Public Financial Management and Corruption Bill Dorotinsky Shilpa Pradhan May 2, 2006

2 Outline Introduction Introduction Definitions and Scope Definitions and Scope Patterns of Corruption and PFM Systems Patterns of Corruption and PFM Systems Measuring Corruption Measuring Corruption Entry Points and Mitigating Measures Entry Points and Mitigating Measures

3 Rome 70 BCE “[His] conduct of his naval affairs was not to defend the province at all. No, it was to extract personal financial profit out of what was meant to be expended on the fleet.” “The power of your position…..was enormous…….Yet it never….crossed your mind that these assets had not been placed in your hands … just to make it possible for you to treat any and every man’s possessions as your own personal loot….” * Conscripted sailors could buy out their service requirements, and the Governor simultaneously pocketed the pay and sustenance allowance for the sailor. From Governor’s trial on corruption charges Example of: Theft of public funds, bribery, abuse of office * Cicero, ‘Against Verres’

4 Introduction Governments throughout history have had a public financial management (PFM) system Governments throughout history have had a public financial management (PFM) system And corruption has always been a concern And corruption has always been a concern The development of PFM systems over time have been largely due to concerns over waste, fraud, and abuse The development of PFM systems over time have been largely due to concerns over waste, fraud, and abuse

5 Definitions Diversion of public resources for private (personal or other non-public) gain, or abuse of public authority and position for private gain Corruption is not necessarily Political leveraging Political leveraging Leaky Bucket Leaky Bucket Diversion of public resources from intended to another public purpose Diversion of public resources from intended to another public purpose All phases of public resource acquisition, safeguarding and use revenue collection and administration (tax, customs, and non-tax revenue) cash management and banking debt issuance and management asset management (physical and financial) budget preparation budget execution accounting and reporting internal control and audit procurement external audit and legislative oversight. Corruption Public financial management (PFM)

6 Basic PFM Functions Resource Acquisition Resource Safeguarding Resource Application taxes (cash, in-kind) non-tax revenue (fees, asset sales) debt (bonds, loans) labor land Treasury National Bank Warehouse Holding site (e.g. grainery) Investments Personnel Goods and Services Capital Debt Repayment Direct Transfers Tax Collection Customs Debt Management Draft Office, Ministry Requisition Office Skimming Receipts Under Collection Write-offs of receivables Lending Abetting draft dodging Staff for personal use Under pricing assets Theft Lending Skimming interest Favoritism in fund placement Unrecorded interest or delayed transfer of resources to Treasury Theft of assets Contract steering Fraudulent invoices Ghost workers Kick-backs Ghost beneficiaries Substandard goods Over pricing goods, services FunctionFunction IssuesIssues CorruptionCorruption AgentsAgents Treasury, MoF General Services Spending Ministries National Bank Land management agency Treasury, MoF General Services Spending Ministries Civil Service Admin Public Works Admin Procurement Office

7 Resource Safeguarding Resource Application Treasury National Bank Warehouse Holding site (e.g. grainery) Investments Personnel Goods and Services Capital Debt Repayment Direct Transfers Theft Lending Skimming interest Favoritism in fund placement Unrecorded interest or delayed transfer of resources to Treasury Theft of assets Contract steering Fraudulent invoices Ghost workers Kick-backs Ghost beneficiaries Substandard goods Over pricing goods, services Treasury General Services Spending Ministries National Bank Land management agency Treasury General Services Spending Ministries Civil Service Admin Public Works Admin Procurement Office Oversight and Accountability FunctionFunction IssuesIssues CorruptionCorruption AgentsAgents Internal Control, Management Control Internal Audit External Audit Accounting, Reporting Planning Bribery Favoritism Treasury Min Finance Min Planning Internal Auditor External Auditor Legislature Pres./PM-Cabinet Procurement Office Basic PFM Functions (2)

8 Basic PFM Cycle -review of prior year spending -setting policies and objectives for new year -planning future spending -drafting budget document -implementation of budget -managing resources -changing budget or managing PFM crises -collecting revenues, making payments In-year reporting; year-end reporting; accounting and recording External audit; legislative review; civil society

9 There are many weeds in the untended garden PFM system nature and quality will largely determine the ease with which public corruption can occur PFM system nature and quality will largely determine the ease with which public corruption can occur and also the risk and personal cost of detection.and also the risk and personal cost of detection. PFM system conditions enable corruption to flourish PFM system conditions enable corruption to flourish PFM systems where corruption can flourish are characterized by high informality and the absence of an ethos of professionalism in the public finance cadre PFM systems where corruption can flourish are characterized by high informality and the absence of an ethos of professionalism in the public finance cadre

10 Better PFM systems have lower perceived corruption

11 PFM Characteristics Enabling Corruption absence of rules and procedures for routine or annual processes (e.g. budget formulation, execution), or general disregard for rules and procedures where they exist absence of rules and procedures for routine or annual processes (e.g. budget formulation, execution), or general disregard for rules and procedures where they exist absence of records, record-keeping, for key transactions, or inability to access the information in a timely way for management control or audit absence of records, record-keeping, for key transactions, or inability to access the information in a timely way for management control or audit highly inaccurate, untimely, non-user friendly reporting, recording, or absence of procedures for testing accuracy highly inaccurate, untimely, non-user friendly reporting, recording, or absence of procedures for testing accuracy absence of controls on spending, goods, stores and equipment, or absence segmentation of key duties/roles in expenditure chain (the latter increases the opportunity for individuals to engage in theft or corrupt practices, while segmentation requires collusion and raises risk of detection and prevention) absence of controls on spending, goods, stores and equipment, or absence segmentation of key duties/roles in expenditure chain (the latter increases the opportunity for individuals to engage in theft or corrupt practices, while segmentation requires collusion and raises risk of detection and prevention) excessively complex or rigid procedures that impede routine program operations and create incentives for special spending procedures or breaking rules excessively complex or rigid procedures that impede routine program operations and create incentives for special spending procedures or breaking rules absence of sound, time-bound, explicit plans for using funds (budgets, necessary for management control and accountability) absence of sound, time-bound, explicit plans for using funds (budgets, necessary for management control and accountability) excess fragmentation of funds, procedures for accounting, reporting (making information consolidation, reporting and management control difficult) excess fragmentation of funds, procedures for accounting, reporting (making information consolidation, reporting and management control difficult) absence of staff or qualified public finance staff, or adequate training, no standardization of PFM positions across government (no cadre of PFM staff or professional ethos, inadequately compensated staff) absence of staff or qualified public finance staff, or adequate training, no standardization of PFM positions across government (no cadre of PFM staff or professional ethos, inadequately compensated staff)

12 PFM System Principles Countering Corruption Comprehensiveness Comprehensiveness - include all revenue and expenditure, all agencies, in common treasury, reporting, budgeting systems- include all revenue and expenditure, all agencies, in common treasury, reporting, budgeting systems Accuracy Accuracy record actual transactions and flows, report accuratelyrecord actual transactions and flows, report accurately Annuality Annuality funding allocations, budgets, and reports should cover a defined (stated) period of time (e.g. one year budget, multi- year forecasts) (with explicit accounting standards)funding allocations, budgets, and reports should cover a defined (stated) period of time (e.g. one year budget, multi- year forecasts) (with explicit accounting standards) Authoritativeness Authoritativeness only spend as authorized by law (budget and finance laws, statutes authorizing ministries and programs), and according to established proceduresonly spend as authorized by law (budget and finance laws, statutes authorizing ministries and programs), and according to established procedures Transparency Transparency information on spending is public, timely, understandable; rules are explicit, and publicly availableinformation on spending is public, timely, understandable; rules are explicit, and publicly available

13 Measuring Corruption Potential Directly measuring corruption is not feasible Directly measuring corruption is not feasible no direct measures of bribery, asset theft, contract steering, cash theft, etc. no direct measures of bribery, asset theft, contract steering, cash theft, etc. External audit capture only some corrupt practices External audit capture only some corrupt practices PFM system quality can be measured and monitored PFM system quality can be measured and monitored There is now an internationally-accepted set of actionable PFM performance indicators (PEFA) There is now an internationally-accepted set of actionable PFM performance indicators (PEFA) See See PFM system quality assessment measures corruption potential PFM system quality assessment measures corruption potential

14 PFM PEFA Indicators Budget Execution Accounting and Reporting External Audit and Oversight Budget Formulation 1.Aggregate expenditure out-turn 2.Composition of expenditure out-turn 3.Aggregate revenue out-turn 4.payment arrears 5.Classification of the budget 11.Orderliness in annual budget process 12.Multi-year perspective 13.Transparency of taxpayer obligations and liabilities 14.Effectiveness of taxpayer registration and assessment 15.Effectiveness of tax collection 16.Predictability of funds for commitment 17.Recording/management of cash, debt and guarantees 18.Effectiveness of payroll controls 19.Competition, value for money and controls in procurement 20.Effectiveness of internal controls 21.Effectiveness of internal audit 22.Accounts reconciliation 23.Resources received by service delivery units 24.Quality and timeliness of in-year budget reports 25.Quality and timeliness of annual financial statements 26.External audit 27.Legislative scrutiny of budget 28.Legislative scrutiny of external audit reports 6.Comprehensiveness of information 7.unreported government operations 8.Transparency of inter-governmental fiscal relations 9.Oversight of aggregate fiscal risk 10.Public access to key fiscal information Cross-cutting Indicators

15 Over-all PFM System Features Budget Execution Accounting and Reporting External Audit and Oversight Budget Formulation PFM Indicators and CorruptionIndicator Corruption Relevance PI- 5 Classification of the budget Enabling factor through transparency of government spending. A good budget classification enables good information on government activities for costing and budgeting, for planning, for monitoring and control of spending, and for auditing and accountability. PI- 6 Comprehensi veness of information included in budget documentati on The more information included in budget documents (greater transparency), the greater the ability of stakeholders to evaluate budget credibility, policies and intentions, and hold Government to account ex poste. PI- 7 Extent of unreported government operations A highly relevant issue for enabling corruption is the absence of reports on spending for some types of operations, frequently a characteristic of extrabudgetary funds, state-owned enterprises, and autonomous agencies. Related to this is the use of different accounting and auditing systems that make consolidation of accounts difficult, and opens reporting to errors. Honduras: 14 % of spending was recorded ex ante and ex poste as ‘assignaciones globales’

16 Budget Execution - Expenditure Budget Execution Accounting and Reporting External Audit and Oversight Budget Formulation PFM Indicators and CorruptionIndicator Corruption Relevance PI- 16 Predictability in the availability of funds for commitment of expenditures Predictable flow of funds to spending units is critical for plan fulfillment and accountability, and unpredictable funds flow leads to arrears and opportunities for discretionary decision-making and corruption in payment of government liabilities. Cash flows should be forecasted and monitored, and variations from predictions understood. Information needs to flow regularly to spending units on fund availability for program operations and fulfillment of plans. PI- 17 Recording and manageme nt of cash balances, debt and guarantees Absent records of debt incurred, there is no way of monitoring total debt and any irregular debt issued outside formal procedures, or debt improperly contracted or contracted at excessive rates. A formal system, with authorized officials, for contracting debt and issuance of guarantees is critical for accountability and minimizing opportunities for corruption or favoritism. Consolidation of cash balances is important for efficient cash management, and also safeguarding cash from improper transfer, theft, or lending. A single treasury account simplifies recording of payments and monitoring for irregularities, enabling better management control and accountability. PI- 18 Effectivene ss of payroll controls Absent payroll controls, funds can easily flow to fictitious employees, and nepotism and favoritism can be rampant. Important elements include the degree of integration and reconciliation between personnel and payroll records to detect anomalies, timeliness of changes to personnel records and payroll records, effective internal controls in personnel and payroll record management, and payroll audits to identify control weaknesses and ghost workers. Loan guarantees were non-transparent in Macedonia, issued by the Minster of Finance. Macedonia changed its budget law, requiring all guarantees to be approved by Cabinet and Parliament. Requests for guarantees stopped.

17 A Framework for assessing reform strategies Outliers

18 Key Challenges Type of States Key Challenges Fragile States (Guinea-Bissau, Haiti, Equatorial Guinea)  Low political leadership and managerial commitment to anti-corruption reforms  Absence of rules and regulations (authoritativeness) governing the budget process  Poor quality fiscal information  Civil Society is not engaged in the budget process  Absence of internal and external oversight Reforming States (Ghana, Armenia)  Improving the accuracy of fiscal information  Disregard for rules governing the budget process  Limited transparency of budgetary information  Ineffective internal and external audits  Sustaining political commitment to reform Capable States (Brazil, South Africa)  Increase performance orientation in public spending, increase coordination and integration between central institutions  Strengthening transparency, external audit and external scrutiny of public spending  Strengthening accountability and enforcement

19 High Level Focus & Sequencing of Interventions Fragile States  Build internal demand for information  Develop basic PFM systems Reforming States  Refine basic PFM systems  Progressively introduce complex PFM System reforms  Strengthen commitment for AC reforms Capable States  Implement complex PFM systems reforms with a performance orientation  Strengthen transparency, accountability and enforcement  Sustain commitment for reforms

20 Budget Execution Accounting and Reporting Budget Formulation External Audit and Oversight Fragile States Assessing Detail Interventions Key Issues that increase the risk of corruption in budget formulation:  Adhoc budget formulation and delays in budget formulation,  Limited or no involvement of key actors in budget formulation  Incomplete budget classification, budget classification system does not facilitate a direct link between programs and executing agencies and does not conform to international standards  Budget not comprehensive and budget documents are incomplete Suggested mitigating measures:  Increase internal demand for information  Strengthen the ability of the PFM system to capture the budget information Authoritativeness: Review the legislative framework for budget formulation to establish a timetable, with clear mandates for key actors (Political leadership commitment is key) Comprehensiveness:  Annual budget document to include all sources of revenues, expenditures  Strengthen budget classification: economic, administrative and functional

21 Fragile States Assessing Detail Interventions Budget Execution Budget Formulation External Audit and Oversight Accounting & Reporting Key Issues that increase the risk of corruption:  Irregular reconciliation of Bank accounts with government accounting data, existence of multiple accounts or the Single Treasury Account is not respected  Accounting books remain open for a long time after year end  Fiscal reports not being produced in a timely manner, are inconsistent and incomplete Key Issues that increase the risk of corruption: External audits weak, non-existent or politically captured Key Issues that increase the risk of corruption:  Cash management on a day to day basis  Absence of clear rules and controls during budget execution  Absence of payroll control  Absence of internal audits Authoritativeness in budget execution Establish budget execution procedures Regular reconciliation of Government accounts with bank data Regularity, timeliness of reports Establish external audit capacity

22 Reforming States: Assessing Detail Interventions Budget formulation Budget regaining its role as a primary resource allocation mechanism, budget increasingly realistic with actual expenditures closer to budgeted …… but budget still not a policy instrument Budget regaining its role as a primary resource allocation mechanism, budget increasingly realistic with actual expenditures closer to budgeted …… but budget still not a policy instrument Comprehensiveness of the annual budget document increasing Comprehensiveness of the annual budget document increasing Extent of unreported government operations is still high Extent of unreported government operations is still high Budget classification may not be along recommended economic, administrative and functional (including sub-functional lines) Budget classification may not be along recommended economic, administrative and functional (including sub-functional lines) Public Access to key budget information is limited Public Access to key budget information is limited

23 Reforming States: Assessing Detail Interventions Budget Execution Accounting and Reporting Budget Formulation External Audit and Oversight Key Issues increasing the risk of corruption in budget execution:  Weak cash planning and management (planning not based on realistic budgetary requirements of line ministries, no systematic review of cash forecasts) affecting predictability of funds for commitment  Weak internal controls during budget execution (controls on commitments may be poor or disregarded, weak controls on payments)  Weak quality of internal audits not conforming to international standards  Weak coordination between key actors during execution Suggested mitigating measures:  Recording and management of cash balances, debt and guarantees  Strengthen internal controls that manage risks, are comprehensive and are widely disseminated and understood  Strengthen internal audit process

24 Reforming States: Assessing Detail Interventions Budget Execution Accounting and Reporting Budget Formulation External Audit and Oversight Key issues increasing the risk of corruption (Accounting and Reporting):  Accounting procedures are not uniformly observed during record keeping  Weak internal accountability for not conforming with accounting procedures  Reconciliation is not regular and comprehensive  Inaccurate and inconsistent in-year budget reports  Inaccurate and inconsistent annual statement Suggested mitigating measures:  Streamline, disseminate and train staff on accounting principles  Incremental implementation of FMIS  Regularity in reconciliation of Bank accounts with government accounting books  Regularity and reconciliation of suspense accounts and advances  Consolidated annual statements are prepared which include full information on revenues, expenditures and financial assets and liabilities

25 Capable States: Assessing Detail Interventions Budget Formulation Generally high capacity of PFM systems and reliable tracking of public expenditures, well established and respected legal framework for the budget process, budget fairly comprehensive, integrated budgeting Generally high capacity of PFM systems and reliable tracking of public expenditures, well established and respected legal framework for the budget process, budget fairly comprehensive, integrated budgeting Budget Execution Fairly high adherence to well-developed Internal controls, good cash planning and management, internal audits functioning but may be limited to financial and compliance audits. Fairly high adherence to well-developed Internal controls, good cash planning and management, internal audits functioning but may be limited to financial and compliance audits. Accounting and Reporting Accounting standards adhere to established standards, timely accounts reconciliation, regular and accurate fiscal reports produced and made available to all key internal actors, and may be available to civil society Accounting standards adhere to established standards, timely accounts reconciliation, regular and accurate fiscal reports produced and made available to all key internal actors, and may be available to civil society There is room for improvement in the basic PFM systems and processes…..

26 Capable States: Assessing Detail Interventions Budget Execution Accounting and Reporting Budget Formulation External Audit and Oversight Key issues increasing the risk of corruption (External Audit, Oversight and Accountability):  External audit institutions are not independent and do not have clear mandate  Scope and coverage of external audit is limited  Audit reports not submitted to the parliament  Ineffective follow up of audit recommendations  Civil society engagement in budget formulation but not in audits Suggested mitigating measures:  Authoritativeness: Legislative mandates for independent external audit institutions with clear mandates, coverage and scope  Develop clear and timely follow up procedures  Timely submission of audit reports to the parliament

27 Back to the Basics….. Mitigating the risk of corruption in public expenditures, is as much about strengthening technical capacity of PEM systems as about changing institutions, both formal and informal, within which the system operates. Improvements to PEM system performance occur in incremental steps with the fundamental elements of expenditure management strengthened before more complex reforms can be undertaken Sustaining reforms requires (i) commitment from stakeholders in the budgetary process, in particular the implementers of the budget, and (ii) capacity of key budgetary departments. Reforming the PFM systems can be a large and complex undertaking which requires strengthening the interlinkages between the different elements of the system and the principles underlying the PEM systems.

28 Q & A