Report No. 32630-CL Republic of Chile Country Financial Accountability Assessment June 27, 2005 Country Management Unit Argentina, Chile, Paraguay, Uruguay Regional Operations Department 1 Operations Support Unit State and Civil Society Programs Division 1 Latin America and Caribbean Region (RE1/SC1) The World Bank Inter-American Development Bank Document of the World Bank and the Inter-American Development Bank Chile Countrv Financial Accountabilitv Assessment iii ABBREVIATIONSANDACRONYMS BCH Central Bankof Chile CAIGG Council for General Government Internal Auditing CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment CGR Controller General of the Republic CODELCO State Copper Company CORFO ProductionDevelopment Corporation CPIA County Policy and Institutional Assessment CUF Single Revenue Account DIPRES National Budget Office DMFAS DebtManagement System(Spanish: SIGADE) ENAMI National MiningCompany ENAP National PetroleumCompany FCC Fondo Comtin Competitivo FONASA National Health Fund GAGAS Generally Accepted Government AuditingStandard GFSM Government Financial Statistics Millennium IAU Internal Audit Unit IDB Inter-American Development Bank IMF InternationalMonetary Fund INDAP Agricultural DevelopmentInstitute INTOSAI InternationalOrganization of SupremeAudit Institutions LAFE Framework Law for Financial Administration MIDEPLAN Ministry of Planning MOF Ministry of Finance MTEF Mid-TermExpenditureFramework NAO National Audit Office OECD Organizationof Economic Cooperation and Development PFM Public Financial Management PMG Management ImprovementPrograms ROSC Report on Standards and Codes SA Service Agency SA1 Supreme Audit Institution SEP System of Public Enterprises SIAPER Personnel Management System SICOGEN General Accounting System of the CGR SIAP Budget Control System in DIPRES SIGFE Integrated FinancialManagement System SIGADE Integrated ExternalDebt Management and Administration System (English: DMFAS) SOE State OwnedEnterprises SUBDERE Undersecretary of Regionaland Administrative Development svs Superintendence of Securities and Insurance VUOP Housing, UrbanandPublic Works Divisionof the CGR WB World Bank Chile Countrv FinancialAccountabilitvAssessment i v ACKNOWLEDGMENTS This Country Financial Accountability Assessment (CFAA) was preparedby Paul Sisk (Task Team Leader, World Bank, WB) and Lynnette Asselin (Inter-American Development Bank, IDB). The CFAA team made a planning mission to Chile in June of 2003. The main mission was conducted from March 22 to April 2, 2004. David Shand (WB), Gloria Coronel (IDB), Marcel0Barg (Consultant), Carmen Paladin0 (Consultant), and Richard Maggs and David Goldworthy of the UK National Audit Office joined the main mission. Beltran de Ramon (Head of the Department of Finance in the National Budget Office, DIPRES) coordinated the CFAA on behalf of the Government of Chile. Gilma Unda (WB) and Paz Barayon (IDB Chile Office) provided administrative assistance. This report has also made extensive use of factual information contained in two earlier reports: Chile: Report on the Observance of Standards and Codes - Fiscal Transparency Module, IMF, August 2003, and an OECD report, Budgeting In Chile (2004). The assistance provided by these reports is hereby acknowledged. Among Chilean government reports, of particular relevance were the annual Report on Public Finance on the Budget Bills of 2003 and 2004 by the Budget Director and Systems of Management Control and Results-Based Budgeting issued by the Management Controls Division of the NationalBudget Office. Peer reviews were provided by Roberto Panzardi and Ivor Beazley (WB) and by the Management Review Committee of the IDB. Internal review for LCOAA was provided by Jamil Sopher. The Government of Chile provided the CFAA Team with additional informationinApril 2005. This information has been incorporated into the report and is identified in the footnotes and Annex 4. The CFAA Team would like to thank Mario Marcel, Director of DIPRES, his staff, Pedro Ortiz Head of the Accounting Division in the Controller General's Office (CGR) and Hernin Llanos, Head of the CGR External Auditing Department, and their staff for the collaboration and support. A list of officials contacted duringthe CFAA missions is given inAnnex 1. ChileCountrv FinancialAccountability Assessment V Table of Contents Abbreviations and Acronyms ... Acknowledgments ................................................................................................... ................................................................................ 111 iv EXECUTIVE SUMMARY ................................................................................... vii x 1 Background . BudgetImplementation ..................................................................................... ................................................................................................................ 1 Country Background ................................................................................................ 1 Objectiveof the CFAA ............................................................................................. 2 World Bank's InvolvementinChile ....................................................................... 3 4 2 . IDB's InvolvementinChile ...................................................................................... CFAA ANALYSIS AND MAJOR ISSUES 5 Institutional and LegalFramework ........................................................................ ............................................................. Overview............................................................................................................ 5 5 5 Legal Framework on Public Financial Management......................................... Organization of the Public Sector...................................................................... 6 Public Financial Management Staffing ............................................................. 7 BudgetDevelopmentIssues Overview............................................................................................................ ..................................................................................... 8 8 InstitutionalArrangements for the Budget ........................................................ 8 Budget Comprehensiveness............................................................................... 9 Budget ProcessandTimetable......................................................................... 10 13 PerformanceInformationinthe Budgetary Process........................................ BudgetDocuments (Annual BudgetLaw) ...................................................... 14 MediumTermFiscalFramework.................................................................... 15 15 The Budget and Sub-national Governments.................................................... State OwnedEnterprises.................................................................................. 17 BudgetImplementation .......................................................................................... Overview.......................................................................................................... 17 17 Monitoringof Budget Implementation............................................................ 17 FinancialManagement InformationSystems and SIGFE ............................... Recommendationson Budget Implementation................................................ 21 23 ExternalFinancial Reporting and Transparency 24 Overview.......................................................................................................... ................................................ Annual Budget Law......................................................................................... 24 24 Reporting on BudgetExecution....................................................................... 24 Annual Report on Public Finances by the Budget Director ............................ 25 25 Annual Financial Report on the Public Sector ................................................ Public Finance Statistics .................................................................................. Recommendation of ExternalReporting ......................................................... 26 28 Internal Control and InternalAudit ..................................................................... 29 Recommendationson InternalAudit ............................................................... 29 Overview.......................................................................................................... 29 External Control ..................................................................................................... 30 Overview.......................................................................................................... 30 Chile Country Financial Accountabilitv Assessment vi Functions of the CGR ...................................................................................... 31 Audit Mandate andRole: Functional Independence....................................... 30 31 Audit Process................................................................................................... Modernization Plans........................................................................................ 32 34 3. RecommendationsonExternal Audit.............................................................. Conclusion 36 Summary ................................................................................................................. ...................................................................................... .......................... 36 Conclusion ............................................................................................................... 37 39 4 ....................................................... 41 5.. FinancialManagementRiskAssessment .............................................................. Annex 1:Officials ContactedduringMission Annex 2: Detail of the PublicFinancialManagementComponents BudgetDevelopment ............................................................................................... ..................43 43 BudgetImplementation ......................................................................................... -44 CashManagement ........................................................................................... 44 47 BudgetImplementation Health andEducation................................................ Investment Costs.............................................................................................. 47 ExternalFinancial Reportingand Transparency ................................................ Reportingby Municipalities............................................................................ 51 Reporting on Military Expenditures................................................................ 51 51 Accounting Standards...................................................................................... 52 ManagingandReporting on Public Debt........................................................ 52 Tax Expenditures............................................................................................. Contingent Liability Reporting........................................................................ 53 54 Asset Management........................................................................................... 54 Internal Controland InternalAudit ..................................................................... Internal Control................................................................................................ 54 54 Internal Audit................................................................................................... 55 57 Internal Audit Operations ................................................................................ Audit Objectives .............................................................................................. 58 External Control 59 Audit Mandate and Role: FunctionalIndependence....................................... ..................................................................................................... Functions of the CGR ...................................................................................... 59 60 CGR Organization, Management and Resources............................................ CGR Modernization Plans............................................................................... 61 61 Audit Process................................................................................................... 63 IncreasingImpact............................................................................................. 64 Annex 3: BudgetTables ......................................................................................... 65 Annex 4: SIGFE coverage ...................................................................................... 67 Chile Country FinancialAccountabilityAssessment vii EXECUTIVESUMMARY Chile i s an upper- to middle-income country of 15.4 million people with the most robust economic performance in the Latin America region. GDP was US$ 72.4 billion in 2003 and per capita income' US$ 4,390, one of the highest in Latin America. Chile's macroeconomic policies and strong fundamentals have, to a large extent, insulated it from regional crises and have allowed continued growth in recent years, albeit at lower rates than inthe mid-1990s. Economic performance continues to outpace that of the rest of the Region, and inper capita terms, GDP growth has averaged4 percent per year since 1990, versus 1percent for the LAC region duringthe same period. This performance is sustained by sound policies and an ambitious structural reform agenda. Public sector reforms of the 1990's resulted in a considerable improvement in public finance, health, education and social security, with emphasis on good and expeditious delivery of services to citizens. In early 2003, the Government and the opposition agreed to a national proposal to modernize state institutions, ensure greater transparency, prevent corruption, and stimulate growth. The main elements of the reform package are: a reform of the civil service regime, including the introduction of performance-based incentives and reduction of political appointees in the senior executive service; an expediting and simplification of administrative proceduresto reduce the uncertainty for the private sector in its dealings with the public sector; a public procurement law, establishing an electronic procurement and information system, and increasing the transparency of government contracts for the purchase or lease of goods; and a package of measures to increase government transparency, the most important of which is campaign finance reform, setting limits on electoral spending, and making political financing more transparent and subject to external controls. Transparency International assignedChile a 7.5 corruption perception rating compared to an average of 3.4 for the LAC region (a rating of 10 corresponds to public perception of zero corruption). Central public sector institutions score high in economic management, structural policies, and overall public sector management, out-ranking regional counterparts andincome group comparators. Overviewof PublicFinancialManagementinChile The abundant trust in government in Chile today can be attributed, in part, to two elements of transparency: its fiscal reporting and the incontestable review by a competent, independent authority -the CGR The relationship between good governance and better economic and social outcomes is increasingly acknowledged. Transparency - opennessabout policy intentions, formulating and implementation - is a key element of good governance. The budget i s the single most Per capita GrossNational Income, Atlas method. Chile Country FinancialAccountabilityAssessment ... V l l l important policy document of governments, where policy objectives are reconciled and implementedin concrete terms. Budget transparency is defined as the full disclosure of all relevant fiscal information in a timely and systematic matter. Recognizing this relationship, in Chile the executive has made a formal commitment with Congress to conform with the OECD Best Practicesfor Budget Transparency.' Furthermore, Chile has effectively centralized policies and procedures to support aggregate fiscal discipline. Aggregate fiscal discipline, measuredby total fiscal balance or public debt, and the related predictable funding of the budget in Chile has been achieved through a well-developed budget system which provides for a realistic and comprehensive budget. The management of service delivery and the corresponding financial operations, on the other hand, is delegated to 190 administratively independent service agencies. The main feature of Chile's public financial management (PFM) operations has been the combination of centralized policies and procedures operated by DIPRES and CGR with decentralized service delivery and financial management operations through 190 service agencies. Although now the subject of a significant reform, DIPRES and CGR use separate, unintegrated processes to monitor budget implementation and prepare the financial statements of the central government. With the development of a centralized integrated financial management system (SIGFE), the strengthening of internal controls inthe service agencies and the modernization of the external audit system, all supported by substantial investment projects from the World Bank and the Inter-American Development Bank, the centralized control can now continue to evolve to greater reliance on accountability for results, with a focus on outputs rather than inputsby the agencies. These developments also allow the functional specialization of the two rector entities of financial management system - DIPRES and CGR - which now have overlapping functions, which i s the case of the CGR, some functions that are incompatible with its ultimate responsibility as the system's external auditor. DistinguishingFeatureof PFMinChile Chile's public financial management i s characterized by a unique blend of strengths and weakness. At present, the systems to support the budgeting and accounting in the public sector operating at the agency level are not state-of-the-art and are not uniform across the public sector since they are the responsibility of each executing agency. The systems in place centrally to support fiscal discipline, efficiency and external reporting are not state of the art and duplicative between DIPRES and CGR. * OECD Membercountries are at the forefront of budgettransparency practicesand drew together a set of Best Practicesinthis areabasedon Membercountries' experiences. The Best Practicesare designedas a reference tool for Member andnon-membercountries to use in order to increasethe degree of budgettransparency intheir respective countries. Chile Country FinancialAccountability Assessment i x Despite these limited systems, Chile scores high on financial management outputs in fiscal discipline, transparency and supporting efficiency in operations because underlying all financial management operations are clear rules, strict adherence to the rules, dedicated and qualified staff and management which rewards ethical and efficient behavior and there i s a matching of responsibility with accountability given the decentralization of financial managementto the service agencies. As such, Chile has in place the two elements3of effective controls systems: workable rules and procedures; and patterns of behavior that accept the rules and procedures as legitimate. It is precisely this solid basis of clear rules andbehavior in line with the rules that will allow Chile to attain the standards of public financial managementwhich it has targeted ( accrual based fiscal reporting and OECD Budget Practices) but it must address remainingissueson the implementation of the new systems and produce anexplicit audit opinion on the general government sector financial reports. Summary o the Financial Accountability Arrangements InstitutionalArrangements The legal framework for public financial management rests first, on a clear definition of roles between the legislature, the executive, and the autonomous external audit institution (CGR). Furthermore, the responsibility for planning, controlling and reporting of funds is set out in the law; responsibilities for treasury, budgeting and accounting are assignedto specific central authorities (Treasury, National BudgetOffice andthe CGR, respectively). Compliance with the legal framework on public financial managementi s encouraged in Chileby the independent oversight provided by the CGR and intervention by the other central authorities -DIPRES, National Civil Service Commission, Council for General Government InternalAuditing (CAIGG). Compliance with this framework i s also encouragedthrough laws on probity which render personnel of the state administration subject to administrative responsibility for their acts inadditionto civil and criminal responsible. Budget Development Chile has a well-developed budget systemwhich provides for a realistic and comprehensivebudget, developedand implemented according to a well-defined timetable and processes. There is alsoa highlevel of budget transparency. Chile also has a strong track record of fiscal prudence. Current fiscal policy (a political commitment of the Government, rather than alegal requirement4provides for a structural 3AContemporaryApproachto Public ExpenditureManagement,Allen Schick, World Bank Institute, 1999 Chile Country FinancialAccountabilitvAssessment X (i.e. underlying, or excluding the impact of short-term output fluctuations and deviations of the copper price from its long-run estimatedmean) budget surplus of one percent of GDP.Necessaryadjustments to achieve this target are madeto budget expenditures duringthe year. This structural target hasenabledthe Government to pursuecounter- cyclical economic policies inrecent years. Chile makes extensive use of performance information in the budget process; under the decentralization of financial management, performance measures and program evaluations are key to align incentives with budget objectives and facilitate supervision by central authorities. This occurs through two main mechanisms, managed through a separate unit of DIPRES : (1) a system of performance indicators developed for ministries and agencies, and(2) a systemof program evaluations. Two exceptions to the comprehensivenature of the budget, however, should be noted: - A transfer of 10 percent of the gross revenues of the national copper company, CODELCO, to the ministry of defense for allocation to the three services for equipment purchases, which is provided for in the reserved copper law.5 This arrangement i s an exception to the general prohibition on earmarking of revenues contained in the constitution. Aggregate informationon this expenditure is contained in the public finance statistics andthe quarterly budget execution reports. - Significant quasi-fiscal activity is undertaken by the state-owned commercial bank, Banco Del Estado, which has the exclusive right to hold public funds, although there i s no reliable estimate of the amount of this activity. The bank does not pay interest on the balances in the estimated near 5,000 ministry and agency bank accounts (with average daily balances of between US$500 million and $800 million), but in return provides government banking services at no charge and social services such as maintaining unprofitable branches inrural areas andprovidingparticular services for poor people. Budget- Implementation Budget implementation is supported by predictable funding, achieved through effective cash allotting and tight budget monitoring, which at present depends on the stand alone budget and accounting systems in the service agencies but is closely overseen by central authorities through the ex-ante review in the CGR and the regular reporting to DIPRESand CGR. The systems inthe service agencies are not integrated with those of agency headquarters andonly report on net movement by account and only inhardcopy or intext files to the central authorities (DIPRES and CGR). These systems do not provide control over the budget commitment process and contribute to the diffusion of government bank accounts. ~~ According to information received from the Chilean Government inApril 2005, the recent amendments o f LAFEreinforce the legal framework of the budget system 'CODELCO's total export revenue for 2003 came to $ USD 3.8 billion. Chile Country Financial Accountability Assessment x i The centralized system SIAF in DIPRES for budgeting and SICOGEN in CGR for budgeting and accounting are not state of the art, duplicative and not integrated with those subsidiary systems inthe service agencies. An integratedfinancial management system (SIGFE)is under implementation to address this and supports the current decentralization of financial management to the service agencies. At the same time, it provides central authorities with a uniform and reliable process in which a consolidated budget, including commitments, and accounting information i s generated by providing central authorities with on-line access to transaction information. Given the role of SIGFE in the aggregate budget control and financial reporting, the steps to cover the outputs of SIAP and SICOGEN and the arrangements for the operation of the centralized applications should be agreed upon well in advance of the 2005 deadline for full conversion to SIGFE. Steps toward this end would begin with settling which entity will operate the centralized SIGFE application; a sign-off that its provisions comply with the reporting needs of boththe CGR and DIPRES and an explicit commitment to rely on SIGFEonce implemented. Fiscal Transparency (i)Fiscalreportingistimelyandcomprehensive,andmuchofitisavailablepublicly on government websites. The draft budget law provides comprehensive information covering the main fiscal aggregates and monthly, quarterly, and annual budget execution reports are published within 45 days of each period's end. Public Finance Statistics are also presented in a Public Finances Yearbook published around April each year, with comparative informationbeing providedfor the previous nine years. (ii)The Government's annual financial report, prepared by CGR, is timely, comprehensive, and reliable, and it is generated in an environment of good internal control with regular ongoing external oversight by the CGR. These statements could be improved however: the notes to the financial statements are incomplete, there is no operating statement to explain changes in net worth between years, significant entities are excluded, including the State Copper Company, CODELCO, and the report i s not accompanied by an audit opinion. Virtually all the information missing from the annual financial report i s disclosed by DIPRESelsewhere, so it would be a small step to include this in the annual financial report. These statements would present for all stakeholders, statements fully in line with disclosure conventions implied in generally accepted accounting standards, thus facilitating analysis of the results and of the financial position of the state. Internal Control and InternalAudit Chile is well advanced inthe adoption of the modern concept of internalcontrol as a management responsibility and as a basis for performance-based government. Since Chile Country FinancialAccountabilityAssessment 1997 it has achieved positive results ininternal control and audit, and i s making progress inthe useandassessment of internalcontrols. Presidential decrees and central overview of the internal audit function in ministries, agencies and public enterprises have assisted in the creation of a culture of positive control. The fundamental components of internal control (planning, implementing, supervising and monitoring) are also embodied in the Management Improvement Programs developed by each agency. Advising management on areas at risk, performing audits of operations and recommending ways to improve operations and strengthen internal controls are becoming an integral part of the work of the internal auditors. External Audit and Review The external control function for Chile's public sector is the responsibility of the CGR, a well-respected institution which has played an important role in strengthening public financial management in Chile and in helping to build Chile's justifiably high reputation for probity and fiscal transparency. The CGR has many functions (pre-audit review, vetting of legislation, setting accounting standards, preparing the financial statements of the public sector, and external audit), not all of which are compatible with the role of a modern external public audit institution. CGR has progressively relaxed its ex-ante control systems. With the growing maturity of internal controls within the Chilean public sector as internal audit units become more developed and as Ministry of Finance-led control systems, for example SIGFE and SIAPER (Personnel Management System), come to fruition, the CGR should consider further reductions in ex-ante controls and build up a broader range of ex-post audit and evaluation activities. This evolution infunctions would provide the independenceand the time required for issuing opinions on the published financial statements. This would reinforce the transparency and the separation of duties within Chilean Public Finance institutions. The CGR does not provide opinions on the consolidated financial accounts or on individual agency financial statements. Assessing the extent to which the accounts of government bodies in Chile are true and fair would exert a useful discipline on public entities in Chile, encouraging accounts to be completed promptly and accurately. Such opinions are consistent with principles of transparency embedded in the public sector modernization agenda of the government and the Congress and would buttress Chile's international reputation for propriety. To position itself to render an opinion on the consolidated financial statements, the CGR would have to distance itself from the preparation of the statements, which would require a Constitutional amendment. Conclusion Chile is well into the second generation of public sector reforms. The current focus has moved beyond fiscal discipline to improving public service delivery, that is, the effectiveness and efficiency of government. Such improvements can be built now only because they can rest on the solid existing base of (i) fiscal stability, (ii) predictable Chile Country Financial Accountability Assessment xiii financing, and (iii) resource use in line with budget authorizations, with reliable reporting on income, uses and financial position. In Chile, the assurance that uses of public funds are in line with authorizations and that there is full and accurate reporting is attributed to clear roles set in law for the executive and the legislature on budget development and oversight, and a clear definition of the responsibilities within the executive for financial management. These roles and rules on the use o f public funds are strictly observed and are supported through: An obvious commitment by public sector management to efficiency and transparency inthe public sector. Incentives in the government-wide Management Improvement Program for buildingfinancial management capacity inthe service agencies. Staffing of financial management positions with qualified professionals in the respective disciplines who operate under clear written rules and regular expert supervision. Independent review by internal auditors under the control of the management of each agency, internal auditors under the Executive, and external auditors reporting to agency management, the Executive and to Congress on the legal compliance and probity o f all administrative acts. Decentralization of financial management to the service agencies, accompanied by well-developed performance measures. UnresolvedIssues Notwithstanding the favorable status o f financial management, to advance with modernization toward the world's most advanced countries in terms of fiscal transparency6, the following issues have to be addressed. SIGFE Chile i s committed to moving to accrual based fiscal reporting (GFSM2001)7. In turn, the steps to prepare Chile for accrual based fiscal reporting involve the successful implementation of the integrated financial management (SIGFE), under development, both at the decentralized level and centrally for aggregation and oversight. Given that a single system now integrates accounting, budget and treasury, there i s a general understanding that a single party must be responsible for the operation of the system and that the existing separate systems must be displaced by SIGFE. There is, however, no formal commitment to this and no detailed steps have been laidout for its implementation. Given CGR's constitutional responsibilities for keeping the accounts of the nation it has to be satisfied that SIGFE meets these ends and has to ensure that it i s operating to their The Director of DIPRES summed up Chile's position on financial management reform in the Report on Government Finances ( 2003): THEAIM ISTO RAISECHILE TO THE SAMELEVELAS THE WORLD'S MOST ADVANCED COUNTRIES INTHE QUESTIONOFFISCALTRANSPARENCY STANDARDS. IMF(2003),Chile-StaffReportfor the Article IV Consultation,paragraphs29 and50andAnnex 11. Chile CountryFinancialAccountabilitv Assessment xiv expectation on an on-going basis. At the same time, the executive (DIPRES) has a duty to maintain a financial administrationinformation system and control the budget. Since DIPRES i s responsiblefor maintaining afinancial administration system, it would follow that they operate SIGFE. Arrangements could foresee that (i) DIPRESoperate SIGFE and (ii) and CGR would have simultaneousreal time access to SIGFEdata .Under DIPRES these, or similar arrangements, a detailedformal plan shouldbe formalized so the arrangements for implementationof the centralized system may be effected. These arrangements would be operational and would not change the responsibilitiesupon accountingfunction definedby the Constitution. ProiectAdministration Mainstreaming A concreteshort term benefitof the full implementation of SIGFEis the possibilityfor the administration of investment project financed by the international financial institutions to be carried out exclusively through the financial managementsystemof the Service Agencies. This mainstreaming of project administration offers efficiencies and economiesto the Government inthat no redundant systems are developed or operated for the individual projects. External Audit OECD Best Budget Practices cover not only the principal budget reports that governmentsshould produce and their general content but also the practices for ensuring the quality and integrity of the reports. Inthis regard, Chile i s at a variance with the external auditing best practice which states "The year-end report should be audited by the SupremeAudit Institutioninaccordancewith generally accepted auditing practices." For Chile to emerge at the forefront of public sector management, it should issue its annual financial statements with an audit opinion and move to closer adherence with internationally accounting standards inits reporting. The lack of any external audit opinion on the government financial statements is not consistent with a modern approach to public sector external auditing. The independent review i s a central pillar of transparency; a key output of the external review is an explicit audit opinion on the financial reports of the general government entities. The acceptedmediumfor expressing the results of this work is to attach the auditor's opinion, ina format and of a content which conform to international auditing standards, to the financial statements so that users of these statements have this comfort when viewing the statements. To renderthese opinions, CGR would have to distance itself from both the ex ante approval role of budgetuses andthe preparation of the annual financial statements. .Thispotential conflict of interest betweenthe preparation of accountsby CGR andtheir role inthe audit of these accounts does not comply with INTOSAIprinciples. However, modifying CGR mandate and activities may be difficult, inpart becauseCGR has a strong reputation, and inother part becauseof role ascribed to CGR inthe Constitution. The Chilean authorities should therefore consider a solution that complies with international practice andaccommodatewith country constraints. Chile CountryFinancialAccountability Assessment xv Financial Management Risk The financial management arrangements in place (clear roles and rules, transparent reporting, good independent oversight, sophisticated budget techniques and decentralization of financial management to the agencies) clearly align with the Government's goals of fiscal stability and greater efficiency in service delivery. These arrangements also indicate that the financial management risk to Bank funds, indeed to public funds in general, i s low. Chile CountryFinancialAccountabilityAssessment 1 1. BACKGROUND COUNTRY BACKGROUND Economic Context 1.1. Chile is an upper- to middle-income country of 15.4 million people with the most robust economic performance in the Latin America region. GDP was $US 72.4 billion in 2003 and per capita income' $US 4,390, one of the highest in Latin America. Chile's macroeconomic policies and strong fundamentals have, to a large extent, insulatedit from regional crises andhave allowed continued growth in recent years, albeit at lower rates than in the mid-1990s. Economic performance continues to outpace that of the rest of the Region, and in per capita terms, GDP growth has averaged4 percent per year since 1990, versus 1percent for the L A C regionduring the same period. 1.2. This performanceis sustainedby soundpolicies and an ambitious structural reform agenda. The country's fiscal position is strong, and public external debt i s low, standing at 12 percent in 2003. A flexible exchange rate and inflation targeting are implemented by an independentcentral bank, and the financial sector is healthy and solvent, having weathered well the economic slowdown since 1998 as well as various emerging market crises. Chile's significant advances in negotiating free trade agreements have helped bolster its external sector. Reflectingthese generally positive conditions, Chile's country riskpremiumhas declined to 70 basis points, the lowest of any Latin American country; Chile's foreign-currency debt rating was raised by Standard & Poor's from A- to A in January 2004, and i s now four notches above that of Mexico, Latin America's only other investment grade-ratedcountry. Modernization of the State 1.3. Chile i s rated highly on law and order and the quality of its bureaucracy, and low on levels of corruption. Transparency International assigned Chile a 7.5 corruption perception rating compared to an average of 3.4 for the L A C region (a rating of 10corresponds to public perception of zero corruption). Central public sector institutions score high in economic management, structural policies, and overall public sector management, out-ranking regional counterparts and income group comparators. 1.4. To buttress its foundations for growth, Chile has continued to promote an impressive reform agenda. The list of structural reforms, many already approved and under implementation, covers a gamut of topics, including: state modernization and transparency, regulatory reforms to spur investment and growth, enhanced financial regulation and supervision, labor market measures, andarecent flock of Free Trade Agreements (FTAs). 1.5. Public sector reforms of the 1990's resulted in a considerable improvement in public finance, health, education and social security, with emphasis on good and expeditious delivery of services to citizens. In early 2003, the Government and the opposition agreed to a national proposal to modernize state institutions, ensure greater transparency, halt corruption, and stimulate ~ Per capitaGross National Income, Atlas method. ChileCountry FinancialAccountability Assessment 2 growth. Between March and May of 2003, the Government took to Congress a package of nearly 50 measures largely related to public sector reform and with a heavy emphasis on state modernization andtransparency. 1.6. The main elements of the reform package are: a reform of the civil service regime, includingthe introduction of performance-basedincentives and reduction of political appointees in the senior executive service; an expediting and simplification of administrative procedures to reduce the uncertainty for the private sector in its dealings with the public sector; a public procurement law, establishing an electronic procurement and information system, and increasing the transparency of government contracts for the purchase or lease of goods; and a package of measures to increase government transparency, the most important of which i s campaign finance reform, setting limits on electoral spending, and making political financing more transparent and subject to external controls. OBJECTIVE THECFAA OF 1.7. The CFAA supports the Banks' development objectives by identifying strengths and weaknesses incountry PFM systems. Itfacilitates a common understanding among the government and the Banks on the performance of the institutions responsible for managing the country's public finances. Also, the information obtained in CFAAs helps the government and Participating Banks to meet theirfiduciary objectives by identifying risks to the use of public funds posed by weaknesses inpublic financial management arrangements. This i s the first assessment ( CFAA) by the Banks of Chile; it follows closely and has made extensive use of factual information contained in two earlier reports: Chile: Report on the Observance of Standards and Codes - Fiscal TransparencyModule, IMF,August 2003, and an OECD report, Budgeting InChile (2004). 1.8. On the fiduciary objectives, the outputs of the CFAA are pertinent to determining the reliance which can be placed on country-wide systems for investment projects and to provide a fiduciary framework for development policy lending i.e. where loan proceeds are not traced to specific expenditures. On the development objectives, while Chile's fiscal performance i s proof of the capacity of its public expenditure management arrangements, this capacity continues to grow with the implementation of well-focused reforms and the high profile given to performance issues in the budget discussion. Chile is seeking evaluation of its public financial management performance as it undertakes to come astride the OECD countries in its budgetary practices and fiscal reporting. Therefore, in addition to the fiduciary assessment, this CFAA's compares what i s being accomplished and the plans of the reforms against what i s neededto reach the stated goals infinancial management. IssuesInfluencing the Coverage and Scope of the CFAA 1.9. Reforms and initiatives in public sector budgeting in Chile include the use of multiyear forecasts, a fiscal surplus rule, and performance measurements and budgeting on the basis of outcomes and results evaluations. In this context of a well-performing public sector and good reformrecord, the two issuesrequiredparticular attention inthe CFAA. 1.10. Decentralization. The current degree of decentralization of budget execution, accounting andcash managementpresents a challenge for the CFAA. While decisions on the level of spending Chile Country FinancialAccountabilityAssessment 3 and the allocation by sector may be centralized, the management of service delivery and the corresponding financial operations are spreadover 190 administratively independent agencies. The only transaction-level records of public sector spending are kept in these agencies. The central authorities cannot guarantee the integrity of the information received as they apply only analytical tests to the input. Reforms to provide uniform systems for these operations are, however, underway. 1.11. Focus on Central Government and Health and Education Sectors. Since budget control, accounting, and cash management for service delivery in central government i s decentralized to 190independent agencies, only a sample of these intwo sectorscould be addressedwithin the time and resources budgetedfor the CFAA. The assessment examined the flow of funds and systems of a sample of agencies under the Ministries of Education and Health as representative of central government service delivery operations. 1.12. The education and health sectors were chosen, in part, because of the significance of their combined spending. Transfers to these sectors come to 31 percent of tax receipts, and the combined uses are over 25 percent of all national government uses (financed by tax receipts, fees and other sources). Additionally, the complex and transaction-intensive nature of operations warranted their selection. 1.13. External Audit. The Supreme Audit Institution inChile (CGR) performs an ex-ante review on selectedtransactions andprepares the financial statements on the central government, but issues no opinion on the annual financial statements. The CFAA studied this arrangement to determine its impact on the auditor's independence. WORLD BANK'S INVOLVEMENTINCHILE 1.14. The WB Country Assistance Strategy (CAS) 2002 sets out three broad goals to support Government's programs: (1) sustain economic growth and social policy; (2) increase inclusion, especially of rural populations and vulnerable groups; and (3) modernize the state as the underpinning for the two previous objectives. Public financial management is central to public sector managementwhich inturni s the main component of modernization of the state. 1.15. The WB's active portfolio consists of eight investment projects with a total value of US$308.8 million, of which $US138 million were undisbursed as of July 2004. All projects are rated satisfactory and, inparticular, financial managementinall projects is satisfactory. 1.16. One active WB investment project i s the Public Expenditure Management Project, effective in 2002, which supports the development of an integrated financial management system for the central government and a centralized human resource management system. This operation supports directly the state modernization programof the Government. 1.17. The proposed lending program for FY02-06 to support the CAS 2002 would be approximately US$500 to US$650 million. The first part would consist of up to six investment loans, roughly one each year, for a total of about US$250 to US$300 million. The second part of the Bank's program would consist of one or two adjustment operations. The composition of the future lendingprogram implies greater reliance on country financial management systems. While ChileCountry Financial AccountabilityAssessment 4 systems contained in specific agencies involved with earlier projects have been assessed as part of project work, central systemshave not previously been assessed. IDB'SINVOLVEMENT INCHILE 1.18. In accordance with the Government's program and the IDB's institutional strategy, the IDB's activities in Chile concentrate on three priorities: (i) for initiatives that increase support competitiveness and productivity; (ii) support for efforts to reduce social and regional inequalities andto improve livingstandards, with particular attention to vulnerable groups; and (iii) for support processes conducive to improving public sector management in the provision of public services, strengthening partnerships between civil society, the public and private sectors, and increasing citizen participation. 1.19. IDB's portfolio as of December 2003 includes 11 projects with a value of $US 733.2 million. An additional six projects valued at $US 263 million are in the pipeline. All projects are rated satisfactory and, in particular, financial management in all projects is satisfactory. Additionally, as with the WB projects, all project audited financial statements have been received by the due date of April 30 and were auditedby the CGR. 1.20. IDB's active portfolio includes a $15 million loan for the Modernization of the CGR, aimed at improving its management systems and enhancing its efficiency and operational effectiveness. This project constitutes a key linkage with the WB Bank's Public Expenditure Management Project. Chile Country FinancialAccountabilitvAssessment 5 2. CFAAANALYSIS AND MAJOR ISSUES INSTITUTIONALAND LEGAL FRAMEWORK Overview 2.1. The legal framework for public financial management rests first, on a clear definition of roles between the legislature, the executive, and the autonomous external audit institution (CGR). Furthermore, the responsibility for planning, controlling and reporting of funds is set out in the law; responsibilities for treasury, budgeting and accounting are assigned to specific central authorities (Treasury, National Budget Office and the CGR, respectively). 2.2. Compliance with the legal framework on public financial management is encouraged in Chile by the active a priori oversight provided by the CGR and intervention by the other central authorities - DIPRES, National Civil Service Commission, Council for General Government Internal Auditing (CAIGG). Compliance with this framework is also encouraged through laws on probity and which provide that civil servants must act with transparency and reveal the procedures, contents and bases for decisions taken, and that they will be subject to administrative responsibility for their acts inaddition to civil andcriminal responsibility. 2.3. Compliance with the legal framework i s evident from the timely financial reportingby the agencies and central authorities. Moreover, the strong control framework i s acontributing factor to the low level of corruption perceived inChile. Organizationof the Public Sector 2.4. Chile i s a unitary state, with three independent powers: the executive branch, the legislature, comprising the senate and the chamber of deputies; and the judiciary, comprising the Supreme Court, ordinary, special, superior and appeal court^.^ As outlined in the Organic Constitutional Law of the Bases for State Administration (Law No. 18575), the Presidentis responsible for the government and administration of the entities set out inthe law. 2.5. The administration of the state comprises: the ministries, governorships, state organisms and service agencies, including the Supreme Audit Institution (CGR), Central Bank, the armed forces, the regional governments, the municipalities and the state enterprisescreatedunder law. Article 3 of the Political Constitution of 1980 Chile Country FinancialAccountability Assessment 6 LegalFrameworkonPublicFinancialManagement 2.6. The constitution provides the general basis for the state administration .lo It calls for an Organic Constitutional Law on the Administration of the State," which should determine the organization of the public administration and rules on the civil service. The constitution calls for an independentreview entity, the CGR, to review the legality of the administrative acts and to control the revenue and investment of treasury funds, municipal funds, and of other public entities, as well as to keep the accounts of the state. It also stipulates that public treasuries may not make any payment without decrees or resolutions by a competent authority which approves the use of funds. Paymentsare to be made only inline with a cashreleaseprogram and after budget availability i s certified. 2.7. The Framework Law on Financial Management of the State, LAFE, defines the system of financial administration of the state (budget, accounting and treasury) and sets out the coverage of the system.12 The entities covered are all those included in the national budget, i.e. all central and decentralized entities: all ministries, the Congress and the judicial branches, the Auditor General, the service delivery organizations; regional governments; and the social security and health funds. The LAFE provides for common standards to be applied to the budgeting, accounting and treasury operations and for the whole systemto be guided by a public sector planning system. 2.8. The LAFE establishes the principles of comprehensive budgeting and a central treasury account, while assigning responsibilities for financial administration, budget formulation and execution to DlPRES and oversight to the CGR. It also provides framework rules for reallocation of funds during the execution of the budget, along with others contained inthe AnnualBudget Law. 2.9. The Annual Budgetlaw sets out other provisions governing budget execution and development such as the size and management of the budget contingency fund, permitted transfers between budget items andthe permitted level of public sector debt, arisingboth from the budget and other transactions. As suggestedin the IMFFiscal ROSC13, inother countries the first two provisions might normally be included in an organic budget law rather than separately legislated each year14. 2.10. All state income and expenditure should be reflected in the budget and the use of tax income must be governed by the priorities set in the budget. The accounting system operates on a decentralized basis with records kept in the service agencies as determined by the CGR. Reportingon the whole of the public sector i s the responsibility of the CGR. loLaw 3464 - Decreto Ley 3464. 11The General Bases for the Administration of the State Law (Ley 18,575). l2Ley Orghica de La Administracidn Financieradel Estado. l3Chile: Report on the Observance of Standards and Codes - Fiscal Transparency Module, IMFAugust 2003, page 67. l4According to information received from the Chilean Government in April 2005, the recent amendments to LAFEreinforce the legal framework of the budget system and the consistency with international practices Chile CountD, FinancialAccountabilityAssessment 7 2.11. The LAFE does not cover the autonomous universities nor the state enterprises, which operate under their own statutes, ,but they are requiredto report yearly to the CGR on their financial position andthe execution of their budgets. 2.12. State-owned enterprises (SOEs) comprise entities which operate under the Companies Act (joint stock companies) and those entities createdby separate legislation. Law 18196provides the financial managementframework for SOEs. PublicFinancial ManagementStaffing 2.13. Reforms on hiring and promoting public servants were introduced in 2003 to establish mandatory open competition for appointment and promotions in the civil service for the positions of director generals in the 100 non-policy-setting agencies, and for staff in all 190 agencies. To strengthen overall personnel management, a new personnel management directorate ( National Civil Service Commission) has been created in MOF, at the same level as DIPRES,to provide oversight of personnel policies and recruitment inthe central government andregional governments for all entities which operate under the public service law for both contract and permanent positions. The Central Bank, Banco del Estado, the armed forces, the CGR and the state enterprises operate under their own framework laws.I5 2.14. For management and staff positions in financial management, both selection and promotions are competitive with positions being advertised; the processes are carried out by authorized external professional recruiting and personnel consulting firms and overseen by an independent panel. Furthermore, the Ministry of Finance, in cooperation with the CGR, is developing and implementing a new integrated financial management system (SIGFB), and as a key element of the agreement with the agencies on its implementation, staff inthe financial management areas must undergo training. 2.15. Ethical behavior in the public service is encouraged by the General Bases for the Administration of the State Law (Law 18575) which was amended to incorporate the following provisions on probity by civil servants:l6 0 that public officials must observe the principle of probity and must act with transparency and reveal the procedures, contents andbases for decisions taken; 0 that personnel of the state administration will be subject to administrative responsibility for their acts, inaddition to civil and criminal responsibility; 0 that administrative acts of state administration and the related documents are public. l5Law 19882of June 17,2003. Law 19563of 1999. Chile Country Financial Accountability Assessment 8 BUDGET DEVELOPMENT ISSUES Overview 2.16. Chile has a well-developed budget system which provides for a realistic and comprehensive budget, developed and implemented according to a well-definedtimetable andprocesses. Performanceissues are well integrated into the budget process and there is a partially developed medium-term fiscal framework. There is also a high level of budget tran~parency.'~ 2.17. Chile also has a long history of fiscal prudence. Current fiscal policy (a political commitment of the Government, rather than a legal requirement") provides for a structural (Le. underlying, or excluding the impact of short-term fluctuations output fluctuations and deviations of the copper price from its long-run estimated mean) budget surplus of one percent of GDP. Necessary adjustments to achieve this target are made to budget expenditures during the year. The budget process is dominated by the Executive since there constitutional restrictions on the role of Congress inthe budget development Institutional Arrangements for the Budget 2.18. The budget development process i s highly dominated by the Executive Branch of government. Under Article 62 of the Constitution, only the President may initiate revenue and expenditure proposals, through the Annual Budget Law. Congress may not increase any revenue or expenditure items in the draft budget; it may only reduce expenditures, and only those not governed by a permanent appropriation, such as debt services. If the draft budget is not passedby Congress within 60 days of receipt from the President, it becomesautomatically adopted. 2.19. Furthermore, Congress may not scrutinize equipment purchases by the armed forces. The President's budget proposal is referred to the Budget Committee, which consistsof 26 members, drawn equally from the Senate and the Chamber of Deputies. 2.20. Congress appears to make little systematic use of the performance information which is presented along with the annual budget proposal. However it appears to take greater interest in each agency's annual Comprehensive Management Report, which contains both financial and performance information (see discussion under Financial Reporting and Transparency). Congressional approval is required for SOE borrowing involving a government guarantee. 2.21. The strong role of the Executive Branch is also reflected in the powerful role of the Budget office (DPRES), located within the MOF. Although reportingto andworking This section of the report has made extensive use of factual information contained intwo earlier reports: Chile: Report on the Observance of Standards and Codes - Fiscal Transparency Module, IMF, August 2003, and an OECD report, Budgeting In Chile (2004). The assistance provided by these reports is hereby acknowledged. According to information received from the Chilean Government in April 2005, the recent amendments of LAFEreinforce the legal framework of the budget system Chile Country FinancialAccountabilityAssessment 9 closely with the Minister of Finance, the Budget Director i s appointed by and answers directly to the President. The budget process operates in a relatively "top down" manner and budget proposals developed by DIPRES are generally adopted with little or no change. 2.22. The Ministry of Planning(MIDEPLAN) also has a role inthe budget process: to evaluatecapital expenditure or infrastructure projects, and advise on their prioritizationin terms of statedgovernment policies. Indoingthis, it uses establishedcost-benefit analysis methodology. It also maintains a "project bank" of approved-in-principle projects, as discussed in the budget execution section of this report. It also advises on the ranking of new expenditure proposals submittedfor the use of the "bidding fund" or Fondo Comb Concursable (FCC).34. MIDEPLAN also carries out systematic household surveys that feed into assessments of the impact of government policies andprograms. 2.23. The Office of the Presidency reviews the President's message to Congress on policy priorities that is issued in May each year before the annual budget circular is issued. It also reviews the draft budget before it is presentedto Congress in terms of the President's statedpriorities. Inconsultation with DIPRES it also has bilateral discussions with ministers to discuss the President's priorities for the budget. 2.24. Within each of the 19 ministries, budget and financial management issues are handled by a directorate of planning and budget, thus facilitating the integration of departmental planning and budgeting. Ministries coordinate the budget proposals of the various service delivery units or servicios under them. DPRES conducts budget discussionswith ministries rather than individually with servicios. BudgetComprehensiveness 2.25. LAFE establishes the principle of a unified budget. The budget covers all ministries and autonomous agencies, whose expenditures are appropriated on a gross basis, i.e., irrespective of receipts. The Copper Stabilization Fund and the Petroleum Fund also operate within the budget. (Also see discussion in Annex 2 under Budget Development.) 2.26. Reflecting the requirement for a unified budget, recurrent and capital expenditures are fully integrated in the budget process; there i s no separate capital or investment budget. Likewise, all external funding from international institutions (such as WB andIDB)is fully integratedinto the budget. 2.27. Staff budgetingi s also fully integrated with financial b~dgeting'~.Although there i s no civil service ministry or equivalent, CGR maintains a register of all approved public service positions and approves all appointments and other changes. Thus each ministry and agency has a well-documented, authorized establishments structure covering both permanent (pZanta)and contract (contratuda) staff, which forms an important part of the l9 Personnel costs account for about 17percent of total expenditures in the 2004 budget. Chile CountryFinancialAccountabilityAssessment 10 base for budget construction. Authorized staff ceilings, which are part of the budget documentation, cover bothtypes of appointment. 2.28. The small number of exceptions to the comprehensivenature of the budget are: o Universities and research institutes, which are national government bodies; o A transfer of 10 percent of the gross revenues of the national copper company, CODELCO, to the ministry of defense for allocation to the three services for equipment purchases, which is provided for in the reserved copper law.20This arrangement i s an exception to the general prohibition. on earmarking of revenues contained in the constitution. Aggregate information on this expenditure is contained inthe public finance statistics and the quarterly budget execution reports. (See discussion in Annex 2, Reporting of Military Expenditure.) o The armed forces may borrow for equipment purchases, although MOF may limit this to amounts consistent with expected future transfers from copper revenues. Suchborrowings are not publicly disclosed. o Significant quasi-fiscal activity is undertaken by the state-owned commercial bank, Banco Del Estado, which has the exclusive right to hold public funds, although there i s no reliable estimate of the amount of this activity. The bank does not pay interest on the balances in the estimated 5,000 to 6,000 ministry and agency bank accounts (with average daily balances of between US$500 million and $800 million), but in return provides government banking services at no charge and social services such as maintaining unprofitable branches in rural areas and providing particular services for poor people. There are proposals for a general policy to remove such subsidized transactions and to have the costs of such services funded from the budget, by developing a transparent and commercial banking relationship between the Government and Banco Del Estado. (See discussion inAnnex 2, CashManagement.) BudgetProcessandTimetable 2.29. Budget formulation proceeds according to a well organized timetable governed both by LAFE and the budget instructions issued annually by DIPRES. (See Annex 2, Budget Timetable). 2.30. The first phase of the budget process involves updating baseline expenditures for ongoing programs and other commitments. This is done by examining the *'CODELCO's total exportrevenuefor 2003 came to $ USD 3.8 billion. Chile CountryFinancial Accountabilitv Assessment 11 implementation of the previous year's budget and costing new programs which have previously been agreed for introduction in the current year. An across-the-board "efficiency dividend" is also deducted from most programs or items. DIPRES uses a web-based budget preparation module (SIAP) which will in due course be replaced by the new SIGFEsystem. ( See SIGFEunder Budget Implementation) 2.3 1. The second phase involves bidding for funding of new policy proposals. In2001 the concept of a "bidding fund" (Fondo Comh Concursable or FCC), which i s the difference between "committed" expenditures and available funds consistent with meeting the structural surplusfiscal target, was introduced. This enables ministries to put forward new policy bids, which are considered in conjunction with bids from other ministries. Proposals compete against each other in terms of their assessed effectiveness and consistency with government priorities, making use of performance information insofar as possible. 2.32. The perceivedneedfor a mechanism such as the biddingfind reflects the fact that the Chilean budget system is relatively "top down" and incremental, with little change beingmadeto the levels of committed expenditure for eachministry, which are set out by DIPRESinthe budgetcircular issuedinJuneeachyear. Ministriestherefore do notplay a very proactive role in the budget process. DIPRES proposals normally receive strong support from the Minister of Finance and the President. Although Ministers are able to propose reallocations of funds within the overall amount allocated to their ministry, it appears that this seldom occurs. This relatively predictable budget process appears to reflect the fact that government policies are relatively stable, are well articulated, and are well understoodthroughout ministries. 2.33. The budget and budget documentation are not required to include contingent liabilities, tax expenditures, or quasi-fiscal activities. However considerable information i s now provided on these outside the budget process and documents, through separate reports to Congress by DIPRES. (See Annex 2, Contingent Liabilities and Tax Expenditures.) BudgetAllocations 2.34. The budget i s developed according to administrative categories for 190 sewicios or spending units grouped into 19 ministries, of which 16 are "sector" ministries. The basic budget entity i s the service agency. Each agency receives a block allocation for personnel expenditures and a block allocation for other operating expenditures, which provides for a significant degree of managerial flexibility. These items are part of several expenditure "sub-titles" or object groupings, others including transfers and capital expenditures. However separate budget limits are imposed on some inputs, such as overtime, travel, training and consultants. Staff ceiling controls operate in addition to the personnel expenditures appropriation. There are also limits on the number of vehicles each ministry may have. In addition, capital expenditure appropriations may be broken down into projects. There i s no functional classification inthe budget documents. Chile Countrv Financial AccountabilityAssessment 2.35. There does not appear to be an overall system of appropriation to programs ( that i s a group of activities related to a specific objective). Rather some spending units may be designated as programs. Within each of the 19 ministries or partidas, appropriations are broken down into: o cupitulos (spendingunits)of which there are 190intotal, ineffect agenciesor sewicios.There are 42 within ministries as well as 14regional governments, which are part of national government. o programas (107 intotal) which are attachedto apartida. 2.36. Some of theseprogramas are equivalent to programs. Other programs are covered by individual line items. Therefore at present programs are not consistently a budget classification, nor are programs broken down by various inputs. However, beginningwith the 2005 budget, it is intended to expandthe programclassification approach, with details of program inputs also being provided, with the aim of applying this approach to the entire budget inthe mid-term. 2.37. Gastos Reservados are "reserved spending" lines in some ministries (Presidency and security related ministries), also referred to as "non-accountable expenditures" which are reported on only globally. However they amount to less than 0.1 percent of total spending. Such expenditures are subject to legal limits on their amount and purposes, and agency heads are required to certify that all expenditures under these items are for appropriate purposes. CGR also may review the legitimacy of these expenditures. 2.38. The budget allocations are maximum amounts that can be spent, and are permissive, not mandatory. The rules on budget flexibility given the service agencies are set out in the annual budgetlaw2' every year and included inthe budget instructions22but must fall within the provisions of Article 26 of the LAFE. Budget transfers between ministries and increases in the budget totals must be implemented by a new law, while the MOF and the executing ministries may approve transfers among the group level of objects of expenditure. Considerable flexibility is granted to the ministries for allocation among the service agencies and to the service agencies in allocating resources within a subtitle of expenditure of an agency; this means that budget can be reassigned by the agency to the service delivery units and among items within a subtitle of expenditure (the exception is from programs which are items but appear inthe budget law). 2.39. Inprinciple the budget operates on an accruals basis. Under LAFE budgets are stated to be "estimates of the maximum amount for public disbursements and commitments", with commitments being defined as accrued obligations. However in practice, the DIPRES budget information system SIAP records information on a paymentsbasis and there is no formal systemto measure and control commitments, so in practice within year budget controloperates on a cash basis. 21 Law 19915 Article 4 22 Decreto (H) No 1171December 16,2003 Chile Countrv FinancialAccountabilityAssessment 13 2.40. Moves to an accruals basis in the budget are further reinforced by an agreement between DIPRES and the IMF to move to the accruals based GFSM 2001 for fiscal reporting. This move will take place gradually and pragmatically. In the first instance a new government operations balance sheet i s being developed, requiring reclassification of budgetary revenue and expenditure information. The second stage will include application of this basis to the 2005 budget and the implementation of systems for recording and controlling obligations as part of SIGFE. This will also lead to the development of a capital or asset usage charge, as part of ministry budget appropriations. 2.41. The aggregate financial statements prepared by CGR are also on an (full) accrual basis, and incorporate an aggregate balance sheet or "patrimonial statement", (see discussion on Financial Reporting andTransparency). 2.42. A budget contingency reserve, which is governed by each annual budget law, is created to fund costs included in laws which may be enacted by Congress after the approval of the budget and other contingencies. For example Congress approves salary increases for government employees in special legislation in late December each year. The use of the contingency reserve is reported on in the budget execution reports prepared by DIPRES and in the Government's annual financial statement prepared by CGR, since the contingency line item is a current transfer to other public entities in the Public Treasury budget.The specific spending agencies which receive the transfers report the uses under the corresponding program and object of expenditure. BudgetDocuments(AnnualBudgetLaw) 2.43. The budget documents provide information for the main fiscal aggregates for the previous four years and the following three years beyond the budget year. The Law is limited to financial information. There i s no discussion of programs or activities and relevant performance measures. Indicators are documented in the forms supplied for preparation of the budget and presented as an integral part of the submission of each agency. The indicators are sent formally to Congress with the budget submission and reviewed along with the appropriation proposal. 2.44. Accompanying the annual budget law i s the Report on Public Finances presented by the Budget Director, which i s also available in English on the DIPRES external website, http://www.dipres.cl/fr-news-english.html. This report includes discussion of macroeconomic conditions andprojections of major fiscal aggregates three years beyond the budget year. There are also discussions of topical issues (which may change between years), such as a discussion of accrual accounting and budgeting in the 2004 budget report. 2.45. Also accompanying the annual budget law are the Instructions for the Execution of the Annual Budget Law, including an Annual Compendium of Regulations on Public Sector Financial Management, so that all applicable rules are available in one comprehensivedocument. Chile CountryFinancialAccountability Assessment 14 PerformanceInformationintheBudgetaryProcess 2.46. Chile makes extensive use of performance information in the budget process.23 This occursthrough two mainmechanisms,managedthrough a separateunit of DIPRES (1) a systemof performance indicators developedfor ministries andagencies, and (2) a systemof program evaluations. In addition the "bidding fund", discussed above, makes extensive use of performance information. 2.47. Reflecting the relatively top-down nature of the Chilean budget process, it i s DIPRES which develops proposed performance indicators for agencies and programs, although these are discussed and confirmed with agencies. For the 2004 budget process, over 1,600 performance indicators had been developed for 132 of the 190 agencies. These indicators cover issues of effectiveness, efficiency, economy and service quality. DIPRES reviews these indicators and target levels of performance in terms of their general consistency with budget appropriations. However no direct or mechanistic link with budget appropriations i s attempted. The indicators are reported to Congress in budget documentation as annexes to the budget submission for service. They are also reported in the Comprehensive Management Report which is submitted to Congress by each ministry or agency at the endof the year. 2.48. Inthe case of education andhealthexpenditures,budgetconstruction is mainly output focused, reflecting the basis of funding. For example ineducation much of the expendituresrepresentstransfers for individual schools, which are funded on the basis of unitcosts for averagenumber of pupilsattending. (These unitcosts aretiedto movements incivil service salaries.) Inhealth the funding of service providers i s based on unit costs of service, usinga case mix approachwhich aggregates and weighs different health servicesprovided to individuals. (See Annex 2, Budget Implementation - Health andEducation.) 2.49. A formalized system of program evaluation was established in 1997, and so far over 150 major evaluations have been carried out. The principles governing evaluations are that they must be public, independent, reliable, relevant, timely and efficient. DIPRES agrees with Congress on the programs to be evaluated and manages the evaluation process. Each evaluation i s undertaken by a team of three external consultants from varied backgrounds, which is seen as ensuring that the evaluation i s fully objective. However the relevant agency is consulted throughout the evaluation andhas a counterpart team to work with the evaluators. A logical framework approach has been used in the past, but there i s now a move to impact assessments to provide a greater focus on final results. Each evaluation report i s delivered within four to nine months and then sent to 23A detailed discussion of this topic is contained inSystems of Management Controland Results-Based Budgeting, The Chilean Experience,Government of Chile, National Budget Office January, 2003. Chile Country FinancialAccountabilityAssessment Congress; the reports are also published on the DIPRES website and are publicly available. 2.50. Such evaluations haveimpactedon the budget in a variety of ways. Insome cases they have confirmed the effectiveness of existing programs. Inothers they have led to major program redesign. MediumTermFiscalFramework 2.5 1. The budget documentation includes medium-term targets for the structural balance and medium-term projects (four years out) of the main fiscal aggregates, prepared by DIPRES. This information i s updated twice yearly by DIPRES. However there is no reconciliation or explanation of the changes in these aggregates from year to year, or as each year is rolled over. Inaddition the projections are only in aggregateform and do not include details of the spending programs, although it appears that DLPRES maintains informationon these. 2.52. However this information i s currently used only by DIPRES, in developing the annual budget scenario (for example, whether or how much funds might be available for a "bidding fund") andpossible expenditure reallocations. Ministries are not providedwith these out-year figures. The projections are not therefore used to provide medium-term indicative funding levels (or changes therein) to spending ministries, as would occur under a fully operational MTEF. Given that this information already exists within DIPRES, it would be a relatively small step to initiate such an approach, which would enable a more active use of medium-term information inthe resource allocation process. StateOwnedEnterprises 2.53. Non-financialSOEs are important inthe miningand oil sectors. Turnover in 2003 of just the three largest (CODELCO, The National Petrolian Company ENAP, and the NationalMiningCompany ENAMI)exceededUS$6 billion. There are some 30 SOEs in total, including 14 partly privatized water utilities. They are divided into two main groups: (1) those which operate asjoint stock companies, andare ownedby CORFO, which is establishedby a separate framework law, to operate as a holding fund for recording the state investment inand flow of funds to and from these entities. C O W 0 operates as adepartment within the Ministry of Economy, Development and Reconstruction. (2) another 13 SOEs (covering the state petroleum and mining companies, postal service, National Television, State Railway Company and 10port authorities), which are established under their own legislation. In all cases they are required to have a board of directors and prepare annual audited financial statements. The cash flow to and from these state enterprises appear as income and uses directly in the Public Treasury budget. Chile CountryFinancialAccountabilityAssessment 16 2.54. Under the Production Development Corporation or CORFO, the Committee for System of Public Enterprises (SEP) has oversight of all public enterprises and provides for MOF financial overview, including a requirement that their annual (cash-based) budgets must be approved by an MOF decree and their budget execution reports must follow GFS clas~ification.~~SEP entities include the Santiago Metro (which receives financial support from the Budget) and the water entities. The state copper company CODELCO, the armed forces enterprises, and Banco del Estado operate under separate arrangements as discussedunderFinancial Reporting and Transparency. 2.55. SOEs pay income tax on their profits (at the standardrate of 17.5 percent) and in addition pay a "surcharge" equivalent to 40 percent of these taxes into the budget, which i s in effect a dividend payment. Quasi-fiscal (social) activities are carried out by some SOEs, for which they receive payments direct from the budget. CODELCO, however, pays all its profits to the Budget, with its capital expenditures being financed through funds retained through the depreciation charge.25Any borrowingby SOEs requires MOF approval through a decree, and if it involves a government guarantee this must be approved by Congressthrougha law. 2.56. All these entities operateunder acash budget approved by the Ministry of Finance and the corresponding sector ministry and publishtheir annual financial statements with an audit report ( with the exception of the military enterprises). The 2004 BudgetLaw adds the following reporting requirements for theseentities. "DIPRES will present to Finance Committee of the Senate and the Congress andthe to the Special Budget Commission the following: 0 Quarterly balance sheet andincome statement by company and for each company and in aggregatewill be preparedby the SEP within 15 days of the due date of suchreports to the Securities Exchange Commission (SVS). 0 Annual balance sheets and semi annual financial statementsof public enterprises, preparedinline with the requirements for listedcompanies, as well as of the NationalTelevision Corporation, CODALCO andthe Banco del Estado within 15 days of the due date to the SVS." 2.57. There i s also consolidated financial reportingon SOEs intwo reports: (1) the GFS basedpublic finance statistics preparedby DIPRES (excluding the military enterprises) and (2) the annual aggregatefinancial statementpreparedby CGR (excluding CODELCO). (See Annual FinancialReportunder ExternalFinancialReportingand Transparency.) 24 SEP operatesas acommittee of CORFO. Ithas a government-appointedcouncil of nine members.It is responsiblefor selectingSOE directors, approving SOE strategic plans and draft budgets, and monitoring overall performance. 25 CODELCO's contribution to the income inthe 2004 Budget comprisesdividend income and income taxes receipts; it was estimatedat 496 billionpesos for 2004 (Annex 4, Table 1.2.2). Chile Country Financial Accountability Assessment The Budget and Sub-national Governments 2.58. Chile has 241 municipalities whose expenditures accountedin 2003 for some 1.5 trillion pesos or 13 percent of national government expenditures. Regional governments form partof the Ministry of the Interior's budget andtheir expenditures comprise primarily investments. 2.59. Municipalitiesshare responsibility with national government for basic education and primary health care. Transfers represent 10percent of their income from central and regional governments, largely reflectingthe number of students or patients, with some top-up of financing from municipalities' own revenues, which are taxes (on vehicles, business licenses, and a share of the territorialtax), user fees, andtransfers. They are not permitted to borrow, although according to the IMFFiscal ROSC, there are apparently cases of expenditure arrears or ad hoc financing. The Municipalities CommonFund, held inthe NationalTreasury, is apoolof municipalproperty taxesfor redistribution to poorer municipalities, provided they meet certain financial management standards. (Also see Annex 2, Reporting by Municipalities.) BUDGETIMPLEMENTATION Overview 2.60. Budget implementation i s supported by predictable funding, achieved through effective cash allotting and tight budget monitoring, which at present depends on the separatebudget and accounting systems inthe service agencies but i s closely overseen by central authorities through the ex-ante review in the CGR and the regular reporting to DIPRES andCGR. 2.61. An integrated financial management system (SIGFE) is under implementation to replace both the stand alone systems in the service agencies and the central systems of DPRESP and CGR. Not all the arrangements are in place for the implementation of SIGFEcentrally. 2.62. The health and education sectors employ a system of budgetingand monitoring of outputs that has provided a method of planning and funding the most important expenditures of the budget (education subsidy and pre-priced services in hospitals) with excellent predictability, since both the rate and volume are reliably estimated. At the same time, demand volumes reported by the providers and compliance with the standards of quality of the service are closely and effectively monitored. Monitoringof Budget Implementation 2.63. Two stages of expenditure are recognized in the reporting on budget execution: accrued and paid. The budget is the limit on accrued expenditures and on the payment so the reports prepared by the service agencies cover the two stages. The earlier commitment stage, however, i s not recorded inthe budget controls or reported. Chile Country FinancialAccountabilityAssessment 18 2.64. While budget development rests mainly with the executive, and within the executive is centralized in the Budget Directorate of the Ministry of Finance (DTPRES), budget execution and accounting, on the other hand, is highly decentralized. Budget control and accounting of the central government depend entirely on the records of the service agencies, from which periodic reports are generated and sent to central authorities (DIPRES and CGR) for monitoring and aggregation. Service agencies have authority to sign contracts (subject to CGR ex-ante approval), exercise control over their assets and cash, hire staff (subject to CGR ex-ante approval), and reallocate funds within their institutional budget, respecting the block allotments to personnel and other operating expenditures and takinginto account the annual rules on budgetuses for specific items. 2.65. Expenditure monitoringrests on: four cross-cutting oversight mechanisms by central authorities (ex-ante review by CGR, personnel cost controls, investment controls (see Institution Arrangements for the Budget), andcash allotments; 0 the individualfinancial managementsystems inthe individual service agencies; two centralized monitoringsystems (SICOGEN inCGR and SIAP inDIPRES). Ex -ante Review by CGR 2.66. The CGR in general is charged with ensuring the legality of all administrative acts; additionally, it is chargedwith the prior review of all ministerialresolutions for their legality. Under its own Framework Law, the CGR i s required to keep a registry of all laws set by the Executive, approve all decrees and resolutions onbudget or resourceuses, and prepare opinions on budget transfers and supplements. It is also required to keep a Registry of Public Servants (permanent and contracted) and the related decrees and resolutions which authorize these. 2.67. Given the decentralization of the execution of the budget to the 190 service agencies the CGR has taken two steps to enable it to discharge its duty: (i)it requires that all personnel contracts be sent to the CGR for recording inthe personnel registry. and (ii) it has extended the review of legality (tomu de ruzon) beyond the review of laws to the review of the contracts involving the use of funds. The instructions on the annualbudget contain an instruction from the CGR on of the threshold defining which contracts will be subject to prior review by the CGR. 2.68. On the prior review of contracts, the time required at present is predictable and taken into account by the executing agencies. There is potential for reducing this delay under the centralized databases of the new integrated financial management system (SIGFE), since the CGR's access will allow automation of a greater portion of the review. This step inthe contract processing would be eliminated if the CGR moved from an ex-antereview basis to an ex-post review. Chile CountryFinancial AccountabilitvAssessment 19 Personnel Costs 2.69. Salary costs represent 17 percent of the national government budget. Chile's public service comprise permanent staff with tenure, who operate under the public service labor law (the CGR, Central Bank and military have separate legislation); contract employees who operate under 12-month contracts with no tenure, and consultants who are paidon a fee-for-services basis. 2.70. While budget execution is decentralized to the 190 agencies, including the responsibility for payroll preparation, recording and payment, there are extensive, centralized controls applied to personnel. Controls over personnel comprise first, the specific budget appropriation, and second, the cash allotments for personnel costs by DIPRES separate from the rest of the budget. Also the number.and the positions which may be filled are statedinthe budgettext for each Service Agency. 2.7 1. As the CGR i s charged with keeping a personnel registry, it has establishedrules to be followed innotifying it of all hiring by all agencies. It i s on this basis that the CGR can certify the compliance with the personnel limits of the budget. To support this, a new government staffing information and control system (SUPER) is beingjointly developed by DIPRES and CGR. The principle objective i s to support CGR in approving and controlling staff recruitment. This new automated system would facilitate CGR giving up its ex-ante role and replacing it by ex-post review; it could also be used to feed a payroll moduleof the new integrated financial managementsystem. CashAllotment 2.72. At the time of the approval of the budget, the annual cash outlay program is also set by DIPRES in conjunction with each agency. This cash program i s reviewed and updated if necessary by the DIPRES on the 25fhof the preceding month. On the basis of an annual cash program, updated monthly, DIPRES instructs Treasury to effect the transfers twice a month to the current accounts of the service agencies to cover their operating requirements. The allotments are separated into amounts for personnel and other expenditures and are paidto the agencies in mid-month and end of monthtranches. 2.73. The monthly cash ceilings are set with the Ministry of Finance without consultation with the spending agencies; however, given the good rate of budget funding (96 percent in 2003) and the flexibility that agencies have for deciding on the uses of the allotted funds, the centralization of setting the cash ceiling is not seen as interfering with program execution. While there i s no authority for short term indebtedness, to support the execution in line with approved cash programs, the Finance Dept of DIPRES may sell a portion of its short securities issued by other state entities and repurchase these before year end. 2.74. Once funds are transferred as cash allotments, they are under the control of the service agencies, or the second-tier entities under the agencies, and are not under any direct or indirect control of the Treasury Department. These funds are deposited in non- interest bearing accounts in the Central Bank and the Banco del Estado. Although there Chile Country FinancialAccountability Assessment 20 are 190agencies, there are also bank accounts inentities which operate under the services (hospitals for example); the number of active current accounts in the central government i s close to 5000. Neither the Treasury nor the Finance Department of the Ministry of Finance has access to the bankinginformation and must dependon the monthly financial reports to determine cash balances. The determination of actual balances in the bank accounts i s not reported andgenerally not available to the central authorities. The central authorities estimate the book cash balances once a year, in October, from the initial balance and the actual transfers less actual expenditures reported in the monthly budget execution reports. It i s estimatedthat the idlebalancesfluctuate betweenUS$500and 800 million. ( See CashManagement inAnnex 2.) Controls inthe Agencies 2.75. In the Chilean public sector each service agency, and operating entities under agencies, have freedom in selecting financial management systems but are governed by the central authorities' reporting requirements for monthly and annual reporting on the budget execution. These systems themselves are rigid (in that transactions are not reported to agency headquarters but only reports on net movement by account), inadequately integrated, and can provide information only inhard copy or intext files to the central authorities (DIPRES and CGR). Informationfrom these individual stand alone systems i s provided in different formats, and transaction and maintenance costs are high given the various software and hardware systems and need for multiple data entry. These systems do not provide adequate control over the budget commitment process and contribute to the diffusion of government bank accounts, which are costly to administer and undermine effective cash management. Furthermore, the dispersion of the central government's financial transaction processing in these multiple systems makes it impossible to link the data to other information systems covering public investment, procurement, and human resources. DIPRES and CGR authorities are particularly concerned about the lack of appropriate controls and information on agencies' outstanding commitments and accounts payable. Central MonitoringSystems 2.76. All service agencies (as well as the municipalities) report monthly to the CGR and DIPRES on the budget execution and provide their patrimonial accounts in standard formats according to the approved budget classification and the government accounting codes; the universities and SOE's report only semi-annually.26To support DIPRES in its budget monitoring an automated budget control system (Sistema de Informaci6n de Administracibn Presupuestaria del Sector Pljblico or SIAP) was developed comprising modules on budget preparation, budget execution, and financial planning. This system is cash based and is used to record all budget updates and the cash program and its 26 The CGR established the reporting requirements, along with the basis for recording and reporting in the Regulations of the Nation's Accounting System (Oficio CGR No. 6,856 de 1992),and these requirements are obligatory for all public entities. Chile Country Financial AccountabilityAssessment 21 execution. Information i s entered on the basis of the monthly budget execution reports providedby the service agencies. This provides DIPRES with information on the rate of budget execution and permits it to detehine if payments are in accordance with budget authorization. 2.77. Reporting to CGR i s done through its Accounting Division, which i s responsible for budget control and the preparation of the financial reports, including reports on budget execution. To this end, CGR operates SICOGEN which provides budget control and updates the financial statements by recording net transactions by major financial statement classification as provided by the agencies. On the budget execution, the CGR system must first record all budget changes against which the actual is recorded. This system i s accrual based and it enables the CGR to express an opinion on the budget changes requested by the service agencies. As discussed later, the development of the SIGFE will enable these two separate budget execution monitoring systems to be replacedby a single system. 2.78. The Treasury Department, on the other hand, keeps its own double entry accounting system as a separate accounting entity (it is a Service Agency) to record the movement in the single treasury account, the tax revenue and the related accounts payable and receivable, as well as its investment and financing operations. These records constitute the official books on the cash balances (cuenta hzicafiscal) of the Treasury , national debt and revenue. The bank balances are reconciled daily with the accounting records. Financial ManagementInformation Systemsand SIGFE 2.79. As noted, to addreess the concerns on poor central and decentralized financial management systems, an integrated financial management system, SIGFE, was developed and i s under implementation. This systems aims to both support the current decentralization of financial management to the service agencies and offer DIPRES and CGR the capacity to aggregate in one system both accounting and budget information generatedfrom the individual service agencies, thereby allowing them to consolidate the entire budget information from a uniform and reliable base. A centralized personnel management system, SIAPER, was also developed. To optimize hardware investment and reduce maintenance cost, SIGFE will operate from a central data center (the operation of which may be outsourced) under the responsibility of either DIPRES or CGR. 2.80. SIGFE applies the new accounting and budget classifications which support the determination of fiscal reporting (GFS) on an accrual basis and therefore directly supports the Government's plans to move to accrual-based fiscal reporting. In the meantime, while fiscal statistics still report on cash, it applies conversions to generate the input for consolidation on the current cash accounting and budgetreportingbasis. At the aggregate level it is planned that SIGFE will provide for the aggregation and consolidation of the accounting balances and the budget execution of the agencies. Considering that not all agencies will implement SIGFE in order to provide government- wide information, while implementation is still underway, it i s planned that agencies Chile Country FinancialAccountability Assessment 22 which have not yet adapted SIGFE will submit accounting and budget information in a format compatible with SIGFE aggregationprocesses. 2.81. At the agency level, SIGFE integrates accounting, budget (including cash programming) and treasury operations. The budget control module provides for the recording and control of budget commitments. The system is similarly applied to independent service delivery units within an agency such as hospitals. It is geared primarily to satisfy central reporting requirements and as such does not displace the more specialized applications for administrative operations of purchasing, asset control, invoicing, personnel, payroll or even highly specific cost and management accounting requirements. 2.82. At present, SIGFE is limitedto budget control, accounting and treasury modules and i s not integrated with Chilecompras, the electronic portal for state procurement of goods and services. Chilecompras which is being revampedto include afull complement of disclosure facilities: procurementplans, invitations to bid, contract awards, database of past transactions and corresponding search and statistical functions, and a standard producthervice coding catalog27. 2.83. On the strictly financial controls, SIGFE stops short of providing the critical integration with physical asset subsidiary ledgers (inventory and fixed assets), A comprehensive system would integrate both purchasing and the related movement in the physical asset controls. Also, although SIGFE's core applications are budget, accounting andtreasury, there is no provision for an automated bank reconciliation, which should be developed inline with treasury and accounting2*. 2.84. To date, 37 service agencies are operating with SIGFE; another 40 are running SIGFE in parallel to their own systems29.Implementation of SIGFE does not affect the decentralization of accounting which i s provided for under the LAFE since the agencies will operate the system and retain the same authority and responsibility. One hundred service agencies will have implemented SIGFE by the end of 2004; by the end of 2005 full implementation is expected, at which time it is stated that the SICOGEN and SIAP systems will be discontinue. It is yet to be decided, however, what organization will be responsiblefor operation andmaintenanceof the system. 2.85. On the implementation at the center, the Constitution and the LAFE assign the CGR responsibility for the accounting of the nation; this does not imply, however, that it must operatethe system which processesthe transactions just as it does not operatethese under the current decentralization. Under the current law, the CGR must satisfy itself that it can rely on the system where the transactions are processed so it can produce the accounts of the nation. "AccordingtoinformationreceivedfromtheChileanGovernmentinApril2005,thedevelopmentofthe `'interfacebetween SIGFE and the `Banco Integrado de Proyectos' is on its final implementation stage According to information received from the Chilean Government inApril 2005, the bid preparation for the procurement of the modules for bank reconciliation and fixed assets ledger i s inits final stage 29Annex 4 of this document provides the status of the implementation o f SIGFE as per the information provided by the Chilean Government in April 2005. Chile Country FinancialAccountability Assessment 23 2.86. At the same time, DIPRESis responsible for regulating the budget, includingthe cash programming and the establishment of a financial and administrative information system to support the application of the LAFE. Given that SIGFE integrates both accounting and budget controls, the needs of CGR and DIPRES would be satisfied by the same system. 2.87. Risks that arise from a failure to implement SIGFE centrally as the sole financial administration system include: undermining the adoption of SIGFE in the decentralized agencies which will perceive a lack of commitment to the system; a lower return on the investment since duplicate systems costs will persist; and inconsistencies between separatesystems underlying the reporting of aggregatebudget information. 2.88. Benefits from having a uniform system operating both at the decentralized and central level, however, include ensuring, at the agency level, a common accounting basis for budget reporting (accrual) and control of commitments for enhanced cash planning and fiscal reporting, reduced maintenance cost and a uniform level of reliability in agencies. Associated with this uniform application would be the opportunity for externally financed projects to be administrated exclusively through the agencies' financial management systems and do away with redundant project financial management systems. This mainstreaming would imply reduced transactions costs of investment financing and improved reporting. RecommendationsonBudgetImplementation 2.89. Given the role of SIGFE in the aggregate budget control and financial reporting, the steps to cover the outputs of SICOGEN and SLAP and the arrangements for the operation of the centralized applications should be agreed upon well in advance of the 2005 deadline for full conversion to SIGFE. Steps toward this end would begin with settling which entity will operate the centralized SIGFE application; a sign-off that its provisions comply with the reporting needs of both the CGR and DIPRES and an explicit commitment to rely on SIGFEonce implemented. 2.90. With the introduction of SIGFE, it i s critical that the recording of the stages of budget uses be integrated with Chilecompras (government-wide and obligatory purchasing system) whereby the issuance of purchasing authorizations under Chilecompras would create the charge.againstbudget availability. 2.91. Although the centralization of the databases under SIGFE would permit the integration with other centralized databases of suppliers, personnel, and public credit, the current design of the systemdoes not provide for this integrati~n.~' 30 Procurement(Chile Compras),DebtAdministration, ProjectBank, andPersonnelManagementSystem (SIAPER) Chile Country FinancialAccountabilityAssessment 24 EXTERNAL FINANCIAL REPORTING AND TRANSPARENCY Overview 2.92. Chile has a high level of fiscal transparency. Reporting is timely and comprehensive, and much of it is publicly available on government websites. However, given the number of financial reports discussed below, it is also somewhat fragmented and duplicative, with both DIPRES and CGR playing major roles. There is room for improvement, both in the aggregate financial statement prepared by CGR and in reporting on the financial operationsof the military. AnnualBudget Law 2.93. The draft budget law provides comprehensive information covering the main fiscal aggregates for the four years prior to the budget and projections for the following three years. As discussed in the section on budget construction, the budget documents provide comprehensive coverage of the public sector, with the exception of universities and researchinstitutions, military expenditures financed under the Reserved Copper Law, andthe quasi-fiscal transactionsof Bancodel Estado. Reporting on Budget Execution 2.94. Reporting by DIPRES on budget execution i s made formally to the Committees on Finance of the Senate and the Chamber of Deputies and i s governed by Law 19915. This information is also available publicly on the DIPRES website. This reporting by DIPRES is cashbasedDIRPRES publishes a monthly operating statement on the central government's budget within 45 days after each month end. Starting in 2004, this statement will be accrual based and presents the budget uses inline with classification of the new IMFGFS 2001 manual, thereby permittingthe generation of an operating result, the financing requirement or surplus, and the disclosure of the detail of the financing of the netborrowingrequirement arising from central government's budget execution. 2.95. DIPRES also produces and publishes a more detailed quarterly budgetexecution report within 45 days after the end of each quarter. It comprises the same operating statement as inthe monthlyreport but the quarterly report presents the results of budgeted activity in one column and adds another column with the non-budget activity. This innovation producesmore comprehensive information and facilitates the reconciliation of the change in debt with the financial performance of the quarter. The report also includes information on the breakdown of taxation revenues, financing items and movements in gross government debt, and aggregate defense equipment expenditures under the Reserved Copper Law. Lastly, the quarterly report includes statement of budget execution (actual against original and modified budget) in the same detail as presentedin the budget law, i.e. by service agency, major expenditure type, and expenditure item where these havebeen set out inthe law. 2.96. An annual report on budget execution is also provided by DIPRES within 45 days after year-end, which i s a summary of the quarterly reports. There i s also a mid-year Chile Country FinancialAccountabilityAssessment 25 report from DlPRES to Congress updating revenue and expenditure projections for the current year. This does not lead to any revision of the formal budget allocations, but it may affect the rate of actual budgetexecution. 2.97. CGR reporting on budget execution i s accruals based, see Annual Financial Report on the Public Sector below. It is contained in the CGR Annual Financial Report, which i s public, and in a quarterly report which is distributed to the Finance Commissions of the Senate and Congress, to the executive and the ministries. AnnualReport on PublicFinances by the Budget Director 2.98. As discussedinthe budgetconstruction section, this report accompanies the draft budget law presentedto Congress. It was instituted in 2002 to enhance Congress's annual discussion of the Budget, by providing in-depth analysis of the macroeconomic framework, as well as other background information on a range of fiscal This report became permanent and mandatory through Law No. 19896 of September 2003. Apart from reviewing the macroeconomic scene and providing forecasts of the major fiscal aggregates. it provides a general analysis of fiscal risks and from 2004 onwards will provide more detailed informationon financial assets andpublic debt, to expand that provided in the annual financial statement prepared by CGR ,along with information on contingent liabilities and tax expenditures. 2.99. The report may also discusstopics of special or current interest. For example, the October 2003 report also discusses the methodology for the calculation of the budget structural balance, fiscal sustainability, moves to adopt the IMF's GFSM2001 systemfor public finance statistics, andthe level of rigidity inChilean budget expenditures. Public Finance Statistics 2.100. Public finance statistics are presentedby DIPRES in a Public Finances Yearbook published around April each year. The information is broken down into four levels: central government, municipalities, general government, and state-owned enterprises (non-financial public sector), with comparative information being provided for the previous nine years. The scope of general government i s broadly consistent with the IMF's GFS 2001 Manual. MOF has agreed with IMF that it will move to adopt the accrual-based GFSM 2001. Since 2002 the publication includes the aggregate expenditure on defenseequipment under the Reserved Copper Law. Comprehensive Management Reports32 2.101. Under LAFE, updated by MOF decree, agencies prepare comprehensive management reports, which review their objectives, management targets, and results. Their preparation i s also governed by the instructions issued by DIPRES and guidelines available on the DIRPRES website, which i s referred to inthe instructions accompanying 31 Prior to this, there was a report accompanying the draft annual budget law, focusing only on macroeconomicissues. 32Known as BIG- BalanceIntegral de Gestion Chile Country FinancialAccountability Assessment 26 the annual budget law. While the focus is on performance indicators, it also covers progress against the targets set by the annual management improvement plan (MIP) required for each ministry or agency, and progress in implementing the results of any evaluations carried out in that agency or ministry. This report also includes financial informationpreparedaccording to the annual instructions preparedby DIPRES. AnnualFinancialReportonthe PublicSector 2.102. Responsibility for the preparation of the aggregateannual accounts on the public sector i s assigned by the Constitution to the CGR.33The framework law of the CGR makes the Auditor General responsible for reporting to the President and to Congress by April 30 of each year on the budget, financial and equity situation of the State for the preceding fiscal year.34To this end, the Accounting Division of the CGR publishes an annual financial report which includes statements on budget execution and the financial position of the public sector. The report i s provided to the President and to the Presidents of the Senate and the Chamber of Deputies. It is also distributed to the ministers and is postedon the website of the CGR (the 2003 report is now on the site). 2.103. The report comprises information on the entire non-financial public sector (Central Bank and Banco del Estado are not included) except for the national copper company, CODELCO. The report i s issued within three months of the year-end. It contains informationon the financial position on a full accrual basis (i.e. including fixed assets and adepreciation charge) and on budget execution on a modified accrual basis for the reporting year and the four preceding years. Information for the reporting year i s presentedby subtitle (object of expenditure) andby sector. 2.104. The statement i s divided into four sections; the Public Sector, comprising all ministries and the service agencies of the central government; the Municipal Sector, comprising the municipalities and their service establishments; State-Owned Enterprises and the state's research institutes; and the public universities. For each grouping, the report includes: a comparative balance sheet, a non-comparative statement of cash flow, andstatements on budgetexecution. A separate Statement of Budget ExecutionandCash Flow Statement of the Treasury are presented in an annex to the report, which presents budgetexecution on a cash andon an accrual basis. 2.105. For each state-owned entity the report summarizes the financial result, assets, liabilities and net equity and where appropriate, budget execution. However the national copper company CODELCO and Banco del Estado are excluded from the CGR report . Furthermore, the state-owned enterprises statement does not include the CORFO- controlled entities, whose investment appears in the Public Sector section, so there i s no comprehensive view on total assets, liabilities or results for that sector. These companies do report individually asjoint stock public companies. 33 Article87 of the PoliticalConstitution of the Republic of Chile (DecretoLey No 3464). 34 Article 142of Law No 10,336 (Framework law of the CGR). Chile Countrv Financial Accountability Assessment 27 2.106. The annual financial statements of the 16 public enterprises established in law (but not the military enterprises), which include the state petroleum and mining companies, Chile National Television and State Railway Company and 10 ports, are separately prepared on an accruals basis, using accounting standards applicable to the Chilean private sector, and are audited by private auditing firms. CGR has access to these companies' records in its work, except CODELCO, but does not duplicate the financial statement audits 2.107. There i s no reporting by the three enterprises operatedby the military beyond the summary information provided in the CGR Annual Financial Statement, and no external audit opinion prepared on their financial statements. (See Annex 2, Reporting on Military Expenditure.) 2.108. Overall this annual financial report is timely and comprehensive, and reliable in that it is generated in an environment of good internal control with regular ongoing external oversight by the CGR. The report facilitates analysis by sector, since it presents the financial position and budget execution of each sector separately, i.e. central government, municipal, state enterprises. It is a useful source of information on the state's equity and financial position; for example, on liabilities. Beginning in 2003, even the vested pension liability for past service under the former social security pension plan (Bonos de Reconocimiento), which i s the most significant liability of the public appears in the general government sector balance sheet .However, this liability i s offset by a corresponding asset, apparently on the basis that the liability i s not payable in some cases for many years. The recognition of such an asset does not appear to be in accordancewith generally acceptedgovernment accounting standards. 2.109. The statement could be improved, firstly, in terms of what would normally be expectedfor such aggregatestatements: (i) isnostatementofaccountingpoliciestoprovidethebasisforrecognition there and valuation of investment, inventories and other assets. Nor is there any informationon the basis of the consolidation within the four components, and (ii) isnoauditopinion, whichisimportantinprovidingcredibilitytothe there statement: and secondly, on more specific matters of content: \ 35As of end December 2003, this liability is greater than the total patrimony stated inthe consolidated balance sheet of the public sector. Inthe public finance statistics published by the Ministry of Finance, the entire debt is now recognizedand the interest on the outstanding bonds is treated as an expenditure, while the paid maturities are treated as a financing operation (below the line). Chile Countrv Financial AccountabilityAssessment 28 (iii) is nooperatingstatementto explain changesinnet worthbetween there years;36 (iv) the National Copper Company, CODELCO, is excluded, meaning a significant under-reporting of the government's assets; (v) interest on debt is not recordedor reported on an accrual basis; (vi) contingent liabilities are not fully reported (see Annex 2, Accounting Standards and Contingent Liabilities); (vii) there is no consolidation of the all entities controlled by the central government into a single statement; (viii) the agency asset registers on which the patrimonial balance i s prepared are known to be outdated and unreliable in many cases (see Annex 2, Asset Management) . 2.110. The statements offer information on budget execution on an accrual basis and the financial position of the service agencies that i s not providedby DIRPES through its SIAP system. With the improvements suggested above, the report would be more useful to Congress as a mechanism for holding the executive accountable. It would be a short step for this key financial statement to achieve closer adherence to international accounting standards by addressingthe deficiencies listedabove. RecommendationofExternalReporting 2.111. For Chile to emerge at the forefront of public sector management, it should issue its annual financial statements with an audit opinion and move to close adherence with internationally accounting standards in its reporting. Most significant i s the lack of any external audit opinion on the government financial statements; this i s not consistent with a modem approach to public sector external auditing. The aggregate statements (Annual Financial Report) themselves must be improved and the range of individual financial reports could be rationalized. Specifically, the financial statements must adopt a full set of notes, include an income statement, and include in its coverage the impact of its principal state enterprise, CODELCO. 36 The budget statement is the only informationavailable to partly explain the change innet worth but is on a modified accrual basis, while the financial position is based on full accrual. It is understood that the Government is reluctant to present a financial result that is different from the one appearing in the budget statement. Chile Country Financial Accountability Assessment 29 INTERNALCONTROLAND INTERNALAUDIT Overview 2.112. Chile is well advanced in.the adoption of the modern concept of internal control as a management responsibility and as a basis for performance-based government. Since 1997 it has achieved positive results in internal control and audit, and is making progress-in some cases, substantial progress-in the use and assessment of internal controls. In accordance with the standards of the Institute for Internal Auditors, the Executive Branch has established an independent internal audit function as a key part of the internal control structure and established objectives for the this function. The Chilean government internal audit function has been organized around three separate but well coordinated units:(1)the Councilfor General Government InternalAuditing (CAIGG),(2) Ministerial internal auditors, and (3) internal audit units of individual service agencies or enterprises 2.113. Presidential decrees and central overview of the internal audit function in ministries, agencies and public enterprises have assisted in the creation of a culture of positive control. The fundamental components of internal control-planning, implementing, supervising and monitoring-are also embodied in the Management Improvement Programs developed by each agency. Advising management on areas at risk,performingaudits of operations andrecommending ways to improve operations and strengthen internal controls are becoming an integral part of the work of the internal auditors. 2.114. Nonetheless, the system i s still evolving and developing in tandem with the financial administration reform. Areas needing attention include active follow-up to ensure that recommendations are fully implemented so that all levels of management understandthe benefits resulting from the internal audit activities; closer coordination of internal audit with the CGR so that each performs its role more efficiently and economically; and more periodic reviews of the quality, utility and effectiveness of the internal audit units to ensure their value added. An adequate legal basis for internal control and audit also needs to be e~tablished.~~ ( See Annex 2, Internal Control and Internal Audit.) Recommendations on Internal Audit 2.115. To preserve the advances made to date a firm legal basis for internal control and audit should be established in an organic law or incorporated in the LAFE which does not cover internal audit. Also, to institutionalize internal audit, arrangements should be developed for internal audit staff to be managed as an overall resource, with a career structure, mobility of staff between internal audit units, and adequate centralized training, while preserving the basic current model of decentralized operations (internal audit units 37 Some observations inAnnex 2 relating to Internal Control and Internal Audit are based ona more in- depth review of the functioning o f internal control inselected organizations - INDAP, Eastern Metropolitan Health Service, and CORFO ChileCountry Financial AccountabilityAssessment 30 located in and reporting to agency management) and centralized monitoring and overview (through CAIGG andMinisterial Auditors). EXTERNAL CONTROL Overview 2.116. The Contraloria General de la Rep6blica (CGR), Chile's Supreme Audit Institution (SAI), is a well-respected autonomous audit office which has played an important role instrengthening public financial managementinChile and helping to build Chile's justifiably high reputation for probity and fiscal transparency. Over the years the CGR has not been afraid of embracing change and, as can be seen by its willingness to embark on a major IDB-supported modernization project, continues to seek ways to provide an ever better service to the Congress, the Ministries and other government entities, and ultimately the people of Chile, while preserving its capacity to fulfill its mission objectively, efficiently andeffectively . 2.117. However, the world is changing rapidly. Across the Chilean public sector, there are major improvements in financial management, internal control and internal audit, performance measurement, programmed evaluation and public reporting. Elsewhere in the world there are wide-ranging changes occurring in public audit as auditors seek to harmonize audit standards with the private sector, develop new products and approaches to monitoring the ways governments raise and use public monies, disseminate best practices, and better keep civil society properly informed on how their taxes and public assets are being managed. The examination of the CGR, its current activities and its future plans, shows that the CGR i s respondingto many of these developments. 2.118. However, to continue as one of the world's leading public audit institutions, the CGR will needto consider engaging even more fully with reforms emanatingfrom within Government, the Congress and Chilean civil society. As part of this process, the CGR may need to review its current wide-ranging functions to determine which it alone needs to continue to fulfill, like the oversight of government reporting and investigation of malfeasance, and which, in the light of other fundamental reforms emerging in public administration in Chile, may no longer be needed, like the ex-ante review of administrative acts, or which could be better carried out by other agents, as inthe case of financial statement reporting. However, modifying CGR's mandate and activities poses constitutional issues that would make very difficult to implement most of the simple solutions to this problem. The Chilean authorities need to consider their options, and come up with a solution that balances the need for transparency and independence as prescribedby INTOSAIprinciples and accommodates country constraints. Audit Mandate and Role: FunctionalIndependence 2.119. To comply with international best practices on independence, an SA1must have, and be seen to exercise, constitutional guarantees of independence, functional or operational independence, managerial or administrative independence, freedom of reporting and financial autonomy. The framework in which the CGR operates is broadly ChileCountryFinancialAccountabilityAssessment 31 in line with these standards. ( See Annex 2 Audit Mandate and Role: Functional Independence). Functionsof the CGR 2.120. The CGR i s a highly complex organization because of the varied and unusually wide rang of functions it carries out. These include: Pre-approval of expenditure and other administrative acts in order to ensure their legality and constitutionality (the Toma de Razon procedure); Maintaining a registry of all laws, and vetting that secondary laws are constitutional andlegal; Compiling the general accounts of the nation from information provided by central government, public enterprises and localmunicipalities; Regulating the national general accounting system, laying down principles, rules andtechnical procedures; Establishing guidelines for internal audit and internal control and training internal audit staff; and Conducting ex-post financial audits, concurrent examinations of fiduciary and legal controls of public works, and other special investigations. Acting as external auditor of projects financed by multilateral financial institutions. 2.121. Inaddition to its routine, planned audit activities, the CGR is expectedto respond to requests from the Congress and the public to undertake special investigations (inspections). These investigations consume a substantial amount of the CGR's resources and mean that much planned audit work i s not completed. The results of the audits and inspections are provided first to the audited organization and then provided Congress where the corresponding Congressional Commission reviews. Under the modernization initiative in the CGR, public reporting through the CGR web site will expand to include the reports from the audits andthe inspections. 2.122. The CGR operates on the assumption that all such requests mustbe fully acted on. It has not sought to actively manage demand for these special investigations, by for example, ensuring that Congress i s fully aware of the impact of such requests on the routine audit work, or by developing criteria to use in assessing whether such requests may be better routed through other services or dealt with in other ways. ( See Annex 2, Functions of the CGR) Modernization Plans 2.123. The CGR is a well-respected institution which has played an important role in strengthening public financial management in Chile and helping to build Chile's justifiably highreputation for probity and fiscal transparency. However, it i s also seen by others as a somewhat traditional and aloof institution, staffed by competent and committed staff but not always actively engaged with the major developments in public Chile Country FinancialAccountabilityAssessment 32 sector management and auditing. It i s seen as doing a good job but a narrow job. The CGR has recognized that it needs to modernize by issuing a Doctrina Institutional in October 2003, outlining high-level policies and directions for each of the institution's major functions, and embarking on a major modernization program. This project i s aimed at improving the CGR's management systems and enhancing the institution's efficiency and operational effectiveness. In particular, project components aim to improve the CGR's approach to strategic planning, help upgrade and integrate IT systems, establish modern human resource management procedures and practices, modernize some of the Regional Offices of the CGR, and improve communications with key stakeholders. 2.124. As part of strengthening its strategic planning processes, the CGR could do more to enter into dialogue with the Congress and key external stakeholdersinthe public sector and civil society about how the CGR can exercise its role better and contribute to the more efficient and effective use of Chile's public resources. It is crucial in producing its strategic plan that it demonstratesboth through the way the plan i s developed and what i s said in the plan that it i s aware of, and engaged in, the changing world of public sector audit and public sector reform of which it should be a critical part. It should also ensure that the strategic plan i s supported by detailed implementation plans which are clearly linkedto the CGR's budgeting processand which set challenging delivery schedules with named staff members responsible for delivery of individual components of the plan and with rigorous review arrangements by senior managers. There are considerable benefits for the CGR to demonstrate publicly that it cannot only practice what it preachesbut that its practices are better than others. 2.125. Over time, the CGR has progressively relaxed its ex-ante control systems, delegating to Ministries and others rights to approve individual items of expenditure up to some US$ 250,000. These -delegations recognize the growing maturity of internal controls with the Chilean public sector. As internal audit units inMinistries and Services mature (see the discussion in Internal Audit) and as Ministry of Finance led control systems, for example SIGFE and SIAPER (see the discussion inBudget Implementation) come to fruition, the CGR may be able to consider further ways inwhich it might reduce its efforts on ex-ante controls and build up a broader portfolio of ex-post audit services. Examples of such work exist in the CGR and are to be encouraged. ( See Annex 2, CGR Modernization Plans, CGR Organization, Management and Resources.) Audit Process Audit Methodoloav 2.126. The CGR does not audit all government entities annually, but targets it resources on the basis of a risk assessment which is based on the results of prior audits and knowledge of the work of the internal auditors, the size of an entity's budget, inherent operational risks, sensitivity or impact of the area, andthe importance attachedto the area by the government. The audit planning and execution procedures are consistent with INTOSAI auditing standards and the CGR has developed a rigorous framework for monitoringthe time and staff resources usedon each audit. Chile Country FinancialAccountability Assessment 33 2.127. There are no audit opinions on any of the Chilean general government financial statements, including the aggregate ones prepared by the CGR itself. Also, the CGR i s retreating from financial statement audits of the principle public enterprises (ENAP and ENAMI),which represent 60percentof the turnover of the public enterprisesincluded in the Annual Financial Report of the Republic. The audit of these and CODELCO, where the CGR has no mandate, are performed by private audit firms. This development may imply less assurance for stakeholders, given the concerns on the requirements to qualify as statutory auditors for listed companies and the regulation of the audit practice in Chile reported in the 2004 Chile Accounting and Auditing ROSC. In part this is a result of capacity constraints, in part a question of demand. However, assessing the extent to which the accounts of government bodies in Chile are true and fair would exert a useful discipline on public entities in Chile, encouraging accounts to be completed promptly and accurately. Such opinions would also assist the public sector modernization agenda of the government and the Congress and would greatly enhance Chile's international reputation for propriety. 2.128. The CGR has the technical capacity to provide such opinions but, at least in the short term, it may lack the staff resources. Inthis regard, Chile is progressively upgrading internal audit within government departments. CGR examinations have shown that at this stage the quality of internal audit is variable but over time there should be improvements. As this happens, the CGR should be able to place increased reliance on the work of internal audits and move to a risk-based audit of systems, thus reducing the need for extensive transaction testing. 2.129. CGR might needto move forward on opinions of the financial statements on an incremental basis. Initially it might consider providing an opinion on the Statement of Budget Execution of the national budget, working with individual public entities to ensure that their reporting systems were adequate. It might also consider introducing a rolling program, giving opinions on individual accounts perhaps once every two to three years. This latter approach would at least avoid the lack of independence of CGR associatedwith the Annual FinancialReport which the CGR preparesdirectly. Enhancingthe Roleof Congress 2.130. Since the CGR i s not an office of the legislature, as SAIs are under the model followed inmany OECD countries, one of the major challenges facing the CGR i s how it can develop better ways of ensuring that the legislature takes more note of its findings and uses the CGR in an appropriate, non-party political way to scrutinize the activities of the executive. Already the CGR's findings receive press coverage and are the subject of heated debate. By focusing on cross-cutting issues common to many government activities andentities, the impact of the CGR's work could be greater. Inmany countries, the legislature receives reports from the Supreme Audit Institution and, in a responsible, but challengingway, uses these reports to encourage improvements inthe managementof public resources. The CGR could use the current modernization project to open up a dialogue with Congress on this issue and seek to set in motion, changes which could dramatically increaseits impact and utility. ChileCountryFinancial AccountabilityAssessment 34 RecommendationsonExternalAudit 2.13 1. The CGR should review its current wide-ranging functions to determine which ones it alone needs to continue to fulfill and which, in the light of other fundamental reforms emerging inpublic administration inChile, may no longer be neededor could be better carried out by other agents. Specifically: 0 the CGR could relinquish the a priori review function as the quality of internal control in the service agencies improves with the strengthening of Internal Audit, moving to depend on the review of internal control and testing for its consistent application to arrive at assurance of the reliability of control and reporting. 0 similarly, with the uniform and reliable transaction reporting and centralization of accounting permittedby SIGFE, CGR may permit the Executive to prepare its financial reports and thus strengthenits position as an independentreviewer. These changes of mandate would enable CGR to avoid a potential conflict of interest particularly between the preparation of accounts and their audit, which is not compliant with INTOSAI principles. However, modifying CGR mandate and activities may be difficult in view of CGR's strong reputation and the constitutional issues related to the role of CGR. The Chilean authorities should consider addressing this matter with a solution that balances the need for compliance with international practice and accommodatescountry constraints. 2.132. CGR does not have a mandateto audit the Central Bank, the Banco del Estado or to review CODELCO, the National Television Corporation or the State Railway Company. Given the CGR's responsibility to provide assurance on administrative acts, any limit in its scope i s inconsistent. This limitation is of more concern given the weak state of controlover who can exercise the role of an external auditor inChile. 2.133. To address the issue of CGR financial independence, an INTOSAIprinciple, the Chilean authorities should study how other INTOSAImember countries treat this subject. Any proposed changes to the current CGR budget process should take into consideration Constitutional implications. 2.134. The CGR should actively manage the demand for the special investigations (inspections), ensuring that Congress i s fully aware of the impact of such requests on the routine audit work, on one hand, and by developing criteria to use in assessing whether such requests may be better routed through other services (internal audit) or dealt with in other ways. 2.135. The CGR should move to providing audit opinion on the financial statements of the general government sector and should campaign for adequate funding to cover key public enterprises while concerns persist over the regulation of the audit profession. On the general government sector, initially it might consider providing an opinion on the Statement of Budget Execution of the national budget, working with individual public Chile Country FinancialAccountabilitvAssessment 35 entities to ensure that their reporting systems were adequate. It might also consider introducing a rollingprogram, giving opinions on individual accounts perhaps once every two to three years. 2.136. As part of the modernization project, the CGR should verify that clients are satisfied with the timeliness of audit reports, the appropriateness of recommendations and the quality of the audit work. Chile CountryFinancialAccountability Assessment 36 3. CONCLUSION SUMMARY 3.1. The abundant trust in government in Chile today can be attributed, in part, to two elements of transparency: its fiscal reporting and the incontestable review by a competent, independentauthority -the CGR 3.2. The relationship between good governance and better economic and social outcomes is increasingly acknowledged. Transparency - openness about policy intentions, formulating and implementation - i s a key element of good governance. The budget i s the single most important policy document of governments, where policy objectives are reconciled and implemented in concrete terms. Budget transparency is defined as the full disclosure of all relevant fiscal information in a timely and systematic matter. Recognizing this relationship, in Chile the executive has made a formal commitment with Congress to conform with the OECD Best Practices for Budget Tran~parency.~~ 3.3. Furthermore, Chile has effectively centralized policies and procedures to support aggregate fiscal discipline. Aggregate fiscal discipline, measured by total fiscal balance or public debt, and the related predictable funding of the budget in Chile has been achieved through a well-developed budget system which provides for a realistic and comprehensivebudget. 3.4. The management of service delivery and the corresponding financial operations, on the other hand, is delegatedto 190 administratively independent service agencies. The main feature of Chile's public financial management (PFM) operations has been the combination of centralized policies and procedures operated by DIPRES and CGR with decentralized service delivery and financial management operations through 190 service agencies. Although now the subject of a significant reform, DIPRES and CGR use separate, not integrated processes to monitor budget implementation and prepare the financial statementsof the central government. 3.5. With the development of a centralized integrated financial management system (SIGFE), the strengthening of internal controls in the service agencies and the modernization of the external audit system, all supported by substantial investment projects from the World Bank and the Inter-American Development Bank, the centralized control can now continue to evolve to greater reliance on accountability for results, with a focus on outputs rather than inputs by the agencies. These developments also allow the functional specialization of the two rector entities of financial management system - 38 OECD Membercountries are at the forefront of budget transparency practicesand drew together a set of Best Practicesin this areabasedon Membercountries' experiences. The Best Practices are designedas a reference tool for Memberandnon-member countries to use inorder to increase the degreeof budget transparency intheir respective countries. Chile Country Financial AccountabilityAssessment DIPRES and CGR - which now have overlapping functions, which is the case of the CGR, some functions that are incompatible with its ultimate responsibilities as the system's external auditor. DistinguishingFeatureof PFMinChile 3.6. Chile's public financial management i s characterized by a unique blend of strengths and weakness. At present, the systems to support the budgeting and accounting in the public sector operating at the agency level are not state-of-the-art and are not uniform across the public sector since they are the responsibility of each executing agency. The systems in place centrally to support fiscal discipline, efficiency and external reporting are antiquated andduplicative between DIPRESand CGR. 3.7. Despite these limited systems, Chile scores highon financial management outputs in fiscal discipline, transparency and supporting efficiency in operations because underlying all financial management operations are clear rules, strict adherence to the rules, dedicated and qualified staff and management which rewards ethical and efficient behavior and there is a matching of responsibility with accountability given the decentralization of financial managementto the service agencies. 3.8. As such, Chile has in place the two elements39of effective controls systems: workable rules and procedures; and patterns of behavior that accept the rules and procedures as legitimate. 3.9. It is precisely this solid basis of clear rules and behavior in line with the rules that will allow Chile to attain the standards of public financial management which it has targeted ( accrual basedfiscal reporting and OECD Budget Practices) but it must address remaining issues on the implementation of the new systems and produce an explicit audit opinion on the general government sector financial reports. CONCLUSION 3.10. Chile i s well into the second generation of public sector reforms. The current focus has moved beyond fiscal discipline to improving public service delivery, that is, the effectiveness and efficiency of government. Such improvements can be built now only because they can rest on the solid existing base of (i) fiscal stability, (ii)predictable financing, and (iii)resourceuse inline with budget authorizations, with reliable reporting on income, uses and financial position. 3.11. In Chile, the assurance that uses of public funds are in line with authorizations and that there i s full and accurate reporting i s attributed to clear roles set in law for the executive and the legislature on budget development and oversight, and a clear definition of the responsibilities within the executive for financial management. These roles and rules on the use of public funds are strictly observed and are supported through: 39AContemporaryApproach to PublicExpenditureManagement,Allen Schick, World Bank Institute, 1999 Chile Countrv FinancialAccountabilitvAssessment 38 0 An obvious commitment by public sector management to efficiency and transparencyinthe public sector. Incentives in the government-wide Management Improvement Program for buildingfinancial managementcapacity inthe service agencies. Staffing of financial management positions with qualified professionals in the respective disciplines who operate under clear written rules and regular expert supervision. 0 Independent review by internal auditors under the control of the management of each agency, internal auditors under the Executive, and external auditors reporting to agency management, the Executive and to Congress on the legal compliance andprobity of all administrative acts. Decentralization of financial management to the service agencies, accompanied by well-developed performance measures. Unresolved Issues 3.12. Notwithstanding the favorable status of financial management, to advance with modernization toward the world's most advanced countries in terms of fiscal transparency4', the following issueshave to be addressed. SIGFE 3.13. Chile i s committed to moving to accrual basedfiscal reporting ( GFSM2001)41.In turn, the steps to prepare Chile for accrual based fiscal reporting involve the successful implementation of the integrated financial management (SIGFE), under development, both at the decentralized level and centrally for aggregation and oversight. 3.14. Given that a single system now integrates accounting, budget and treasury, there i s a general understanding that a single party must be responsible for the operation of the systemand that the existing systems must be displaced by SIGFE. There is, however, no formal commitment to this and no detailed steps have been laid out for its implementation. 3.15. Given CGR's constitutional responsibilities for keeping the accounts of the nation it has to be satisfiedthat SIGFEmeets these ends and has to ensure that it is operating to their expectation on an on-going basis. At the same time, the executive (DIPRES) has a duty to maintain afinancial administration informationsystemand controlthe budget. 3.16. Since DIPRES i s responsible for maintaining a financial administration system, it would follow that they operate SIGFE. Arrangements could foresee that (i) DIPRES operate SIGFE and (ii) DIPRES and CGR would have simultaneous real time access to SIGFE data. Under these, or similar arrangements, a detailed formal plan should be 40 The Director of DIPRES summedup Chile's positionon financialmanagementreforminthe Reporton GovernmentFinances( 2003): THEAIM ISTORAISECHILETO THESAMELEVELAS THEWORLD'S MOST ADVANCED COUNTRIESINTHE QUESTIONOF FISCALTRANSPARENCYSTANDARDS. 41 IMF(2003), Chile-StaffReport for the Article IV Consultation, paragraphs 29 and50 and Annex 11. Chile Countrv FinancialAccountability Assessment 39 formalized so the arrangements for implementation of the centralized system may be effected. These arrangements would be operational and would not change the responsibilities upon accounting function definedby the Constitution. ProiectAdministration Mainstreaming 3.17. A concrete short term benefit of the full implementation of SIGFE is the possibility for the administration of investment project financed by the multilateralbanks to be carried out exclusively through the financial management system of the Service Agencies. This mainstreaming of project administration offers efficiencies and economies to the Government in that no redundant systems are developed or operated for the individualprojects. External Audit 3.18. OECD Best Budget Practices cover not only the principal budget reports that governments should produce and their general content but also the practices for ensuring the quality and integrity of the reports. In this regard, Chile is at a variance with the external auditing best practice which states "The year-end report should be audited by the SupremeAudit Institutioninaccordancewith generally acceptedauditing practices". 3.19. For Chile to emerge at the forefront of public sector management, it should issue its annual financial statements with an audit opinion and move to closer adherence with internationally accounting standards in its reporting. The lack of any external audit opinion on the government financial statements is not consistent with a modern approach to public sector external auditing. The independent review i s a central pillar of transparency; a key output of the external review is an explicit audit opinion on the financial reports of the general government entities. The acceptedmediumfor expressing the results of this work i s to attach the auditor's opinion, in a format and of a content which conform to international auditing standards, to the financial statements so that users of these statements have this comfort when viewing the statements. 3.20. To render these opinions, CGR would have to distance itself from both the ex ante approval role of budget uses and the preparation of the annual financial statements. This potential conflict of interest between the preparation of accounts by CGR and their role in the audit of these accounts does not comply with INTOSAIprinciples. However, modifying CGR mandate and activities may be difficult, in part because CGR has a strong reputation, and in other part because of role ascribed to CGR in the Constitution. The Chilean authorities should therefore consider a solution that complies with international practice and accommodates with country constraints. FINANCIAL MANAGEMENTASSESSMENT RISK 3.21. The CFAA assessed the financial management risk to Participating Bank funds that are managed through the public financial management systems of the central government of Chile. At issue in financial management risk i s whether there is insufficient transparency (quality of information) to determine how public funds were spent or managed. The following was assessed: whether (i) budget i s implemented as the Chile CountryFinancial AccountabilityAssessment 40 passed; (ii) significant government activities are covered by the budget; (iii) all sufficient reliable information exists on budget execution and (iv) practices match rules. In Chile's public sector, these components of fiduciary risk are managed in the following key cross-cutting areas which have been assessed in the CFAA: budget comprehensiveness, budget realism, adequacy of internal control systems, including information flows; and adequacy of fiscal transparency, bothinternalandexternal. 3.22. This CFAA establishesthat there are many strengths in the Chilean PFM system. These canbe listed as follows: - a strong legal framework inLAFE,the annualbudget law andelsewhere, which is invariably observed, - strong culture of control, reflectedinthis observance of requirements, the strong constitutional positionof CGR and awell developed system of internal audit. Reflecting this, there is ahighlevelof probity inthe managementof public funds, - animpressive recordof fiscal discipline, - a realistic andcomprehensivebudgeting system, operating according to a predictable timetable and rules, which is well understoodby participants and which provides good fundingpredictability to spendingagencies, - ahighlevel of fiscal transparency overall, notwithstanding some omissions concerning the military. Extensive and reliable informationon budget execution, and the results and position of the public finances overall i s available in a wide range of reports, many of which are on Government of Chile websites, - a strong focus on performance through the budget, inparticular through a well developed system of program evaluation. 3.23. The overall conclusion is that the financial management risk i s low; this indicates the substantial institutional capacity of the Chile public sector, strong performance inmany fiduciary areas, and the advancesmade inrecent years to improve public sector financial management. Chile Country FinancialAccountabilityAssessment 41 4. ANNEX 1:OFFICIALS CONTACTEDDURINGMISSION Deuartment Position Name DTPRES I Budget Director Mario Marcel Headof FinancialDept Beltrande Ramon Deputy Budget Director Sergio Granados HealthSector Analvst Jacaueline Canals Education Sector Analyst Jose Esuinoso Project SIGFE Coordinator of Financial Leonard0 SanchezGonzalez I Develonmentof Coordinator Financial Rodolfo Sepulveda Development Ministryof Health Director of Planningand Dr.ClaudioFarah Jaime Arriagada East (Servicio de Salud Headof Finance Vincente Escobal Metro Oriente) Internal Audit, Chief Dr.Adolfo Brinner I Internal Internal Audit Unit Patricio Malinarich Audit U.nit Pilar Bizamo 0. Dr.Dolores Toha Diego Sola Administration I Headof Accountinn ElbaZufiina Ministry of Education Director of Planning and Teresa Ferrada Budgeting MinisterialAuditor Andres Rodriguez Ley I NationalDirector of JosC Lopez Miranda ~~ Treasury of the Republic Finance NationalCivil Service Director Catalina Bau Aedo NationalAudit Office Accounting Division, Chief Pedro Ortiz GAvez (CGR), Accounting Division Deputy Head of LuisTellez Mellado Accounting: Division Deputy Head of Jose Allende Accounting Division, Standards Deputy Headof Jose Aravena Accounting Division, Government Accounting Chile Countrv FinancialAccountabilitv Assessment 42 Deputy Headof Alejandro Olquin Accounting Division, ReDorts and Statistics National Audit Office Chief Patricio Ptrez Fariiia (CGR) Audit Division, Deputy MartinGarrido VUOP National Audit Office Chief MargaritaGonzalez (CGR) Audit Division, Planning National Audit Office Pedro Sanchez (CGR) Audit Division, Human Resources National Audit Office Chief, InformationCenter Gerard0 Vergara Velasquez (CGR) Audit Division InformationTechnology NationalAudit Office Vicente Romero (CGR), Internal Audit NationalAudit Office Deputy LuisVtlis Baeza (CGR), Audit Division, Municipalities NationalAudit Office Chief Hernfin Llanos (CGR), Audit Division Subdivision Chief Jose Fco. PachecoNavarrete Subdivision Chief NelsonF.Palominos G. SvstemsAuditor -I Jorge E. MeridaMuiioz Council for Government Executive Secretary Gonzalo Shchez G.H. Internal Auditing (Consejo de Auditoria Internade Gobierno) Ministry of Finance, MinisterialAuditor Carlos C.Ogno Canales Internal Audit Deuartment INDAP InstitutionalInternal Daniella Caldana Auditor Hospital Calvo MacKenna CORFO Head of InternalControl InteriorMinistry InstitutionalInternal SUBDERE Auditor I National Treasurv Office Head of Public Credit SuperintendenciaValores y Chief, Control Division Seguros Proffesional Accountants' President Dr.LuisWerner-Wildner Q. Association (Colegio de Contadores) I Chile Country Financial AccountabilityAssessment 43 5. ANNEX 2: DETAIL OFTHE PUBLICFINANCIAL MANAGEMENT COMPONENTS BUDGETDEVELOPMENT Structural Adjustment Policy 5.1. Chile also has a long history of fiscal prudence. Current fiscal policy (a political commitment of the Government, rather than a legal requirement; there i s no fiscal responsibility legislation) provides for astructural (i.e. underlying, or excluding the impact of short-term fluctuations) budget surplus of one percent of GDP. Necessary adjustmentsto achieve this target are made to budgetexpenditures duringthe year. This structural target enables the Government to pursue counter-cyclical economic policies if it wishes. Two independentprofessional panelsannually determine the calculation of this budget surplus target, one reviewingthe effect of the economic cycle on tax revenues and the other determining the expectedprice of copper, since Chile's fiscal revenues are heavily influenced by the price of copper. Copper Stabilization and PetroleumFunds 5.2. LAFEestablishesthe principleof aunifiedbudget.The budgetcovers all ministries and autonomousagencies, whose expenditures are appropriated on a gross basis, i.e., irrespective of receipts. There are two funds which operate within the budget: (1) The Copper Stabilization Fund, set up in 1987 to isolate the effect of changing copper prices on budget revenues. This effect i s now of relatively little importance, with any such budget adjustments being governed by the structural fiscal surplus commitment, discussed above. Only a small balance i s held in this Fundand its use is governed by a Presidential decree. When economic conditions are good, it is used to repay debt; when economic conditions are less favorable, additional borrowing may be undertaken. Information on transactions of the Fund i s provided in the quarterly budget execution statements of DIPRES under a program of Public Treasury. The Annual Financial Report on the Public Sector by the General Accounting Division of the CGR presentsonly the ending balances of the fund. (2) The Petroleum Fund, which operates in a similar fashion with the same disclosure as the Copper Fundbut i s considerably smaller. Budget Timetable 5.3. Budgetformulation proceeds according to the following regular timetable (governedbothby LAFE andthe budget instructions issued annually by DIPRES). Chile Country FinancialAccountabilitv Assessment 44 Figure 2. Budget Formulation Timetable. (fiscal year begins January 1) ipril-May Updatingbaselines Initialbilateral meetingbetween budget office and line ministries May President's message to Congress, setting out policy priorities June Maximumamounts for ongoing programs established by DIPRES Budget Circular issuedto ministries Early August Bilateral meetings between Budget Officeand line ministries Early August Meetings of panels on economic assumptions End August1 Line ministries submit proposals to "Bidding Fund" (ifavailable) Early September 2"dweek of Draft budget discussed with President September 3rdweek of Bilateral ministerial meetings between Minister of Finance and September line ministers 4thweek of Finalpreparation of documentationandpricing September Lastday of Budgetproposal presented to Congress September MidNovember CongressBudget Committee reports to Congresson the Budget proposal Budget approved by Congress November Protocols agreedbetween DIPRES and Congress 1December The Budget i s formally published Source: OECD 2004 (adapted) BUDGET IMPLEMENTATION CashManagement 5.4. The Treasury Department within the Ministry of Finance is responsible for tax collection and recordkeepingof taxpayers, including fines and follow-up on late paymentswith taxpayers. Taxpayers may remit taxes directly to Treasury or through agents of the government i.e. commercial banks, as noted above; banks have agreements Chile Country Financial Accountability Assessment 45 with Treasury on tax collection service whereby the banksholdfunds for three days as compensation for the services rendered.This income and income collected by the service agencies is depositedby the treasury departments of the service agencies inthe central revenue account (Cuentu Unicu del Fisc0 or CUF), as called for inTitle IIof the LAFE. 5.5. Inaddition to cashplanningandthe cashprogram, two keyinstruments are used byTreasury to effect control over revenue; the single taxpayers account andthe single fiscal account. The single taxpayer's account (cuentadnica tributaria) i s a sub-ledger of the revenueaccounts whereby all tax revenueis noted underthe corresponding taxpayer's individual account. Uponcollection, direct or by agents, the type of revenue and the individualtaxpayer's code i s recordedwhich support the entry inthe taxpayers account are the subsidiary ledger level and inthe revenue accounts at the level of the general ledgeraccounts of the Treasury Dept. As such, revenueis identifiedfrom the moment of collection to a relatedtax accountspayableheceivable. There i s also a mid-year report from DIPRESto Congress updating revenue and expenditure projections for the current year. This does not lead to any revision of the formal budget allocations, but it may affect the rate of actual budget execution. 5.6. At the time of the approval of the budget, the annual cash outlay program is also set by DIPRES in conjunction with each agency. This cash program i s reviewed and updated if necessary by the DIPRES on the 25`h of the preceding month. On the basis of an annual cash program, updated monthly, DIPRES instructs Treasury to effect the transfers twice a month to the current accounts of the service agencies to cover their operating requirements. The allotments are separated into amounts for personnel and other expenditures and are paid to the agencies intwo tranches; the first goes out to pay the salary costs between the 12th and 15th of each month; the balance goes out on the 25`h. On the salary costs, the agencies effect withholdings for statutory benefit plans and record the relatedcharge to their budgets on a cash basis.42 5.7. The monthly cash ceilings are set with the Ministry of Finance without consultation with the spending agencies; however, given the good rate of budget funding (96 percent in 2003) and the flexibility that agencies have for deciding on the uses of the allotted funds, the centralization of setting the cash ceiling i s not seen as interferingwith program execution. While there i s no authority for short term indebtedness, to support the execution in line with approved cash programs, the Finance Dept of DIPRES may sell a portion of its short securities issued by other state entities and repurchase these before year end. 5.8. The Finance Department within DlPRES determines the cash available for short- term investments and inconjunction with the Finance Committee determines the funds to be placed in time deposits with the Banco del Estado on short and longer terms in line 42The amounts related to these withholdings are not transferred to the agencies but held in Treasury until the following month, when they are remitted to the correspondingprograms. Although these withholdings are recorded as cash uses in the budget execution, they not actually paid untilthe following month. Chile Country Financial AccountabilityAssessment 46 with forecast needs. Short-term fixed rate investments are done exclusively with the Banco del Estado and, as such, are not granted on competitive biddingof yields. 5.9. Once funds are transferred as cash allotments, they are under the control of the service agencies, or the second-tier entities under the agencies, and are not under any direct or indirect control of the Treasury Department. These funds are deposited in non- interest bearing accounts in the Central Bank and the Banco del Estado. Although there are 190 agencies, there are also bank accounts inentities which operate under the services (hospitals for example); the number of active current accounts in the central government i s close to 5000. 5.10. Neither the Treasury nor the Finance Department of the Ministry of Finance has access to the banking information and must depend on the monthly financial reports to determine cashbalances.The determination of actual balancesinthe bank accounts i s not reported and generally not available to the central authorities. The central authorities estimate the book cash balances once a year, in October, from the initial balance and the actual transfers less actual expenditures reported inthe monthly budget execution reports. It is estimated that the idle balances fluctuate between US$500 and 800 million; no interest is paid on these balances, but in return Banco del Estado provides free banking services and some social services. The relationship with the Banco del Estado i s not governed by any contract for services, so there is no separation between the cost of idle balances and cost of banking services renderedto the agencies. 5.11. The procedures in place support the service agencies' autonomy but involve a significant opportunity cost through the idle funds of the average balance in the current accounts of the service agencies. A common practice incommercial banking is the use of zero balancing accounts whereby executing entities under the coordination of a central treasury can draw funds up to an established cash allotment without actually holding funds intheir respective current accounts. The central treasury would have on-line access to the movement in all current accounts and ensure adequate funding while at the same time investing all idle funds. The use of these modern techniques and access to short investments at the best riskhate relationship should be established in new arrangements betweenthe Ministry of Finance and the Banco del Estado. 5.12. Reasonable predictability in budget execution i s evident from a review of the following percentages of execution of Original Approved Spending Budgets, for years 2000-2003. Variation by sector from the original budget averages 5 percent, arising primarily from the redistribution of the contingency for pending legislation. Execution by sector on the endingapproved budget i s also uniformly high; exceptions in 2003 arose for investment spending on CGR (79 percent), as project execution was delayed, and for the Ministry of Economy (75 percent), attributed to variations from budget on financial investment inCORFO. Chile CountryFinancial AccountabilityAssessment 47 Table 1.Plannedvs. Actual Spending, CentralGovernment, 2000-03. I Total Spending Total Spending % Executedof Original Budget Executed Original Budget Year I 2000 9,704,558 9,621,337 99.1 2001 10,338,129 10,162,985 98.31 2002 11,210,188 10,494,13 8 93.61 2003 11,978,684 11,575,879 96.6 Investment Costs 5.13. Ministry of Planning (MIDEPLAN) is responsible for reviewing all central government investment proposals involving budget expenditure. The review is limited to establishing that the project satisfies the demand for an adequate level of return in economic and social terms. Once reviewed and accepted, projects are assigned a unique project number and enteredinthe project bank. Acceptance does not imply financing but all investment projects included in the budget proposal of an agency must be previously entered in the project bank. The application i s Web-based, so once a project is under implementation, the executing agencies can update the project bank with the financial and physical advance. The project bank is not integrated with any other systems. ( Also see Institutional Arrangements para. 2.23.) Budget Implementation Healthand Education 5.14. Given that budget control, accounting and cash management is decentralized to 190 independent agencies, two ministries - Health and Education - were selected for more detailed review of budget monitoring in the agencies. Their combined spending comes to 30 percent of total expenditure. Their operations involve thousandsof payments to thousands of different recipients; such transaction-intensive operations put high demands on the financial managementsystems and have highinherentrisk. 5.15. As discussed in other sections, there is general acceptance and compliance with rules on public financial management in Chile. This favorable control environment has allowed a move from the control over budget inputs to a control over outputs based on performance indicators, particularly in the health and education sectors. The distinguishing feature of the budget control in the health and education sectors, which sets it apart from other sectors in Chile and from common budget control in the region, i s the absolute reliance on the control over outputs, as opposed to inputs, for their key expenditures. The focus of the central authorities moves from controlling inputs to Chile CountrvFinancialAccountability Assessment 48 controlling outputs, although there i s some inconsistency with the ex-ante intervention by CGR on specific types of contracting. Health 5.16. The Ministry of Healthadministers expenditures amounting to over 12percent of the 2004 budget andhas organized its functions under six budget envelopes: three support agencies (Public Health Institute, Central Supply Services and Superintendenceof Health), the Sub secretary of Health, the administrative unit of the ministry and the central funding agency, National HealthFundor FONASA, and the Health Service Agencies: clinics and hospitals which operate under the six Regional Health Services. 5.17. FONASA operates the national health insurance program under which all employees contribute 7 percent of their income (up to a specific limit); employees have the right to use this coverage in the public hospitals or to cover a share of the cost of services inprivate hospitals. The public hospitals offer medical care to those who do not contribute to FONASA and have no private coverage. All funding for the health delivery units is funneled through FONASA and comprises the insurance income, user charges, andsubsidies inthe form of transfers from the national government. 5.18. Each Regional Health Service i s autonomous in its financial management and is assigned a budget and receives transfers from FONASA in line with the budget funding arrangements and service levels/ The Administrative Directorate within each Regional Health Service i s organized to support the financial management operations and comprises the human resources, internal audit, asset management and finance departments. The National Health Fund, FONASA, i s funded by employee contributions but the transfers to the Regional Authorities are made under the specific programs authorized inthe budget, such as Primary Care, Pre-priced Services, InstitutionalServices andContingency Programs. 5.19. Primary care funding goes to municipalities for residents who are registered as having no other health coverage. The funding i s made on a per capita basis based on the number of registered residents. A technical supervision unit in each Regional Health Authority carries out ongoing supervision of compliance with the service standards of the municipalities and the eligibility of those registered. 5.20. Pre-priced arrangements are used to fund the majority of hospital expenditures and are related to the provision of a projected volume of specific packages of services at an agreed unit cost. The annual budget of the hospital contains the detail on the volume of each package of service. Fundingi s made against the volume estimated in the budget for each establishment under agreements (convenios) with FONASA. Budget may be reallocated by the Regional Health Service among its hospitals to cover service volumes Chile Country FinancialAccountabilityAssessment 49 that are over or under the target volumes. The balance of the funding comes under the heading of Institution Support, which is the amount of transfers or fixed funding that the Regional Authority provides, basedon the history of expenditures, less that portion which i s converted to pre-priced arrangements. 5.21. Because the composition of contributors and of users is directly affected by variations in income and unemployment variations of the population, the Ministry includes a contingency program which may be drawn on to finance changes in the demands for pre-priced arrangements and other funding to the hospitals. Despite these arrangements, where funding falls short of the recurrent costs required to provide the volume actually materializing, the hospitals have incurred commitments and liabilities beyond authorized budget levels and this has resulted in the accumulation of payment arrears. These arrears can go undetected in the current year but there is now a provision for budget allocation to pay off these arrears. 5.22. The Regional Health Services operate, on one hand, financial management systems to support their own budget and, on the other hand, simple Excel tools to control the approved budgets of the service delivery units under their responsibility, and to aggregatebudgetexecution data. 5.23. Inthe case of the EasternMetropolitanHealthService, the financial management system used to support their direct operations is the same as that used by the hospitals: a customized financial and clinic control application comprising the core budget, accounting, andtreasury, inaddition to inventory, invoicing and clinic control. While the transfers from FONASA appear as transfers to specific programs and are tied to outputs of volumes of specific services, the uses of these funds in the hospitals are reported in the monthly budget execution reports [along the lines of inputs by very detailed objects of expenditure This practice provides the service delivery units with the cost center and object of expenditure informationcritical to costing of their outputs. 5.24. As noted, the hospitals have comprehensive financial and clinic control systems in place. A number of these have already implemented the integrated financial management SIGFE system which provides for core budget, accounting, and treasury control. 5.25. Overall then, the health units can count on a flow of funds in line with the volume of service demanded (outputs), and mechanisms are inplace to adjust funding to this volume; nonetheless the health units will resort to running up arrears for supplies purchases to meet their service levels. Budget monitoring goes beyond comparing approved to incurred expenditure, since the efficiency of the operations i s inferred by comparing the budget outturn (reported by object of expenditure by health unit) to the volume achieved (reported against the performance contract). Given the advantages in supporting results of the pre-priced arrangements, the sector should expand the share of this form of financing. ChileCountry Financial AccountabilityAssessment 50 Education 5.26. The Ministry of Education oversees 10 agencies (sewicios publicos) which together form the education sector and represent 18 percent of the national budget (2004). The provision of public primary and secondary education is outsourcedto municipal and private schools; this activity is considered a separate agency in the budget presentation. Over 10,000 establishments provide primary and secondary public schooling, requiring a monthly disbursement of around US$ 200 million that takes us over 60 percent of the education budget and over 10 percent of the national budget. Outsourcing payments are called Subsidies to Education Establishments, and are managedby the Undersecretary of Education. 5.27. Budget formulation for the subsidy is determined in part by the laws, which set out the entitlement to a fixed rate per student days-of-attendance. The rate was set inthe 1980s and is tied to the increase in civil servant salaries. This rate is applied to the estimated student population and attendance, calculated on the basis of demographic statistics from the National Statistics Institute and of classroom statistics from the Ministry of Education (numbers of students in each grade who will be advancing to the next level or graduating). 5.28. Budget execution of the subsidy operates through a central system of subsidy control (sistema de pagos) managedby the Education Undersecretary, where the records of attendanceandpayment by establishment are maintained. 5.29. The subsidy control system i s updated for changes in the educational establishments supplied by the Regional Education Authorities under the Ministry of Education. On the basis of the validated and authorized set of establishments, the attendanceof each establishmenti s provided on forms that can be readoptically to update the attendance records. This input i s reviewed and authorized by the Regional Educational Authorities, provided through the Ministry's communication network to the Subsidy Control system, and is processed in the Undersecretary's office under the supervision of the Subsidy Control Unit and the regional authorities. Once processed, the regional payment analysis specifying disbursement by school i s provided to the regional authorities. 5.30. The funds relating to the cost per region are transferred from the Ministry's treasury to the accounts of the regional authorities, from which they are withdrawn for electronic transfer to the individual educational establishments. 5.31. The appropriate use of funds under this arrangement depends on the reliability of the information provided by the establishments and the quality of their services as compared to the agreed criteria under which the establishments were admitted to the program. Inspection at the level of each establishment i s organized under the Provincial Department of Educationand provides an independent evaluation of compliance with the agreed terms of the service and the accuracy of the attendance reported. These reviews are supervised and consolidated at the regional level; at the Undersecretary level, the Chile Country FinancialAccountability Assessment 51 reports are used to establishwhether the program of inspection of establishments is being carried out inline with the program targets. 5.32. The Ministry has thus successfully implemented a method of planning and funding 60 percent of the budget (primary and secondary education subsidy) that provides excellent predictability, since the both the rate and volume are reliably estimated. At the same time, the volume reported by the providers and compliance with the standardsof quality of the serviceareclosely and effectively monitored EXTERNAL FINANCIAL REPORTINGAND TRANSPARENCY Reporting on Military Expenditures 5.33. The Ministry of National Defense (partida 11 of the national budget) encompasses all the armed forces services. Their operation i s funded through the national budget and subject to the LAFE, the administrative and probity laws as well as all budget regulations as with all other decentralized services agencies. Similarly, andthe related operations are under the purview of the internal auditor of the executive and the CGR. 5.34. In the following respects, however, there is inadequate reporting on military expenditures. The uses of public funds transferred to the armed forces under the Reserved Copper Law of 10 percent of CODELCO's total revenue:3 destined under law for military equipment, is not reported in the budget documents or inthe Annual Financial Report of the CGR. However, under a January 2003 protocol aggregate information on this expenditure will be included in the quarterly budget execution reports prepared by DIPRES. Since 2002 this aggregateinformationhas also been includedin the Public Finance Statistics prepared by DIPRES. Although this information is not included in the CGR Annual Financial Report, CGR may review this expenditure and report internally e.g. to Ministers, as appropriate. However it may not report publicly on it. The armed forces may borrow to finance equipment purchases (subject to certain limits) but this debt i s not included in the public debt statistics or reported in the annual financial report. The only reporting on the financial operation of defense enterprises is a summary for each enterprise in the SOE section of the CGR Annual Financial Statement.44There are no detailed published or audited financial statements. Reporting by Municipalities 5.35. Municipalities are subject to the same standards of reporting as central government, set by CGR. Consolidated reporting on municipalities is part of the Public 43CODELCO's revenue came to 3.8 billion USDin 2003. 44Total revenue from the three military enterprises came to USD 145 million in 2003. Chile Country Financial Accountability Assessment 52 Finance Statistics published by DIPRES and discussed above. The municipal sector i s also part of the Annual Financial Report prepared by CGR; that report contains an aggregate balance sheet and cash statement, the budget results are presentedin aggregate and by region. CGR also prepares a quarterly report on municipal budget execution, finances and assets. These are provided to Ministers, DIPRES, Congress and MIDEPLAN but are not formally published. On the other hand, municipalities are required under the Municipalities Act to present an annual Public Account to the Municipal Council and to the community at large in April of each year. This account includes a balance sheet, budget execution statement, detail on investments and key finding of the CGR. AccountingStandards 5.36. Under the LAFE, the CGR is empowered to set public sector accounting principles and the standards under which the government accounts are kept. Although the Association of Professional Accountants has established a commission on public sector accounting and the CGR will be active member, there are no standards outside of those set by the CGR. Chile is participating in a program with the TDB which includes the alignment of the CGR's public sector accounting standards with the P A C Public Sector Accounting Standards. 5.37. The current accounting standards issued by the CGR are documented and published in CGR Office Pronouncement 6856/92. These standards aim to apply generally accepted accounting principles to the Chilean public sector. They comprise general principles: identify the economic entity, require accruals based reporting, define the reporting period and attributes of accounting. The Pronouncement also contains principles for specific areas on the valuation of financial and physical assets. The CGR i s empowered to provide rulings on accounting treatment where doubts arise. The framework i s very limited. Inaddition to not providing guidance on many specific issues which are provided for in international accounting standards, it does not provide for minimum requirements of financial reports in line with international public sector accounting standards. Managingand ReportingonPublicDebt 5.38. Both external and internal central government debt i s managed by the Treasury Department of the Ministry of Finance, where a debt administration system and register has been used since the mid-1980s. The register contains details of each loan and projection of service costs until maturity. The system generates information for preparation of the budget of debt service payments. The loans recorded in the register may be accountedfor ineither the Treasury Department's general ledger or in the records of a service agency. As such there are no automated outputs from the debt registry for producing accounting reports. The Treasury debt register i s also limited to the non- financial sector; it does not include the debt of the Banco del Estado or the Central Bank. Similarly, off-budget debt incurred by the military in relation to equipment purchases is not includedand SOEs manage andreport their debt separately. Chile Country Financial AccountabilityAssessment 5.39. The LAFE calls for all income to be included in the budget which includes borrowings that are authorized in the Budget law and its annexes. The Annual Budget Law therefore includes an explicit global authorization for public borrowing. Chile has been highly transparent on reporting debt; a comprehensive statistics report on debt, The Statistical Public Debt Report, is published annually on the DIPRES website. The Chile Fiscal ROSC concludes that Chile "more than fully complies with the best practice criteria" on public debt statistics set out in the IMF Fiscal Transparency Manual. 45 Information on year end 2003 balances was available within the first quarter of 2004. The report covers debt for the entire public sector: central government, central bank, state enterprises and the pension liability. Summary information on debt of the central government i s includedinthe annualPublic Finance Statistics publishedby DIPRES;this report includes the bonds relating to the vested pension liability. Similarly, a report on debt is produced half yearly for the Finance Committee of the Senate and House of Representatives. This report covers net and gross debt with explanatory notes and background material and is presentedwithin 90 days. Additionally, the Annual Financial Report prepared by the CGR includes a Consolidated Debt Statement for the central government. However, debt incurred inrelation to military expenditure i s not disclosed in any of these reports.. Contingent Liability Reporting 5.40. Contingent liabilities are liabilities which may arise depending on future events or contingencies Generally accepted accounting principles, such as IPSAS 19, identify the circumstances in which contingent liabilities should be recognized and how they should be measured and disclosed. While contingent liabilities are not recognized in the balance sheet as liabilities, they should be continually assessed as part of managing budget risks and disclosed inthe notesto the financial statements. 5.41. All significant contingent liabilities known to the Government are disclosed in the Budget Director's Annual Report on Public Finance, except loan guarantees which are disclosed in the Annual Financial Report on the Public Sector by the CGR. These include the state's share of the minimumpensionunder the state pension plan andvarious guarantees to concessionaires of public infrastructure operations. The CGR Annual Financial Report on the public sector includes in the notes to the Consolidated Balance Sheet the total amount of loan guarantees issued by the national government but there i s no disclosure of other contingent liabilities. Given the significance of these contingent liabilities and the implicit recognition that there i s more than a remote possibility of payment, the CGR Annual Financial Report should contain details of all contingent liabilities. 45 Chile: Report on the Observationsof Standards and Codes- Fiscal TransparencyModule, IMFAugust, 2003. p. 30 Chile Country Financial Accountability Assessment 54 Tax Expenditures 5.42. Tax expenditures are tax concessions to sectors or groups that result in a loss of revenue, and may be regarded as an alternative to direct budget transfers as a form of assistance to these sectors or groups. The Budget Director's Report on Public Finances accompanying the 2004 Budget contains an analysis of tax expenditures. However there do not appear to be any arrangementsfor their systematic reporting. Asset Management 5.43. The Framework Law of the Auditor General (CGR) on the Accounting Department's responsibilities calls for the CGR to keep a fixed asset register (inventario general de Zos bienes) and to verify the fixed assets reported therein. However CGR has effectively delegatedthis responsibility to the individual service agencies and other state entities. The CGR accounting guidelines require the service agencies to record all fixed assets over a specified amount, to maintain administrative control over them, and to conduct periodic physical ~tocktaking.~~However within agencies there i s considerable variation in the quality of controls exercised over fixed assets. In many cases asset registers are not up to date, no comprehensive physical stocking taking has been carried out, and the registers do not balance with general ledger balances. These practices undermine the reliability of the equity statedinthe balance sheet included inthe financial reports of each service agency and in the consolidated financial statements of the central government. 5.44. A project with IDB funding is underway to create a centralized comprehensive real estate registry and management system which will contribute to the efficient use of the real estate inthe hands of the public sector. This initiativereflects the inadequatestate of centralized records and the need to assign costs to real estate occupied by the service agencies in order to support results-based management. The Accounting Department of the CGR, as the authority for accounting and financial reporting, should complement this initiative with an effort to integrate the fixed asset controls (once brought up to date) with the accounting module of the SIGFE system that i s being implemented throughout the central government. INTERNALCONTROLAND INTERNALAUDIT4' Internal Control 5.45. The Chilean Professional Accounting Organization issued Chilean Generally Accepted Government Auditing Standard (GAGAS) No. 9 "The Study and Evaluation of Internal Controls'' in December. 1986 and Standard No. 14 on "Audit Standard for the 46Oficio CGR No 6856 de 1992 47Some observationsin Annex 2 relating to Internal Control and Internal Audit are based on a morein- depthreview of the functioning of internal control in selected organizations-INDAP, Eastern Metropolitan Health Service, and C O W 0 Chile CountryFinancial AccountabilityAssessment 55 Internal Control Structure" in 1995.48According to Chilean GAGAS, the internal control system includes an organization's plans, including all methods and coordinating measures adopted to protect its resources, ensure accuracy and reliability of information systems, contribute to efficient operation, motivate compliance with established policies, and healthy managementpractices directed by senior management.49 5.46. COSO is the internal control framework used by the majority of the Chilean ministries and service^.^' 5.47. Internal control policy is set by the Council for General Internal Government Auditing (see below) which also oversees internal audit throughout the executive; CGR is responsiblefor the independentreview function, exercises legal control over execution of the budget but also exercises ex-ante approvals of many administrative decisions, and evaluates agencies' internal control systems as part of the external audit process. 5.48. Law No. 19.553 (February 1998) which established the mandatory Management Improvement Programs (PMGs) has played an important role in strengthening internal control. Article 6 states that the headof each service must present to the Minister a yearly PMG that will contain, at a minimum, the institutional mission, the medium and long- term strategic plans, and the annual objectives for management, institutional efficiency and quality of services provided to users, with relevant performance indicators. The program is connected to a merit pay system linked to compliance with management goals, which include several of the systems that comprise the internal control system. Thus improvement of planning, monitoring and control is an important aspect of many PMGs. Validating achievement of these goals though reviewing the performance indicators i s a function of the internalaudit units. 5.49. The concept that a strong internal control structure is fundamental to the control of the organization and its successful operations appears to be generally accepted by government managers. An excellent example of this was the April 2004 seminar of the Sub secretary of the Ministry of Education, which focused on the role of internal control inthe delivery of the educational services. It was attendedby the heads of the Ministry's five divisions and ledto the formation of a Consultative Audit Council. InternalAudit 5.50. Internal auditors are a part of a governmental organization's internal control framework, but to preserve their independence and objectivity they are not responsible '' 48Law No. 13.011obliges the Colegio de Contadores de Chile to "issue standards related to the rofessional exercise of accounting and auditing in Chile. Technical Document No. 3. 50 COSO broadly defines internal control as: "a process, affected by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: a Effectiveness and efficiency of operations Reliability of financial reporting a Compliance with applicable laws and regulations. Chile Country Financial AccountabilitvAssessment 56 for implementing specific internal control procedures. Their role is to audit internal control policies, practices, and procedures to assure that controls are adequate to achieve the organization's mission.51 As such they provide important information to top management of the organization. 5.51. There are three main components to the Chilean government internal audit function (1) the Councilfor GeneralGovernment InternalAuditing (CAIGG), (2) Ministerialinternalauditors, and (3) Internal audit units of individual agencies or enterprises. 5.52. The importance of internal audit was strengthened by the creation of CAIGG in 1997 through a Presidential decree52as an advisory entity to the President to coordinate government internalcontrol and government internal audit. A further Presidential decree in 2003 requires all Ministers, Sub secretaries and Heads of Service to fully collaborate with the CAIGG and ensure that it is informed of all areas of risk in each institution and the actions being taken to mitigate those risks. Nevertheless current work on internal control and audit i s based on Presidential decrees, which despite their importance do not have the force of law and can be readily changed or dropped. Consideration should be given to developing a law on internal control and audit, as applies to other components of the public financial management system. For example internal audit i s covered in Organic Law on municipalities. 5.53. The CAIGG is composed of a Council, Technical Committee and Executive Secretariat. The Council consists of a group of nine high-level public officials chaired by the Budget Director, plus the Executive Secretary. The Technical Committee i s made up of the ministerial internal auditors from each of the 13 sectoral ministries and i s chaired by the CAIGG Executive Secretary. The CAIGG has a staff of 15, mainly specialists in management, auditing and law. The Executive Secretary's position i s now entitled "Auditor-General," reflecting an envisaged strong coordination and policy role for CAIGG. 5.54. The CAIGG acts as advisor to the President on establishing mechanismsthat will identify and detect possible weakness in the government control function. It undertakes work in three main areas: audit, transparency and probity. (Inthe latter area monitoring compliance with the Integrity Law, identifying ways to recognize infractions early, and providing training on the Integrity Law have been important activities.) I t i s responsible for preparing the overall General Internal Control Plan for the central government as well as providing the President with information on all of the Annual Internal Audit Plans for the government sectors and priorities selected for each period (see discussion below on internal audit objectives for 2004-2005). 51InternalControl: Providinga Foundation for Accountability in Government. INTOSAI. 2001, 52 Supreme Decree No 12, 1997 Chile Country FinancialAccountabilityAssessment 5.55. The CAIGG is also responsible for technical advice on internal control. It issues technical bulletins on the development and maintenance of the internal control system, of which 19 have been issued to date and together with seven reference documents are available on the website (www.caigg.gov.cl). Although it i s also responsible for ensuring that adequate training is being provided for all internal audit staff, the budgetary responsibility for training has beenpassedto the Service or Ministry. 5.56. Ministerial internal auditors are professionals assigned to provide advice to the ministers in areas of internal control and audit and to coordinate the application of the government internal audit policy in all services and organizations in the Minister's portfolio. They are appointed by the Minister and report directly to the Sub secretary, preside over the Ministry Audit Committee, and are a member of the CAIGG Technical Committee. 5.57. Each of the 190 services (ministry, public enterprise or service) has an internal audit unit with a broad audit mandate to evaluate the level of economy, efficiency and effectiveness of institutional resource management and the achievement of the institution's objectives. The actual work undertaken depends on areas of risk identified within the service, but may include compliance auditing, review of systems and performance auditing. There are approximately 570 internal auditors in the central government. They maintain an adequate level of independence with respect to the development of systems and procedures subject to their audit. The head of each unit is appointed by the Head of Service. Most Internal Audit Units report to both the Ministerial Auditor and the Head of Service on a monthly basis. The CAIGG also receives copies of all internal audit reports, as part of its monitoringrole. Audit Objectives 5.58. The President has issued two Government Audit Objectives for 2004-2005 for the entire central government: all internal audit activities should be geared towards ensuring public control over the probity of expenditures, procurement and staff operations; and secondly to carry out all audits that ministers or heads of Service request. These objectives are established on the advice of CAIGG which also monitors their implementation. 5.59. The Ministry Audit Objectives are issued annually by the Minister on the advice of the ministerial internal auditor, and aim to strengthen the performance of the sectoral ministry while providingincentives for adherence to the General Internal Control Planfor the central government. Some ministries may be focused on determining risk in operational systems, others on specific expenditures such as procurement or transfers, and others on preventive systems or improving efficiency. An example of the Ministry Audit Objectives was the Ministry of Health's decision to audit in 2004 the operations of all the pharmacy units-their organization, procurement processes and controls, inventories and dispensingprocesses. 5.60. The Institutional Audit Objectives are issued by the Heads of Service andor enterprise management to meet the specific control requirements of the institution. Each Chile CountryFinancial Accountability Assessment 58 internal audit entity has an annual audit work plan and some have multi-year audit work plans. Although the specific objectives vary from entity to entity, the overall objective of the internal audit unit of INDAP was common to most of the units interviewed: "The work of the Internal Audit Unit has a preventive character and its objective i s to add value to what the entity (Service) does, collaborating with the Administration in achieving its objectives within a systemic focus and discipline in order to improve the effectiveness of the managementprocesses". 5.61. The three levels of internal audit objectives clearly must articulate with each other and be mutually consistent. Ministerial internal audit advisors have a key role in ensuring appropriate linkage between the plans of internal audit units, the overall needs of the ministry and linkage with overall government audit objectives. The process of setting the three levels of objectives thus involves both a "top-down" and a "bottom-upy' approach. InternalAudit Operations 5.62. Compliance with IIA Performance Standard 2000: Managing the Internal Audit Activity, was generally found during the interviews by the CFAA team. Although the process varies from ministry to ministry, once the President (through the CAIGG), the Ministers and the Heads of Service issue their audit objectives for the period, the Internal Audit Units prepare their annual work plan based on a risk analysis, using the COS0 methodology. In some cases, the proposed plan i s approved first by the Head of Service, while in others, it may go to the Audit Committee or Ministerial Auditor. The Ministerial Auditor, as a member of the CAIGG Technical Committee, provides the information on the internal audit activity. Generally the audit resources are appropriate, sufficient, and effectively deployed to achieve the annual plan. Each unit has manuals on policies and proceduresas required by law. 5.63. The size of the Internal Audit Unit varies from service to service. INDAP has nine professionals in Santiago and two in each of the six most important regions. However the Eastern Metropolitan Health Service has only one auditor for seven hospitals. CORFU has 10 staff professionals, 10 auditors from a private audit firm that are assignedto CORFU full-time, and an additional contract with a private auditing firm for the equivalent of a further two to three audit staff. 5.64. The internal audit activity appears to assist the organization in maintaining effective controls by evaluating their effectiveness and efficiency and by promoting continuous improvement as stipulated in the IIA standards. The 2003 work plans include a range of issues reflecting the broad scope of internal audit work-legality of administrative acts, administrative and control weaknesses, ways to improve client service, procurement policies and procedures, verification of Ethic Committees and their relationships with government officials, verification of debt at December 31,2003 and always, the follow-up of recommendations from previous audits. 5.65. The relationship between the InternalAudit Units,Ministerial Auditors and CGR varies from formal to close depending on the service and the number of audits carried out Chile Country Financial Accountability Assessment 59 by the CGR in the institution, Le. since the scope of substantive testing i s based on the compliance and internal control quality in an audit. In entities such as the Ministry of Education, where CGR auditors maintain a full-time physical presence, there is a greater degree of informality. CGR has full access to and uses internal audit reports where appropriate. The CGR has also provided technical training and provided speakers to many of the units.All CGR audit reports are sent to the Ministerial InternalAuditor. 5.66. The CAIGG's assessment is that the quality of internal audit work has improved greatly over the last two years. However, it considersit too early tojudge whether impact i s increasingat the same rate. Lack of staff numbersin some services i s a limitingfactor, but this can only be addressedthrough increasedfunding for internalaudit units.CAIGG i s also concernedabout lack of funds for external training, the need to ensure that internal auditors are sufficientlyindependent of their own organization (for example, their role in validating the achievements under Management Improvement Programs on which salary bonuseswithin their organization occur may put themunder undesirablepressure), and the needto create a career service with staff mobility across internal audit units. 5.67. On this latter issue, there is now some discussion as to whether internal audit staff might be part of the MOF, rather than formally attached to their respective services. The present Chilean arrangements have the advantage of firmly anchoring internal audit as a tool of agency management, which is consistent with current corporate governance concepts. Pertinent to this is the use of an Audit Committees or similar body to ensurethe impact of internal audit work within the agency. At the same time in Chile, the existence of Ministerial Internal Auditors and the CAIGG, and the setting of internal audit objectives at three levels, provides some central overview of this work, to ensure its quality and relevance to the government overall. Thus the present arrangements appear to combine the best features of both a centralized and decentralized system, although CAIGG's concerns mentioned above should be addressed. EXTERNAL CONTROL Audit MandateandRole:FunctionalIndependence 5.68. The CGR was founded in 1927 as a co-equal branch of government and its functions are established in the Chilean Constitution. The Office of the Comptroller General performs its functions autonomously, but it does not have independent legal status and acts under the Treasury's legal mandate. Given the constitutional status of the CGR, the rules governing its organization and functioning have the rank of constitutional statutes. Its charter (Law 10.336), and subsequent amendments, set out the objective and organization of the Office, its staffing structure, specific regulations on collection and payment of public funds, the responsibilities of staff, guarantees on fulfillment of duties and obligations, scrutiny and audit of public accounts, investigations and enquiries. The CGR is headed by the Comptroller General who i s nominated by the President of the Republic, and approved by the Senate. The Comptroller General does not have a fixed term of appointment, although he or she currently mustretire at 75 years of age. Chile Country Financial AccountabilityAssessment 60 5.69. The CGR is functionally independent of both the executive and the legislature. It determines what it examines, and how and when it carries out such examinations. Its audit coverage is extensive and includes the revenue and investment of public funds, some 190 central government service agencies, 24 public enterprises, eight mixed ownership companies, some 340 municipalities, the public universities, concessions grantedby the Government to agenciesfor the exploitation of public resources, as well as the powers to examine the use made of public monies by non-government organizations and private companies. It does not audit the Central Bank, the Banco del Estado or have mandate to review CODELCO, the National Television Corporation or the State Railway Company. The CGR review the operations of the military equipment purchases but cannot report publicly on its findings. Itundertakes audits of loans and grants provided to Chile by international banks and donor agencies. It has extensive powers to obtain the releaseof documents and other informationif auditees are reluctant to release suchdata. 5.70. Inaddition, the Comptroller General hasextensive managerialpowers including the powers: to select a deputy or Subcomptroller; to recruit, promote and dismiss staff; and to set salary levels and other terms of employment. Both the two top positions at the CGR must be occupied by lawyers. The Comptroller General and Sub comptroller have the prerogatives and legal protection enjoyed by HighCourt Judges. 5.71. Annually, the Comptroller General must provide a report on the budget and a report on the activities of the CGR to the President and both houses of Congress. Heads of regional offices of the CGR must produce a similar report on their operations for the regional governments The Comptroller General may also releaseother reports as he sees . fit bringingthemto the attention of Congress, the mediaor the generalpublic. 5.72. The CGR's budget i s negotiated with the Ministry of Finance, who present it to Congress as part of the national budget for central government. Congress may propose budget cuts but not increases. This entails a conflict of interest, and the Supreme Audit Institution i s not independent as prescribed by INTOSAI principles. There is therefore scope for Chile to look at how other INTOSAI member countries finance their Supreme Audit Institutions in order to foster their financial independence. . However, changes to the current CGR budget process would have a high probability of Constitutional implications and therefore be difficult to implement. The Chilean authorities should therefore consider a solution that complies with international practice while also taking into account of country constraints. Functions of the CGR 5.73. In 2003, the CGR reviewed 177,804 administrative acts through the Toma de Razon function, and issued 20,012 legal opinions and instructions. CGR inspections and audits implied visits to 1,288 different organizations and gave rise to 6,373 audit and inspection reports, of which 2,731 related to regular audits, and 3,642 were specially requested. Inaddition, during this period, the CGR processed41,139 accounting reports, issued 589 accounting instructions andresponded to 408 inquiries. Chile CountrvFinancialAccountabilitvAssessment 61 5.74. Its ex-post audit activities are mainly connected with reviewing the financial accounts of audited bodies and the adequacy of internal controls. It also carries out reviews of IT systems. It has no statutory requirement to, nor does it, undertake performance audits or value for money studies, though equally it i s not precluded from examining and reporting on efficiency and effectiveness issues as an adjunct to its financial audits or as self-initiated special investigations. It has always performed the external review of investment projects under terms of reference agreed with the IDB and the WB. This review is regularly reviewed by the Banks and i s considered of high quality. 5.75. As noted above, 3,642 different engagementswere requestedin 2003, this is 911 more than the audit engagements. In 2003, approximately, 10 percent of the requests originated with Congress, where they arise during debate, 30 percent of the requests come from the executive, 40 percent from private parties and 20 percent from within the services agencies. In 2003 for example, inspections were requestedby Congress on the use of fiduciary funds for equipment purchases by the National Firefighters Corps, inspections also covered: advances for works to the University of Chile, the cash managementoperations of NationalPetroleum Company and the training contracts inthe Post Office. CGR ModernizationPlans 5.76. The Division de la Vivienda y Urbanism0 y Obras Piiblicas y Transportes of the CGR in February 2000 produced a report summarizing key findings emerging from its audit of public works concessions. The CGR could usefully produce more such reports identifying common themes and lessons which emerge from its financial and regularity audits. For example, are there common themes emerging in commissioning, developing and introducing new hardware and software initiatives which could be extracted from a range of different audits and disseminated to all government entities. The impact of this work could be further enhancedby giving more attention to presenting such information to Congress and Ministries in accessible formats and through varied media, including special conferences, and short-targeted publications or checklists. There is scope for the CGR to validate performance information reported to the Government or add further value by carrying out audits to test, for example, the robustness of the systems providing such data. Furthermore, as the lead auditor of municipalities, the CGR could do more to produce and analyze comparative data on the relative performance of municipalities across the country. CGR Organization,Managementand Resources Peer Review 5.77. The CGR is required by its own organic law to report annually to the President and Congress on its performance in the annual Public Account (Cuentu Pu'blicu) wherein he details principle activities, major issues on the application of the administrative laws, and other issues on control reported at the discretion of the Auditor General. However, it i s not routinely subjected to external audit or review. While this guarantees its ChileCountrv Financial Accountability Assessment 62 independence, it also means that the CGR is not formally and regularly placed in a position whereby it has to justify itself and demonstrate its contribution to the Chilean people. Many SAIs elsewhere are subjected to regular external audit andor periodic peer reviews. The CGR may needto consider whether such an approach i s meritedinChile. The CGR is one of the few audit institutions inthe regionto have createdits own internal audit function. The impact of the internal auditors work and its independence could be enhancedby adopting good corporate governance practices whereby internal audit units report to an audit committee, which itself reports directly to the Comptroller General. Management 5.78. The CGR has an annual budget of some US$22 million. It employs some 1,400 staff across its central office and 12 regional offices. Of these, some 400 are professional auditors, just over half of whom are based in Santiago. Other staff are involved in legal work and general administrative functions. The CGR also employs engineers, quantity surveyors and other experts to assist with the monitoringof major public works projects. 5.79. The CGR's ex-post financial audit function is carried out by three major divisions in Santiago, and the 12 regional offices. The Central Division of Administrative Audit plans and executes, with assistance from the regional offices, financial audits of the central government Ministries and associated entities. The Division de la Vivienda y Urbanism0 y Obrus PLibZicas y Transportes (VUOPT) audits major public works across different ministries and services, and the Municipalities Division audits the 52 Municipalities in the Santiago region, as well as setting overall policy for the audits of municipalities carried out by the Regional Offices. 5.80. While there i s scope for improvements inthe way the way the CGR captures and uses internal management data, the organization has a solid foundation for an integrated computerized management information system. It routinely and systematically collects data on the use of staff time on different audits and can compare planned and actual activities and the cost of audit. Human Resources 5.81. The CGR is an attractive environment inwhich to work and there is no difficulty recruiting staff. Most of the audit professionals have university qualifications, mainly in accounting, audit or business and CGR staff are heavily involved in lecturing on such courses. Once staffjoin the CGR they are providedwith a three-month inductionprogram and then regular opportunities for continuous professional development. The CGR has made a firm commitment to providing staff with professional development and training opportunities and staff are expected to undertake some 40 hours of training each year. However, meeting this expectation i s not embedded in CGR staff management systems and has no direct link to achieving annual bonuses or promotion. As part of the modernization project, plans are underway to review the CGR's training needs and its general approach to training. This exercise will enable the CGR to seek feedback from Chile Country Financial AccountabilityAssessment clients on the extent to which CGR staff skills are perceived to be adequate and to check that staff have the skills neededto rigorously audit accrual accounts. 5.82. Wages are above the average for other civil servants and there i s little turnover. Furthermore, pensions are low and people do not retire early. The average age of staff in the CGR i s 45 and the oldest staff member 77. While providing a valuable pool of expertise, this situation provides few opportunities to bringin and promote younger staff and makes it difficult to dislodge under-performing staff. As part of the modernization project, the CGR is seeking ways of helping staff over 60 to retire. It i s trying also to maintain the skills and enthusiasm of staff by starting to rotate staff between audit areas. This needs to be more vigorously pursued, and monitored. The CGR might wish to consider introducing a formal limit to the number of years any auditor can spend on any one account. Another way movement could be encouraged, and the CGR skill base enhanced, might be through a formal program of secondment to private, public, NGO or international agencies. The CGR might like to consider linking promotion to having undertaken aperiod on external secondment. 5.83. The CGR has the powers to hire consultant specialists and to contract out audits and has indicated in its Doctrina Institutional that it wishes to use such measures. Both offer ways in which the skill base of the CGR can be enriched. Hiring consultants can bringspecialist skills to bearon particular audits, while contracting out audits provides an opportunity for an organization to compare its own procedures with those of the private sector. However, neither of these options has yet beenusedby the CGR. Audit Process Audit Methodology 5.84. Building on the INTOSAI Auditing Standards, the CGR has developed an extensive range of audit manuals and guidance materials which are being progressively updated. It is inthe processof creating an audit methodology team with responsibility for co-coordinating audit methodology across the organization and for providing specific technical advice to auditors. It has a five stage audit review program to ensure the integrity of audits. However, no part of the organization i s charged with overall audit quality control. The CGR may wish to consider attaching this function to the audit methodology unit with a view to reviewing on a rolling basis, a sample of audits across the different divisions and regions, assessing overall quality and identifying lessons which need to be applied more generally. There i s substantial expertise across the SA1 community internationally in developing and running such audit quality review teams which the CGR couldusefully harvest. 5.85. The modernization programmed is seeking to substantially increase IT capacity throughout the CGR. Increasingly staff will be provided with laptops and will be able to operate away from their offices on the premises of clients and elsewhere. This process provides an opportunity to substantially improve the quality and reliability of audits by obtaining appropriate audit software and standardizing many of the audit practices. Chile Country FinancialAccountability Assessment 64 Commercial packagesexist which facilitate this move and, by allowing audit managersto access the work of auditors at a distance makequality controleasier. 5.86. As part of the modernization project, the CGR should verify that clients are satisfied with the timeliness of audit reports, the appropriateness of recommendations and the quality of the audit work. IncreasingImpact PerformanceIndicators 5.87. For its financial audit activities, the CGR currently records its impacts in terms of the number and types of weaknesses encountered, the number and types of legal proceedings, and the sums recovered. In line with other public sector organizations in Chile, the CGR is currently exploring ways of introducing performance indicators which better monitor the impact of its work. Again the CGR could profitably examine the types of measures in use elsewhere in the SA1 community, including measures of financial savings, as well as other quantitative and qualitative impacts. One issue which would facilitate such impact monitoring would be moving from commenting in management letters on what was not working well to making specific recommendation on the improvements or changes which are needed. A greater focus on the impacts would also put pressure on the CGR to develop more robust arrangements for following up past recommendations to ensure that they have been implemented and are achieving the desired improvements. Public Reaorting 5.88. The CGR produces a wide range of documents, from management letters to reports summarizing achievements. These documents are one of the major windows through which Government, Congress and the general populace view the CGR. However, they are not user-friendly and do not market the CGR well. Regardless of how good the contents of the reports are, if they do not look good they are not likely to be read widely. The CGR needs to establish a modern publishingcapability to ensure that all its products carry a common house style and gain a reputation for brevity, clarity, accessibility and overall quality. Chile Country Financial Accountability Assessment 65 ANNEX3: BUDGETTABLES Table1.2.2. RevenueProjections,2004. Variation 2004l2003 Millons of % of GDP From Budget Law From September Pesos 2003 2003 Projections CURRENTREVENUE 1.307.068 21,3 2,0% 4,9% Operatingrevenue 699.625 1,3 -1,2% - 3,9% Socialcontributions 817.476 1,5 11,0% 11,0% Net tax revenue 8.899.209 16,8 4,2% 6,4% Net copper revenue 496.723 0 3 10,0% 67,6% Transfers 38.932 0,6 -57,9% -59.84% Other revenue 326.644 0,1 -38,1% -36,8% Operatingrevenue(Previous years) 28.458 090 1,3% -27,7% CAPITAL REVENUE 177.480 0 3 -13,8% -21,3% Sale of assetts 25.926 0,o -16,6 % -9,4 % Loanredemption 151.554 0 3 -13,4 % -23,O % TOTAL REVENUE 1.484.548 2 6 1,7 % 4,4 % Source: Budget Office. Table1.2.3. Leveland Compositionof Expenditures,2004. Millonsof ..:I,____ - r Variation 2004/2003 1 Pesos resos % of GDP Projections From 2003 2004 CURRENT EXPENDITURES 9.872.330 18,6 4,2% Operatingexpenses 2.970.096 5,6 -1,3% CAPITAL EXPENDITURES 2.044.248 3,8 4,6% Investment capitaltransfers + 1.847.974 3,5 6,2% (TOTAL DE GASTOS 11.916.579 22,4 4,3% EXPENDITURESWITH MACROECONOMIC EFFECTS 11.013.451 20,7 4,0% ISource: BudgetOffice. I ChileCountrv Financial Accountability Assessment 66 Table 1.2.4. CentralGovernmentBalance,1997-2004. (% of GDP) 1997 1998 1999 2000 2001 2002 2003 2004 Actual central governmentbalanceon cash basis 1,8 0,4 -1,4 0,1 -0,3 -0,8 -0,8 0 8 Actual central governmentbalanceon accrual basis 2 8 0 4 -2,3 -0,7 -0,5 -1,3 -0,6 -0,l Total cyclicaleffecton revenues 0,8 -0,3 -1,4 -0,8 -15 -2 -1,4 -1,l Cyclicaleffect of tax revenues and social security contributions 0 3 0,4 -0,5 -0,4 -03 -1,0 -0,9 -0,8 Cyclical effect of copper 0 2 -0,7 -0,9 -0,4 -1,o -1,0 -0,5 -0,2 Centralgovernmentstructuralbalanceon accrualbasis 1 2 0,7 -0,7 or1 170 098 038 190 Budget Unit Modified Budget Expenditure Percentage of Total Execution of Budget Officeof the President 7,400.50 7,305.30 0.06 98.71 National Congress 50,607.60 50,326.20 0.43 99.44 Judiciary 141,992.40 126,798.40 1.10 89.30 IOffice of the Comptroller 27,220.70 21,384.90 0.18 78.56 Ministry of the Interior I 390,370.10 I 345,706.90 I2.99 I 88.56 I Ministry of Foreign Affairs 25,468.50 23,852.90 0.21 93.66 Ministry of Economy, DevelopmentAnd Reconstruction 834,635.60 629,801.80 ' 5.44 75.46 Ministryof Finance 178,028.70 169,677.80 1.47 95.31 Ministry of Education 1,985,430.90 1,937,884.00 16.74 97.61 Source: CGRAnnual FinancialReport Chile Country FinancialAccountability Assessment 67 ANNEX4: SIGFECOVERAGE SIGFE COVERAGE (By March 2005) I ITEMS I Mar-05I TOTAL ENTITIES 390 IA)WITH SIGFE AGREEMENT II371 I A1 ) WITH IMPLEMENTATIONPROTOCOL 1 In ProductionEnvironment .- II 339 II 299 1.1 In production 92 1.2 Working in parallelwith prior system 207 2.- InTesting Environment 8 3.- Without SIGFE baseline, in Set up stage (Financialand IT1 31 4.- Processesunder review I l l ~5.- ImplementationProtocol Signed 0 A2 ) AWAITING HOMOLOGATIONAGREEMENT 32 B ) WITHOUT SIGFE AGREEMENT YET: 19 IM05 (Implementation2005) Protocol is Projected to be signed in 2005 MAP SECTION