Completion Report. Project Number: Loan Number: 2126 March Indonesia: State Audit Reform Sector Development Program

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1 Completion Report Project Number: Loan Number: 2126 March 2010 Indonesia: State Audit Reform Sector Development Program

2 CURRENCY EQUIVALENTS Currency Unit rupiah (Rp) At Appraisal At Program Completion (15 November 2004) (31 December 2007) Rp1.00 = $ $ $1.00 = Rp8,980 Rp9,405 ABBREVIATIONS ADB BAWASDA BPK BPKP DPR DPRD IDP IMC MOF MOHA PCR PLMU RRP SAL STARSDP TA TACR Asian Development Bank badan pengawasan daerah (regional internal audit body) Badan Pemeriksa Keuangan (Audit Board of the Republic of Indonesia) Badan Pengawasan Keuangan dan Pembangunan (Financial Supervisory and Development Board, now the government internal auditors) Dewan Perwakilan Rakyat (House of Representatives of the Parliament) dewan perwakilan rakyat daerah (regional parliament) institutional development plan interministerial committee Ministry of Finance Ministry of Home Affairs project completion report program loan monitoring unit report and recommendation of the President State Audit Law State Audit Reform Sector Development Program technical assistance technical assistance completion report NOTES (i) The fiscal year (FY) of the Government and Implementing Agencies ends on 31 December. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2010 ends on 31 December (ii) In this report, $ refers to US dollars. Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General K. Senga, Southeast Asia Department (SERD) Director J. A. Nugent, Indonesia Resident Mission, SERD Team leader Team member R. Budiman, Senior Financial Management Specialist, IRM, SERD L. Munandar, Senior Project Implementation Officer, IRM, SERD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

3 CONTENTS Page BASIC DATA i I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 2 A. Relevance of Design and Formulation 2 B. Program Outputs 3 1. Program Conditions 3 2. Institutional Development 7 C. Program Costs 8 D. Disbursements 8 E. Program Schedules 8 F. Implementation Arrangements 9 G. Conditions and Covenants 9 H. Related Technical Assistance 9 I. Consultant Recruitment and Procurement 10 J. Performance of Consultants, Contractors, and Suppliers 10 K. Performance of the Borrower and the Executing Agency 10 L. Performance of the Asian Development Bank 11 III. EVALUATION OF PERFORMANCE 11 A. Relevance 11 B. Effectiveness in Achieving Outcome 12 C. Efficiency in Achieving Outcome and Outputs 12 D. Preliminary Assessment of Sustainability 12 E. Impact 13 IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 14 A. Overall Assessment 14 B. Lessons Learned 14 C. Recommendations Program Related General 15 APPENDIXES 1. Program Frameworks Policy Matrix Development Policy Letter Status of the 25 Nontranche and Program-End Conditions Audit Training Schemes Covenants and Compliance 38

4 i BASIC DATA A. Loan Identification 1. Country 2. Loan number 3. Program title 4. Borrower 5. Executing agency 6. Amount of loan 7. Program completion report number B. Loan Data 1. Appraisal Date started Date completed 2. Loan negotiations Date started Date completed 3. Date of Board approval 4. Date of loan agreement 5. Date of loan effectiveness Actual Number of extensions 6. Closing date In loan agreement Actual Number of extensions 7. Terms of loan Interest rate Maturity (number of years) Grace period (number of years) Indonesia 2126 State Audit Reform Sector Development Program Republic of Indonesia Ministry of Finance $ million ($ million disbursed and $ million cancelled on 28 December 2007) PCR: INO August August November November December December December 2004 None 31 December December 2007 None London interbank offered rate 15 years 3 years 8. Disbursements a. Dates Initial Disbursement 17 December 2004 Effective Date Final Disbursement 17 December 2004 Original Closing Date Time Interval 0 Time Interval 17 December December months b. Amount ($ million) Category or Subloan Original Allocation Last Revised Allocation Amount Canceled Net Amount Available Amount Disbursed Undisbursed Balance 01 STARSD Program Total

5 ii C. Program Data 1. Program cost ($ million) Cost Appraisal Estimate Actual Foreign exchange cost Local currency cost 0 0 Total Financing plan ($ million) Cost Appraisal Estimate Actual Implementation costs Borrower financed 0 0 ADB financed Total ADB = Asian Development Bank. 3. Cost breakdown by program component ($) Component Appraisal Estimate Actual None 4. Program Schedule Item Appraisal Estimate Actual Date of contract with consultants Program performance report ratings Ratings Implementation Period 17 December 31 December January 31 December January 31 December January 31 August September 27 December 2007 Development Objectives Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Implementation Progress Satisfactory Satisfactory Satisfactory Satisfactory Partly Satisfactory D. Data on Asian Development Bank Missions Name of Mission Date No. of Persons No. of Person- Days Specialization of Members Appraisal mission 6 27 Aug a, b, c, f, g Loan negotiations Nov a, b, c, d, e, f, g Program completion review 9 20 Nov a, h a = senior financial management specialist, Indonesia Resident Mission, b = counsel, Office of the General Council, c = principal economist, Indonesia Resident Mission, d = senior programs officer, Indonesia Resident Mission, e = financial control specialist, Disbursement Section 5 Loan Administration Division Controller's Department (CTLA5), f = control officer, Indonesia Resident Mission, g = senior project implementation officer and project officer, Indonesia Resident Mission, h = staff consultant.

6 I. PROGRAM DESCRIPTION 1. On 13 December 2004, the Asian Development Bank (ADB) approved a package of financial assistance to the Republic of Indonesia to support the State Audit Reform Sector Development Program (STARSDP). 1 The package comprised (i) a program loan, (ii) a project loan, and (iii) the administration of two technical assistance (TA) grants for (a) program loan coordination and monitoring and project loan monitoring and quality assurance and (b) implementation assistance for the project loan. The program loan of $200 million (STARSDP), to be released in two tranches of $100 million each, was from ADB s ordinary capital resources. The project loan STARSDP came from the Asian Development Fund, in the amount of SDR16,680,000 (about $25 million). The Government of the Netherlands provided $10 million in cofinancing, which consisted of $5 million ($1.3 million in TA for the program loan and $3.7 million in TA for the project loan) and a grant of $5 million for the project loan. 2. The goal of STARSDP was to enhance governance and the efficiency, economy, and effectiveness of the public sector audit. This would be achieved by strengthening audit institutions, which would operate to internationally accepted standards. The objectives of the program loan were to (i) strengthen the legal and regulatory framework for public sector audit, (ii) initiate the realignment of national auditing resources to enable audit institutions to fulfill their mandates, (iii) support measures to enhance parliamentary oversight of public audit institutions, and (iv) provide strategies to increase public awareness of audit and audit institutions. 3. The project loan s objectives were to enhance the capability of the audit institutions by building upon past support and introducing techniques and approaches that would allow the institutions to operate effectively and efficiently and to incorporate international best practices. The framework summarizing the program s goal, purpose, outputs, and performance targets is in Appendix 1, and the policy matrix is in Appendix The TA of $5 million comprised two grants, one for $1.3 million (TA Support for the Implementation of the State Audit Reform Sector Program 2 ) allocated to the program loan monitoring unit to ensure that the deliverables on the policy matrix were achieved, and the remaining $3.7 million (TA Support for the Implementation of the State Audit Reform Investment Project 3 ) was allocated to the investment loan monitoring unit to provide in-depth project monitoring and reporting assistance and to ensure quality assurance through the establishment of regional monitoring systems. This TA also supported the audit reform program by enhancing the capacity of governmental audit institutions. Appendix 13 of the report and recommendation of the President (RRP) gave the details of the terms and reference and costing for the TA. 5. STARSDP became effective on 17 December 2004, to be carried out over 30 months from January 2005 to June It was structured for release in two tranches and closure on 31 December The first tranche of $100 million was released on the date the loan became ADB Report and Recommendation of the President to the Board of Directors: Proposed Loans to the Republic of Indonesia for the State Audit Reform Sector Development Program (STARSDP). Manila (Loans 2126-INO for $ 200 million and 2127-INO[SF], for $ 25 million, approved on 13 December). ADB Technical Assistance Support for the Implementation of the State Audit Reform Program. Manila. (TA 4473-INO, for $ 1.3 million, approved on 13 December). ADB Technical Assistance Support for the Implementation of the State Audit Reform Investment Project Manila. (TA 4474-INO, for $ 3.7 million, approved on 13 December).

7 2 effective. The second tranche of $100 million, to be released by 30 June 2006, was cancelled at the request of the government, as it could not fully meet the conditions for release. The particular condition related to the need for the President of Indonesia to approve the Regulation on Internal Audit. 4 Therefore, it was decided to cancel the second tranche with effect from 28 December The program was closed on 31 December TA Support for the Implementation of STAR Program was completed on 31 December 2007 and closed on 27 May 2008, followed by the completion of TA completion report Activities under the STARSDP investment loan were to be carried over 5 years from January 2005 to December The loan was to be closed on 30 June 2010 but was extended in September 2009 for 6 months, to close on 31 December The scope of the investment project loan consisted of five main components: (i) project management; (ii) the introduction of new systems and practices for effective external audit; (iii) institutional enhancement and repositioning through new regulatory structures and practices for effective internal audit covering, as applicable, the inspectorate generals, badan pengawasan daerah (BAWASDAs, regional internal audit bodies), and Badan Pengawasan Keuangan Dan Pembangunan (BPKP, government internal auditors); (iv) the establishment of a formal and informal education and certification program for internal auditors; and (v) the introduction of new practices for parliamentary oversight of public sector audit covering national and regional parliaments. The investment project loan (STARSDP) and TA for supporting STAR Investment Project are still being implemented. 6 II. EVALUATION OF DESIGN AND IMPLEMENTATION A. Relevance of Design and Formulation 7. STARSDP design was relevant at appraisal. At that time, Indonesia had reached a critical juncture in its transition from a centralized authoritarian state to a decentralized democracy. 7 To consolidate the success of ongoing democratization and decentralization, 8 measures were needed to improve governance, strengthen fiduciary aspects and internal controls, and establish an effective accountability framework. The government recognized these concerns and took measures to address them, as reflected in its medium-term planning document for and its 2003 white paper. STARSDP supported these measures. 8. The rationale for STARSDP was that a strengthened state audit function was necessary to serve as an effective accountability framework for parliaments, the executive, the judiciary, and civil society. To help control public sector management, the audit function provided an independent, objective, and professionally conducted assessment of the veracity, accuracy, credibility, and reliability of information on the economy, effectiveness, and efficiency of government. Another feature of STARSDP design was that it aimed at the public sector audit The government advised ADB by letter dated 19 December 2007 of the borrower s decision to cancel the $100 million second tranche under the program loan. Accordingly, ADB cancelled $100 million from the loan account effective 28 December 2007, thereby reducing the loan amount to $100 million. ADB Support for the Implementation of the State Audit Reform Program. Manila. At the government s request, ADB agreed to extend both the investment loan (loan 2127-INO) and TA (TA INO) by another 6 months, and they are now scheduled to close on 31 December In July 2004, for the first time the country elected its president through direct vote, and a new government was in place by October 2004.Under laws 32 and 33 of 2004, which underpin decentralization, all functions other than foreign policy, defense, security, the judiciary, monetary and fiscal matters, and religious affairs were devolved to regional governments. The regional share in government spending was expected to exceed 40%, in sharp contrast with the average of 15% in the 1990s.

8 3 function as a whole, both central and regional, external and internal, including internal controls. Previous limited external assistance had been to strengthen individual audit organizations. 9. STARSDP was a major step in the long-term partnership between the government and ADB. Building upon collaborative experience, STARSDP was an integral part of a cluster of programs formulated by ADB to support aspects of decentralized budget formulation; strengthen intergovernmental fiscal relations; and support controls and checks related to budget execution, financial management, and public oversight. The program was in part the outcome of intensive policy dialogue between ADB and the government, which started in December 2002 and was maintained throughout project preparatory TA and STARSDP missions. 9 B. Program Outputs 1. Program Conditions 10. The first tranche was disbursed after the government adequately met the conditions for its release (Appendix 2). The outputs achieved to support the first tranche release are summarized as follows: (i) (ii) (iii) The Ministry of Finance (MOF) (a) revised the State Finance Accountability Bill as the State Audit Law (SAL); (b) revised the Badan Pemeriksa Keuangan (BPK) Bill as the BPK Law; (c) submitted to Parliament amendments to the SAL; (d) had the SAL approved and enacted by Parliament on 9 June 2004; (e) established an interministerial committee that drafted a government regulation on internal control systems that included clarifying the roles of the internal audit function at the central and regional levels, in line with their respective legal mandates, as well as made recommendations for drafting the necessary presidential decree(s); (f) obtained confirmation from the inspectorate generals of each ministry that they had prepared the annual financial accountability statements in line with the MOF guidelines; and (g) issued a decision letter to establish a team to review any existing training of public sector financial management and auditing staff. The Ministry of Home Affairs (MOHA)-Inspectorate General formulated and disseminated criteria to have an indicative list of regional governments suitable for support under STARSDP. The BPK (a) initiated revisions to the 1995 auditing standards to bring them in line with international standards; (b) sought additional supplementary budget in 2005 to enhance its coverage in the regions; (c) organized peer reviews of institutional effectiveness beginning in 2004; (d) drafted and adopted technical guidelines to integrate assessments of internal control systems as a standard part of the external audit process; and (e) compiled and submitted to Parliament the key findings of the financial audits of three state-owned enterprises, including compliance with regulations and internal controls for fiscal year (FY) Following the first tranche release in December 2004, the government continued action to complete the conditions for the second tranche release and the conditions that needed to be monitored in accordance with the policy matrix (Appendix 2). There were 17 conditions that needed to be met by 30 June 2006 for second tranche release, of which 13 were met on time, while four were not met within the prescribed time limit (items 9, 10, 11, and 23 of the policy 9 ADB Technical Assistance to the Republic of Indonesia for Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

9 4 matrix), despite about 2 years of consultations between the government and ADB to weigh options. As consensus could not be reached, the second tranche was cancelled at the government s request. 12. The 13 conditions that were met for the release of the second tranche and outputs achieved are summarized as follows: (i) The BPK (a) submitted to Parliament amendments to the BPK Bill consistent with deliberations in policy action and containing the agreed provisions; 10 (b) drafted regulations to implement the SAL; (c) conducted a legal review and prepared a report on laws or regulations that inhibited the BPK s fulfilling its legal mandate; 11 (d) submitted a draft of the auditing standards to the government through the MOF, academia, and the Indonesian Accountant Association (Ikatan Akuntan Indonesia) for consultation, finalized the revised public sector auditing standards, and drafted the related regulations; (e) issued external auditing standards as required by the SAL; (f) adopted and implemented the technical guidelines for internal control systems; (g) formulated a model program for public awareness aimed at enhancing public awareness of the roles and responsibilities of public sector audit institutions and public understanding of audit reports issued centrally and regionally; and (h) carried out audits and submitted to Parliament the key findings of the financial audits of three large public institutions for FY2004. (ii) The interministerial committee submitted to the State Secretariat a draft government regulation on internal control systems. (iii) The MOF issued a decision letter and established a team to review the existing training of public sector financial management and auditing staff, and a report was issued on the assessment and the recommendations. (iv) The MOHA-Inspectorate General disseminated the standardized regulation nationwide and established a tracking system to monitor its adoption by regional governments. 13. Of the four conditions that were not met on time, three concerned the internal control system: (i) The MOF was to draft a regulation on an internal control system; coordinate and prepare such a system; and prepare a government regulation (peraturan pemerintah); (ii) The MOF then needed to submit it to the State Secretariat and ultimately organize the adoption of the government regulation; and (iii) Certification procedures for internal auditors were to be revised, with the MOF drafting the necessary revisions to the existing regulation or institute a new government regulation that adopted the interministerial committee s recommendations. Thereafter, the MOF should have submitted a draft to the State Secretariat. Although the government could not meet these four conditions for the release of the second tranche, the government and ADB continued to work on their successful completion. 14. Concerning the internal control system, the government and ADB needed to reach a consensus in accordance with the government commitments in STARSDP and the development policy letter (Appendix 3). 12 This related to the mandate and resource issues for internal audit, These provisions were in respect of the scope of BPK authority; auditing standards that meet international standards; indemnity from court action to include all relevant supreme audit institutions staff; minimum relevant qualification criteria for board candidates and the appointment of board members by Parliament; and the end of tenure of the board or board members not coinciding with an election year. This review would help the government to identify conflicting clauses in other legislation that might need to be amended. The government s development policy was explained in a letter addressed to the President of ADB and dated 10 November 2004

10 5 which were to have been clearly delineated in the proposed regulation. In particular, the resources of government internal auditors, the BPKP, needed to be reallocated to other internal audit institutions in provincial and regional governments, as well as to external auditors, the BPK. These institutions need experienced and qualified staff. 13 Regarding the fourth unmet condition, ADB s view was that, if the government regulation relating to the internal control system adequately covered both (i) the mandate and resource issue with respect to the realignment of the BPKP and (ii) the responsibility for the certification of internal auditors, then there might not be any need for further government regulations to follow with respect to those issues. 15. There were 25 nontranche release and program-end conditions that needed to be met by the program closing date of 31 December They were all met at the time of the program completion report and their status is detailed in Appendix The government continued to work on commitments it made in the development policy letter regarding systems for internal control and certification of internal auditors. On 28 August 2008, the government enacted Peraturan Pemerintah [Government Regulation] No. 60/2008 on the internal control system. Although this was about 2 years after the second tranche release deadline of 30 June 2006, that the regulation was ultimately enacted showed the government s continuing commitment to strengthening the public sector audit and internal control systems. Its ultimate enactment, albeit with a delay, also reflected ADB s continuing dialogue and efforts, including those of the TA consultants, to have these outstanding issues resolved satisfactorily. 17. The new regulation on the internal control system appeared to explain to some extent, as clarified later, the government s commitment to ADB regarding the delineation of the specific mandates of the different state audit institutions. Prior to the issuance of Peraturan Pemerintah No. 60/2008, the BPKP was mandated to supervise and oversee the government's finance and development in accordance with the relevant laws, i.e., Keppres (Keputusan Presiden [Presidential Decree}) No. 64, In practice, however, under the current Peraturan Pemerintah No. 60/2008, the BPKP, as the government's internal auditors, might have overstepped its mandate by, for example, undertaking some regular audits of institutions. The BPKP also had offices in the provinces. On the other hand, the BPK was designated under UU (Undang-undang [Law]) nos. 15/2004 and 15/2006 as an independent auditor. This dichotomy of roles between the BPK and the BPKP in the state audit work brought conflict between agencies, delays in audit work, and inefficiency in the use of resources. 18. The new regulation on government's internal control clarified and elaborated the demarcation of mandates between the BPK and the BPKP. The BPK has been mandated as the sole external auditor of the government and is responsible to the public through national and provincial parliaments. Its scope of work has been defined and clarified to include performing audits on (i) financial statements of government institutions, (ii) financial performance of government institutions, and (iii) other specific items. The BPKP has now been mandated as one of the four internal auditors of the government and is responsible to the President of Indonesia (Article 1, Section 4 of Peraturan Pemerintah No. 60/2008) via the MenPAN (Menteri Negara Pendayagunaan Aparatur Negara (Ministry of State Apparatus) based on UU (Law) 9/2008. Its scope of work has now been mandated as (i) conducting audits of projects that cutacross more than one ministry, agency, region, and other audits as instructed by the president; 13 The ADB review mission in February 2006 noted that a general consensus was necessary on the action required with respect to the BPKP, which had seen its mandate significantly reduced following decentralization. That review mission also noted the complexity of the issues that the government faced in dealing with the BPKP, an institution with a staff of 6,000 and a history of power under President Soeharto.

11 6 (ii) reviewing the government's financial statements prior to submission to the president, and (iii) managing the implementation of the government's internal audit system. 19. Peraturan Pemerintah No. 60/2008 also specified the other three internal auditors of the government as follows: (i) inspectorate generals of each ministry; (ii) BAWASDAs and inspectorate generals of each provincial government, 14 and (c) BAWASDAs and inspectorate generals of districts (cities and regencies). 15 The inspectorate generals of ministries report to their respective ministers, inspectorate generals of the provincial governments report to their respective provincial parliaments, and district inspectorate generals report to their respective heads of districts. The mandates for state audit work have now been significantly clarified, compared with prior to the issuance of the regulation. 20. Two issues have continued to be unresolved. First is the need to realign BPKP staff resources with other state audit institutions that need them, considering its reduced scope of work as a result of Peraturan Pemerintah No. 60/2008. Second is the need to decide on the responsible internal auditors certification, i.e., to provide the appropriate training, conduct examinations, award certification, and establish the procedures to be followed. On the first issue, the BPKP is now of the view that its staff resources need not be realigned with others, as they are now needed by the BPKP itself to undertake the five new tasks assigned to it under Article 59 of Peraturan Pemerintah No. 60/ The PCR view is that the resources of the BPKP are far in excess of those required to undertake its new mandate and the five additional tasks to be undertaken under the new internal control regulation. On the second issue, it appears that the government is still working it out. The outcome of both issues needs to be followed up by ADB. This could be done through continuing policy dialogue and as part of any future assistance for strengthening the public sector audit system. 21. In summary, the key outputs encompassed a basic framework for operating a public sector audit system, both internal and external, central and regional. This framework includes (i) a legal framework, with the State Audit Law to specify the role of audit in public sector financial management and the amendment of the Supreme Audit Institution Law (BPK Law); (ii) an appropriate regulatory framework to implement the SAL and the BPK Law (for example, the eight regulations mentioned earlier); (iii) new regulation on internal control systems that reorganized internal audit institutions and clearly delineated their mandates and functions; (iv) a proper institutional structure for state audit work with the BPK as the external auditor, the BPKP as the internal auditor, inspectorate generals of the ministries as internal auditors of their ministries, and BAWASDAs as internal auditors at the regional and district levels with appropriate policies, procedures, and staffing structures; (v) sufficient budgets for the efficient operation of the BPK, the BPKP, and ministry inspectorate generals, but insufficient for BAWASDAs; (v) public sector auditing standards that meet international standards, and (vi) a public awareness program on the public sector audit function There are now 33 provinces in Indonesia. There are now 510 districts in Indonesia. The five new tasks are (i) preparing technical guidelines on implementing new internal control regulations, (ii) disseminating new regulations to inspectorate generals of ministries and BAWASDAs, (iii) education and training on the new regulation, (iv) providing guidance and consultancy on new regulation, and (v) improving the auditing competency of the government s internal control body.

12 7 22. These outputs helped to lay the foundation for the Indonesian public sector audit system to begin operations and resolve such issues as an unclear legal and institutional framework, inefficient allocation of resources between institutions, lack of transparency and accountability in the audit process, and lack of understanding on the part of legislators and the general public of the role of public sector audit. These outputs should, however, be considered as only the beginning, and much more needs to be done to build on this basic framework and enforce its proper, efficient, effective, and sustainable operation. 23. The areas that appear to need further strengthening include: (i) technical guidance on implementing new legal, regulatory, and auditing standards, as well as the policy framework for internal and external audits; (ii) capacity building and human resource strengthening, particularly in BAWASDAs; (iii) cooperation between BAWASDAs, as the internal auditors of local governments, and BPKP and inspectorate generals, as the internal auditors of the central government; (iv) adequate budget allocations for BAWASDAs to carry out their mandated internal audits functions efficiently and effectively; (v) improvement in communication between (a) the BPK and the national government, (b) BAWASDAs and regional parliaments, and (c) district BAWASDAs and their chief executives; (vi) further strengthening of the training institute of the BPK and its equivalents in the BPKP and BAWASDAs for capacity enhancement, and (vii) general improvement of the quality of internal audit units (the BPKP and provincial and district BAWASDAs), including the introduction of new regulations as the state audit system evolves, grows, and becomes more sophisticated Institutional Development 24. According to BPK officials interviewed by the PCR mission, Indonesia has only 6,000 qualified accountants and auditors. The country needs another 21,000 of them to undertake the state audit function on the scale and with the veracity the government expects. It appears to be a considerable challenge for the authorities and the development partners to produce enough staff with the appropriate skills in a reasonable period of time. Otherwise, all the work being done to set up a state audit system with ADB support, such as through this program, cannot be enforced effectively and operated properly to realize the expected outcomes in terms of strengthening governance and accountability and ensuring the efficient and effective use of public funds. Efforts are being made by various authorities such as the MOF-Inspectorate General, various other ministry inspectorate generals, the Ministry of National Education, the MOHA-Inspectorate General, regional and district BAWASDAs, 36 accredited universities, the BPK, and the BPKP to produce the needed competent staff, as detailed in Appendix 5. Most of these training schemes are supported by ADB under the investment loan [loan 2127 (SF)- INO], 18 grant 0024, and TA Support for the Implementation of the State Audit Reform Algemene Rekenkamer (Netherlands Court of Audit) Peer Review of the Audit Board of the Republic of Indonesia. Netherlands, July Among the investment loan s components are (i) establishing formal and informal education programs (part D under the Ministry of National Education-Inspectorate General and MOF Training Center (Badan Pendidikan dan Pelatihan Keuangan), and (ii) developing and introducing new practices for parliamentary oversight of public sector audit covering national and regional parliaments (part E under the secretariat of the National Parliament and MOHA-Inspectorate General for 50 regional parliament secretariats).

13 8 Investment Project 19. In addition, the consultants under TA Support for the Implementation of the State Audit Reform Sector Program 20 supported implementation under the various conditions of the program. This helped to improve staff expertise and strengthen institutional aspects of the program loan monitoring unit (PLMU) and the various implementing agencies of the program. C. Program Costs 25. The adjustment costs of implementing the policy matrix of the program were estimated to be about $234.4 million, as detailed in the RRP, para. 52. That cost was expected to be partly funded by a loan of $200 million from ADB s ordinary capital resources, with the balance of $34.4 million to be funded by the government. Complementing the program was associated TA Support for the Implementation of the State Audit Reform Sector Program 21 of $1.3 million administered by ADB and funded by the Government of the Netherlands as a cofinancing grant. The TA was allocated to the PLMU to ensure that the deliverables of the policy matrix were achieved. D. Disbursements 26. The first tranche of $100 million was disbursed on 17 December 2004 upon loan effectiveness. The second tranche of $100 million was not disbursed, as it was cancelled at the request of the government in light of the continued difficulty in reaching a consensus on new regulations needed for internal control, realigning staff and budget resources among the various audit entities, and establishing an internal auditor certification system. Only $775,460 of TA Support for the Implementation of the State Audit Reform Sector Program 22 funding was disbursed, with the balance of $524,540 cancelled because of failure to complete the reform program in full, as detailed in the technical assistance completion report (TACR). Disbursements under TA Support for the Implementation of the State Audit Reform Investment Project 23 are continuing, with $2,039, disbursed by the date of the PCR. It appeared that the government had disbursed a minimum of $234.4 million toward adjustment costs in respect of the program loan, as estimated in the RRP. E. Program Schedules 27. The activities under the program component were to be carried out over 30 months from January 2005 to June The first tranche of $100 million was released upon loan effectiveness. The second tranche of $100 million was expected to be released by June 2006 but was cancelled at the request of the government. The program was closed on the scheduled date of 31 December The new regulation required for internal control was ultimately adopted in August 2008, about 8 months after the program closed, but did not appear to fully meet the program requirement as envisaged at appraisal ADB Technical Assistance Support for the Implementation of the State Audit Reform Investment Project Manila. (TA 4474-INO, for $ 3.7 million, approved on 13 December). ADB Technical Assistance Support for the Implementation of the State Audit Reform Program. Manila. (TA 4473-INO, for $ 1.3 million, approved on 13 December). Ibid Ibid ADB Technical Assistance Support for the Implementation of the State Audit Reform Investment Project Manila. (TA 4474-INO, for $ 3.7 million, approved on 13 December).

14 9 F. Implementation Arrangements 28. The arrangements made for program implementation were outlined in the RRP, paras Except for a slight delay in establishing the PLMU, the arrangements were generally followed in program implementation and proved effective in meeting the conditions for the timely release of the first tranche, which included 13 of the 17 conditions required for the release of the second tranche, and for meeting almost all of the non-tranche and program-end conditions. The PLMU, various implementing agencies, consultants, and ADB had long and intense dialogue and came up with various options to have the second tranche released on time. However, three of the four unmet conditions, related to reducing the scope of work and realigning staff and budget resources of the BPKP, could not be implemented because of the resistance of this powerful entity with political backing, forcing the cancellation of the second tranche. G. Conditions and Covenants 29. Appendix 6 gives the status of compliance with conditions under the program. During implementation, the government complied with all conditions for the release of the first tranche, 13 of the 17 conditions for release of the second tranche, and almost all the nontranche and program-end conditions. The loan agreement covenants on implementation and coordination arrangements and reporting requirements were satisfactorily complied with, except the one that required the PLMU to submit to ADB a completion report within 3 months of the physical completion of the program loan conditions (RRP, para. 58). H. Related Technical Assistance 30. TA Support for the Implementation of the State Audit Reform Sector Program 24 formed an integral part of the program. It was provided to help the timely processing and implementation of program conditions. The performance of the consultants and their contributions to program implementation is detailed below under performance of consultants, contractors, and suppliers. As mentioned above, a TACR rated the TA successful, as it helped to achieve most of the tranche release conditions and milestones of the policy matrix. The TA contributed to restructuring the audit institutions, strengthening their functions, building their capacity, and developing legal and regulatory frameworks in the public sector audit system. Although the consultants tried hard to ensure compliance with those four conditions, which could not be met within the program period, it did not succeed because of their political implications. Nevertheless, their work led the government to come out with the new regulation on internal control in August 2008 (Peraturan Pemerintah No. 60/2008), which went part of the way toward meeting the four unmet release conditions for the second tranche. 31. TA Support for the Implementation of the State Audit Reform Investment Project 25 is to monitor project activities and output delivery and quality, while assisting the investment loan monitoring unit secretariat and project implementation units with daily project management. PT Mazars, formerly PT Moores Rowland Indonesia, was recruited and mobilized in mid-october The consultants' performance is satisfactory. It is expected that the consultants will be extended until the project end date of 31 December This TA is still under implementation, with disbursement totaling $2,039, at the date of this PCR ADB Technical Assistance Support for the Implementation of the State Audit Reform Program. Manila. (TA 4473-INO, for $ 1.3 million, approved on 13 December). ADB Technical Assistance Support for the Implementation of the State Audit Reform Investment Project Manila. (TA 4474-INO, for $ 3.7 million, approved on 13 December).

15 10 I. Consultant Recruitment and Procurement 32. ADB's Guidelines on the Use of Consultants (2007, as amended from time to time) were followed in recruiting and engaging consultants. The TA required 24 person-months of international consultancy and 35 person-months of national. The inputs were provided through seven consultant contracts over 23 months. J. Performance of Consultants, Contractors, and Suppliers 33. The TACR rated the TA as successful. The consultants worked closely with the executing agency, the PLMU, implementing agencies, and ADB to formulate and monitor the policy matrix conditions and to assist in implementing the reform program. Report submission was timely, which helped to monitor progress in meeting tranche release conditions and audit reform. A considerable amount of work was done to put in place a legal, regulatory, policy, and institutional framework. This framework is to operate a state audit system covering both internal and external audits in the central, regional, and district governments. Efforts were made to get the public interested in the state audit function through awareness programs. Their significant contribution was the support given to develop and enact law no. 15/2006 on the State Audit Board (BPK) in October Although the vital internal control regulation could not be achieved in time, the TA nevertheless laid the basis for its subsequent approval in August 2008, albeit falling short of ADB s expected outcome of the entire program. Since the implementation of the audit reform program was more drawn out and complex than anticipated, the TA needed to be extended until 31 December 2007, the closing date of the program. However, by that date, only about half of the TA budget was spent, mainly because of the failure to complete the reform program. Of the $1.3 million TA amount, $775,460 was utilized and the balance of $524,540 was cancelled at its date closing on 27 May The consultants performance in terms of efficiency, teamwork, and cooperation with counterpart agencies was satisfactory. K. Performance of the Borrower and the Executing Agency 35. This was a complex program involving enacting new laws, adopting implementing regulations, formulating new policies, developing institutions, enhancing capacity, and realigning resources among state audit entities. These were time-consuming exercises that needed coordination and cooperation among state agencies for satisfactory resolution. Despite the demanding and challenging nature of the objectives, the government showed commitment to reform and put in place the basic framework for a state audit system comprising the legal, regulatory, policy, and institutional frameworks. To this extent, the performance of the government was satisfactory. 36. However, the government fell short of achieving the overriding spirit of the program. This was to establish in Indonesia a state audit system that operated on business-like principles of efficiency and economy and ensured the judicious utilization of public funds. The new regulation on internal control that was subsequently adopted did not fully meet the spirit of the program. The regulation, as required, delineated quite precisely the roles and functions of state audit entities. However, at the same time, it earmarked five new tasks for the BPKP (i.e., Article 59 of Peraturan Pemerintah No. 60/2008), which again paved the way for the BPKP to continue to play a dominant role in the state audit system. This is where the program endeavored to downsize and realign its resources in line with its expected reduction in mandate in the interests of efficiency and economy in the whole state audit system. The diluted or watered-down version,

16 11 apparently to appease conflicting forces, brought the status of the state audit system more or less back to what prevailed at the start of the program in terms of efficiency and economy. These principles appeared to have been compromised by the lack of political and bureaucratic will to withstand resistance to change, mainly by the BPKP. Taking these adverse developments into account, the performance of the borrower (the government) and the executing agency (MOF) is only partly satisfactory. L. Performance of the Asian Development Bank 37. This was a well designed reform program. With the assistance of project preparatory TA, ADB identified weaknesses in the state audit system and proposed appropriate policy measures to resolve them. TA was provided to help formulate and implement the program. An appropriate investment loan and TA Support for the Implementation of the State Audit Reform Investment Project 26 were provided to support the program through institution building and capacity enhancement in line with the program measures to be adopted. 38. The first loan tranche of $100 million was released on time at loan effectiveness. The second one of $100 million was cancelled, because of the government s failure to meet some of the conditions on time. Through numerous review missions and workshops and continuous dialogue, ADB endeavored to see the unmet measures fulfilled as well, but without success. Various options were presented to the government, but it decided not to proceed and was prepared to forego the second tranche of $100 million. This was to avoid the required internal control regulation, which appeared to have political ramifications. With the benefit of hindsight, ADB s agreement to cancel that tranche without further postponement appears to have been the right one. The internal control regulation subsequently adopted by the government did not fully meet ADB expectations at program appraisal and during implementation. The performance of ADB is satisfactory. III. EVALUATION OF PERFORMANCE A. Relevance 39. The relevance of the program declined during implementation and at completion. This can be attributed mainly to lack of political and bureaucratic will to carry through a vital reform measure included in the program: internal control regulation. This required reforming and reorganizing the BPKP to realign its relatively large funding and staff resources in line with its reduced scope, in the interest of efficiency and economy in the whole state audit system. The BPKP also failed to put in place an appropriate internal auditor certification system, which was required to facilitate a much-needed increase in the supply of competent auditors. They are needed to effectively enforce and properly operate the legal and regulatory framework for the state audit system introduced under the program. These unfulfilled reforms ultimately forced the cancellation of the second tranche of $100 million. Therefore, the program became less relevant during implementation and at completion. The government is continuing to work on both outstanding issues, and ADB should track their early resolution in line with appraisal expectations. 26 ADB Technical Assistance Support for the Implementation of the State Audit Reform Investment Project Manila. (TA 4474-INO, for $ 3.7 million, approved on 13 December).

17 12 B. Effectiveness in Achieving Outcome 40. Some outcomes were achieved, while some vital ones were not. The legal and regulatory framework was strengthened. Auditing standards meeting international standards have been introduced. These have helped the BPK in particular to perform its function as the country s only external auditor independently and responsible only to parliaments. The BPK has developed adequate policies, procedures, organization, and staff to conduct its role effectively. It has begun to adopt the latest audit methodologies such as risk-based audits, quality assurance audits, and financial performance audits, and to produce high-quality audit results. 41. Some high-profile audits have been conducted using these methodologies, with findings presented to the national and regional parliaments. This has helped to improve the performance of the audited entities. In parallel, the capacity of parliamentarians has been strengthened through education and the adoption of user-friendly formats to help analyze, interpret, and follow up on audit findings. Public awareness programs have helped the public to begin to recognize the role and value of audits. These positive developments have enhanced the reputation of state audit institutions, particularly the BPK. This enabled it to obtain the support of parliamentarians and bureaucrats for much-needed budgets and to further strengthen legal and regulatory frameworks. Similarly, inspectorate generals in individual ministries and the BPKP are now able to perform their internal audit functions more effectively with the strengthened legal, regulatory, and institutional frameworks. The role of BAWASDAs continues to be constrained, however, by the lack of appropriate budgets and capacity. The clear lack of capacity in BAWASDAs has hampered their oversight function at the regional levels. Capacity improvement for auditors in BAWASDAs should be a priority. 42. The outcomes that were not achieved are in relation to the lack of progress in achieving the main objective of the program, which was to make the overall state audit system function with efficiency and economy and to ensure a more prudent use of public funds. This was not achieved because of the failure to reorganize the BPKP, whose mammoth size, staff strength, and budgets are not in line with its reduced scope of work. The program also failed to put in place an independent internal auditor certification program to increase the number of sufficiently skilled and competent internal auditors. Until that is done, much of the improved state audit system will not be able to function effectively, as expected under the program. The achievement of outcomes is only less effective. C. Efficiency in Achieving Outcome and Outputs 43. The first tranche of $100 million was released on the date the program became effective. The second tranche of $100 million could not be released on the forecast date of 30 June 2006, as the conditions necessary for that release were not met by that date despite considerable dialogue between the government and ADB. These discussions continued even after that date. However, the program needed to be closed on the forecast closing date of 31 December 2007 for lack of progress in instituting reforms as envisaged at appraisal. Due to delays in achieving the desired reforms, the program is less efficient in achieving the envisaged outcomes and outputs in terms of helping the state audit system function with efficiency and economy. D. Preliminary Assessment of Sustainability 44. The preliminary assessment is that the program s sustainability is likely. This is based on a number of considerations: