Report No. 29693-TJ Tajikistan Country Financial Accountability Assessment June 22, 2004 Operations Policy and Services Unit Europe and Central Asia Region Document of the World Bank Tajikistan: Counfrv Financial Accountability Assessmenf i TABLE OF CONTENTS TABLE OF CONTENTS .................................................................................................. i PREFACE ........................................................................................................................ i11 EXECUTIVE SUMMARY ............................................................................................. V ICOUNTRYCONTEXT . ................................................................................................ 1 Governing Structures .............................................................................................................. 1 EconomicProspects and Public Sector Reform ...................................................................... 1 Strategic Directions and Policy Dialogue............................................................................... 2 I1 PUBLICSECTOR BUDGETMANAGEMENT . ...................................................... 5 Budget Comprehensiveness- TheLegislative Framework..................................................... SovietLegacy and Progress to Date ....................................................................................... 5 5 Budget Planning and Approval ............................................................................................... 6 Budget Execution: TheRole of Treasury................................................................................. 7 Cash and Debt Management ................................................................................................... 8 Budget Classification .............................................................................................................. 9 Recommendations.................................................................................................................. I O I11 PUBLICSECTORACCOUNTINGAND FINANCIAL REPORTING . ............11 TheSovietLegacy..................................................................................... ........................ 11 Accounting and Reporting by Line Ministries.......................................... ........................ 11 Treasury Accounting ...................................... .................................................................. 12 External Reporting......... ............................ Integration of Public Sec Accounting ........................................................... ..........................................................................13 14 Recommendations.................................................................................................................. 14 I V INTERNAL CONTROL AND INTERNAL AUDITING . ..................................... 15 15 LegislativeFramework.......................................................................................................... TheSoviet Legacy and Transition to Date ............................................................................ 15 Treasuiy Internal Audit Department..................................................................................... 16 Implementation Issues and Concerns.................................................................................... 16 Recommendations.................................................................................................................. 17 V EXTERNAL OVERSIGHT OF PUBLIC FINANCIALMANAGEMENT . .........18 A. STATEFINANCIALCONTROLCOMMITTEE ................................................................ 18 Legal Framework -Lack oflndependencefrom the Executive Branch................................ 18 Scopeof Responsibilities ....................................................................................................... 18 Activities and Procedures...................................................................................................... 19 Dissemination of Audit Findings ....................................................................... StafJing.................................................................................................................................. 20 Audit Methodology ................................................................................................................ 20 B.Links betweenInternal and External Audits. and other State Supervisory Activities ...........21 LEGISLATIVE OVERSIGHTOF THE EXECUTIVE ........................................................... 22 Constitutionaland LegislativeBackground.......................................................................... 22 Checksand Balances within Parliament............................................................................... 22 Recommendations............................................ .............................................................. 23 VI. STATE-OWNED ENTERPRISES ......................................................................... 24 Tajikistan: Countrv Financial Accountability Assessment ii Overview........................ ............................................................ TheImportance of Quas cal Expenditures................................. Financial Management..................................................................... Internal Controls. Internal and External Audits ................................................................... 25 Recommendations.................................................................................................................. 27 VI1 LOCAL GOVERNMENT AND COMMUNITY-LEVEL INSTITUTIONS . ....28 Background ........................................................................................................................... 28 Local Government Budgets ................................................................................................... 29 Accounting and Treasury Systems......................................................................................... 30 Reporting............................................................................................................................... 30 Internal Controls and Audits ................................................................................................. 31 External Oversight................................................................................................................ 31 Recommendations.................................................................................................................. 31 VI11 ACCOUNTING AND AUDITING INTHE PFUVATESECTOR . ...................33 Background ........................................................................................................................... 33 Financial Reportingfor Enterprises ..................................................................................... 33 Auditing ................................................................................................................................. 33 TheProfession ....................................................................................................................... 34 Capacity Building.................................................................................................................. 34 Recommendations.................................................................................................................. 35 I X BANKINGARRANGEMENTSINTAJIKISTAN-FIDUCIARY ISSUES . .....36 Overview.,....................................................................................................................... National Bank of Tajikistan................................................................................................... 36 Prudential Requirements and Risks in the Banking Sector ................................................... 37 X PORTFOLIOFIDUCIARY CONSIDERATIONS . ................................................ 39 Reliance on Public Sector Financial Management Framework ........................................... 39 Project Financial Management............................................................................................. 39 Issues in the Country Portfolio Pe$ormance Review ........................................................... 39 Project Financial Management Staff .................................................................................... 40 Project Financial Management Systems............................................................................... 40 Audit Arrangements............................................................................................................... 40 ANNEX 1 DEVELOPMENT ACTION PLAN - ANNEX 2: EXECUTION OF REVENUES AND EXPENDITURES OF LOCAL, BUDGETSIN2002 LIST OF BOXES: Box 1 .Selected Macroeconomic Indicators. 1998. ............................................................. 2002 2 Box 2 .Contents of Annual Accounts of StateBudget Execution ................................................ 13 Box 3 .InternationalFederationof Accountants (IFAC) . Accounting Standardsfor the Public Box 5 - Measurement o f Impact in S A I -UKNational Audit Office ........................................... Box 4 - Standards for the Professional Practice of IntemalAuditing (SPPIA) ............................. Sector..................................................................................................................................... 14 17 21 Box 6 -Case Study - Tajik AluminumPlant -TADAZ ............................................................... 26 Box 7 -Community-based activities inTajilustan........................................................................ 29 Tajikistan: Countrv Financial Accountabilifv Assessment iii PREFACE This report was prepared after missions to Tajikistan in2002 and 2003 by a Task Team comprisingAndrew Mackie, Task Team Leader, (ECSPS), Sandro Zanus Michiei, Lead Financial Management Specialist (ECSPS) ,Allen Wazny, Senior Financial Management Specialist (ECSPS) and Aziz Khaidarov, Local Research Consultant. The team cooperated closely with Bank staff who were engaged in a Public Expenditure InstitutionalReview (PEIR) conducted duringthe mission, which included Roland Clarke andTonyVerheijen, Senior Public Sector Management Specialists. The report is based on interviews with officials and staff at public institutions, as well as on detailed analyses o f laws, documents and other information. Government counterparts lent their full and proactive support and engaged with the Bank team in a comprehensive dialogue about the issues identified by the assessment. A draft CFAA was submitted to the Government in June 2003 and the Team conducted a workshop in Dushanbe in October, 2003, when it discussed the findings o f the Report with participants and senior government officials. The Bank is grateful to the Government o f Tajikistan for this cooperation. Scope of the Report This CFAA concentrates principally on public sector financial management. Its results will serve as a fiduciary tool in developing future lending strategies for Tajikistan and highlight areas where the donor community can support the Government's public sector reform program. The CFAA also clarifies the Bank position regarding the financial management o f on-going projects, particularly on the capability o f Tajikistan's institutions in the area o f public financial accountability. The CFAA complements the PEIRandCPAR, botho fwhich will becompleted inthe next twelve months. Purposeof the Report A CFAA considers the strength o f the financial accountability framework in both the public and private sectors. The aim is to assess whether existing practices can ensure proper use o f funds- both the country's own resources as well as those provided by the Bankand other institutions. A key aim is to assess the risks that the financial accountability framework poses for implementing Bank programs and usingBank funds, and to propose suitable measures to manage them. It also supports dialogue with the borrower country and development partners on financial accountability matters, and helps design programs to build financial management capacity. While a CFAA diagnoses a country's financial management systems, it i s not an audit and does not assure that all hnds are being used for their intended purposes. Rather, it provides a well-informed and objective assessment o f the strengths and weaknesses o f financial management systems, a diagnosis o f problems and advice on their resolution, and an indication o fthe level o f financial risk. Tajikistan: Countw Financial Accountability Assessment iv Each CFAA i s expected to evaluate the following aspects o f a country's public and private sector financial management: Budget development - comprehensiveness, realism, classifications and processes Budget execution and monitoring - intemal controls, information systems, cash flow and debt management Extemal fiscal reporting and transparency Internal and external audits Legislative scrutiny o fbudget execution State-owned enterprises -transparency, governance, monitoring and supervision Accounting professioncapability and education Fiduciary risks inBank- assistedprojects. In the context of a country's governance environment, the executive arm of the Government i s obliged to safeguard public resources and use them properly; also, it must provide a credible legalhegulatory framework to promote good financial governance in both private and public sectors. The institutional and legalhegulatory regime created to provide this assurance constitutes a country's public financial accountability framework. Inthe private sector, the framework should provide reasonable assurance that financial operations are conducted properly and that investments are managed with due care and protected from fraud and misuse. Scope andterms of referenceof CFAA The scope and terms o f reference o f the CFAA were articulated and agreed both internally within the Bank and externally with the Government o f Tajikistan inthe CFAA Initiating Concept Memorandum of February 3,2003. Acknowledgements The Mission wishes to acknowledge the extensive cooperation and assistance received from officials and staff o f the public organizations, state agencies and other institutions interviewed. Gratefbl thanks go also to the Bank's Public Expenditure Institutional Review task team as well as the staff o f the World Bank funded Institutional Building and Technical Assistance I1Project for their considerable research on which a significant proportion o f this CFAA i s based. Cevdet Denizer, Country Manager, ECCTJ provided extensive in-country assistance and invaluable advice. John Hegarty, Financial Management Manager, ECSPS and peer reviewers David Shand, Financial Management Adviser, OPCFM; Alma Kanani, Senior Public Sector Specialist, SASPR; and Peter Dean, Consultant, offered much appreciated comments and inputs; and Ana Cristina Hirata andRoula Balkash, ECSPS assisted with the editingand formatting ofthe report. Tajikistan CFAA: Executive Summarv v EXECUTIVESUMMARY Tajikistan's economic and political transition until 1997 was largely influenced by two factors: The loss of transfers from the former Soviet Union and the civil war that erupted in 1992. The signing of a peace accord in 1997 brought a more stable political environment but the country faces several issues which make future development extremely challenging: For example, it is geographically isolated, has under-developed natural resources and shares 1,200 kilometers o f border with Afghanistan. Further, over 80 percent o f the population is below the poverty line and about 30 percent live in absolute poverty. Nevertheless, in recent years Tajikistan has managed strong economic growth, albeit from a low base. The Government's Poverty Reduction Strategy Paper (PRSP) identified effective governance as one o f the four elements needed to tackle poverty. The PRSP found that current systems o f public administration have obsolete structures, inadequate personnel and duplicated functions, and lack cohesion. Indeed, the weak institutions and governance problems undermine the efforts to implement structural reform and threaten the sustainability o f the country's recent economic growth. The Government has taken measures to tackle these problems-such as creating a treasury system in 1999 and approving laws on the budget system and State financial controls in 2001. While the legislative reforms were welcome, additional actions are neededto develop the capacity o f the executive, legislative andjudicial branches o f government. This CFAA, the first for Tajikistan, is a key diagnostic study aimed at identifying the overall financial management risks. It's timing coincides with a meeting o f the Tajik Consultative Group in April 2003, which pledged US$900 million o f support over the next three years. Addressing the numerous, systemic financial management weaknesses in Tajikistan will have an important impact on the governance arrangements which, in turn, will affect donor disbursements against these commitments. In this respect, the CFAA also aims to provide a roadmap for future advice and technical assistance in public sector accountability. It assesses structural reforms inpublic sector budget management, accounting and financial reporting, the treasury system, internal controls and internal and external audits. It also examines the mechanisms o fpublic accountability at the sub-national and community levels. OVERALL FIDUCIARYASSESSMENT Because the country's fiduciary environment i s extremely weak, the CFAA assessedthe risk to public funds as high. It noted that systems o f public accountability function poorly and public sector transparency i s still a problem at all levels o f government. Control and supervisory checks and balances are weak. While legislative reforms were introduced to the Treasury, budget processes and control agencies, they could be undermined through capacity constraints (both human and technological). Some of the main risks involve fragmented budgets, poor cash management and execution controls, lack o f transparency in state-owned enterprises' (SOEs) and inadequate checks and balances in the Government and Legislature. In turn, the risks affect the quality and credibility o f governance. The risks posed by the weaknesses in financial accountability, in both the private and public sector, concern the World Bank from a fiduciary perspective. To reduce these risks, Tajikistan TajikisfanCFAA: Executive Summarv vi must fundamentally change the objectives and institutional arrangements governing financial management. And, since the financial accountability framework i s weak, tight control must be maintained over Bank-funded investment projects--until the systemic weaknesses are adequately addressed. For adjustment lending, it i s recommended that loan proceeds be disbursed into a ring-fenced deposit account inthe name o f the National Bank o f Tajikistan at a correspondent bank acceptable to the World Bank and that this account be independently audited. To enable the Bank to place greater reliance on systems o f public accountability, the Government and donor community are working to improve overall financial management. To date, the Bank has been focusing on budgetary and public administration reform, the IMF has been providing support to improve treasury systems, extemal debt management and controls, the AsDB is providing technical assistance to the external Aid Coordination Unit, and USAID has recently begun providing assistance to improve accounting standards. Although all these activities will affect the quality o f financial accountability, the Development Action Plan (see Annex 1) notes that the challenge i s significant and will require sequenced technical assistance over the short, medium and longterm. The World Bank, other MDBs and bilateral donors recently committed to working more closely together in order to coordinate their financial management requirements across their client countries. Giventhe desperately low financial management capabilities in Tajikistan, it i s important to identify opportunities to reduce the transaction costs o f doing business with the donor community. The CFAA recommends that, in line with the OECD-DAC guidelines, the donor community should develop a joint strategy to reduce such costs and better coordinate financial management requirements. The main sources o f risk and the key recommendations for establishing a sound financial accountability framework are described below. Budget fragmentation. The Law o f State Finances (2002) is a modem, well-constructed law on budget processes. However, it will be difficult to apply due to the limited capacity o f the Ministry o f Finance (MoF) and line ministries, and the fragmented nature o f the budget preparation process. In addition, quasi-fiscal activities, particularly in the energy sector, are extensive andnot fully reported inbudget documents. These issues translate into a level o f risk that is unknown and make it impossible to ensure that funds are used transparently and for the purposes intended. Failure to link budget processes to strategic priorities. The PRSP and Medium-Term Expenditure Framework (MTEF) are not effectively linked into the budgetary process. Institutionally, the budget processes are centralized within the MoF; and, it is difficult to determine whether public expenditures reflect strategic priorities or respond to the various stakeholders inthe budgetdebate. Inadequatecash and debt-managementarrangements. Such arrangements are hamperedby serious problems: (1) weak systems o f cash management or forecasting exists, which creates arbitrary variations in payment dates and inefficient use o f resources; (2) the system o f prioritizing payments i s excessively centralized and requires daily decisions on the part o f Tajikistan CFAA: Executive Summarv vii senior MoF officials; (3) cash controls are particularly weak in local treasury branches which still largely use manual systems; (4) systems developed to record and control commitments are incomplete and there i s no system to record arrears within the Treasury; and (5) several instances of misreporting o f state debt have occurred in recent years. The Government has taken several recent actions to address the issues listed above, notably the recent creation o f the External Debt Management Unit within the Ministry of Finance; supported by technical assistance from the IMF. The present environment has still got significant weaknesses through a highly inefficient and ineffective use o f cash and the a risk of misappropriation o f funds through weak controls, particularly inthe local treasury branches. Weaknesses in public sector accounting and financial reporting. The treasury accounting process i s hampered by a lack of computerization in local treasury offices; this slows the consolidation process and leaves little time for critical analysis, monitoring and supervision. Line ministries adopt an accrual-based accounting system, while the Treasury uses a cash- based approach. Further, there are deficiencies in the accounting regulations and the information provided i s not being used to manage budgetary institutions. Moreover, while the Law on State Finances (2002) provides for a comprehensive annual budget execution report, compliance i s undermined by weaknesses in the technical capacity o f financial managers and lack of systems to fully capture accounting data across Government. Ineffective internalaudits within Government. The Financial Control and Revision Unit in the M o F was disbanded in2001 when the State Financial Control Committee was created. The existing control framework fails to address the role, hnctions and accountabilities o f internal audit within G o v e p e n t . A clear differentiation o f the role o f internal and external audits has yet to evolve. Weak institutions of public accountability. While the creation of the SFCC is a positive development, the Committee needs to conduct its activities in a more transparent and open manner. Further, although it has extensive legal powers and responsibilities, capacity is seriously constrained, which means it has difficulty carrying out its mandate. Similarly, the Parliamentary Budget Committee does not have the capacity to carefully scrutinize budget submissions or enough technical staff with which to analyze budget proposals and execution reports. Weak governance and monitoring of state-owned-enterprises (SOEs). The State-owned sector is substantial, despite the ongoing process o f privatization. Inthe energy sector, quasi- fiscal expenditures are estimated to be around 6-10 percent o f GDP and a large stock o f arrears exist, but are inadequately controlled or reported by Government. Also, SOE governance arrangements are fragmented and lack transparency. Recommendations The most important recommendations to address the weak public sector acc.ountability system are as follows: Improve the timeliness and accuracy o f accounting and financial reporting. To achieve this, the Government mustbuildon the first phase o ftreasury reforms by (1) improving the links between local and central treasury networks and (2) integrating accounting between treasury and budgetaryinstitutions. 0 Develop the newly created inter-ministerial Budget Commission' to (1) oversee the development o f medium-term revenue and expenditure forecasts, (2) approve budget instructions, (3) approve aggregate resources the Government expects to mobilize duringthe next fiscal year and (4) set expenditure ceilings for lineministries. 0 Create a Cash Management Unit within the M o F with appropriate staff training and capacity buildingto improve their methodological skills. 0 Constitute all SOEs as joint stock companies with Boards that have clearly defined roles and responsibilities. Prepare and audit financial reports o f key SOEs according to international standards that are transparent and available to the public. 0 Prepare a strategy for developing public sector internal audits that covers (1) staffing and skill requirements, (2) approaches and methodology and (3) structuralhnstitutional arrangements. 0 Strengthen institutions o f public accountability by (1) improving SFCC's capacity to conduct financial attestation audits and (2) revising the audit methodology according to international norms. Parliamentary scrutiny should be strengthened by improving the reporting lines between itself and the SFCC. Inthe long term, CFAA recommends to subordinate the SFCC to the Parliament. See Annex 1for a matrix o f the proposedaction plan. PRIVATE SECTOR FINANCIALACCOUNTABILITY Evenby the standards of its neighbors, overall governance, financial reporting and auditing in Tajikistan are extremely poor, due in large part to the country's isolation and lack o f foreign investment. As a result, the business community, accountants and civil servants are not familiar with concepts of financial accountability. For this reason, all aspects o f basic financial management training are needed. The Government, with the support o f donors, has started addressing accounting and audit reforms, but development will be hampered by a lack of financial expertise. Also, the foundations for a modern auditing profession are extremely weak; none o f the international audit firms have representative offices in Tajikistan, and the demand for audits i s largely driven by the requirements o f aid and development organizations. In addition, audits are often seen as an extension o f control activities, which has created resistance to introducing audit legislation. Finally, while commercial banks are required to apply International Financial Reporting Standards, due to financial and capacity constraints, they have not beenadopted inday-to-day operations. Recommendations This Commissionwould be separate fromthe Budget Committee inParliament. Tajikistan CFAA: Executive Summaw ix The main recommendations to address the weak private sector accountability arrangements are as follows: Financialreporting 0 Adopt a fully translated set o f International Accounting Standards (IAS) as the National Accounting Standards. Compliance should focus on public interest companies that would include (but not be limited to) banks, insurance companies, other financial institutions/ intermediaries and significant publicly andprivately owned enterprises. Relax the requirements for International Accounting Standards (IAS) reporting for small and medium-sized entities according to guidance from the IASC, when it becomes available. 0 Include representatives o f enterprises, key SOEs and audit firms in the Government's working party on financial reporting. Auditing 0 Apply the statutory audit requirement to financial institutions, listed companies (ifany) and entities of significant public interest, including SOEs. Also, mechanisms to monitor and license auditors need to berevisedinline with intemational norms. DEVELOPMENT ACTION PLAN It would be unrealistic and impractical for the authorities to try to simultaneously address the manyrecommendations inthis report. The CFAA team discussed the draft assessmentwith the Government during the dissemination mission in October 2003 to clarify and prioritize the recommendations. Responsibility for implementing the Development Action Plan (DAP) rests with the President's Office, although the MoF, Majlisi Namoyanagon (Assembly of Representatives) and State Financial Control Committee will also play significant roles. See the final Development Action PlaninAnnex 1ofthe CFAA. I.COUNTRYCONTEXT GoverningStructures 1. The country consists o f four tiers o f government: (1) the central, Republican level, (2) the City of Dushanbe, two oblasts (Sugd and Khatlon) and one autonomous oblast (Gorno Badakhstan) which mainly have a unifiedbudget relationship with the central Government; (3) the district level, where cities and raions are subordinate to oblasts--four districts are under Dushanbe city and 13 raions are under the republican budget; and (4) the community level, which includes villages and towns in rural areas (jamoats). Each oblast, raion and city has its own executive authority (khukumat). 2. The Constitution provides the President with strong powers, including the right to appoint and dismiss senior officials o f the judicial and executive branches both in central and local government. The President i s the main initiator o f policies and does so with a team o f advisors on the economy, legal issues, international affairs, social issues and human resources. In addition, several sector units in the Presidential Administration shadow the policy development work o f the State institutions and exercise quality control over policy proposals prepared by line ministries and other institutions. EconomicProspectsandPublicSector Reform 3. Tajikistan's economic performance until 1997 was largely influenced by the loss o f transfers from the former Soviet Union (which accounted for half o f State revenues in 1990), and the eruption o f civil conflict in 1992. The signing o f the peace accord in 1997 brought a more stable political environment. However, several factors still make the road to development extremely challenging. For example, the civil war took 50,000 lives and destroyed mucho f the country's infrastructure. Also, Tajikistan is endowed with few natural and under-developed resources, i s geographically isolated and shares 1,200 kilometers o f border with Afghanistan. Further, almost the entire Government investment budget comes from official development assistance and the country has accumulated very high debt, with debt service absorbing 47 percent o f fiscal revenues in 2001. Over 80 percent o f the population are below the poverty line and about 30 percent are inabsolute poverty. 4. Despite these enormous obstacles, Tajikistan achieved strong growth, averaging over 7 percent from 1999-2002, driven by the industrial and agricultural sectors. The country depends heavily on cotton and aluminum prices, which make up 70 percent o f its exports. However, sluggish land reform and a weak banking sector profoundly impede sustained economic growth. Further, weak institutions and governance problems undermine efforts to introduce structural reforms and threaten the sustainability o f the improved macroeconomic performance. Moreover, many groups accommodated in the peace accord are part o f the Tajikistan power base and exploit rent-seeking opportunities. While the Government i s aware o f the weakness in public administration, financial management and the legal/judicial system, the low salaries make it difficult to attract new talent. Thus, progress inreforming key institutions i s likely to remain slow. Box 1 Selected Macroeconomic Indicators, 1998- 2002 - 1320 1087 991 1056 1135 Real GDP (% change) 5.3 3.7 8.3 10.2 8-10 GDPper capita (inUS$) 215 177 161 170 180 Consumer prices (12-month change, e.0.p.) 2.7 30.1 60.6 12.5 13.0 Consumer prices (year-on-year) 43.2 27.5 32.9 38.6 12.2 Budget deficit (% of GDP) 3.8 3.1 0.6 0.1 0.2 Merchandise exports (US$ mil) 586 666 788 652 723 Merchandise imports (US$ mil) 725 693 834 773 819 Current account balance (% GDP) -9.1 -3.3 -6.3 -7.0 -4.1 Gross internationalreserves (months o f imports) 1.5 1.7 2.1 1.9 2.3 External debt outstanding/GDP (%) 95 118 105 100 95-98 NPV-of-external debtlexports (%) ... ... 176 140 126 NPV-of-external debtlfiscal revenues (%) ... ... 579 514 408 Debt service ratio (% exports) ... 11.9 17.5 25.6 21.0 Official exchange rate (average, in Somoni/US$) 0.8 1.2 1.8 2.4 2.76 Source: WorldBanUIMF Staff Estimates 5. Governance and institutions are being further tested by a fallout from events in Afghanistan. The increase in drug use and trafficking since 1995 has accelerated substantially since the war; and growth in the latter is a major risk factor in the country's effort to improve governance. 6. Such are the enormous tasks that the Government and donor community face in shaping the new Tajikistan. Indeed, all aspects o f the country need rebuilding--public institutions, local communities, physical infrastructure andhuman resources. Strategic Directions and Policy Dialogue 7. The Government's Poverty Reduction Strategy Paper (PRSP) identified effective govemance as one o f the four elements needed to tackle poverty. The PRSP noted that the systems o f public administration had obsolete structures, inadequate personnel, duplicated Tajikistan CFAA: Countrv Context 3 functions and lack o f cohesion, thus hindering economic reform. The Government has taken some measures to tackle these problems, creating a Treasury system in 1999, the Agency on the Procurement o f Goods and Works in 2001, State Financial Control Committee in2001 and the Ministry o f Revenues in 2002. While these institutional reforms are welcome, additional actions are needed to develop the capacity o fthe executive, legislative andjudicial branches. 8. The 2003 Country Assistance Strategy (CAS) emphasizes the importance o f issues o f governance, public sector management and accountability; recognizing that institutional barriers and capacity limitations inkey public institutions are factors that inhibit growth and economic transfomation. As Tajikistan works to build a better foundation for its core institutions in the medium to long term, the CAS also supports the immediate needs o f the population, especially the poor, through a strong commitment to community-driven development. 9. This CFAA, the first for Tajikistan, aims to create the basis for future advisory and technical assistance inpublic sector accountability. It considers the work inprogress inpublic sector budget management, accounting and financial reporting, the treasury system, internal controls and internal and external audit. Moreover, it examines the mechanisms o f public accountability at the central, sub-national and community levels. 10. The Bank's interest in the CFAA lies inproviding inputs for managing fiduciary risks and supporting its development objectives. The Bank's fiduciary responsibility to its shareholders andthe borrowing government's fiduciary responsibility to its citizens are closely related: Ifthe Government meets its responsibilities, the Bank's are also realized. The CFAA needs not only to focus on existing systemic weaknesses giving rise to fiduciary risks, but also to advise on development needs. Thus, the CFAA aims to identify and prioritize a long-term program o f institutional buildingscaled to Tajikistan's modest implementationcapacity. 11. Reforms to produce greater fiscal transparency and accountability require a comprehensive budget, accompanied by strong accounting, reporting and auditing systems. To this end, the Government has established a Treasury system, enacted a Law on State Finance, created the State Financial Control Committee and reorganized the tax administration authorities. However, further investment i s needed to achieve consistent accounting and fiscal reporting in the public sector as a whole. In addition, while some progress has been made on budget execution, this effort needs to be complemented by improved policy and budget formulation, monitoring and evaluation o f SOEs, greater effectiveness and transparency o f external audits and legislative oversight, and a comprehensive strategy to tackle corruption. 12. At the same time, broad civil service reform is needed to overcome problems o f duplicated bctions, in order to standardize the chaotic and over-regulated policies faced by the private sector and investors. Through the Bank-financed IBTA2 project, the functions o f key ministries have been reviewed, but the Government has been slow to act on the findings. L o w public sector wages andweak governance have further limitedprogress. 13. Consistent with the "Low-Income Country under Stress" (LICUS) approach, IDA is accelerating its investment in the country's knowledge base. An expanded ESW program i s being carried out, focusing first on the CFAA, Public Expenditure and Institutional Review Tajikistan CFAA: Country Context 4 (PER) and Country Procurement Assessment Review (CPAR)? and then on analyzing bamers to progress in key sectors and developing a consistent medium-term institution building program. This work will create a foundation for future advice, technical assistance and lending that will be consistent with Tajikistan's financial and implementation capacities. * In parallel, the Asian Development Bank (AsDB) is preparing a Governance and Institutional Review. Tajikistan CFAA:Public Sector Buduet Manauement 5 11.PUBLIC SECTORBUDGET MANAGEMENT 14. The decision to make the transition from a centrally planned to a democratic, market orientated economy involves a radical transformation o f public sector institutions, particularly the MoF, which occupies a central role inmanaging public finances. Indeed, a modelbased on central planning is illsuited to the needs o f the market economy and, while the process o f economic and political transformation has started, manyvestiges o fthe old systemremain. Soviet Legacy and Progress to Date 15. Under the Soviet Union, the budget was a subset of nationalplanning, and allocations were made largely in physical terms rather than on a monetary basis. Normative standards were developed for Government programs which formed the basis on which the budget operated. The role o fproduction units was to execute the central plan. 16. However, independence has forced the Government to develop new tools and procedures for formulating, executing and evaluating the budget. In this respect, the long process o f economic transformation and institutional adaptation has involved the gradual elimination o f many practices and mechanisms of an economic system which was based essentially on barter. The fact that taxes were not collected, offset mechanisms were widely applied, and taxes were overlooked in exchange for goods and services, created unrealistic budgets and an inadequate framework for accountability ina largepublic sector. Budget Comprehensiveness -The LegislativeFramework 17. The Law o f State Finances (2002) is a modern, well-constructed piece of legislation on budget processes. The following points are worthy o f further discussion: 0 Government is defined in a way that meets international standards. The State budget consists o f a first level--the republican budget and State-targeted funds---while a second level consists o f local budgets. There are no extra-budgetary funds and the only targeted-fund (from earmarked revenues) that remains is the Social Protection Fund (SPF). 0 Budget documents cover the State and republican budgets and provide detailed estimates for the budget year, with current year implementation. They also provide information on forecasts for the next two years. However, coverage i s incomplete in ways that undermine the budget's capacity to set policy and prioritize functions. First, donor funds (grants and loans) and related expenditures are not included. Second, the Public Investment Program (PIP) is prepared separately from the budget, is obtained from external sources and not channeled through the budget or Treasury. Third, it appears the division between ministries and State enterprises i s unclear. The PRSP notes that some ministries are living o f f their enterprises, which suggests that significant hnds are available to them outside the formal budget. In conclusion, the budgetdocumentsprovide for abroadbut not yet complete coverage o f fiscal activity. 0 Quasi-fiscal activities, particularly in the energy sector, are extensive and are only partlyreportedinthe budget documents: The IMFestimates these activities are equal to 5?4percent o f GDP. Further, governance, public oversight, monitoring and reporting mechanisms for SOEs are inadequate (see Section VI for a broader discussion o f this problem). 0 The SPF budget follows the same calendar as the rest o fthe budgetandis confirmedby Parliament at the same time as the State budget. The latter includes the credits and grants from the intemational donor community, as well as debt service repayments. Budget reports also include all State borrowings, Government debt guarantees granted during the budget year, a list o f all outstanding State debt and other debt management operations, and an overview o f investments made from the State budget. Concern over the management and accounting for debt remains, although the Government i s addressing these issues (see the section on cash and debt management below for a broader discussion on this point). 0 The budget provides for a contingency fundY3o f which 2 percent is earmarked for a President's Reserve Fund: both o f which are disclosed in the budget and reported in the annual executionreport to Parliament. BudgetPlanningandApproval 18. While Tajikistan's macroeconomic performance and fiscal discipline have improved in recent years, much remains to be done to ensure that public expenditures conform to strategic priorities and are efficiently utilized. Expenditure allocations across and within sectors do not yet reflect Government priorities; for example, the Poverty Reduction Strategy Paper (PRSP) describes the strategy for reducing poverty but it has not yet been effectively linked to the budget process. Also, within social sectors, inadequate attention is given to the relative contribution and effectiveness o f different programs inalleviating poverty. 19. The budget process begins in April when the MoF Budget Department drafts instructions for preparing it. (In the 2002 budget cycle, the M o F issued final budget instructions to ministries, agencies and local units in June). The instructions indicate incremental increases allowed on programs and to budgetary organizations by economic classification. However, since budget formulation is primarily a distributive rather than re- distributive exercise, the instructions are not linked to Government priorities or intentions for the period in question. The draft budget goes to the Government for review in September and the final budget i s submitted to Parliament byNovember 1. 20. The Government developed its first medium-termbudget framework (MTFB) for 2002- 2004, which linked policy, planning and budgeting decisions in the planning and resource management cycle. As inother countries, fundamental changes inthe budget process take time to implement. For this reason, while a major output o f the first MTBF was the Budget Framework Paper, it received little attention in the MoF, was not broadly circulated in The Governmentdeterminesthe sue ofthe ContingencyFund, its distributionanduse. This reserveis spent by order ofthe President. Government, and was not issued as an official document. Accordingly, the MTBF i s not yet effectively integratedinto the budgetprocess. 21. It is vital that this process improves the link between Government policies and expenditures, and captures actual public spending intentions. One proposal, which was discussed in the past, i s the formation o f a Budget Commission (different from the Parliament's Budget Committee), appointed by Government to (1) oversee the development o f medium-termrevenue and expenditure forecasts, (2) approve budget instructions, (3) approve the aggregate resources that the Government expects to mobilize during the next fiscal year and (4) set expenditure ceilings for line ministries. These activities would occur in the early months o f the budget cycle and be an integral part of the process. Shortly before the CFAA workshop in October 2003 the Government issued a decree setting up a Budget Commission along the lines proposed by the Report. During the CFAA discussions the Government recognized continued weaknesses in the budget planning process and requested further technical support fkom the donor community inthis area. 22. Along with building its capacity at the central level, the Government also piloted the concept o f program budgeting in the ministries o f education, health, and agriculture and included performance indicators to reflect program outcomes. As in other countries, the line ministries' capacity to undertake this program has been limited. To date, little evidence exists o f any tangible outcomes o f these pilots. Thus, more training will be needed, along with disseminating the lessons learned fiom the pilot programs, until staff hlly absorbs the concepts. Budget Execution: The Role of Treasury 23. MoF's Treasury Department executes the budget. The Department includes the central Treasury, headed by a Director, which serves ministries and budgetary organizations financed from the republican budget, and 79 local treasury branches, which finance the local budget. Local treasuries report to the Director o f the Treasury. According to the Law on the Treasury, the institution controls republican and local budget execution and prepares budget execution reports. In 2002, the Treasury processed approximately 220,000 payment requests: 41,000 o f these averaged 8,600 somoni in the central Treasury and 179,000 averaged 1,000 somoni in local treasury branches.' 24. The central Treasury i s divided into two divisions. One includes accounting policy, revenues and budget execution reporting, and the other involves expenditures (both financing and reporting) and internal audits. Each division i s headed by a First Deputy Director. Regional treasuries are small and have separate divisions for managing expenditures and revenues/accounting. 25. Since 1999, the Treasury has operated a single treasury account through which all republicanrevenues and expenditures pass (the account is heldat the NBT). At the local level, all revenues and expenditures are also handled through a treasury single account held either at 5Source: Central Treasury of the Ministryo f Finance. Tajikistan CFAA: Public Sector Buduet Manaaement 0 local branches o f the NBT or at the nearest branch o f Amonat Bank, the State-owned savings bank. 26. The central Treasury financial management systemi s automated and based on one used inKazakhstan. The system has automated access controls and appears to have adequate back- up arrangements. The Treasury, which plans to extendthe systemto localtreasuries inthe near future, should review the lessons in other countries in the region where some treasury offices have experienced slow system response times (delays due to poor communications' infrastructure), which resulted indelays incompleting transactions. 27. The Treasury's role in accounting/financial reporting and internal controls is discussed inSections I11andIVYrespectively. Cash andDebtManagement 28. The objectives o f cash and debt management are to ensure that sufficient cash is available as needed to (1) meet commitments and make payments, (2) provide a predictable flow o f fhds to spending ministries, (3) to minimize the cost o f borrowings, net o f any returns o f surplus hnds and (4) control aggregate cash flows withinfiscal, monetary and legal limits. 29. The MoF has overall responsibility for cash management. With regard to debt management,the role is divided between the ministry's External DebtDepartment and the Aid Coordination Unit (ACU), which was founded in 2001 and i s under the Executive Administration o fthe President. 30. The use o f the single treasury accounting system has imposed stronger control over cash at the aggregate level. However, there are weak systems o f cash management or cash forecasting, which leads to arbitrary variations in payment dates and inefficient use o f resources. The system o f prioritizing payments is excessively centralized and requires daily decisions on the part of senior officials at the Treasury and MoF, including the Minister. The Law o f Treasury contains no provision to regulate the cash flow process or borrowing procedures inthe event o f a cash shortage, or to invest when cash i s abundant. 31. For effective budget execution, Treasury systems need mechanisms to effectively control commitments that can prevent the build-up o f excessive expenditure arrears. In Tajikistan, the system o f recording commitments is incomplete; employee salaries are not recorded in the system for example. This weakness allows spending units to take on commitments beyond their annual budget appropriations. There is no system to record past arrears in the system and the system needs to be modified to record and recognize them. Recording commitments will be particularly difficult at the local level, where systems are largely manual based. 32. Tajikistan's external debt has grown rapidly since independence. Untillate 1997, when the country launched comprehensive economic reforms, the Government maintained trade relations with most former Soviet republics on the basis o f annual inter-governmental agreements that covered most o f the country's exports and imports. Under the agreements, the Government guaranteed import payments by state enterprises and effectively acquired the responsibility o f financing the foreign trade deficit from the center. As a result, its public debt Tajikistan CFAA: Public Sector Buduet Manauemenf 9 rose to over US$1 billion (100 percent o f GDP) by the end o f 2001. With Government revenues amounting to US$160 million that year, the NFV o f debt-to-revenues was 514 percent. This ratio is projected to stay above 250 percent up to 2007 and debt service i s expected to absorb more than 40 percent o f revenues. As a result, unless restructured, Tajikistan's external debt i s not fiscally sustainable. This indicates that the resource envelope i s going to be very tight inthe immediate future and it i s important that public expenditurepolicy calculates these constraints into the medium-term public expenditure framework. 33. The IMF has noted several instances o f misreporting o f external debt, which have affected disbursement conditionalities on the PRGF.The Government has acknowledged these problems and improvements were noted in 2002; authorities completed an inventory o f government, government-guaranteed and state-enterprise debt and wrote to bi-lateral creditors to confirm its status. That said, much still needs to be done to improve the MoF's debt monitoring, analytical capacity and debt reporting systems. To this end, the MoF has been strengthening its Department o f External Debt and i s currently receiving technical assistance from the IMF. 34. To increase transparency, the Government began submitting quarterly reports to Parliament on its external debt, including debt service obligations and accumulated arrears. These reports were also incorporated into the Annual Budget Execution Report. 35. In2001, aPresidential DecreeestablishedtheAidCoordinationUnit(ACU) withinthe Executive Administration o f the President. It i s proposed that the Unit will (1) market public investment projects to development partners, (2) ensure resources are mobilized according to Government priorities and (3) serve as an information center with regard to current and hture Government and other development partners' programs. The ACU, headed by a Director and supported by four technical staff, currently receives technical assistance from the AsDB. 36. Based on the CFAA team's discussions with Government officials during the main mission, there appeared to be considerable confusion on the role o f the A C U and the MoF with regard to managing external debt. During the October 2003 CFAA workshop stakeholders noted that these problems had been resolved and the core responsibilities o f the Ministry o f Economy (MoE), MoF and A C U hadnow been clarified. BudgetClassification 37. After January 2000, the classification o f fiscal accounts followed a system presented in the Government Financial Statistics (GFS) manual. The 2002 budget was prepared following these classifications, as was its execution report. In addition, data covering the consolidated central and local governments are now reported inthe GFS Yearbook. 38. While the Government has been using the 14-sector GFS 1986 functional classifications, these did not anticipate the use o f modem financial management systems or o f organization-based budgets. Thus, the Government recently developed new improved functional classifications that will, for the first time, automate budget analysis at the level o f the budgetary organization. This exercise will involve aligning the coding systems in the Budget and Treasury Departments; once accomplished, the linkage between the two systems Tajikistan CFAA:Public Sector Budset Manaaement 10 will save substantial time, especially in automating the quarterly distribution o f finances to budgetary organizations. Recommendations 39. To make the budget preparation process more inclusive, the CFAA recommends that the Government form a Budget Committee with representatives from the President's Office, line ministries, and regional administrations6. 40. The CFAA supports the MoF proposal to further computerize the local treasury network; however, it recommends that this be carried out with caution and consideration for the communications problems inremoteparts o f the country. 41. Systematic efforts are needed to record commitments and arrears in the Treasury system. The CFAA recommends that the Treasury develop procedures to record commitments through the automated expenditure controls already embedded inthe system. 42. The CFAA recommends that a Cash Management Unit be set up within the MoF to improve the predictability o f cash releases and communicate cash forecasts to line ministries. The recording and monitoring o f debt, guarantees and state-enterprise debt needs to be improved and the CFAA recommends further capacity-building to improve the MoF's debt monitoring, analysis and reporting systems. This recommendation was implemented between the submission of the draft CFAA and the finalization o f the Report. Considerable technical assistance will be required to ensure develop the roles and responsibilities of the Commission within the budget planning process. Tajikistan CFAA: Public Sector Accounting and Financial ReDortinu 11 111.PUBLIC SECTORACCOUNTING AND FINANCIALREPORTING 43. If the Government is to have the information it needs to make decisions, devise management controls and prepare budgets, it must have accurate fiscal reports on current and previous years' executed budgets. Because o f the inadequate resources inthe budget, particular emphasis has been given to revenue collection; also, weekly reports are being closely scrutinized at senior levels o f Government. Due to the progressive development o f the treasury system, accounting and reporting are more timely and effective, and plans for computerization o f local treasuries inthe near future should improve matters further. 44. At the same time, the production o f more timely and reliable data onbudget outcomes, and financial data being made available to the public (after appropriate external audit procedures have been followed) will increase transparency and accountability. The provisions inthe Law on State Finances offer a strong legal foundation for improvingthe annualbudget execution report. The first independently audited accounts, based on the 2002 budget execution, will be submitted to Parliament by October 1, 2003. However, given the limited technical capacity o f the MoF, line ministries, budgetary institutions and SFCC, fulfilling the Law's requirements will present an enormous challenge. The Soviet Legacy 45. Under the Soviet Union, the banking system served to maintainpublic sector accounts. The system, through its regional network, was relied upon not only for disbursing funds but also for government accounting--with accounting and bookkeeping systems parallel to those maintainedby government ministries. 46. Many o f the current practices in Tajikistan are holdovers from the old system. For example, a dual system of accounting i s followed; line ministries use an accrual-based system for financial accounting and the Treasury uses a cash-based approach for budgetary accounting. While accounting inthe line ministries follows a prescriptive rule-based approach that provides many financial details, its main purpose i s to track expenses vis-&vis budget provisions. The Treasury, with its cash-based approach, maintains records o f all revenues and payments from a budget accountingperspective. Accounting and Reporting by Line Ministries 47. The MoF i s responsible for developing and issuingaccounting andreporting guidelines together with formats for budget institutions. Accordingly, its Accounting Methodology Department' issued the "Instructions on Accounting in Budgetary Institutions, 2000," which incorporate accounting rules, regulations and a chart o f accounts. The rules are reasonably comprehensive although a number o f deficiencies do exist, such as combining debtors and creditors inone account code. 'This Department is responsible for developing and issuing accounting, auditing and financial reporting instructions and regulations inthe public and private sectors. Tajikistan CFAA: Public Sector Accountins and Financial Reporfins 12 48. The purpose o f issuing an accrual-based accounting plan was to facilitate financial management-- particularly for liabilities. However, its requirements actually impose added burdens on budget institutions, which must then also maintain cash-based budget classification accounts that are reconciled with treasury records. Inaddition, given the limited capacity inthe line departments, it i s unlikely that much use i s made o f the information in the accrual-based financial statements. 49. Within the budgetary institutions, accounting i s laborious and almost always done manually. These institutions are required to maintain several registers and produce numerous reports; thus, much time is spent reconciling figures instead o f producing meaningful information that could be useful for management control and decision making. In general, officials in line ministries and budget institutions find the reporting process cumbersome and complex. 50. Interms o f monitoring and evaluation, historically there has been little reporting on budget outcomes. Some efforts were made to develop performance indicators in selected ministries, but these were half-hearted and not linked to fundamental changes in institutional arrangements or the accountability of spendingunits. TreasuryAccounting 51. The Treasury has a difficult time in accurately reporting on budget execution due to a lack o f computerization. Indeed, the paper-based systems that are used to collect data on budget implementation, particularly at the local level, do not give the Government the quarterly and annual budget execution reports it needs to supervise and monitor the budget plans. Fundamentally, the reporting exercise i s time consuming and MoF staff does not have timeto analyze reports so as to make financial management decisions. 52. The Treasury records transactions when it receives revenues or makes payments on behalf o f a budgetary institution. However, as noted earlier, commitments are not completely recorded in the Treasury ledgers. Regional treasury offices maintain manual single-entry ledgers for each budgetary institution. The allocations are recorded against each account and disbursementsare allocated against this amount. This manual system has the attraction o fbeing simple butmakes analysis andthe consolidation process difficult andprone to error. 53. Banks conduct reconciliations on a daily basis and electronic data exchanges between the N B T and Treasury are planned for the near future. Treasury offices prepare periodic reports on the execution o f revenues and expenditures. Revenue receipts are reconciled with the N B T each day and a report on revenue execution is sent to the Government each week. Tax revenues are reconciled regularly with the tax authorities and privatization proceeds are reconciled with the State Property Committee (SPC). Consolidated state revenue figures (including the local budgets) are prepared monthly. Execution reports for budget expenditures are prepared quarterly, as part o f the consolidated budget execution reports. 54. The Treasury collates and consolidates reports received from the regional treasuries. The Law o f State Finances requires the MoF to prepare quarterly reports on the State and republican budgets, which are submitted to the Government. Once approved, the Government Tajikistan CFAA: Public Secfor Accountina and Financial Reoorfina 13 sends them to Parliament and the media, which publishes the reports no later than two months after the end o fthe quarter. ExternalReporting 55. The annual report on the execution o f the 2002 budget will be submittedto MN (the Assembly) in 2003. This is the first report that i s required to comply with the Law on State Finances, which states that ministries, agencies and other budget organizations must submit their annual reports to the MoF within two months o fthe end of the financial year.8 Based on these reports, the M o F prepares the consolidated annual report on the execution o f the State budget and submits it to the Government by M a y 1(see Table 2 for the contents o f the report). The report i s comprehensive and should improve the overall level of Government transparency. Box 2 Contents of Annual Accounts of State Budget Execution - 1. Revenues and grants receivedduringthe year 2. Functional and economic expenditures according to budget classifications, with comparisons betweenbudget and actual outlays 3. The size of the budget deficit and financing 4. The beginningand end-of-year balances ofthe Treasury Single Account 5. An explanation of major discrepancies betweenactual budget allocations and the approved budget 6. A report of all state borrowings, government debt guarantees granted during the budget year, a listing of all outstanding State debt and other debt-management operations 7. An overview of State investments 8. A report of expenditures from the President's Reserve Fund and the Contingency Reserve Fund 56. The Law requires the Government to submit the Annual Accounts to the Parliament and the SFCC by June 1. The SFCC is required to submit its audit o f the annual execution report to the President, Government and Parliament by October 1. The CFAA anticipates a number of challenges in the process used to prepare accurate and timely annual financial reports. First, the quality o f financial information, particularly from the line ministries, i s poor; thus, the MoFwill needto develop systems andprocedures to monitor the quality andaccuracy o f financial information (largely produced on manual systems) prior to the consolidation done by the MoF. Second, systems need to be introduced to capture data on Government borrowings, guarantees and investments. As mentioned earlier, databases are being developed to improve performance inthis area. Third, financial audits o f the execution reports are new to Tajiki~tan.~The SFCC needs to develop the capacity to conduct these audits according to Art. 58 ofthe Law. Experience elsewhere in the region has shown that supreme audit institutions (SAIs) do various discrete audits according to a work-plan duringthe year, and submit an annual report on their activities Taiikisfan CFAA: Public Sector Accounfina and Financial Repodha 14 international standards. Finally, the Law improves the quality and detail of the financial information available, but its presentation needs to be improved in order to reflect user requirements. For this reason, public sector reporting requirements need to be reviewed regularly to ensure that the needs o fthe public andother users are filly met. Integrationof PublicSectorAccounting 57. As is common in other FSU countries in transition, the lack o f consistency between budgetary reporting and public sector accounting rules needs to be addressed. This is a challenging process which involves a clear vision as to how the rules will evolve in the medium-long term. A start would be to integrate the two coding systems, the budget classifications and Chart o f Accounts (COA), so that all spending units are brought into a single classification system and COA. Along with ongoing work in the private sector (see Section VIII), the CFAA recommends that the Government should consider the IFAC IPSAS's, which are an important international effort to improve government financial reporting (see Box 3 below). Box 3 InternationalFederationof Accountants(IFAC) -Accounting Standards for the Public - Sector The IFAC Public Sector Committee is developing a set of International Public Sector Accounting Standards (IPSASs), based on International Accounting Standards (IAS). IPSAS's cover both cash and accrual-based accounting. Under cash accounting, the IFAC released "Financial Reporting under the Cash Basis of Accounting" inJanuary 2003, which highlights the information to be disclosed inthe Statement of CashReceipts and Payments. Recommendations 58. The CFAA recommendsthat a multi-user training program be provided on financial management information to aid in decision-making. Such training should be offered to various users, includingcivil servants andparliamentarians. 59. The CFAA recommends that the Government create a working group o f experts to review the long-term requirements for its financial management system, including reforms to integrate accounting in Treasury and budgetary institutions. The working group should consist o fparticipants from the MoF, the President's Office, line ministries, Parliament and the SFCC, with support from international experts. 60. Preparation o f the 2002 annual, independently audited budget execution report is an important learning exercise for the Government, MN and SFCC. Thus, the CFAA recommendsthat the Government convene a working group that includes international experts to evaluate the preparation and attestation processes o fthe 2002 Report. to the parliament along with the annual budget execution report. They do not actually audit it, nor do they express an opinion on it. IV.INTERNALCONTROLAND INTERNALAUDITING The Soviet Legacy and Transition to Date 61. Under the Soviet Union, various budget controls were applied. These included: (1) checks and balances within each ministry, (2) verifications exercised by the Central Bank and the State banking apparatus, which were in charge o f disbursement and transfer o f funds, (3) inspections exercised by the MoF's Directorate o f Financial Control and Revision, and (4) ad hoc controls by the Party. Control activities monitored conformance with decisions made at higher levels on the allocation o f financial resources and the direction o f physical operations under the economic plan. 62. Duringthe transition period, the wide rangeo finstitutions that hadbeenresponsible for control and investigation practices in Tajikistan were substantially weakened. As a result, practices such as paying illegal salaries (by maintaining fictitious posts) and the widespread abuse of budget finds for business trips and office supplies hadbecome commonplace. Also, informal payments are often made to state employees (to compensate for the very low official salaries) at all levels o f government and are a serious problem. 63. Since it i s well understood that internal controls are seriously defective in many institutions, it will be difficult to develop a modern internal audit h c t i o n . Nevertheless, a new institutional framework i s evolving. The Financial Control and Revision Unit (FCR) was disbanded in 2001 upon the creation o f the State Financial Control Committee and Treasury Internal Audit Department. These bodies should have clearly defined functions. Given the evolving nature o f activities ofboth SFCC and Treasury's Internal Audit Department, there is a need for W h e r improvement towards bringing their functional responsibilities and accountabilities to internationally accepted standards. 64. Internationally, a consensus on the approach to government internal controls" has been evolving and are now seen as a management tool to assure that objectives are being achieved. TO develop systems that no longer review individual transactions but instead analyze the quality o f an organization's management controls and procedures, the Government will need technical assistance. The challenge will be for Government to develop a new professional orientation that i s seen as a management tool focusing on service delivery and diagnosis, insteado fmerely imposing rules and sanctions. LegislativeFramework 65. According to the Treasury Law, the central treasury and local treasury branches are responsible for controlling the budget execution and spending process. Their responsibilities include applying controls over republican and local budget execution, preparing reports on State budget execution, and issuing instructions as well as accounting and reporting forms on loFor example see "Internal Control: Providing a Foundation for Accountability in Government" - INTOSAI, 2001. Tajikistan CFAA: Internal Control and lnternal Auditino 16 the budget execution. However, the Treasury Law does not address the roles, functions and accountabilities o f a modem internal control framework. TreasuryInternalAudit Department 66. Once the Treasury was created, a more disciplined public financial management system was developed, supported by the Treasury's Internal Audit Department (IAD);this unit covers both the republican and local budgets. Its activities, which involve on-site inspections, focus mainly on assessing compliance with the budget law and determining if funds are misused (for example, funds being allocated to inappropriatepurposes). 67. The IADhas a staff o f 25--seven in the Central Treasury and 18 inregional treasuries. However, the quality o f the staff dropped when many former members left to join the new SFCC, due to the reorganization o f control functions in2000/2001. Inaddition, there are some hdamental problems with the structure o f the IAD. For example, the Treasury Manual envisaged the IAD Director to be directly subordinate to the Director o f the Treasury; at present, however, the IAD is managed by the First Deputy Director o f the Expenditure Division and the IAD Director i s also acting as head o f a payment unit within the Treasury. Unfortunately, this management structure does not allow for an objective and independent internal audit function. Thus, the structure needs to be revised according to the guidelines defined inthe Treasury Manual. 68. Besides staffing and structural difficulties, the IAD is limited in the scope, number and effectiveness o f its control activities by insufficient human capital and poor information technology. As it i s a new department, it could benefit from exposure to the work o f a well- established internal audit institution, to learn the latest audit techniques. 69. IAD activities are based on an annual work plan that sets up audits of all budgetary organizations once a year. When violations and misuse o f funds are identified, the Deputy Minister o f Finance writes to the budgetary organization. If the unit agrees with the IAD assessment, the letter i s countersigned by the organization's director and its budget allocation is reduced. The IAD then submits a quarterly report to the MoF, listing the number o f audits andviolations as well as the amount of misusedfunds andthose returnedto the budget." ImplementationIssues and Concerns 70. Current legislation fails to adequately address the role o f internal controls and internal audits within Government. First, it does not define and set accountabilities for maintaining the internal control framework. Thus, it needs to identify the role o f spending agencies in maintaining adequate financial management systems, including internal controls. 71. Second, apart from the small IAD in the Treasury, the Government has yet to address the role o f internal audits inthe public sector. With its present governance problems, the most important objective should be to ensure compliance with the financial laws and regulations. The CFAA Team was informedthat the 2002 activities identifiedSOMl.9 million of misusedfunds, of which SOMl.2 millionwas returnedto the budget. This could be achieved if an internal audit function were developedwithin MoF, with a special cadre and concentration o f scare audit resources. 72. Third, once the IAD's structural issues are resolved, the MoF needs to develop a professional internal audit hnction for the public sector, using international standards and practices. The Institute o f Internal Auditors' Framework for Standards for the Professional Practice o f Internal Auditing (SPPIA) includes a Code o f Ethics, Glossary, Attribute Standards, Performance Standards, Implementing Standards, and Practice Advisories that offer detailed guidance and a practical interpretation o f the standards (see Box 4 for a summary o f the standards") . ~ Box 4 Standards for the ProfessionalPracticeof InternalAuditing (SPPIA) - Attribute Standards 1000Purpose, Authority and Responsibility 1100 Independence and Objectivity 1200Proficiency and Due Professional Care 1300 Quality Assurance and Improvement Program Perform ance Standards 2000 Managing the IA Activity 2100 Nature o fWork 2200 Engagement Planning 2300 Performing the Engagement 2400 Communicating Results 2500 Monitoring Progress 2600 Management's Acceptance o f Risks Implementing Standards apply the attribute and performance standards to specific types o f engagements (for example, a compliance audit, fraud investigation, control self-assessmentetc). Source: TheInstitute of InternalAuditors: www.theiia.org Recommendations 73. The CFAA recommends that the arrangements for organizing the Treasury IAD be revised according to the Treasury Manual; also, that the Govemment prepare a strategy for developing public sector internal audits that covers (1) staffing and skillrequirements, (2) audit approaches andmethodology and (3) structuralhstitutional arrangements. 74. Recommendations with regard to cooperation between the IAD and SFCC are proposedinSection V. l2As the CFAA study is not exhaustive, it shouldnot be considered a formal review o f the internal audit system's compliance with SPPIA. Tajikistan CFAA: External Oversight of Public Financial Management 18 V. EXTERNAL OVERSIGHT OF PUBLICFINANCIAL MANAGEMENT 75. It is generally recognized that a sound way to increase Government accountability is to oversee the manner inwhich it and other public institutions raise and spend public funds. This section reviews the role, responsibilities and effectiveness o f the State Financial Control Committee (SFCC), the MajlisiNamoyandagon (Assembly) and its committees. A. STATE FINANCIALCONTROLCOMMITTEE 76. The establishment o f the State Financial Control Committee (SFCC) in 200213as the country's Supreme Audit Institution (SAI) filled an important gap in the financial accountability framework. While the law defines and regulates the SFCC's activities, the Committee has considerable freedom to choose what and how to audit. The Committee also develops its own methodology, standards and manuals. However, some fundamental problems surface with respect to its role as set out inthe Law, and are discussed below. LegalFramework-Lack of Independencefrom theExecutiveBranch 77. Unambiguous independence from the executive branch i s the sine qua non o f objective and effective external auditing. Measured against this standard, the SFCC fails the test as a fully independent entity, since it was established by and reports to the President. Further, the President(1) appoints and can dismiss the chairperson, (2) approves the regulations, number o f staff and total amount o f salaries and (3) i s the sole recipient o f its detailed quarterly activity reports. 78. Although varied SA1 models are evolving in the former Soviet Union, a particular weakness o f the SFCC i s the lack o f transparency in its reporting relationships. A clearer link between it and the MN could help correct this problem, as well as having more transparent reporting procedures -thereby increasing its accountability. These changes would also support the MNinits oversight role o f the Executive branch (see Section Bybelow, for a more detailed discussion). Scope ofResponsibilities 79. Pursuant to the Law, SFCC's primary role is to supervise and audit State transactions, the use o f State budget and funds, loans received, guarantees, grants, humanitarian assistance and Stateproperty, andreport its findings. 80. The Committee's scope o f activities i s broad and includes supervising and controlling the (1) revenue and expenditure parts o f the republican and local budgets, (2) use o f State funds andproperty, (3) use o f gold and foreign currency reserves, (4) legitimacy and timeliness o f the movement o f public resources in State and commercial banks and (5) use o f credit l3 The SFCC was created by Presidential Decree and the legal and organizational framework established in the Law on State Financial Control, 2002. Tajikistan CFAA: External Oversishf of Public Financial Management 19 resources and external debt. It must also analyze the draft revenue and expenditure parts o f the State budget and identified deviations from the indicators o f the State budget and SOEs. 81. Given such a large range o f activities, it i s important that the SFCC does not lose sight o f its primary function, which is to examine ex-post if resources have been used for the purposes intended. Thus, the SFCC needs to evaluate its capacity to deliver on the broad mandate envisaged within the Law. For example, the SFCC is required to analyze the formation o f the revenue and expenditure budget. According to the SFCC, inpractice, they do not get involved during the budget formulation process, but review the draft of the already agreed budget. While some SAIs inWesternEurope help legislatures oversee the budget inthis manner, there is a danger that this activity will take capacity away from the SFCC's core function. 82. Traditionally, parliamentary Public Accounts Committees (PACs)-named the Economy, Budget, Finance and Taxes Committee in Tajikistan-advise governments on the budget and are not allowed to participateinany activities they will later audit. Instead, they are involved in the budget cycle only once governments report to the legislatures on budget execution: The concern i s that an SAI's involvement before an agreement on the budget i s reached would compromise its ability to independentlyassess the use o fbudget funds. Thus, in Tajikistan, any involvement by the SFCC in the budget discussions before this period would inevitably politicize its audits. 83. For this reason, the SFCC's role should be limitedto ex-post auditing; responsibility for providing the President and the Legislature with expert opinions on budget preparation, revenue and expenditure forecasts, as well as analyzing draft laws, should be the role o f the Legislature's Budget Committee. Further, any direct contact between the parliamentary committees and SFCC should be limited to the latter's responding to specific requests for advice only after the draft budget law and interim reports on budget execution have already beenreviewed. Activities andProcedures 84. One o f the SFCC's main activities is to prepare the work plan for its activities. Such plans are submitted to and approved by the President, who may later authorize any changes. In addition, when requested by a law enforcement agency, the SFCC Chairman may also approve a change. 85. Based on its work plan, the SFCC conducts its control activities. The size and composition o f teams making on-site visits depends on the complexity and size o f the assignment. Following the visits, SFCC experts prepare reports that list financial or other violations, and include monetary values. The SFCC Chairman submits the findings (by letter) to the entity, which has a month to respond, describing the measures taken to correct violations. In serious cases, the Office o f General Prosecutor may also be contacted to take further action. Tajikistan CFAA:External Oversiuht of Public Financial Manauement 20 Disseminationof Audit Findings 86. Every quarter, a summary o f SFCC activities and measures taken is prepared by each sector department and submittedto the Department o f Organization and Methodology, then to the Chairman, who approves it and sends it to the President. Unfortunately, the dissemination o f the SFCC's findings lack transparency. Besides the quarterly report to the President, the SFCC is only required to submit a summarized annual report on the results of the audits to the Majlisi Namoyanagon (MN). Staffing 87. The SFCC has 157 staff, 94 of whom are at central offices and the others at four regional offices. Staff are organized into four divisions, depending on which units they control: (1) local budgets, (2) joint ventures andjoint stock companies with Government participation, (3) line ministries and State committees and (4) SOEs. In addition, it has two support departments: (1) Organization and Methodology of Financial Control and (2) Information Technology. 88. While most SFCC staff have a strong background incontrol l4activities, they have had little exposure to modern public sector auditing techniques. Thus, its auditors would benefit from substantial training and on-the-job experience with international audit procedures. Audit Methodology 89. As with other SAIs inthe former Soviet Union, cultural and historical attitudes towards State control functions shape the SFCC's methods. Based on past practices, the Committee reviews documents pertaining to the executed budget, which involves analyzing payment documents, verifying them and comparing them with MoF's and the budgetary organization's own accounts. However, many o f these activities duplicate functions more properly carried out by Government units involved ininternal audits (see the section on linksbetween external and internal audits, below). 90. The SFCC investigates documents (assessing the regularity o f administrative fimctions from a formal and substantive viewpoint), and focuses on compliance (determining if corrective actions adhere to rules and regulations). The 2002 Law o f State Finances now requires the SFCC to report on the performance of the Government budget, submitting its findings to the President and MNno later than nine months after the year's end. However, the SFCC needs technical assistance towards conducting audits o f financial statements in accordance with International Standards on Auditing. 91. The SFCC is required to issue a general audit assurance on the Government's annual execution report; this step i s vital to achieve transparency and accountability within Government operations, as well as public confidence. To achieve these aims, the SFCC needs to improve its financial audits and expand them to cover annual execution reports o f individual 14Many SFCC staffjoined from the Department o f FinancialControl and Revisionin2002. Government entities, inorder to strengthen the general audit assurance on the overall execution report. 92. The narrow scope o f the SFCC control activities i s reinforced by its own measurement o f performance, which focuses on identifying and quantifying misuse o f public finds and ensuring that they are returned to the budget. While this task is crucial, inspectors have little incentive to identify broader issues such as weaknesses in internal controls or potential improvements in administrative efficiency. If these issues were addressed, it would improve the long-term development o f budget organizations and could be used as a measure o f institutional performance (see Box 5). Box 5 Measurementof Impact in SAI - -UKNationalAuditOffice The UK National Audit Office (NAO) measures the impact of its work by calculating the numberof significant changes made by auditedbodies as a result ofNAOrecommendations, annually. For example, in 1999, about 1,700 significant changes followed financial audits and another 550 evolved from value-for-money work. The Office also estimates that its work led to savings or economies of approximately &140 million and ;E353 million, in these areas, respectively. 93. Senior SFCC management has observed that the Committee should retain a percent o f resources returned to the budget. However, if this practice were adopted, it would provide a perverse incentive for auditors to maximize receipts rather than focus on the primary and boarder objectives o fpublic sector auditing. LinksbetweenInternalandExternalAudits, and other State Supervisory Activities 94. CIS countries have found the task o f rationalizing institutional controls and audits to be extremely challenging. During the CFAA Mission it became clear that the donor community needs to put considerable additional effort into explaining internationally accepted norms o f the role o f internal control, internal audit and external audit in the public sector. InTajikistan, there i s still a need o f improving interface between the MoF's Internal Audit Department (IAD) and the SFCC. Thus, the goals should be to (1) coordinate the activities o fboth and (2) reinforce the process through which policies, procedures and practices regarding public financial management are made adequate and sound. 95. Internal and external audits are complementary and both should follow a risk-based approach. The task o f the former is to exercise preventive control, ex-ante, and current control over an organization's operations. The latter's task i s to (1) provide an ex-post assurance that financial statements accurately present an organization's financial position and results and (2) detect systemic weaknesses and associated risks in a professional manner, listing practical recommendations to correct them. 96. To be more effective, the SFCC should be able to monitor the IAD's work, but it should not have the primary responsibility for this task or duplicate IAD activities. However, communication between the two bodies should be improved so as to build cooperation, at the Tajikistan CFAA: External Oversiahf of Public Financial Manaaement 22 same time as the areas o f specialization and prerogatives o f internal and external audits are recognized. B. LEGISLATIVE OVERSIGHTOF THE EXECUTIVE Constitutional and Legislative Background 97. The Constitution provides for legislative oversight o f the Executive branch in several ways. (1) The Government presents its draft budget law to the Majlisi Namoyanagon (MN), as Article 60 states that the MN will supervise its implementation. (2) The 2002 Law o f Government Finances states" that MNwill approve the Law on the State Budget for the next financial year, exercise control over budget execution, analyze its use by recipients, and approve the report on budget performance for the previous year. (3) The Law requires that before November 1, the Executive must submit the budget to the MNand include forecasts l6 for the next financial year (prepared according to functional and economic classifications), with details as to the funding of any budget deficits. (4) Government quarterly execution reports and anMoF monthly report on revenue execution must beprovided to the MN. (5) The Government must send the MNa final account o f the previous year's budget execution by June 1." (6) The SFCC must send its report on the erformance o fthe State budget to the President, Government and the h4Nbefore October 1.'* The SFCC will submit its first report for the P execution o fthe 2002 budgetin2003.20 Checks and Balances within Parliament 98. Parliament has a Budget Committee which reviews the draft budget law. Other MN sector committees also discuss areas o f specific interest regarding budget submissions and the Budget Committee summarizes all comments at a plenary session o f Parliament. Key officials from the President's Office, M o F and line ministries are invitedto attend these sessions. 99. At present, the Budget Committee operates with seven representatives and a small support unit. However, the Committee readily recognizes its current capacity to conduct detailed reviews o f the budget submissions is extremely limited; it does not have enough specialized staff to research and analyze both the budget proposals and execution reports. For this reason, the Committee should explore creating a fiscal analysis office in Parliament, staffed by economists and financial experts. It would also be useful ifthe Committee had more exposure to similar entities in other countries, so as to adapt international best practices to Tajikistan. 100. The current legislative framework needs to be improved, since the MN does not have enough power to exercise its constitutional role of monitoring the budget's execution. It i s the Government's responsibility to ensure that executed funds are properly managed and 15Article 27. l6Articles 39 and 40. '*Article 60 l7 58. Article l9At the time offinalizing the CFAA the 2002 attestation report was overdue. 2oThis is discussedingreater detail inSection IV. Tajikistan CFAA: Exfemal Oversight of Public Financial Management 23 weaknesses eliminated, and the M N ' s task i s to ensure that the Government takes appropriate actions. For the MN to adequately fulfill its oversight role, there must be greater interaction between it and the SFCC. Currently, the Law does not require Parliament to approve the SFCC's annual report on budget execution, nor does it empower Parliament or its committees to summon the Chairman or SFCC staff to meetings to discuss the audits or budget execution reports. Recommendations 101. To strengthen transparency and public accountability, the CFAA recommends an approach to (1) build capacity within the SFCC, (2) eliminate weaknesses in the Law o f State Financial Control and (3) improve M N ' s capacity to review the Executive branch's output. 102. To improve SFCC's capacity, the CFAA recommends that in the short term, a program be designed that would (1) strengthen the staffs financial attestation audit and diagnostic skills, (2) expand compliance audits beyond cataloging errors so as to identify systemic problems and (3) describe ways to improve the management o f public resources. Until now, the SFCC has had no substantive technical assistance; thus, if it entered into a twinning arrangement with a well-established SAI, its staff could learnthe latest approaches in government audits. 103. Section IX o f the CFAA discusses SFCC's role in auditing projects financed by the World Bank and other IFIs. The CFAA recommendsthat SFCC staff be trained inthe Bank's project-specific operational policies and procedures (including financial management, disbursement andprocurement) so as to perform their work more effectively. 104. The Bank's Country Procurement Assessment Report (CPAR) found that SFCC staff lack the necessary skills to conduct procurement audits. Thus, the CFAA endorses the CPAR recommendationto offer training to SFCC staff to deepen their understandingo fprocurement issues and audits. 105. To ensure quality, the CFAA recommends that, besides establishing a dedicated organizational unit incharge o f internal quality control, the work o f the SFCC should regularly be reviewed by another SAL 106. Further, the CFAA recommends that Parliamentary oversight over SFCC activities should increase. In the long term, the recommendation is to subordinate the SFCC to the Legislature. (consistent with the positioning o f Supreme Audit Institutions in a democratic state). Given the country's background and existing political constraints, any actions with respect to increasing Parliamentary oversight should be taken only after a detailed analysis o f the current SFCC roles andresponsibilities is performed. Taiikisfan CFAA: Sfafe-OwnedEnterorises 24 VI. STATE-OWNED ENTERPRISES Overview 107. Tajikistan largely retains a system o f public administration based on the former Soviet model: It involves small ministries that manage large numbers o f subordinate bodies, including State Owned Enterprises (SOEs) and a broad network o f sector units at the oblast and raion level. Under this system, ministries focus on control tasks androutine administrative functions. Few incentives exist for ministries to relinquishcontrol over SOEs, which provide both income andprestige. 108. According to the SFCC, despite the ongoing privatizations, 583 SOEs remain, with differentpercentages o fGovernment ownership. About 38 percent have over 200 employees. Government ownership No. of SOEs Y O Under 25 % 58 10 25% - 99% 467 80 100% 58 10 Total 583 100 109. The SOEs are constituted under charters or closed joint-stock companies. Except for two companies, Tajik Aluminum and Vastok Redmek, all SOEs report directly to their designated line ministries.21 Legally, they are autonomous bodies, but the respective ministries appoint directors and key personnel. Thus, inpractice, SOEs are quite regulated and experience a highdegree o fministry interference. The Importanceof Quasi-FiscalExpenditures 110. SOEs are quasi-fiscal entities, legally separate from the Government, and are not included in the official budget. However, they affect the budget in several ways, as they receive Government equity injections, loans and subsidies, repay loans, and pay interest, taxes anddividends. 111. Inthe utility sector, given the collapse o f personal incomes and the lack o f structural reforms, significant quasi-fiscal expenditures have arisen. Energy companies, as a result of below-cost tariffs and poor collection ratios, have recorded large financial losses and built sizeable arrears. While this has shielded the public in the short term, it has caused the main utilities' capital stock to deteriorate. Inturn, this has created power outages and problems with gas delivery infrastructure, which affect the public welfare and private sector development. The IMF estimates that quasi-fiscal expenditures are 6-10 percent o f GDP, coupled with a large stock o f arrears. 21TADAZ andVastok Redmek report directly to the Office o fthe President. TajikistanCFAA: State-Owned EnteriJrises 25 FinancialManagement 112. SOEs submit monthly, quarterly and annual data to the ministries on key quantitative indicators. Also, they produce annual accrual-based financial statements, includingincome and expenditure accounts and balance sheets, which are subject to the same accounting rules as private sector corporate financial statements. The reports are supplied to the line ministries, the M o F and the State Committee o f Statistics. Such information i s used primarily for statistical rather than managerialpurposes. 113. The SOEs maintain records and prepare financial statements according to the Tajik accounting and tax system. Some steps have been taken to adapt their accounting standards to International Accounting Standards (IAS) but, even in the largest SOEs, the capacity to understand and develop modem accounting and financial management systems i s still quite low. InternalControls,InternalandExternalAudits 114. The issues raised inthe section on internal controls also apply to the SOEs: Corporate governance is weak andmanagers frequently override internal controls. 115. All SOEs with Government ownership above 25 percent are subject to an SFCC compliance audit every two years. An average audit lasts about 20 days, involving two or three specialists. While copies o f the audit summary are sent to the SOE managers and line ministry, detailed findings are not published or subject to legislative scrutiny. Besides the mechanisms described above, no other legislative requirements exist to audit the SOEs. The policy matrix o f the SAC2 conditionalities required that, from 2001 onwards, ISA audits should be carried out by firms acceptable to the Bank for TADAZ, Barki Tajik and Tajik Air. The same requirement has been introduced for Tajik Telekom (from 2002), Tajik Rail and Tajik Gas (from 2004). 116. As discussed in Section XI11 (on enterprise accounting and auditing), the CFAA recommends that the financial audit requirement should be introduced gradually. The largest SOEs should be subject to international accounting and audit requirements and the results o f these audits should be available both to the public and Parliament. 117. Because o f its overall significance to the economy, financial arrangements within TADAZ are discussed inBox 6. Box 6 - CaseStudy Tajik Aluminum Plant- TADAZ - The Company. TADAZ is a 100percent state-owned-enterprise incorporatedinTajikistan. InAugust 1991, ownership of the company's plant was transferred from the Soviet Unionto Tajikistan. TADAZ produces aluminum. In2002, production totaled 307,000 tons with a sales value of around US$405 million. More than 98 percent i s exported to a limited number o f customers incorporated overseas, under exclusive contractual agreements. The ownership o f these companies i s unknown. TADAZ, which employs about 13,000, is a major player in the economy. It is the largest enterprise and accounts for 35 percent of electric energy consumption, 30 percent-40 percent o f exports and a significant share o f GDP. Production i s concentrated in a single mill, constructed in 1975. The Company's assets constitute the national property of Tajikistan, however TADAZ has the full right to use them and distribute whatever profits are produced. Neither TADAZ nor the Government are liable for the other's obligations. One o f the actions the SAC2 Action Plan (April 2002) proposed was to convert TADAZ into ajoint stock company. The actioni s still pending. Management structure and corporate governance. The Company is not governed by a Board o f Directors or any other type of executive committee. Instead, it is under the sole command o f its Director, who reports only to Tajik President at a monthly meeting. Since SOEs normally report to their respective line ministries, TADAZ's arrangement i s an exception. The only other exception involves the Vastok Redmek, a company that produces precious metals. The company's operations are subject to numerous checks by various Government control bodies. However, the company does not report to Parliament, except during the approval of the State budget when the company's chief accountant provides information and reports to the Budget Commission, uponrequest. Financialmanagement.TADAZ maintains its records and prepares its financial statements inthe nationalcurrency (somoni) accordingto the Tajik accounting andtax legislation. It was only in2000 that the Company first presented financial statements,prepared according to International Accounting Standards (IAS). SAC2 required TADAZ to have an audit o f its I A S statementsconducted according to International Standardsof Audit (ISA). The financial statements issued under Tajik accountingregulations differ from the 2000 IAS financial statements audited by an international audit firm. The main variations involve: (1) accounting for inventory, (2) valuation, depreciation and impairment of property, plant and equipment, (3) foreign currency translations, (4) deferred income taxes, (5) allowances for baddebts and (6)recognition ofrevenues and expenses. I A S skills and capacity in the company are still very limited. The SAC2 action plan also requiredthe fullintroduction o fIAS accounting andthe re-evaluationofthe Company's fixed assets and inventory. As for the former, it i s unclear if TADAZ management intends to fully comply, while the latter action has not yet been introduced. Audit arrangements.The SAC2 Policy Matrix requiredthat from FY2001 TADAZ prepare I A S financial statements to be audited by an audit firm acceptable to the World Bank. Initially, a firm of auditors acceptable to the Bank was contracted to audit the FY2000 and Tajikistan CFAA: State-Owned EnterRrises 27 FY2001financial statements. Duringthe audit o f the FY2000 financial statements, a dispute arose between the auditors and the Company, and TADAZ dismissed them before they issued a final report. The Company claimed this was due to the audit firm's unsatisfactory performance. The auditors claimed the main reason was TADAZ's management's dissatisfaction with the related party transaction disclosures proposed by the auditors. The Company then appointed another auditor to complete the FY2000 AND FY2001 audit, although this firm was not listed among those auditors qualified to audit World Bank- financed projects. InDecember 2002, on an exceptional basis, after they had completed their audit field work on TADAZ, a Bank team reviewed this firm to assess if it had met the Bank's minimum requirements. Upon an examination o f workmg paper files related to the audit o f TADAZ the Bank team concludedthat this firmwas not acceptable to the Bank. Going concern and related-parties transactions.According to the audit report issued on the financial statements for FY 2000, "the company had an accumulated deficit o f US$529 million and net current liabilities o f US$l58 million. In addition, the company i s heavily reliant on a single group of companies as a supplier o f material, purchaser of finished goods and provider o f credit." Recommendations 118. To enhance the business climate and the country's economic development, it i s vital to improve corporate governance inprivate sector enterprises and SOEs. The CFAArecommendsthe following: 0 All SOEs shouldbe constituted asjoint stock companies with Boards o f Directors with clearly defined roles andresponsibilities; 0 SOE financial statements should be prepared under I A S and piloted for the largest companies identified in SAC2. The statements should be audited each year by a firm acceptable to the Bank with the audits conducted according to ISA; 0 The Government should create a unit to monitor SOEs' quarterly financial flows, debt and arrears, as well as financial and other performance targets. In addition, the unit should oversee governance arrangements, including the appointment o f Directors and the publication of regular financial information, audited financial statements and company charters. The monitoring unit would focus initially on the largest SOEs. Tajikistan CFAA: Local Government and Communitv Level lnsfifutions 28 VII. LOCAL GOVERNMENTAND COMMUNITY-LEVELINSTITUTIONS Background 119. The country's Constitution establishes the concept o f local autonomy and addresses the organization and functions o f local governments, which consist o f three tiers.22The first is the oblast level, which includes the City o fDushanbe, Khatlon, Sugd and the autonomous oblast o f Gorno-Badakhshan, all under the central Government. The second i s the district level, which includes cities and raions under the oblasts, four districts inDushanbecity as well as 13 raions directly under the republican budget. The third i s the village and community level in rural areas, which includes the jamoats, local councils composed o f several villages. Local government expenditures are significant, accounting for about a third o f total State budget expenditures. A schedule of the execution of the revenues and expenditures o f local budgets is detailed inAnnex 3. 120. Tajikistan consists o f the capital city, three oblasts and 62 raions (58 rural raions and four raions in Dushanbe), with a total o f 22 cities, 47 towns, 356 jamoats and 3,500 villages. While not recognized in the Constitution or the Law o f Self Government in Towns and Villages (1994), each village has a mahalla or informal decision-making body. 121. The first local council elections since the civil war were held in 2000 and council members were elected for five-year terms inthe oblasts, Gorno-Badakhshan, cities andraions. 122. Local executive authority at the second and third tiers i s exercised by the chairman o f the local administration (khukumat), who represents the central Government. Khukumat chairmen are appointed and dismissed by the President and approved by their respective councils. At the first level o f government, the chairman o f the jamoat i s nominated by the city or raion chairman and elected by thejamoat. 123. Overall, the Government i s highly centralized and the extent o f local government authority is weak. To address this, the Government is working on a new law on local government which seeks to better define the roles and responsibilities o f the different levels o f government, including the informal community-level institutions. See Box 7 for a description o f some of the fiduciary aspects of community development. 22For a betterunderstandingo fTajikistan's geography, see the map inAnnex 2. Box 7 - Community-basedactivities inTajikistan The World Bank's 2003 Country Assistance Strategy (CAS) recognizes the importance o f community-based activities to improve support to public infrastructure and services, especially health and education. Given the major implementation weaknesses in central and local administration identified ina number o fprevious studies, community programs are seen as a way o f empowering poor people and improving governance, in order to ultimately enhance social and infrastructure services. Many donors and NGOs already support community development in Tajikistan. Among the most prominent are the Aga Khan Development Program, Counterpart, Merci Corps, UNDP and USAID. The World Bank's own experience i s primarily through the Tajikistan Social Investment Fund project. However, no coordinated effort exists that could increase these donor activities inorder to reachmost o f the poor. A number o fobstacles to expanding the process are: Lack o f commitment from central and local government. From the Government perspective, community programs are a threat to the status quo. This problem i s exacerbated by the fact that there i s little dialogue between the administration and donors during the development and appraisal o f interventions. Thus, donors need to involve the Govemment more inthe design, monitoring and evaluation o f programs. Inadequate legal framework. As discussed elsewhere in this section, the roles o f the various levels of government lack clarity; in addition, resources, particularly at the local level, are extremely thin. Control i s highly centralized and community leaders at the jomoat and khukumat level have minimalroles inrepresenting their communities. Problems with the flow o f funds. Donors cite weaknesses in the local banking and treasury systems and a major implementation difficulty, particularly in rural areas (as documented elsewhere in the CFAA). One donor group described the process o f training local banks in basic procedures, such as preparing bank statements. Other donors avoid the system completely and rely heavily on cash-based systems that they control. Also, there i s a serious problem o f counterpart fundinginthe poorest rural communities. Lack o f a longer-term approach. Most community programs are designed for a two-four year period, which is not long enough to make a significant and sustainable impact. Thus, donors need to fashion programs that give sufficient timeto develop and scale-up initiatives. Local GovernmentBudgets 124. Local budgets refer to the budgets o f oblasts, cities and raions. Budget preparation is a highly centralized and structured process, with the MoF playing the dominant role: It instructs the sub- national units on preparing their budgets, providing estimates o f inflation and other factors that the unitsneed during the process. Tajikistan CFAA: Local Government and CommunityLevel lnstitutions 30 125. Raiodcity levels prepare their budgets based on inputs and cost estimates. Much is entered manually, including calculations and summaries; as they do not have computers, the process i s extremely time consuming. 126. Once the raions/cities estimate their budgets, they defend them at the oblast level. At this point, changes can be made based on revenue and expenditure estimates and the overall level o f hnds available. The process repeats from the oblast to the national level, with the M o F reviewing the oblast submissions. 127. Oblasts can defendtheir estimates before the Budget Commi~sion,2~which can include the Minister o f Finance, DeputyMinister, department heads within the MoF, Ministry o f Taxes andRevenues, State Statistical Committee andrepresentatives o fother ministries. 128. Despite the high degree o f centralization in this process, local governments have some flexibility to set tax rates within limits defined and approved by the MoF. Local councils can use revenues collected in excess o f the revenue estimates and can reallocate some funds, although this excludes protected itemssuch as salaries, social security, stipends andpensions. 129. Inter-governmental transfers basically involve reallocations from donors to recipient regions through revenue sharing o f taxes specified in the budget law. The local units that do not receive subventions and have some o f their taxes applied to the republican budget are Sugd Oblast, Dushanbe City and Tursunzade City. All other local units receive grants and retain 100 percent o f local taxes provided for them within the Budget Law for that year. Jamoats obtain their financial resources intwo ways: The first is from the raion budget, which draws from a local treasury account, while the second is from economic activities and voluntary contributions from enterprises or individuals which are earmarked for cultural, educational and other purposes. These funds are kept in a separate local account and are expended depending on the social and economic needs o fthe residents. AccountingandTreasury Systems 130. At the local govemment level, Treasury accounting records for budget organizations are held in pro-forma manual systems. One o f the local treasuries visited by the CFAA team used a very simple spreadsheet to consolidate the budget by functional and economic classifications. However, maintenance o f these records is time-consuming and prone to error. Also, there was no evidence that the records are reconciled with those o fbudget organizations. Reporting 131. Reports on local budget execution are preparedon a quarterly basis and are supposed to be disseminated to the public through local newspapers to increase transparency. However, no system exists for publishing annual performance reports that reflect the cost o f services provided by local governments. 23 The Budget Commission has no formal structure; nor i s there any regulation or decree identifying its membership or functions. 132. With the planned computerization o f the local treasury function, heads o f finance departments at the oblast and district levels should be able to receive more detailed fiscal reporting on which to base decisions. Thus, local government needs must be considered when the new system i s designed and introduced and local finance staff should be consulted to ensure they have input. InternalControls andAudits 133. Many local government transactions are settled in cash, which carries a greater risk o f misappropriation. In the short-term, due to a lack o f confidence in the local banking system, this is likely to continue. However, there are some simple controls, such as prominently posting information about the arrival o f funds (for salaries) at the local government and strengtheningcontrol mechanisms that can help prevent fraud andmisappropriation o ffinds. 134. The level o f skills andquality o fcontrol work inlocal treasury offices is weaker thanin the central Treasury. Thus, IAD staff from the central Treasury visit the oblasts to try and improve the quality o f work and local staff are included in an annual training seminar held in Dushanbe. ExternalOversight 135. Local budgets are preparedby local khukumats and approved in sessions o f the local majlisies. The SFCC has offices in each oblast and conducts control activities bi-annually, according to law. Inorder to increase public participation and transparency, local governments may consider forming Budget and Audit Committees that include representatives o f civil society and ensure that budget execution reports are publicly available on a timely basis after the year's end. Recommendations 136. The new local government law is an important initiative and will need high-level support to ensure that local institutions have both the mandate and capacity to provide local services. 137. The donor community needs to work with central and local government institutions and help them understand the benefits o f greater decentralization o f services. Although this will be a challenging process, it is key to buildinglocal government institutions. The CFAA therefore concludes that a dual approach to capacity-building is essential: Central and local government officials need to be trained, and at the same time, community leaders and implementing agencies needencouragement to exchange experiences and coordinate efforts. 138. The CFAA recommends that the Government take steps on a pilot basis to develop capacity at the local level--both o f elected council members as well as executives working in local government institutions. This will require the fill commitment o f senior Government officials to decentralized models o fpublic service delivery. 139. The CFAA proposes the pilot program cover a range o f reforms to improve local government financial management, including: (1) simplifying public sector accounting laws Tajikistan CFAA: Local Government and Communifv Level lnsfifufions 32 and regulations to make them more comprehensible, (2) preparing annual performance reports which would be made available to the public, (3) developing an institutionalized financial management training program for local government staff and (4) forming both budget and audit committees. Tajikistan CFAA:Accounting and Auditins in the Private Sector 33 VIII. ACCOUNTING AND AUDITING INTHE PRIVATE SECTOR Background 140. By the standards o f other transition countries inthe region, progress is slow inthe area o f accounting and audit reform. Geographic isolation and the lack o f any substantive capital market activity means that Tajikistan has had little exposure to modem international concepts o f financial management. Demandfor international standards o f accounting and auditing have been restricted to banks with foreign ownership and donor-financed projects. At present, no international audit firms and only a small number of local audit firms have opened offices. Audits that are carried out according to international standards are conducted by firms based outside Tajikistan. Thus, costs are high and there i s little evidence o f significant knowledge transfer. While there are signs of change, much more needs to be done to bring modern methods o f financial management to local enterprises. Because o f particular fiduciary concerns regardingthe bankingsector, these are discussed separately inSectionIX. FinancialReportingfor Enterprises 141. The requirements o f the Tajik Accounting System(TAS) are laid out inthe 1999 Law o f Accounting. The Law, which applies to both the private and public sector, i s based on rules rather than principles and is driven by bookkeeping and tax reporting requirements. The system's inadequacies are recognized bythe Government, which, with assistance from USAID, i s introducing a program to develop national accounting standards that conform with International Accounting Standards A working led by the Department o f Accounting Methodology inthe M o F was formed inFebruary2003. 142. A Presidential Decree26acknowledges the need for a gradual introduction o f new financial reporting standards. Given the severe capacity weaknesses (highlighted below), the CFAA supports this approach. A number o frecommendations are included. Auditing 143. For the reasons mentioned above, development o f the auditing profession is at an early stage. By a 2001 Order o f the MoF,*' insurance companies, investment institutions, joint stock companies, extra-budgetary finds, charities and joint venture companies must all be audited annually. All organizations listed inthe Order must submit audited financial statements to the tax authorities and statistical agencies. However, it is unclear how the Government intends to enforce compliance, giventhe low capacity o f the accounting and auditing profession. 241nternationalAccounting Standards (IAS) are set by the International Accounting Standards Council (IASC). The IASC is anindependentintemational body, financed from private funds, with headquarters inLondon. 25 The working group includes members o f the Association of Auditors and Accountants of Tajikistan, the Public Institute o f Professional Accountants and Auditors, the Ministry o f Tax and Revenues, National Bank o f Tajikistan and practicing accountants and auditors. 26 Decree on InternationalFinancial Reporting Standards No. 428 (November 4,2002) 27 No13 dated January 29,2001. Taiikisfan CFAA: Accounfina and Audifina in the Privafe Sector 34 144. The 1999 Law defines the licensing and certification procedures for auditors. To help incorporate them, the Governmentcreated a qualifyingcommission for auditors which includes representatives from the MoF, Ministry o f Justice, universities and the Ministry o f Tax and Revenues. Candidates, who must take a three-hour exam, must have a degree and a minimum o f five years practical experience as accountants, economists, financiers or lawyers. Applications cost 400 somoni and auditors who pass the examination are certified for five years. According to the MoF, certified auditors are required to take 20 hours o f continuing professional education each year inMoF training courses conducted by the State University o f Commerce. 145. The Law also provides for ensuring auditor independence, as well as the rights of auditors and clients. Inaddition, the MoF issued six audit standards which appear to have been influenced by, but do not completely correspond to International Standards of Auditing2* (ISA). The MoF recognizes that current regulations for auditors need to be upgraded and it plans to prepare standards which correspond to ISA. The Profession 146. Approximately only 50 professionals hold audit certificates and licenses issued by the MoF. As yet, few audit firms exist, although more local firms are seeking licenses due to the new mandatory audit requirements. Thus, the challenge o f developing an audit profession that meets international standards remains daunting. 147. The Audit Law provides for a Chamber o f Auditors to coordinate audit activities and promote the development o f audit activities; however, to date, the Chamber has not been licensedandno activities havebeen conducted. 148. Two accounting institutes currently operate: the Association o f Accountants and Auditors o f Tajikistan and Public Institute o f Professional Accountants and Auditors. Both have roots in academic institutions and their role has focused on training activities. Senior members in both institutes are collaborating with the M o F on the Accounting Standards Working Party mentioned above. 149. A USAID project is supporting the development of professional accounting and audit institutions by helping devise charters and by-laws that reflect international standards in governance and professional requirements. CapacityBuilding 150. The supply of accountants, auditors and financial managers with an understanding o f international auditing standards is still extremely low. Thus, continued effort will be neededto create a larger pool of financially literate professionals. With donor support, some attempts have already begun to improve the level o f skills. For example, in 2001, USAID introduced a Certified International Professional Accountant (CIPA) training, education and certification program. GiveninRussian, it has been conducted in several o f the FSU countries. The course 28International Standards of Auditing are promulgated by the InternationalFederation of Accountants. Taiikisfan CFAA:Accounfinu and Audifinu in the Privafe Secfor 35 and examination system are transparent and the technician level qualification seems appropriate to the current needs o fTajikistan accountants and financial managers. Recommendations 151. Financial reporting. The CFAA recommends that the I A S financial reporting, particularly for highprofile andpublic interest entities, be introduced inphases. 152. Based on experience in other developing countries the CFAA recommendsthat: (1) full U S compliance should be requiredfor public interest companies such as banks, insurance firms, other financial institutionshtermediaries and significant public and private commercial entities; (2) hllIAS financial statements should be preparedby all entities, but the requirement (as is practiced internationally) should be relaxed for small and medium-size enterprises (SMEs). This should be based on forthcoming guidance issued by the IASC as part o f a harmonized approach to SME reporting; (3) a structured and adequately resourced arrangement should be established to ensure the full and timely translation o f the unabridged IAS, along with any implementation guidance that takes account o f the Tajik context. The arrangements for translating the standards, which should be consistent, accountable and transparent, should focus on common solutions to common problems and involve representatives o f audit firms and enterprises; and (4) the technical capacity of the Department o f Accounting Methodology and the National Bank o f Tajikistan should be strengthened, especially with respect to its practical understanding o f IAS. 153. Auditing. The CFAA recommends that the 2001 MoF Order with respect to mandatory audits should be clarified and phased in gradually, in keeping with the technical (auditing) capacity available. This recommendation gives top priority to improving the quality o f I S A audits o f IAS financial statements for a small group o f large enterprises, financial institutions and other public interest entities. 154. Strong enforcement i s the key to improving the quality o f financial reporting and auditing. Thus, the CFAA recommends the Government review the institutional arrangements for overseeing the accountingprofession and licensing auditors. 155. Professional exams and training arrangements for bank and enterprise auditors need to be upgraded. These should correspond to IFAC education guidelines. The CFAA recommends the Government review the institutional arrangements for the training and continuing education of auditors and accountants. Tajikistan CFAA: Bankina Arranaemenfs in Tajikistan- Fiduciarv Issues 36 IX.BANKINGARRANGEMENTS INTAJIKISTAN-FIDUCIARY ISSUES 156. This section evaluates the fiduciary risks associated with the role o f the central bank and commercial banks. The National Bank o f Tajikistan (NBT) has a key role inWorld Bank- financed projects because, under the credit arrangements for Structural Adjustment Credits (SACS), borrowers must open and maintain a separate Deposit Account2' intheir central banks. Loanproceeds must be used for eligible purposes as definedinthe Credit Ag~eement.~' 157. The NBT also supervises commercial banks, several o f which have Special Accounts that hold revolving funds for World Bank investment projects. Thus, from a fiduciary perspective, the World Bank is concerned with the governance and financial management in these banks as well as the quality and transparency o fthe NBT's supervision. Overview 158. As o f October 1, 2003 the banking sector, governed by the Law on the National Bank o f the Republic o f Tajikistan and the Law on Banks and Banking Activities, consists o f the NBT and 13 commercial banks, 1 foreign bank and 4 credit association^.^^ It is highly concentrated, with the four largest banks - Agroinvestbank (AIB), Orienbank, Tajiksoderotbank (TVOB) and Amonatbank - controlling about 86 percent o f assets and 87 percent o ftotal deposits. NationalBank of Tajikistan 159. The NBT is independent, accountable to Parliament and responsible for supervising all commercial banks. It prepares financial statements according to International Accounting Standards (IAS) and has them audited according to Lnternational Standards o f Auditing (ISA). The audit for the year ending April 30, 2002 was performed by the Amsterdam office o f Pricewaterhouse Coopers. The financial statements are not published. 160. Inits recent Article IV Con~ultation,~~the IMFnotedthat the NBTneeds to improveits operational and policy performance so as to achieve macroeconomic stability. The Report also noted a number o f serious accounting and administration issues in 2002, including (1) the payment o f dividends at the same time that the Bank had a negative net worth, (2) the financing o f non-core expenditures and (3) the absence o f a centralized record o f guarantees, pledgesand other central bank contingencies. The IMF thus required an interim external audit o f the 2002 financial statements. In addition, the IMF observed that, "While both reports33 recommended remedial measures, the staff recommended the NBT to formulate a comprehensive restructuringstrategy that will enhance the implementation o f monetary policy 29See Bank Operational Directive 8.60. 30 Typically, if loan proceeds are used to finance items imported from a non-member country or goods and services from the standard negative list. 31 This section of the report draws extensively from the IMF Country Report no. 03/5 2003 Tajikistan Selected Issues Paper (January 2003). 32IMFCountry Report No 03/10 -January 2003. 33IMFSafeguards Assessment 2001 andthe PwC Audit for 2002. and strengthen operational efficiency. Key measures that need to be included are better coordination and timing o f policy actions, improved coordination o f intervention in foreign exchange and domestic-liquiditymarkets, improved accounting procedures, a reduction in staff and facilities, and the elimination of non-core activities." 161. NBT now keeps accounting records for bank guarantees, directed credits and pledges. The most recent Staff Report o f the IMF notes that the NBT is conducting a restructuring process to improve its institutional integrity and the implementation o f monetary policy. This restructuringplanwas agreed with the IMF34. 162. The CFAA notes the recent progress to resolve some o f the accounting and administrative issues in NBT. However, given the serious nature o f the issues described, the CFAA recommendsthat when future adjustment operations are prepared, the Government and World Bank need to agree on detailed fiduciary arrangements. To avoid the commingling o f Bank finds with other foreign exchange heldby the NBT the CFAA recommendsthat funds are disbursed into a ring-fenced bank account inthe name o f the NBT at a correspondent bank acceptable to the World Bank. As with the current arrangements, the M o F will continue to have a separate account with NBT, until it sells the foreign exchange to the NBT and i s in receipt o f counterpart local currency in return. The negative list restrictions apply to the NBT account at the correspondent bank. The CFAA also recommendsthat the Bank should receive copies of the NBT's annual audited financial statements together with the management letters from its auditor. PrudentialRequirementsandRisksinthe BankingSector 163. The NBT has progressively raised the minimum capital requirements, and progress in the consolidation o f commercial banks has been slow but satisfactory. As of October 1, 2003 eight banks met the minimum capital requirements; with six banks complying with all prudential standards. 164. All banks are required to implement IAS; however, due to financial and capacity constraints, this has not been filly realized indaily operation^.^^ Further domestic audit firms, as noted elsewhere in the Report, do not have the capacity to conduct ISA audits; audits performed by international firms places substantial financial burden on the banking sector. Compliance with I A S remains a serious long term problem which needs to be addressed by further training both o f accountants and the Tajik auditing profession. 165. A recent IMF report concluded that, "As indicated by the lack o f compliance with prudential regulations and international accounting standards, the banking system i s weak and vulnerable. Amongst the problems facing banks is credit risk, stemming from weak 34 According to the NBT the restructuring strategy was completed after the draft CFAA was submitted to the Government. 35 Common non-compliance inthe banks' financial reports includes inadequate provisioning and cash accounting o f revenues. Tajikistan CFAA: Bankins Arranoemenfs in Taiikisfan- Fiduciary h u e s 38 information on borrowers and inadequate credit risk management, as well as sizeable non- performing loans." 166. To strengthen the banks, the NBT will increase the minimumcapital requirement from $1.5 million to US$2 million by the end o f 2004. NBT has intimated that the practice o f granting waivers to banks will be discontinued. Authorities will close or merge all banks that do not comply with prudential requirements and/or are not subject to a restructuring agreement with the NBT. 167 The CFAA Mission didnot review banks with Special Accounts (for managing investment projects). However, giventhe fragile state o f the commercial banks, the World Bank andNBT need to exercise particular care inthe maintenance, exposure and operations o f these Accounts. Thus, the CFAA recommends that the Loan Department in the World Bank should closely oversee the number and authorized allocations o f Special Accounts and avoid concentrating fimds ina single bank36. 36 During the 2004 Country Portfolio Performance Review (CPPR) it was agreed that the World Bank would conduct a review, to be completed by June 2004 to ensure that commercial banks holding Special Accounts for IDA-fbndedprojects adhereto minimumstandards acceptable to the Bank. Taiikisfan CFAA:Portfolio Fiduciarv Considerations 39 X. PORTFOLIOFIDUCIARY CONSIDERATIONS Relianceon PublicSector FinancialManagementFramework 167. Given the previous analysis, public financial accountability needs to be substantially strengthened. Because o f systemic weaknesses, it would be inappropriate to rely on the existing framework to satisfy the World Bank's fiduciary financial management requirements. Rather, during the project cycle, the Bank and senior Tajik counterparts need to acknowledge the inherent problems and buildappropriate safeguards to minimize risks. ProjectFinancialManagement 168. This section o f the CFAA does not constitute a detailed assessment o f the financial management arrangements affecting World Bank-financed projects. Also, the CFAA does not seek to confirm the appropriateness o f the projects' financial management arrangements; it i s not a substitute for regular project supervision. Rather, the CFAA identifies and addresses certain generic financial management issues inthe portfolio. Issuesinthe Country PortfolioPerformanceReview 169. The Country Portfolio Performance Review (CPPR) was held inDushanbe inFebruary 2002 with representatives o f the Bank, Government and project implementing agencies. The following issues that bear on the financial management o f Bank-financed projects were noted: 0 Government counterpart funding. As in previous years, the 2002 State Budget allocated funds to cover the Government's contribution to projects financed by the Bank and other development organizations. However, due to cash flow problems described earlier, there have been delays in counterpart funds which slowed project implementation and can contribute to misuse o f funds. The CFAA Team understand that delays and shortfalls in counterpart funding have decreased since the draft CFAA was submittedto the Government inJune 2003. 0 Taxes. The 2002 CPPR had discoveredthat there were occasions o f inappropriate use o f the Bank's funds to finance taxes which are ineligible expenditures. Duringthe 2004 CPPR, this was not identified as an issue inthe World Bank financed projects. 0 Transparency and openness in project implementation. The CPPR discussed a number o f specific measures which could be taken by Project Lmplementing Units (PIUs) to ensure greater openness and transparency o f project activities. The A C U would have a key role to ensure that (1) tenders are conducted transparently, (2) bid prices are announced at a public meeting, (3) tender awards are announced to the public, (4) all project financial reports and audits are available to the public, (5) all PIU staff are selected in an open and competitive manner according to defined selection procedures, and (6) PTU and Government staff are strictly prohibited from accepting gratuities or remuneration (either monetary or in-kind) from contractors or other suppliers. 0 Project audits. As noted earlier, capacity is lacking among local auditors. As a result, audit firms from outside Tajikistan are conducting project audits, which has translated into high costs and (frequently) low quality. The CPPR agreed that the 2002 audits should be a block tender, which should lower such costs through economies o f scale. 0 PIU staff and salaries. Frequent and non-transparent changes in PIU staff have contributed to implementation problems. Also, significant salary differentials between PIUandGovernment staff can cause delays inproject implementation. ProjectFinancialManagementStaff 170. Project financial management staff (at the PIUs) consist o f one or two local staff and consultants who are employed at pay levels that differ significantly from Government civil servants and among projects; staff are paid mainly from credit and grant funds with co- financing by the Government. Responding to the CPPR, the Government passed a decree3' on March 31,2003 that set maximum salary levels for the staff implementing investment projects. However, manyproject personnel fear that salaries for new and existing qualified staff will be reduced to levels that would cause them to seek higher paying jobs in the private sector-a problem shared by other countries inthe region. The effect o f the decree needs to be monitored closely over time. ProjectFinancialManagementSystems 171. Project implementing agencies are free to develop their own financial management systems. As there has been no guidance or oversight regarding the type o f systems purchased, many have been adopted, ranging from simple spreadsheets, to standard accounting packages and fully customized project accounting software. Until recently, the most widely used package was TALLY, designed by an Indian company. However, it does not have the Russian language within its operating system. Thus, in 2002, many projects introduced the 1C Bookkeeping System, a simple Russian accounting software package. The price for a fully- implemented accounting software tailored to a particular project that is able to produce appropriate financial monitoring reports, deliver on-site training, develop relevant financial management manuals, and offer post-implementation support is US$9,00O-US$30,000. The fact that there are such diverse systems among projects has resulted in a highlevel of financial management-related costs for software and consultants. Further, little, ifany, integration exists with the line ministries and their financial management systems. Thus, the CFAA recommends that the Government establish a forum to oversee the development o f project financial management systems, drawing on PIUstaff experience. Audit Arrangements 172. Based on the Bank's current audit policy and weighing alternative approaches, the CFAA recommends maintaining the current audit arrangements o f Bank-assisted projects which require that annual audits be conducted by private sector firms. To reduce costs, the 37Decree of the Government o f the Republic o f Tajikistan # 119 as of March 31,2003. Tajikistan CFAA: Portfolio Fiducianl Considerations 41 CFAA supports the single audit approach which should result in significant savings to the Government. 173. As noted above, a key consumer o f international audit services in Tajikistan is the donor community. The CFAA also recommends that the Bank, other donor groups and the A C U review the financial management and audit arrangements in investment projects to explore what more can be done to reduce costs, improve quality and address the very limited capacity o f local auditors. 174. The SFCC routinely performs compliance audits o f externally-hded projects. The CFAA recommends that the Bank review them and consider their findings when preparing and supervising projects. Also, although SFCC reports offer important information for monitoring and evaluating portfolios, they are not submitted to Bank staff. Thus, the CFAA recommendsthat the reports routinely be sent to Bank staff as well as project auditors, as part o fnormal audit procedures used to supervise Bankprojects. 2 c 2 c 4a d 2 Y rr 0 l I i, t I k I rl 2 d 2 d N GE cEE B .2 B .B B E 2 U 2 U 0 c1 2 d 24 2 d 2d 2 4 2 d W 8z0 2 c 2 4 u >1 Y3 3 R 0 2 d 2 d eJ 0z a 3 m d m \o hl hl hl hl hl I Tajikistan CFAA: Annex 2 - Execution of Revenues and Expenditures of Local Budsets in 2002 ANNEX 2: EXECUTIONOFREVENUESAND EXPENDITURESOFLOCAL BUDGETSIN 2 0 0 2 ~ ~ Actual Actual Revenuesof the Expenditures of Nameofthe revenues expenditures local budgetto the local budget budget statebudget to state budget Som. (000) Som. (000) revenues(in YO) expenditures (in Y O ) Statebudget --- Localbudget, I88,657.3 172,275.2 34.7 32.9 including I GBAO 10,764.2 1 10551.4 2.0 2.0 Khatlon oblast 48,176.8 I 46,507.7 8.8 8.9 Sogd oblast 8.4 8.7 Dushanbecity 53,239.9 39,999.2 9.8 7.6 Kofarnihon 5,888.8 1.1 1.o City II5,166.7 Roguncity 1,505.3 1,462.5 0.3 0.3 Tursunzade city 0.9 0.9 Varzob rayon 1,147.6 I 3,900.3 1,141.0 0.2 0.2 ~~ Garm rayon 4,074.4 0.7 0.7 Hissar rayon 0.3 0.4 Djirgitalrayon 1,336.7 1,336.1 0.2 0.3 Darband rayon 1,146.3 1 1,146.3 0.2 0.2 Leninrayon 0.7 0.7 Tavildara rayon 747.5 727.3 0.1 0.1 Tajikabad 842.1 0.2 0.2 rayon II842.1 Faizabad rayon 1,892.2 1,637.8 0.3 0.3 Shahrinav 1,683.2 0.3 0.3 rayon I 1,647*2 38Source: Ministry o fFinance. 39Finalestimations. MAP SECTION