Document of The World Bank PROJECT PAPER ON A PROPOSED ADDITIONAL FINANCING CREDIT IN THE AMOUNT OF TO THE REPUBLIC OF INDONESIA FOR A

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT PAPER ON A PROPOSED ADDITIONAL FINANCING CREDIT IN THE AMOUNT OF SDR MILLION (US$123 MILLION EQUIVALENT) TO THE REPUBLIC OF INDONESIA FOR A THIRD KECAMATAN DEVELOPMENT PROJECT, SECOND PHASE Social Development Unit Sustainable Development Department East Asia and Pacific Regional Office April 4,2007,v Report No ID This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective December 7,2006) Currency Unit = Rupiah Rp.9,115 = US$1 US$lOO = Rp. 91 1,500 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AAA ACI ADB BAPPENAS BPKP BRR CAS CCT CDD CG CIDA DA DANIDA DFID DG DPL DSF EIRR ESW GO1 GTZ HH IBRD IDA IFC IFR IRR JBIC JSDF KDP3b KPPN M&E MDF Aceh MDG MIS Analytical and Advisory Activities Anti Corruption Committee for Indonesia Asian Development Bank Badan Perencanaan dan Pembangunan Nasional (National Development Planning Agency) Badan Pengawasan Keuangan dan Pembangunan (State Internal Audit Commission) Reconstruction and Rehabilitation Agency for Aceh and Nias Country Assistance Strategy Conditional Cash Transfer Community-driven development Community Group Canadian International Development Agency Designated Account Danish International Development Agency Department for International Development, United Kingdom Directorate General Development Policy Loan Decentralization Support Facility Economic Internal Rate of Return Economic and Sector Work Government of Indonesia German Agency for Technical Cooperation Household International Bank Reconstruction and Development International Development Association International Finance Cooperation Interim Financial Reports Internal Rate of Return Japan Bank for International Cooperation Japan Social Development Fund Third Kecamatan Development Project, second phase Ministry of Finance s Treasury Office Monitoring and Evaluation Multi-Donor Trust Fund for Aceh and North Sumatra Millennium Development Goals Management Information System *. 11

3 FOR OFFICIAL USE ONLY MOF MOHA NGO NRM O&M OPCS osu PAD PDO PENSA PMD PMU PNPM RPM QCBS SAD1 SPP SUSENAS TA TOR TPK UPK UPP WB Ministry of Finance Ministry of Home Affairs Non-Governmental Organization Natural Resources Management Operation and Maintenance Operations Policy and Country Services Operations Support Unit Project Appraisal Document Project Development Objectives Program for Eastern Indonesia Small and Medium Enterprise Assistance Department of Community Development Project Management Unit Program Nasional Pemberdayaan Masyarakat (National Community Empowerment Program) Regional Procurement Manager Quality and Cost-Based Selection Smallholder Agribusiness Development Initiative Payment Request National Socioeconomic Survey Technical Assistance Terms of Reference Tim Pengelola Kegiatan (Implementation Teams) Sub-district Financial Management Unit Urban Poverty Project World Bank Vice President: Country Director: Sector Director/Sector Manager: Task Team Leader: James W. Adams Andrew D. Steer Christian Delvoie/Cyprian Fisiy Scott E. Guggenheim This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization

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5 REPUBLIC OF INDONESIA THIRD KECAMATAN DEVELOPMENT PROJECT, SECOND PHASE TABLE OF CONTENTS Page Project Data Sheet Introduction Background and Rationale for Additional Financing Proposed Changes Consistency with CAS V Appraisal Results Economic and Financial Analysis Scale-up and Absorption Issues Project Implementation, Financial Management and Procurement Arrangements Financial Management Procurement Expected Outcomes Benefits and Risks Financial Terms and Conditions for Additional Financing Annexes Annex 1 : Indonesia s National Community Empowerment Strategy Additional Financing Annex 2: Revised Results Framework and Monitoring - Additional Financing Annex 3 : Financial Management Assessment Annex 4: Anti-corruption Action Plan Annex 5: Donor Support to KDP Annex 6: Procurement Arrangements Annex 7. Technical and Operational Issues and Actions Annex 8. Project Preparation and Supervision Annex 9. Documents in the Project File MAP JBRD 33420R1 iv

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7 INDONESIA KECAMATAN DEVELOPMENT PROJECT, SECOND PHASE Date: April 4, 2007 Country Director: Andrew D. Steer Sector Director: Christian Delvoie Project ID: P [ ] Loan [ X ] Credit [ ] Grant For Loans/Credits/Grants: Total Bank financing (US$m.): Proposed terms (IBRD): Grace period (years): Commitment fee: Proposed terms (IDA): Standard Credit Grace period (years): 10 Commitment fee: % PROJECT PAPER EAST ASIA AND PACIFIC REGION EASSO PROJECT DATA SHEET Team Leader: Scott Guggenheim Sectors: Sub-national government administration (25%); Water supply (20%); Irrigation and drainage (20%); Roads and highways (20%); Primary education (1 5%) Themes: Public expenditure, financial management and procurement (P); Rural policies and institutions (P); Participation and civic engagement (P); Social safety nets (P); Rural services and infrastructure (S) x s m e n t ) For Additional Financing Years to maturity: Front end fee (FEF) on Bank loan: Payment for FEF: Capitalize form Loan Proceeds Years to maturity: 35 Service charge: 0.75% Financing Plan (US$m.) Source Local Foreign Total Borrower IBRD 0 0 IDA Total Contact Person: Ayip Muflich Tele: ( vu 4 I V

8 Does the project depart from the CAS in content or other significant respects? ReJ PAD A.3 Does the project require any exceptions from Bank policies? ReJ PAD D. 7 Have these been approved by Bank management? Is approval for any policy exception sought from the Board? Does the project include any critical risks rated substantial or high? ReJ PAD C.5 Does the project meet the Regional criteria for readiness for implementation? ReJ PAD D. 7 Project development objective Re$ PAD B.2, Technical Annex 3 [ ]Yes [X ] No [ ]Yes [XI No [ ]Yes [ 1 No [ ]Yes [XI No [ ]Yes [XI No [XIYes [ ] No vi

9 INDONESIA KECAMATAN DEVELOPMENT PROJECT, SECOND PHASE INTRODUCTION 1. This project paper seeks the approval of the Executive Directors to provide additional financing for IDA credit of US$123 million for the Indonesia: Third Kecamatan Development Project, second phase (KDP3b). 2. KDP3b was approved by the Executive Directors for a total amount of US$160 million in March The project became effective on June 30, It is the latest operation in a long running series - the KDP Program -- initiated in To date, the total financing provided under the KDP Program is approximately US$1.45 billion. The proposed additional financing is needed to provide a bridge for KDP activities in Support to a larger national anti-poverty program (described below) will be considered at a later stage. 3. On August 16, 2006, President Yudhoyono of Indonesia announced a national anti-poverty program. This initiative will be the first Indonesia-wide Government program for sustainable poverty reduction since the East Asian crisis in 1997 plunged nearly 40 percent of Indonesia s population into poverty. The national program will have two separate components: a National Program for Community Empowerment and a Conditional Cash Transfer Program. The National Program for Community Empowerment or Program Nasional Pemberdayaan Masyarakat (PNPM) would cover both rural and urban areas. By 2009, all 70,000 villages in the 5,300 rural and urban sub-districts (or kecamatans) in Indonesia would be covered (see Annex 1). 4. The total financing requirements for PNPM are expected to reach US$l.5 billion per year. Most of this funding will be provided from the national budget. However, due to the late introduction of the program, no provisions were made in the 2007 national budget to cover the approximately US930 million needed. These funds are needed to help launch the first phase of PNPM for improved access to tertiary infrastructure and core social services by the poor. Out of the US$930 million needed, the Government of Indonesia (GOI) has requested the Bank to provide an additional US$130 million for the rural component of PNPM through the well-functioning KDP model. 5. Additional financing for the successful KDP Program is particularly well suited in this regard as it can quickly and effectively expand coverage to very poor and marginalized communities. The additional financing will not only allow expansion of a successful program, but will also signal support for the larger effort by GO1 to emphasize inclusive development and sustainable poverty reduction. 6. The proposed additional financing would help finance the costs associated with scaling up a welltargeted project that is reaching the intended beneficiaries and providing them opportunities for increased income generation, decision making, and accessing better services. There will be no change to the project s original development objectives. The additional financing will not involve any significant changes to the profile of beneficiaries, safeguard requirements and implementation and fiduciary arrangements. The urban component of PNPM would be covered by scaling-up the Bank-funded Urban Poverty Project (UPP). 1

10 BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING 7. The KDP Program provides block grants to finance economically productive activities, identified through bottom-up and participatory development planning, using the community driven development (CDD) approach. It is the hallmark of Indonesia s CDD interventions and is now the largest Bankfinanced CDD program in the world. More than 27,000 Indonesian villages have benefited in 1,592 subdistricts, with 75 percent of the funds going for socioeconomic infrastructure and 25 percent for economic activities. 8. The World Bank has been involved with KDP since its launch in The project has also received substantial grant support from donors, and, as Indonesia emerges from the economic crisis, contributions from national and local government budget resources are increasing very rapidly. 9. Project Objectives and Design. KDP3b has an overall development objective of reducing poverty and improving local-level governance in rural Indonesia. It is part of a long-term village level governance program that began with the first KDP in The development objectives for KDP3b include: (i) institutionalizing participatory processes in local government; (ii) providing cost-effective, basic social and economic infrastructure; (iii) strengthening the capacity of the micro-finance institutions to manage and monitor funds sustainably; and (iv) providing emergency reconstruction assistance. 10. KDP s block grants are planned through facilitated village and sub-district meetings. Sub-district grant amounts are fixed within categories established by population density. Village proposals can vary within a pre-determined range. Grants are disbursed directly to collectively held village accounts (through a transfer bank), without entering the inter-governmental financial transfer system. Villagers can receive a small planning grant to hire technical advisers to help design proposals. KDP also provides engineering assistance and oversight, as well as training in proper double-entry book-keeping and procurement. 11. The KDP Program has introduced a number of unique design features, that include: (i) a clear focus on Indonesia s poorest rural communities; (ii) a boost to Indonesia s ambitious decentralization program through a mechanism which has introduced local level planning, decision making and management; (iii) a direct disbursement system, which channels funds to communities and seeks to minimize transfer loss (this system has now been adopted by all Indonesian CDD projects); (iv) a mechanism to channel funds common to multiple donors, including Australia, Canada, Japan, Netherlands, and the United Kingdom instead of parallel support; and (v) a robust and comprehensive anti-corruption framework, including community participatory monitoring, government oversight, consultants and civil society monitoring, financial reviews and audits, and a grievance and complaints resolution mechanisma2 12. Project Performance to Date. Project performance for the KDP Program series has been satisfactory. Economic and social impact evaluations are positive, with a weighted average IRR of approximately 35 percent. Quality of output reviews is similarly favorable. The project has also been very robust in the face of Indonesia s post-crisis turbulence. Not only did it scale up rapidly during the crisis, when much of the Bank s portfolio was being cancelled or restructured, but in many poor parts or conflict-affected parts of the country, KDP has been the only donor-supported project able to function. It should be noted that KDP was the first World Bank funded project to appraise an anti-corruption action plan -- now mandatory for all projects in Indonesia -- and to carry out empirical measurements of actions designed to reduce project leakage. 2

11 13. The project is currently active in 1,300 sub-districts - about 28,800 villages - and it covers 30 of Indonesia s 31 provinces. Table 1 summarizes the main financial inputs into KDP.3 Project Phase KDP 1 KDP Supplemental a/ KDP2 KDP3a b/ KDP3 b KDP3 b with Additional Financing C/ Table 1: KDP s Financial Structure and Coverage (in US million) I I I I I I No. of I No.ofSub- I No.of I IBRD/IDA Trust Funds Government Contribution Total Districts districts Villages Covered Covered Covered , , ,592 27, O , , ,800 36,000 I Total I I I I 14. As of December 1, 2006, KDP3b has disbursed US$35.4 million, although almost all funds are now committed. The program has helped rehabilitate schools, health facilities, water and sanitation systems, roads, bridges and market systems. The unique design of the program involves engagement of social and technical facilitators who know the communities well. Overall, evaluations and international audits of these sub-projects show that return rates average percent. Table 2 summarizes the main outputs from the program. 15. KDP is among the most thoroughly evaluated operations in the Bank s portfolio. Positive evaluations demonstrate the following: Poverty targeting is successful (Alatas, 2005); Infrastructure built by KDP has high economic returns (Dent, 2001, Torrens, 2005); Infrastructure quality is good to very good (Ekart et al, 2004; Torrens, 2005; MOHA 2005); KDP s construction costs are 30-50% less than. alternative means (Torrens 2005); There were no significant safeguards cases in 250 randomly selected sub-projects (Gnagy 2005); Corruption rates are low (PwC, Moore s Rowland, BPKP, MIS); Participation of women and the poor is generally high (MIS); Voluntary community contributions are high (MIS); and KDP forums reduce conflict (Barron et. al. 2006). In addition, 26 provincial and district governments have launched parallel KDP programs of their own. 3

12 Table 2: Outputs from the Kecamatan Development Project, Subproject Type KDP ( ) KDP Totals to Date ( ) ( ) Loan Activities Loan Recipientkoan group members Education and Health Health Education 18,000 economic loan activities 24,93 1 loan activities 42,93 1 loan activities 280,000 loan recipients 471,554 loan recipients 75 1,554 loan recipients 140 health posts 1,868 health posts 2,008 health posts supported 285 new schools built 1,046 new schools built 1,331 new schools built 190 school rehab 1,159 schools rehab 1,349 schools rehabilitated 380 individual 94,801 individual 95,181 individual scholarships scholarships scholarships 16. Evaluations have also shown the main areas requiring improvement: (i) new statistical methods can improve targeting (Alatas 2005); (ii) heightened audit samples and improved audit procedures will lower losses (Olken 2005); (iii) community institutions lack adequate representation (Evers, Olken 2005); (iv) management capacity is weak (aide-memoirs); and (v) O&M is inadequate (MOHA 2005). 17. KDP s planning for 2007 responds to these concerns. Poverty targeting will be improved by using new village mapping techniques to recalculate the eligibility list. KDP s Aceh reconstruction program piloted an improved audit design (based on the Olken study) on corruption and village roads, and, pending final evaluation, will extend the approach to the national program. Also as part of the national program, GO1 is working with donors through the Decentralization Support Facility (DSF) and the Development Policy Lending (DPL) series to design a reform program for improving sub-district and village governance. And a DSF-financed study will be assessing village cash flows to identify whether the poor communities covered by CDD programs can afford user fees to improve maintenance. PROPOSED CHANGES 18. The only major change with the proposed additional financing is the expansion of geographic coverage. Neither the original project objectives nor the components will change. The implementation arrangements would also be the same as for the ongoing project. 4

13 19. GO1 has not yet fully formulated the details of PNPM other than to confirm that it will build on KDP and UPP to cover the entire country by 2009 and continue until However, for the 2007 launch of the scale-up, GO1 wants to introduce no changes to the project s operational procedures other than normal technical adjustments required to cope with the scaled-up project. 20. The proposed scale-up for which additional financing is requested consists of the following: The number of participating sub-districts will rise from a planned 5504 to approximately 1,800; and The block grant amount per sub-district used for investment will rise from a current Rp. 1.0 billion to Rp. 1.2 billion. 21. The proposed additional financing of US$130 million in 2007 would be matched by national budget resources and a parallel loan being prepared by ADB for US$lOO million. GO1 is also currently working out a co-financing framework for sub-national governments, but anticipates raising approximately US$50 million annually from district government contributions. 22. In 2008, the national program will be fully on-budget. It is expected to cover all 70,000 villages in Indonesia. Donor support by that time will be through a larger partnership approach with additional funding requested from the ADB and the Japan Bank for International Cooperation (JBIC). 23. Revised Project Description. The five project components -- with minor modifications from the description in the PAD for KDP3b -- are summarized below: Block Grants to Poor Communities: These constitute approximately 80 percent of KDP. The block grants consist of unearmarked transfers to sub-district financial management units, where they are used to support priority investments identified and selected through a participatory planning process and ratified in a sub-district selection meeting. Other than a small negative list (e.g., weapons, civil service salaries etc), menu choices are open. Up to 10 percent of the block grant can be used to purchase engineering services. Sub-categories of the block grant cover: i) ii) iii) Planning Grants: These cover the cost of the participatory planning process, engineering design services, and village level training. Main Block Grants: Approximately 65 percent of these funds are used for economic infrastructure such as roads, tertiary irrigation and the like, although in the past two years there has been an increase in using the grants for education and health services as well. The block grants are allocated based on the decisions of the sub-district decision meeting. Up to 25 percent of the grant can be allocated to village-level revolving funds for women. MDG Achievement Grants: These fund a randomized pilot evaluation that will test whether using KDP grant mechanism to support village-level poverty reduction action proposals produces results on MDG performance indicators. Implementation Support: Villages are supported by social and technical kecamatan facilitators. These facilitators oversee the planning process, provide technical advice and training, manage the project s reporting system, and certify project completion. There are usually two facilitators per kecamatan, although in particularly isolated areas there are three. 4 Launched in 1998, by 2007 KDP was expected to scale-down to 550 sub-districts from its 2006 high of 1,350. 5

14 (c) Technical Assistance: This constitutes the formal project administration. It consists of three levels, each of which reports to a corresponding level of government. Overall coordination is through a national management team within the Ministry of Home Affairs, which is implementing the project. (d) Monitoring and Evaluation: KDP provides both quantitative and qualitative monitoring, and it also has a mix of internal and outsourced evaluations. For the proposed additional financing, the internal system will be strengthened through better technology, additional training, and improved oversight. KDP reserves approximately 2.5 percent of its budget for monitoring and evaluation. (e) Operational Expenses: This component (less than 1 percent of project costs) covers government incremental expenses, particularly for the incremental travel and contract management costs. It does not cover salaries. 24. The Bank team believes that the proposed changes, although minor, offer substantial benefits with few risks. KDP is already operating in 1,350 sub-districts, so the total increase is relatively small. The increase in the block grant amount is also long overdue: total block grant amounts have remained unchanged since the project s launch in 1998, while the cost of labor and materials has risen substantially. CONSISTENCY WITH CAS 25. The proposed scale-up of KDP is fully consistent with the Bank s Country Assistance Strategy (CAS) for Indonesia. The 2006 CAS update states that: The Bank s large Community Driven Development (CDD) portfolio seeks to combine high-return investments with innovations in participation, planning and monitoring, designed to improve governance in sub-districts and villages. The CDD platform has performed very strongly over the CAS period, improving access to community level infrastructure and services, while contributing to improvements in transparency and accountability in over half of Indonesia s villages and towns. The government has announced its plans to scale up and apply the approach as a nationwide, pro-poor service delivery program. 26. KDP is part of the World Bank s overall CDD program in Indonesia. That program rests on three strategic directions. KDP (and the UPP) provide the main architecture for bottom-up development planning. Linked to KDP and UPP are an increasing number of sectoral programs that provide specialized inputs to improve the delivery of poverty services. Finally, KDP, working together with IFC and AusAid, recently launched a long-term program to promote private sector linkages to community development programming. 27. The long-term sustainability of the program to some extent hinges on stabilizing the public administration environment within which community development operates. GO1 and the Bank agree on a three-year action program that will cover the following themes through a mix of analytical and advisory activities supported through the Decentralization Support Facility, DPL triggers, and policy actions sponsored through KDP s high level coordination group: Clarifying the national procurement law to allow for community participation (2007); Reforming the bottom-up planning regulations (2007); Revising the law on village government (2008); Stabilizing sub-district structure and functions under decentralization (2008); and 6

15 Developing a long-term budget transfer mechanism for community planning (2009). 28. KDP and the National Community Empowerment Program (PNPM): KDP is well-rooted in a long history of the Indonesian government s efforts to push development resources to the poor. As early as the mid-1980s the government supported a series of district-level reform programs, and by the early 1990s an array of donor-assisted projects such as the Water Supply and Sanitation for Low-Income Communities, the Village Infrastructure Project, and the government s own small grants program for disadvantaged areas were launching innovative mechanisms to work directly with communities. 29. KDP drew heavily on these experiences. What is different from past programs is to some extent its scale and scope. While KDP grew most directly out of the Village Infrastructure Project, over time it has broadened its scope from being a more efficient way to provide tertiary infrastructure to a more consolidated form of multisectoral village-level planning. A broad range of donor-assisted pilots have helped KDP develop a number of innovative, efficient ways to link community-based planning to public and private service delivery. 30. World Bank engagement with PNPM is close and deep. The 2004 CAS organized almost a third of the lending program around a community development platform, and it is this platform that has now become the foundation for the PNPM. The 2006 CAS update projects a sustained involvement with PNPM as it becomes the flagship program for poverty reduction in Indonesia. However, the scale being requested by the government is considerably larger than previously envisioned. Key issues for the Bank would include how to structure the lending program to meet the government s requests; which mix of lending instruments support the system objectives most effectively; and how best to involve sectoral programs and technical expertise into PNPM support. APPRAISAL RESULTS 3 1. GOI s additional financing request was appraised in November 2006 by a multi-sectoral World Bank team that included headquarters representatives of OPCS and the East Asia Region s Operational Services Unit. Appraisal concentrated on fiduciary oversight, project management, and absorptive capacity. During appraisal, the Bank agreed with GO1,on a number of technical improvements. They include: Restructuring the national management arrangements; A strengthened and outsourced MIS system; Increase BPKP audit sampling to at least 20 percent of the kecamatan using the special audit program that has been developed for CDD projects; A revised consultant management and evaluation system; and Strengthened training for facilitators and village leadership. Economic and Financial Analysis 32. Economic analysis of the scaled-up project does not change the analysis presented in the PAD for KDP3b. Even at full funding, total amounts remain less than 5 percent of district budgets. Although upto-date surveys of Indonesia s tertiary infrastructure gap are not available, it remains quite large, particularly off-java. Lack of access infrastructure reduces the viability of rural production. KDP economic rates of return are high in large part because KDP infrastructure creates substantial producer surpluses. 7

16 33. KDP currently has funds sufficient for 575 sub-districts in 2007, which receive approximately Rp. 0.8 billion each. Factoring in an additional 25 percent to cover the costs of technical assistance, training, and evaluations, this means that 2007 without the national program would require project financing of approximately US$72.0 million. This amount is available from the original KDP3b. 34. The proposed 2007 scale-up consists of approximately 1,800 kecamatans, with their block tentatively grants set at an average of Rp. 1.2 billion, or US$240 million. Total costs of all other KDP components amount to approximately 20 percent of the block grant, or US$50 million. Scaling up KDP to the level proposed by government for 2007 therefore requires additional financing of US$290 million. Subtracting the US$110 million available from KDP3b leaves a financing gap of US$180 million, of which the government has already allocated US$50 million. Scale-up and Absorption Issues 35. Of special relevance for the proposed additional financing is KDP s modular structure. Each subdistrict is a self-contained unit which supports activities that are not dependent on a master procurement or disbursement plan other than the overall budget. As a result, each year the number of sub-districts can expand or contract depending on the availability resources without jeopardizing contracts or budgeting. KDP s management structure is also flexible. The large majority of staff are hired as individual consultants and paid directly through a payroll managed by a bank. This minimizes the extent to which contracts must be procured and amended as the annual plan is adjusted. 36. The proposed changes should have little impact on KDP s disbursement arrangements. The project disburses quickly and, because of its modular structure, can absorb extra sub-districts with little difficulty. KDP currently disburses approximately US$165 million per year. The scaled-up program will disburse approximately US$400 million over the following 18 months. Experience suggests that this amount will be absorbed without difficulty. At present KDP only disburses to a small number of villages within each sub-district. The larger per sub-district amount will allow a larger number of villages to participate. 37. The first possible issue with scale up, increasing the block grant amount by 20 percent should not pose absorption problems. In fact, an even larger increase has been a long-standing recommendation of the Bank given the good performance of the current project and the need to increase the poverty benefits flowing to the poor from this system. In Aceh and Nias reconstruction, though admittedly operating under abnormal conditions, KDP disbursed as much as Rp. 6 billion per sub-district in less than 8 months and, with 90 percent of its US$79.0 million disbursed by May 2006, was by a significant margin the fastest disbursing project funded through the Multi-Donor Fund for Aceh and Nias. 38. A second possible scale-up issue is whether a sufficient number of technical and social facilitators can be mobilized and deployed quickly enough. KDP currently employs 75 percent of the staff that would be required for the scale-up and while there are some difficulties securing qualified facilitators for the most isolated islands, for the large majority of proposed locations a trained body of facilitators already exists. However, providing sufficient amounts of proper training to the new facilitators is going to be challenging and will require special efforts by PMD. This issue was flagged during appraisal and an appropriate action program would be reviewed by the Bank before the project is launched. 39. The third issue concerns local government financing. The current KDP requires local government participation at a rate ranging from percent depending on their ability to pay. However, with block grant amounts increasing and the number of sub-districts rising well after the normal budget preparation period for local governments has passed, it would not be realistic to maintain this level of local government participation. It is proposed that mandatory local government participation be waived for 8

17 2007 while a realistic and equitable formula can be developed that will apply to all districts in the 2008 cycle of the program. Provincial and district governments that have already allocated counterpart funds for 2007 would be encouraged to use them to add additional kecamatans. 40. The fourth innovation concerns a pilot program to improve poor villager performance on MDG indicators. In this pilot, KDP villages sign a compact to improve their performance on a number of Indonesia s most difficult MDG indicators. In return, they receive an extra allocation of KDP funds. There are no changes to KDP s normal disbursement, accounting, or management procedures; changes come from more specialized facilitation and additions to KDP s systems for performance measurement. This pilot is highly relevant to the overall PNPM strategy since, if successful, it would be scaled up through the national program. Project Implementation, Financial Management and Procurement Arrangements 41. The institutional and implementation arrangements would be largely the same under the additional financing as for the ongoing KDP3b, as they are working effectively. KDP is executed through the Ministry of Home Affairs. The core executing team is guided through a coordinating group at each level of government that includes the finance department, the development planning board, and the relevant line agencies such as health, education, and public works. 42. A major outcome of the project has been to build the capacity of sub-district teams to plan and manage resources, and in addition creating demand for transparent resource allocation at the village level. Financial Management 43. The financial management capacity in the institutions involved in the project is satisfactory, having been strengthened over the years under the different phases of the KDP Program. In view of the proposed additional financing, an updated financial management assessment of the project has been undertaken. The following aspects were reviewed: country situation, performance of existing project entities, additional project features and related internal controls. A major risk is posed by KDP s block grants, particularly with respect to how effectively beneficiaries and community groups use and account for the funds. Another area of potential risk is the capacity of district and sub-district staff to supervise and monitor sub-project implementation, especially for local governments that do not have previous experience with the KDP program. However, KDP has a successful record of mitigating these risks through a strong training and oversight system. 44. Overall, the financial management risk for additional financing is assessed as being high. Over the past year, KDP has also taken several steps to strengthen its financial monitoring and reporting, including progress in cleaning up its backlog of unresolved cases. Supervision of project financial management would be based on a risk-based approach and would be conducted at least twice a year. Supervision would review the project s financial management system, including but not limited to subgrant expenditures, accounting, reporting and internal controls. Financial Management Assessment shows in Annex 3. Procurement 45. A revised procurement plan has been prepared and is being reviewed by the Bank s procurement team. There will be very little new procurement; existing contracts will be amended to reflect the changed scope of work. The final amendment will not be approved without RPM sign-off on the procurement plan. Contracts will be re-tendered for the national scale-up. 9

18 46. The villagers follow simple procurement procedures cleared by the Bank s procurement team. Procurement risk is higher at the national PMU level that selects project consultants, including field consultants, The large majority of KDP consultants are hired as individual consultants and paid directly through a payroll system managed by a commercial bank. EXPECTED OUTCOMES 47. The increase in outputs is largely linear, without qualitative changes to the development objectives or performance indicators. Because the additional financing is justified as Bank bridging support to the national program, the logframe will assess progress on planning the national program and its associated policy reforms. The revised performance matrix is attached as Annex 2. BENEFITS AND RISKS 48. Benefits of the project are twofold. First, KDP provides demonstrably valuable benefits to poor communities across Indonesia. These would be increased and they would reach a larger number of poor communities. Second, and more importantly, GO1 is now making the transition into transforming all these community based programs into on-budget support for all villages across Indonesia. Making community transfers predictable and sustained will allow the model to expand into new areas already being piloted: 0 Partnerships for improved education and health service delivery; Village links to private sector suppliers and marketing; Village-based safety nets; and Rapid responses to disasters and emergencies. 49. Risks are primarily macro and are unchanged from the risk matrix described in the KDP3b PAD. KDP s higher profile (and bigger block grant) increases corruption risks; for that reason a strengthened anti-corruption plan is proposed (see Annex 4). However, to date KDP s confirmed corruption rate has been quite low and the risk should be appraised as moderate rather than high. Indonesia s ever-changing institutional environment is also always a challenge. 50. Appraisal carried out a full fiduciary review, which is available IRIS. The purpose of this assessment was to identify improvements needed both for the additional financing in 2007 but also for the larger national program that will start in Recommendations from that assessment were to: Strengthen the fiduciary training program for local government and communities; Strengthen the financial management teams and financial controls within PMD; Provide an expanded FM training and supervision to facilitators; Increase BPKP audit sampling to at least 20 percent of the kecamatan using the special audit program that has been developed for CDD projects; Train local government auditors (Bawasda) and include them in auditing of the kecamatan financial management groups; Introduce and train a kecamatan supervisory board and make them the community auditor for the UPK Expand the current program of community-based cross audits and to provide small fund for helping community groups to pursue their own legal cases; and Place the complaints handling database, including audit findings, online. 10

19 5 1. Anti-corruption Plan: A summary of KDP s anti-corruption action plan and the improvements proposed for the additional financing is attached in Annex 4. Corruption levels in KDP are generally low, with independent audits by national and international audits recording them as less than 1 percent of the total value and 90 percent of them for US$4,000 or less. Corruption rates have declined over time. KDP, the Bank, and the national audit board work closely together to improve the quality and suitability of fiduciary control measures for KDP (see Annex 4). FINANCIAL TERMS AND CONDITIONS FOR ADDITIONAL FINANCING 52. The terms and conditions will be the same as those for KDP3b. 11

20 ANNEX 1: INDONESIA S NATIONAL COMMUNITY EMPOWERMENT STRATEGY ADDITIONAL FINANCING 53. On August 16, 2006, the President of Indonesia announced that his government would support a national program for poverty reduction. This will be the first national program for sustainable poverty reduction - rather than crisis management -- since the East Asian Crisis plunged nearly 40 percent of Indonesia s population into poverty. The program consists of two main approaches: Conditional Cash Transfer Program and the National Program for Community Empowerment. 54. Approximately US$4.0 billion would be invested in a conditional cash transfer program (CCT) to improve poor people s use of social services. In its first year the CCT program would target 1.7 million poor families, with a plan to rise to 18.0 million poor families by The second wing of the poverty program is called the National Program for Community Empowerment. Called PNPM in Indonesian, (Program Nasional Pemberdayaan Masyarakat), the PNPM covers both rural and urban parts of Indonesia. Both rural and urban areas will be built by scaling-up two World Bank-financed community driven development projects, the Kecamatan Development Project and the Urban Poverty Project and. By 2009, all 5,300 rural and urban sub-districts in the county will be covered with one of these two programs. 56. Indonesia s PNPM is an evolving idea that will be planned over the course of 2007 before going national, but its main outlines have been provided by the Coordinating Minister of Social Welfare. PNPM will be part of a national poverty reduction framework that includes a social safety net, improved asset security, and increased use of core health and education services. 57. PNPM will be developed over the period. When fully developed, the program will cover all rural and urban communities in Indonesia. The program will consist primarily of scaling up the existing Bank-assisted KDP and UPP programs, but the scale-up would be supported by a number of evaluations to identify improvements or missing elements. Other donor programs will also be evaluated and brought into the national design. 58. A number of strategic choices must be made as part of the national scale-up. They include: (i) one national program or many projects united by an umbrella concept; (ii) coordination with line agency service delivery; (iii) management of the national PNPM given that the existing poverty programs are implemented by different ministries; (iv) centralized or decentralized management; and (v) long-term financing framework. 59. A preliminary economic assessment of PNPM showed that by 2009, when the program would cover all kecamatans at the proposed benefit level of Rp. 3 million per kecamatan, it can potentially benefit nearly 14 million families, increasing their income by 11 percent by providing an average of 60 days of work. Some 7-9 million households would be pulled out of poverty. 60. The additional income would benefit primarily workers when they need it the most. It will raise the wages of all unskilled workers significantly, even those that had no contact with the program, by reducing the competition from desperate workers who drive all wages down. By developing economically productive roads, irrigation and drainage works, water supply and sanitation works, PNPM will permanently increase employment and income. Injecting purchasing power into villages and poor urban area will have an indirect effect in activating the village economy. 12

21 61. GO1 has already indicated that it anticipates a need for start-up support to help the PNPM program. Estimated financing needs from the World Bank, ADB, and JBIC for the periods are approximately US$600 million. The government plans to use 2007 to discuss with donors the most suitable form of medium and longer term donor assistance. The government has asked the Decentralization Support Facility, a multi-donor trust fund managed by the World Bank, to promote harmonized dialogue with the government, to coordinate donor engagement on the PNPM. 13

22 ANNEX 2: REVISED RESULTS FRAMEWORK AND MONITORING - ADDITIONAL FINANCING PDO Villagers in KDP3 locations benefit From improved socio-economic and local governance conditions Intermediate Results One per Component Component One: Block Grants for Poor Communities Villagers participate in a process to plan, select and manage basic social and economic infrastructure provided through block grants. Component Two: Implementation Support Local government councils use their new skills to fulfill their local governance functions. Outcome Indicators Improved HH expenditure rates and improved access to economic and social services in 2,000 poor subdistricts or over 30,000 villages. Improved health and education indicators for: Health: immunization rates, antenatal care, and weighing. Education: increased enrollment and attendance rates for primary and jr. secondary schools EIRRs >30% for major infrastructure types 80% satisfaction levels from beneficiaries regarding improved services and local level governance Results Indicators for Each Component Component One: Min. 40% participation rate of women and poorest community members in planning and decision-making meetings 85% of agreed workplans completed. #/type of infrastructure works, and education and health subprojects/ activities completed in 2,000 kecamatan 70% of infrastructure works are evaluated as high quality 80% of the devastated areas (Aceh and Nias) benefit from KDP technical and economic assistance. Component Two : 65% of KDP villages forming implementation regulations (perdas) Local government adoption and level of contributions to the program. Use of Outcome Information Determine if KDP3 is having - its desired effects on socio-economic welfare. In disaster areas, to determine if assistance is getting to populations in need Use of Results Monitoring Component One: Assess if planning and inclusion procedures and policies need adjustment to encourage greater participation. Assess if sub-district sites are benefiting from KDP assistance. Monitor and evaluate if reconstruction aid is assisting those areas in need and speeding area recovery Component Two: Review if training and capacity building plans need adjustment and if learning interventions meet the needs of the councils to perform satisfactorily their new duties. 14

23 ~~ ~ Component Three: Technical Assistance Subdistrict micro-finance institutions (UPKs) have the skills to carry out their credit activities successfully and sustainably. Component Four: Monitoring and Evaluation Project stakeholders use results of M&E activities and studies to improve project performance. Component Five: Operational Expenses Local governments and communities use planning and facilitation skills for participatory planning of development projects. Component Three: Min. 200 UPKs retaining >Rps 100 million in financial reserves Component Four: >70% of study and evaluation findings used to improve the project. Studies on long-term maintenance and sustainable finding options completed and findings used to improve the program. Component Five: >70% of planned consultants and facilitators mobilized and recruited in time for project launch kecamatan. Component Three: Assess if the UPKs are performing well and if additional technical assistance is needed. Component Four: Findings from M&E and studies will allow the project to adjust and improve its operations and procedures. Studies will help the program examine options for sustainability and integration into government budgeting and financing system. Monitor and evaluate whether local governments and communities are receiving the type of support they need in a competent and timely fashion. 15

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27 ANNEX 3: FINANCIAL MANAGEMENT ASSESSMENT Executive Summary and Conclusion 62. The project has major risk posed by the use of community block grants, particularly with respect to how effectively beneficiaries and community groups (CG) use and account for the funds. There is a second risk that concerns the capacity of district (kabupaten) and sub-district (kecamatan) staff to supervise and monitor the sub-project implementation, especially for local governments that do not have previous experience in KDP program. 63. Balanced against the potential risk is KDP s successful record of mitigating these risks through a strong training and oversight system. Internal and independent audits report low lbss rates. Over the past year KDP has also taken several steps to strengthen its financial monitoring and reporting, including progress in cleaning up its backlog of unresolved cases. 64. There is no outstanding audit report due under any KDP project. Submission of all report is 100% and is received within 90 days. Over the last three years, all audit reports were received before or on the due date. In collaboration with the Bank s OSU team, BPKP has been developing a specialized audit program and procedures for CDD projects, including for KDP. The auditor expressed a qualified opinion in the last audit report due to overstatement and understatement of the project financial reports between KDP2 and KDP3. The central PMU has taken followed up action to resolve such accounting qualifications. The majority findings in the village level are related to the weak capacity of the community groups in aspects of financial control such as accounting and payment verification. 65. Overall, the financial management risk for additional financing is assessed as being high. This assessment has concluded that with the implementation of the recommendations proposed here, the risks will be substantially mitigated, and the proposed financial management arrangements will satisfy the Bank s minimum requirements under OPD3P10.02 and Country Issues 66. Based on Country Financial Management Assessment (CFAA) and other reports, there are major acknowledged deficiencies in Public Financial Management (PFM) area that have been accepted by the government. These are; e Inefficiency budget formulation process, e Separation of recurrent and development budgets. e Fragmented cash management and government banking arrangements e Unreliable of accounting and reporting systems. e Unclear roles and responsibilities in external and internal audit arrangements e Lack of capacity in audit institutions e Poor salary structure and lack of sanction in the civil services 67. Recent PFM reforms in Indonesia have been part of a broader reform agenda of macroeconomic stability set out in the Government White Paper of The Government has plan and a target to have sound PFM system by The Indonesia PFM reform agenda is led by the Government, with technical support being provided by many donors, including the World Bank. There are major progresses in PFM areas as of to date, including new law on State Finance Law, Audit Law, Government Accounting Standards. Other important changes in the budget documents that the government use unified budget started FY

28 Institutional Arrangements 68. A central project management unit (PMU) will be continued through the Ministry of Home Affairs, Department of Community Development (PMD) which manages all KDP activities. At each administrative level of the project, PMD will work with the local government to form a coordination working group (Tim Kordinasi Pengelolaan Program) whose functions are to provide information to villagers about planned development programs, to provide technical support as requested and/or required by project technical criteria, and to solve administrative bottlenecks and problems. 69. Within kecamatan and villages, communities will carry out planning through locally elected administrative councils. Each sub-district and village council forms a small team for project implementation each year to help with project record keeping. The financial management unit (UPK) will be set in kecamatan level; while the project implementation team (TPK) will be set up within each village. The kecamatan block grant includes funds to finance overhead costs such as a small honoraria for the UPK and the TPK. The project will use a variety of specialized consultants to develop local capacities through training in project management, legal aid, dispute resolution, and grassroots advocacy on behalf of villages. Initially these consultants will be managed through project contracts, but over time their services will be contracted and paid for directly by the communities. The facilitator will also assist the community group to prepare the project financial report of the sub-grant implementation. The facilitator should control and monitor any risk of overlap between different projects operating in the same village. Strengths and Weaknesses 70. The existing project has strengths and weakness in several areas. The project design has strengths that derive from using a CDD mechanism to work with communities, as follows: Community Groups receive the fund directly in their bank account from MOF s Treasury Office (KPPN), based on joint approval by community representatives and certification by a registered government officer; The community has stronger ownership, which creates incentives for community control over funds. An external monitoring and evaluation unit is hired through the PMU. An internal financial management team provides hands-on training and oversight to provincial groups. Adoption of proven CDD management tools and systems has been use under existing KDP, UPP and CSSRP projects, such as the flow of fund mechanism, independent reporting and monitoring. 71. Based on supervision missions and audit reports in the existing projects, we note weaknesses in some locations as follows: The capacity of untrained community groups to manage and implement the grant is weak. The capacity of local governments to supervise and assist community groups is weak. The capacity of facilitators to provide financial management is weak. Internal controls in the PMU and community groups are not adequate. Channelling bank internal controls are not adequate, especially in small branch offices. 72. The project s weaknesses create some risks to project implementation. The Bank recommends several mechanisms to mitigate these risks. Among them are: To substantially strengthen training program to local government and CG; To strengthen financial management teams and financial control within PMD; To strengthen national and local financial management teams to deliver an expanded FM training and supervision to facilitator (field consultant) and CG; 20

29 To increase BPKP audit sampling at least 20% of the kecamatan and use audit program that has developed for CDD; To train local government auditor (Bawasda) and include them in auditing of the UPK. Bawasda may expand the project audit coverage; To introduce and train Badan Pengawas (UPK Supervisory Board) and make them as community auditor for the UPK To expand community-based cross audit and to provide small fund for helping CG to pursue their own legal cases; To place the complaints handling data based, including audit findings online for public review. 73. The mission is concerned about some cases that involved the channeling bank s staff. We recommend a high level discussion with the channeling bank to discuss on how to resolve the cases and procedures to avoid and resolve similar cases in the future. Risk Assessment Summary 74. A detailed analysis of financial management risks arising from the country situation, the existing project entities, additional project features and related internal controls has been completed during this additional assessment. This analysis is summarized below. These risks have been rated on a scale from High, Substantial, Moderate and Low. Issues A. Inherent Country Risks 1. Budgetary procedures. Delay on budget documents issue 2. Civil Services Poor civil service payment structures & lack of sanction Overall Country Risk A. Entity specific risks 1. Implementing Entity Organization Status of the entity 2. FM staff capacity. Inadequate of FM staff 3. Internal Audit Limited capacity of the audit staff Risks Summary Comments Condition of [High / and Risk Mitigation Negotiationdof Substantial / Effectiveness Moderate / (Y/N?) Low] H The budget documents have been issued N late. Line ministries received the budget documents in the second quarter in the last three years. MOF needs to speed up the budget process and issue the document at H 1 The government has started civil services I N H reform. However, payment structure remains inadequate and need further enforcement to exercise sanction. M PMD is under Ministry of Home Affairs. N S PMD has long experience managing all KDP programs. Technical assistance is provided to PMD to manage the project. PMD follows the government s accounting N H system and uses the government accounting software (SAK). PMD has adequate staff under its financial department. Implementation of a new accounting standard remains a challenge. Inspectorate General (IG) has a mandate as N internal auditor of the ministry. Risks arise from the integrity and limited capacity of the IG staff, Many IG staff does not have an adequate audit background. However, IG

30 Overall Entity specific Risk S does not perform its role in this project. B. Project Specific Risks 1. Flow of Fund CG does not receive the block grant timely 2. Accounting & Reporting Reliability offnancial report and produce timely 3. Internal Control Inadequate payment ver$cation and caswbank management 4. Procurement Selection on quality consultant 5. External Audit Integrity of the auditor and poor follow up on the audit findings H H S KPPN will transfer the funds directly to the consultant account and for the block grant; KPPN will transfer directly to the CG account. In the national level, PMD will prepare a separate financial monitoring report and submit it to the Bank each quarter. Project financial reporting may be developed through excel sheets. Collecting information from many kecamatan will take time. Field consultant (facilitator) will assist PIU (PJOK) to submit the report. In the kecamatan, UPK s prepare simple financial reports. The project provides technical assistance to UPK. Sub-project locations are scattered. The project will be supervised by independent monitoring unit. Segregation of duties takes place. Internal control system and procedures are included in the existing operation manual. Provision of FM consultant to perform interim audit to review internal control and project implementation in the community level (UPK). There will be verification and reconciliation as part of routine internal control in the local as well as national level. There will be three reconciliations. The first reconciliation takes place in CG level. UPK will reconcile its book with the bank statement. The second reconciliation will be in PIU (PJOK) level. This reconciliation will be based on payment order (SP2D) that issued by Treasury Office (KPPN). PIU with facilitator assistance will reconcile and report this payment (SP2D) to Kabupaten and National Management Consultant (NMC) as part of hidher regular report. The NMC will also receive a copy of SP2D from the facilitator. The last reconciliation takes place in National PMU level. PMU with NMC assistance will reconcile all SP2D with the SA statement. To Select and hire quality consultants will be a challenge. Independent consultant will assist PMU to monitor and oversight the field consultant. BPKP will be assigned as an acceptable auditor to the Bank. The auditor will audit the project financial report and submit the report to the Bank six months after the fiscal year closes. The audit report and the N N Y, revised operation manual as effectiveness condition N Y, acceptable TOR to the Bank before negotiation 22

31 Overall project specific Risk H grant. Accounting and Reporting 75. Similar to the existing project, all financial transactions for the additional financing will be recorded in the government accounting system and included in the government accountability reports. The PMU will prepare a separate set of project financial report which suitable for project monitoring purposes, including the additional financing. The specific accounting procedures are included in the Project Operation Manual. The PMU and Local Project Unit (PJOK) in the kecamatan will maintain separate accounting records, on a cash basis. UPK s are also required to have simple accounting and financial reports. Facilitators will assist the UPK to administer the block grants. 76. The PMU will be responsible to prepare an aggregate Interim Financial Reports (IFR) and submit this to the Bank on a quarterly basis, in formats to be agreed with the bank. The reports include all consultant contracts and block grant payment to the UPK. A Special Purpose Financial Statement for this project will be prepared annually for audit. Internal Controls 77. The majority of the project activities will be conducted by communities in the villages (desa) where communities will monitor and check the project progress. In addition, field consultants (facilitators) will countersign UPK and TPK reports. The UPK cannot withdraw funds without a countersignature by the facilitator. In order to obtain the approval of the facilitator, the village implementation team (TPK) has to produce an acceptable funds utilization plan or utilization report and bank account balance (for the second and remaining payment). The frequency of withdrawals depends in part on physical proximity to the bank from the village, but in principle the amount of cash kept in the village is as small as practical. PMU will prepare memorandum of understanding with the local participant bank and require additional control on the community account. 78. The TPK should submit the project report to the UPK. The report will be aggregated in kecamatans and should be announced in the kecamatan forum and public arena. Internal controls in villages follow the project operational manual. This control mechanism is expected to create community controls over project implementation. Overall, internal controls meet minimum standard requirements. Although there may be some questions about the effectiveness of government internal controls, likely impacts of any weaknesses are limited since the government will only be responsible for very narrowly defined administrative activities. This is because all of the sub-grants are directly transferred from the treasury office (KPPN) directly to community group accounts. The project will also create a national financial management oversight and training unit staffed by at least 7 qualified specialists. 23

32 79. There will be verification and reconciliation as part of routine internal control in the local as well as national level. There will be three reconciliations. The first reconciliation takes place in CG level. UPK will reconcile its book with the bank statement. The second reconciliation will be in PIU (PJOK) level. This reconciliation will be based on payment order (SP2D) that issued by Treasury Office (KPPN). PIU with facilitator assistance will reconcile and report this payment (SP2D) to Kabupaten and National Management Consultant (NMC) as part of hidher regular report. The NMC will also receive a copy of SP2D from the facilitator. The last reconciliation takes place in National PMU level. PMU with NMC assistance will reconcile all SP2D with the SA statement. 80. The project will introduce a Badan Pengawas (UPK Supervisory Board). The project will provide a training program to Badan Pengawas and make them as community auditor for the UPK. The project will expand community-based cross audit and to provide small fund for helping CG to pursue the legal cases (if any). Other Controls 8 1. The project has included non-governmental organization (NGO) on monitoring sub-project implementation. 21 NGOs involved in 2005 monitoring activities in 20 provinces. Due to the varying quality of reports and articles received from journalist, it was decided to discontinue external monitoring by journalists. However, KDP maintains good relationship with many journalists who are consulted on various issues and invited to write articles about KDP. Journalist who wants to write article about KDP, will receive full cooperation from KDP teams. Complaints Handling 82. The Complaints Handling Unit (CHU) of the National Management Consultant (NMC) continued to receive and process complaints during FY 05. About complaints were received. This number included unresolved complaints from the previous year cases or 5 1 % complaints are resolved and the rest are in process to settle the cases. The majority of complaints (1.028 cases) were related to the misuse of fund. 407 or 39.6% cases were resolved, with IDR 5 billion recovered. The recovered amount does not include recovery and sale of individual assets or work donated in lieu of cash. Audit Arrangement 83. The PMU will be responsible for preparing a special purpose financial statement. The audit for the financial statement will be carried out by government auditors (BPKP) acceptable to the Bank. The annual audit report will be furnished to the Bank no later than six months after the end of the government s fiscal year. The acceptability of auditors will take into account specific audit methodologies that are needed to audit widely dispersed community based activities, as has been established under other on-going KDP projects in the country. 84. The audit assignment will be in accordance with the agreed Terms of Reference (TOR). The TOR will basically include an assertion on the reliability of the project financial statements, and will also include a verification of accounting information at community level on the sample basis. The annual audited financial statement will include a review and reconciliation of Special Account transactions and quarterly interim financial reports. The audit reports will be made accessible to the public. 85. In addition, the auditor is required to conduct an operational audit to UPK and TPK level. The agreed TOR has been developed and agreed with the Bank. The auditor will use the audit program that has developed for CDD. The audit sampling coverage will be determined based on kecamatan number. A minimum 20% kecamatan should be included in the auditor samples. BPKP plans to train local 24

33 government auditor (Bawasda) through the existing project. Bawasda will be included in audit assignment of the UPK. Bawasda may expand the project audit coverage. 86. Based on the Olken 2005 study which found that heightened audit samples and improved audit procedures will lower losses, the project will increase the audit sample to at least 20%. This study estimated that villages that were audited have 10% lower losses (from all sources) than village that were not audited. The auditor will also present the audit findings in fiont of the community, including in kabupaten and kecamatan. This auditor presentation has been piloted in KDP 2 and KDP Aceh. Disbursement Arrangement 87. Disbursement arrangements would be the same as for the current KDP3-B. A Designated (Special) Account (DA) denominated in US dollars has been opened by DG Treasury at the Bank Central Bank (BI). The same DA would be used under this additional financing. DG Treasury has instructed its relevant Treasury Offices (KPPNs) located near to the implementation units to authorize payments of eligible project expenditures by issuance of SP2D (remittance order) and providing guidelines and criteria for eligible project expenditures in accordance with the CreditiLoan Agreement. 88. When expenditures are due for payment, PMUPJOK will prepare SPP (payment request) to the payment officer within the Satker. After verification, the payment officer will issue SPM (payment order) together with the supporting documentation for submission to the relevant KPPN. The KPPN will check the budget eligibility and issue an SP2D to the operational bank. The operational bank will transfer the block grant directly to the consultant or UPK s account and debit the DA for the credit/loan portion. 89. The applicable disbursement methods include: 1) Advance, and 2) Reimbursement. Although management of the DA will be under the responsibility of DG Treasury MOF, the PMU at PMD will be the one responsible to reconcile the DA, report on the use of the DA, and to prepare the application for withdrawal for advances, duly approved by DG Treasury before their submissions to the Bank. Copies of the DA s bank statement will be provided to the PMU by DG Treasury, MOF. The ceiling of the advance to DA will be variable, and the advance(s) will be made on the basis of the six month projected expenditures. Applications for reporting of use of the DA funds would be supported by quarterly IFR (Interim Financial Report), and list payments for contracts under the Bank s prior-review. Applications for the advance to the DA shall be submitted together with the reporting on use of DA funds which will consist of: (a) IFRs, (b) projected expenditures for six months; and (c) the DA reconciliation statement. 90. All documentation for expenditures submitted for disbursement will be retained at the implementing unit and shall be made available to the auditors for the annual audit and to the Bank and its representatives if requested. Supervision Plan 91. Supervision of project financial management will be performed on a risk-based approach at least twice a year. The supervision will review the project s financial management system, including but not limited to sub-grant expenditures, accounting, reporting and internal control. The financial management supervision will be conducted by financial management specialist and Bank consultants. 25

34 Action Plan Action 1. A revised project operation manual for KDP PNPM, including establishment of UPK Supervisory Board 2. Reconfirmation that BPKP would be assigned to audit this project with an acceptable TOR to the Bank, including at least 20% of kecamatan audit sample 3. Recruitment of additional consultant, including FM consultant 4. Training and socialization for field consultant and local government Responsibility Due Date PMD Effectiveness Condition PMD Before Negotiation PMD PMD first quarter after project effectiveness first quarter after project effectiveness 26

35 ANNEX 4: ANTI-CORRUPTION ACTION PLAN 92. This Annex summarizes the general anti-corruption strategy for the activities in KDP as it expands during 2007 and begins to lay the groundwork for an even larger program in It draws on the general anti-corruption framework used for Bank-funded operations in Indonesia, the recently issued World Bank guide for fiduciary management in CDD projects and on KDP field experience. It outlines the general good governance principles that form the basis on which KDP innovations are built and it also signals some of the fine-tuning that will take place in the coming years. 93. Identifying Corruption in Indonesian Community Projects. Traditional community development projects in Indonesia have a relatively limited number of well-known points of leakage, inter alia: e e e e e e e e Transfers: Financial transfers to communities usually come earmarked or in kind. Loss rates from the transfer system can be very high. Poor contractor management: Contractor management for communities is normally handled by district technical offices, not by villages. With this system there is a danger of contract awards being directed to favored companies, regardless of qualifications or experience. Reviews have found endemic problems of substitution of inferior materials, unfinished works, and off-the-top payments for contract awards. Under-delivery of materials: Suppliers frequently deliver fewer materials than were purchased. This can often happen through collusion (e.g. with village leadership). Poor pricing practices: Because contractor markets are not competitive, both over-billing and over-design are common. False taxes and charges: Government charging for services is so common that some officials will even issue receipts for illegal practices, such as a standard 5% charge on funds requested through a village head. Virtually every financial transaction in traditional development projects has a charge on it to get the proper form signed and the funds released. Standard financial control systems often work against rather than in favor of sound financial management: Villagers report recurrent charges being levied by auditors and inspectors to not find fault with financial reporting, often on formats that either have never been given to villagers or else contradict the ones already in use. Cuts in salaries and travel allowances: Often QCBS winners can beat the competition because apparently competitive overhead costs are subsidized by later cuts from staff salaries and travel allowances. Price fixing between TA staff and local government (including village heads) is also common, aided by a general lack of public information about prices. Sanctions are rarely imposed even for dire levels of performance or serious cases of abuse of power. 94. KDP and the ACI s Six Key Elements. The World Bank s Anti Corruption Committee for Indonesia is trying to promote six key elements in the fight against corruption. Enhanced disclosure of information. KDP ensures that information is disclosed to a wide range of interested groups through a series of sub-village, village and sub-district meetings. The process is assisted and monitored by KDP s facilitator network. This two-way communication system, further strengthened through the use of public information boards and creative use of local media, tries to ensure that villagers know about the project and have multiple opportunities to participate in its processes. Civil Society Oversight. KDP involves Non-Government Organizations under contract as formal partners in monitoring and also informally as a part of the public decision-making system 27

36 0 described above. A further innovation has been the inclusion of journalists in monitoring over recent years. Some of these activities have not been as effective as was originally hoped, so the program still needs to seek new, more effective links to civil society. One concept that the project has successfully championed is that of Public Accountability Meetings, through which projectrelated information can be discussed openly. Mitigation of Collusion. KDP has enabled communities to manage their own funds and, wherever possible, it has allowed them to solve their own problems. Usually the issue is related to simple, small cases, such as the pocketing of an undeclared discount that is not reflected in a receipt. Communities almost invariably find such deceits as soon as details of purchases are made public (hence the importance of disclosure). Almost all known cases of collusion have been resolved by the communities forcing the perpetrators to make good on the losses - either by returning funds or providing in kind support to the activity of equal or greater value. Mitigation of Forgery and Fraud. KDP relies upon strict but simple accounting processes and high levels of direct accountability. KDP has also proven that audits can be a very useful tool, particularly when the perceived threat of being audited is high (e.g. large samples), and where the audit includes an element of direct feedback at a Public Accountability Meeting. Complaint Handling Systems. KDP has been a leader in the development of complaint handling systems since its commencement in 1998, though in recent years a lack of technical support has led to some serious weaknesses that must be addressed. The M&E action plan reviewed by the mission provides a sufficient upgrade. Sanctions and Remedies. KDP enforces appropriate remedies to ensure that problems are rectified. For example, districts that have been slow in resolving sub-district level problems have faced suspension of disbursement, or even cancellation. Such actions by the KDP central team put the emphasis of problem solving back at the local level, where it should be. The central government has become increasingly adept at using sanctions to promote compliance. 95. KDP s anti-corruption strategy has four main themes: (i) eliminate complexity; (ii) shine bright lights on every financial transaction; (iii) respond quickly to complaints; and (iv) apply sanctions. The guiding principle underlying the anti-corruption program is that KDP procedures must encourage oversight and action by multiple stakeholders, not just the World Bank or the government. 96. Eliminate complexity: In many traditional community-oriented projects, money disappears due to the welter of transfer levels, intermediaries, and processing requirements involved in turning project funds into bridges, roads, and water supply system in distant villages. KDP simplifies every aspect of this system. Because money goes straight from the national level to the village accounts, there are almost nont of the delays or leakages normal to traditional designs. Transferring standard block amounts directly to village accounts promotes end-user accountability. 97. KDP has specifically simplified all of the steps involved in financial management and disbursement so that many kinds of stakeholders can easily understand them, use them and monitor them. No hidden charges allowed. MoF ratification included notes to auditors that no other financial reporting or license documents were to be used other than those negotiated with the project. 98. Shine a bright light: Transparency lies at the core of KDP s anti-corruption work. There are a broad range of materials and procedures to ensure that all financial information is both public and publicly displayed within the villages. For example, local shopping price quotations for materials must be read out loud in public meetings to be valid; signboards posted around the villages state material and labor unit costs; and all bookkeeping is managed by an elected implementation committee. Unlike standard practice, there isn t a single format in KDP that would allow a lone official to withdraw or transfer funds: all require at least three signatures, including one from an elected villager and a second from the project facilitator. 28

37 99. The government management group has also taken many steps to ensure national level transparency. KDP is the first World Bank project in Indonesia to send its audit summaries to civil society oversight groups. Contract provisions and follow-up letters for the NGO monitors provide them with full discretion to share all findings, and the independent journalist contracts specify that there is no prior review. PMD will be publishing an expanded version of the problems database summarized below in commonly read provincial newspapers so that independent organizations can check for themselves whether problems have been reported and fixed Respond to complaints: The third major element in the strategy is to follow-up on reported cases of corruption - and to be seen to be following up on corruption by the villagers and other stakeholders. KDP has several channels for villagers to complain, including a national complaints box whose address is printed on all village graphical materials. However, by far the most common source for complaints are those relayed by or through the facilitators and technical consultants. 77% of all complaints received by the oversight team came from the field consultants themselves; an additional 7% were reported by Home Affairs and 2% were sent through the mass media. 101, Table 3 summarizes the reporting and follow-up from KDP. This is a national level database, updated weekly, which is routinely shared with civil society watchdog groups, including the press. At the provincial level, reports by field staff, villagers, and the monitors are logged in, reported to local government and the national team, and then pursued every two weeks until resolved. (By way of providing some perspective, the database refers to a total of 1 10,000 village subprojects.). Table 3: KDP s national corruption complaints report status in 2005 Type of Complaints KDP procedures violated Misuse of KDP funds (possible corruption) Inappropriate intervention by government and consultants Force majeure Totals Total Further Solvedl received investigation , , Apply sanctions: KDP has increased its use of sanctions. As a part of this effort the project supported an innovative randomized evaluation that assessed the efficacy of increased audits. The review found that increasing the frequency of audits reduced significantly the rates of unaccounted for losses. A pilot program to use these findings in the operation was tried out in 2005 using a 7.5% audit sample rather than the usual 2.5%, and a special audit manual was prepared to implement the advice on public engagement with audit findings. This new manual will be used in An expanded audit will also be carried out on the KDP activities in the Aceh recovery program The national government has become increasingly vigilant. In KDP2, three districts and two entire provinces were suspended for not providing restitution in cases where corruption was identified as being tied to the local administration. In both provinces and one of the districts the problems were then fixed. In several districts and provinces, increasingly active project coordination teams also pursue corruption problems. In some extreme cases they have removed abusive subdistrict and village heads (e.g. North Sumatra, Lampung, South Kalimantan) and succeeded in getting missing funds restored. More 29

38 common than restoring funds is fixing bad quality infrastructure, and project files document several cases where corrective action plans were proposed and implemented. Table 4: Incentiv map of KDP STAGE (1) Dissemination of information & selection of consultants (2) Socialization: villagers learn how the project works and what their rights are (3) Villages prepare proposals (4) Technical teams look at the proposals to see if they are feasible (5) Villages choose proposals that will be funded (6) Preparations for implementation: funds are released (7) Implementation: Materials are bought Village labor is mobilized 0 Roads & bridges are built (8) Post-implementation: Loans repaid; revolving funds set up rn Maintenance of infrastructure OPPORTUNITIES FOR CORRUPTION Low But risk of nepotism in choosing consultants & elite capture for later kickbacks Low But risk of elite capture High Kickbacks with selection of TA; collusion; budget-markups; false groups formed to get micro-credit Low But incentive to try to influence results of assessment in village s favor Low But incentive to simply split funds among villages: leads to bad projects High Main threat is collusion among three signatories of bank withdrawal to take a cut of funds before transferring to village Extremely high Most common source of corruption in KDP is with procurement of materials. Implementation teams buy cheaper materials than those specified and pocket the difference. Medium Loan repayments managed badly; risk of corruption with user fees for maintenance. Building on KDP3 s anti-corruption strategy 104. KDP-3 already extends the basic principles of the strategy outlined above, and it also adds some additional elements. The most important new decision facing KDP3 s anti-corruption strategy has been how to deal with decentralization. Decentralization in principle offers new opportunities to promote government accountability. In practice, at least during the transition to a decentralized administration, the opportunities for rent-seeking are more likely to rise than to fall. Nevertheless, just as center-district relationships are being entirely re-worked, executive-legislative relationships are also a site of struggle. KDP s anti-corruption strategy charts a course through this broken landscape in the following ways: Technical assistance procurement remains centralized although all field staff will be from their province. Other programs have tried to decentralize contracting to the provinces but failures have been common and severe5; Encouraging increasingly deep involvement of district parliaments, including routine provision of audit reports and the joint implementation monitoring teams; E.g. under the Bank-supported VIP-2 project which helped lay the groundwork for KDP. 30

39 Carrying out spot audits from the center by the national management consultant company; Linking prior year performance to the size of each district's allocations; Preparation of an on-site auditing manual, to be issued by MoF and distributed to all KDP participants with an MoF cover letter saying that no other auditing formats are allowed; No projects will be allowed to enter a new project year until problems in the master MIS complaints database have been satisfactorily resolved; Distribution and public posting in districts of unit cost price data based on real expenditures; More sharing of information with civil society watchdog groups KDP's local implementing agencies are now part of local government, not Jakarta line agencies and ministries. Part of the new anti-corruption strategy, therefore, consists of encouraging the Jakarta group to exert their regulatory role more forcefully. Evidence that there is some willingness to move this way is already appearing within the current KDP3/3b and the plan presented for additional financing shows further progress: Substantial progress on resolving old cases, with more than $200,000 recovered; Training programs for local auditors; Strong PMD support for the idea of legal advocacy by using university-based lawyers to help bring legal cases against corruption in KDP; Strong involvement in local parliament alliance-building; Improved networking with civil society groups and other sources of development aid; A stronger management information system more closely linked to payment processes; More public access to salient information using a wide range of media, including print, radio and the internet; Good, critical audits by BPKP, the state project audit board; Expansion of the pilot programs for training villagers in cross audits. Each of these activities can be further developed in preparation for the expanded 2008 program The World Bank: The Bank's program for KDP oversight involves a number of managerial innovations. OSU involvement in capacity assessment and prior reviews is extended much further. OSU staff routinely join field supervision, and they also organize hands-on short courses for task teams and senior counterpart staff. Hands-on involvement in KDP's anti-corruption work provides a close link between the general institutional reform strategy for fighting corruption being coordinated through OSU, and day-to-day practical actions in a large Bank-funded operation Aside from the above, three further activities promote anti-corruption work in the project. First, because KDP is managed through the resident mission, it is feasible to adopt a supervision strategy that involves constant rather than periodic oversight. Supervision missions visit field sites every month Second, the Bank plays a very active role in pursuing corruption cases. Project supervision is not done randomly: the project's MIS is used to select cases where corruption or other anomalies have been reported. The government and Bank pursue verified cases until restitution has been made or the subproject suspended Third, the Bank's ESW program on governance and anti-corruption includes several KDP-based activities, such as the work on mapping corruption in CDD projects, an AAA activity on how poor communities can access the legal system, or a recently started program to conduct research on the effectiveness of incentive and sanction regimes in community programs. While results from such programs benefit the Bank's overall governance reform strategy, they also provide immediate benefits to KDP implementation. 31

40 110. Bank oversight for the national program that will be launched with the proposed additional financing can be strengthened in a number of ways. For example, project supervision will pay special attention to the quality of the mechanisms for receiving and responding to complaints from the field. The Bank team will provide monthly reviews of this system for the first six months of operation. In addition, the Bank s new disclosure policy allows for a more in-depth involvement by civil society organizations, particularly those concerned with transparency and governance reform in Indonesia. Finally, grant funds provided from the Decentralization Support Facility will be used to strengthen government capacities for resolving corruption cases in the national program. 32

41 ANNEX 5: DONOR SUPPORT TO KDP KDP has benefited from generous support from many donors. Donor aid has helped develop KDP in several critical ways that would not have been possible through a normal program that lacked donor support. First, donor contributions to the overall program provide a clear vote of support for KDP s bottom-up planning model. Second, donor aid has allowed KDP to become a rapid-response mechanism for critical emergencies such as the 2002 Bali bombing or the 2004 tsunami in Aceh. Third, donors currently support several highly innovative pilot programs that, if successful, potentially offer significant benefits for scaled-up poverty reduction. WB - IBRD WB - IDA Donor MDF for Aceh/Nias Dutch JapadJSDF CIDA AusAid DFID Amount (US$ m.) Years Objective KDP overall KDP overal Reconstruction and post conflict reintegration Budget support, MDGs Gender, project preparation NRM, environment Private sector M&E, governance 112. KDP s conceptual framework for donor support is built around the bottom-up planning model described in Figure 1 below: 33

42 Figure 1: Conceptual Framework for KDP Support Improving Planning and Management Crisis response (MDF, Netherlands, AusAid, DFID, NZ Aid, CIDA) Women s participation (DANIDA, DFID, Japan) Papua program (Netherlands) Anti-corruption (DFID) Environmental management (CIDA) Providing Public Goods Better infrastructure quality, O&M (Netherlands) Education and health delivery (Netherlands, DFID) Rural energy and environment (GTZ, DANIDA) Providing Private Goods SAD1 (Australia) Women s revolving funds (Japan) ICT(DF1D) I I 113. Improving planning: Dutch cooperation and support from DFID through the poverty reduction partnership and decentralization support facility have strengthened the overall KDP planning and management structure. Some specific programs funded by donor grants include: i. ii Dutch grant funds allowed for rapid responses to the Bali, Maluku and Aceh crises. As part of those responses, KDP developed methodologies for damage assessment and accelerated response programs. These are now used routinely; DFID s support through the poverty reduction program funded the path breaking randomized evaluations of how to reduce corruption in community infrastructure. Findings from this study are being scaled up through the national program. Denmark and DFID funded specialized programs to improve women s participation in the village planning process. iv. Canada supports a large program to introduce better environmental awareness and management into community planning across the island of Sulawesi. DANIDA is likely to replicate this program for the island of Sumatra in 2008, with a special program for renewable energy and watershed protection Improving service delivery: KDP increasingly works with community based health and education service delivery. For Indonesia, the two critical questions are how to link supply and demand more effectively, and how to improve the technical quality of works and services. Dutch cooperation has sponsored a series of large-scale pilots to improve poor village access to basic education and to link 34

43 sanitation with water supply in eastern Indonesia. GTZ and CIDA cooperate with KDP on a program for rural electrification through microhydro, and it is expected that DANIDA will join this program in New Zealand contributed useful design and training for KDP s engineers in Aceh, who are using the manuals on how to build earthquake resistant infrastructure to other parts of Indonesia Improving poor communities access to markets: KDP is a partner in the AusAid funded SAD1 program that works with IFC and an international agricultural research organization to improve poor community s ability to produce and market higher value products. The multidonor decentralization support facility (DSF) will also provide assistance to expand this aspect of KDP during 2007 through reviews of option for sustainable micro-finance, value-chain analysis done in collaboration with the IFC PENSA program, and pilots in using information technology to help rural communities obtain market information. 35

44 ANNEX 6: FROCUREMENT ARRANGEMENTS General 116. Since this is an additional financing to the Kecamatan Development Project 3B (LN 4771/Cr 4045), the existing organization set up and management will be used for this Project. The idea is to expand the existing KDP to include several other villages throughout the country into this Program, and the implementation will be using the existing mechanism and system. The procurement would remain to consist of hiring a number of management consultants (large value contracts), monitoring consultants, and individual facilitators (as service delivery contracts), in addition to some 70% of the project funds for community grants following the existing community participation procedures Procurement for the proposed project would be carried out in accordance with the World Bank s Guidelines: Procurement under IBRD Loans and IDA Credits dated May 2004; and Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated May 2004, and the provisions stipulated in the Legal Agreement. The general description of various items under different expenditure category is described below. For each contract to be financed by the LoanICredit, the different procurement methods or consultant selection methods, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Community Grants The community grants include the Kecamatan Grants (US$ million equivalent) and the Community Grants for Health and Education (US$49.0 million equivalent). The additional financing will disburse community grants in various villages scattered in all provinces. The procurement under community grants will follow the community participation, using forms and procedures as defined in the existing Project Operation Manual of KDP 3B. Selection of Consultants 119. Consultant services required under this Project would include the following: 5 contract management and administration services as follows: o A TA for contract management and administration services for managing the national team, including organizing training events and printing of training materials (referred to as the National Management ConsultantNMC, total contract amount is US$ 5.9 million equivalent for one year up to the end of the project; o 4 contract packages for TA management and administration for managing the district team including village facilitators (referred to as the District Management ConsultantsDMC). The contracts (vary from US$ 300,000 up to US$ 1.4 million) will be for one year up to the end of the project. 30 provincial based monitoring NGOs (a total of US$ 1.7 million) A large number of facilitators (a total of 6,000 facilitators, for a total amount of US$ 24 million equivalent), to be based in 1900 villages An NGO for assisting the PMU in providing legal advocacy to villages (US$ 0.4 million equivalent), and an evaluation consultant to conduct studies/evaluation of the implementation at the village levels (US$2 million equivalent). 36

45 The 5 contract management services will be single sourced to the existing firms with the following justification, consistent with para 3.10 of the Bank Consultant Guidelines: 1. Due to the urgent demand in the country in reducing poverty, it is the government s policy (endorsed by the Bank country management) to escalate the community based projects to become a national program, which will be implemented starting January 2007 for the pilot, that otherwise a more sustainable program (starting 2008) will not be initiated. This demand was not anticipated until September 2006, when this decision was made by the Government. Therefore, there is an urgent need that this program be implemented on a timely manner in early There are knowledge and skills that have been invested to these consultants to assist the Ministry of Home Affairs (MOHA) in managing the existing KDP projects. Therefore, they already have the system to respond to the urgent need for expanding and scaling up the projects. 3. These firms have been assessed to perform satisfactorily, and have the capacity to carry more loads to respond to this urgent demand. 4. This SSS is justified with the understanding that all consultants will be on board carrying out the proposed assignments by March 2007, and the new selection process for similar contract packages will be carried out if the Project will be expanded further in 2008, as will later be developed and defined in the new separate LoadCreditIGrant. For this purpose, if necessary, the selection of new consultants for the next coming project in 2008 will be initiated 6-8 months ahead before the loan negotiation. All of these SSS contracts will be subject to the Bank s prior review. Further background to the 5 management contracts are described in the Box 1 below Village facilitators (annual contract range from US$ 4,000 up to US$ 12,000 equivalent) will continue to be hired as individuals under service delivery contracts. These facilitators will be hired by the Government; however, the management of salary payments will be done by the respective contract management services firms The Project will also hire up to 30 NGOs, to be based in each province. The amount of contract for each package will be very small (estimated at US$ 60,000 for 1 year up to the end of this Project). Therefore, the selection will follow CQS procedures The TA for legal advocacy as well as the evaluation consultant will be hired following QCBS procedures, subject to prior review by the Bank The thresholds for prior review as well as revised procurement method will be determined in the procurement plan, taking into account inputs from the Bank s supervision missions. Assessment of the agency s capacity to implement procurement 124. Procurement activities will be carried out by the Ministry of Home Affairs through the Directorate General of Village Community Development (DG-PMD). The existing staff, organization structure, and system that are running the KDP 3B will be used to run this proposed Project. This also includes the existing consultant firms will support the Agency in managing the contracts and funds (including operating costs) for the projects, including managing the village facilitators. With this kind of management set up, the capacity of DG-PMD in managing procurement and contract administration under the project is considered as adequate. 37

46 125. The major risk remains on corruption, and efficiency of the project management in managing the contracts. For this purpose, the following actions have been agreed and costed into the project design: The Project Manual will be revised to include these additional villages. The provincial NGO monitoring will be continued to include the additional villages, while the journalist monitoring will still remain the program as it is financed by KDP 3B. Samples for independent ex post review will be increased to 7.5%, to cover wide range of villages, and 10% samples for individual consultant contracts. The independent ex post review will be conducted by the internal state auditor (BPKP) due to the fact that BPKP has the experience in dealing with CDD type projects, and it has offices throughout the country. A special addendum to the current TOR of BPKP is also made to include end use check and spot check the integrity of information and expenses of the large value consultancy contracts. However, the size of contractsaoan amount as well as the short implementation period makes the overall project risk for procurement is HIGH. Procurement Plan 126. The Borrower, at appraisal, developed a Procurement Plan for project implementation which provides the basis for the procurement methods. This plan has been agreed between the Borrower and the Project Team on December 16, 2006 and is available at the Ministry of Home Affairs, Department of Community Development It will also be available in the Project s database and in the Bank s external website. The Procurement Plan will be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Frequency of Procurement Supervision 127. In addition to the prior review supervision to be carried out from Bank offices, the capacity assessment of the Implementing Agency has recommended annual supervision missions to visit the field to carry out post review of procurement actions. The ex-post procurement review will rely on BPKP s audit, to will carry that for the community grants and individual facilitator contracts. 38

47 Box 1. Additional Background of Contract Management and Administration Services Basically the management of the project funds (including payments against eligible expenditure) under the KDP is run by a number of consulting firms. For this purpose, there are three separate master accounts set up by the PMU, i.e. (i) one for the payment of salaries of facilitators, (ii) one for the payment of operating costs of the firms in managing and administering the projects, and (iii) one for the payment of the firms overhead and profits. Payments to the firms are made through the local treasury offices to these master accounts, as advances (for Master Account (i) and (ii)) and performance (for Master Account (iii)). The payment of community grants will be made directly through the local treasury offices directly to the community accounts at local banks. The payment included under master accounts (i) and (ii) are made at actual costs and, therefore the detailed expenditures are part of the subject of regular audit by BPKP. The payment made through Master account (iii) is transferred directly to the firms bank accounts as part of the firms normal profit. The overhead and profit of each firm was determined as a percentage of the managed funds, however, starting year 2004, this is set to be a fixed amount per month. The average overhead and profit is now at around 5-7% of the total funds managed by respective firms. The TA for contract management and administration services under KDP projects consists of a National Management Consultant (NMC) and 4 District Management Consultants (DMC). The NMC assists the national team, particularly on managing a team of individual experts, holding workshops/trainings, and printing of workshop/training materials. DMC firms are to assist the PMU in the payment of salaries of village facilitators, salaries of a number of individual experts, and the payment of community grants. Individual facilitators have contracts directly with PMU, except during the period of April - December 2005, where these are included as part of the DMC contracts. These are annual contracts, renewable every year subject to the firms performances. Each contract has the following structure: 1. Program support: including (i) actual salaries of a number of individual experts (including their related overheads, typically for NMC), and (ii) actual consultants direct costs (such as: office spaces, office furniture, computers, local office operating costs, vehicle rental, per diem costs of government staff, and primarily for NMC: workshops/trainings and printing of training materials). 2. Administration services: including (i) mobilization-demobilization, (ii) actual salaries of the firms staff (including their related overheads), (iii) actual operational travel expenses of firms staff, experts, and related government staff, (iv) actual head office operating costs, (v) actual costs for producing reports, and (vi) the firms overhead and profit. All payments against program support and administration services will be made through the Master Account (ii) above, except for one for the payment of the firms overhead and profit, which is through the Master Account (iii). Since all of the cost components are predetermined and paid to consultant firms based on actual expenditures (subject to the regular BPKP audit), basically it is only the firms overhead and profit that varies, subject to competition, with the following details (in million US$, excl VAT):, No Consultants/ Original Current Additional Add. TOTAL Overhead and Profit Date of Original Contract Sign Contract Contract Due to PNPM (since contract signing under KDP Jan-Dec 07 up to Dec 07 including (a) 3B up to Dec PNPM) 07 (b) (C) (b+c) National Management Consultant October, 2002 District Management Consultant 1 1.O October, 2002 District Management Consultant o April, 2004 District Management Consultant October, 2002 District Management Consultant November, 2002 TOTAL