PUBLIC FINANCIAL MANAGEMENT ISSUES IN GOVERNANCE AND ANTI-CORRUPTION

1. PUBLIC FINANCIAL MANAGEMENT ISSUESIN GOVERNANCE AND ANTI-CORRUPTION David Shand PFM Consultant dshand@worldbank.org February 14-16, 2006 Washington, DC

2. INTRODUCTION • SOUND PFM PRACTICES ARE A SIGNIFICANT ANTI-CORRUPTION TOOL - POOR PFM PRACTICES MAY FACILITATE CORRUPTION • MAJOR COMPONENTS OF SOUND PFM • Comprehensive and realistic budget • Clear allocations of responsibilities and accountabilities across all levels of management • Well designed and functioning systems of internal control • Reliable, relevant and timely flows of financial information to all levels of management • Sound revenue administration • Sound procurement practices • Independent, timely and competent external auditing and follow up

3. SOUND PFM COUNTERACTS CORRUPTION BY • Imposing discipline by setting out requirements of actors • Strengthening the probability of detection through information flows (audit trails) and review mechanisms • Creating a disadvantage for the corrupt – exceptions are needed for corruption to occur and this increases fear of detection • Protecting vulnerable areas – through identifying areas of higher risk (e.g. procurement, major capital projects are typically seen as higher risk areas) for particular attention • Facilitating auditing – by providing a system and information to audit • Permitting proper management and oversight through providing the necessary management information

4. BUT THERE NEEDS TO BE SIGNALS AND INCENTIVES • Observance of the rules and requirements • Consistent enforcement of the rules • Consequences of non-compliance

5. “FIDUCIARY” ISSUES • Fiduciary risk – important to demystify the concept • Best assurance that donor funds are well managed is the existence of a sound PFM system • Therefore developmental (helping improve PFM) and fiduciary concerns are complementary or inseparable • and using the same PFM diagnostic information • Donors need ex ante assessment and documentation of quality of PFM and procurement systems to inform decisions on financial support • Note that there are separate governance and anti-corruption diagnostic tools

6. “FIDUCIARY” ISSUES (cont’d) • Going in to financial assistance with “eyes open” – no assistance is risk free (just as there is never zero corruption) • Need to compare costs and benefits of the assistance, and determine our “risk appetite” or threshold • Fiduciary risk has been seen as a donor issue – but the country is equally concerned with the management of its funds • Just as good governance and anti-corruption activities are primarily the responsibility of the country , countries are committed to take the lead on PFM and procurement reform (Paris HLF etc)

7. RISK OF WHAT? • That donor funds may not reach the budget – diverted for unknown or unknown purposes (oil revenues ?) • That donor funds reach the budget but it is not known how they are spent because of lack of reliable and timely information on budget execution • That funds reach the budget but are not spent according to the budget – the budget is not executed • And/or are misspent on corrupt, wasteful or otherwise inappropriate purposes • Budget system may not focus adequately on poverty (PREM territory, not FM) • Note that issues other than PFM issues also influence these risks • Therefore the term “financial management risk” is increasingly used to indicate that PFM is only part of fiduciary risk

8. PAUSE FOR THOUGHT • Bank requirement that our funds are spent on the purposes for which they are intended? • What is meant by “intended purposes”? • If we mean the government’s budget, what if it is poorly constructed – inadequately prioritized and/or unrealistic? • How can we track funds in a budget support environment?

9. OTHER RISK CONCEPTS • Sovereign financial risk – risk of non payment • Development risk – assistance will not achieve the objective of poverty reduction • Reputational risk – perceptions may be real or otherwise of waste or corruption

10. POSSIBLE RISK MITIGATION MEASURES • Flow of funds issues – the funds reaching the budget • Review of the control environment of the central bank, through which Bank funds flow (IMF does this) • Audit of the deposit account • Quality of PFM issues • PFM improvement plans, technical assistance – the developmental objective (issues of realism, sequencing and country ownership are important)

11. POSSIBLE RISK MITIGATION MEASURES (Cont’d) • Requirement for timely, reliable and audited financial statements covering budget execution (frequently a major failing) – but rejected by the World Bank board in 2000 as a requirement for adjustment lending • Issues Concerning “appropriateness” of expenditures • Deeming or earmarking assistance to particular budget items (positive list) – virtual poverty funds • Requiring the funds to be deposited into a dedicated account, to be used only for designated purposes (again, a positive list) - real poverty funds

12. Possible Risk Mitigation (Cont’d) • Adopting a negative list - (defense, luxury items, nuclear reactors, jewelry, alcohol ) c.f. OP 8.60 Development Policy Lending • Given fungibility of budget resources, positive and negative lists are really “fig-leafs” , but may be important to lessen reputational risks • Both positive and negative lists may involve audit verification • Public expenditure tracking surveys (PETS) – did the funds reach the point of service delivery (assuming this was specified) • On all risk mitigation measures it is desirable for donors to coordinate and avoid short-term fragmented measures

13. USING THE PFM INFORMATION IN DECISION MAKING ON BUDGET SUPPORT • No minimum PFM standard established by the Bank for DPL • DPL may be supported in a weak PFM environment where there is country commitment to PFM reform, and PFM is improving • Therefore PFM improvements may be a result of rather than a precondition for DPL • PFM conditionality in adjustment lending – same issues as other conditionality, moving to prior actions rather than ex post conditions, fewer and more results oriented etc , using programmatic DPLs recognizing the long-term nature of needed reforms

14. KEY PFM ISSUES IN ANTI-CORRUPTION • PEFA PFM Performance Measurement Framework and CFAA Guidelines provide useful PFM framework • Comprehensive Budget • Limited off-budget accounts • What is “off-budget” ? • Transparency concerning off-budget activities • Realistic Budget • Unrealistic budgets cannot be implemented • Therefore in budget execution the formal budget may be replaced by a non-transparent system, of cash rationing – deciding who gets paid

15. KEY PFM ISSUES (Cont’d) Clear Allocation of Responsibilities • Budgets should be allocated to service delivery units • As opposed to being centrally controlled by an all-powerful finance director • In the latter case “intended purposes” is less clear • Authority should be clearly designated – whose approval is required for what? • But should not be overly complex – too many layers of approval may facilitate corruption

16. KEY PFM ISSUES (Cont’d) • Internal Control Systems • Is the system adequate? (control risk) • Does it operate as intended ? (inherent risk) • Should include appropriate segregation of duties • Should be clearly documented, with appropriate training for all actors • Should include internal audit • Mechanisms should not be overly complex - complexity may facilitate corruption • Staffing/payroll controls may be an important aspect (ghost workers, nepotism, etc

17. KEY PFM ISSUES (Cont’d) • Information Systems • Timely, reliable and relevant financial reporting is needed for management as well as for accountability • Computerized IFMIS assists in information integrity – but no need to over-design • Sound Revenue Administration • limited official discretion • clear and non-complex laws • transparency of tax-payer obligations • provision for review/ appeal

18. KEY PFM ISSUES (Cont’d) • Sound Procurement Procedures • Competitive bidding and transparent procedures • Avoiding excessive complexity • Provision for review/appeal • External Auditing and Follow Up • An external audit institution which has independence and capacity

19. KEY PFM ISSUES (Cont’d) • Focusing on systems as well as substantive cases “road conditions, not just traffic accidents” • And impact, through follow up of recommendations by Executive and legislature • But audit is not a magic bullet – cannot provide absolute assurance, and is not specifically tasked with uncovering corruption • And audit institutions may be corrupt, too

20. GENERAL ISSUE • What if requirements are simply not observed e.g. required approvals, submission of required reports etc • PFM therefore involves institutional issues (incentives etc), not just “technical” fixes • Do we adequately understand these institutional issues?

21. CONSIDER NOW THE PARALLELS WITH FINANCIAL MANAGEMENT IN INVESTMENT LENDING • Requirement for reasonable (acceptable) assurance that funds are spent on intended purposes - tracking the use of funds is possible • Prime responsibility for maintaining an adequate control framework rests with the country • Upstream diagnosis of the project financial management system, (FM Assessment Report) identifying risk areas and overall level of risk country, organizational and project specific • Importance of realistic budget, financial reporting for management and external monitoring (FMRs) and competent and timely auditing

22. PARALLELS WITH INVESTMENT LENDING (Cont’d) • Simplification of procedures – complexity may promote corruption • Use of country systems (i.e. the PFM system) is the preferred option where the system is acceptable • Desirable harmonization with other donors (sharing the risk ?) • Under SWAps, acceptance of pooling and no need to trace Bank funds to individual items • Note role of Department of Institutional Integrity (INT) – forensic auditing

23. PERFORMANCE MANAGEMENT INITIATIVES • Many performance management reform initiatives – results based management/budgeting, performance budgeting, etc. • This is PREM rather than FM territory (PERs, not CFAAs) • Corruption/poor governance will reduce reported performance levels • Reductions in performance over time or poor performance compared with other relevant areas (benchmarking) may indicate corruption • But be aware of the limitations of performance measures and of benchmarking

24. Discussion