ANNEX 1. Sector Budget support - Sector Reform Contract (Centralised Management) DAC-code Sector Rural Development

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1 ANNEX 1 1. Identification Title/Number Khyber Pakhtunkhwa District Governance and Community Development Programme - DCI-ASIE/2012/ & Total cost EUR 80,000,000 (36% of MIP) All EU Contribution 2012 Budget: EUR 51,300, Budget : EUR 28,700,000 (subject to adoption of the 2013 budget by budgetary authority) Aid method/ Management mode Sector Budget support - Sector Reform Contract (Centralised Management) DAC-code Sector Rural Development 2. Rationale and country context The Government of Khyber Pakhtunkhwa province in the north-west Pakistan is responding to unprecedented levels of destruction and disruption caused by militancy and civil unrest resulting from the Afghan war and the 2010 monsoon floods. The insurgency spill-over, initially contained to the Federal Administered Tribal Areas (FATA) along the Afghan border, expanded into Khyber Pakhtunkhwa province by the end of 2007, severely affecting the northern mountainous and predominantly rural Malakand division. The military offensive in spring 2009 to re-establish the State's writ displaced some 2,300,000 people and resulted in severe losses of infrastructure. Large parts of the Malakand division were further devastated by flash floods in August 2010, virtually wiping out the entire local economy. Whilst the provincial government re-established administrative control over all seven districts of the Division, socio-economic situation of the approximately 6,300,000 inhabitants remains precarious and fragile. Cognisant of the root causes that triggered the extremist forces to build a foothold in the area, the Government of Khyber Pakhtunkhwa seeks to consolidate and stabilize the current transition process of post-crises measures and to overcome the trust deficit with its citizens. Building on a successful provincial budgetary reform programme, the Government of Khyber Pakhtunkhwa, therefore, proposes to prioritise Malakand division for a roll-out of an innovative results-based approach to district budget management, governance and community driven development. The approach entails implementation of a local development strategy that combines restoration and enhancement of frontline public services and livelihood opportunities across all 238 union councils 1 of the division. The EU intends to support this intervention, through a Sector Reform Contract in accordance with the objectives defined for rural development as one of the focal sectors under the Multi-annual Indicative Programme Country Context and National Policy and Strategy Economic and social situation and poverty analysis Pakistan s GDP growth has been lower and more volatile when compared to other regional economies. Structural problems, including shortage of energy, decline in investments and persistent high inflation and security issues, have been exacerbated by the global financial and 1 The administrative organisation of Pakistan is composed of provinces, divisions, districts, tehsils and union councils Page 1 of 35

2 food commodity crises in 2008 and the impact of unprecedented monsoon floods in 2010 and Poverty levels reported in 2008 having previously declined to 17.2 per cent 2, are widely perceived as to be on the increase. Food insecurity and malnutrition are high in rural areas and progress in key sectors, such as education and health, has slowed down in recent years. Pakistan ranks 145 th out of 187 countries on the United Nations (UN) Human Development Index 3 and has gradually fallen behind its neighbours. Within the national context, the economic situation and prospects in Khyber Pakhtunkhwa province have been chronically constrained by difficult geography, years of regional instability, natural disaster, poor governance, limited investment in human capital and a policy environment that has not been conducive to private sector growth. With its economic potential largely unexploited, especially in mining and hydro-power, the province has consistently underperformed compared to the rest of Pakistan. The latest Millennium Development Goals (MDGs) data for the province are bleak, with progress against most targets being off-track 4. Between 31 per cent and 50 per cent of children are underweight compared to an MDG-1 target for the eradication of extreme poverty and hunger for Pakistan of < 20 per cent. The 10 + literacy rate is 50 per cent, 7 per cent less than the national average, compared to an MDG-2 target to achieve universal primary education for Khyber Pakhtunkhwa and Pakistan of 75 per cent and 88 per cent, respectively. The gap is especially pronounced for female literacy, which is estimated at 31 per cent for Khyber Pakhtunkhwa (compared to a national average of 45 per cent). Gender disparity is endemic and is evident in health, education, employment and political representation. Most districts have a primary education gender parity index of less than 0.7 (MDG-3). Security issues in general and more specifically the Malakand insurgency, have significant impact on the provincial economy through direct losses in private assets, decrease in investments and drastic increase of public spending on law enforcement. No suitable statistics are available on the post-crisis situation, but estimates for some of the affected areas suggest 10 to 15 per cent points increase in poverty. The federal government granted various relief measures to compensate the economic losses, including an additional one per cent of the net divisible pool under the 7 th National Finance Commission award National Development/ Cooperation Policy and Strategy The province of Khyber Pakhtunkhwa has an extensive package of coherent development policy frameworks starting from the Comprehensive Development Strategy formulated in In August 2009 the Malakand Comprehensive Stabilisation and Socio-Economic Development Strategy was published by the provincial Government, shortly after the end of the military activity. Its aim was to coordinate relief and early recovery and to prepare the transition to a sustainable development. The Strategy foresees pursuance of communitydriven participative development approaches as basis for social regeneration and to strengthen the resilience of local communities. In October 2010 a more profoundly analysed and publically consulted peace-building strategy, the Post Crisis Needs Assessment for Khyber Pakhtunkhwa and FATA (PCNA), was developed with support of the federal government and international community including the EU. Recommendations relate to the need for the state to enact fundamental reforms that will 2 PSLM survey 2008, Pakistan Planning Commission 3 UNDP Human development report 2011: Page 2 of 35

3 ensure basic rights, empower citizens and address key governance, security and development shortcomings and inequalities through an inclusive and participatory approach. Community driven activities are emphasized as key to achieving better service delivery and economic development, as well as re-engagement of citizens with the state. Implementation of the PCNA was costed at EUR 2.1 billion for four years, i.e. annually about the same magnitude as the combined development budget for Khyber Pakhtunkhwa and FATA. 2.2 Sector context: policies and challenges Community infrastructure and public services in large parts of rural Khyber Pakhtunkhwa are insufficient and often poorly functioning. Investments are mostly narrowly defined sector driven schemes and are decided with limited consultation of beneficiaries. Notwithstanding many problems to sustain funding, NGOs and associated community based organisations in Khyber Pakhtunkhwa have filled much of the growing vacuum in service delivery, which emerged from the losses and destruction caused by the recent natural and security calamities 5 that have affected the province. There and across Pakistan an effective indigenous approach to social organisation has emerged. The three tier model addresses mobilisation at community level and as organisations mature, foresees federating these member based and often gender segregated organisations at village and union council level. For Khyber Pakhtunkhwa the current rate of penetration of this type of social mobilisation is 56 per cent of the union councils, albeit with a variation in levels of intensity and actual coverage. The PCNA, reinforced by the recent Economic Growth Strategy for Khyber Pakhtunkhwa, provides the principal components for a provincial rural development strategy. It acknowledges an increased role of civil society and the need for the government to re-orient and strengthen its collaboration at local level to improve service delivery. It links in detail the stimulation of employment and livelihood opportunities to the recovery of the agriculture and livestock sector as also the importance of skill development and off-farm employment in economic growth. It underlines the need for better living conditions and elaborates an integral approach for improvement of education, basic health care, water and sanitation, sustainable energy supply and social protection. The 7 th National Finance Commission award in 2009 and the passage of the 18 th Amendment to the Constitution in 2010 transferred substantial additional responsibilities and funds to the provinces. Legislation and administration of local government bodies from districts to municipalities and union councils have become exclusive provincial domain. A new provincial Local Governance Act was passed in May 2012, replacing the defunct federal Local Governance Ordinance of Local elections should be held before the next national elections due early 2013, but may be postponed until after. The government of Khyber-Pakhtunkhwa has been implementing a comprehensive provincial public finance management (PFM) reform since As a next step it wants to enable district governments to be more responsive to priority needs of rural communities by making available, in a transparent way, financial resources to support community action. A successful pilot initiative in two districts during the financial year has shown significant gains in efficiency and effectiveness of spending. The government is now looking to expand the roll-out to more districts to adapt the Medium-term Budget Framework and to introduce Output Based Budgeting while augmenting the budgetary space for discretionary spending on community driven initiatives. 5 Earthquake 2005, food market crisis 2008, Malakand insurgency , monsoon floods 2009 Page 3 of 35

4 The current provincial annual budget is estimated EUR 2.33 billion and projected to increase to EUR 2.85 billion in The proportion of funds directly transferred to districts is to be increased from 29 per cent to 35 per cent. The budget for a typical rural district is EUR 15,000,000 25,000,000 of which per cent covers salaries. The roll-out of the reforms is expected to augment the fiscal space for community driven development by EUR 2,000,000 3,000,000 per district (equivalent to an average of EUR per union council) over a period of 5 years. In parallel and following the re-establishment of elected local government bodies, opportunities and scope for local revenue will be explored. The success of this is directly linked to the population recognising an improvement in living conditions as a result of an increase in investment resources made available by the local authorities. 2.3 Eligibility for budget support Building on the externally supported Fiduciary Risk Assessment based on the financial year and the provincial Public Expenditure and Financial Accountability (PEFA) assessment, the government of Khyber Pakhtunkhwa consolidated end of 2011 its PFM reform with the adoption of an Integrated Public Financial Management Reforms Strategy. The reforms strategy consolidates a number of reforms which were already under way with donor support such as output budgeting and MTBF and includes budget funding to implement and further extend initiatives, including internal audit and development of provincial business plans. The process is meanwhile making good progress as is evident from the quality in presentation of the provincial budget Medium Term Budgetary Framework and Output Based Budgeting have been introduced to all departments, as also measures for better reporting on budget execution, capacity building of staff and the establishment of the internal audit function. The initiative for expansion of PFM reforms into the districts is supported by an additional budgetary allocation of EUR 8,300,000. At the Federal Level, the PEFA update from the first half of 2012 confirms that there has been progress, even if it was slow. Pakistan has established elements of an effective PFM system which have the potential to place it on an improvement trajectory, even though the update also confirms the persistence of previously identified weaknesses. Notwithstanding this, there is an imperative for change and during the formulation mission for the new PFM support programme envisaged for AAP 2012, a broad range of key government and stakeholder representatives confirmed willingness and expressed enthusiasm and support for reform. The development of a comprehensive, integrated, over-arching and sequenced PFM reform strategy at the federal level will be supported by the EU under the above mentioned new programme. The government of Khyber Pakhtunkhwa has taken a series of measures under the PFM reform programme to improve transparency and accountability on the utilisation of public resources. The full annual budget documentation as presented to the provincial assembly is made available on-line. The recently adopted Monitoring and Evaluation Framework structures the reporting on results based budgeting. The capacity for audit has been significantly increased and as the first province in Pakistan it succeeded in clearing its backlog of annual audit reports with the Public Accounts Committee. The sector policy that is supported by this programme, to improve community infrastructure and basic service delivery in a context of strengthened and more effective local administration, is derived from the Malakand strategy, the PCNA and the PFM reform strategy. The principal policy documents described under section and 2.2 set out objectives for inclusive economic development and governance reform in Khyber 6 Page 4 of 35

5 Pakhtunkhwa. They take into account areas disproportionately affected by catastrophic floods and militancy, serve as a platform for dialogue and donor assistance and as a basis for planning resource allocation. The government introduced earlier this year its first Annual Strategy Review, to make sure that budget allocations are in line with development strategies. Detailed analysis of the last two Annual Development Plans against the Comprehensive Development Strategy demonstrated a compliance for the thirteen key sectors of more than 67 per cent. Similar work has also started for the implementation of the four strategic objectives of the PCNA. The PCNA recommends a high-risk, high-reward approach, involving citizens in funding allocations for development. More specifically, all PCNA efforts are based on an inclusive and participative identification of prioritised needs for investments at community and district level. This is what this Sector Reform Contract seeks to support. Concerning macroeconomic policy, the situation remains fragile. The stand-by arrangement with the IMF helped the economy avoid a full-blown crisis in , but it expired in 2011 without being fully implemented. According to the Pakistan Economic Survey , economic growth will be 3.7 % this year compared with 3 % last year. Workers remittances reached more than USD 1 billion monthly and inflation has been reduced to 10.8 % from 25 % last year. However, risks due to excessive Government borrowing remain a burden on inflation as well as to private sector credit. The federal budget deficit for FY 2012/2013 is of Rs trillion, which is 4.7% of the GDP and out of Rs trillion total expenditure, Rs trillion is recurrent expenditure and Rs 564 billion development expenditure and net lending. Rs 925,775 million will be spend on interest payments, almost one third of the budget and defence is the second largest expenditure with Rs 545,386 million. These figures confirm the inflationary tendency of the budget. The administration acknowledges the structural problems and is generally aware of the required solutions such as how to increase state revenues and tackle the problems related to high subsidies in the energy sector and subsidised state owned companies. Further measures to improve the fiscal situation were announced with the budget, however, the level of implementation is uncertain in the run-up to the elections early Possibilities for a new stand-by arrangement with the IMF are again being explored. During a budget constrained period the proposed action will help to sustain adequate fiscal space for pro-poor community development which will be the basis for tranche releases. The budget reform process (MTBF and output based budgeting) is to ensure that this is dome in a way which can be sustained and guarantees efficiency. This underpins the importance of budget support as compared to other aid delivery modalities. The need to better manage budgetary deficits and improve the national tax base to control inflation is therefore of utmost importance and shall be addressed in the regular dialogue with both the provincial and federal governments. In terms of the respect of fundamental values, the transition from military rule to democratic government in 2008, the liberty in press, the decentralisation process and the increasing control exercised by the national and provincial assemblies and the judiciary, confirm a clear progress in the democratic process. Following requests from the international community and the EU, Pakistan removed the majority of the reservations to international human rights instruments such as the International Covenant on Civil and Political Rights and the UN Convention against Torture, and the EU will be partnering Pakistan for effective implementation of these instruments. Reinforcement of the Ministry for Human Rights, the recent legislation improving human rights and in particular with regard to the protection of women, as well as the establishment of an the National Commission on the Status of Women and an independent Human Rights Commission, confirm a growing engagement in the area of human rights. Page 5 of 35

6 2.4 Lessons learnt The most important key lessons are summarized in the PCNA. These incorporate experiences over three decades from several national and donor funded programmes in rural development in Khyber Pakhtunkhwa and FATA, put in the wider peace-building and stabilisation context. A functional state society relationship that is publically recognised and associated with the delivery of basic services, remains fundamental to peace and economic progress. Whereas greater involvement of civil society and promotion of participatory approaches are essential for efficient and effective implementation of relief and development, long-term impact and sustainability are more likely to be successful if such actions have a proper institutional anchoring. Mountainous areas in general, including large parts of Khyber Pakhtunkhwa, have limited economic and employment opportunities. The public dissatisfaction this deprivation is causing, not only in Pakistan but across the entire Hindu-Kush Himalayan region, has been identified as an important driver for conflict and insurgencies. Remittances from migrant workers represent an important potential source of private investment. This, however, is unlikely to be fully realised, if the quality in public infrastructure and services remains poor. A broader package of public investment in local development is essential not only to trigger private initiative, but also to generate employment opportunities and retain skilled labour to stimulate growth in services and trade. 2.5 Complementary actions The proposed action enhances ongoing activities under several EU funded programmes for Khyber Pakhtunkhwa. It complements the missing link to district administrative reforms in the Refugees Affected and Hosting Areas programme (RAHA) implemented by UNDP and the Programme for Economic Advancement and Community Enhancement (PEACE) implemented by the Sarhad Rural Support Programme. Both programmes are supported by the EU with each EUR 40,000,000 and work on community driven local development in 203 union councils of which 119 are in the Malakand division, thus covering 50 per cent of the area. The ongoing social mobilisation and infrastructure investments in these union councils and work of other donors will be taken into account when developing the programme for each of the target districts. Financed from another project 7 the EU will assist authorities in target districts as from October 2012, in training of district planning and output based budgeting and to establish and refine procedures for contracting, monitoring and supervision of community driven development interventions. Accordingly districts are expected to present a plan of investment as part of the annual government budget Design and preparation of the proposal have been closely coordinated with UK Department for International Development (DFID) and Germany. In addition to the EU funding, DFID under its new Sub-national Governance Programme is expected to support a similar output based budgeting reform programme into six more districts elsewhere in the province. Germany is supporting capacity building in public administration and revenue management at tehsil level in few districts of the Malakand division and may consider further investment in renewable energy and local infrastructure. 7 "Supporting rural development and natural resources management in NWFP and Balochistan through capacity building and promotion of sector-wide approaches", DCI-ASIE/2008/ Page 6 of 35

7 2.6 Donor coordination There has been a strong joint international engagement in support of post-crisis interventions in the western border regions of Pakistan, including Khyber Pakhtunkhwa, initiated through the Friends of Democratic Pakistan process and continued in various bilateral and multilateral declarations, including the recent EU Pakistan 5-years Engagement Plan. Sector coordination in rural development in Khyber-Pakhtunkhwa is evolving around the US$ 140,000,000 Multi Donor Trust Fund (MDTF) administered by the World Bank that was set up in It implements a range of projects across Khyber Pakhtunkhwa, FATA and Baluchistan. The newly developed MDTF 5-year engagement strategy of October 2011 defines an active involvement of the MDTF secretariat with the respective provincial governments and the FATA secretariat. The government of Khyber Pakhtunkhwa wants to reestablish a bi-monthly donor coordination forum to allow coordination of activities of all major donors in the region and across sectors, including bilateral interventions. The main EU contributors in Khyber Pakhtunkhwa (UK, Germany and the EU) are collectively engaged with the MDTF secretariat in order to coordinate activities of their ongoing programmes related to PFM, sub-national governance and administrative reforms, as well as community development. 3. Description 3.1 Objectives The programme contributes to an effective development and peace building strategy for the government of Pakistan that supports transformation of the functioning of the State in Khyber Pakhtunkhwa and FATA, improving democracy and rule of law, making it more accountable and providing equitable opportunities for better health, education and employment. The programme addresses three of the four strategic objectives of the PCNA: Build responsiveness and effectiveness of the State to restore citizen trust Stimulate employment and livelihood opportunities Ensure the delivery of basic services The purpose is to support the government of Khyber Pakhtunkhwa in reforming public administration at district level to improve service delivery, economic growth and local governance through promotion of community driven development in the crisis affected Malakand Division. 3.2 Expected results and main activities i. Increased investment in community development in six district budgets of the Malakand Division responding to specific local demands for public investment in service delivery and community infrastructure (rehabilitation, expansion and maintenance of intra- and intercommunity social and productive assets and infrastructure - education, health, water and sanitation, access, disaster risk reduction, irrigation, renewable energy, agriculture and livestock and natural resource management). Main activities (GoKP and service contract: funding and technical support (service contract) for the design and implementation of community demands and initiatives as identified and presented by the joint community based organisations of individual or Page 7 of 35

8 several union councils and in accordance with the strategic district development plan; training and coaching of government staff in support of the roll-out of Output Based Budgeting and other relevant aspects of the provincial PFM reform at district and tehsil level (service contract); establishment of a functional and participative system of strategic district development planning and monitoring (GoKP and service contract); increase of district budgets to be gradually phased out and substituted by the dividend from a more efficient and effective resource utilisation (GoKP). ii. An inclusive, representative system of community mobilisation that federates villages exists in all union councils of the Malakand division. Main activities (grant component): support civil society organisations in the promotion and expansion of the three tier membership based model of community mobilisation; stimulate dialogue between community based organisations and local authorities on issues of increase and quality of delivery of public services; train and coach community based organisations in planning, implementation and monitoring of development investments; facilitate integration of the community based organisations with the local governance structures that are planned to be reorganised with the coming local elections. iii. Enhanced human, technical and organisational capacities of district and tehsil government agencies to support community driven development and be more service and outcome oriented. Main activities (service contract): training and coaching of government staff from line departments to re-orient their technical concepts and methods of working that can support and oversee better community led planning and implementation of development investments; third party verification of all development investments that are funded from the district budgets; assist government institutions at provincial and district level to monitor and evaluate the progress achieved by the programme in the wider context of the ongoing reform process, including to establish performance and monitoring frameworks. 3.3 Risk and assumptions Five risk categories have been assessed: political (covering universal values, fundamental rights, conflict and security), developmental (credibility and pertinence of provincial government policies), macroeconomic (the extent to which the policies are stability-oriented), public financial management (regulatory framework, financial compliance and control systems, budget comprehensiveness, controls in revenue collection/budget execution, procurement and external audit), and corruption and fraud. Concerning the risk management framework, mitigating measures include the following: i. Political: Continued dialogue at political level. Use of the regular contacts between the Delegation and the Government as well as high level meetings (strategic dialogue, joint commission, visits from Commissioners and MEPs). ii. Developmental: Capacity building for authorities and communities in order to ensure their buy-in, continued political engagement. Page 8 of 35

9 iii. iv. Macroeconomic: Suspension of tranche releases, inclusion of a specific obligation to pass on funds from the federal to the provincial Government will be included in the Financing Agreement. Public financial management: Suspension of tranche releases, support to ongoing PFM reforms under this programme, in a separate project under AAP 2012 and by a member state (UK). v. Corruption and fraud: Building of the technical and managerial capacities of the frontline managers and the communities for increased public finance management efficiency and effectiveness and contribution to an enhanced public oversight of the budgetary discharge. Third part audits and validations are supported under the programme. The analysis of the risks and benefits will be updated at annual review (early warning system) to facilitate risk management and identify possible risk increases e.g. in macroeconomic policy, economic governance (public procurement, corruption) or PFM (delays in reform, etc.). 3.4 Stakeholders The main stakeholders of this programme will be involved communities themselves, the Finance and Planning & Development Departments of Government of Khyber Pakhtunkhwa and the Ministry of Finance and the Planning Commission at federal level. Further roll-out of the output-based budgeting model will directly or indirectly have a positive effect on all line departments and other government institutions. Non-state actors and civil society will be involved in capacity building, programme reviews and awareness raising. 3.5 Crosscutting issues The capacity building of local communities will allow the programme to foster links with local government structures that lead to more transparency, reduced corruption, improved human rights. The mobilisation and strengthening of local organisations will foster cohesion and stabilisation, thereby reinforcing reconciliation and sustenance of peace. The gender dimension will be specifically targeted through awareness-raising by providing information on women s basic human rights, providing training to female staff of the government and local institutions, creating employment opportunities for women, facilitating and promoting the social and economic advancement of women, and delivering priority social services and community infrastructure identified by women s groups. As the programme supports integrated rural development, environmental sustainability, control of resource degradation and disaster risk reduction, mitigation and management will be included in all development interventions. 4. Implementation issues 4.1 Method of implementation The programme will be implemented under Direct centralised management through the signature of a Financing Agreement with the Government of Pakistan, represented by the Economic Affairs Division (EAD). In order to support the Government of Khyber Pakhtunkhwa's budget reform process using the Sector Policy Support Programme modality, the EU programme will partner the Government of Khyber Pakhtunkhwa. The untargeted EU budget support (EUR 64,000,000) will be used during four budget years to support the provincial government to sustain Page 9 of 35

10 adequate fiscal space in the district budget for community-driven rural development. It will be complemented by: i) EUR 7,500,000 support to involve civil society organisations to facilitate mobilisation of rural communities including preparation of quality proposals for possible district government financing, as well as remain engaged in the follow-up and decisionmaking processes i.e. in the demand side of governance; and ii) EUR 7,500,000 of technical cooperation aimed at supporting capacity development of the administration and reinforcement of government audit control. The social mobilisation component will be implemented through approx. 2 to 4 grant contracts following a call for proposals and the technical cooperation component will be implemented through approx. 6 service contracts following calls for tender. The programme will be implemented by the European Union, through its Delegation in Pakistan. The implementing agency of the programme will be the Department of Finance of the Government of Khyber Pakhtunkhwa. The Department already created a special unit in its PFM reform cell, to plan and coordinate the roll out of output based budgeting to the districts as proposed to support by the EU and DFID. 4.2 Procurement and grants award procedures Contracts All contracts implementing the action must be awarded and implemented in accordance with the procedures and standard documents laid down and published by the Commission for the implementation of external operations, in force at the time of the launch of the procedure in question. Participation in the award of contracts for the present action shall be open to all natural and legal persons covered by Regulation No 1905/2006 of the European Parliament and of the Council of 13 December 2006 establishing financing instrument for development cooperation. Further extensions of this participation to other natural or legal persons by the concerned authorising officer shall be subject to the conditions provided for in articles 31(7) and (8) of DCI Regulation Specific rules for grants The essential selection and award criteria for the award of grants are laid down in the Practical Guide to contract procedures for EU external actions. They are established in accordance with the principles set out in Title VI 'Grants' of the Financial Regulation applicable to the General Budget. When derogations to these principles are applied, they shall be justified, in particular in the following cases: Financing in full (derogation to the principle of co-financing): the maximum possible rate of co-financing for grants is 100% of the total accepted costs, however a co-financing from grant beneficiaries will be encouraged during community mobilisation. Full financing may only be applied in the cases provided for in Article 253 1(b) of the Commission Regulation (EC, Euratom) No 2342/2002 of 23 December 2002 laying down detailed rules for the implementation of the Financial Regulation applicable to the General Budget. Derogation to the principle of non-retroactivity: a grant may be awarded for an action which has already begun only if the applicant can demonstrate the need to start the action before the grant is awarded, in accordance with Article 112 of the Financial Regulation applicable to the General Budget. Page 10 of 35

11 4.3 Budget and calendar The total project budget is estimated at EUR 80,000,000 of which EUR 80,000,000 shall be financed from the general budget of the European Union. The indicative breakdown of overall amount by specific programme components is as follows: Programme Components EU contribution (EUR) Total (EUR) 1. Sector Budget Support Grants Social mobilisation Services Training and coaching of government agencies Monitoring Evaluation Audit Visibility Total Contracting/ Paying Authority European Commission The operational duration of the programme is 84 months from the signature of the Financing Agreement, of which the operational phase will be 60 months and the closure phase 24 months. Indicative calendar: Dec 2012 Financing Decision Finalization of the Policy Matrix with Government of KP, including Appendix 1 to 1 st semester 2013 the Technical and Administrative Provisions Fixed and Variable Tranche Release Matrix. 1 st semester 2013 Signing of Financing Agreement with Government of Pakistan 1 st semester 2013 Launch tenders for "training and coaching" and "monitoring " technical cooperation components 1 st semester 2013 Launch call for proposals for "social mobilisation" and "impact study" components Aug 2013 Signing of service contracts training and coaching and monitoring and grant contracts social mobilisation and impact study. Oct 2013 Request for fixed tranche 1 release Nov 2013 First periodic external monitoring Feb 2014 Fixed Tranche 1 release (based on the four eligibility criteria) Mar 2014 Start of budget release by the GoKP to support OBB based rural community driven development projects May 2014 Second periodic external monitoring Sep 2014 Request release of tranches II and formal progress review on fixed and variable tranche I (fiscal year ) Nov 2014 Third periodic external monitoring Sep 2015 Request release of tranches III and formal progress review on fixed and variable tranche II (fiscal year ) Sep 2016 Request release of tranches IV and formal progress review on fixed and variable tranche III (fiscal year ) Page 11 of 35

12 Variable tranches will be introduced representing 58 per cent of the budget support tranches. Indicators will be identified to provide initial leverage for the reforms necessary for successful implementation of the Sector Budget Support. Indicators for a variable tranche will serve to focus the dialogue on key points relating to the reform objectives supported by the programme, including public-financial management reform. Indicative budget support tranche releases (million EUR): Year n+1 n+2 n+3 n+4 (FY2013/14) (FY2014/15) (FY2015/16) (FY2016/17) Amount Fixed Tranches Amount variable tranches Total Amount Performance monitoring and criteria for disbursement Progress and performance will be assessed during annual joint reviews with the Government of Khyber Pakhtunkhwa, based on agreed policy implementation milestones and process indicators, using the policy matrix and results framework developed for the programme. In addition, there will be two joint reviews annually to discuss on-going implementation issues. The release of tranches of the Sector Budget Support will be conditional on satisfactory completion of the following general and specific conditions General conditions for the disbursement of all tranches; eligibility criteria for (sector) budget support: i. Satisfactory progress in the implementation of the sector policy and strategy. Indicative sources of verification: Progress reports by government of Khyber Pakhtunkhwa on implementation of the budget reform agenda, implementation of the Monitoring and Evaluation Strategic Framework, procurement reforms, conditional grants, creation of additional fiscal space for community-driven development approaches, etc. ii. Satisfactory progress in the maintenance of a stability-oriented macroeconomic policy. Indicative sources of verification: Information provided by government of Khyber Pakhtunkhwa, economic reports by Government of Pakistan and State Bank of Pakistan as well as other international financing institutions like World Bank, Asian Development Bank and IMF (including IMF programmes in the country and Article IV Consultations). iii. Satisfactory progress in the implementation of its programme to improve PFM. Indicative sources of verification: Information and reports provided by the government of Khyber Pakhtunkhwa and other public institutions (Parliament, Auditor General of Pakistan, Controller General of Accounts, provincial institutions). Reports published by other donors and international or national organisations on PFM, including assessments like PEFA and Organisation for economic co-operation and development (OECD) Development Assistance Committee (DAC) procurement assessments. iv. Transparency and Oversight of the Budget. Indicative sources of verification: Publication of the budget Page 12 of 35

13 4.4.2 Specific conditions for disbursement of individual tranches: Indicators, expected performance levels, time table, base and target values per year, and indication of disbursement triggers will be finalized (including Appendix 1 to the Technical and Administrative Provisions (TAPs) Variable Tranche Matrix) before signature of the Financing Agreement. The specific conditions for disbursement of individual tranches will be defined in line with the draft policy matrix and are planned to cover the following areas: 1. More efficient use of provincial government budget 2. Increased community development, social mobilisation and capacity building 3. Improved front line public service delivery 4. Improved community infrastructure 4.5 Evaluation and audit External evaluations and audits of the service contracts and the grant contracts will be carried out by independent consultants recruited directly by the Commission in accordance with EU rules and procedures based on specifically established terms of reference. Joint evaluations with other donors and third party validations of various programme sub-components are foreseen. 4.6 Communication and visibility The EU will ensure visibility through: i) engagement with government, donors, media and other partners in the context of policy dialogue and aid effectiveness, as well as ii) other means such as the Delegation s website. The Communication and Visibility Manual for EU External Actions will be applied by the programme beneficiary. The Government of Khyber Pakhtunkhwa will launch a specific website to disseminate the information about the programme and the engagement of partner organizations. Public relations/awareness campaigns will be undertaken regularly to make the EU s contribution visible. Page 13 of 35

14 ANNEX 2 1. IDENTIFICATION Title/Number "Public Financial Management Support Programme for Pakistan, PFM-SPP" DCI-ASIE/2012/ Pakistan Total cost EUR 15,000,000 Aid method / Method of implementation EU contribution: EUR 15,000,000 Project approach direct centralized management DAC-code Sector Public finance management 2. RATIONALE 2.1. Sector context The public financial management (PFM) sector in Pakistan is characterised by an uneven development. Whereas some critical elements are equivalent or approaching international better practice, such as the computerised public finance information system and chart of accounts, other elements continue to display significant deficits. These latter include the lack of an overall PFM reform strategy, practically nonexistent internal audit and control, poor revenue mobilization mechanisms, continuing drains on the national budget associated with loss making public sector organizations, an inadequate macroeconomic framework for budget and strategic planning, lack of effective enforcement of procurement regulations, and ineffective public debt management. The EU mission carried out in support of the Action Fiche in February-March 2012 confirms earlier findings of the Public Expenditure and Financial Accountability appraisal (PEFA) that, while Pakistan has established some elements of an effective PFM system which have the potential to place it on an improvement trajectory, recent progress has been slow. The latest PEFA update conducted in the first half of 2012 has confirmed the persistence of previously identified weaknesses. Notwithstanding this, there is an imperative for change. The mission confirmed willingness and expressed enthusiasm and support for reform and change from a broad range of key government and stakeholder representatives consulted. The poor macro-economic performance and faltering economic governance are severely constraining the economic and social development process in Pakistan. Successive attempts to reform the economic management of the country have rarely been accomplished because of a highly complex political economy. Repeated changes in leadership between democratically elected and military governments have resulted in a continuously weakening of public administration. Development policies 14

15 have been overly biased towards public sector projects and arbitrary incentives impeding competiveness and sustainable economic growth. The current Government, in its 5 th and final year mandate, has been fully cognisant of the root causes of the aforementioned problems. It has introduced a series of measures of which the most far-reaching were the 7th National Finance Commission award and the adoption of the 18th Amendment to the Constitution by the Parliament. As from the financial year , eighteen ministries have been devolved to the provinces and the provincial share of the federal budget has grown to 57.5 % as against 47.5 % in Provincial taxation has been enhanced and provinces have the authority to raise domestic and foreign loans albeit with federal consent. The wider implications and success of this unparalleled devolution of federal power are yet to be seen as the provinces continue to build up their administrative capacity and understanding of the opportunities for more direct political oversight of the budgetary process through the provincial assemblies. The devolution process re-emphasizes the need for a full modernisation of fiscal and budgetary management to the provinces. Khyber Pakhtunkhwa and Punjab provinces have both made substantial progress in adopting comprehensive approaches to strategic development planning and public finance management reforms 8. In contrast, and apart from a few isolated sector-related initiatives, public finance management practices in Sindh and Balochistan remain weak. Neither of these provinces has elaborated overarching development strategies, and planning and budgeting is in practice input driven. Sindh has initiated, with limited donor support and using its own resources a Medium Term Budgetary Framework (MTBF) approach from 2010 in five pilot ministries (Irrigation, Power, Education & Literacy, Livestock & Fisheries and Agriculture). However, the initiative has achieved limited progress due to a combination of lack of technical skills, and capacity and resources to consolidate and expand the MTBF and demonstrate its benefits to decision makers. The proposed programme will assist the Government of Sindh to introduce a fullfledged public finance management reform. It foresees a long-term approach and is expected to cover all sectors with a possible expansion into selected districts. Assistance will also be extended in consolidating the ongoing budgetary reform process at federal level, with the aim to devise a comprehensive and overarching reform strategy in coordination with the provinces. This should provide for a growing capacity to sustain and expand the reform process into other parts of the country, such as Balochistan or those areas that may transit into separate devolved provinces in the near future. The programme proposes cooperation at two levels of governance (Government of Sindh and Federal Government) as PFM systems in Pakistan are clearly interlinked and there is no separation between Federal and Provincial systems. The Constitution defines the basic PFM principles which apply to Federal and Provincial Governments alike. In spite of having separate parliaments and executives, core PFM functions like accounting and auditing remain under the domain of federal institutions. The existence of a fixed formula for the distribution of resources between the Federal Government and the Provinces approved every five years does not undermine the fact that provinces remain highly dependent on the centre for financial transfers (80-90%). The new powers devolved to the provinces in 2010 have been accompanied by 8 Khyber Pakhtunkhwa Integrated Public Financial Management Strategy; KP Comprehensive Development Strategy; Strategy for Accelerating Economic Growth and Improving Service Delivery 15

16 the strengthening of the Council of Common Interests and other provincial intercoordination bodies on which the Federal Government and institutions play a leading role. The programme will work on the same areas of reform at both levels, thus providing an inclusive perspective and facilitating coordination between the federal and provincial level. In response to the new paradigm set out in the Framework for Economic Growth (May 2011), which includes a major focus on improving the efficiency of public sector management, the programme will support the federal government to improve macroeconomic forecasting and modelling to better understand potential impacts for macroeconomic and fiscal policy formulation - including enhanced capacity and flexibility to respond to changing economic circumstances and shocks for a more informed political decision making process. The programme will support the Government in improving its public finance management systems, improve service delivery and tackle poverty reduction Lessons learnt The experience from a wide range of past interventions in support of economic reforms and better management of public finances in Pakistan has demonstrated the need for: Long-term engagement. The new programme, therefore, needs to be process oriented and sufficiently flexible and robust. The long implementation period will allow any necessary adjustment in case problems arise during the execution of the programme. Ownership and commitment. Throughout the EU and donor literature and in discussions with beneficiaries and stakeholders, a consistent message is that without real beneficiary commitment and support particularly in the Pakistan context interventions are at significant risk. The proposed programme is therefore formulated pursuant to extensive discussions to ensure local input into the design of the programme, and to ensure it supports interventions articulated and strongly supported by beneficiaries and stakeholders. The proposed interventions have been extensively discussed with relevant officials of the Federal Government and the Government of Sindh. A debriefing session was held in the Economic Affairs Division of the Federal Government and in the Finance Department of the Government of Sindh to receive official support to the programme. Technical feasibility and sustainability. The proposed programme takes account of the status of technical progress and capacity. Reforms cannot take place without the appropriate technical infrastructure. At the federal level, this is assessed through the confluence of the Project to Improve Financial Reporting and Auditing implemented public sector information system and building on the emerging MTBF and macroeconomic frameworks. In Sindh, the emphasis will be on consolidating and expanding the existing MTBF pilot and developing a reform strategy with the Sindh authorities that will mesh with their reform objectives and technical capacities to improve their PFM system. A clear strategic framework. Drawing on PEFA reports and emphasised in extensive discussions with beneficiaries and stakeholders, there is a critical need to develop a comprehensive, integrated, over-arching and sequenced PFM reform 16