Report No. 28990-GZ West Bank and Gaza Country Financial Accountability Assessment June 2004 West Bank and Gaza (MNCA4) Operational Core Services Unit (MNACS) Middle East and North Africa Region Document of the World Bank CONTENTS INTRODUCTION 1 EXECUTIVE SUMMARY 1 1. BACKGROUND 7 2. SUMMARY OF RECENTPFMREFORMS 7 3. DONORSAND THE PA 8 4. AID MANAGEMENT 9 5. THE WORLD BANI While changes in the legislative framework are an intermediate rather than an immediate priority, deficiencies in the regulatory framework, particularly in accounting provisions, are reflected in various failings in the operation of the accounting system- as discussed later. However, most o f these steps can be taken inadvance o fany changes inthe legal framework. P The development o f an accounting manual, to amplify aspects o f the Financial Directives andprovide guidance to accounting staff is a particular priority. 8. BUDGET CONSTRUCTION 38. Chapter 3 of the Organic Budget law sets out detailed and appropriate procedures for Budget construction. The budget includes all PA ministries and agencies in addition to public institutions such as the Palestine Water Authority, Palestine News Agency, National Radio and Television, Tobacco Authority, Environment Authority, Palestine Such a review would assist inproviding more complete financial regulations and in developing a separate government accounting manual. These would provide a basis for training o f staff, and a permanent source o f guidance. 16 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - Information Center, Civil Aviation Authority, and Ports Authority. Their expenditures are covered bybudget appropriations and their revenues are paidinto the CTA. 39. The following table summarizes the 2004 Budget. PalestinianAuthority Summaryofthe 2004 BudgetProposal (in millionsofUS dollars) - 2004 Budget Revenue 806 Domestic 298 Taxes collected by Israel on behalf of the PA 508 Total expenditures 1694 Current expenditure 1444 Development expenditures 250 Balance -888 Financing 888 External budgetary financing 900 Financingto cover recurrent expenditures 650 Financing to cover development expenditures 250 Funds releasedby Israel from stock o f frozen tax revenue 180 Expenditure arrears (net accumulation) -180 Gross arrears accumulation 0 Gross arrears repayment -180 Domestic bank financing -12 Domestic bank borrowing 0 Domestic bank repayment -12 Financinsgap 0 (Source: Ministry of Finance) 40. The budget circular must be issued to line ministries and agencies by 1 July (Article 26 o f the Organic Budget Law). The budget circular contains indicative figures developed by the Budget Department o f MOF. Ministries and agencies have one month to respond. Duringthis period line ministries and MOF engage in detailed discussions o f ministries'needs andtheir cost. 41. Under the Organic Budget Law the proposedbudget should be submittedby MOF to the Council o f Ministers (Cabinet) by 15 October. In turn, Cabinet is required to present the budget to the PLC by 1November, to be passed before the commencement o f the Fiscal Year on January 1. This timetable does not provide much time for serious consideration by Cabinet or PLC, but this may reflect the budget's role as a purely financial document, focusing on the expenditure side as a detailed costing o f inputs, rather than a policy document explicitly focusing on the PA's economic and social priorities (see discussion below inparagraph 53 and following paragraphs). 17 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - 42. Article 37 of the Organic Budget law provides for a budget contingency allowance, or reserve - controlled by the Minister o f Finance subject to the approval o f the Council of Ministers, and intended for emergency expenditures or expenditures unforeseen at the time when the budget was prepared. The amount allocated in the 2003 budget was relatively small - only US$10 million. This item does not appear to have been accounted for in the recently published 2002 financial statements. The amount allocated in the 2004 budget to the reserve is US$63 million. At about 3 percent o f the total budget this i s highby international standards, which makes it particularly important that the use o f the reserve is reported in the budget execution reports, and eventually in the audited financial statements for 2004, so that it does not become a source of significant non-transparent expenditure. 43. Budget allocations are an authority to make payments i.e. the budget is cash based. There is no formal system o f commitment control, an issue which MOF will need to consider as it further improves the PFM system. The Organic Budget Law (Article 50) provides that spending units may not reallocate from one o f the 11 predefined expenditure chapters to another". Each chapter has sub-items, and spending units may transfer between these items with the approval o f MOF. 44. The budget document (the Annual Budget Law) for 2004 is a comprehensive document, consisting o f some 300 pages o f revenue and expenditure tables, figures and narrative explanation. information i s provided for each spending unit on actual expenditure in 2002, the 2003 budget allocation, a "best estimate" o f actual expenditure in 2003, and the 2004 budget allocation. Expenditure is broken down into expenditure chapters. Actual revenues by item are provided for 2002 and 2003. Although this i s a public document (published inArabic), only 400 copies were printedand it is not posted on the web. 45. The Minister's budget speech and a budget summary document are published in Englishon the MOF website". The budget summary does not, however, provide details of individual revenue and expenditureitems, and could usefully be expanded. 46. In pre-2003 budgets, many of the requirements of the Organic Budget Law concerning the submission and processing o f the budget were not observed. For those budgets, MOF prepared an "emergency budget", which did not require approval o f and was little discussed by the PLC. These budgets were not perceived as realistic expressions o f likely funding, or as constraining ministry or agency operations. 47. The 2003 budgetwas the first serious attempt to observe the Law's requirements, and was the first budget formally presentedto the PLC and published. The 2003 budget exercise was characterized by good dialogue between MOF and spending ministries on the level o f the proposed allocations, and by orderly processes govemed by the budget lo The eleven expenditure chapters (each of which has sub-items) are: salaries and wages, operating expenditures, transfers, studies and plans, equipment, vehicles, landpurchase, buildings purchase, buildings construction and furniture and fixtures. ......~.:~~~.w..~.,..m~?:~~)~~~~.~!~ tJ 18 WEST BANKAND GAZA COUNTRYFINANCIAL - ACCOUNTABILITY ASSESSMENT timetable. This encouraging trend was continued under the 2004 budget exercise, which was conclude when the PLC approved the budget inJanuary 2004. 48. The 2003 and 2004 budget documents were prepared on the basis o f careful macroeconomic analysis. For the 2004 budget this was carried out jointly with the Palestine Central Bureau o f Statistics (PCBS), the Bank and the IMF, and has led to one common set o f macro-planning indicators. The 2004 budget document offers three macroeconomic scenarios (based on political developments), anddiscussed exchange rate assumptions and monetary statistics and provides information on public debt. Budget transparency i s further enhanced by a comparison of actual budget performance in 2002 and 2003 with the budget as formally passed by the PLC. It indicates proposed financing transactions, including borrowing from the banking system. It also includes comprehensive data on authorized civil service employment, and sets a legal limit on civil service employment growth. 49. Revenue estimation i s inherently difficult, given uncertainties about the continuation o f closures and their economic impact, likely levels o f donor financing and the stability o f the transfers of customs and VAT revenues by Israel. There i s thus a need to develop several annual planning scenarios, and this was done for both the 2003 and 2004 budgets. 50. The allocation for the President's Office has traditionally been an area characterized by little transparency. The 2004 Budget represented a significant improvement compared to earlier years. Notably, the large discretionary transfer appropriation for the President's Office was been virtually eliminated (from US$49.75 million in 2003) to US$0.62 million in the 2004 Budget. These funds were instead allocated to relevant service ministries (Health, Education and Social Affairs). However, at US$33 million in 2004, the operating cost budget o f the President's Office remains large. N o breakdown of these operating expenditures is provided, as is done for other ministries. A more detailed disclosure o f the breakdown o f these operating expenditures on the same basis as for other spendingunits i s therefore needed. 51. Discussions with the security services, which account for around 25 percent o f the total budget l2 take place at an aggregate level. The depth o f these discussions i s questionable, despite efforts by the MOF Budget Department. There is also a lack of transparency in that as with the President's Office (see paragraph 50 above) the budget provides no detailed breakdown o f the operating costs devoted to the various security services (US$35.7 million in the 2004 Budget). The standard level o f detail should also beprovidedfor these operating costs. 52. Inmid-2003 anew MinistryofPlanningwas created. Coordination with MOFhas improved markedly. While MOP i s responsible for aid coordination and capital planning, the Minister o f Finance now has the sole authority to conclude loan and financial support *'Thiscovers the eight separate security services, which either come under the Ministry of the Interior or report direct to the President. 19 WEST BANK AND GAZA COUNTRY FINANCIALACCOUNTABILITY ASSESSMENT - agreements with donors, and with the exception o f activities o f the Islamic Development Bank and the Saudi government. 53. There are two major weaknesses inbudget construction - The budget dialogue between M O F and line ministries appears to be almost entirely about costing o f necessary inputs (salaries, travel, transfers etc) with no explicit focus on performance or prioritization. - Most donor funding is still excluded, making it difficult to properly determine priorities and to integrate capital or developmental expenditures with recurrent expenditures into the budget. 54. Building on the solid dialogue between MOF and line ministries during the preparation o f both the 2003 and 2004 budgets, attempts should be made inthe future to deepen these discussions. Inparticular, more emphasis should be placed on performance and on prioritization, as opposed to exclusively focusing on the costing o f necessary inputs (salaries, travel, transfers etc). A discussion ofpriorities has generally beenlimited to a guiding policy that expenditures on health, education and the judicial system are to have priority -which inpractice applies mainly to new staff recruitment. 55. On the issue o f prioritization in the context o f the 2003 budget, a one-year emergency plan was developed by MOP, which arguably represented the first realistic plan to provide some basis for expenditure prioritization. It was supplemented in mid- 2003 by MOP'S Quick Impact Intervention Program (QIIP), a creditable effort to focus donors on an updated set o f needs/opportunities arising in the context o f Roadmap implementation. 56. Inthe fall of 2003 work on a two-year emergency plan was undertaken (under a credible joint exercise headed by the Ministry o f Planning, partnered by M O F and the Ministry o f National Economy and involving discussions with all line ministries and agencies) to develop a more comprehensive Socio-Economic Stabilization Plan 2004-5 (SESP) which dovetailed with the 2004 budget and included capital expenditures for local government. The SESP prioritizes donor financing among four broad categories, namelyinvestment projects, humanitarian assistance,job creation andbudget support. 57. This provides the opportunity for a move to a strategy and performance-based approach to the budget. The execution o f the SESP should form an important criterion in the 2005 Budget discussions, as should the proposedthree-year Medium Term Planbeing developed under MOP'S leadership. 58. The past exclusion o f donor funding from the budget has meant that P A Budgets have contained no information on capital or project expenditures financed by donors, and that the budget has not itself financed any capital expenditures - all public investmentwas previously financed by donors. For the first time, the 2003 budget included a projection of the capital expenditures likely to be financed by donors, a total o f US$212 million in project assistance from donors now using sub-accounts within the CTA (e.g. EU, World Bank and Norway) - as well as including a small PA contribution to capital expenditures 20 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - of US$27 million. The 2004 budget represents a much more careful attempt to calculate likely needed development expenditures (totaling US$250 million by all donors and a further US$40 million to be financed by the PA). 59. The fact that a significant share o f donor funding is provided outside the CTA without the PA having adequate information on this further complicates priority-setting, and hampers the integration of capital expenditures with recurrent expenditures in the budget. 60. For the PA to prioritize development and emergencyexpendituresthe following is required: - A well-formulated and articulatedPA development andemergency reliefstrategy. - Coordination among donors and between donors and the PA, to ensure that collectively their expenditures address the key development and relief needs o f the Palestinianpopulation ina coherent manner. - A system under which the PA (MOP and MOF) has full information about donor activity. 61. The formulation of the SESP was in important first step. Going forward, both donors and the PA need to build upon the experience to improve coordination and increase information flows. 62. Two important players were not hlly integrated into the SESP. The first i s the large NGO community that directly provides services to a considerable number o f the Palestinian population. The second i s UNRWA (United Nations Relief and Works Agency), which operates basic services inthe refugee camps andprovides direct financial assistance to registered refugees. 63. Information on donor funding i s available to MOF to the extent that it i s channeled through CTA. As mentioned above inparagraph 13 use by donors o f the CTA does not necessarily imply co-mingling o f funds with the PA budget. Rather it provides information that the PA can use indeveloping its own budget priorities. To overcome the problem o f lack o f information on donor activities, M O F requested information from all 47 donors with a view to establishing a database to be used in the development o f the 2004 budget. However, only about half the donors replied and not all o f those replying provided adequate information. This was a predictable reaction, based on past history. Currently MOP i s engaging the donors in another data-gathering exercise. This i s a well- designed effort and should be given prominence by the PA and the Local Aid Coordination Committee (LACC) co-chairs. MOP i s staffing up to conduct quarterly surveys, andwill beprovided with LACC Secretariat support. 64. This data base should allow MOP to better consider issues of prioritization, permit donors to review expenditures priorities, and assist MOF.inintegrating capital and project expenditures into the budgethdentifying the recurrent cost implications o f donor activities. 21 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - SUMMARY 0 The 2003 and 2004 budget documentation and processes represent a considerable advance over previous budgets. A serious effort was made to develop a comprehensive and realistic budget, notwithstanding the current difficulties inP A revenue estimation and the uncertainty concerning budget support from donors. 0 The budget includes only a small portion o f total capital or investment spending, reflecting the exclusion o f donor financing. 0 In2004, a first substantive effort was made to integrate the recurrent and capital budgets, though work i s still needed to factor inthe recurrent cost implications o f donor investments. 0 The budget construction exercise i s primarily a detailed costing o f inputs rather than an explicit attempt to prioritize expenditures, based on their relative contribution to government objectives DESIRABLEFURTHER ACTIONS > Donors should supply full information on their programs to MOP under the new data collection exercise. > Donors should channel their funds through the CTA, unless prevented by their own legal requirements. As part of this issue PECDAR payments, should also be made through the CTA, subject to the agreement o f relevant donors (see paragraph 14 above). > Future budgets should aim at the full integration o f donor funding and should fully factor inrecurrent cost implications o f capital or investment expenditures. > The budget should develop a greater performance focus, with a gradual move to performance budgeting, beginning with the development o f ministry programs and activities and their incorporation into the classification system, and subsequently moves to develop a system o f performance indicators to inform budget preparation and implementation. > The use o f the large contingency reserve in the 2004 budget should be carefully monitored and full details o f its use reported in budget execution reports and the P A 2004 aggregate financial statements, so that it does not become a source o f significant non-transparent expenditure. > The budget should provide a breakdown o f operating expenditures o f the President's office and the Security Services in the same way as for other spending units. 22 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - > The amount o f budget information provided on the MOF website should be increased. 9. CENTRAL TREASURY ACCOUNT CASH MANAGEMENT AND - BUDGET EXECUTION 65. As mentioned earlier in this report (paragraph 22) all PA revenues are now channeled through the CTA and a separate M O F unit has been set up to monitor the receipt o f these revenues. IMF monitoring and a review by the CFAA team confirm that clearance revenues from Israel, receipts o f individual spending units, profits from PA commercial undertakings and budget support provided by donors are being paid into the CTA. 66. Some of the undesirable aspects of the previous cash management arrangements which have now ceasedwere as follows: - cash was held in many separate ministry and agency bank accounts, making it hard to establish the overall cashposition o fthe PA and to manage it so as to meet payment obligations and minimize borrowing requirements. Such a system ranthe risk o funnecessary borrowing andinterest payments. - multiple centers able to give spending instructions existed in MOF; in addition, letters from the President were usedto authorize specific expenditures. - lump sum cash transfers were made to ministries and agencies without specified identification o f final expenditures. - extra-budgetary expenditures were made from bank accounts controlled by spending ministries and agencies into which they paid their "own" revenues. - scarcity o f resources and lack of cash management led to payment arrears; suppliers were not paid on time; govemment payment orders were distrusted and suppliers to government therefore began to insist on prepayment incash. 67. At present the balance ofthe CTA is heldinseveral commercial bank accounts. In addition spending agencies can choose (with MOF approval) from about 15 commercial banks for the operation o f bank accounts from which their expenditures are funded. Due to the large number o f bank accounts for both revenues and expenditures, the chart o f accounts includes more than 1500 accounts and sub-accounts, including over 650 bank accounts and over 400 accounts used for advances only. 68. Steps have recently been taken to correct the problems identified inparagraph 66 above. - Spending agencies were instructed to close bank accounts used for holding their "own" revenues and banks were instructed to transfer the balances to the CTA. This hasbeen implemented. 23 WESTBANKAND GAZA COUNTRY FINANCIALACCOUNTABILITY ASSESSMENT - - Spendingagencies are now permittedto open designated bank accounts to be used only for making payments. Separate accounts were opened for the deposit o f revenues. These revenue accounts can no longer be used to make payments and are swept regularly (each week) and transferred to the CTA. - Commercial banks were instructed that loans could not be provided to spending agencies; that the bank accounts used to fund their expenditure were not to run into overdraft, and that no new bank accounts were to be opened without MOF approval. This instructionhas also been implemented. - Some expenditure payments have been centralized in MOF. As discussed below under accounting issues (paragraphs 79 and 80), MOF now makes payments on behalf o f line ministries and agencies on certain budget lines in accordance with their approved budgets.For other items it transfers monthly sums to line agencies own bank accounts for them to make payments, but again only in accordance with budget approval. 69. The resultant cash management arrangements are a considerable improvement on what went on before. There is, however, scope for further improvement. - Revenueand expenditure accounts could be swept daily rather thanweekly (with a system o f zero bank balance at the end o f each day's business), and the number of bank accounts could be further reduced. Consideration should be given in the longer term to consolidating all bank accounts into one single account, with sub- accounts as necessary - More attention should be given to regular checks between accounting records and bank statements ("bank reconciliations"), and the practice o f writing and then holding payment orders before issuingthem should be eliminated. - The practice o f borrowing from commercial banks should be brought under strict control, with the PLC involved in approving both temporary and end o f year borrowing limits and receiving reports o f actual borrowing compared with the agreed borrowing limits. Under the 2003 budget law the P A cannot now borrow from the PMA or other PA institutions. Indue course such controls on borrowing should be incorporatedinto the Organic Budget Law. 70. It is hardly surprising, given various sources o f instability, that a systematic cash forecasting system governing both cash management andbudget execution does not exist. This reflects the current abnormal, unpredictable conditions. At present, expenditure releases are determinedby two factors: available liquid funds and an assessment o f day- to-day priorities. With a return to more normal conditions, cash forecasting will be necessary as a basis for better cash management and budget execution. Indeed, such conditions would permit a more systematic approach to cash management. 24 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - 71. As explained in a recent IMF report13, financial planning is needed for both smooth budget execution and minimal borrowing costs. A cash plan should be prepared to support the orderly execution o f the budget. Such plans should be regularlyupdatedto reflect changes in key parameters. In the case o f WB&G it may not be possible to implement the budget as planned, due to revenue uncertainties. But a Cash Management Committee with representation from the Budget, Treasury and Revenue Departments of M O F could be an effective means of ensuring regular and frequent updating o f budget execution and cash management plans. SUMMARY 0 All PArevenues are now beingpaidinto the CTA. 0 Inaddition, cash management practices and budget execution arrangements have been significantly improved and strengthened. 0 Cash forecasting and management remains rudimentary,reflecting inpart current revenue unpredictability. DESIRABLE FURTHER ACTION 9 MOF should sweep all bank accounts on a daily basis, with consideration being given in the longer term to consolidating all banking arrangements into one account with sub-accounts as necessary for ministry and agency operations. 9 MOF should ensure that all ministries (MOF and line ministries) regularly carry out bank reconciliation. 9 MOF should also ensure that line ministries do not issue payment orders until funds are available. 9 A system of cash forecasting (involving a Cash Management Committee comprising different parts o f MOF) should be developed, in order to alleviate the current short-term (day by day) approach to funds release and to provide a basis for monitoring the extent to which the budget (bothrevenues and expenditures) i s on track. 9 Provisions goveming limits on borrowing from commercial banks should be incorporated into the Organic Budget Law. These provisions should include appropriate reporting on actual levels o fborrowing to PLC. l3 Fiscal Management Reform Strategy, by 0.Hovland and K.Nashashibi, September 2002. 25 WESTBANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - 10. EXPENDITUREARREARS 72. Under the 2003 and 2004 budget laws the PA cannot borrow from the PMAI4or from other PA institutions, such as PIF. In due course, such provisions concerning borrowing should be incorporated in the Organic Budget law. Expenditures arrears are monitoredby IMF as part o f its overall monitoring o f the WB&G budget implementation. 73. Debts or arrears o f expenditures exist to - private sector suppliers, estimated at US$370 million at end-2003, (equivalent to 10percent o f GDP) - commercial banks, estimated at US$193 million at end-2003 (equivalent to 5.4 percent of GDP) - other PA institutions. According to IMF figures past borrowings here include $150 million (end of 2002) in pension deductions from security personnel (10% of salaries) for a pension scheme which has not yet been established and $100 million (end o f May 2003) o f employee deductions owing to the Gaza Pension Scheme. - transfers to municipalities withheld (about $10 million), to be offset against electricity supply arrears owed to Israel by municipalities and paid by the PA. However overall the PA i s owed more than this by municipalities and i s thus a net debtor. 74. Inaddition, the two separate pension systems for West Bank (pay as you go) and Gaza (funded) are not financially sustainable in the longer term, although the Gaza scheme currently operates on a cash surplus. The West Bank scheme has been closed to new entrants andnew civil service appointeesjoin the Gaza scheme. 75. On the "credit side" Israel owes a substantial (but disputed sum) to PA for health and national insurance deductions made from Palestinian workers in Israel, dating back some years, plus withheld PA revenues currently amounting to NIS 832m (approximately US$200m), heldby Israel as a result o f legal claims against the PA by Israeli citizens. 76. The level o f these arrears is known and transparent, and i s being managed as part o f the budget process. The size o f these arrears reflects the significant fiscal problems beingfaced by the PA. 11. DEBT MANAGEMENT 77. Debt management is a responsibility of MOF. A unit responsible for a debt recording and management has been established in MOF. It uses the UNCTAD (DMFAS) debt information system, installation o f which was completed at the end of l4Nor under its legislation is the PMA permitted to lendto the PA. 26 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - 2001. Previously there was no central recording o f PA debt and debt servicing payments were not always made on time, leading at one stage to a suspension o f World Bank loan disbursements. The system i s deemed to operate satisfactorily, but an independent audit would be required to confirm this. 12. GOVERNMENT ACCOUNTING SYSTEM 78. Within a few days at the end o f each month, the PA prepares budget execution reports that provide consolidated budget revenues and expenditure o f WB&G for the month just ended. As some expenditure amounts represent advances to spending ministries and agencies rather than final expenditures' 5, and accounting for these advances is necessary before final figures can be reported, the initial budget execution reports contains only preliminary figures, which are revised as new information becomes available. The reports are posted on the M O F website, thus providing a high level of transparency. BASICDESIGN 79. The accounting system has two main parts: a central system (Oracle-based) operated directly by MOF, and separate systems operated by line ministries and agencies based on varying platforms. The first part covers the CTA, which the M O F operates in accordance with the authorized budget, making payments on budget lines that it controls directly (the main ones being all wage-related expenditure, rental charges, overseas traveling expenses, expenditure on training courses and interest payable). There i s no accounting manual setting out procedures and other operating guidance to accounting staff. 80. The second part concerns monthly transfers fi-om the CTA into bank accounts controlled by the line agencies. Line ministries make payments from these accounts in accordance with the budget lines for which they are responsible, and are also responsible for accounting for them. Typical items of expenditure paid directly by ministries and agencies are power, fuel, communications, office expenditure, maintenance, transportation and consumable stores. The proportion o f such direct expenditure varies between ministries. For example, Ministryo f Social Affairs directly pays only 5 percent of its budgeted expenditures; for Ministry o f Healththe figure is 50 percent. 81. Ministries and agencies report their monthly expenditure to MOF. The accounting systems o f line agencies have been established individually. Thus the information l5 The presence o f a large number o f advances where money has been provisionally disbursedbut where months or even years after the advance was made, the recipient ministry has still not accounted finally for the use o f the funds delays the reporting of final expenditure. Advances arise when expenditure already made by spending ministries has not (yet) been subsequently approved by MOF. In such cases the whole o f the advance is treated as un-discharged. This i s a needless complication; expenditures should be treated as final when made. MOF proposes to make this change as discussed in paragraph 141 under financial controllership. 27 WESTBANKAND GAZA COUNTRYFIXANCIAL - ACCOU~TABILITYASSESSMENT technology solution varies from agency to agency. Some have accounting manuals. Some report quickly and accurately; others do not. Some still operate manual accounting systems. The detail and frequency of management reporting for expenditures also varies. Some ministries (MOSA and MOED) have developed their own systems in house, and these appear to operate satisfactorily. On the other hand a purpose built system developed with donor assistance for MOH is now being set aside in favor o f the existing MOF system. 82. Insummary, responsibility for accountingis partly centralizedinMOF andpartly decentralized to line ministries.16 A uniform chart o f accounts, a single set o f financial regulations and uniform reporting requirements bring the two parts o f the accounting systemtogether. For such a system to provide accurate, timely and complete consolidated reports, two conditions must be fulfilled. First, line ministries must report their final expenditures to MOF in a form suitable for aggregate monitoring and reporting. For this they need good accounting systems to produce. Without this, expenditures o f line ministries can only be reported in a preliminary way as lump sum advances received. Second, M O F must establish and comply with standard accounting procedures and carry out comprehensive accounting routines according to a set schedule. This involves inter alia carrying out regular proofs o f accuracy to ensure that final figures can be easily prepared, verified, aggregated and reported. 83. The current chart of accounts consists o f eight digits: - Firstdigit shows the main account classification: 1. Assets 2. Liabilities 3. Revenues 4. Expenditures - Second digit shows the main sub-group, e.g. General Treasury Account (Account no. 11) - Third digit shows the main category o f the sub-group, e.g. General Treasury Account at the Palestine Monetary Authority (account no. 111); or General Treasury Account at commercial banks (account no. 112) - Fourth and fifth digits provide further details at ministry level, e.g. General Treasury Account-Cash at line ministries (Account no. 1111). Treasury account at Ministryo fEducation is 11111. - Sixth digit indicates the currency used - Seventhand eighth digits reflect the location o f account (e.g. at Arab Bank). l6 Itcan be noted that a donor project to develop a comprehensive GFMIS (Government Financial Management Information System) commenced by the World Bank in 1994 and later taken over by another donor was eventually abandoned. 28 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY - ASSESSMENT 84. The chart o f accounts facilitates the recording o f accounting transactions. It does not, however, allow an economic classification on the use o f funds or on major government functions as recommended under the IMF's system o f government finance statistics (GFS). Nor is there any functional or program classification, reflecting the input focus o f the current budgeting system, which will be required in future under any gradual move to performance budgeting. RECENTINNOVATIONS 85. As part o f on-going reforms MOFhas unified the accounting systems inGaza and West Bank and placed strong emphasis on bringingthe accounting systems of MOF and line ministries closer to international best practice. The new government accounting system currently being phased in aims at meeting line ministry and agency financial management needs as well as those o f MOF and was developed internally by MOF. The system i s oracle-based and uses an IBM server. It consists o f the following modules: budgeting, payments, bank accounts, accounting and revenues. The next phase (within 18-24 months) is planned to include payroll, procurement and internal audit. The MOF offices in West Bank and Gaza are linked through leased telephone lines. It is envisaged to use satellite facilities to link West Bank with Gaza inthe future and to use microwave telecommunication systems within Gaza strip. For West Bank, microwave facilities would be usedwithineach city and satellite facilities between different cities.17 86. The new central accounting system automates all financial transactions from initiation to final settlement through bank transfer or issuance o f payment check to the ultimate beneficiary. It also automatically generates accounting records and permits financial reporting. The system has a single point o f data entry and thus a transaction is entered only once. All authorizations are automated through the system. Access to the accounting system is restricted to authorized personnel who furthermore have only access to modules under his or her assigned duties. 87. Currently, MOF loads the annual budget o f all line ministries into the budget module at the beginning o f the fiscal year. Inthe future it is intented that budget data will be entered at the level o f the line ministries or their basic units and aggregated at MOF level. This will facilitate budget preparation and execution and also expedite the implementation o f changes to budget allocations that may happen during the fiscal year. Also, the PLC will be given access to the system, and thus be able to directly review budget execution. 88. The new central accounting system provides a wide range o f financial reports including: balance sheet data, bank balances, payment status, and advances. Backup is made daily by MOF. The new system i s currently being piloted at MOF and will be l7 Allowing P A to use microwave and satellite facilities requires coordination with Israel. Estimated costs of introducing microwave and satellite services is US$ 2 million for Gaza and US$ 7 million for West Bank. This change i s expected to improve communication significantly and reduce costs. 29 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - rolled out to all line ministries within 12-24 months, with priority given to the Ministries o fHealth and Education. PRODUCTION OF FINANCIAL STATEMENTS 89. The annual financial statements for 2002, the first aggregate financial statements produced by the PA, were presented in January 2004. The extended processing time was partly due to problems o f consolidation and reconciliation o f outstanding advances by spendingministries, and partly due to unfamiliarity with the task Procedures for closing accounts, proving their accuracy, making final adjustments and formulating financial statements have not been formally established. Such procedures are needed. For 2004 the PA should set a target for completion and issue o f the annual financial statements of no more than six months after the year-end. For the following year, the target completion date should be further advanced. In the meantime, formal procedures for the closing o f accounts and the finalization o f financial statements should be established. SUMMARY 0 The central accounting system, operated by MOF, as being developed, is a well designed, functional system, which will have the capacity to meet MOF needs. It remains to be determined, however, whether this system can meet the more detailed information needs o f spending ministries and agencies or whether separate, but compatible systems are more appropriate. 0 The classification system could usefully be expanded to include activities and programs, to provide improved information to ministry and agency management and to facilitate a greater performance focus inthe budget inthe future. 0 Monthly figures o f revenue and expenditure are available ina matter o f days after the month-end. It should be noted that these are only provisional due to difficulties o f integrating line agency expenditure data. There were delays in finalizing the 2002 aggregate financial statements because o f lack o f documented procedures for closing and consolidating accounts. Much could be gained by further streamlining o f accounting system o f line ministries and by harmonizing those systems with MOF's. DESIRABLE FURTHER ACTION k Assess ministryand agency information requirementsand determine the extent to which they can be met from the central MOF system. If necessary, provide guidance for development o f ministry accounting systems harmonized with the central system. P Indue course, review the existing classification system so that it is able to provide information on departmental activities and programs. 30 WEST BANKAND GAZA COUNTRY FINAXCIAL ACCOUNTABILITY ASSESSMENT - P Develop an accounting manual, to provide financial staff with more guidance on accounting procedures, including procedures for consolidation and reporting, so as to reduce the current delays in reporting final figures in monthly budget execution reports and inpreparing the aggregate financial statements. 13. PUBLIC SECTOR PAYROLL 90. Salary payments, which in 2004 are expected to account for some 60 percent o f recurrent budget expenditures, are treated a priority item for payment. As of end June 2004, salary payments were made on time and there were no salary arrears. At end 2003 total public sector employment stood at 129,560, comprising 72,920 civil servants and 56,640 security personnel. As with 2003, the 2004 budget document includes comprehensive data on civil service employment, including the security services. 91. There are three major related issues conceming the payroll: - ensuringthat decisions on staff numbers(new recruitment etc) are consistent with the funds providedinthe budget - ensuringthat payments are appropriately made, only to authorized personnel (and are thus not liable to be used for other unauthorized or unknownpurposes) - establishingthe reliability o f the payroll system through a comprehensive audit 92. On the first issue, until2002, decisions on staffing (hiring, promotion, etc.) were madeby the General Personnel Council (GPC) outside the control o f MOF. The President signed a decree on 10 January 2000 transferring the GPC to MOF, but the decree was only implemented in August 2002. The move o f the payroll management from GPC to M O F was a significant development in improving budgetary control over the payroll, as recruitment had previously been undertaken by GPC without explicit consideration o f budget allocations. GPC remains responsible for personnel policy issues and regular promotion decisions, but MOF now controls new recruitment, and promotions outside normal salary progression. GPC continues to maintain the central employee data base and its full cooperation with M O F i s essential in preparing an accurate budget, maintaining control o f staffingnumbersandmaintaining the integrity o fthe central payroll system. 93. The budget allocation for staffing is now determined by MOF as part o f the budget dialogue with each line ministry and agency and budget execution reflects only the agreed allocation o f funds. The 2003 and 2004 budget laws set limits on civil service employment increases, distributed across ministries and agencies. While hiring by security organizations i s to be limited by the amount o f the budget appropriation, the MOF's mechanisms for enforcing this need strengthening. 94. On the second issue, all new civil service recruitments are required to be submitted to the Budget Office of MOF to check funds availability and are personally approved by the Minister. No person can be placed on the payroll without the approval of the relevant financial controller, the budget department o f MOF, the Director-General of 31 WEST BANKAND GAZA COUNTRYFINANCIAL - ACCOUNTABILITY ASSESSMENT Financial Control in MOF and finally the Minister himself. This highly centralized control may be appropriate given current budgetary problems, but will need to be relaxed in the longer term as trained, professional financial controllers are placed in each line ministry. 95. However, the recruitment process has not yet been fully regularized for all the security services. It appears that the system o f submitting new recruitment proposals to M O F for approval by the Minister which operates for civil servants, does not always operate in the same way for the security services. Thus while the budget allocations for the security services are intendedto act as limits on new recruitment, this may not always occur. 96. The 73,000 civil servants have been paid through bank accounts since the establishment o f the PA. Until August 2003, security personnel salaries were paid in cash, with funds transferred by M O F to security service bank accounts for this purpose, thus creating an inherent potential for diversion of funds. InAugust 2003, the salaries of some 25,000 security personnel from four agencies (including civil police and preventive security), but excluding 31,000 security personnel from units which report direct to the President were moved from cash to personal bank deposit payments using the MOF central payroll system. Following a Presidentialdecision inFebruary 2004, the remaining 31,000 security personnel have been transferred to direct deposit payments at end March 2004. 97. Withregardto the thirdissue, MOF has initiated an audit o fthe payroll. However, focus has so far primarily been on lower level systems issues rather than the issue o f whether all persons currently on the payroll are authorized (and whether they even exist). MOF is aware o f the need to broaden the scope o f this audit and this should be a high priority, once an adequate internal or external audit system is established (see separate discussion on audit arrangements in Sections 18 and 19). Full cooperation o f GPC in carrying out this audit will be needed, as it holds the central personnel records o f civil servants. In the meantime M O F will be undertaking sample reviews across a range o f departments, comparing its payroll records with those o f individual ministries and checking that salary levels correctly reflect the formal qualifications o f individual civil servants. SUMMARY 0 Considerable progress has been made in integrating staff budgeting into the overall budget exercise and ensuring adequate control over and transparency o f staff numbers. 0 But there is still inadequate MOF control over security service staff numbers and recruitment. 32 WEST BANRANDGAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - ~~ ~ DESIRABLE FURTHER ACTION The following actions shouldbetaken: > Undertake a comprehensive audit (by the new Internal Audit Department o f MOF) ofthepayroll system, with the full cooperationof GPC, bothto ensure that the system provides adequate controls to ensure payment only to appropriate persons and that the existing payroll data base is correct. > Develop a comprehensive employee data base which includes security personnel as well as civil servants > Apply the same MOF controls over recruitment of security personnel as apply to civil servants 14. PA COMMERCIALINVESTMENTS 98. The PA has invested in a range o f commercial undertakings, both with a view to generate revenue for the PA, and to stimulate economic growth in WB&G through strategic local investments. As mentioned earlier, using PA revenues not paid into the budget (petroleum, tobacco and alcohol excises plus ongoing profits from these commercial operations) the PA-owned Palestine Commercial Service Organization (PCSC) investedP A funds insome 79 commercial undertakings, both within WB&G and abroad. These included monopolies in cement and petroleum, which were acquired at an early date. The President appointedthe chairman o f the PCSC. 99. There was little transparency and accountability concerning the operations o f the PCSC. However, as part of the Economic Framework reforms o f June 2000 an o f international auditing firm was retained to assess the value (subsequently estimated at US$345 million) o fPCSC's commercial holdings. It was agreed that the valuation was to be a precursor to transferring commercial profits and other diverted revenues back to the PA budget.However this didnot happen, nor was a Presidential decree, issuedinOctober 2000, establishing the Palestine Investment Fund (PIF) to manage these assets on a commercial basis, including sellingwhere appropriate, implemented at that time. 100. However the PIF was formally established in October 2002, as a component o f the 100days Palestinian ReformPlan. PIF is an autonomous entity, wholly owned by the PA and is incorporated under PA companies legislation. Under the decree it is illegal for the PA to conduct any commercial activity or hold commercial assets outside ofPIF. 101. The articles o f association of PIF outline the authorities and responsibilities o f the Board o f Directors and the management o f the company, and provide for proper management and governance of the PIF. The Minister o f Finance chairs the seven member board o f directors, which includes four members from the private sector, one of whom who serves as deputy chairman. The other two directors are the Minister o f Economy, Trade and Industryand the managing director (who is the former chairman o f 33 WESTBANKAND GAZA-COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT the PCSC and the President's financial advisor). Three directors' signatures are required for any investment decision. Apart from the Articles o f Association, a detailed policies and procedures manual governs its operations. However it does not appear that PIF has adequate professional staffing, given the size o f the portfolio and the complex policy issues it faces, and this matter should be reviewed by the PIF Board. 102. Under its Articles PIF is required to prepare an annual report within a "reasonable time" of the end o fthe financial year. It is also required to prepare quarterly (un-audited) and annual (audited) financial statements. In April 2004 PIF presented its first annual report and annual financial statements - for the year 2003. These statements were audited by the international firm Ernst and Young and received an unqualified audit opinion. They are available on the PIF website l8 show total assets, including investments, and fixed assets, cash and receivables o fUS$799 million, and net equity o f US$713 million. 103. PIF has initiated a review its entire portfolio with a view to formulating an investment and privatization strategy. It may dispose o f its holdings in companies operating in WB&G where it considers that government involvement is no longer necessary. While PIF i s able to invest in WB&G companies to promote economic development it i s likely that this will be done only where entities have no alternative access to capital, and that revenue earning and capital growth will be the dominant objectives, with the Board determining the balance between these two objectives. PIF is allowed to invest liquid fbnds intemporary investments, but is not allowed to lend to the PA budget. 104. Nevertheless MOF now has a direct role in over-seeing the operations of PIF, which establishes a direct link with the budget so that the Minister may determine what amounts should flow from PIF as budget revenues. The 2004 budget includes a line item covering this revenue o f US$35 million, compared with US$31 million in2003 and zero in2002. 105. Inlate 2002, the new PIFboard engaged the international firm of Standard and Poors to undertake a valuation and "transparency assessment" o f the companies inwhich PIF held shares A report was issued on March 9, 2003 listing all investments along with their valuation, totaling some US$633 million". Inaddition, the report also listed current bank accounts formerly controlled by the Palestinian Commercial Services Company (PCSC) with cash balances o f $74 million inseveral banks. 106. The transparency assessment reviewed the availability and reliability of financial and other data, as well as how each entity i s owned, organized and operated, and whether based on the findings it will bejudgedboth "transparent and respectable" by international standards. The intention i s that all PIF investments must reach this standard. Anti- competitive behavior, unfair or preferential relationships with the PA or corruption issues '*tltto:.'.~www.pa-inv-fund.comiIassz.asp l 9The total valuation o f U s 6 3 3 million for investments suggests that the 2000 PCSC valuation by SABA may have been incomplete in its coverage. The Standard and Poor report along with PIF bylaws are published onthe PIF website ~ ! t t ~ i . ~ ~ ~ ~ . ~ ~,.co.mi!ass.~.,asiI ~ ~ . ~ . a ~ i . ! ~ ~ ~ f u n ~ ~ 34 WEST BANKAND GAZA COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT - ~~ were included in the diagnostics. This diagnostic information concerning each entity i s also available onthe PIF website. 107. The report was presented to and discussed by the PalestinianLegislative Council. 108. The largest PA investments (totaling US$336 million), their valuation and the Investment YOheldby PIP Valuation (US%m) Orascom Telecom Algeria (23%) $90.0 Orascom Telecom Tunisia (20%) $50.0 Orascom parent company (3%) $25.2 Fastlink (Jordan Mobile Telecommunications) (14%) $66.1 PA Cement (100%) $54.0 Palestine Telecommunications (PALTEL) (6.75%) $13.6 Palestine Cellular Communications (PALCEL) (35%) $36.9 109. The Petroleum Commission, which i s both a regulatory and a marketing organization, is not included in PIF, having been made directly accountable to the MinisterofFinance. SUMMARY 0 The establishment o f the PIF and the listing and valuation o f PA commercial investments, particularly the disclosure o f investment details on the PIF website, is a major step in overcoming the previous insufficient transparency in these investment operations. It provides the opportunity to ensure that these entities are managed inthe financial interests o f the PA, either through providing revenue to the budget or through privatization or sale where appropriate. 0 Likewise the publication o f the PIF annual report and audited financial statements for 2003 represents a significant advance infiscal transparency. DESIRABLE FURTHER ACTIONS. > The PIF Board should review the adequacy o f PIF professional staffing to assist it initsmanagement o fPIF. 15. STATE OWNED ENTERPRISES 110. WB&G has relatively few state owned enterprises (SOEs), Le. commercial entities controlled and managed by P A to provide public services within WB&G. The 35 WEST BANKAND GAZA COUNTRY FINANCIALACCOUNTABILITY ASSESSMENT - main active SOEs, are the Petroleum Commission 2o (now directly administered by MOF), the Electricity Monitoring Distribution Company (owned jointly by PA and Gaza municipalities), Al-Bahr Company (responsible for information technology and computer programming services to the PA), Palestine Development Company (a construction company jointly owned by PA and Italian interests) and Al-Sakhra Company (the purchasing arm of the security services - which i s in the process o f being wound up). Paltel, the telecommunications monopoly in WB&G i s not an SOE; it is a public company listed on the stock exchange, albeit with a small PA equity held by PIF. Likewise the postal and water systems are operated by budget entities and hence are not SOE's (see Section 16, below). 111. SOEs were part o f the 2003 valuation study carried out by Standard and Poors (see paragraph 105 above) and are part o f the PIF investment portfolio2'. However, as of November 2003 no market values had been determined for SOE's on the basis that their objective is to provide services to the PA on a cost recovery basis, usually on a monopoly basis. Therefore, a business valuation o f those companies using a market approach was not considered appropriate. 112. Each SOE operates on commercial basis and i s not included in the PA budget. They operate under the Companies Law. The Companies Law requires SOE's to prepare auditedfinancial statements, a requirementthat not all SOE's have thus far adhered to 113. At the direction o f the Minister o f Finance a special-purpose audit o f one o f the largest SOEs (the Al-Sakhra company) was conducted by a qualified West Bank auditor and coordinated by MOF. The audit report identified substantial control weaknesses and misuse o f funds. Among the litany o f control weaknesses were signing of blank checks, lack of documents to support various material financial transactions and lack o f clear basis for payroll calculation and benefits. Various unjustified perks to the general manager and financial manager were identified. More substantively, significant revenues recorded elsewhere as havingbeingpaidto Al-Sakhra were not receivedby the company, and appear to have been deposited into other bank accounts, including in one case the personal account o f the general manager. A building was registered in the name o f the general manager and various motor vehicles in the names of company staff. As a consequence the Al-Sakhra company is to be wound up and its functions transferred back into the security services, and a senior staff member was removed. 114. The situation in this company reflects what may arise in the absence o f a clear financial management and accountability framework for SOEs. The operation o f PIF provides this framework. Nevertheless, as discussed in Section 14 above, for this framework to work it i s important that PIF have adequate professional staff and that the Company law requirements for preparation o f audited financial statements are observed 2oThe Petroleum Commission i s both a regulatory and a marketing organization. It is intended to privatize its commercial activities at some future stage, and for the Commission to then function only as a regulatory authority. 21According to the 2003 Standard and Poors valuation report, 15 SOEs ceased operations as o f January 1, 2003. They include companies o f trading nature (e.g. glass company, logo company, Al-Borhan company) 36 WESTBANKAND GAZA COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT - DESIRABLE FURTHER ACTION k Ensure that all SOEs are appropriatelymonitoredunderPIF and that theyprepare the annual financial statements, audited by professional firms, as required under the Companies'law. 16. OTHER COMMERCIALACTIVITIES 115. Included in the P A budget are a number o f agencies which are primarily o f a commercial nature. These include the Ministry o f Posts and Telecommunications which operates the postal system. These institutions operate as autonomous public institutions, but like ministries and agencies, their expenditures and revenues are part o f the budget. DESIRABLE FURTHER ACTION P Given the inherentlycommercial nature o f their operations, consideration should be given in due course to having these organizations operate on a commercial basis subject to a performance accountability regime - with boards o f directors, financial targets, and annual reports, including audited financial statements prepared on a commercial basis. 17. PUBLIC INSTITUTIONS 116. These are autonomous entities whose revenues and expenditures are included in the government budget. Examples, such as the Palestine Water Authority and Palestine News Authority are set out in paragraph 38 above. Each institution maintains its own books of accounts, generally on a cash basis. So far, none have prepared annual financial statements. They are subject to the Organic Budget law and Finance Directives, and to GCI audit and are requiredto follow government procurement procedures. DESIRABLE FURTHER ACTIONS k Public institutions should prepare and publish annual reports to the PLC, including audited annual financial statements. 18. EXTERNAL AUDIT 117. The P A external audit institution i s the General Control Institute (GCI), established under Law 17 of 1995. It has about 90 professional and 20 support staff, with requested increases in staff numbers being provided for in both the 2003 and 2004 budgets. Its staff are public servants but are remunerated at a higher level than comparable civil servants. It operates from Gaza, with other offices inRamallah, Nablus and Hebron. 37 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY - ASSESSMENT 118. The Law gives GCI a wide scope o f activity. The audit mandate covers financial, value-for-money and compliance auditing. It i s authorized to carry out ex post audits o f all PA organizations, including the security services, public enterprises and companies in which the PA holds shares, as well as local govemment, although it does not appear to currently exercise its role in local government (see separate discussion on Local Government in Section 23 below). Underthe Law the President i s able to exclude certain undertakings from its audit coverage, although it i s not clear whether any organizations have been exempted to date. GCI i s required to audit the annual financial statements o f the PA, although the recently completed 2002 financial statements do not carry an audit opinion (see paragraph 162 below). The GCI i s also requiredto audit the quarterly budget execution reports and forward them to ministries with its comments. It i s not clear the extent to which GCI i s currently auditing revenues. This i s an important area for scrutiny. 119. G C I is also charged with a number o f tasks that are extraneous to a national audit institution, although these are not a large part o f its total work. For example, it investigates complaints from the public about poor services or misconduct o f PA staff, which in other jurisdictions would normally be the responsibility o f a separate administrative body (or, for the latter issue, GPC). It is also authorized to monitor the implementation o f investment projects, which i s usually considered a management role. 120. GCI has no prosecutorial role. It refers any cases requiring legal action to the appropriate authorities. 121. The institutional arrangements for GCI have a number o f desirable features for a national audit institution. It has adequate budgetary independence. Its authority covers all PA organizations, it has a broad scope mandate and full authority to obtain information it requires. There are, however, a number o f deficiencies in its legal set-up. The President appoints the Chairman (on recommendation o f the Cabinet) and the Chairman reports directly to the President, with no formal provision for reporting to the PLC or otherwise making the reports publicly available. Although the President may forward its reports to the PLC, he has not done so since 1997. And it carries out a number o f extraneous functions, as discussed above inparagraph 119. 122. GCI i s a member o f INTOSA122and its associated organization ARABOSAI, which brings together the supreme audit institutions o f Arab nations. However it is not clear what professional auditing standards it uses inits work. 123. No information is available on the content o f GCI reports forwarded to the President, as these have not been made public since the report provided to the PLC in 1997. The 1997 report was stated by PLC to contain inaccuracies and generally to not be useful. Without access to any of GCI's audit reports it has not been possible to form a clear judgment on its work. However from discussions by the CFAA team with MOF, line ministries, a PLC representative and some donors it appears that GCI i s adding little or no value in its current role. It is perceived as lacking technical skills and focusing on relatively small compliance issues rather than on issues o f systems, materiality and risk. 22International Organization o f Supreme Audit Institutions 38 WEST BANKANDGAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - Neither MOF nor line ministries interviewed considered that GCI identified material issues which needed correcting. Nor i s there evidence of any o f its recommendations beingimplemented. 124. No international donor, with the exceptiono fthe Islamic Development Bank, uses GCI for the audit o f its projects in WBG. GCI reports on the quarterly budget execution reports do not appear to be usedby MOF, the line ministries and agencies concerned nor bythe PLC. 125. Although PLC mayrequest GCI to review certain issues it has not done so, except on a few occasions. When it has made requests no response has been forthcoming from GCI (see discussion ofPLC in Section 20) 126. Conflicts o f interest regarding the current Chairman o f GCI are a matter of concem and need to be resolved. The Chairman i s currently the Govemor o f the Islamic Development Bank representing the PA, in which capacity he has signed financial agreements on behalf o f the PA that only the Minister o f Finance is authorized to sign. In addition he i s a board member o f the Palestine Monetary Authority (PMA). 127. There i s a clear need to strengthen both the legal basis and the capacity o f the PA's external audit institution. A new draft law has been developed for the Committee o f Budget and Financial Affairs of the PLC. This draft law would establish a Council o f Financial and Administrative Control, to replace GCI. It contains many of the requirements for an adequate external auditing law. In particular it provides for independence in funding and for PLC approval of the President's appointment of the head of the Council. It provides for full right o f access to information, coverage o f all P A organizations and for quarterly and annual reporting to the PLC as well as the President and has provisions conceming conflict o f interests. 128. However the draft law also has some deficiencies. The GCI's role is extended well beyond external audit to include hnctions related to an administrative tribunal or ombudsman, and others that are functions of the executive arm o f government. In addition the audit provisions lack clarity. There i s no clear statement that compliance, financial and performance audits are required and there i s no clear requirement for the audit o f budget execution reports and annual financial statements. In addition, the law should make reference to the minimum auditing standards (as for example issued by the Intemational Federation o f Accountants (IFAC) and the Intemational Organization of Supreme Audit Institutions (INTOSAI) that the work o f GCI shouldbe subject to. 129. To become the basis for a fully satisfactory external audit institution the draft law therefore requires some redrafting - both clarification and narrowing. The PLC Budget and Financial Affairs Committee should address this, as the draft law proceeds through subsequent legislative stages. 39 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - SUMMARY 0 GCI does not meet intemational standards for a professional external audit institution. In the P A context, with heavy donor support and an extensive PFM reform program being implemented, the need for a professional audit institution on which boththe P A and donors can rely to add credibility to published financial statements and to provide some assurance that new systems and arrangements are functioning as required, cannot be over-emphasized. 0 A particular weakness is the current lack o f formal relationship between GCI and the PLC, resulting in a lack o f responsiveness to the PLC. The authority o f the President to exempt any undertaking from audit i s another deficiency. 0 The draft law to establish a new external audit organization, the proposed Council of Financial and Administrative Control, while containing many of the requirements for a good external audit law, requires some clarification and modification to be fully satisfactory as the basis for a new external audit organization. DESIRABLE FURTHER ACTIONS P The PLC Budget and Financial Affairs Committee to revise the draft new audit law as suggested in paragraph 128 above, as it moves through subsequent legislative changes. > Urgently institute a program o f capacity building, with assistance from the national audit institution of one or two donor countries. This could first take the form o f a "peer review" o fthe quality o f GCI's work P Resolvethe conflicts ofinterest ofthe current chairmano fGCI. 19. FINANCIAL CONTROLAND INTERNALAUDIT 130. The financial control and internal audit functions were previously discussed as one issue in PA P F M reform plans, giving rise to some confusion. However MOF has now correctly made a clear distinction between ex ante financial control (sometimes referred to confusingly as "pre audit") and ex post internal audit. A recent Ministerial Decree formally establishes separate Internal Audit and Financial Control Departments within MOF, with the internal audit and financial control staff posted in each ministry to become formally part of these MOF departments. FINANCIAL CONTROLLERSHIPROLE 131. Prepayment checks, which are the main component o f the PA financial controllership function, are a necessary part o f any PFM system. Inriskier environments and where the control systems o f spending agencies are less advanced, it is common for 40 WEST BANKAND GAZA COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT - MOF to undertake such checks. In more mature systems the spending agencies are responsible for the integrity o f their own prepayment controls. Audit institutions (either internal or external) might review the effectiveness o f these controls on a selective basis butwould not beinvolvedindetailed checks oftransactions. 132. Obligatory pre-payment checking i s mandated in the Fiscal Directives (article 21/5). For expenditures (which included to commitments entered into and to procurement) to be correctly incurred, the following conditions must be met (as also outlined inparagraph34 above): - The relevant appropriation account has sufficient funds to cover the proposed expenditure - the proposal is backed by correct documentation including the necessary authorizations - the sums involved have been correctly calculated, classified and described - that the proposed expendituredoes not violate the law, directives inforce etc. 133. Havingverified this, financial controllers authorize individualexpenditures. Ifan error i s found the transaction i s referred back to the ministry or agency concerned for correction. Ifthere are no errors, payment may be made. 134. Financial control has been carried out by the internal control and audit department of M O F and by similar units located in line ministries. MOF and line ministries each carry out prepayment controls on their own expenditures. 135. A plan for comprehensive development of the financial control function was laid out in the 2004 Budget Speech of the Minister o f Finance and was approved by Cabinet on February 9, 2004. The objective of the plan i s to develop a fully effective financial control function by making financial control a clear MOF responsibility, with all financial controllers inspending units beingMOF staff, and reporting to the new director- general of financial control in MOF. In addition methodological guidance will be developed and training provided to financial control staff. 136. It should be noted that financial control will extend beyond pre-payment checking, to checks on key financial duties o f line ministries. While the extent and type of control have not yet been defined, it i s anticipated that they would apply to the timeliness and correctness of accounting reports and to bank reconciliations prepared by line ministries. 137. About half o f all ministries (including all large ministries) now have financial controllers. M O H has five financial controllers; M O S A has one, appointed in 2003. In due course this will extend to all ministries, as provided in the 2002 100 days Reform Plan. At present, financial controllers do not issue reports concerning their work. It would seem desirable for them to do so (to the chief executive of the ministry concerned with a copy to MOF). 41 WESTBANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - 138. Once the new system o f financial control i s established, M O F will abandon its system of post-disbursement audits (paragraph 141 below) At the same, intemal control staff currently employedby line ministries will be transferred to MOF. The staffing needs of the new system are currently estimated at about 320 (200 in West Bank and 120 in Gaza). These needs are expected to be met by the reassignment o f staff and not by new recruitment. 139. Manuals, check lists and computer programs have already been developed by MOF, along with training programs, to support the development o f this function. SUMMARY 0 Financial controllers have a key role in meeting the PA's current need both to ensure and to demonstrate that expenditures are only incurred as authorized by the annual budget law, and that they are correctly classified and reported. An effective financial controller system can also provide significant comfort to donors about proper use o f funds. 0 Financial controllers are not yet fully inplace inall ministries and it i s too early to judge their effectiveness. But useful steps have been taken, including the appointment o f a director-general o f financial control in MOF to manage and develop this function. An effective extemal audit institution could usefully review the effectiveness of the financial controller role, once it i s fully operational. It i s clear the financial controllers must have both capacity and independence to operate effectively. 0 It is important that the financial control function operate in a timely and cost- efficient manner, avoiding duplication inprocedures and staff. DESIRABLE STEPS NEXT 9 Strong support should be given to the policy of putting financial controllers in place in each ministry, ensuring they have adequate authority and independence and that they report on their work to MOF 9 MOF should ensure that the structure, objectives, responsibilities, reporting standards and operational procedures o f the financial control function are properly defined and documented, and do not overlap with the responsibilities o f intemal audit. (EX POST) INTERNALAUDIT 140. A prior appreciation o f the weakness o f extemal audit in the P A and its causes and impact (see section 18 above) i s necessary to an understanding o f the current development of ex post intemal audit in WB&G. At present, M O F does not posses the means to verify the correct operation o f its financial management systems (for example 42 WESTBANKAND GAZA- COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT the government accounting system, the CTA, and the payroll, procurement and debt management systems). A well-functioning internal audit system would provide an effective means o f verifying whether these systems are indeed operating correctly and satisfactorily. As mentioned above in Section 13, a comprehensive audit o f the public sector payroll is a priority for such a new department. 141. In addition, MOF carries out ex post audit of the completed payments of line ministries. Expenditure of line ministries before this M O F audit remains an advance and i s not treated as final expenditure. This arrangement duplicates work and results in multiple, time-consuming checks and authorizations. Often, because disbursement has already occurred, M O F checks are too late to prevent irregularities. Moreover the system results in excessive sums being treated as advances, which delays the completion o f financial statements (see footnote 16 above). 142. MOF has established an internal audit department, to be headed by a director- general of internal audit, to carry out ex post system-based audits. In the interim an expatriate Palestinian consultant with strong professional qualifications was recruited for several months to advise on internal audit issues, to undertake the necessary staff development and to ensure the development o f a fully professional internal audit department. MOF has now recruited 52 staff for this department, to carry out state-of-the- art audits for MOF. An international auditing firm currently provides training (classroom based and on the job) plus drafting o f procedural manuals to achieve this, with hnding assistance from the European Commission. 143. A draft internal audit charter has been approvedby the Minister o f Finance. Apart from providing for an independent, fully professional internal audit department as part of MOF, it contains internal audit procedures and standards based on those published by the Institutes o f Internal Auditors in USA and UK. It covers the following topics: role and objectives o f the internal audit directorate, its relation to other ministries and public institutions, scope o f work, quality standards, professional standards and the qualifications o f internal auditors, the nature o f internal audit (covering both operational and financial audit), the development o f audit programs and steps to be taken as part of internal audit assignments. The draft charter constitutes a sound basis for developing internal audit ingovernment o f WB&G. 144. This initiative has the potential to fill an existing gap in the PA's public financial management architecture. The P F M reforms, which aim to establish financial management systems that will match international best practice. cannot progress satisfactorily without a systems-based audit. It is therefore important that the internal audit initiative be given maximum support. To accomplish this the following are suggested: - clear differentiation between the roles o f financial controllers and internal auditors (different names, ,different roles expressed in separate charters or statements o f objectives, and different responsibilities) 43 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - - steps to ensure that the leadership o f internal audit remains professionally qualified23and to ensure that internal auditors are properly trained and equipped with appropriate skills - adequate backingauthority to ensure appropriate access to the information and documents o f line agencies - the publication o f comprehensive procedural guidance regarding internal audit and financial control 145. The short-term aim, once the unit is staffed and the auditors trained, should be to establish internal audit formally in the structure o f government (e.g. by amending the organic budget law or fiscal directives) so that its role, responsibilities and powers are clear. 146. Inthe longer-term, the internal audit initiative raises transitional problems. These will become clearer when the PA's systemo f external audit has developed further: - how will the roles o f internal and external audit be defined? - how will those roles develop once external audit i s put on a sound footing? - with two separate sets o f MOF staff operating inthe financial control and internal audit environment at spending agency level, how will spending agencies develop responsibility for their own financial control systems? 147. Possible duplication o f hnctions between external and internal auditors might be a concern in the longer term. In the near term, however, such considerations are secondary and the priority i s to establish a credible audit capacity to underpin the current PFMreforms. SUMMARY 0 The development o f the ex post internal audit function based in MOF is a high priority, both for donors and the PA. In due course, the relationship o f this development with upgrading o f the external audit institution, GCI, will need to be determined. DESIRABLE FUTURE ACTIONS P MOF shouldprovide strong support to the development o fthis function, to ensure that there are appropriate staffing and training arrangements put in place as soon as possible, so that the envisaged internal audit program can begin. 23 This means holding the full accountinglauditing qualification o f an intemationally recognized professional institute and having experience of leading the audit function in a large, modem organization. 44 WEST BANKANDGAZA -COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT k MOF should give a comprehensive audit of the payroll, both civil service and security services priority inthe internal audit program. 20. THE ROLEOF PLC INPFM 148. The PLC Committee on Budget and Financial Affairs, which consists o f 14 members out of the total membership o f the PLC o f 120 has the following terms o f reference: - review the draft budget law (it can propose reductions in expenditure but not increases) and recommend approval/rej ection to the PLC - question the govemment on its financial plans and issues o f fiscal stability - question ministers on financial matters - ensure integration between budget and economic plan - discuss/approve proposedbudget amendments duringthe year 149. The Committee may also request an investigationinto the financial operations o f any ministry or agency. It may also request copies o f GCI reports on MOF budget execution. However various PLC requests to GCI for its reports on budget execution, for a review o f PMA and for a review o f the award o f a hospital construction contract (financed by Saudi Arabia) have elicited no response from GCI. The Organic Budget Law (Article 52) requires quarterly reports on budget execution to be submitted to the Council o f Ministers and to PLC, and this i s now being done. However it does not appear that the PLC makes use o fthese reports. 150. As discussed above (paragraphs 41) under the Organic Budget Law, the budget is required to be submittedto PLC by 1 November and passed before the beginningo f the fiscal year. The PLC may reduce proposed appropriations, but may not increase them. Its review o f the 2003 budget was active and it reducedthe level o f staffing increases sought inthe draft budget.The Committee expressedviews onthe priority to be given to various payments in view o f the PA's difficult budgetary situation, stressing the importance o f expenditures on infrastructure rehabilitation and medicines and payments to families of prisoners, amongst other items. However, the PLC has also been preoccupied with other issues including proposed civil service reform and laws on civil service pensions and capital markets, a report on the PMA, and the review and approval o f the changes to the Petroleum Commission proposed by the Minister o f Finance, which has limited the time it devoted to reviewing the proposedbudgets. 151. The fact that the budget is largely a detailed listing o f inputs, with no explicit focus on performance or priorities (see paragraph 53 above) may limit the level o f PLC interest in the budget. A future program or performance budgeting approach may change this. It does not appear that the PLC review has focused on the overall fiscal strategy and position o fthe PA. 45 WESTBANKAND GAZA- COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT 152. M O F provides quarterly budget execution reports to the PLC, as required by the Organic Budget law. The Committee previously discussed budget execution issues with the Minister o f Finance on a weekly basis, until movement restrictions put in place throughout the West Bank and Gaza by Israel prevented this. Indeedbecause o f travel difficulties caused by closures it has been difficult for the PLC, let alone any of its committees, to meet on a regular or predictablebasis. 153. However the Committee has beenparticularly active in developing and reviewing the draft new audit legislation, discussed inparagraphs 127 and 128 above. SUMMARY 0 The capacity o f PLC and inparticular its Budget and Financial Affairs Committee should be enhanced in order to strengthen the system o f public financial accountability. 0 The PLC requires improved information, professional staffing resources and a formal linkage with the external audit institution to be able to do this. DESIRABLE FUTURE ACTION > The PLC should receive copies o f the annual PA financial statements and annual reports including audited financial statements o f the PF, individual state-owned enterprises andpublic institutions. > GCI should also formally submit its reports to the PLC, and be responsive to requests and other informationneeds identified by the PLC. > The PLC and its committees should be adequately staffed to enable it to analyze andpursue budgetary issues with the executive. 21. PROCUREMENT 154. Procurement in WB&G i s governed by two separate laws: Procurement Law No. 9 of 1998 on "General Supplies" (the Goods Law) and Law No. 6 o f 1999 on public works tenders (the Works Law). While the former is supplemented by detailed regulations, there are no such regulations under the Works law. Two ministries are thus involved in procurement policy - the Ministry o f Finance, which has a procurement monitoring unit, andthe Ministryo f Public Works and Housing. 155. Both laws are only partially enforced, and many spending units have developed their own independent procurement practices. The situation is further complicated by many purchases being funded under donor projects, with a range o f different donor procurement requirements to be met. There is some anecdotal evidence that this leads to significantly higher costs, and that greater harmonization o f donor requirements would be advantageous. A further issue in procurement is the extent to which generally accepted 46 WEST BANK AND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - good procurement practices such as intemational competitive biddingor national bidding are feasible given current circumstance on the ground inthe West Bank and Gaza. 156. In many countries procurement systems have significant risk of financial irregularity. A World Bank CPAR (Country Procurement Assessment Review) is now commencing, with a draft report expected by June/July 2004 and a final report by October/November 2004. For this reason discussion o f procurement issues inthis C F A A i s brief and contains no recommendations. 22. FISCAL REPORTING 157. Reliable fiscal reporting, both at aggregate and organizational level, is a key component o f sound PFM. There have been significant improvements inthis area, mainly the publication o f monthly budget execution reports on the MOF website, the publication of actual figures for 2002 in the 2003 budget documents, the publication of the first PA aggregate financial statements (for the 2002 year) and the publication o f the first audited financial statements for PIF (for the 2003 year). 158. A missing factor continues to be the absence of an adequate audit of the budget execution reports and the absence of any aggregate financial statements. This i s needed to verify the integrity of data and to add credibility to the fiscal reporting - or to comment on the adequacy o f controls inthe systems used to prepare this information and to verify the likelihood that financial transactions are beingcorrectly recorded. AGGREGATEFINANCIALSTATEMENTS 159. The PA submittedits first set o f aggregate financial statements, those for 2002, to the PLC in January 2004. This roughly complies with the Organic Budget Law, which requires the final statements to be presented to the Council o f Ministers within one year of the end o f the fiscal year. This permitted time i s overly generous and should be reduced to six months. Article 65 requires preliminary accounts to be submitted within six months, and somewhat anomalously the Fiscal Directives (Article 58) require the year's fiscal accounts to be prepared by 30 April. The Organic Budget Law also contains certain requirements about the contents o f the annual financial statements but these do not include showing actual and budgeted expenditures for major items, or provide for comparative figures. Nor i s the definition of the budget/surplus deficit adequate. 160. Overall, the 2002 statements are a reasonable first attempt to present meaningful financial statements and provide important aggregate budget information. However they require clarification, rearranging and expansionto provide an adequate basis for financial accountability. This should be addressed in the preparation o f the 2003 financial statements, which desirably should be completed no later than 30 June 2004, and then audited by an international firm. 161. The 2002 statements consist o f some twelve pages covering a series of sub- statements, which are difficult to link with each other. They include: 47 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - - a summary o f actual budget revenues and expenditures, and financing sources - a summary o frevenue and financing sources - a summary o f current and development expenditures, broken down by spending unit under four categories (development, transfer, operating and salary expenditures) and showing actual compared with budget - a statement setting out the overall budget deficit and its financing - a statement of cash receipts and payments, including changes in deposits cash balances and loans (this statement i s particularly hard to follow) Development expenditures are included to the extent that they are financed by the PA or the transactions take place through the CTA. 162. As mentioned above (paragraph 160) the 2003 statements should address the deficiencies inthe 2002 statements. Onprocedural issues, for the 2002 statements there is - no statement o f accountingpolicies or what the statements are intended to convey - no certification o fthe statements by the Minister or any responsible officials - no audit opinion 163. In terms of desirable informational content, the 2002 statements do not contain information on the financial position o f the PA. It i s important that these statements contain more than a statement o f budget execution. Information should also be provided on the PA investments in various commercial organizations such as a summary o f their financial results, assets and liabilities or net value (see separate PIF discussion in Section 14), o f the PA financial assets and financial liabilities (public debt including amounts owing to commercial banks and creditors including payment arrears to suppliers, and arrears to the separate pensions funds - all o f which are discussed in Section 10 above) and o f contingent liabilities. There i s no statements o f the use o f the contingency reserve or o f losses or write-offs. Comparative figures for previous years should also be provided. 164. While it is recognized that some o f this information, for example on public debt and arrears i s included in the budget document, inclusion in the financial statements provides independent verification through the audit o f the statements. 165. A legal provision exists for the annual financial statements to be audited but not for an audit opinion attached to the financial statements testifying to their accuracy and reliability. To meet international standards the financial statements should in future be audited by an independent auditor (in this case an intemational audit firm i s suggested) and should bear the certificate o f the auditor expressing a professional opinion on their adequacy and reliability. 48 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY~SESSMENT - 166. A legal provision also exists for quarterly (budget execution) financial statements to be submitted to the Palestinian Legislative Council (PLC). Intemational standards require that an annual financial statement be submitted so that the authority that authorized the budget (the legislature) can reach an opinion on whether the money has been raised and spent according to its decisions. This procedure is not yet properly established inpractice. FINANCIAL STATEMENTS OF PIF, SOESAND PUBLIC INSTITUTIONS 167. As discussed separately in Section 14 above, an important recent development is that the PIF now brings all P A investments under the purview o f the Minister o f Finance and his Ministry. As discussed inparagraph 102 above under its Articles PIF is required to prepare quarterly un-audited and annual audited financial statements. The first audited financial statements, for the year 2003, were issued in April 2004 and are'posted on the PIF website. 168. Likewise, the requirement that state-owned enterprises to produce annual audited financial statements i s not beingobserved inall cases (see paragraph 112 above) 169. For autonomous public institutions no such annual reporting requirements have been developed (see paragraph 116 above) SUMMARY 0 Considerable progress has been made in improving fiscal reporting through the publication o f budget execution reports. The 2002 financial statements, the first to be presented by the PA are a reasonable first attempt, but improvements in clarity and coverage are needed for the 2003 financial statements, which should also be audited. PIF has produced its first set o f audited financial statements (for the 2003 year). 0 But there remain some gaps in annual financial reporting. Not all state owned enterprises have yet produced required audited financial statements. Annual reporting arrangements also need to be developed for public institutions and in due course for ministries and agencies. DESIRABLE FURTHER ACTION The following steps shouldbe taken: P The form and content ofthe PA annual financial statements for the preparation of the 2003 aggregate financial statements should be reviewed. P The 2003 PA financial statements should be finalized by 30 June 2004 and auditedby an intemational auditingfirm. 49 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - > The audited financial statements required from SOEs should be prepared in all cases. k An annual reportingregime including financial statements for autonomous public institutions (and indue course for ministries and agencies) should be developed. 23. LOCAL GOVERNMENT 24 170. The quality of PFM in local government is not directly examined in this CFAA. However the following brief discussion provides some context to their operations and their impact on the operations of the PA. Transfers from central government are small, consisting only of 45 percent of automobile licensing fees and fines, which are allocated inproportionto their populationsize. Thisamounted to around $5 million in2002. 171. Local government units (LGUs), including 120 municipalities and 251 village councils provide local services such as water, sewage, health inspection, waste disposal and roads and in some cases electricity supply. The bulk o f their revenue comes from user charges (e.g. water and electricity charges) with smaller amounts from property tax and limited transfers from the central government. Overall LGU operations are relatively small, accounting for about 8 percent of total public expenditures or 2.6 percent o f GDP (2000 figures). Total staff employed is around 11,400, compared with 130,000 in central government. 172. As discussed in Section 3 above on donor activities, some LGUs have inthe past negotiated directly with donors for project assistance, although this has now ceased. The current initiative by MOP and MOF to develop a data base o f donor funding and projects and to develop a Medium Term Plan 2004 - 2005, incorporates LGU capital expenditures. 173. LGUs have recently accumulated payment arrears (much o f it to Israel for electricity supply) because of falling revenues due to the economic contraction since the Intifada. The Law permits them to borrow (which in practice means from local banks) subject to MOLG approval. Recently fiscal transfers due from the central government have been withheld because of the PA budget difficulties and also as an offset against arrears o f utilitypayments due to Israel, which have been paidby the central government. 174. Underthe Local Government Law (1997), local governments inWBG are defined as "local bod(ies). ..considered as a financially independent juridical body corporate." But they are at least in theory subject to extensive overview by the Ministry of Local Government (MOLG). For example the law25 states that MOLG i s responsible for endorsing the annual budget and the year-end financial statements o f local governments. While local councils are authorized to set and collect fees, taxes, revenues, fines and 24 The World Bank's MNA Decentralization and Municipal Management: An Assessment of Intergovernmental Fiscal Relations in Eight MNA Countries (work in progress) has been a useful source o f information for this section. 25Local Government Law, Article 15, para 25. 50 WESTBANKAND GAZA- COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT expenditures26, these too are contingent on M O L G approval. Local governments have latitude inestablishing salary scales but these expenditure commitments mustbereflected inthe annual budget, which requires MOLG ratification. It appears that many of these MOLG roles have been exercised irregularly and compliance with the requirement to submit annual financial statements has beenvery irregular. 175. All local government units use a standard financial management system prescribed by MOLG; a unified system o f accounts has been developed to record expenditures and revenues in accordance with standard budget line items used across all LGUs. However the quality o f these accounting systems appears variable. While a major initiative i s underway to automate these systems, a focus on improvingmanual systems i s needed urgently inthe interim. 176. LGUs are required to follow a uniform system o f procurement but this has been observed irregularly in the past. LGUs are also subject to audit either by GCI or an auditor acceptable to MOLG, but it appears that in general private auditors are used (if any audit i s undertaken at all) and that GCI does not currently exercise its possible role. 177. The Emergency Municipal Services Rehabilitation Project (EMSRP) currently being undertaken by the World Bank aims to provide emergency financial assistance to address the fiscal crisis now being experienced by most LGUs ,reflecting the economic downtum since the Intifada. It also includes measures to improve compliance with reporting requirements, leading to the establishment o f a municipal data base to enable MOLG to more effectively exercise its oversight role. An audit firm is to be engaged to carry out a special purpose audit o f selected LGUs to develop an action plan to strengthen financial management and reporting, including developing a standard format for the annual financial statements. 24. PFMCAPACITY AND POSSIBLETECHNICALASSISTANCE NEEDS 178. This CFAA has not attempted a review o f the PFM capacity in the PA to implement in a sustainable way the ambitious PFM reform program already commenced by the Minister o f Finance, and the additional steps proposed in this CFAA. Correspondingly there has been no attempt in this CFAA to systematically identify areas where various donors might usefully provide technical assistance. 179. However it is clear to the CFAA team that the Ministryo f Finance is not currently able to provide the Minister o f Finance with the high-level support he requires to develop and carry these PFM reforms through, and that without further support the sustainability of some of the reforms may be in doubt. For example, weaknesses in the Treasury are indicated by the delay in producing aggregate financial statements and the lack o f documented procedures. In addition, it i s questionable whether the PIF has adequate professional staff to provide its Boardwith the highlevel analysis and advice it requires. 26Article 15, Section B, para 1. 51 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY hSESSMENT - 180. The CFAA team i s aware o f the Minister's desire that the reforms should be "home grown'' ifthey are to be sustainable, o f his intention to develop and promote more promising junior officers and o f his preference for avoiding external consultants wherever possible. Reflecting this, only one consultant has recently been employed on PFM reform issues - a Palestinian expatriate employed under the Worlds Bank's Professional Expatriate Palestinian Program (PEPP), to develop intemal audit. Nevertheless the CFAA team believes that further analysis o f training and possible technical assistance needs i s warranted. 181. To name but a few areas where external assistance may be desirable, this CFAA identifies the need for accounting manuals to be developed and for a policy on the form and content o f the aggregate financial statements to be developed. External assistance would be highly desirable here. In addition it seems clear that external audit cannot be improved without significant external assistance to develop capacity within a new external audit organization. 182. In addition, it appears that not all ministers, PLC members and senior officials fully appreciate the need for and the objectives o f the PFM reform program. For this reason it is highly desirable that following acceptance o f the final CFAA report by the Minister o f Finance, the report be widely disseminated among key players to make sure there is full understanding o f the objectives and content o f the reforms. It would also be desirable for donors to participate in this dialogue. A widely representative workshop may be the appropriate basis to commence this dialogue. 52 ANNEX 1:LIST OFDESIRABLE FURTHER ACTIONS LEGAL FRAMEWORK PFM FOR > While changes in the legislative framework are an intermediate rather than an immediate priority, deficiencies in the regulatory framework, particularly in accounting provisions, are reflected in various failings in the operation o f the accounting system - as discussed later. However, most o f these steps can be taken inadvance ofany changesinthe legal framework. > The development o f an accounting manual, to amplify aspects o f the Financial Directives andprovide guidance to accounting staff i s a particular priority. BUDGETCONSTRUCTION Donors should supply full information on their programs to MOP under the new data collection exercise. Donors should channel their funds through the CTA, unless prevented by their own legal requirements. As part o f this issue PECDAR payments should also be made through the CTA, subject to the agreement o f the relevant donors. Future budgets should aim at the full integration o f donor funding and should fully factor inrecurrent cost implications o f capital or investment expenditures. The budget should develop a greater performance focus, with a gradual move to performance budgeting, beginning with the development o f ministry programs and activities and their incorporation into the classification system, and subsequently moves to develop a system o f performance indicators to inform budgetpreparation andimplementation. The use o f the large contingency reserve in the 2004 budget should be carefully monitored, and full details of its use reported inbudget execution reports and the P A 2004 aggregate financial statements, so that it does not become a source o f significant non-transparent expenditure. The budget should provide a breakdown o f operating expenditures o f the President's office and the Security Services inthe same way as for other spending units. The amount o f budget information provided on the MOF website should be increased. 53 WEST BANKAND GAZA COUNTRYFINANCIALACCOUNTABILITY ASSESSMENT - ~~ CENTRAL TREASURY ACCOUNT MOF should sweep all bank accounts on a daily basis, with consideration being given in the longer term to consolidating all banking arrangements into one account with sub-accounts as necessary for ministry and agency operations. MOF should ensure that all ministries (MOF and line ministries) regularly carry out bank reconciliation. MOF should also ensure that line ministries do not issue payment orders until funds are available. A system o f cash forecasting (involving a Cash Management Committee comprising different parts o f MOF) should be developed, inorder to alleviate the current short-term (day by day) approach to funds release and to provide a basis for monitoring the extent to which the budget (both revenues and expenditures) i s on track. Provisions governing limits on borrowing from commercial banks should be incorporated into the Organic Budget Law. These provisions should include appropriate reporting on actual levels o fborrowing to PLC. GOVERNMENT ACCOUNTING SYSTEM > Assess ministry and agency information requirements and determine the extent to which they can be met from the central MOF system. If necessary, provide guidance for development o f ministry accounting systems harmonized with the central system. > Induecourse, reviewthe existingclassificationsystemsothatitisabletoprovide information on departmental activities and programs. > Develop an accounting manual, to provide financial staff with more guidance on accounting procedures, including procedures for consolidation and reporting, so as to reduce the current delays in reporting final figures in monthly budget execution reports and inpreparing the aggregate financial statements. PUBLIC SECTOR PAYROLL The following actions should be taken: > Undertake a comprehensive audit (by the new Internal Audit Department of MOF) o f the payroll system, with the full cooperation o f GPC, both to ensure that the system provides adequate controls to ensure payment only to appropriate persons and that the existing payroll data base i s correct. 54 WEST BANKAND GAZA COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT - 9 Develop a comprehensive employee data base which includes security personnel as well as civil servants 9 Apply the same MOFcontrols over recruitment of security personnel as apply to civil servants PA COMMERCIAL INVESTMENT 9 The PIFBoardshouldreview the adequacy ofPIFprofessional staffing to assistit inits management ofPIF. STATE OWNED ENTERPRISES 9 Ensure that all SOEs are appropriatelymonitoredunder PIT andthat theyprepare the annual financial statements, audited by professional firms, as required under the Companies law. OTHERCOMMERCIALACTNITIES 9 Given the inherently commercial nature of their operations, consideration should be given in due course to having these organizations operate on a commercial basis subject to a performance accountability regime - with boards of directors, financial targets, and annual reports, including audited financial statements prepared on a commercial basis. PUBLIC INSTITUTIONS k Public institutions should prepare and publish annual reports to the PLC, including audited annual financial statements. EXTERNAL AUDIT P The PLC Budget and Financial Affairs Committee to revise the draft new audit law as suggested in paragraph 128 above, as it moves through subsequent legislative changes. k Urgently institute a program of capacity building, with assistance from the national audit institution o f one or two donor countries. This could first take the form of a "peer review" of the quality o f GCI's work 9 Resolvethe conflicts ofinterest ofthe current chairmanofGCI. 55 WEST BANKAND GAZA COUNTRYFINANCIAL ACCOUNTABILITY ASSESSMENT - FINANCIALCONTROLANDINTERNALAUDIT Strong support should be given to the policy o f putting financial controllers in place in each ministry, ensuring they have adequate authority and independence and that they report on their work to M O F MOF should ensure that the structures, objectives, responsibilities, reporting standards and operational procedures o f the financial control function are properly defined and documented, and do not overlap with the responsibilities o f internal audit MOF should provide strong support to the development o f the internal audit function, to ensure that there are appropriate staffing and training arrangements put inplace as soon as possible, so that the envisaged internal audit program can begin. MOF should give a comprehensive audit o f the payroll, both civil service and security services priority inthe internal audit program. THEROLEOF PLCIN PFM > The PLC should receive copies o f the annual PA financial statements and annual reports including audited financial statements o f the PIF, individual state-owned enterprises andpublic institutions. 3 GCI should also formally submit its reports to the PLC, and be responsive to requests and other information needs identified by the PLC. 3 The PLC and its committees should be adequately staffed to enable it to analyze andpursue budgetary issues with the executive. FISCALREPORTING The following steps should be taken: 3 The form andcontent ofthe PA annual financial statements for the preparationof the 2003 aggregate financial statements should be reviewed. 3 The 2003 PA financial statements should be finalized by 30 June 2004 and audited by an international auditing firm. 3 The audited financial statements required from SOEs should be prepared in all cases. > An annual reporting regime including financial statements for autonomous public institutions (and indue course for ministries and agencies) should be developed. 56 , ANNEX 2: LIST OF KEYOFFICIALSAND OTHERSMET Name De artment Ministry Mr.FaridGhannam Director Budget Finance Mr.SaedAl-Kidra Director Treasury Finance Mr.MazenJadallah Director Development Projects Finance Ms. Muna Al-Masri Acting Director Financial Controller Finance Dr.Hussein Abu-A1Nada Director Information Systems Finance Dr.NaserTahboub Director Tax Finance Mr.Tayseer Barzakh Manager Treasury Finance Mr.NafezAbu-Samra Manager Banks Accounting Finance Mr.Jamal Al-Uztaz Manager General Accounting Finance Mr.JawadA1-Baz Manager Revenues Finance Mr.GhanemAl-Astal Director Finance Health Mr.BassamAbu-Gharbieh Director Finance Public Works Mr.Mohammed Jubran Director Finance Education Mr.Basri Saleh Director International Relations Education Dr.JihadAl-Wazir Director Planning General Dr.RaisaAI-Tibi Director Finance Social Affairs Dr.Jawad Al-Tibi Chairman Budget and Finance Legislative Committee Council Mr.Jarrar Al-Kodwa Chairman General Control Institute Mr.MohamedAbu-Hafseh Director Banlung Supervision Palestine Monetary Authority Other Key Stakeholders: Dr.KarimNashashibi Resident Representative IMF Mr.Hila1Salah Internal Audit Consultant MOF Ernest & Young Deloitte Touche Tohmatsu (Audit Capacity BuildingProject) 57