Yanukovytch government removed from power, Ukraine committed to modernize its administration and institution, signed the political and economic components of the Association Agreement, and joined an International Monetary Fund Extended Fund Facility to restore macroeconomic stability and spur growth.

Decentralization was a flagship initiative in Ukraine’s reform program. The country set out to simplify its multi-level governance structure, and fiscal decentralization—ultimately enabling local governments to plan and efficiently spend budgets—was a key element of this reform and of Ukraine’s participation in the European Neighbourhood Policy.

LOGICA's Third Steering Committee Meeting, July 2019. Photo: EU LOGICA.

Up to 2015, reports on fiscal decentralization in Ukraine testified to chronic inefficiency in public spending by local governments, a failing that colored citizens’ perceptions of their administration and diminished their regard for elected bodies generally. Trust, also, was an issue, leaving local communities far from motivated to pay taxes.

In February 2017, therefore, the Ministry of Finance (MoF) and other relevant public institutions released a four-year public finance management strategy, which in turn led to increased assistance from the EU. The EU’s Support to Local Governments in Ukraine (LOGICA) project—successfully completed in the final quarter of 2020—was launched in that same year to support Ukraine’s push for “Europeanization” and enable a more capable, efficient, transparent, and accountable local financial management system.

“One of the underlying motivations to build public financial management capacity in any transitioning country, such as Ukraine, is the prosperity of citizens,” recalls Boris Petkov, LOGICA Team Leader. “Although citizens might not clearly understand what the benefits of decentralization are, they all expect efficiency of public administration, transparent and accountable governance, improved public service delivery, and—ultimately—prosperity and security.”

The Logic of Fiscal Administration

“Among the key challenges of public finance management systems for local governments were inefficient budget processes, which were prone to errors with potentially inconsistent use of accounting principles, weak fiscal frameworks, and [lack of] oversight of local government borrowing,” said Petkov. “The limited accountability of local governments was also a problem which Ukraine had to overcome.”

DAI’s technical assistance team spent the better part of three years in Ukraine, working closely with the MoF and peer organizations. For decentralization to work effectively, said Petkov, simply transferring responsibilities to lower levels of government is not enough: you have to ensure that subnational authorities have adequate capacities to carry out their function, proper coordination mechanisms, effective monitoring systems, and a better balance in the way policy functions are decentralized.

LOGICA focused on three main axes of Ukraine’s public financial management: modernized budgeting, modernized accounting, and the MoF’s capacity to monitor local government borrowing.

Modernized Budgeting

The budget decentralization support under LOGICA aimed to build a viable, efficient, transparent, and accountable local financial management system and increase financial capacity at the local level.

“The added value for the Ukrainian Government was to build proficient territorial communities, whose budgets assume the same budgetary powers as budgets of cities of regional significance, by switching to direct relations with the state budget and directly receive intergovernmental transfers,” said Petkov.

To assist the MoF in improving budget planning and budget execution processes at the local level, the LOGICA team supported MoF staff in strengthening and accelerating the drafting, analysis, amendment, and eventual passage of legislation.

“We developed proposals for making amendments to one law of Ukraine (Law No. 8044 “On Amendments to the Budget Code of Ukraine Relating to Medium-Term Budgetary Framework”), one resolution of the Cabinet of Ministers of Ukraine, six decrees of the Ministry of Finance, and the form for consolidating plans and reports on the network, personnel, and contingents of the institutions funded by local budgets,” said Petkov.

Among the many guidelines, model procedures, or action plans delivered during the project, the team prepared a Standard Form of a Local Budget Forecast and guidelines for Preparation of Local Budget Forecast Guidelines. This will help identify future revenue and expenditure trends that may have an immediate or long-term influence on local policies, strategic goals, or community services. As the forecast is an integral part of the annual budget process, the project helped local governments to have tools for improved decision-making in maintaining fiscal discipline and delivering essential community services.

Modernized Accounting

LOGICA’s development of a digital solution to support fiscal decentralization and public financial management was welcomed by all project stakeholders as a major breakthrough. “[We] achieved so much in such a short time, where many previous attempts to do so had failed,” said Petkov.

Developed in concert with the MoF, the tailored information and analytical management system—dubbed IAS LOGICA—facilitates the management of budgets by local governments and enables the ministry to apply a “consistent approach to the management of budgetary operations across different systems and vendor solutions used by local governments,” said Petkov.

By automating public finance management processes locally and improving the exchange of information with the MoF, IAS LOGICA helps the ministry track and oversee the local government budget preparation of all local governments nationwide. For their part, local authorities and others involved in the budget process now have access to a tool that automates the drafting of local budget forecasts, supports the implementation and management of funds, and informs local budgeting decisions.

Improved Monitoring of Local Government Borrowing

As the decentralization agenda gained momentum, local governments seized the opportunity to finance development projects in their territories, so the number of loan applications arriving at the MoF is growing exponentially—which raises the issue of MoF surveillance capacity.

Tasked with building the MoF’s capacity to monitor debt at the local level, LOGICA set out to enhance information quality and information flow, exploring inconsistencies in the data, suggesting improvements to clarify and accelerate information exchange, and ultimately proposing a completely new framework. In support of this framework, LOGICA developed comprehensive manuals describing all the steps needed to enable swift, timely, and compliant exchange of information between local governments and the MoF as they assess and process various loans, guarantees, or bonds. Most of LOGICA’s operational recommendations were consolidated in ready-to-tender functional and technical requirements for a forthcoming upgrade of the debt management information system.

LOGICA’s Legacy

In addition to modernizing the local governments’ budget process, the project was also successful in incentivizing villages to join and form amalgamated territorial communities (ATC). The new, more independent ATCs are granted budgetary privileges and are now allowed to maintain direct budgetary links with the central government, and to keep a substantial portion of their local tax revenues (including 60 percent of personal income tax collected).

The ATCs also receive subsidies from the central government—including, until 2020, funds for establishing their newly merged institutional and social infrastructure. Special ‘equalization’ grants are available for correcting disparities in local development between communities. Block grants for healthcare (until July 2018) and education have further improved the financial capacities of the ATCs, allowing them to take on more responsibility for public services. The ATCs are, for instance, responsible for managing primary and secondary education in their territories. And the project’s emphasis on transparency and efficiency seems to be translating into greater citizen trust.

“Previously, the concept of auditing carried with it a punitive message, or at least the idea that auditing was an adverse process which seeks to expose errors and omissions, causing only disciplinary actions for the audited organization,” said Petkov. “The purpose of our work was to reinforce the concept of auditing as an ongoing and routine aspect of any effective organization’s management processes and cycle.”

With more transparent fiscal procedures, citizens and local communities are increasingly motivated to pay taxes, because they see that money is being spent to meet their needs. Economic indicators reflect this growing confidence: the resources commanded by local budgets doubled between 2015 and 2020, and local budget revenues—expressed as a share of gross domestic product—increased from 6.5 percent in 2014 to 7.6 percent in 2019. Personal income tax revenues in 2019 increased 2.6 times compared to 2014.

Finally, from the political perspective, LOGICA’s support for the practical administration of decentralization advances Ukraine’s Europeanization. Alongside other liberalizing and democratizing reforms, this political and social transformation aligns Ukraine with other European states, where power is similarly less concentrated, and positions it for political integration in the long term.