Report No. 25685-BR Brazil Country Financial Accountability Assessrnent June 30, 2002 Brazil Country Management Unit Accounting and Auditing Unit LCOAA Latin America and the Caribbean Region ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~DT X GM12 A Abbreviadolns and Acrofnymns CAS Country Assistance Strategy CCF Fiscal Control Commission CFAA Country Financial Accountability Assessment CFC Federal Council of Accounting CMPOF Congress' Joint Committee on Plans, Public Budgets and Auditing CPAR Country Procurement Assessment Review CUT single treasury account DEST Department for the Control of State Enterprises (MOP) DGQUA General Coordination of Evaluation and Quality of Audits TCU) FY Fiscal Year GDP Gross Domestic Product GFS Government Finance Statistics IA Internal Auditing Unit (of indirect entities) IAPC International Auditing Practices IAS International Accounting Standards IFAC International Federation of Accountants IMF International Monetary Fund INTOSAI International Organization of Supreme Audit Institutions LDO Budget Guidelines Law LOA Annual Budget Law LRF Law on Fiscal Responsibility MOF Ministry of Finance MOH Ministry of Health MOP Ministry of Planning and Budget MOT Ministry of Transportation NGO Non-Governmental Organization OECD Organization for Economic Cooperation and Development OGU Annual federal budget proposal OLACEFS Latin American Organization of Supreme Audit Institutions PER Public Expenditure Review PFC Basic Accounting Principles PFM Public Financial Management PPA Multi-Annual (National) Plan PPF formal medium term rolling expenditure plan PREM Poverty Reduction and Economic Management Network (World Bank) 3 PSBR Public Sector Borrowing Requirement ROSC Report on the Observance of Standards and Codes SCI Federal Internal Control System SEAIN Secretariat of External Finance (MOP) SERRPRO Central information technology unit, STN SFC Secretariat of Internal Control (Federal Control Secretariat) SFPO Federal Planning and Budgetary System SG Secretariat of Management (MOP) SIAFI central financial management information system SIAPE central personnel management system SIDOR central budget information system SIEST information system, capital expenditures of state enterprises SIGPLAN program performance information system SOE State Owned Enterprise SOF Federal Budget Secretariat (MOP) SPI Secretariat for Public Investment (MOP) SRF Secretariat for Revenue (MOF) SRH Secretariat of Human Resources (MOP) STN Treasury Secretariat (MOF) TCE State Court of Audit TCM Municipal Court of Audit TCU Federal Court of Audit UNDP United Nations Development Program 4 BRAZIL COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT CONTENTS Paragraphs Objectives and Terms of Reference 1-7 Executive Summary ............................................ 8-26 List of Findings and Recommendations ............................................ 27-34 The World Bank's Relationship With Brazil ............................................ 35-40 The System of Inter-Governmental Relations ............................................ 41-49 Components of the Public Financial Management System ....................................... 50 The General Nature of the Budgetary System ............................................ 51-52 Organizational Responsibilities in the Budget Process ...................................... 53-59 Aggregate fiscal controls ............................................ 60-65 Scope of Budget ............................................ 66-70 Law on Fiscal Responsibility (LRF) ............................................ 71-75 Budget Preparation Issues ............................................................................................... Treatment of Personnel Costs ............................................ 76-79 Rigidities in the Budget Process ............................................ 80-89 Managing Contingent Liabilities ............................................ 90-92 The Multi-Annual Plan (PPA) ............................................ 93-107 The Budgetary Cycle ........................................................................................................ Process and Legal Framework ......................................... 108-113 Budget Preparation Dialogue ......................................... 114-118 Budget Review by Congress ......................................... 119-129 5 Budget l[mplemnentation . ..................................... 130 Expenditure Programming and Control ...................................... 131-139 Budgetary Adjustments Within Year ...................................... 140-146 Accounting and Cash Management Accounting Practices, Rules and Legislation ...................................... 147-148 Operational Description of Financial Management ...................................... 149-152 Accounting System - SLAFI ...................................... 153-156 Redevelopment of SLAFI ...................................... 157-161 Management of External Resources ...................................... 162-163 Reform of Debt Management Institutions ...................................... 164-165 Fiscal Tlransparency ...................................... 166-177 Internal and External Audit ...................................... 178-181 External Audit .....................................: 182-184 Institutional Independence and Autonomy .................................... 185-186 Types of Audit and Reports .................................... 187-188 Standards and Quality Control .................................... 189-190 Congressional Review of Financial Statements .................................... 191-196 linternal Audit .................................... 197-199 Institutional Independence and Autonomy .................................... 200-201 Types of Audits and Reports .................................... 202-206 Standards and Quality Control .................................... 207-209 Internal Auditing Units in Indirect Entities .................................... 210-211 6 CFAA TEAM David Shand Financial Management Advisor, Task Manager Patricia de la Fuente Hoyes Financial Management Specialist with assistance from the Brasilia Office Team Claudio Mittelstaedt Consultant Tulio Correa Financial Management Specialist Flavio Chaves Consultant and local consultants Joaozito Brito Macedo, and on the budgetary process Luiz Carlos Nerosky Silvio Caracas De Moura, Jr. on budget programming and execution Lucius Maia Araujo on the auditing process OBJECTIVES AND TERMS OF REFERENCE I1. While there has been no previous CFAA there is some pre-existing diagnostic work on Brazil's system of public financial management (PFM). A review of Brazil's fiscal management prepared in August 1999 contains a significant amount of information, albeit now slightly dated, on Brazil's PFM system . Much of this information, updated as appropriate, was used in the documentation in support of the 2000 Fiscal Reform Structural Adjustment Loan.' In addition technical assistance being provided on Brazil's multi-year planning system (PPA) by Bank PREM staff provides much valuable information on the planning and budgeting system.2 Recently a Country Procurement Issues Paper has been issued, in preparation for a planned Country Procurement Assessment Review (CPAR). 2. A fiscal transparency assessment published by the IMF in December, 2001, covers some of the topics to be covered in this CFAA.3 It also contains significant coverage of sub-national governments. Information from this assessment has been used in this review in a number of topic areas, and its findings are generally consistent with this review. 3. Other major source of information for this CFAA have been ' See Bank Report No. P 7427 BR, December 26, 2000. 2 PPA Review, Green Cover Report, September 17, 2001 3 Brazil: Report on Observance of Standards and Codes (ROSC) - Fiscal Transparency Module, IMF Country Report No.01/217, December 2001 7 - a mission to Brasilia and workshop held with representatives of central agencies in October, 2000 - local consultants' reports commissioned for this workshop, which covered budget preparation, budget execution and auditing. - a subsequent one week mission to Brasilia in August, 2001 for discussions with relevant officials. - a final one week mission to Brasilia in April, 2002 for further discussions with officials, including staff of the Congress Joint Committee on Plans, Public Budgets and Auditing, and with the country team. A first draft of this report was completed in December, 2001 and subsequently translated and forwarded to the Government in January 2002 for its review and comments. Extensive comments were received from SPI, SOF, STN and SFI and have been incorporated where appropriate, into this report. 4. In discussions in 2000 concerning this review, the Government indicated its interest in receiving a Bank perspective on its recent public financial management reforms and Bank suggestions on how it might further strengthen its public financial management. However its understanding was that this is not a formal Bank assessment which would be made available to outside parties without its agreement. Nevertheless this review in substance meets the requirements of a CFAA. 5. As with all CFAAs, this Brazil CFAA is also a "fiduciary" assessment, meaning it examines Brazil's PFM system to form a judgment on the risk to Bank and country funds within the Brazilian budget of which and the level of accountability and transparency conceming such spending are key components. This CFAA will also feed into the Bank's lending program, in particular a second Fiscal Reform and Structural Adjustment Loan envisaged in FY 03. 6. Partly reflecting the lack of a PER, this CFAA also focuses on "upstream" budget development issues, including the linkage with government planning system, as well as on "downstream" budget execution issues. It was commenced before the current CFAA guidelines were promulgated in September 2000, but in general reflects these guidelines, except that an action plan has not been included. The Govemment has previously indicated it did not see an action plan as an appropriate output of this review. Nor is the issue of financial accountability in the private sector covered, as it is in many other CFAAs 7. Sub-national govenmments are not covered in the CFAA, although paragraphs 41- 49 describe the system of federal financial relations, to provide an understanding of flow of funds from the national budget. EXECUTIVE SUMMARY 8. Brazil has a well developed and centralized system of public financial management. Overall it is able to reliably track budget expenditures. However the institutional arrangements and processes are complex. While they achieve good results in terms of aggregate fiscal control, they are less successful inachieving good expenditure prioritization and operational efficiency. 9. Brazil's central institutions, the Ministry of Planning and Budget (MOP), which is responsible for national planning and the development of the budget, and the Ministry of Finance (MOF) which is responsible for budget execution, with both having responsibility for budget monitoring, have good capacity and are professionally well staffed. However in such a divided institutional arrangement a key issue is ensuring appropriate coordination between the these two ministries, as well as between different secretariats within each ministry, for example between the Secretariat for Public Investment (SPI) and the Federal Budget Secretariat (SOF) in MOP. In general this coordination appears to work well, but it is an open question as to why each ministry should operate its own separate centralized information system (the SIDOR budgeting system operated by MOP and the SIAFI accounting system operated by MOF) even if these systems can communicate with each other. 10. There is a well established legal framework for the development, implementation and monitoring of the budget, starting with the Constitutional provisions concerning financial management generally, the multi-year National Plan (PPA), each year's Budget Guidance Law (LDO) and Annual Budget Law (LOA), along with the Law on Fiscal Responsibility (LRF). These legal provisions are observed. 11. The Brazilian government appears strongly committed to improving its public financial management. In particular it has undertaken two'o major initiatives in recent years, which significantly impact on public financial management * The Multi-Annual Plan (PPA) for 2000 - 2003 adopted a new approach aimed at improving resource allocation through a program based approach covering all budget expenditures - involving the setting program objectives and measuring performance. It is not yet clear how successful this ambitious undertaking will be in improving expenditure prioritization * The Law on Fiscal Responsibility (LRF) which appears likely to have a significant impact on reinforcing the commitment to fiscal discipline at the federal government level and enforcing greater fiscal discipline on sub-national governments. It has also made a major contribution to fiscal transparency The current major redevelopment of the central accounting system SIAFI is another example of this commitment to improvement. 12. Brazil's budget is comprehensive and there are no off-budget funds. There is good linkage between capital and recurrent expenditures in developing and implementing the 9 budget. A well functioning centralized budget information system (SIDOR) is used by MOP to develop the budget and to monitor implementation in terms of financial commitments. 13. The budget system incorporates a forward look, through its linkage with the four year National Plan - PPA and the multi-year fiscal targets set under LRF. A formal medium term rolling expenditure plan - the PPF, is currently being developed. 14. Budget execution in terms of cash payments, monitoring of cash flows and preparation of financial statements is carried out through a well developed centralized financial management information system (SIAFI), operated by MOF. First installed some 14 years ago it is currently being redeveloped through the SIAFI 21st century project, which includes technical assistance from the Bank. It provides reliable and timely information on actual expenditures. 15. SIDOR and SIAFI use the same classification system, so there is consistency between budgeting and accounting information. The systems communicate with each other through exchange of computer tapes. Although having such separate systems is not an ideal arrangement, in practice it does not appear to create problems. 16. There is a high level of fiscal transparency - reflected in the public availability of PPA, budget documents and laws, budget monitoring reports, the annual reports of the 1,100 federal entities and the federal government's consolidated financial statements or public accounts. The public accounts contain extensive information on a consolidated and disaggregated basis of both above and below the low financial transactions. Significant parts of all this information are accessible on government websites. Reporting is timely. However it is unclear how some of the information in the public accounts, such as real assets, is used and how it relates to international accounting standards. The public accounts are complex and difficult to follow (and have no audit report) and it would be useful to review their current form and content. The budget construction process is also transparent in its involvement of business and citizen groups and through the Congressional procedures for reviewing and passing the budget laws. 17. The two major audit institutions, the Court of Audit (TCU) which reports to the Congress and the Secretariat of Internal Control (SFC) which reports to President are professional in their approach, and have adequate operational independence. There is a need to ensure that internal audit units in indirect entities provide adequate support to management. One concern is that although SFC is an acceptable institution for the audit of Bank financed projects and the quality of thisaudit work is generally satisfactory, it is not assessed by relevant Bank staff as being consistently satisfactory, although its performance has improved in FY 02. 18. A greater concern in the audit area is the lack of a formal audit report on the government's aggregate financial statements, in accordance with auditing standards. Further, audit reports by SFC and TCU on the financial statements of individual entities are not in a form consistent with accepted auditing standards. TCU reports on the consolidated financial statements and on the annual reports of the 1,100 federal entities 10 need to be more timely. SFC reports on entity annual reports should be made fornally public. TCU reports appear to attract little interest, either from Congress or the public. 19. There are aspects of the budget system which need to be simplified and modernized. The budget system is fragmented and complex, in the following ways * substantial (and growing) earmarking of revenues to protect to certain spending areas, and the designation of certain expenditures as mandatory or priority. * civil service salaries and wages are centrally managed, separately from the main budget exercise. Ministries are thus not accountable for managing their personnel costs. * some lack of clarity on the relationship between the PPA and the budget exercise, including the formal budget being on a program basis but budget execution being on a ministry basis, with programs not always coinciding with organizational structures * frequent within year adjustments to the budget * budget implementation controls and monitoring being based on both commitments or obligations (managed by MOP) and on cash payments (managed by MOF). 20. While this complexity and fragmentation does not threaten aggregate fiscal control, it makes it difficult to achieve an allocation of resources in line with stated priorities. Budget execution does not fully reflect program priorities. 21. There are substantial differences for some individual ministries between initial budget allocations as set out in the annual budget law and actual budget out-turns, mainly under- expenditures. These reflect the need for the Executive to adjust the annual budget law figures because of unrealistic revenue (and thus expenditure additions) made by Congress. Other reasons may include poor project or budget planning by spending ministries and possibly subversion of PPA priorities by some spending ministries. They also reflect the many changes made to the budget during the year which occur for a variety of reasons. While spending ministries should not necessarily expect to receive their full (possibly unrealistic) budget allocation, there appears to be some unpredictability of funding in relation to the amounts set out in the Budget Execution Decree, which appears to have an adverse effect on project implementation and service delivery in some ministries. SOF and STN should jointly examine ways of increasing the predictability of funding to spending ministries. 22. There is a need for the Government, both the Executive branch and Congress , to review and simplify budgetary processes, to reduce unnecessary rigidities and to generally facilitate budgetary management by spending ministries. Although some of the complexities are the result of a federal system of government and the division of powers 11 between the Executive branch and Congress and would be difficult to change, some changes are possible in the medium term to long-term, as discussed in more detail below. 23. Congress plays an important role in the PFM system and may amend the budget legislation propose by the President. However it may not alter the figures for the civil service payroll, for debt servicing and for other legally protected transfers such as social security payments and transfers to sub-national government. It may alter revenue estimates if it perceives that the Executive has made "mistakes". It needs to adopt more realistic budgeting and would benefit from using independent professional advice in its work. The budget is permissive, not mandatory, meaning that the Executive may implement the budget differently than as passed by Congress; it may decide not to implement certain expenditures, in particular if the budget passed by Congress will breach fiscal targets. While Congress has significant involvement in budget construction, it appears relatively uninterested in following up matters of budget execution. 24. This review has not specifically examined issues of corruption in relation to Brazil's public financial management. It is difficult to draw conclusions in the absence of any systematic corruption diagnostics. However it may be noted that on the Transparency International Corruption Perceptions Index, Brazil is in the middle range. Its ratings have moved from 46h out of 88 countries in 1998, to 49th out of 90 in 2000, to 46'h out of 91 in 2001. 25. Notwithstanding the desirable improvements discussed above, the overall conclusion of this assessment is that the Brazilian system of public financial management provides reliable information. Adequate systems exist to manage and track the receipt and use of funds at national level and theDre is a high level of fiscal transparency, both of which would support any program of adjustment lending. The risk to both Bank and country funds is low. List of Findings and Recommendation 26. Personnel Expendituires Personnel expenditures should be integrated into the budgetary process and considered along with other expenditures, and required to be managed by ministries along with other expenditures. This may be achieved either by allocation of salaries to programs, which may be a complex exercise, or by giving ministries some discretion over the use of the personnel costs item. (However this would not alter the existing central arrangements for fixing salary levels) Either way, the impact would be to allocate personnel costs consistent with government program priorities, to require ministries to manage their overall salary budget and to provide them with incentives for economizing on and reallocating staff 27. Rigidities in the Budget Process - Overall earmarking appears to lead to difficulties in achieving expenditure allocations which are consistent with the priorities set out in the Multi-Annual Plan (PPA), discussed below. 12 - The Executive branch and Congress should note that the existing system of earmarking does not appear to be achieving its objectives, and should consider improving budgetflexibility through reducing or eliminating earmarking of revenues and designation ofpriority expenditures, - The focus should instead be on better developing a performance oriented budget system, with transparency on costs and results, as envisaged in the overall PPA approach. 28. The Multi-Annual Plan (PPA) There is a need to improve the linkage between planning and budgeting through general changes such as better coordination between SPI and SOF, between SOF and STN and between planning and budget units within ministries. More specifically the linkage could be improved by - allocation ofpersonnel expenditures to programs - increased ministry ownership of programs by better relating programs to organizational structures - reducing rigidities in the budget process, as discussed above. 29. Process and Legal Framework Congress should consider giving priority to the consideration and passing of Complementary Bill 135 30. Budget Review by Congress There is a need for Congress to adopt more realistic budgeting. It would benefit from using independent professional advice (possibly using the model of the US Congressional Budget Office). 31. Budget Implementation SOF and STN should jointly review budget execution arrangements with the objective of providing greaterfunding predictability to spending ministries The Executive and Congress should jointly consider ways of reducing the number of within-year budget adjustments. One option would be to consolidate all changes into a formal mid-year budget review. 32. Accounting and Cash Management Efforts to modernize and update SIAFI's technology should continue. These efforts should include consideration of synergies between existing systems, such as SIDOR, 13 SIAPE and SIGIE, that can feed valuable infonnation to SIAFI and increase its management capabilities. 33. Fiscali Transparency - the form and content of the aggregate annualfinancial statements should be reviewed, to make the information more understandable and relevant - consideration should be given to providing a role to the CFC as a professional organization, in the development ofpublic sector accounting 34. Internal and External Andit Both the SFC and the TCU appear to function adequately as professional audit institutions. However, a number of issues need attention o An audit opinion should be provided by TCU on the government's aggregate financial statements, in accordance with auditing standards o The audit opinions issued by SFC and TCU on the financial statements of individual federal entities should be in a form consistent with accepted auditing standards o The reports of TCU, both on the four volume report of the President and on the annual reports of the 1, 100 federal entities should be more timely o The audit reports of SFC on entity annual reports should also be made formally public o The relationship of indirect entities' internal audit units to SFC should be reviewed, to ensure that these units provide adequate support to management. THE WORLD BANK'S RELATIONSHIP WITH BRAZIL 35. The Bank has been assisting Brazil with its development efforts since 1949, since when it has financed over 240 projects, totaling some $24 billion. The Brazil program is the Bank's fifth largest in terms of lending volume with around over $8.4 billion in loans outstanding, covering 66 loans. The current active portfolio covers 55 projects totaling $5.7 billion, of which $2.9 billion has been disbursed. The program has three main objectives * poverty alleviation * support for structural reforms that promote economic growth * support for fiscal improvements to bring budget deficits at all levels of government under control. 36. The CAS program envisages a continuing mix of substantial investment and adjustment lending, and analytical work over the period 2000-2003. This includes adjustment lending in support of structural fiscal reform and specific improvements in fiscal institutions and public sector management. There was $2 billion of special adjustment lending in 1999-2000 and regular adjustment lending in 2001-02 will also total $2 billion. 37. Although the Bank's lending constitutes only about 5 percent of Brazil's external financing requirements, this is leveraged through a focus on improving the institutional framework for fiscal management. Investment lending is leveraged through financing a significant proportion of public investrnent spending and through targeting of high poverty areas in the north-east of the country. 38. Thus a considerable amount of recent Bank adjustment lending and analytical work has supported Brazil's program of fiscal reforms which focus on * achieving fiscal balance * improving the structure, assignment and earmarking of taxes * improving the allocation of budget resources and the efficiency of their use * improving debt management 39. Recent lending in this area has included * Fiscal and Administrative Reform Loan March, 2000, which focused on administrative reform and debt refinancing * Fiscal Reform Structural Adjustment Loan December, 2000 of $757 million to support improvements in aggregate fiscal discipline through 15 incentives for fiscal responsibility and to improve the allocation and operational efficiency of public expenditures. A second programmatic Fiscal Adjustment Loan is envisaged for FY 03. 40. Both the above loans also being supported by Bank technical assistance. Under a Financial Management Technical Assistance Loan of $8.8 million approved in April2001, the Bank is working with the Government in five areas - strengthening of the Multi-Year Planning system PPA, strengthening public debt management, implementing the fiscal responsibility framework, redeveloping the central SIAFI accounting system and improving project management. THE SYSTEM OF INTER-GOVERNMENTAL RELATIONS 41. Brazil is a federal republic comprising the federal government, 27 state governments and approximately 5,600 municipalities. Inter-governmental transfers are a significant aspect of the budgetary system - from federal state and local governments and from state to local governments.4 Under the 1988 Constitution sub-national governments have substantial operating autonomy, for example in determining their expenditure priorities. The larger states have significant own-source revenues and all sub-national governments receive legally based transfers from the national budget. In practice there is considerable overlap of responsibilities between the federal and sub-national governments in some areas, such as education and health. 42. The Federal government collects income, import, industrial product and payroll taxes. Around fifty percent of income and industrial products taxes and rural land tax are constitutionally mandated to be shared with states and municipalities (for example federal property tax is shared 50 percent with municipalities) and account for about 13 percent of federal expenditures. The states' independent sources of revenue are a value added tax and taxes on motor vehicles, services and real estate. While the system of direct taxation has recently been substantially reformed, reform of the complex system of indirect taxes, which would significantly impact on sub-national government finances, is now being considered. 43. Other controls exist over sub-national governments. The Constitution provides for the Senate to set limits on sub-national debt (although it Senate has not yet done this) and for Senate approval of any sub-national borrowing proposal. There are also limits on lending by banks to sub-national governments. Under debt relief programs negotiated with the federal government some states have been required to accept a package of fiscal targets. 4 See Brazil: Structural Reform for Fiscal Sustainability, (Report No. 19593-BR), Volume I, page 46 for further discussion. See also Brazil Issues in Fiscal Federalism, (Report No. 22523-BR), June 27, 2001 16 44. The Law on Fiscal Responsibility (LRF), discussed in more detail later requires all governments - Federal, state and local, to establish fiscal targets and to incorporate these in their annual budget guidelines law. One of its major objectives is to enforce greater fiscal discipline on sub-national governments, many of which have had a history of fiscal profligacy. LRF requires all governments to disclose fiscal results against these targets in regular budget monitoring reports and in their end of year accounts, all of which are required to be widely disseminated. 45. LRF provides for national reporting on the fiscal performance of all governments, including a consolidated set of financial statements covering all levels of govermnent, the accounts of the Union. However for 2000, the first year for these statements, not all sub-national governments were consolidated. While this position improved in 2001 there is still some way to go in consolidating all sub- national governments. 46. To facilitate realistic budgeting and sound revenue administration, sub-national governments which do not fully collect budgeted revenues cannot receive certain discretionary transfers from the federal government. (Major social sector expenditures such as health and education are protected as non-discretionary expenditures.) 47. LRF also impacts on sub-national governments through placing limits on personnel expenditures and on public debt as a percentage of current revenues, and through prohibiting inter-governmental lending except by public financial institutions. 48. States receive about 20 percent of their revenues from the federal government by way of general (revenue sharing) or specific grants, but transfers to municipal governments account for about 25 percent of their total spending. Municipalities receive about 70 percent of their revenues through transfers from the federal government. 49. Each state operates its own financial management system, which does not communicate directly with SIAFI, although several states have systems similar to SIAFI. All have to observe Law 4320 (see paragraph 52) and the budget classification system is generally the same across all levels of government. Each state has a State audit Court (Tribunal de Contas do Estados - TCE), but only the cities of Rio de Janeiro and Sao Paulo have Municipal Audit Courts (Tribunal de Contas Municipais -TCM). The accounts of all other municipalities are reviewed by their respective TCE. The professional capacity of TCEs appears to vary considerably between states. However many federal programs are implemented at the state or local level through transfers from the federal government. In these cases the federal government audit institutions have the power to follow the money through to the point of expenditure. 17 COMPONENTS OF THE PUBLIC FINANCIAL MANAGEMENT SYSTEM 50. The Presidential decree of June 27, 2000 defines the organization of the federal planning, budgeting, financial administration, accounting and internal controls systems as follows o The Federal Planning and Budgetary System (SFPO), administered by Ministry of Planning and Budget (MOP) o The Federal Financial Administration System, administered by Treasury (STN) o The Federal Accounting System, administered by STN o The Federal Internal Control System (SCI) administered by Federal Internal Control Secretariat (SFC) THE GENERAL NATURE OF THE BUDGETARY SYSTEM 51. Article 167 of the Constitution provides a detailed framework of financial controls. It prohibits the Government from - initiating programs or projects nor included in the annual budget law - incurring expenses or assuming obligations that exceed budgetary resources - borrowing in excess of the amount of capital expenditures - having special or supplementary appropriations without legislative authorization - reclassifying, reallocating or transferring funds from one program to another or from agency to another without legislative authorization - granting appropriations not limited by an amount - using funds from the tax and social security budgets to cover the deficits of - companies, foundations and funds - establishing any separate funds without legislative authorization - carrying out any capital expenditure going beyond one year which is not included in the PPA 52. The budget system, SFPO, is provided for in the Constitution (Article 165 , 9 II) and regulated by Law 4320 of 1964. Budget appropriations are formally to programs, rather than organizational units, as discussed later. The system provides 18 for control over the level of commitments, administered by SOF as well as control over cash payments, administered by STN. Although the formal budget is based on obligational or commitment authority, both commitment and cash payments controls are contained in the Presidential Budget execution decree, issued jointly by MOP (SOF) and MOF (STN). Organizational Responsibilities in the Budget Process 53. Budget and financial management responsibilities in the federal government are split between two central ministries, the Ministry of Planning and Budget (MOP) and the Ministry of Finance (MOF). The Federal Budget Secretariat (SOF) in MOP is responsible for the formulation of the annual federal budget proposal (OGU), and jointly with STN programming its execution once it is approved by Congress. Budget monitoring is also the responsibility of spending ministries themselves and of SOF and STN. SOF liaises closely with the Secretariat for Public Investment (SPI) in MOP, which is responsible for the PPA and budget capital expenditures, including negotiations on foreign funding of projects. It prepares the budget using a central budget information system, SIDOR. The MOF, through the National Treasury Secretariat (STN) is responsible for the control of and accounting for budget execution in terms of cash receipts and payments, and the financial programming needed for this, as well as for preparation of the financial statements. It uses the SIAFI central accounting system for these purposes. 54. Together these ministries exercise a strong "gate keeping" role in the budgetary process, and control the overall budget preparation and execution agenda. Reflecting the Brazilian civil service as a whole, the relatively high level of civil service salaries coupled with merit based recruitment and promotion have ensured a strong professional budgeting and accounting cadre in these ministries, and also in spending ministries. 55. However, this division of budget responsibilities, with each of the two ministries having its own separate central information system (although these two systems can communicate with each other electronically by way of exchange of tapes, and use the same classification system) presents potential problems of ownership and timeliness of information. However at present there is excellent high level cooperation between the two major units concerned, SOF in MOP and STN in MOF. 56. Previously the Fiscal Control Commission (CCF) established in 1998, comprised of senior officials from both MOP and MOF, provided a high level coordination mechanism. It monitored budget progress and developed measures necessary to achieve the fiscal targets At the time it was considered an important mechanism for bedding down the LRF, but by 2000 it was considered too formal and slow a process and was abolished. Currently senior officials of STN and SOF appear to consult regularly on budget implementation and there are formal consultations on the development of the following year's budget. 19 57. A Fiscal Management Council, comprising representatives of all three branches of government (executive, legislative and judicial), of federal and sub-national government as well as external parties, has been formally established, to provide coordination and consultation on overall fiscal strategies. However it is not yet operational. 58. The Department for the Control of State Enterprises (DEST) within MOP exercises oversight over the financial operations of federal state owned enterprises, using the SIEST information system, which covers the capital expenditures of state enterprises. Federal enterprise out-turns are monitored on a monthly basis and reconciled with the budget accounts on a cash basis, for calculating the primary budget balance of the federal SOE sector. 59. The Secretariat of Human Resources (SRH) in MOP manages the central personnel management system (SLAPE) and thus has overall control over the allocation of civil service salaries and wages and the information for the release of funds for the civil service salaries during budget implementation. However SIAPE covers only the civil service and not other areas of federal personnel expenditure such as the military. The Secretariat of Management (SG) in MOP manages personnel policy issues. Aggregate fiscal controb 60. Despite a history of significant budget deficits Brazil has significantly improved its fiscal results in recent years, and strongly so since 1999. It has achieved a primary budget surplus for all but two of the past ten years. A Fiscal Stability Program established in 1998 has transformed Brazil's fiscal situation. It sets ambitious targets for FY 2001 to FY 2003, with high primary fiscal surpluses of around 3.5 percent of GDP for each year. However as Table 1 indicates, net public sector debt has risen significantly, because of the impact of exchange rate changes on foreign currency debt (30 percent is designated in US dollars) and major arrangements for the refinancing of sub-national debt negotiated between the federal government and states (the level net debt increases because of the interest differential). The Table also indicates the improvement in the financial results of sub-national governments and state-owned enterprises. Table 1: Brazil - Consoldated Public Sector Borrowng Requfirement, Primary Defleit and Net Debt: 1996-202 (Percent? G LfDP} Year 96 97 98 99 00 01* 02* Total PSBR 5.9 6.1 7.9 10.0 4.6 7.9 3.9 Central govermment 2.6 2.6 5.4 6.9 3.2 5.9 3.1 Subnational governments 2.7 3.0 2.0 3.2 2.1 3.3 1.3 State-owned Enterprises 0.6 0.5 0.5 -0.1 -0.8 -0.3 -0.5 Total primary surplus -0.1 -1.0 0.0 3.2 3.5 3.4 3.5 Central government 0.4 -0.3 0.6 2.4 1.9 1.8 2.3 20 Subnational governments -0.6 -0.7 -0.2 0.2 0.6 0.8 0.6 State-owned Enterprises 0.1 0.1 -0.4 0.7 1.1 0.8 0.6 Net Public Sector Debt 34.4 35.2 43.4 49.4 49.6 56.3 56.5 Source: IMF *program figure 61. A previous problem has been unrealistic budgeting, on both the revenue and expenditure sides, although it has not led to the accumulation of payment arrears because of tight expenditure controls. To ensure fiscal control the Budget Execution Decree releases about ten percent less than the formal budget allocation to programs, to in effect provide a further general contingency reserve. Some expenditures in the past have been made contingent on the receipt of certain revenues or a level of revenues - mainly when Congress has added expenditure items to the Executive's proposed budget and inflated revenues estimates to cover them, a practice which appears to still be common. However the budget is permissive rather than mandatory and the Executive is not obliged to spend in full the appropriations passed by Congress in the annual budget law. 62. While LRF has not so far apparently prevented Congress from providing for additional expenditures by increasing estimates of revenue, under LRF the Executive cannot undertake spending which would result in the fiscal targets being breached. Budget execution must limit expenditure commitments if revenues fall below target. 63. Budget execution is based on monthly cash releases to ministries, set out in the Budget Execution decree, based on updated STN forecasts of cash receipts and payments. This means that programming of ministry funding is not directly based on the budget appropriations. 64. There is thus a considerable divergence for some ministries between initial budget allocations and actual expenditures for individual items, mainly under- expenditures. Under-spending on a considerable number of items reflects budget revenues falling below Congress' budget estimates, thus requiring downward adjustments in discretionary expenditure. In part it also reflects the many changes typically made during the year after the annual budget law is passed, through supplementary, special or extraordinary budget credits. It may also reflect poor budget and project planning by ministries or even subversion of PPA program priorities by spending ministries. 65. There are no payment arrears beyond a "normal" level of creditors (suppliers). The Budget Execution decree, which covers both commitment levels and cash payments, is normally set so as to avoid any increase in liabilities to suppliers. However the expected level has recently been increased to R 12.5 billion, or about eight to ten weeks of purchases, which total around R 60 billion per annum, from a previous figure of R 8 billion or about six weeks of purchases. 21 Scope of the Budget 66. The budget is comprehensive. It has three components, but all are combined into a consolidated budget o the fiscal budget, covering the expenditures of the Executive, Legislative and Judicial branches, and of the Attorney-General's Office, direct and indirect administrative entities and including foundations receiving public funding. (However under the Constitution the judiciary is able to set its own employment conditions and salaries, separate from other public employment, subject to the approval of Congress) o the social security budget, covering social expenditures - health, pension and severance payments and social assistance o the capital expenditures of state owned enterprises 67. The budget includes foreign financed expenditures - as does the PPA. However the budget is narrower than the PPA, as the latter includes projects which may be partly funded by the private sector. The budget figures differ somewhat from the overall fiscal targets; whereas the budget covers only the capital expenditures of state owned enterprises, the LRF fiscal targets cover their overall financial results. 68. Both recurrent and capital expenditures are fully integrated in the budget exercise. Autonomous agencies are handled in the budget the same way as ministries i.e. their total expenditures are appropriated. 69. There are no extra-budgetary funds, although there are a number of separate funds within the budget with certain earmarked revenues, such as the recently established Poverty Reduction Fund. Such funds can only be created by passing a specific law. The new Constitution prohibits off-budget spending, which had previously been common, without legislative authorization. Such funds within the budget may also carry forward balances to following years. 70. There is adequate reporting of tax expenditures. Operations between the budget and public financial institutions are transparent and there are no longer any significant quasi fiscal transactions involving these institutions. Likewise the relationship between the budget and state owned enterprises is also transparent, and their quasi fiscal transactions have been largely eliminated. A substantial privatization program has reduced the number of state owned enterprises, although government equity holdings remain high, particularly in the oil sector. State owned enterprises generally have substantially improved their financial performance in the past five years. LAW ON FISCAL RESPONSIBILITY (LRIF) 71. Passed by Congress in May 2000, and giving effect to the Government's 1998 Fiscal Stability Program, this is a major contribution to improved budgeting and 22 fiscal transparency. It covers the fiscal activities of the federal government and sub-national governments. It requires fiscal targets to be set for a three year period covering the revenues, expenditures, the overall and primary budget balance and level of debt in relation to GDP. Implicit in these targets is the "golden rule", permitting borrowing to be used only to finance capital expenditures; this is also set out explicitly in the Federal Constitution. Debt limits in relation to revenues, are also required to be established. LRF also sets limits for non-discretionary expenditures and for public sector personnel expenditures in relation to revenues. Personnel expenditures are limited to 50 percent of revenues for the federal government and 60 percent of revenues for sub-national governments. In addition net increases in non-discretionary expenditures mandated for more than two years cannot exceed the increase in permanent revenues. 72. LRF also includes mechanisms to bring the budget back on target if necessary, and to require realistic revenue forecasting. Unauthorized lending and granting of guarantees are forbidden. 73. LRF also makes a major contribution to fiscal transparency. It requires underlying economic and other assumptions behind the targets to be stated, and four monthly fiscal management reports on compliance with LFR targets. It also requires publication and wide dissemination of the budget laws, public accounts, public debt reports and the two-monthly budget implementation reports. Analysis and reporting of contingent liabilities and fiscal risks is also required in the budget documents. A register of public sector debt, which includes sub-national governments is also provided for. 74. Enforcement of LRF is based on both fiscal and legal remedies. Officials (the President, Ministers, state Governors and state Secretaries) may be subject to legal sanction. For example under the Fiscal Crimes law borrowing illegally, exceeding expenditure limits, undertaking unauthorized expenditures, increasing personnel expenditures in a final year in office or failing to reduce expenditure commitments and payments when required to do so by law may result in imprisonment, dismissal or fines. However there have not so far been any prosecutions for fiscal crimes. On the fiscal remedies side discretionary federal payments to sub-national governments may be withheld under certain circumstances, such as failure by sub-national governments to adequately collect their own taxes. 75. While such fiscal laws may be circumvented by opportunistic behavior and creative fiscal reporting, there is every indication at this stage that at the federal level LRF is treated seriously by the Executive branch, although to a lesser extent, by Congress. It has created a legal obligation for the federal government to achieve primary budget surpluses for the next three years, and this must also be consistent with the three year macro-economic scenario. However it is too early to judge how successful it will be in the medium to long term. The most significant current problem concerning fiscal discipline appears to be some lack of acceptance by Congress of the need for hard budget constraints and a realistic 23 budget. However Congress has not so far sought to amend the LRF fiscal targets proposed each year by the Executive. Both acceptance of and capacity to implement LRF may be a problem in some sub-national governments, but they are not covered by this review. BUDGET PREPARATION ISSUES Tlreatment of Personnel Costs 76. Overall control of staffing numbers is exercised by the Secretariat of Human Resources (SRH) in the MOP, which maintains a central personnel management information system SIAPE and publishes extensive data on the number and allocation of civil service employees. But staff budgeting is not integrated into the overall budgeting exercise. It appears that spending ministries have little involvement in or dialogue with SRH on total staff and their allocationRather, civil service salaries and wages are budgeted and controlled centrally, through the cross-ministry program for Administrative Support (Apoio Administrativo). The budget figures include civil service pensions as well as salaries, which in total amount to around one quarter of total budget expenditures. This support program is also separately allocated to each ministry. However it appears that ministries do not manage this part of the budget in that it is a fixed or non-discretionary item, determined for them by the Secretariat of Human Resources (SRH) of MOP.5 77. This approach reflects the fact the civil servants in Brazil may be dismissed only in limited circumstances and therefore that existing staff levels represent a fixed budgetary commitment.6 Nor are personnel costs allocated to programs, which are the basis of budget appropriations. However the hiring of staff under contract is now permitted. However MOP has indicated that it is looking at the possibility of including personal costs in program costs in the future. In addition the "establishment" (staffing numbers, gradings and organizational structure) for each ministry is established by Presidential decree, which makes changes difficult. This has led to arrangements to by-pass these decrees under which staff may be working in an area different to which they are formally assigned, but with budget allocations being nevertheless based on the formal establishment decree. Again, this does not provide accountability of spending ministries for personnel costs. 78. This current approach detracts from transparency of program costs and budgetary accountability of ministries. And it overlooks the fact the while staff may be dismissed only in limited circumstances, they may be re-allocated within or even between ministries, and that hiring of staff under contract is now permitted. The current approach gives ministries little or no incentive to economize on staff numbers or to seek to reallocate staff. From a budgetary perspective personnel are a "free good" to ministries. S However it appears that autonomous agencies have greater flexibility and are required to manage their staffing numbers and budget. 6 Under a recent amendment to the Constitution civil servants may be removed for poor performance - although it is not clear how extensively this power will be used. 24 79. Recommendation Personnel expenditures should be integrated into the budgetary process and considered along with other expenditures, and required to be managed by ministries along with other expenditures. This may be achieved either by allocation of salaries to programs, which may be a complex exercise, or by giving ministries some discretion over the use of the personnel costs item. (However this would not involve any change to existing central arrangements for determining salary levels) Either way, the impact would be to allocate personnel costs consistent with government program priorities, to require ministries to manage their overall salary budget and to provide them with incentives for economizing on and reallocating staff. Rigidities in the Budget Process 80. These rigidities arise from two related sources - earmarking of revenues to finance certain categories of expenditure and protection of certain expenditures from reductions. Although such arrangements may improve the stability of funding in some areas, they may equally result in "un-funded mandates" which cannot be implemented because of insufficient total funds. They may also be mutually inconsistent.7 81. There is considerable and increasing earmarking of revenues within the budget - about one half of total revenues. Although this earmarking is at a very broad level of expenditure classification and expenditures are inherently fungible, it reduces budgetary flexibility and complicates priority determination. About one third of tax revenues are constitutionally earmarked to social expenditures (education - which receives 18 percent of total revenues, health, retirement and severance payments). Payroll taxes are earmarked to severance payments, housing credits and education, and two percent of payroll taxes are earmarked for primary education. 82. Earmarking also occurs in the sense that such certain levels of expenditure must be appropriated and are then treated as "non-discretionary" and protected in budget execution. "Discretionary" expenditures are estimated by the Bank's review of PPA to account for only three percent of recurrent expenditures; investment expenditures have a much higher "discretionary element". Non- discretionary expenditures include civil service salaries and wages and payments of social benefits to people without means and others which are declared (by the annual budget Law) to be non discretionary. But this appears to simply recognize the reality that certain entitlements have to be paid, regardless of the budget situation, and does not represent any special earmarking or rigidity in expenditures, compared with say the budgetary systems of OECD countries. 7These rigidities are fiurther analyzed in the Bank's PPA Review, Green Cover Report, September 17, 2001 25 83. The 52 strategic programs in the PPA (reduced from the previous 80) also have priority over other expenditures, but it appears that this may conflict in some cases with the constitutional earmarking requirements. 84. In addition another high-level budget allocation requirement, the limitation on civil service salaries as a percentage of revenues (covering the Executive, Legislative and Judicial branches) set under LFR is a further potential rigidity or complexity in the budget process, despite its worthy objective of maintaining an affordable civil service wage bill. 85. In addition a new Poverty Reduction Fund has recently been created by Congress, amounting to about R 2 billion in 2001, creating further potential fragmentation within the budget. 86. A mechanism to reduce these rigidities is the Fiscal Stabilization Fund, which receives revenues from a notional twenty percent "tax" imposed on all earmarked revenues except transfers to the states and municipalities, so as to provide a source of funds to be allocated to other purposes. While this mechanism appears to have an important role in managing rigidities, it adds another layer of complexity and fragmentation. 87. There do not appear to be any other countries at Brazil's level of development with such institutionalized rigidities in the budget system. The only parallel appears to be the system of budgetary norms employed by centrally planned and some formerly centrally planned countries, which also in many cases appear not to be implemented in practice because of their complexity, unaffordability or mutual inconsistency. 88. It is doubtful whether the overall earmarking of resources in Brazil is achieving its objectives. To some extent it appears to reflect Congress desire to prevent the Executive from changing its priorities, through non-implementation of the budget passed by Congress. But it is in any case a poor substitute for a performance oriented budget system with transparency on costs and results, through the PPA, which Brazil would do better to focus on. The Bank's review of the PPA system8 establishes that overall the budgetary process performed relatively poorly in FY 2000 in protecting the funding of the PPA strategic programs. 89. Findings and Recommendation - Overall this earmarking appears to lead to difficulties in achieving expenditure allocations which are consistent with the priorities set out in the Multi-Annual Plan (PPA), discussed below. - The Executive and Congress should note that the existing system of earmarking does not appear to be achieving its objectives, and should 8PPA Review, Green Cover Report, September 17, 2001 26 consider improving budget flexibility through reducing or eliminating earmarking of revenues and designation ofpriority expenditures, - The focus should instead be on better developing a performance oriented budget system, with transparency on costs and results, as envisaged in the overall PPA approach. Managing Contingent Liabilities 90. Generally there has been active management of fiscal risks in the budget process, including contingent liabilities. LRF requires fiscal risks, including contingent liabilities to be reported in the Budget Guidelines Law (LDO). Most contingent liabilities relate to legal cases involving the Government, before the Courts. Contingent liabilities are clearly reported in the budget documents, and a new unit is being es,tablished in STN to assess and quantify contingent liabilities. 91. Guarantees are made mainly to sub-national governments, but in these cases a counter-guarantee such as a state on the sub-national government's revenue is obtained as collateral. Guarantees to the private sector are no longer significant. The issuing of guarantees is controlled by STN. Guarantees are required to be reported in the statement of contingent liabilities in the LDO. LRF forbids the issue of unauthorized guarantees. 92. Guarantees to state owned enterprises also exist, although the level of exposure has been reduced by privatization and by the now generally profitable nature of SOE operations. THE MULTI-ANNUAL PLAN (PPA) 93. The Multi-Annual Plan (PPA), coordinated by SPI, is presented by the President at the beginning of his four year term. Enshrined in the 1988 Constitution it reflects Brazil's longstanding commitment to social and economic planning. The Constitution requires that e Budget Guidelines Law and regional, sectoral or other national plans (and thus any amendments to them) be prepared so as to be consistent with the PPA. PPA is an internationally unique, if complex approach to integrating planning and budgeting. A key feature is its integration, through a program focus, of recurrent and capital expenditures 94. The Constitution and LRF require that the PPA cover all public expenditures, but do not prescribe in detail how plans should link with the budget. Beyond this there is no particular form or content for the PPA, and the current PPA is somewhat different in approach from the first PPA of the current administration, which covered the 1996-1999 period. The 2000-2003 PPA, Avanca Brasil, approved by Congress in July 2000, reflects the new programmatic classification (as opposed to the previous project based approach) and the four year spending figures also cover expenditures to be covered by external financing. Of its 388 27 programs (which include centrally managed programs such as civil service wages and salaries) many involve partnerships with sub-national governments or the private sector. However debt servicing payments and special debt programs and transfers to sub-national government are excluded from the programs. The previous PPA was less detailed, as well as not having the current programmatic approach. 95. The PPA is officially a fixed four year plan, rather than a rolling plan. It is required to be submitted to Congress by 31 August of the first year of the President's four year tern. It is based on a multi-year spending framework and forms the base for developing the budget. For example the first year of the 2000- 2003 PPA also constituted the 2000 Budget, prepared by the Executive. However it is not possible for the PPA to remain fixed and at the same time to guide changing fiscal circumstances. Otherwise the Plan and the budget will diverge. For example in 2000 the PPA was adjusted, following changes made to the budget by Congress. In future it will be updated annually. 96. In response to this issue MOP is transforming the PPA into a rolling multi-year expenditure plan, to be called the PPF, to better integrate multi-year planning with the annual budget. Ministers will also see the PPF when considering the PPA. But the numbers are not legally mandatory as in the PPA, and the PPF will be intemal to the Executive, and not provided to Congress. The PPF will provide indicative funding levels for the next four years (i.e. extending beyond the 2003 timeline of the current PPA), commencing in fiscal year 2002. 97. In its current form the PPA is seen as a key vehicle to improve resource allocation in terms of 28 key government priorities or "macro objectives". It is also seen as a vehicle for greater performance orientation in the public sector. It sets out objectives and targets of some 388 programs, which cover both recurrent and investment expenditures. Thus PPA has created programs which relate to govemment objectives and whose performance may be evaluated by use of various indicators, thereby laying a foundation for performance accountability. 98. Programs may cover activities by different ministries, thereby crossing ministerial boundaries. Some programs involve partnerships between the federal and sub-national govermments and the private sector. Some focus on infrastructure development (energy, communications, transport and water), including "eixos" which focus on infrastructure inter-connections between different parts of the country. Some 52 (reduced from 80 previously) are designated as strategic programs, including 10 "eixos". 99. The PPA is the starting point for the construction of budget requests by spending ministries. It also guides or is reflected in any strategic plans developed by 28 ministries. However the World Bank's recent review of PPA9 suggests a relatively weak link between sectoral strategies and the PPA. 100. In some cases program managers must operate across organizational boundaries, which requires a matrix form of management. However such program managers appear to lack resources and sufficient authority to ensure that the program is fully implemented by line ministries. To some extent this lack of authority is intended - program managers are seen as facilitators, catalysts, program monitors and sources of information, rather than as formal managers. However managers of strategic programs have greater authority. 101. Performance monitoring and evaluation is an important aspect of PPA, although this capacity is not yet fully developed. In particular SFC audits suggest that many programs have yet to develop adequate performance indicators. Program costings may in some cases also be inadequate. MOP is aware of these deficiencies and is working to overcome them. Program objectives are stated and performance indicators have been developed. A separate information system, SIGPLAN, which draws on information from the SIDOR, SIAFI and SIEST systems record this performance information which is used by SPI to monitor and evaluate program performance. SIGPLAN provides information on physical progress of programs in relation to costs. It may also record restrictions or reasons why program implementation is delayed. Program managers may use this information to seek action by line ministries or MOP to overcome program delays. However SIGPLAN is generally considered to need improvement. The redevelopment of SIAFI envisages a new module to support PPA planning and evaluation. 102. A comprehensive evaluation of programs and their consistency with PPA was - presented to Congress in April 2001. It appears that this evaluation was used in determining strategic programs for the 2002 budget. 103. - The current approach to the PPA is an ambitious attempt to coordinate the activities of different ministries so as to achieve broader government objectives, thus improving the prioritization and effectiveness of public expenditures. It is too early to say how successful this initiative will be. The World Bank is providing technical assistance to MOP to review and help refine the PPA process. Preliminary analysis suggests that so far the new PPA has not had a major impact in improving resource allocation. This may reflect the need for greater ownership . or programs by line ministries and the need to obtain a clearer link between PPA figures and line ministry spending allocations, for which a closer alignment of organizational structures and programs would assist, as well as more clearly linking PPA with sectoral strategies. 9 PPA Review, Green Cover Report, September 17, 2001 29 104.. It is recognized that there is a need to develop policy and program evaluation capacities both in spending ministries and in MOP. Translating the PPA into budget allocations of ministries which must implement the programs, appears complex. The programs are used as the basis for budget formulation but need also to be allocated to spending ministries for budget implementation. As mentioned above program costs focus on direct costs and do not include personnel and administrative costs - although it is proposed to progressively include personnel costs in programs, starting in FY 2003. 105. The need to better link planning and budgeting appears to be generally recognized by senior officials. In general the PPA is presented to Congress and discussed before submission of the annual budget law (LOA). However in 2000 the PPA and LOA were presented at the same time and Congress passed the LOA before the PPA, reflecting its greater interest in the expenditure details of the LOA than in the policies and priorities of the PPA. As a result some changes to the PPA were required to make it consistent with LOA. However in 2002 the revised PPA was submitted to Congress on October 4, before approval of the 2002 LOA. 106. The rigidities in the budget process (discussed in paragraphs 80-89 above) also impede the linking of planning and budgeting. 107. Findings and Recommendations There is a need to improve the linkage between planning and budgeting through general changes such as improved information flow between SPI and SOF, between SOF and STN and between planning and budget units within ministries. More specifically the linkage could be improved by o allocation ofpersonnel expenditures to programs o increased ministry ownership of programs by better relating programs to organizational structures o reducing the rigidities in the budget process, discussed in paragraphs 80- 89 above These issues are examined in much greater depth, along with more detailed recommendations, in the Bank's 2001 review of the PPA. 10 TIHIE BUDGETARY CYCLE Process and Legal Frameworrk ' PPA Review, Green Cover Report, September 17, 2001 30 108. The budget exercise proceeds according to a clear timetable and is a reasonably predictable and orderly process. The process is governed by a number of legal requirements, which are invariably observed. 109. The Budget Guidelines Law (LDO) managed by SOF, is submitted by the President every April 15 for approval by Congress by 30 June. It sets out background to and guidelines for preparing the next year's budget, commencing on I January, namely - the proposed medium-term fiscal targets currently targets for the primary budget surplus over the next three years - the macro-economic scenario for the next three years and the consistency of fiscal and monetary policy with this scenario - priorities (for 2000 the 28 macro objectives underpinning the PPA, and the proposed strategic programs ) - proposed changes in taxation laws. - the proposed capital expenditures and limits on unit costs of public works ( e.g. cost per square meter of new buildings) - a listing and analysis of fiscal risks, including contingent liabilities - the proposed level of the budget contingency reserve (one percent of expenditures in 2001). - detailed information on tax expenditures - the investment policy for official financing promotion agencies 110. In effect LDO provides guidelines for the preparation of line ministry spending budgets, and forms the link between the PPA and the annual budget law. However there is some question about the adequacy of this link, given the apparent ability of Congress to pass an annual budget law not fully consistent with the PPA, as discussed later. 111. Complementary Bill 135 of 1996, which seeks to better regulate the preparation and organization of the PPA, LDO and LOA. Has been under consideration by Congress for some years. In effect it is an organic budget law the absence of which requires inclusion of material in the LDO and LOA each year. Enacting it would also regularize other aspects of the budget system, and reduce the annual legislative burden. 112. The Annual Budget Law (LOA) is submitted by the President before 31 August for Congress approval before by 15 December, for the fiscal year commencing on I January. It includes revenue and expenditure data (original budget and 31 revisions) from the previous year. It sets out proposed expenditure allocations by program and proposed rules and limits on the reallocation of funds during the year. 113. Recommendation Congress should consider giving priority to the consideration and passing of Complementary Bill 135 Budget Preparation Dialogue 114. The development of the budget by the Executive branch is also a transparent process involving consultations with business and civic groups. 115. With the Budget Guidelines Law not being passed by Congress until around 30 June there is effectively only a two month period for bilateral discussions between MOP and spending ministries, before the finalization of the proposed annual budget law. However ministries may subsequently directly lobby the President, and even subsequently Congress, for changes. 116. SOF provides spending ministries with their proposed budget allocation once the Budget Guidelines law is passed, as well as a suggested detailed breakdown of the total allocation. This allows about a month for discussions between SOF and spending ministries before LOA is sent to Congress. This time period may not be sufficient for meaningful discussions between spending ministries and SOF. 117. Spending ministries have their own planning and budget units - but they may lack adequate cost information for good budget preparation. There may also be inadequate integration of the planning and budgeting function within spending ministries. The SIDOR system is also used by spending ministries in the budget construction exercise. However a survey of four of these ministries during the PPA review indicates that SIDOR does not adequately meet their needs in budget preparation. 118. There is a formal professional cadre of budget analysts and technicians. However staffing levels for budget construction do not appear to be high. Spending ministries appear to have only some 147 analysts and 124 technicians. The need for additional budget analysts in spending ministries, with a sound understanding of PPA and expenditure policy issues generally, should be reviewed. Budget Review by Congress 119. Congress comprises two chambers, the House of Representatives and the Senate, the latter in effect representing the states. Regional or state considerations appear to play a strong role in Congress' participation in the budget exercise. The role of Congress in the budget was significantly enhanced by the 1988 Constitution. All documents - the PPA and the annual LDO and LOA are considered by the Congress' Joint Committee on Plans, Public Budgets and Auditing (CMPOF) and 32 Congress can amend any of these documents. The Committee also examines additional budget credits proposed during the course of the year by the Executive. 120. The Committee appears to have around 30 professional staff to assist in its work, but not fully dedicated to budget analysis, and working also on the Committee's follow up of reports by the Court of Audit (TCU). It also receives assistance from the TCU in this latter role. It also has full access to all the budgeting and accounting databases of the Executive branch, including SIDOR and SIAFI. 121. The Committee's role in providing a coordinated congressional response to the Executive's budget is limited by the ability of thematic committees of the Congress to also propose changes to the budget, not necessarily coordinated with the Committee, and by the existence of a separate Taxation Committee, which examines budget revenue issues. 122. The LDO is presented to Congress by April 15 and is passed by Congress by the end of June, allowing two and a half months for consideration. Congress is able to change the fiscal targets proposed in the LDO but has so far chosen not to do so. 123. The LOA (annual budget law) is first examined by sectoral subcommittees, followed by the preparation of a general report. Public hearings are held, usually over a period of about fourteen days, adding to the overall transparency of the budget process. Congress has some three and a half months from receiving the draft annual budget law from the President, by 31 August until the required passing of the law by 15 December. 124. Congress may amend the budget proposals, in either LDO or LOA, except it may not alter the figures for civil service payroll, debt servicing or other legally mandated transfers such as social security payments and transfers to sub-national government, and technically may only alter revenue figures when it perceives the Executive has made a "mistake" Many amendments are proposed to LDO and even more to LOA. There are limits on the number of amendments to LOA which may be proposed - by each member of congress and by political groupings, and in relation to each state and ministry. These limits correct the previous situation where several thousand amendments would be proposed each year by individual members of Congress. For example in 1993 76,114 changes were proposed, of which 18,944 were actually approved by Congress. This reflects the strong local focus of Brazil's political system as well as the division of powers between the Executive and the Congress. 125. Any proposed changes must leave the annual budget law consistent with the PPA, but this is interpreted in general terms - consistency of program objectives and strategies rather than financial targets. Thus there does not appear to be any direct check on unrealistic adjustments by Congress to both revenue and expenditure figures. Congress has frequently added new items to the proposed budget and added to the revenue estimates, so as to appear to finance them. In practice such additions not genuinely covered by revenues have not been implemented by the 33 Executive. Congress therefore needs to adopt more realistic budgets and would benefit from using independent professional advice (possibly using the US Congressional Budget Office as a model.) 126. Thus the budget is permissive rather than mandatory and the Executive will make necessary adjustments through the Budget Execution decree and through other within year adjustments to ensure that the LRF fiscal targets are achieved. This is a major reason for differences between budget allocations and budget execution figures for some ministries, as discussed in paragraph However members of Congress may directly lobby MOF for the release of certain appropriations during the year. 127. However consistency of the budget passed by Congress with the PPA is not necessarily achieved even in terns of program objectives and strategies. This is reflected by the need to subsequently adjust the PPA following the passing of the annual budget law in 2000. As mentioned earlier Congress considered the annual budget law before it considered the PPA, reflecting its greater interest in the expenditure details of the annual budget law. 128. Congress generally submits its version of the LOA to the President by 15 December, to then be signed into law by the President before the commencement of the fiscal year. The President can veto any line item approved by Congress within 15 days. However Congress may override this by a majority vote in a joint session of the two chambers within 30 days of the veto. The LDO contains provisions to govern expenditure if the LOA is delayed for any reason. For example, the 2001 LDO permits continuation of non-discretionary expenditure such as personnel expenses, social security benefits and debt servicing payments. 129. Finding and Recommendation. There is a needfor Congress to adopt more realistic budgeting. It would benefit from using independent professional advice (possibly using the model of the US Congressional Budget Office) BUDGET JIMPLEMENTATION 130. Overall responsibility for budget implementation and monitoring rests with the Treasury Secretariat (STN) in MOF and with SOF in MOP. The budget implementation system is highly centralized and managed by STN in MOF through the central financial management information system (SLAFI) which was established in 1987, and a single Treasury account maintained at the Central Bank of Brazil, established in 1988. Expenditure Programming and Control 131. The President's Budget Execution decree, managed jointly by SOF and STN, provides for monthly cash releases to ministries based on updated forecasts of cash receipts and payments by STN following the poassing of the LOA. The 34 Decree is issued within 30 days of the passing of LOA; for the 2002 budget it was issued on January 10 and sets out in advance the proposed monthly releases to each ministry. This Decree is designed to ensure * timely release of funds to administrative units to carry out their work * maintenance of a balance between revenues and expenditure during the year Adjustments are made during the year to relate budget execution to the pace and level of revenue collections. In practice these adjustments affect only discretionary expenditures. Revenue estimation by the Executive is reasonably accurate and is based on appropriate techniques. 132. The Budget Execution decree also sets out limits for obligations or commitments to be entered into, this aspect of budget execution being managed and monitored by SOF. STN uses SLAFI for the programming of federal expenditures in accordance with the guidelines established in the Annual Budget Law (LOA). STN records the budgetary limits for each administrative unit in SIAFI from a magnetic tape prepared by SOF from its SIDOR system., following Congress' approval of the LOA. This establishes the annual commitment limits corresponding to the authorized budget credits of each ministry. STN then establishes the monthly disbursement limits for each ministry based on their authorized budget allocations. Thus the SIDOR and SLAFI systems are not directly linked they are able to communicate. Consideration is being given in the redevelopment of SIAFI, discussed below, to developing a direct communication link between the two systems. 133. STN releases funds to the ministries during the month - usually two or three releases each month in accordance with the monthly limits. These priorities affect both discretionary and non-discretionary expenses as established during the budget preparation process and in consultation with the MOP. STN also establishes daily limits for cash payments from the single treasury account (CUT). In releasing funds STN leaves to ministries decisions on how to allocate funds among discretionary programs, as long as the total for any program is not exceeded. 134. In practice the two objectives, timely release of funds and maintaining a balance between revenues and expenditures may conflict. Downward adjustments to expenditure allocations during the year are a regular feature of the Brazilian budgetary system. Administrative units comment on not receiving their full budget credits (but ministries would not necessarily expect to receive the full budget allocation - as mentioned above the Decree allocates less than the approved budget to "discretionary" areas of expenditure as a general contingency reserve, and in addition the Decree may allocate less than the budget allocation because of unrealistic budgeting by Congress), and some also comment on lack of predictability of resources. 35 135. This apparent lack of predictability of funding (and major variations from the initial budget) is confirmed by the Bank's review of the PPA,"1 which indicates the following variations during FY 2000. The level of allocations released to the Ministry of Health (MOH) programs was 98 percent of the authorized budget level, compared with 51 percent for Ministry of Transport (MOT) programs. Combined with increases in spending authorized during the year, by year end MOH had spent 16 percent more than the initial budget, compared with 18 percent less than the original budget in the case of MOT's expenditure. In MOT there was a rapid increase in the level of budgetary obligations at the end of the year as STN proceeded with significant releases of funds, as it became more certain of the availability of funds. 136. While MOT is one ministry where there is significant discretionary expenditure and where Congress frequently inflates expenditure allocations using unrealistic revenue estimates, it appears that there are still concerns by spending ministries about the predictability of funding indicated in the Budget Execution Decree. The same Bank review indicates that over one third of program managers complained that interruption to funding flows adversely affected program implementation. It is not clear, given the quality of Brazil's revenue forecasting within the Executive branch, why greater predictability in funding cannot be provided to spending ministries. However one factor may be STN caution because of its need to ensure that targets for the consolidated public sector (i.e. including those other parts over which it has limited control (state owned enterprises and sub-national governments) are achieved, not just those of the federal government. Nevertheless budget execution arrangements should be jointly reviewed by SOF and STN with the objective of providing greater predictability of funding to spending ministries. 137. As mentioned earlier, personnel expenditures are handled separately from other expenditures in the budget exercise and are a non-discretionary part of expenditures. Information on authorized levels of personnel is maintained by the Secretariat of Human Resources (SRH) in the centralized personnel management system SIAPE. Release of funds for the civil service payroll is based on information held in the SLAPE system and advised by SRH. However information from SIAPE must be manually entered into SIAFI, as the two systems cannot communicate directly with each other. This is being addressed in the redevelopment of SIAFI. 138. Throughout the year MOP's SIDOR and SIGPLAN systems extract data from SIAFI to monitor and control compliance with budget programming by spending units and to evaluate program performance under PPA. Modifications to the budget through additional budget credits and other reallocations of expenditure are inputted into SIDOR by SOF, and then passed to STN for entry into the SLAFI system. l PPA Review, Green Cover Report, September 17, 2001 36 139. SLAFI produces the two-monthly budget monitoring reports and the four -monthly fiscal management reports. The former report budget execution against appropriations and the latter are used to monitor progress against the fiscal targets, which differ somewhat from the budget format - for example fiscal targets include the overall results of state owned enterprises but the budget covers only their capital expenditures. Budgetary Adjustments Within Year 140. A significant number of adjustments is typically made during the year. These are of two types - reallocations of funds authorized by the LOA and changes to the LOA initiated during the year. Changes of the former type appear to be an increasing part of the total. 141. In general ministries have little flexibility to reallocate funds (and staff) during the year. Ministries are not permitted to reallocate between projects (capital expenditures) but have flexibility to reallocate funds between activities (current expenditures)- which may lead in some cases to their reallocating funds to programs which they perceive as a priority, but which may not reflect PPA priorities. The LOA generally authorizes the Government to increase the allocations of individual sub-projects or sub-activities up to a certain percentage, through allocations from other items or through the use of the budget contingency reserve established in the LDO (one percent of expenditures for 2002) 142. The ability of spending Ministries to reallocate funds between activities during budget execution has been seen as one reason for actual expenditures not necessarily reflecting the priority areas set out in the PPA. For this reason SOF is proposing a new method of protecting resource allocations to strategic programs by a system of monthly cash controls, monitoring program execution on a monthly basis and reallocating resources among discretionary strategic programs based on execution performance. This impacts on the role of STN in budget execution; however STN perceives it to be operating well. 143. There are many supplementary appropriation laws during the year, but they may be initiated only by the Executive. However under LRF the source of funding for any such a credits must be identified. These adjustments cover * supplementary credits, which may be implemented by Presidential decree. Typically these cover changes as a result of revenues being higher than forecast, of reductions in another appropriation or of an under-spend carried forward from the previous year. LOA sets limits as to how much any appropriation may be increased or reduced - usually about 10 percent. * special credits. These relate to changes such as new policies adopted during the year and approved by Congress. 37 o extra-ordinary credits, for urgent and unforeseen expenditure. . These arise from events such as natural disasters, and may be created by Presidential decree, but with subsequent approval by Congress. These credits are not always fully executed. For example in FY 2000 less than 60 percent were implemented. 144. Access to funds in the general budget contingency reserve provided for in LDO (one percent of total expenditures in 2001) is governed by a regulation issued jointly by SOF and STN. The President may be involved in decisions on the use of this reserve, which provides some budget discretion to the Executive branch. STN is mainly concerned with the issue of how much of the margin should be used, and SOF mainly with what it should be used for. 145. While the ability to make reallocations during the year may provide necessary flexibility, making it too easy may result in lack of attention to preparing a realistic budget and which reflects resource allocations in line with Government priorities. This may partly explain the many changes during the year to the Brazilian budget. 146. Findings and Recommendation. - SOF and STN shouldjointly review budget execution arrangements, with the objective ofproviding greaterfunding predictability to spending ministries. - The Executive and Congress shouldjointly consider ways of reducing the number of within-year budget adjustments, to encourage better formulation of the budget and to provide greater predictability in budget execution. One option would be to consolidate all changes into aformal mid-year budget review. ACCOUNTIlIG AiND CASE MANAGEMEPNT' Accountng Practices, Regilations and Legislation 147. Law 4320 of 1964 establishes the guidelines for accounting in the federal government (and state and local governments) covering financial and budgetary accounting, real asset and commercial accounting, and the preparation of financial statements. Complementary Bill 135 of 1996, still under consideration by Congress would institute further guidelines for financial systems, execution and control of budget plans, balance sheets and budgets, with a specific provisions on government accounting. 148. The principles and regulations governing public sector financial management appear to be applied consistently and uniformly. Laws have clearly established parameters and objectives which makes their implementation more transparent. 38 Operational Description of Financial Management 149. Responsibility for accounting, reporting and cash management fall under STN in MOF and the Central Bank. STN's responsibilities include supervision of budget execution, operation of the central accounting system SIAFI, management of public and external debt. consolidating the financial information of sub-national governments. The Central Bank provides below the line information on the consolidated public sector. 150. The STN uses a single treasury account (CUT), which is maintained at the Central Bank of Brazil, to manage federal funds. SIAFI records all CUT transactions. There is regular reconciliation of monthly budget execution reports with bank account information. Two ministries, Foreign Affairs and Defence operate separate bank accounts for special purposes, but nevertheless use SLAFI to record financial transactions and payment requests from these accounts. 151. All federal revenue collections must be transferred to the CUT. The CUT receives transfers from authorized banks which collect government revenues. These banks have up to two business days to complete the transfer to the CUT. Ministries and government agencies make payment requests through SIAFI system in order to access the CUT funds. 152. Resources and expenditures are classified in SIDOR and SIAFI using the same account code classification, meaning that budgeting and accounting information have a consistent format. The accounting classification, a mixture of functional and economic approaches which meets GFS requirements, has several levels. * Organizational unit (e.g., Senate, Ministry, University, Public Foundation, Naval ship etc.) * Function and sub-function (e.g., Education, young adults' education; Health, etc.) * Programs, based on the 388 programs contained in the PPA. Within each program, expenditure is classified on the basis of * Expenditure object (travel expenses etc.) * Source of Funding (taxes, transfers, external debt, etc.) * Nature of the transaction (e.g. asset, liability, capital etc) Once a transaction is entered into SIAFI, it can be traced by any of these classifications. 39 Accounting System - S]iFI[ 153. SIAFI is the centralized accounting system managed by STN, first implemented in 1987. It operates through an extensive telecommunications network, connected to spending units of all agencies of the Federal Administration, including those of the Legislative and Judicial branches, with links to foreign locations as well. The system is-centralized in Brasilia. It does not cover sub-national government, state owned enterprises and private-public companies. 154. SIAFI users include approximately 5,000 agency management units, equivalent to over 30,000 operators, who access the system on a daily basis. The users have access to functions including data entry, queries, and on-line access to information or printed reports. There are over 3,000 users from outside the Executive who have direct access to SIAFI, mainly TCU and members of Congress, the latter being a useful aspect of social control. 155. SIAFI is used from the registration of the initial budget through payments, receipts and other transactions to the issue of monthly and annual reports including the opening and closing procedures each fiscal year. The system performns the following general roles: - financial programming - controlling implementation of the Budget - centrally processing and recording all budget payments, including transfers to sub-national governments and public debt disbursements - receiving and recording revenues - producing the accounting statements and reports required by different management levels - managing and reconciling the single treasury account - providing access and reporting services for financial managers of administrative units Each transaction is entered only once, and automatically updates any related data. SLFI does not permit budget execution in excess of authorized limits. 156. SIAFI provides the necessary financial information to support federal financial administration even though it has some limitations due to the age of its technology. The information it produces is reliable and timely. Since its implementation in 1987, SLAFI has evolved significantly with the addition of various modules. However its inability to directly exchange information with other key government systems, such as SIDOR and SIAPE, has led to limitations 40 in data analysis and a lack of flexibility for managers to in querying and preparing reports with comparative information. Redevelopment of SIAFI 157. The govemment recognizes the need to upgrade SIAFI's technology and has developed the SIAFI 21St Century project to redevelop SIAFI. The new system will be structured around four basic subsystems. * budget, financial and real asset subsystem * asset and liability administration subsystem * LRF monitoring subsystem * intemal management of STN subsystem These reforms are being undertaken on a phased basis. 158. Additionally the integration with SLAFI, of the MOP performance information system for monitoring PPA programs SIGPLAN, is being considered, but the work is still in its preliminary stages. 159. With the redevelopment of SLAFI, its capacity to assist management will increase. The system will have the ability to prepare reports on program executiori versus planned targets and asset tumover rates and utilization. The auditing of financial data will become more efficient as almost all financial information will be contained in one system. 160. The redevelopment is being undertaken on a phased basis. However there have been delays, based on funding shortages. The redevelopment is being undertaken by STN's central IT unit, SERRPRO. It is important in this redevelopment that user needs be fully taken into account and costs adequately controlled. 161. Recommendations Efforts to modernize and update SIAFI's technology should continue. These efforts should include consideration of synergies between existing systems, such as SIDOR, SIAPE and SIGPLAN, that can feed valuable information to SIAFI and increase its management capabilities. Management of External Resources 162. Multilateral debt is managed by MOF and the Central Bank of Brazil. Within the MOP SEAIN is responsible for negotiating foreign loans, whether from private, governmental or international institutions. The MOF is represented on the Foreign Funding Committee located at SEAIN. MOF's role is focused on evaluating proposals to ensure compliance with fiscal objectives. The Central Bank of Brazil is responsible for receiving and managing these funds. 41 163. For World Bank financed projects separate Project Implementing Units exist, with their own financial reporting systems. STN is responsible for maintaining the Special Accounts in US dollars, distributing funds to the implementing ministries for payment of eligible expenditures, reconciling the Special Account, and reviewing Statement of Expenditures (SOE) and disbursement applications prior to final submission. Ministries are responsible for ensuring that project accounting information is inputted into SIAFI on a timely basis, as the project accounting systems are not part of SIAFI. Reform of Debt Management Enstitutdons 164. In 1998 the debt management function, covering both internal and extemal debt, was transferred from the Central Bank to STN, However, the Central Bank retains an important role in issuing federal securities in the extemal market. SLFI generates reports on intemal and extemal federal public debt, which are periodically reconciled with the Central Bank's data. A register of public debt covering all levels of government, required under LRF, is being developed by the Central Bank. A by a new unit in STN will monitor state and local government debt. 165. STN is upgrading its professional staffing and information capacities to carry out this debt management function, with technical assistance from the World Bank. Improvements include the creation of a debt analysis office. IFISCAIL TR~ANSPAREFNCY 166. Budget development occurs through a transparent process - both within the Executive branch and in the Congress. It is an orderly process, govemed by a legally established timetable as discussed in under budget preparation. This builds on another major transparent and consultative exercise, the development of the PPA. 167. There is a high level of public fiscal reporting in Brazil, given impetus by LRF. In terms of budget documentation, as discussed LRF provides transparency concerning budget assumptions (set out in the LDO) as well as information on fiscal plans, results and position, including fiscal risks, contingent liabilities and tax expenditures. The PPA , the Budget Guidelines Law and the Annual Budgetary Law, the annual Public Accounts (contained in General Balance of the Union report of the President), as well as TCU audit reports are all readily available to the public, much of it on government websites. "Sensitive" issues such as subsidies, tax expenditures and defence expenditures are fully disclosed in the budget documents. 168. In terms of within year reporting the following information is publicly available. (STN also publishes a schedule at the beginning of the year indicating the date its reports are expected to be available) 42 - budget execution reports (every two months) - fiscal management reports, which relate to LRF fiscal targets (every four months) - monthly (above the line) out-turns of the consolidated financial operations of central government including the Central Bank , published on STN website with a one month time lag - monthly reports on federal revenue collections, published by the Revenue Secretariat (SRF) within MOF, with a one month time lag - monthly report on financing transactions for the consolidated public sector - monthly reports on the level and composition of, the net debt of the consolidated public sector, published by the Central Bank - monthly reports on the implementation of PPA, prepared by SPI 169. Annually STN consolidates the financial information in SIAFI to prepare the aggregate financial statements for the federal government, which are part of the annual report of the President to Congress, the General Balance of the Union (Balanco Geral da Uniao) . This reporting is timely. The statements are submitted to Congress in a report by the President by 15 April following the end of the fiscal year. Once received by Congress they are referred to TCU which is required to report back to Congress within 60 days. 170. This four volume report of the President, prepared by SFC, includes both financial and non-financial information. Volume 1 contains general discussion of fiscal conditions and results, program performance information and the aggregate financial statements. These aggregate statements comprise - a budget implementation statement, comparing actuals with budget - a statement of financial transactions, showing all receipts and payments of the federal government, including non-budgetary receipts and payments, and including balances carried forward - a balance sheet, showing assets and liabilities of the federal government, divided into real, financial and non-financial , and a net balance , and changes during the year in the net balance resulting from budgeting and financial transactions, and from changes in real assets. The net balance (or equity) is broken down into capital, reserves and accumulated results. 171. The other three volumes contain the financial statements of direct entities (ministries and agencies), indirect entities (autonomous institutions and foundations) and state owned enterprises, the latter statements being prepared on a full accrual basis. The entities' statements also comprise a budget implementation 43 statement, a statement of financial transactions and a balance sheet. These statements have been subject to some auditing by SFC, although there is nor formal audit report by SFC. They are referred to TCU for its review and reporting to Congress (see paragraph 192). 172. Sub-national public accounts are required to be published by April of the following year. For FY 2000, STN commenced the development of the financial statements covering the entire Brazilian public sector - federal and sub-national govermments, to be available by mid-year, consolidating the information from SIAFI and from the Central Bank. However not all municipalities were able to be consolidated. It is intended that the FY 2001 statements will include all municipalities. 173. Extensive data on the number and location of civil servants is also published annually by SRH. 174. While overall this represents a commendable volume of fiscal transparency it is unclear how some of these detailed reports, such as the various balance sheets, are actually used in fiscal management. While information on financial assets and liabilities is used as part of debt management, it is not clear that the information on real assets is used in real asset management. Nor is it clear how the statements overall, relate to intemational accounting standards. These aggregate statements are complex, not well classified and difficult to follow and as discussed later have no audit report. There is a need to review the form and content of these statements to improve their understandability and relevance. 175. The Federal Council of Accounting (CFC), which was created in 1946 to regulate the accountancy profession has created a working group to develop accounting standards for the Brazilian public sector. Currently the financial statements are prepared under basic accounting principles developed by the CFC. However, it is not apparent to what degree the government supports this group or if any of their results have been useful and approved as standards, and how they relate to intemational accounting standards. Nevertheless, reflecting the lack of clear objectives or uses of these statements the Government could consider providing a role to the CFC as a professional organization, in the development of public sector accounting standards. 176. In addition to the comprehensive report of the President, an annual report prepared by each of the 1,100 federal entities, which contains an audit opinion from SFC. These annual reports are technically not publicly available, but can be obtained under Brazil's Freedom of Information Legislation if desired. The reports are required to be completed by 31 May each year, signed by the responsible minister and forwarded to TCU for their financial statements to be judged. The reports comprise - a list of authorities (who is responsible for what in the organization) 44 - the financial statements (the same as those contained in the earlier four volume report of the President - see paragraph 169 above). - report on activities all prepared by management of the organization - a certification by SFC on financial statements, legal compliance and efficiency (see paragraph 203) - a statement by the minister TCU then has one and a half years to prepare its report to Congress, although in practice it may take longer. 177. Recommendations. - The form and content of the aggregate annual financial statements should be reviewed, to make the information more understandable and relevant. - Consideration should be given to providing a role to the CFC as a professional organization, in the development of public sector accounting standards INTERNAL AND EXTERNAL AUDIT 178. The Brazilian Constitution provides for two main audit institutions * The Federal Secretariat for Internal Control (SFC), created in 1994, which since 2001 reports to the President (but previously was located within the Ministry of Finance), which is the Executive branch's internal audit agency * The Court of Auditors of the Federal Union (TCU), dating originally from the 1 890s, which is the external audit organization reporting to the National Congress, and covers all three branches of government - executive, legislative and judicial. TCU is the national audit institution in terms of membership of INTOSAI (International Organization of Supreme Audit Institutions. 179. The Presidency, Government Legal Office and Ministries of Defense and Foreign Affairs are not covered by SFC and have their own internal control secretariats, equivalent to the SFC. A Commission for the Coordination of Internal Control promotes harmonization of approach between these different institutions. 180. In addition all indirect entities (autonomous government bodies, foundations and state owned enterprises) are now required to have their own internal audit units 45 (lAs), which work closely with SFC. The financial statements of state owned enterprises are also audited by private auditors. 181. Audits are generally concurrent or ex post in nature. There is no general practice of ax ante audit, under which prior approval of transactions would be required from the audit institution, as is found in some other countries of the region. This places Brazilian auditing on a relatively professional and modem basis. EXTERNAL AuDrr 182. The National Court of Accounts (Tribunal de Contas de Uniao, or TCU) is the external control and oversight arm of Congress. Apart from other reports which are referred to it, for example by the SFC, the TCU also conducts inspections based on media reports or at the request of members of Congress. The President, with Senate approval, appoints three of the nine members of the Court. Two of the presidential appointees must be auditors or federal prosecutors from the TCU. Congress chooses the remaining six members, who are frequently former politicians. An autonomous public prosecution unit is also located within TCU. 183. TCU reviews the (four volume) annual report of the President including financial statements and non-financial information.. This review includes the appropriateness of tax collections and exemptions, the adherence to the fiscal targets set out in LRF and adherence to constitutionally mandated revenue assignments and expenditure allocations, including transfers to sub-national governments. It also exercises a broad performance or operational audit role and has chosen to issue reports on broad subjects such as the impact of Brazil's energy crisis. Other specific tasks include reviewing the legality of civil service retirement, severance and pension payments, the recruitment and dismissal of civil servants, acting on complaints of irregularities and reviewing the privatization of public enterprises. Much of this work is undertaken on a continuing basis through the year, drawing on SFC reports as appropriate. However for the financial statements the bulk of the audit work is undertaken by SFC and TCU does not carry out interim financial audit work. 184. TCU has approximately 2,000 staff although it considers it needs about 600 more to fill gaps in its work. Currently 900 are analysts and 1,100 are technicians although of these technicians, 800 are only partially involved in audits and investigations. All TCU staff are regular civil servants, recruited through a competitive process. TCU operates in a relatively decentralized way, with offices in 26 state capitals, as well as Brasilia. Institutional Independence and Autonomy 185. TCU's budget is set in the same way as for other administrative units, with Congress deciding the budget based on the budget proposals of the President. It has full operational autonomy in determining its work program for the year including any special projects that it wishes to pursue, and in the contents of its 46 reports. This preserves its independence and objectivity. It also has legal powers to prosecute irregularities identified by SFC, apply sanctions and present cases to the Attorney General for further legal investigation. It has right of access to any necessary to carry out its duties, including direct access to the SIAFI system. 186. TCU may also consult with Congress on what Congress would like to see in program of inspections, but Congress cannot directly determine the topic or content of such inspections. However, Congress can determine that a report contains insufficient informnation, and request further work to be carried out. Types of Audit and Reports 187. Inspections are carried out using different methodologies depending on their nature, such as performance audits, operational audits, system *audits, or monitoring of specific operations or management of public resources. Inspection are reviews of transactions or organizations, as opposed to audits, which involve the use of audit methodology, involving tools such as sampling and risk assessment. TCU carries out its inspections based on a two year plan prepared in consultation with the MOF and reflecting the results of inspections performed by SFC. 188. TCU sends quarterly and annual reports to Congress. All TCU reports are publicly available on its website. Standards and Quality Control 189. TCU is a member of two international audit organizations; the International Organization of Supreme Audit Institutions (INTOSAI), and the Latin American and Caribbean Organization of Supreme Audit Institutions. (OLACEFS). TCU abides by the standards issued by INTOSAI, which are the same standards used by SFC. 190. Apart from the Congressional review of TCU reports, there does not appear to be any other quality control mechanisrm in place. Congressional Review of Financial Statements 191. The TCU report on the financial statements (see paragraph 169 above) is in four parts reflecting the four volumes of the President's report - program perforrnance issues, the financial statements of direct entities (federal government organizations), the financial statements of indirect entities (organizations such as foundations, receiving funding from the federal government) and the financial statements of State Owned Enterprises. On the financial statements (but not including the aggregate statements), TCU issues a "preliminary opinion", to guide the discussion in Congress to either approve or not approve the statements, but does not issue a formal audit opinion in accordance with intemational auditing standards. Its preliminary opinion also appears to be based more on legal compliance issues than on accounting and auditing standards. 47 192. TCU has sixty days from the receipt of this report to provide its report to Congress. Congress then appoints an individual deputy or senator to review the statements and the TCU recommendation, and to recommend that Congress either approve or disapprove the statements. In the case of disapproval Congress can request TCU to conduct a further review of the statements. 193. Although TCU has submitted its recommendations as required for all years, this has sometimes been considerably after the end of the fiscal year. For example the recommendation concerning the 1998 financial statements was not submitted until some time in 2000. There is thus a need for more timely reporting by TCU. For 1996 and 1997 the designated deputy or senator has not completed the review work and made a recommendation to Congress. But more importantly Congress has made no final decision of approval or otherwise of the financial statements since 1995. 194. Thus this process of Congressional review does not appear to be functioning, although it needs to be seen in its political context. Any debate on approval or disapproval, involving a detailed discussion of the President's annual report provides an opportunity for opposition parties to attack the fiscal policies and record of the President. Approval or disapproval thus does not relate to the quality of the financial statements. But there also appears to be some lack of interest by Congress in reviewing past events, and a correspondingly greater interest in issues of budget construction. TCU reports generally appear to attract little Congressional or public interest. 195. However a key issue is that TCU does not issue any audit opinion on the aggregate financial statements, in accordance with international auditing standards. This situation is not fully consistent with the role of a national audit institution. 196. The TCU's audit report on the financial statements of the 1,100 organizations follows a similar format to the SFC's, except that it may add penalties and determinations, which are required to be implemented. TCU has 18 months from the receipt of these reports to prepare its report to Congress. Thus reporting is not generally timely. ]INTERNAL AUDIT 197. The Federal Secretariat of Internal Control (Secretaria Federal de Controle Interno -SFC) is the Executive's Branch central audit agency, reporting to the President. It covers direct and indirect federal bodies, except those under or linked to the Presidency of the Republic, the Ministry of Foreign Relations, the Ministry of Defense, and the General Solicitors of the Union. These entities have their own internal control secretariats, which report to their respective Ministers. 198. SFC is formally responsible for the federal internal control system (SCI) which is provided for in Article 74 of the Constitution. This system comprises 48 - assessment of compliance with goals set out in the PPA, in the execution of govermment programs and the budgets of the Union - verifying legality and assessing efficiency and effectiveness in the federal government's budgetary, financial and asset management - exercising control over borrowings, guarantees and the financial rights and receivables of the Union. - supporting the extemal control function (administered by TCU) in its mission 199. Staffing of SFC is currently around 1,400 but it has assessed its needs as around 3,500. A recent request for an additional 200 staff was proved and it anticipates that next year another 200 will be approved, moving to a total staffing of over 1,800. Institutional independence and Autonomy 200. The creation of SFC represented a centralization of the internal control system of the Executive Branch, at that time within the MOF. This departed from the previous structure under which Secretariats in individual ministries reported to their own Minister 201. SFC's staff are regular civil servants and its budget is established in the same way as for other administrative units. However it has extensive operating autonomy and the legal right of access to all available govemment information it needs to carry out its functions. Its operations are decentralized through 26 regional management units, although all work planning is carried out in Brasilia. Types of Audits and Reports 202. The SFC performs interim financial audits from June to December and then prepares reports from January to May. The audits are carried out for the Federal government as well as for projects financed by the World Bank, UNDP, Inter- American Development Bank and other multilateral sources. However the majority of the work focuses on audits of the federal financial statements including budget compliance, preparation of financial statements, operational performance results, strength and weaknesses of the internal control systems, legality of personnel payments, and control of assets. 203. In its reports on the financial statements of the 1,100 federal entities SFC provides a management report as well as the formal opinion. This audit opinion states whether overall the financial statements were prepared adequately or in a satisfactory manner, whether relevant laws and other requirements have been complied with and whether the organization has operated economically and efficiently, listing any exceptions to these. However this form of audit report on 49 the financial statements is not consistent with accepted auditing standards (which would refer to fair presentation in accordance with relevant accounting standards). 204. TCU has direct access to all of SFC's reports, workpapers, and databases. Usually TCU will select areas that SFC has identified as risky to probe further. This is especially true of SFC review of staff pension payments. This review is required by the Constitution and SFC uses a significant portion of its staff exclusively for this task. Based on the results of its review, TCU may then decide to probe in further detail any irregularities revealed. 205. In addition to financial audits the SFC undertakes performance audits of government programs. SFC has designed its own database to monitor program objectives, expenditures and results. Then using criteria to establish classify programs from small and non-essential programs to essential, SFC applies a statistical sampling method to select the programs to investigate. The focus is on the adequacy of planning and management informnation to support the program, rather than being a substantive program evaluation. As such, performance audits are carried out in less depth than financial audits During FY 2000 SFC performed 18,000 program investigations or inspections, compared with 3,000 financial audits. 206. SFC reports are not publicly available, although technically they may be obtained under Brazil's Freedom of Information legislation. SFC is intending to place its audit opinions on its website. Standards and Quality Control 207. SFC appears to use modem audit methodology, to have appropriate quality control arrangements. It uses intemational auditing and accounting standards promulgated by IAPC (IAS) and IFAC. 208. Intemal quality review of the audit work is carried out by the General Coordination of Evaluation and Quality of Audits (DGQUA). This review is carried out concurrently as well as ex ante, with a stronger emphasis on foreign financed projects. 209. The World Bank currently accepts audits performed by SFC to fulfill the annual audit requirements of Bank financed projects. Apart from minor delays in submitting the audit reports for certain projects, the audit reports have generally, but not consistently, met Bank standards. Internal Auditing Units in Indirect Entities 210. SFC has worked to strengthen the Internal Auditing Units (IAs) in indirect entities, such as autonomous bodies, foundations, and state owned enterprises. A recent decree requires that lAs be established in all indirect entities and provided with the necessary resources to assist the management of these entities. LAs have the role of examining and issuing audit opinions on the annual financial 50 statements of the entity and the Special Investigation Accounts (Tomadas de Contas Especias). This assists SFC in its own audit work on these financial statements; lAs are required to send their audit reports to SFC, which uses these reports in its work. 211. The SFC evaluates the performance of LAs. These evaluations have not yet been performed on a systematic basis as the working relationship between SFC and IAs is still being established. It appears that legally the IAs are support units that are subordinate to the SFC. As such there may be concerns that this will divert their focus from assisting entity management. 212. Findings & Recommendations Both the SFC and the TCU appear to function adequately as professional audit institutions. However, a number of issues need attention * An audit opinion should be provided by TCU on government aggregate financial statements, in accordance with auditing standards. * The audit opinions issued by SFC and TCU and the financial statements of individual federal entities should be in a form consistent with accepted auditing standards. * The reports of TCU, both on the four volume report of the President and the annual reports of the 1, 100 federal entities should be more timely. * The audit reports of SFC on entity annual reports should also be made formally public. * The relationship of indirect entities' internal audit units to SFC should be reviewed, to ensure that these units can provide adequate support to management. WB90540 L.\davjd\BRAZIL CFAA REPORT June 02 final doc July 11,2002 6.36 PM