Pakistan Managing Fiduciary Risk

Pakistan Managing Fiduciary Risk Introduction This analysis is intended to supplement an assessment of the developmental benefits of direct budgetary support to Pakistan. This report is in line with DFID s guidance on Managing Fiduciary Risk. It analyses the system of public financial management in Pakistan and assesses the fiduciary risk. The information has been extracted from recent reports 1 and a visit to Pakistan with the World Bank PIFRA team in Jan 2003. It does not incorporate ongoing work for the Public Expenditure Review or SAC III discussions. Summary This analysis concludes that the level of risk for Direct Budget Support to Pakistan is high, but with very different levels of risk at the different levels of government. At the sub-government (district, tehsil and union) level, this risk is extremely high; at the provincial level, good financial management is limited; at the federal level, there is evidence of improvements, which constitute Transformational activities [that] may warrant toleration of a higher degree of risk than more transactional activities. The risk also varies across the three key processes of Budget Formulation, Budget Execution and Independent Oversight. In diagrammatic form, the exposure to the sources of risk is: Budget Formulation Budget Execution Indep t Oversight Federal Medium Exposure Low Exposure Low Exposure Provincial High Exposure Medium Exposure Medium Exposure Sub- Governmental High Exposure High Exposure High Exposure Before 1999, the quality of public financial management in Pakistan was very low. Under Musharraf, political commitment to better financial management has led to short-term improvement in the processes of Budget Execution and Independent Oversight, mainly at the Federal Level of Government. Substantial weaknesses in Pakistan s financial management system still remain in the Budget Formulation process, and in all three processes at the Provincial and Sub-Governmental Levels. In terms of Budget Formulation : fiscal management responsibilities are unclear and pose considerable extra fiduciary risk to DFID in the context of devolution. The lack of fiscal space is the major issue that confronts both Federal and Provincial Governments. Some 90 percent of the Recurrent Budget is effectively not subject to scrutiny. There is little emphasis on performance orientation in budget Formulation. 1 Country Financial Accountability Assessment Part 1, June 2001, World Bank Accountable Fiscal Management Framework, March 2002, IMF Report on the Observance of Standards and Codes FT Module, Pakistan, Nov 2000, IMF 1

These weaknesses will only be addressed by systemic reform and reforms are underway. However, there are serious obstacles to their successful implementation. Reforming Budget Formulation depends on a Medium-Term Budget Framework and good cost classification. The efforts to improve cost classification are focused on the implementation of the New Accounting Model. The roll out of NAM is a priority, which is not being sufficiently addressed at present. This has an impact on the systemic reform of the weaknesses at the Provincial and Sub-Governmental Levels. The increase in expenditure at the sub-governmental level from 5% to 15% of total government expenditure confers a special responsibility on the CGA to account for, or at a minimum establish a process to account for these funds. However, the independence of the CGA has not materialised in practice. This lack of authority may have impeded the CGA s attempt to establish his mandate over accounting at the sub-governmental levels. The weakness of the CGA s position has also exposed divisions with the Provincial Governments about the provincialisation of accounts, (c.f. the Local Government Ordnance), which may exacerbate the lack of control of sub-governmental accounting. In conclusion, the CGA has a key role to maintain effective budget Formulation and execution during devolution and this is not happening meaning there is still a high level of fiduciary risk. In the medium-term, the government s strategy to achieve reforms of the public finance system relies heavily on the ongoing PIFRA reforms. The end result will be a highly formalised and computerized system of financial management. Actual progress on PIFRA I has been very slow. It is not yet possible to say whether PIFRA I will be implemented successfully. In reality, the major implementation issues lie ahead and there is no clear project implementation plan against which to prioritise activities or allocate resources. While it is so difficult to move forward, there are two major threats to the short-term improvement in financial control (Budget Execution and Independent Oversight). First, the reversion to a more democratic form of government may test the sustainability of the short-term improvement, coming as it does before the institutionalisation of reform. Second, the usefulness of the Fiscal Monitoring Committees may have plateaued. They were very useful as shock tactics but a committee is rarely accountable. Good internal control must lie within the management of the departments/ministries. In conclusion, the financial probity practiced under Musharraf has taken reform of financial control and independent oversight as far as it is likely to go without systemic reform of financial management. The obstacles to reform are considerable and the expectation of systemic improvement is limited. This leaves considerable weaknesses at the Provincial and Sub-Governmental Levels that are sources of fiduciary risk. Even at the Federal Level, a major source of fiduciary risk remains in the process of Budget Formulation because the link between resource allocation and policy objectives is weak. Assessment of progress towards good practice principles The grades have not been benchmarked against other countries and it would be misleading to compare across countries. Grades are conservative and based on results, not the prospects or intentions of reform. The ratings (A to C) reflect the need to make a more subtle distinction than pass or fail. A represents a situation where there is basic compliance, although coverage may not be 100%. A score of B indicates that there are some significant weaknesses in compliance or that the 2

procedures need to be changed. A score of C indicates substantial failure to comply with the rules or that the system will require substantial upgrading to meet the standard. 3

Good Practice Principles A clear set of rules governs the budget process Benchmarks for Assessment 1. A budget law, specifying fiscal management responsibilities, is in operation Rating (A to C) and current status Rating B The operational rules for preparing and executing Federal Government budgets are defined in the General Financial Rules of the Central Government, the Rules of Business, and the New System of Financial Control and Budgeting (NSFCB), June 2000. Budget management rules for the Provincial Governments are presented in corresponding manuals prepared by Governments of Punjab and Sindh, while NWFP and Balochistan follow federal procedures. In practice, a weak CGA and devolution pose considerable extra fiduciary risk to DFID. The GoP enacted a Controller General of Accounts Ordinance in 2001. The new Ordinance transfers the responsibilities for the preparation and maintenance of the accounts of the Federation, the Provinces and Districts from the Auditor General to a Controller General of Accounts (CGA). However, the independence of the CGA has not materialised in practice. The increase in expenditure at the sub-governmental level from 5% to 15% of total government expenditure confers a special responsibility on the CGA to account for, or at a minimum establish a process to account for these funds. This lack of authority may have impeded the CGA s attempt to establish his mandate over accounting at the sub-governmental levels. The weakness of the CGA s position has also exposed divisions with the Provincial Governments about the provincialisation of accounts, (c.f. the Local Government Ordnance), which may exacerbate the lack of control of sub-governmental accounting. In conclusion, the CGA has a key role to maintain effective budget Formulation and execution during devolution and this is not happening meaning there is still a high level of fiduciary risk. 4

The budget is comprehensive 1. All general government activities are included in the budget 2. Extra budgetary expenditure is not material Rating C At the sub-government level, expenditure will increase from 5% to 15% of total government expenditure. This raises key issues about financial control and financial information at the sub-governmental level. This section deals with the financial information aspect. If the New Accounting Model is applied to the District, Tehsil and Union Levels, the financial information can be integrated into the national accounts. If not, the information can only be consolidated, i.e. one budget line for 15% of government expenditure with no capacity to see a national picture of what this is spent on. This is a serious step away from transparency. However, even if the information is integrated under NAM, PIFRA, which (in time, probably) will bring full automation of accounting to Federal and Provincial Levels, is too complicated to apply to tehsil and union level accounts. So data from the sub-governmental level would still need to be integrated, which would be difficult. This issue has not been picked up and addressed at a sufficiently senior level. n.b. This is a classic example of the problems caused by PIFRA not having an experienced project manager with an integrated project plan, which would include the introduction of the New Accounting Model. The Accountable Fiscal Management Framework report supports the conclusion of the IMF s ROSC-FT and the GoP s Debt Reduction and Management Strategy report that the Federal budget has in the past failed to manage contingent liabilities, tax expenditures and quasi-fiscal activities (QFAs). Pakistan has also created considerable pressure on the budget through inadequate treatment of public debt in the budget preparation process of the Federal Government and through its past creation of assets leaving maintenance costs severely underprovided for. 5

The budget supports propoor strategies 1. Budget allocations are broadly consistent with any medium term expenditure plans for the sector or for the overall budget 2. Account Code Classifications are published and applied In 2002/3 tax reforms have reduced tax expenditures (i.e. exemptions) from 1% to 0.6% of GDP. The omission of contingent liabilities is a significant factor as in FY 1999-00 the losses of public sector enterprises amounted to 1 percent of GDP. QFAs have reduced but continue to exist in the gas sector and the power sector as electricity tariffs of WAPDA and KESC remain below cost recovery prices. This causes substantial financial stress, as the government has to provide explicit budget support as well as borrowing guarantees. Public debt management is still constrained by lack of coordination and inadequate monitoring. Budgeting for almost all the resources under the Recurrent Budget has taken place in a strictly incremental manner. As a result, completed development projects have continued to move over to the Recurrent Budget irrespective of the lack of resources to cater for them, with consequent under-funding and poor service delivery. Rating C The Federal Government has tried to improve the FY 2000-01 budget preparation processes and in particular the coordination between current and development budgets. The Budget Call Circular of 2001-02, has identified the following new procedures: (i) preparation of a draft macroeconomic framework, and sectoral ceilings and their approval by the Cabinet by November; (ii) submission of Ministry proposals based on mission statements and performance indicators by December; (iii) joint review of current and development expenditures by the Priorities Committee in consultations with the line Ministries to be completed by end of February; and (iv) final submissions and estimates to be prepared by March and April. In practice, the lack of fiscal space is the major issue that confronts both Federal and Provincial Governments. Some 90 percent of the Recurrent Budget is effectively not subject to scrutiny. The budget process allows little 6

The budget is a reliable guide to actual expenditure 1. Budget outturn shows a high level of consistency with the budget scope for a Ministry to scale back, or close down, a given permanent activity that is no longer a priority. The result is a consolidation of the existing structure of activities irrespective of its efficiency or the nature of the outputs that are associated with it. There is also little emphasis on performance orientation in budget Formulation. Systemic reform through a medium-term expenditure framework aims to link resource allocation to policy objectives. However, the ability to target, monitor and assess expenditure in social sectors has been and may continue to be undermined by poor cost classification. The efforts to improve cost classification are focused on the implementation of the New Accounting Model. The roll out of NAM is a priority, which is not being sufficiently addressed at present. NAM must address the sectors outside the scope of PIFRA, (Defence, Foreign Affairs, SOEs & Sub- Governmental Level) but this is currently not happening. The poor implementation of NAM has also led to confusion over the Budget Circular. This has led to one demand from the MoF for budgets according to the old rules and one demand from the CGA / PIFRA team for figures under NAM. It is not certain what the result will be! For the medium term, expenditure is likely to be poorly targeted resulting in failure to meet policy objectives. Rating C Although current results have improved significantly, this characteristic of fiduciary risk remains high. This is the product of a complex interrelationship of processes and it is not clear that the improvement is sustainable, preventing a return to the situation in previous years when, for Federal and Provincial governments, poor budget preparation and implementation processes failed to meet the objective of aggregate fiscal management. 7

Expenditure within year is controlled 1. In-year reporting of actual expenditure 2. Systems operating to control Estimates of expenditures in the first seven months of FY 2000-01 revealed that there was a large shortfall of expenditures in the social sectors, and in infrastructure development and that expenditures on non-salary current expenditures and development were particularly affected. Large expenditure increases in debt servicing and retirement of deferred liabilities to utilities have resulted in a shortfall of expenditures in other areas. Thus, at the end of January, development expenditures were only 51% of the prorated expenditures. This has particularly hurt non-salary and development expenditures in health and education sectors: as of end December only 11% and 6% of their annual non-salary SAP budgets had been spent respectively. The conclusion is that deviations in budget implementation reflect inadequate budget preparation processes including overoptimistic resource forecasting, incomplete budgeting of debt service requirements, and lack of prioritization of expenditures. This results in resource shortfalls and irregular disbursements, necessitating cutbacks during the year in budgetary allocations. The consequence is that expenditure during the year is controlled mainly through arbitrary means, such as delayed or inadequate release of budgetary funds; requirements of special clearance from Finance Ministry/Department to incur expenditure; and arbitrary restrictions on certain spending. Rating B The strengthening of control appears to have been the result of political commitment at the highest level. Structural, procedural and organizational reforms have been introduced and the meltdown of financial control in the late 1990s has been reversed. The change in financial management occurred in April/May 2000, when the MoF refused to release funds to Divisions/Departments until there was a 8

virement, commitments and arrears satisfactory level of reconciliation of receipts and expenditures. The Federal and all four provincial Governments last year set up fiscal Monitoring Committees with the responsibility of ensuring the reconciliation and preparation of accurate fiscal accounts. Finance ministries, the Accountant General s office, and State Bank representatives are represented in these committees. Accounts are reconciled with the Central Directorate of National Savings and Banks. At the federal level, close to 100% reconciliation was achieved. The same process of reconciliation occurred at the Provincial Level with less satisfactory results. At the Provincial Level, the CFAA Part 2 will address the efficacy of the FMCs and overall level of financial control in detail and will supersede this analysis. However, the initial conclusion is that capacity is weak and the levels of financial control are variable. At the Sub- Governmental Level, control by the centre is very weak At the federal level, there are two main concerns about these short-term improvements. First, the reversion to a more democratic form of government may test the sustainability of the short-term improvement, coming as it does before the institutionalisation of reform. Second, the usefulness of the Fiscal Monitoring Committees may have plateaued. They were very useful as shock tactics but a committee is rarely accountable. Good internal control must lie within the management of the departments/ministries. The procedural focus on internal control is contained in the New System of Financial Control and Budgeting issued on 30 th June 2000. This statement makes the Secretary of the Ministry/Department and the Principal Accounting Officer (PAO) explicitly accountable for the proper implementation of the Budget, and the enforcement of internal controls. The PAO has been made responsible for any laxity in control over expenditure including that on the part of his subordinate. He has also been made 9

responsible for effective reconciliation of receipts and expenditure and to hold meetings of the Departmental Accounts Committee (DAC) on a regular basis. There are also clearly established procedures for virement. Virement procedures have to be approved by the Ministry/Departments of Finance at the time of each month s reconciliation processes and the Accountant General office has to be advised. Government carries out procurement in line with principles of value for money and transparency Reporting of Expenditure is timely and accurate 1. Appropriate use of competitive tendering rules 2. Decision-making is recorded and auditable 3. Effective action taken to identify and eliminate corruption 1. Reconciliation of fiscal and bank records is carried out on a routine basis. Insufficient information to make an assessment Rating C moving towards B The trajectory of fiduciary risk for reporting of expenditure is moving from high to medium. The level of reconciliation rates has been greatly improved but the quality of accounting and reporting is low. Accounting, Reporting and Reconciliation issues were indicative of the failures of Pakistan s public sector financial management system due to the breakdown in compliance with established policies and procedures. In the medium-term, the government s strategy to achieve reforms of the public finance system relies heavily on the ongoing PIFRA reforms. The end result will be a highly formalised and computerized system of financial management. PIFRA I encompasses the technical design, systems implementation and business process reengineering. PIFRA II will 10

encompass the training and capacity building. In essence, PIFRA II is sequential to PIFRA I. Actual progress on PIFRA I has been very slow. It is not yet possible to say whether PIFRA I will be implemented successfully. In reality, the major implementation issues lie ahead and there is no clear project implementation plan against which to prioritise activities or allocate resources. Furthermore, it is clear that the absence of an experienced project manager on the GoP side is severely hampering progress. 2. Audited annual accounts are submitted to parliament within the statutory period. The Certification of the Auditor General has little meaning because the assessment is at such a high level. It skirts over the deficiencies noted in the individual audit reports. The audit plan produced by the Dept of the Auditor General is not substantiated by results. There is effective independent scrutiny of government expenditure 1. Government Accounts are independently audited. 2. Government agencies are held to account for mismanagement 3. Criticisms and recommendations made by the auditors are followed up Rating C moving towards B The trajectory of fiduciary risk for independent scrutiny of government expenditure is moving from high under the PACs established by the national and provincial assemblies towards medium under the Ad Hoc Public Accounts Committee established by the Musharraf administration. In respect of public auditing and oversight functions, the Government has established Ad Hoc Public Accounts Committees (PACs) comprising members from civil society including eminent retired senior government officials and private sector financial professionals to fill the gap created by the suspension of the Federal and Provincial legislatures across Pakistan. These Committees have started functioning in all jurisdictions and are working towards completely eliminating the multi-year backlog of audit reports under review within the next 12 months. Significantly, the federal ad-hoc PAC has, for the first time in Pakistan, opened up its sittings to representatives of the media. In the area of civil service reform and corruption, the new Federal Public 11

Service Commission (FPSC) Ordinance has increased the autonomy of the agency, reduced the scope for political interference, and expanded FPSC s responsibilities in recruitment. The Civil Service Act has been amended to enable premature retirement of inefficient long serving staff. A Removal from Service (Special Powers) Ordinance now enables Governments to expeditiously remove from service officers found to be corrupt or those who have entered the civil service through irregular procedures. The Government is also attacking corruption through a National Accountability Bureau (NAB), which has been established to investigate and prosecute past cases of financial impropriety and corruption. Measures have been taken that have led to the prosecution of politicians, bureaucrats, private sector workers and members of the armed forces. However, it is difficult to assess the overall impact of these measures. 12